Private Equity, Public Exits

Bullish stock markets make exits easier for PEs12

When the Private Equity (PE) funds invest in companies, they always have an exit plan generally 5 to 7 years after the entry. But the actual exit and the return on investment depend on a variety of factors like performance of the invested company, the overall situation of the economy and, above all, the state of the IPO (Initial Public Offer) market.

In India, the present market conditions appear to be conducive for exit as stock indices at the Bombay stock Exchange (BSE) and National Stock Exchanges have shot through the roof. According to a report in Business Standard, four PE investors are soon going to exit Justdial Ltd which has planned for a Rs 950 crore IPO.  With market sentiments looking up, PE funds expect the IPO market will continue to be strong, offering opportunity to exit.  In Justdial, PE funds together had invested $57 million which will fetch a return of 8 to 12 times at the proposed IPO price.

While the future look good, the overall size of IPOs that were floated by the PE-backed companies has fallen by 70 per cent in the last three years. According to the data from VCCEdge, the year 2010 witnessed 28 PE-backed IPOs worth $2.6 billion. In 2011 the figure dropped to $1.3 from 20 IPOs and 2012 it dropped further to $778 million from only five offers, wrote Business Standard.   Whereas in 2013, till date, five IPOs have been floated by PE-backed companies raising about $126 million. The E industry analysts also believe that in 2013 a large number of PE-to-PE deal (or secondary transactions) where one PE investor sells holdings to another.

Meanwhile, on the brighter side, India remains to a be hot destination for funds. Apart from equity investments from FIIs, they have together pumped in a whopping Rs 65,309 crore in Indian equity market since the beginning of 2013, the country is also attracting large amount o foreign direct ivestments. Baring Private Equity, for example, has just announced that it will pick up a 14 per cent stake in Lafarge India, the Indian venture of Lafarge SA, the France-based cement manufacturer, by investing $260 million or Rs 1430 crore. This is the largest ever PE investment in India’s cement sector, whose fortune is closely linked to the economic prosperity of the country.

Surely, many believe that the Indian economy has bottomed out as the government expects a GDP growth rate between 5.5-6 per cent in the current financial year, up from 5% the previous year. Latest low inflation figures also has raised that the central bank will cut interest rates further, lowering the cost of fund for the industry. The Finance Minister P Chidambaram’s recent road shows in the US and in Canada to woo investors have also reassured them on India’s commitment to economic reform that began towards the end of last year. It is expected that the reform measures taken by the government will start showing positive results from the first half of 2013-14 and will pick up further momentum in the second half. Prediction of normal monsoon resulting in decent agricultural growth has also added to the optimism. This only shows that the ‘India story’ is still alive despite an unusually poor economic growth in 2012-13. The economy is also getting support from the drop in international prices of crude oil, gold and coal, the three together form a large part of India’s import basket.

FIIs pouring in Money

Its raining $$$

FIIs are having a ball in India

Indian stock markets are on a roll. Defying gravity, the Bombay Stock Exchange’s Sensex closed at 19939 and the National stock Exchange’s Nifty closed at 6050. At these levels these two key market indices are slightly lower than their all-time peaks and near about at the same levels of 31 January, 2013. The main reason behind this bull run is the foreign investment coming in hoards.

Since the beginning of 2013, Foreign institutional Investors (FII) have pumped a whopping Rs 65,309 crore in Indian equity shares, and no one is complaining. There are several reasons for the FII’s euphoria, though many may call it an ‘irrational exuberance’ considering the challenges India faces in the future.

The significant and consistent fall in borrowing cost abroad, a result of monetary easing and lowering of interest rates by the central banks in America, Europe, Japan and Australia, has stoked the inflows in the emerging markets. The European Central Bank reduced interest rates to a record low last week to boost borrowing and investment. The US Federal reserve has just reiterated its commitment that it will keep buying $85 billion of Treasury bonds a month to stimulate US economy. Japan and Australia too have lowered interest rates. With foreign funds seeking investment opportunities, India was the biggest beneficiary as the largest chunk came here.

