PE funds ‘top up’ to average out their investment costs

PE funds ‘top up’ to average out their investment costs

Mumbai: Be greedy when others are fearful, billionaire investor Warren Buffett once famously said.

Some private equity investors in India are now taking him seriously. They are aggressively topping up earlier investments made in listed companies at a time when valuations are at a fraction of what they were a year ago.

Among the big firms scooping up equity in listed entities to average out costs are ChrysCapital and Singapore-based Orient Global which have made direct secondary market investments.

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“There are some very attractive valuations. The corrections have taken place and depending on our investment thesis, we have an opportunity to take a position in listed companies, and top it up, too," said Sanjiv Kaul, managing director of ChrysCapital, while declining to provide further details.

Others such as Standard Chartered Private Equity Ltd and Blackstone Group Lp. have also been buying, the only difference being that these have had some promoter-level engagements at an earlier stage.

Since January this year, India’s benchmark Sensex index has fallen by 53%. The price to earnings ratio, or the measure of how expensive a stock is, of the 30 companies that represent this index has fallen from a high of 28.57 to 11.96 now.

The underlying principle the private equity (PE) firms are following is the same as for retail investors, who are being advised by their stockbrokers to buy again into existing portfolio companies to average out costs.

The way it works is simple: A PE firm bought 10 shares of company X at Rs200 a share a year ago, but the value of the value of one share is Rs100 now, so it buys another 10 shares. Its total investment is Rs3,000, and cost per share is Rs150, so it now stands to profit if the stock goes above only Rs150, instead of above Rs200, as earlier.

Orient Global has followed up its first-quarter investment in the country’s largest bank by assets, State Bank of India (SBI), with an additional investment in the second quarter.

A spokesperson for Orient Global said it does not discuss its positions in companies.

However, according to Mint research, Orient Global bought a 1.63% stake in SBI for an average price of Rs1,536.82 per share in the first quarter of the current fiscal year, and topped it up with an additional 0.64% in the second quarter at an average price of Rs1,410.40 per share.

Where block or bulk deal data—for which stock exchanges report the price—was not available, Mint has taken the average price of the stock for that entire quarter (see chart)

Similarly, Orient Global seems to have increased its stake in mortgage lender Housing Development Finance Corp. Ltd (HDFC), from 2.51% in the last quarter of fiscal 2008 to 3.74% in the first quarter of fiscal 2009. HDFC’s average stock price fell from Rs2,625 to Rs2,463 during this period.

This sort of tactical move also seems to have been employed by ChrysCapital, one of the largest home-grown PE funds with $2.25 billion (Rs10,980 crore) under management.

Its 1.13% stake at an average price of Rs270.82 in HCL Technologies Ltd at the end of the first quarter of fiscal 2009 went up to 3.96% at Rs226.17 at the end of the second quarter.

It was the same for its investment in Hexaware Technologies Ltd, in which its 4.21% stake, at Rs134.34 at the end of fiscal 2008, more than doubled to 9.96% at the end of the second quarter of fiscal 2009, when its stock had tumbled to Rs46.46.

Buying at lower levels is the shortest route to building in a downside protection, said a Mumbai-based investment banker on condition of anonymity, as a number of PE investors are his clients.

The other way private investment in public equity (PIPE) can be done is to engage directly with the promoter where funds to the promoter are linked to performance benchmarks, which in itself is the downside protection.

Kaul, however, disagrees, saying that topping up isn’t the same as building in downside protection.

“Private equity is all about smart capital. If we strongly believe in the growth fundamentals of companies, we support them. It’s a vote of confidence when we invest in them," he said.

ChrysCapital raised a $1.25 billion private equity fund late last year, of which $450 million has been deployed via secondary market transactions on the stock exchanges in such firms as Infosys Technologies Ltd ($220 million), HCL ($200 million) and Amtek India Ltd ($30 million).

Following the second route of increasing stakes in firms where they had early promoter-level engagement are Blackstone’s top-up in Nagarjuna Construction Co. Ltd—from 8.94% at Rs307.51 to 9.34% at Rs190.90—and Standard Chartered Private Equity’s in Mahindra and Mahindra Financial Services Ltd—from 5.47% at Rs300.50 to 7.14% at Rs248. All prices are average for the respective quarters.

“When you have prior engagement with the promoter, it becomes easier to do secondary market purchases, because you already have a fundamental view on the company," said the head of a private equity fund, who did not wish to be named. “If this fundamental view hasn’t drastically changed, it makes immense sense to pick up more shares at lower valuations."