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PRIVATE EQUITY IN INDIA

(2010-11)

CURRENT TRENDS & ISSUES

ROLL NO. 14-2010

MBA(FS)

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INTRODUCTION

PRIVATE EQUITY - THE NEW FACE OF CAPITAL IN INDIA

Private Equity is a form of equity capital that is not quoted on a public exchange. It

consists of investors and funds that make investments directly into private companies or

conduct buyouts of public companies that result in a de-listing of public equity. Capital

for private equity is raised from retail and institutional investors, and can be used to fund

new technologies, expand working capital within an owned company, make acquisitions,

or to strengthen a balance sheet. The majority of private equity consists of institutionalinvestors and accredited investors who can commit large sums of money for long periods

of time. Private Equity firms are generally organised as limited partnerships where

private equity firms serve as general partners and large institutional investors and high

net worth individuals providing bulk of the capital serve as limited partner. The seeds of

the Indian private equity industry were laid in the mid 80s. The first generation venture

capital funds, which can be looked at as a subset of private equity funds, were launched

by financial institutions like ICICI and IFCI.

Year 2010 saw Private Equity (PE) investments in India turn the corner, recovering to

reach $8.13 bn across 328 disclosed transactions from the low of $4.25 bn across 250

deals made in 2009a healthy rise of ~90%. In fact, the past five years have seen a wild

roller coaster ride for PE investments in India - with the good times being in 2007 when

investments crossed a huge $19 bn, only to see an equally sharp and heart-wrenching fall

in 2009. PE players in India spent 2010 doing what they were supposed to do puttingmoney to work and showing meaningful returns to LPs before they could bargain for

fresh funds.

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FACTS ABOUT THE INDIAN PE MARET

India has attracted maximum investment in private equity within Asia Pacific.

Limited Partners do not have too many avenues in the developed world. Currently,

they are fully committed to China and are exploring India as an investment

opportunity. If there is political stability to introduce reforms and if GDP

continues to grow over 7 percent, in the medium term, India has a potential to

become very important on the PE radar

Indias PE market has grown at an annual growth rate of 2 percent over 10 -year

period from 1998 to 2007.

In calendar year 2010, private equity and venture capital firms invested 7.97billion dollars in 325 deals (excluding real estate) as against 4.07 billion dollars in

290 deals during the previous year.

The energy sector was the biggest draw with 34 investments worth 2.14 billion

dollars while IT and ITeS with 79 investments worth 696 million dollars topped in

terms of volume, said The Associated Chambers of Commerce and Industry of

India (ASSOCHAM).

During 2010, Financial Services Sector has been the 2nd most favourite sector of

Private Equity Investors during 2005 to 2010.

Information Technology, Consumer discretionary and Financial are the favourite

sectors among the Venture Capital Investors in 2010.

Following several years when exit volumes were low relative to the number of

new deals being done, 2010 was a record year. PE funds unwound positions in 120

companies last year, taking in US$5.3 billion.

Buyback was the preferred route last year with deals worth 1.7 billion dollars. The

next preferred routes were open market (1.5 billion dollars) and M&As (1.2

billion dollars).

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PRIVATE EQUITY INVESTMENT TRENDS

The remarkable economic boom of India during the early 2000s opened up many

opportunities for Private Equity (PE) Investors in the Indian market. From 2003 to the

first half of 2008, PE investors were flushed with funds due to low interest rates,

favorable liquidity conditions and growing equity markets in the developed world. India

today is among the more attractive investment destinations globally, driven by a

combination of strong economic growth, an improving regulatory environment and

favorable demographics. As India continues on its rapid growth path, several large

potential investment sectors such as financial services, infrastructure and domestic

consumption offer significant opportunities for PE investor. India is generally considered

a must have destination for foreign institutional and PE funds, who recognize the

potential of Indian Companies to generate high returns leveraging on the countrys

economic growth. PE investors have played a significant role in the development of

several sectors in India over the past decade eg Telecom, Healthcare, Technology, Retail,

Education etc. PE investments have grown from US$ 2.0 bn in 2005 to US$ 19 bn in

2007. Thereafter, investment value fell to around US$6.2 bn in 2010 registering a CAGR

of 25% over the last six years.

Based on experience It is clear that the PE route has severalbenefits if the right PE is chosen for the value addition and the chemistry between the

entrepreneur and the investor works well.

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PRIVATE EQUITY:INVESTMENT TRENDS

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PRIVATE EQUITY: SECTOR TRENDS

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KEY ISSUES IN THE PE INDUSTRY

Indias PE and VC industry is far from reaching its full potential. The biggest

barrier holding it back is lack of regulatory support. Indian policymakers still do

not regard PE and VC as a distinct asset class, nor have they given sufficient

attention to creating a regulatory environment more conducive to the industrys

growth.