The reasons are familiar. Among the top ten Asian markets, in the last 40 days only Tokio NIKKEI gave higher return (18 per cent) than the NSE Nifty at 6.40 per cent and BSE Sensex at 5.97 per cent. Return from all other stock markets was lower than India with Shanghai being at the bottom at 0.53 per cent. Going forward, market analysts expect that India will continue to perform better than its peers in the middle & near term and will continue to attract foreign funds more than others. The result of FIIs buying quality Indian stocks is that the FII ownership in top 500 Indian companies has hit an all-time high of 21.2 per cent, said a study by Citigroup.

Surely, the Finance Minister P Chidambaram’s recent road shows in the US and in Canada to woo investors have also reassured them on India’s commitment to economic reform that began towards the end of last year. It is expected that the reform measures taken by the government will start showing positive results from the first half of 2013-14 and will pick up further momentum in the second half. Prediction of normal monsoon resulting in decent agricultural growth has also added to the optimism. This only shows that the ‘India story’ is still alive despite an unusually poor economic growth in 2012-13. The economy is also getting support from the drop in international prices of crude oil, gold and coal, the three together form a large part of India’s import basket.

While the domestic investors are yet to join the FII party, it is recommended they exercise caution and be very selective in their investment. We must remember that money flowing-in in stocks is ‘hot money’ that can start flowing out quickly any day if India’s economic conditions worsen or other countries offer higher returns. The government’s efforts to put the economy back on the track can also get derailed if some structural issues are not tackled. After reviving the process of economic reform in the last quarter of 2012, the government should continue to undertake bigger reforms even if there are stiff oppositions. Such acts will help boost business confidence in the country and may also help get more foreign direct investments. Of course, the compulsions of coalition politics may restrain or slow down the reform process to the dismay of foreign investors. With the general elections due in the middle of 2014, the possibility of an even weaker government at the Centre is a cause of worry.

Unilever reiterates India growth story

The Anglo Dutch consumer products company’s announcement this week to invest $5.4 billion in the shares of its Indian subsidiary Hindustan Unilever (HUL) once again reiterates the faith of global businesses in Indian economy and, more specifically, in the Indian middle class.

Unilever’s plan to invest $5.4 billion or Rs 29,000 crore, the largest ever share purchase offer in India by a parent company, is for buying 487 million shares of HUL at Rs 600 per share, a price 25 per cent higher than the average market price of the previous three months. The move clearly re-establishes the fact that foreign investors are still very bullish on India growth story. They also believe in the phenomenal purchasing power of the Indian middle class – a young and upwardly mobile population that is expected to touch 300 million in the next five years, according to a study by the National Council for Applied Economic Research (NCAER).

HUL being the largest FMCG (fast moving consumer goods) company in the country with products ranging from shampoo to soap and toothpaste to tea, it is right at the top to cash in from the emerging middle class boom. No wonder, the Unilever CEO Paul Polman, while making the announcement, was explicit that the company’s strategy is to invest heavily in emerging markets and India is one of the most important countries in this basket.  If successful, the share purchase will see Unilever’s stake in HUL going up by 22.15 per cent to 75 per cent.

Surely, the stagnating growth in the developed economies, especially in the American and the European markets is making global players turn their focus on emerging markets like India and Unilever is not alone. In the last five years or so, many multinational companies like GlaxoSmithKline, Reckitt Benckiser, Cadbury, Kodak, Panasonic etc, have either increased their shareholding or have acquired 100 percent of the Indian company.

Some observers, however, saw an additional reason behind Unilever’s move. They are of the view that the share purchase plan is an effort to drive the share price up as HUL’s shares, considered to be bluechips, remained subdued since the beginning of this year as investors were perturbed by the company’s increased royalty payout plan. Analysts also believe that Unilever’s plan to acquire more shares in its Indian subsidiary, though looks expensive, will ultimately pay off as HUL’s valuation is expected to rise steadily in the coming years. Moreover, higher dividend payouts will also flow in into the parent company. This is also the reason some market experts are advising shareholders to perpetually reap the benefit from the company’s upside and not to go for one time profit by selling out. Sounds a good advice as Indians should believe in country’s growth story more than the foreigners.

