Singapore: Private equity (PE) deal-making slowed in India last year, in sharp contrast to rest of Asia, on account of high valuations, and this is unlikely to see a turnaround in 2017, says Juan Delgado-Moreira, head of international at Hamilton Lane, an independent alternative investment management firm. While calendar year 2016 saw record high PE exits in Asia, this was not the case in India, he pointed out in an interview. Edited excerpts:

We are now seeing Canadian pension funds as well as sovereign wealth funds become increasingly active by themselves and invest directly rather than investing in PE firms. Will this lead to a scenario in Asia where firms have plenty of money but we have a scarcity of deals? Several reports say PE firms’ cash piles are the highest they’ve been since the financial crisis. Also, new PE players from China and even corporates from that country are competing for deals. How does that change the PE landscape in Asia?

The most relevant bit of data here is effectively... the time it would take you to deploy the capital overhang. For PE, you will always have an overhang because you’ve always raised capital ahead of need. Structurally, this industry always has capital.

The best way to look at that (is) this is the time to deploy that overhang at the current run rate—if you look at the very long-term average for the last 16-17 years globally—it is about three years. And there are sometimes in the cycle where it can take you six years, and there is sometimes in the cycle where it has taken you an average of two. And today, we are at three years. So the data-driven answer is no—there is not too much capital by industry standards and at the current investment pace, and this already takes into account participation of the Canadians and other sovereign wealth funds and large pension funds that have been quite active of late—in fact, they have been active for quite a while. And data also take into account the investment activity of the Chinese, who too have been active for a while.

This is the global scenario. In Asia specifically, there has been a surprising slowdown in fund-raising among Asia-focused private equity funds in 2016. So in Asia, the build-up of that overhang is lower than the global commentary.

I do agree that the deal doing environment has slowed —both in Asia and globally. There are other factors at play—Asia PE fund contributions as a percentage of global private equity contributions was lower in 2016 when compared to the last 2-3 years. Asia-focused PE distributions, as a percentage of all PE distributions, has also come off in 2016—so the extended run of record distributions that Asia enjoyed also ended in 2016.

What about India in particular? PE deals in India are down despite the country having one of the fastest growing economies, a great consumer story, and an enviable youth population. GDP (gross domestic product) growth is very encouraging and so, how can we be in a situation where deals are not happening? Can we expect deal activity in India to turn around?

Our perspective on why deal-making in India is down is because of valuations—the prices are full. No market is really cheap and that includes India, China and even South-East Asia—they are not really screaming buys form an entry point of view.

As growth has been slowing down in China and as South-East Asian markets are challenging, fund managers are looking at their options. And one of the things that fund managers have decided to do is invest more slowly, and I do not think that is about to change. There are triggers around that lead us to believe that investment pace is not going to change that dramatically. On the exit environment, if you look at the Asia data—leave India out—2016 was a great year of PE exits—it’s the third best year for exits in Asia, though lower than 2015 —but 2014, 2015 and 2016 were the three biggest years.

Another way to look at it is that, are investors overall getting more cash than they are contributing? That’s the key metric for investors, and the answer is ‘yes’. Again, only for the third time in history, 2016 has seen a positive liquidity ratio—so we are seeing more distributions than contributions in overall portfolios in Asia. But, this is not the case for India.

So how does India compare to the rest of Asia when it comes to exits for PE firms?

India does not stand out in terms of slowdown in fund raising, it does not stand out in slowdown in deal doing, it does not stand out in the number of funds, because there’s plenty of funds in India… but it does stand out in terms of poor liquidity. In my view, that is nothing new but today, think it stands out more because, 3-5 years ago, in 2011 when India was in the doldrums, the metrics were negative for all of Asia. But in 2014-2016 period, China and Asia have turned the corner. At the moment, India continues to have structural issues, and these include an environment where promoters are very large players, its public markets are very illiquid, and a lot of companies though listed are not really public. So, PE prices come from the public market, and India’s public market moves very quickly on sentiments. That drives a really high price, and if you combine that with a very heavy dose of leverage, which happens at all levels, this creates complex funding structures, high valuations of the public markets, with very limited real liquidity. And that’s been a special case quite a while in India, and affects PE and continues to affect PE.

In the PE space, the biggest difference between India and China is the public markets. In China, the public markets are able to take two-third of all PE exits, and this is an anomaly, because globally, public markets are only about 20%-30% of all the exits. In India, public markets don’t even provide for a third of the PE exits. That’s the missing liquidity channel and I don’t see that changing.

If you look at PE in India, the focus is on making businesses attractive for control with strategic buyers, or making business attractive for international listings, or making them attractive for larger international private equity buyers. So strategics, other and larger PE players and international public markets are three of the biggest areas of liquidity that are currently being explored in India.

Look at the distress and debt side. We have an interesting credit story in Asia, and how does the India credit story play into that?

The comeback of the Indian markets has really reduced the level of financial distress and operating distress in the system. So while you’re left with a weak banking system, you don’t have too much financial distress or promoters are not as leveraged as they were in 2011-12.

Debt investing in India has been attractive for a while. It comes and goes—obviously against the equity cycle. Today, we’re on a bull equity cycle in India, and so distress investing is actually having a hard time finding deals. I would say the Indian banking system has been ahead of the Chinese—for example, there is more investment happening in India’s stressed credit than in China. PE has been expanding its private debt activities for awhile in Asia. That has been a theme in Asia for the last six years. That India has been ahead is known.

But right now, the India story of fast growth, and its consumer story is actually not helping the distressed investors. And you have to recognize India is an environment where its GDP growth story has been fully priced in very quickly—so its market is right up there as an expensive equity market. And that’s a challenge.

Even though there are some lower valuations and some pretty well covered consumer kind of companies, the overall market is on a pretty high valuation. So Indian companies have to focus only on growth, profitability and execution.

How will the investors’ community look at India vs China in 2017? Given a choice between these two markets, where would they put their capital?

I do think that if you were to do a survey of CIOs (chief investment officers) globally, will find that they will continue to make allocations to India. It will be driven by some of the points we discussed earlier, and also driven by the impact of the slowdown in China. And that was the commentary before the US presidential elections, and it remains the commentary now—after the elections.

So on a relative basis, Chinese allocations will always be the largest part of Asia, because it is the largest economy, because it has the largest M&A (merger and acquisition) market, largest IPO (initial public offering) market and we do not see that changing.

But again on a relative basis, the allocations to India are expanding because the macro outlook is better for India.

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