Much has been written about India’s private equity woes. There’s the multi-year declines in exits, deals and fundraising. Then there’s the disappointing returns: 10-year IRR (as of Q2 2013) for India is 5.8 percent, versus the global emerging markets IRR of 12.4 percent, according to Cambridge Associates data.
There have been various arguments put forward as to what went wrong. But an interesting recent addition to the canon came from fund of funds Siguler Guff, which looked at 290 deals by 60 private equity firms (foreign and domestic). Its conclusion? That poor GP performance in India can be traced to five interrelated “errors in judgment”.
The broad theme that connects them all is over-exuberance, driven by the belief (of both GPs and LPs) that the China model could be replicated in India, according to Praneet Singh, managing director at Siguler Guff, who authored the report.
For instance, getting carried away about the macro story was mistake number one, the report says. Rising GDP and a large population don’t necessarily result in a lot of private investment opportunities, particularly since India has more publicly-listed companies than the US or China.
“In a classic case of crowd logic, each GP thought that it would be easy to find one or two good deals a year, and set about to raise sizeable funds,” the report said. $60 billion of private equity capital has been deployed in India over the last seven years, it pointed out. “Even as a percentage of GDP, this is almost 2.5 times that of China.”
That led to another herd error – chasing the hottest sector. It was software in the early 2000s, infrastructure at the end of the decade (partly as a way to deploy large amounts of the capital raised) and now healthcare and consumer. “Arguably, almost every single GP now wants to own a hospital and an FMCG (fast-moving consumer goods) company”, the report said.
But the biggest mistake cited is a complete underestimation of India’s execution and expansion challenges. Culture, language, infrastructure and regulation can differ substantially by state, creating big obstacles for scaling businesses. China, by comparison, has a homogenous population with a central government that tends to standardise key regulations across the country.
Brian Lim, partner at Pantheon, which is also invested in India, adds that in the mid-2000s, “a lot of Chinese companies scaled up faster than their peers and as a result, many managed to catch an exit window that was open”. Indian GPs, in a patchwork environment, could not do the same.
A related miscalculation was placing too much emphasis on top-line growth and not enough on profit growth. The report said few teams used the crucial measure of “return on capital employed” of a business before investing. Data showed that 76 percent of well-performing deals were in high-ROCE businesses, while 98 percent of the poor performers were low-ROCE companies.
Finally, little operational value has been added to investments. Nearly 70 percent of deals with fund manager-defined “serious value-add” are struggling and will disappoint in term of returns, the report said. In fact, promoters “see such investors as a nuisance rather than a help”.
Not all deals have performed poorly, of course – and Siguler Guff remains positive about the country’s prospects overall. “We still believe India is an attractive place to invest, but we have become more selective about the teams we invest in.”
Notably, neither Siguler Guff (nor Pantheon) has relaxed return expectations for India. However, “investment performance in India continues to be under pressure compared to other emerging markets”, Singh says. ?