Indian economy on a recovery path

The government is bullish but one should be cautiously optimistic.

Good news is flowing in from the Centre. The Prime Minister’s Economic Advisory Council (EAC) has just projected that in the current financial year (2013-14) Indian economy will bounce back from the low it reached in the last financial year. EAC has projected the GDP in 2013-14 will be 6.4 per cent as against the estimated 5.0 per cent in the last financial year. The government’s forecast follows International Monetary Fund’s report last week which also projected better growth prospects for the country.

It is expected that the reform measures taken by the government in the second half of 2012, will start showing positive results from the first half of 2013-14 and will pick up further momentum in the second half. Normal monsoon predictions resulting in decent agricultural growth and the resumption of iron ore mining will also add to the economy’s well-being.

This only shows that the ‘India story’ is still alive despite an unusually bad year in 2012-13. In fact, according a study by a Mumbai-based bank, in the last 12 months Indian stock market provided the highest return among the BRICS (Brazil, Russia, India, China and South Africa) countries. The economy is also getting support from the drop in international prices of crude oil, gold and coal, the three together form a large part of India’s import basket.

Surely, with early signs of recovery, the optimism is back. But it can be short lived if things do not pan out the way they are projected. Moreover, not all are equally positive as the sharp drop in venture capital funding activities in India in the quarter that ended on 31 March 2013 was a disappointing news. According to VCC Edge the private equity (PE) investments in the first quarter of 2013 were pegged at $1.8 billion spread across 123 deals, significantly lower than $2.4 billion spread across 186 deals during the same period in 2012.

After ruling high in the last financial year, inflation has softened in the recent months. This, in turn, has created a clamour for a reduction in interest rates by the RBI. If the central bank listen to the plea, interest rates could come down between 50-100 bps in the near future.  If that will spur growth is debatable, but the cost of money will come down. There are also concerns if the government’s fiscal deficit targets would be met, and, more so, in view of the lack of robust growth in tax revenue.

On the foreign trade front too things are bleak as demand contraction in Europe and USA has curtailed exports. Imports, on the other hand, driven mainly by crude oil, fertiliser and gold, continued to remain high, creating a widening gap in current account deficit. Sensing the uncertain time ahead, the foreign institutional investors (FII) have started pulling out their money. FII’s invested a net amount of Rs 138,586 crore in Indian equity shares in the financial year 2012-13, but in the first 17 days of April 2013, they have net sold Rs 666 crore worth of equity.

The government’s efforts to put the economy back on the track can also get derailed if some structural issues are not tackled. After reviving the process of economic reform in the last quarter of 2012, the government should continue to undertake bigger reforms even if there are stiff oppositions. Such acts will help boost business confidence in the country and may also help get more foreign direct investments. Of course, the compulsions of coalition politics may restrain or slow down the reform process to the dismay of pro-reform lobbyists. With the general elections due in the middle of 2014, some expect it to take place around November this year, it is likely that the government will take some radical steps to boost business confidence. It may also resort to large spendings in welfare measures and big projects that can boost rural demand. But the possibility of an even weaker government in the next parliament is a cause of worry.

Another structural issue that needs to be tackled is the over-leveraging of Indian companies, particularly the big groups, and their increasing inability to service debt. According to a study by, 177 non-financial Indian companies have raised their capital expenditure five times to Rs 10,892 crore in the last seven years, hoping to cash in from the bullish growth prospects. Funded mainly with borrowed money, these companies are now finding it difficult to service debts as new assets are grossly underutilized due to lack of demand. Consequently, banks are now sitting on NPA levels larger than last year.

In all, its an uncertain stretch of an otherwise certain highway to progress. The optimistic shall be appropriately rewarded !

Actively or Passively?

Passive Investing or Active Investing, Active or Passive Management – the debate over the merits and shortcomings of active versus passive management that began several decades ago remains ongoing. Reports on the topic by investment professionals and academics continue to be published unabated and seem to be one of the investment world’s more popular literary pursuits.

In many prominent quarters, passive management is gaining market share, especially among institutions, for good reason. Long-term results have favored this strategy, most notably among large capitalization stocks and in bonds as well. What’s more, investors have been inundated with advice by the media and academia to invest passively after watching their active managers perform poorly over the last 3-4 years.

