India: secondary deals to rise?

The latest deal data from India highlight the challenges currently facing investors in one of global private equity’s most difficult markets.

GPs put about $1.3 billion to work during the third quarter of 2013, according to local data provider Venture Intelligence – a 67 percent decline year-on-year. That meant total investment for the year to date was $5.1 billion, 38 percent down on the equivalent figure for 2012 (which itself was hardly a banner year for the industry in India).

At PEI’s India Summit in Mumbai in mid-October, practitioners complained about the difficulty of persuading promoters (i.e. business owners) to sell equity at this low point in the cycle, instead of holding out for the upturn.

This reticence is not entirely surprising. The summer months saw huge capital outflows from India in the wake of the Federal Reserve’s suggestion that it would begin tapering its asset purchasing programme; this sent the rupee plunging against the dollar, hitting valuations and pushing up import costs. And with a general election coming up next year, the government seems to be in a state of paralysis that is likely to stymie any efforts to remove various longstanding regulatory roadblocks.

In light of these challenges, it’s equally unsurprising that India seems to be very much out of vogue with international LPs at the moment (a big problem for a country whose industry is almost entirely reliant on foreign capital). On the sidelines of the Summit, one GP told of a meeting with a US public pension arranged through an intermediary, after which the latter was privately castigated by the indignant official for having the temerity to even suggest the idea of investing in India.

That said, returns from Indian private equity have (on the whole) been dismal for a decade; the frequent complaint from LPs is that managers have just not done a good enough job of returning capital. Too much capital was raised that was then spent on too expensive assets that now languish in portfolios at valuations no one wants to crystallise – and there even remains an overhang of this money still needing to be deployed.

No wonder, then, that total fundraising this year by Indian GPs currently stands at barely a quarter of the total raised as recently as 2011, according to data from PEI’s Research & Analytics division.

So if you have some firms that desperately need to invest, and others that desperately need to return cash to LPs, could an increase in secondary deals be the answer to India’s problems?

Local practitioners certainly expect this; when delegates were asked for their predictions for the industry in 2014, this was the most popular forecast. But it will require a bit more realism about pricing from vendors as well as buyers; as one delegate pointed out, GPs are often just as guilty as promoters of holding on for jam tomorrow, rather than settling for cash today.

And the interesting question is whether this would be a good thing. The second most common prediction among delegates was that the industry would see a wave of closures and consolidation amongst fund managers – something it patently needs. But the risk is that by creating a wave of deals and exits, a rise in secondaries could sustain some firms that don’t really have a good reason to exist.

Secondary activity arguably re-presents the best chance most LPs have of seeing some returns from India. But it may be better for the market in the longer term if that activity is focused on restructuring end-of-life funds, not giving them a stay of execution. ?