The PIPE paradox

Private investments in public entities (PIPEs) have always divided opinions amongst India’s GP and LP community, with the number of people sitting on either side of the fence rising or falling in line with the performance of the country’s stock markets.

Between January 2008 – when the Indian stock market began its slide from an all-time high of more than 21,000 points – and 27 October 2008 – when the markets slumped to 7,697 points –detractors of the strategy had a field day, painting those GPs that include PIPE investments as a core part of their investment strategy as imprudent.

However, things have since turned around pretty quickly. The Sensex had recovered to a healthy 15,675 points by 4 September, marking an increase of more than100 percent from the lows of October 2008. Those managers with a focus on PIPE investments are once again standing on more solid ground as the valuation of their listed portfolios remains on the rise.

Taking advantage of the drop – and subsequent rise – in valuations seen on the listed markets, firms other than those like ChrysCapital and Nalanda Capital, which have traditionally invested heavily in the listed markets, have also become more active in this space.

In March this year, for instance, Norwest Venture Partners (NVP) made its first investment in a publicly listed Indian company when it acquired a stake of less than 5 percent in OnMobile, a telecom service provider, for about INR770 million ($15 million). The firm followed it up with an investment of INR1.2 billion in Shriram City Union Finance for a stake of more than 8 percent in July.

Sequoia Capital India too has made a few investments in listed Indian companies since the stock markets bottomed out in October 2008. At time of going to press, its most recent PIPE deal was the acquisition of a stake of about 6 percent in eClerx, a knowledge process outsourcing (KPO) firm.

In fact, in the first six months of this year, PIPE investments made up 20 percent of the total amount invested by private equity firms in India in terms of value, up from 15 percent in 2008, according to data from Venture Intelligence, an Indian private equity and venture capital research provider. The growth in proportion was echoed in terms of number of investments; PIPE investments as a percentage of all private equity transactions increased from 15.6 percent in 2008 to about 23 percent in the first six months of this year (see charts below).

LP view

It seems PIPEs have won new – albeit opportunistic – fans amongst India’s GP community since the downturn hit the stock markets, but is this enthusiasm shared by LPs? For many, there remain some strong arguments against the use of PIPEs by a private equity fund. The justification of private equity management fees is one of them.

“Why pay 2-and-20 for a listed investment?” asks Low Han Seng, executive director and head of the private equity funds business at Singapore-based United Overseas Bank, which has backed between five and 10 Indian fund managers.

“Fundamentally, I’m not going to pay fees because in a PIPE investment, you cannot be an active investor,” he says. Low remains unconvinced by the claims of some GPs that they can secure additional rights to those that ordinary shareholders in a listed company can get.

Wen Tan, managing director at Hong Kong-based fund of funds manager Squadron Capital, which has been committing to India-focused funds since 1996, says: “It’s something we are less favourable about, to be honest: there’s the increased dependency on movements in the public market to generate returns, and the fact that it is difficult for legal and regulatory reasons to structure the same levels of downside protection than you can in a private transaction.”

He says that all things being equal, “there are other ways to get more bang-for-your-buck as an investor than by paying 2-and-20 fees for what is essentially a long-only public equities fund”.

The fact remains that to justify high private equity management fees, most LPs need to be convinced managers can apply private equity standards – a level of influence on the company, access to management, voting rights – to all their investments.

UOB’s Low does, however, point out that in the last 12 to 24 months there has been a dislocation in valuations: managers have argued that while valuations have become much more attractive in the listed market, the same has not happened in the unlisted space. In some cases, managers have told him that they can find larger companies in the listed space, trading at better valuations. “In such cases managers have asked us if we can be more flexible – sometimes we can,” he says.

Tan agrees there is money to be made in a climate like the one being seen now: “In a rising market the returns can be impressive, particularly in emerging markets where public valuation multiples can get much too far ahead of themselves when sentiment is strong.” However, he says that if one looks at the market on a risk-adjusted basis throughout the cycle, PIPEs are less attractive than ‘proper’ private equity.

Indian companies like to list

But it’s not only now that managers claim there are richer pickings to be had on the stock markets than in the private space. A common view put forth by Indian GPs is that there are not sufficient opportunities to invest in the unlisted segment of India’s economy, as many companies list at a much earlier stage of development than comparable companies in other countries. 

Tan says that this is one reason why the trend toward PIPE activity will continue. “There are proportionately fewer large-cap businesses which are still private and – given that some GPs have been raising sizeable funds – it is highly likely that the relative lack of large-cap private investment opportunities will result in some of the available private equity capital spilling over into the public markets,” he says.

Of course, PIPEs are not an India-specific trend. Tan points out that industry figures published last quarter suggest PIPEs were the largest single sub-segment of the private equity market in each of China, India and Southeast Asia.

Furthermore, there is an unshakeable view amongst many in the private equity industry that PIPE investments in India have worked. Managers such as ChrysCapital, which have maintained a heavy bias towards investing in listed equities, have produced returns that vindicate their strategy, one Indian GP says.

He adds that many of the same LPs who voiced their concerns about PIPE investments when public valuations plummeted last year seemed to have no objections to such transactions when the market was experiencing a bull-run. As valuations around the region continue to pick up in the public markets, increasing the likelihood of high returns from investments in listed companies, he expects LPs’ stances against PIPE investments to soften again.

There are LPs who have never objected to PIPEs. The vast majority of the LPs who were new to Asia and looking to invest in 2007 and 2008 bought into the PIPE thesis, says UOB’s Low. He says some GPs had the numbers to prove their thesis that PIPEs were the way to the best returns in the Indian market.

A placement agent speaking to PEI Asia says it is no surprise that PIPEs are so popular in India and the rest of Asia. For one, they give LPs and fund managers more liquidity than traditional private equity investments in unlisted companies. More importantly, he says, if one were to look at historical returns, Asian public equities have consistently outperformed Asian private equity in terms of returns generated for LPs when leverage used by private equity is factored in. This is important, he says, since levered private equity deals may generate better numbers, but they come with more risk.

“It may not be traditional private equity,” he says, “but it is one of the more popular ways to make money in Asia.”

That PIPEs are here to stay in India, and in Asia more broadly, seems beyond doubt. Whether the debate that surrounds investment in listed equities in a private equity context will ever die down, however, remains to be seen.