The Restrictive regulations which exist also are becoming the biggest hurdle for

PE investors operating in India and more specifically domestic funds. The industry

needs serious cohesive reforms from the decade old regulations. In particular,

there is a need to look at tax policy on clear tax-pass through sector restrictions,

prohibitions on purchasing secondary shares and convertible instruments and

investments in non banking finance companies for SEBI registered funds.

Further, with frequent changes in foreign investment regulations, PE investors

are tending to spend more time with lawyers and accountants than their investee

companies just to enable even long term FDI investments.

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Private Equity in India needs to operate in the space where public markets are

unable to calibrate/map or price a business. Most of the success stories (both from

an investor and an investee perspective) have been around new sectors, business

models or sometimes entrepreneurs themselves. It is also important to recognize

that extraordinary returns will only come from solving difficult problems for such

companies / businessmen. The era of riding the wave of rising markets is well

behind us.

Expectations over asset valuations on the part of PE investors and company

owners need to come into closer alignment. The expectations mismatch showed up

in the Bain survey as the principal challenge the PE and VC industry faces, with

one-half of all respondents identifying it as the principal barrier to the industrys

growth (see Figure 2.4). A tough competitive environment for high-quality assets

has further driven up prices. With rare exceptions, the high price to-earnings

multiples Indias PE investors pay put India at a relative disadvantage to China

and other fast-growing emerging markets

Macroeconomic uncertainties: Indias growth story remains intact owing to

sound fundamentals, but Indias powerful economic engine has lately shown some

signs of strain. Mounting inflationary pressures and occasional friction between

Indias economic expansion agenda and political pressures risk introducing

distortions in the growth trajectory. Not only do these conditions have the

potential to suppress adjusted earnings ,but they could also derail PE deal making

in sectors where the regulatory direction is unclear. Sectors like infrastructure and

microfinance are particularly sensitive to these concerns. If left unaddressed,

investors worries about these barriers could slow fundraising in the long run, as

LPs could seek greener pastures in other markets.

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Post-deal collaboration between PE investors and promoters: Although there

have already been major changes on both sides, developing greater trust and

rapport between PE investors and entrepreneurs is a key area. For entrepreneurs,

the fruit of that closer collaboration would be to benefit from PE investors value -creation skills and experience. But even lacking a direct hand in helping to set

operational goals, PE owners can bring considerable financial sophistication to

their portfolio companies. They can also provide access to their networks of

relationships and experience derived from their work with companies across a

broad spectrum of industries. Furthermore, the two sides can work together to

strengthen corporate governance by making boards more professional, recruiting

more seasoned executive talent and sharing best practices in systems and

processes. Suboptimal corporate governance and a tendency on the part of some

entrepreneurs not to be fully forthcoming with a current or prospective PE partner

can hinder the value-creation potential in the PE investment

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CONCLUSION

With its solid performance in 2010, Indian PE has re-emerged in good shape from the

testing times of the global credit meltdown and subsequent economic retrenchment. Deal

activity has rebounded more quickly than in other Asia-Pacific markets, the exit markets

are healthier than ever and capital continues to pour into an expanding number of

domestic and international PE funds. While the period ahead looks bright, it remains to

be seen whether current conditions will prove to be a sturdy platform for sustained

growth. Certainly, the Indian growth story remains on track and continues to attract PE

interest. New opportunities in several under-penetrated sectors like infrastructure,

financial services, healthcare are waiting to be tapped .The number of domestic funds

continues to expand, GPs with experience gained in the global PE funds are spinning out

new breakout funds and promoters are warming up to the idea that PE partners are more

than just another source of capital and can help them achieve exceptional growth, way

beyond what the promoters can achieve alone.

Three regulatory changes, in particular, merit immediate attention. First, PE and VC

funds should be allowed to purchase at least 25 per cent of the capital of companies they

target for investment. Under current law the threshold is set at just 15 per cent. Second,

Pension funds are prohibited from PE and VC entirely. Steps that would progressively

allow them to participate would not only help mobilize capital but should enable the

institutional investors better to diversify their portfolios and increase their returns. Tax

simplification, is a third regulatory reform that would make a significant difference.

Indian private equity stands poised to enter its second major decade and far exceed the

remarkable growth and contributions to the development of Indias economy it made

during its first. For that to happen, attitudinal, behavioral and regulatory barriers will

need to be removed that prevent the industry from achieving its promising potential.

Promoters, policymakers and PE firms themselves have a major part to play in ensuring

that happens.