Sri Lanka still underdeveloped for PE

The country continues to open up to foreign investment, but ticket sizes and family-run companies are holding back private equity firms.

Private equity remains underdeveloped in Sri Lanka, despite growth averaging 6 percent over the last decade, poverty reduction and an increase in development finance institutions funding local businesses.#

Sri Lanka, with a population of about 20 million and gross domestic product growth of 4.8 percent, is in many ways a development success story. The country has survived a three-decade civil war, a tsunami in 2004 and global recession. Today, Sri Lanka has transitioned from a rural-based agriculture economy to a more urbanised economy, giving Sri Lankans increased spending capacity.

However private equity firms are still reluctant to enter the Sri Lankan market and only two global private equity firms, TPG and Actis, have tapped into the country's considerable potential. In 2014, TPG invested up to $117 million for a 70 percent stake in Union Bank of Colombo. A year later, the firm bought multi-speciality hospital group Asiri from Actis, with the aim of boosting the company’s operations in the local market and across Asia. Emerging markets investor Actis previously invested in South Asia Gateway Terminals, which operates the Port of Colombo, and industrial gas supplier Ceylon Oxygen.

Local private equity firms are also struggling to find deal opportunities. NDB Zephyr, a joint venture between Sri Lanka’s National Development Bank Holdings and New York-based private equity and venture capital firm Zephyr Management, has only made one investment since raising its $42.5 million Emerald Sri Lanka Fund in 2014. Meanwhile, Ironwood Capital Partners, which raised about $30 million for its debut fund almost two years ago, has yet to announce a deal. 

Zakir Mohamedally, chief executive officer of CT CLSA Capital Colombo, told Private Equity International the small ticket size is one of the main barriers for private equity to take off in Sri Lanka. “The lack of transactions with ticket sizes of $30-50 million has been a key deterrent in attracting private equity investments in Sri Lanka.”

Senaka Kakiriwaragodage, managing director of NDB Zephyr, points out that private equity is still a new concept for local entrepreneurs and many family-run companies are wary of giving up control to private equity firms.

“The mentality is to hold on to the company for the third and fourth generation instead of growing the business,” Kakiriwaragodage says.

In addition, development finance institutions are pouring capital into Sri Lankan retail and financial services, which presents added competition for private equity firms looking for attractive deals. Among those that have direct investments in the country are the International Finance Corporation, Germany’s DEG, Dutch development bank FMO and the Asian Development Bank, who are also limited partners in Sri Lanka-focused funds.

Sri Lanka is also facing fiscal and governance challenges. The country has one of the lowest tax-to-GDP ratios globally (13.9 percent), with a system characterised by a number of exemptions and weak administration, according to the World Bank. The country's almost 30-year civil war, which ended in 2009, has also impeded Sri Lanka's development because of political fragmentation, poor governance, and ethnic division.

Things are however looking positive for the country as a number of significant trade agreements with China, Japan, and Singapore are underway. SME growth has grown 25 percent year-on-year, according to CLSA data, and further reforms are expected in the next year to broaden the tax base.

“Sri Lanka is in a transition phase and for the country to stay on the path towards recovery it needs sustained support from foreign investors – they play a vital role for much-needed growth capital and expansion,” Mohamedally said.