How PE firms missed the mark in India

Under- and over- estimation of key factors are why PE has delivered weak returns in India, according to a Siguler Guff report.

Private equity has made major“errors in judgment” in India, which has resulted in weak returns from investments in the country, according to a recent report from Siguler Guff. 

The average 10-year Indian private equity return (as of Q2 2013) was 5.8 percent compared to the global emerging markets average of 12.4 percent, according to Cambridge Associates’ data cited in the report.

The study found that the error that had the most significant impact on returns was an underestimation of the execution and scale-up challenges in Indian businesses.

“In many cases, the expansion capital provided by private equity funds has often diluted the return on invested capital for the business,” the paper said.

Private equity strategies tend to become tangled in India’s patchwork of cultures, languages and regulations, which vary across states and make scaling difficult. In addition, the paper cited “extremely poor infrastructure; prohibitive real estate costs; rapidly escalating costs for recruitment; and training and retention of employees”.

Firms have “wrongfully prioritised capital as the main requirement for business growth rather than focusing on sustainable business models and strong management teams”.

“We came across very few private equity teams that apply the all-important screen of return on capital employed of a business before investing. Most overlook the underlying capital efficiency of the business so once the funding engine stops, growth becomes elusive and the capital crunch begins.”

Siguler Guff found that 83 percent of underperforming deals “had business models with low scalability, defined as the ability of a business to double in four years without diluting current return on equity. 

Another area that private equity floundered is value-added work with portfolio companies, which is “missing or ineffective”, the report said.  “Nearly 70 percent of investments with `serious value-add’ (as defined by the fund manager) are struggling and will disappoint in term of returns”.

“In fact, the perception of private equity teams’ value-add has become so tarnished that promoters actually ask for a premium to allow private equity teams to have special rights and influence. They see such investors as a nuisance rather than a help.”

One area private equity overestimated was the size of India’s investment opportunities. India’s GDP, large population and young demographic “does not automatically translate into a large private equity opportunity”, the paper said.

Aside from addressing the five points raised in the report, the authors suggested that GPs in India reduce fees to LPs, raise smaller funds and expand the investment scope to include public companies.