You do need a minimum standard of education to understand what you’re doing and choose a sensible selection of funds, but the passive route should ensure that fees are minimised, returns are maximised and risk is as high or low as you want it to be. Also, passive investors will develop a much greater understanding of their investments over time, and should find the process far more enjoyable as a result.

I have heard, read and experienced that passive management can be effectively utilized by investors, especially when they are considering investments in the highly efficient large cap universe. Clearly, this strategy is preferable to selecting active managers who are ‘closet indexers’ struggling to perform net of fees, expenses and taxes. It is believed that it is also appropriate for those investors who seek broad diversification, are comfortable with the configuration of indexes and can live with their drawbacks.

As pointed out by few experts in the equity business, the distinction between passive and active is not very sharp anywhere in the world, but on average you would expect that an active investor would at least be involved at the board level in terms of strategy setting, and would be more actively engaged in receiving and processing information at the board level. Sometimes, it can get more involved than that, for instance, they might be pretty closely involved in setting up a 100 day plan etc.

In terms of what we see in India, it is believed by some experts that not much information is available in the public domain, but from the available information, one understands that the investors do take board decisions, however they pretty much leave it to the incumbent management or the new management to run the business. They don’t do the kind of things that private equity players like KKR or Carlyle do with their investments in the US or Europe. So, it seems to be more of a passive approach.

Another point which proponents for passive investing usually point out is that typically 80-90% of the returns comes from asset allocation, and the balance comes from stock selection. In layman terms, this means that if you happen to be in the right asset class (for example, equity) at the right time, you can literally close your eyes and buy any equity and you should register gains. Furthermore, there is no guarantee that the returns which come from stock selection will be positive but it is almost a given that the expense ratio for such funds will be higher than that of the index funds.

At the same time, there may be an important role for active management as well, even beyond the inefficient markets referred to earlier. Indexes are far from perfect and may not accurately reflect a manager’s strategy or target universe or, for that matter, the investor’s objectives. Moreover, the performance of active and passive strategies runs in cycles.

Active managers might also be able to exploit what promises to be a different and undoubtedly more complex economic and investment environment than anything we have witnessed in our lifetimes.

The active versus passive debate does not yield a clear-cut solution that would eliminate one or the other. There are just too many variables on both sides that raise questions while offering no unambiguous answers.

So let’s just leave it to time and we may be quite surprised to know in a few years down the line that we were all the way treading the wrong path – actively or passively.

It’s time for Good Governance


There are lessons to learn, unlearn and relearn in every module of business. In the PE business, this is everyday truth. While the complex module followed by PE in undertaking their business depends on high levels of adroitness, it often leaves enduring lessons. For one, I would say that the PE business has been influential in raising the bar of corporate governance in private companies. I have seen the trend grow in the last few years and it is more true in today’s circumstances.

PEs have significantly evinced that good governance can be accomplished by relying on management ownership, focused value creation, eyeing financial indicators, advocating shareholder activism, undertaking due diligence, and taking calculated risk. Public companies can adopt certain elements of this style of governance from PEs to strike a balance between risk-taking and governance compliance in order to promote economic health and innovation.

As India continues to be recognized for its high growth potential, several cross-border and local PE funds are wooing emerging companies, aiming to be a part of their growth. At this juncture, governance, which often gets sidelined has its own significance, which should be understood well.

I was reading an article on the significance of governance with respect to PE. It said, governance requires a fine balance of the interests of the owners on the one hand and of the other stakeholders on the other hand. Organizations will need to increasingly manage the interest of other stakeholders if they have to scale up profitability and sustainably. To achieve and sustain profitable growth, they will increasingly need to attract and retain talented human resource. Today’s business managers don’t look for just a financial reward; they need an organized and transparent method of working and an environment that offers challenging role with enough room to apply their knowledge and wisdom, and they look for an organizational culture that promotes scope to ideate and take initiative.

A point which has tangible repercussions, I also feel that the issue raised has its own complexities in terms of risk management. But then every change has its own bit of challenges. Eventually, it is about success and governance in its good form in a balanced ounce in every business will surely translate failures into growth prospects.

