Lessons learnt in India

For private equity in India, general partners are working diligently to improve the previously bumpy situation by taking on a more hands-on approach, finding the ‘right’ partner, and exploring multiple exit options The Emerging Markets Private Equity Association’s (EMPEA) Special Report: Private Equity in India takes a look at the lessons learnt over the past two decades.

The first half of 2015 has seen Indian private equity raise $2.5 billion – an amount equal to what was raised in all of 2014 and also more than any first half fundraising total since 2008, according to EMPEA. The growth has taken place in spite of the fact that commitments to emerging market private equity vehicles overall fell in annualised terms during this time period. In addition, India-focused funds represented 14% of the total private capital committed to emerging markets in the first half of the year.

The outlook has brightened considerably for India, following a year of economic troubles, persistently high inflation and pessimism among businesses and consumers.

India-focused funds are being raised more quickly and there is a lot of deal flow at the moment, further highlighting what appears to be growing interest from limited partners.

According to the report, general partners in India are operating in a transformed landscape and working diligently to correct mistakes from the previous cycle where lofty valuations, poor underwriting and lack of exits persisted. “There now exists a more developed and stratified ecosystem of entrepreneurial finance, and a much deeper pool of entrepreneurs who are both familiar with private capital and ready to partner with institutional-quality investors.”

Here are the lessons that seem to resonate throughout India’s private equity community.

Taking a hands-on approach
Previously, GPs in India had little to no influence in a portfolio company. Capital went into minority non-control investments where the exit was largely dependent on the sponsor of the business; there was also an overall reluctance to sell at depressed valuations.

The report revealed that the real change in Indian private equity now is that a lot of PE firms are shaping themselves to do control-oriented/buyout transactions.

“In the current environment, GPs in India are increasingly seeking either significant minority stakes or in some cases, control transactions in order to create value through actions such as being on the board, influencing management hires, or implementing operational improvements.”

GPs are also pursuing more deals across buyout, growth and secondary strategies. Buyouts have grown in prevalence and risen to a peak of 13 in 2013. On a broader scale, amongst transactions with disclosed equity stakes, control deals have grown from 11% of deal flow in 2009 to 35% in 2014, the report said. Meanwhile pure minority transactions – those with less than a 30% equity stakes – have declined from 77% to 50% over the same period.

Picking the right partner to achieve alignment
Another important lesson is selecting the right company to invest in.

Niten Malhan, Managing Director at Warburg Pincus, noted in the report, “Valuations for good businesses have always been rich in India. But the real problem was more than this; the companies that GPs invested into were a combination of good quality businesses and mediocre businesses that just had a good run on the back of a great market cycle. Not distinguishing between good underlying businesses and some that just had good tailwinds was a bitter lesson learned coming out of that cycle.”

In the current environment, GPs are selecting wisely whom they would like to be associated with. In some cases, a good fit with the investor has even superseded the valuation expectation. GPs are taking their time to find the right partners who are aligned with the company’s leadership and value creation goals.

Exploring multiple exit options
The lack of exits was identified as the biggest struggle in private equity in India. The report revealed that numerous investments made in the mid- to late-2000s failed to perform well just as the IPO markets nearly dried up. Many fund managers were then stuck holding a company for longer than they may have wanted.

As CDC Group’s Muru Murugappan puts it, “Exits in India have been disappointing; of the total amount invested in India of over $100 billion in the last 10 years, only $40 billion has been returned. But we expect this to improve in the near future.”

Due to volatility in the stock market, other modes of exits have gained traction over the years. Instead of the periodic option for going public, more non-traditional opportunities are emerging such as management buybacks and secondary sale transactions, as indicated by deals between GIC and Vasan Healthcare and the investment by General Atlantic in logistics company Fourcee.

After a much-needed reality check, it seems that the increasing control mindset and operating perspective among GPs may bode well for private equity in India.