I surely feel that the time has come to give governance the right bit of focus especially in companies with a PE portfolio.

The Market is in the Middle

In the recent past, the middle market has been able to hold its own quite well compared to the big-deal market. Middle-market currently are those transactions with enterprise values of $10 million to $250 million and this small to mid-sized sector of the market might be the sweet spot for investors.

Not long ago, the focus was mainly on highly leveraged transactions predicated on financial engineering. But today, value creation through operational improvement has become vital to generating returns. This shift has changed the way deals are sourced, financed, and executed- and in turn the skills necessary to succeed.

The spike in the middle market reflects continued improvement in the overall mergers & acquisitions landscape. It is been widely accepted that the trends that have driven this activity are improvement in corporate performance, increases in public equity values, and increased availability of capital. Those are trends that affected larger companies in the private equity world first, and they worked their way down to the middle market and the emergence of these trends in the middle market is a bright sign that the recovery in the capital markets is solidifying.

As private equity trends have gained visibility and affected investment opportunity in the middle market private equity sector, it is important to have a broad perspective on their current and emerging impact – how they developed?, what is driving them?, how widespread they have become?, how they affect market participants?, and what challenges they create for the middle market?

To understand these there is definite need to explore several aspects like the impact of the credit crunch, the explosion of cross-border M&A activity, the proliferation of operational partners, the emergence of sovereign wealth funds, the middle-market compensation squeeze, and hot sectors for investment.

Then there is another trend within the mid-market buyout. The growing disparity in premiums paid for smaller mid-market buyouts ($10m-$25m enterprise value) and larger mid-market buyouts ($100m-$250m). One reason that smaller businesses are at more of a discount is because cash flow-based lending has not yet come back, which means that the low valuations are a problem for buyers as well as for sellers.

Mid-market buyout investing is particularly interesting for a number of reasons, including attractive acquisition multiples; reduced competition for smaller non-auctioned businesses; opportunity to add value and scale; and strong exit opportunities.

Many of these companies targeted by mid-market buyout managers operate in highly fragmented industries and are entrepreneur-founded, and/or family-owned businesses undergoing generational change. They present significant opportunities for mid-market buyout managers to create value through consolidation and professionalization of business operations, which make them attractive acquisition targets for strategic and larger financial buyers.

On the whole, typical minority private equity investments have internal rates of return expectations of 10-15%, while mid-market buyout returns could be 30-40% or even more, as per industry norms.
So, private equity firms are returning to the days where they spend substantially more time looking for quality companies to invest in,and they are performing more thorough due diligence rather than jumping in to an investment headfirst.

And here the middle market is definitely a big catch.

China-India’s PE affair

INSEAD’s, the world’s leading business school, study of private equity in the markets of China and India in the recent past have revealed that PE performance in both these countries is less linked to public equity trends than in Western markets, but originates more from company and deal situation specifics.

I would believe that PE investing in China is growth capital investment; providing a growing company with capital to build factories or expand its distribution channels. It works in China unlike PE investing US or Europe. Aptly put in a recent report on China’s PE, in the country, ‘PE firms support winners. In the rest of the world, PE firms generally try to heal the wounded.’

In India, the PE market is fragmented, often involving family owned businesses and minority stakes, and with little to no opportunities for leveraged buy-outs. Caution is a good word mainly around governance, income tax and general regulatory issues, which remain as major challenges in the country.

Coming to PE exits in these two countries; in China majority of exits happen through public markets. Here private equity investment gives local companies a chance to jump the IPO queue because an outside investor is seen as an endorsement of the firm. In India, on the contrary, mergers and acquisitions have dominated exits with more than two thirds of deals exited this way.

The INSEAD study states that while exits are clustered around times of strong stock market performance in China, in India exits are spread out more evenly over time. Definitely, there is a clear trend toward a shorter holding period for private equity investments in both these markets. In China, the holding period from the initial investment to the first exit had shrunk to just under two years and in India to just over two years prior to the financial crisis, although holding periods may have lengthened since then.

But unlike China, PE exits in India continue to be stricken with difficulties; the state of the capital markets adding pain to the IPO avenue.

Both these markets, I believe have a strong character to it, in their differences, be it investing or exiting, but definitely for the world of PE, these two (along with Brazil) will be where their money will vacation.

When Discipline pays.


Last year saw Venture capital winning all the tracks in competition with the private equity. Although no records were set, it clearly indicated that India is now witnessing entrepreneurs with some great innovative ideas. The gold medal that the VCs got last year is surely in millions of dollars, a result, I believe, came through discipline.

According to the Economic Times, investment in start-ups and early-stage companies totalled just $300 million in 2010. But last year, it expanded more than four-fold, making up $1.2 billion of the $9.3 billion in total risk capital. On the other hand, the proportion of growth capital investment in more mature companies fell to 61% from 83%.

VC, world over is at the level which both banking and private equity crossed before. In India too it is no different. As the second fastest growing economy, India has shown a unique business culture which has shown amazing results in terms of growth for every stakeholder. This growth story will attract more number of mature VC/PE investments in coming years.

Of course, it is conditional to the point that there has to be a liberal policy change in allowing investment in restricted sectors, particularly in retail market, initializing a Bond Market & LBO transaction…all leading to a mature stage in the Indian Investment Market.

The Indian investment market had anticipated that the deal activity will increase reasonably in 2011 from the already better levels of 2010. While they see deal-making opportunities across all sectors, they have better pipeline and the Investors are bullish about Infrastructure, consumer products and healthcare sectors.

Surely there are challenges. The main being the challenge of valuation, which is high priced relative to the other emerging markets. Large numbers in terms of funds with dry capital to be invested are chasing the same verticals and companies which drive high valuations. The other challenge is in terms of structuring of deals, and there are regulatory limitations involved in structuring of some transactions. As markets progress, I would expect to see more favorable regulations from the policy makers towards FDI.

But then, I would quote from Financial Times which recently quoted a Venture capitalist – “Our greatest enemy is losing our discipline. We did that once and it took a lot of time and work to rectify it. We know the consequences of binge investing and we don’t want to go back to rehab.”

Yes, it is sometimes much to the advantage of those who keep low and are disciplined. It surely does work well and in India, discipline definitely pays.

Midget Domestic, Giant Global ?


Sometime back I was going through an article in BusinessToday which focused on the year 2012 and what investors can expect out of India. It clearly stated many challenges that India will face as a hangover from 2011 and 2010, but it also stated that ‘foreign institutional investor inflows have a huge influence on our markets. For instance, in 2007, FIIs pumped in $16 billion and the market rose 44%. This was followed by a 45% drop in 2008 when FIIs took out $12 billion. In 2009, the Sensex rose 85% amid FII inflows of $19 billion. It rose 25% in 2010 when FIIs invested $30 billion.’

So the big question here is whether the foreign investors will return in 2012?

Another is, can the domestic investor make up for it?

The Indian market is nascent and immature, when compared to the developed market. But the outlook will change in the coming year when the full potential of Private Equity industry will be accomplished by embarking on a restricting of bond market and leveraged buyout transactions (LBO), which is still in a very nascent stage in India.

When you compare the domestic investor with the global investor, there are a lot of constraints the former faces. The factor driving behind the domestic fund is the difficulty in return of capital as redemptions are done only through profits and buyback of shares by a company is restricted to a maximum of 25% of its paid up capital. Winding up domestic fund is exceedingly time consuming and cumbersome. And Debt Market is too high compared to the US & European market.

The bulk of new capital is available from Global investors, which made more investment flow using various fund raising strategies like LBO, Bond Market structuring and Private Placements.

Positively, if there is a dip in investor interest from the Global Player, it will only remain for a short term. There is a huge surge in Indian fund houses to setup modules in Mauritius and Singapore to attract global investors and working with fund raising strategies like credit swap and overseas listing.

I believe the global investors will definitely find India more attractive if the policies are tweaked and inflation has a formal support; there are improvised systems in place for food item and raw material supply for the industry.

But for now, yes, the domestic investor needs to look up to see the global investor.

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