The Resurgence of Private Equity

The Resurgence of Private Equity



Private equity (PE) and venture capital (VC) investors brought $4.4 billion into India between January 2003 and December 2005. They poured $2.3 billion[1] into India in 2005 and $3 billion in the first six months of 2006. The first nine months[2] of 2006 have witnessed eight buyouts by PE investors, compared with six during the whole of 2005 and just two in 2004. Clearly PE seems headed for a big boom in the country.

In India, PE investors are generally striking deals with large business houses which want to exit some of their non-core businesses and companies where some members of the promoter family want to move out. Take the case of Nilgiris, the country's oldest supermarket chain. Actis, a PE firm pumped in $65 million to buy out a section of the promoter group.

The Indian PE investors can be divided into two groups — incumbents and new entrants. The first category consists of players who have been investing since pre-2000. Most of the big exits in the last couple of years have come from this camp. The major players include Warburg Pincus, Actis, CVC, ICICI Venture and ChrysCapital. The second group consists of players like Temasek, Blackstone, General Atlantic, Carlyle, Kotak Mahindra and IDFC.

The PE boom in India only reflects what is happening globally in general and the US in particular. While the US which accounts for more than 60% of the world’s private equity market, remains the most preferred investment destination, the action is now spreading across the world. According to a survey, 20 per cent[3] of the 545 investors plan to expand globally over the next five years, with China and India being the top emerging destinations.
In 2000, at the height of the Internet boom, PE activity in the US touched its peak, $180.5 billion was raised that year alone by a total of 795 funds. Following the dotcom bust in 2001, 9/11 and the US economic slowdown, PE activity declined dramatically. India was also hit hard, with more than 90 per cent of the country’s private equity money coming from the US. Leading firms like ChrysCapital (then known as Chrysalis Capital), Draper International, eVentures India and ConnectCapital burnt their fingers. ChrysCapital wrote off nearly 40 per cent of its Internet portfolio. It was in 2003 that PE started recovering. By early 2004, fundraising in the US had begun to stabilize. Now PE investors are back in the limelight. And in India, too the momentum has been building.
In the last couple of years, global heavyweights like Blackstone, Carlyle, Kohlberg Kravis Roberts (KKR), Temasek, Actis, General Atlantic and Warburg Pincus fought for deals with domestic firms like Kotak Mahindra PE, IDFC PE and ICICI Venture. Some large corporate houses (Bennett, Coleman & Co and Reliance Capital) have also got into the fray. Some entrepreneurs have preferred PE to traditional sources of capital. These include, Mahindra & Mahindra, L&T, Kinetic, Gujarat Ambuja, Punjab Tractors and Shriram Group, to name a few. As a result, PE has made inroads into infrastructure, financial services, manufacturing, energy and utilities, healthcare, media and engineering. Investors have also experimented with deal types — KKR pulled off India’s first leveraged buyout with the $900-million acquisition of Flextronics Corporation’s Indian IT assets. On a smaller scale, ICICI Venture signed up a $56-million R&D deal with Dr. Reddy’s.

Global investors have taken a different approach in India and built up a diversified portfolio. ChrysCapital’s portfolio ranges from early-stage deals to growth and expansion deals. PE funds have also been prepared to look at new businesses. Warburg has invested $38 million in Gujarat Ambuja, its only cement investment globally.

The need for flexibility has made PE players in India look seriously at PIPEs (private investment in public equity) which constitute nearly 40 per cent of deal-flow (it is less than 10 per cent in the US). In a PIPE transaction, investors buy securities directly from a publicly-traded company through a private placement. A PIPE transaction can either be done at a premium or at a discount in relation to the market price of the company’s stock. Typically, such transactions are done by secondary market investors like financial institutions and mutual funds.

Some of the PE deals have delivered spectacular returns. In August, Oracle acquired Citigroup Ventures’ (CVC) 41per cent stake in Mumbai-based i-flex Solutions for $593 million. CVC’s original investment in 1992 was $0.4 million. Then, in September, Pune-based wind energy manufacturer Suzlon entered the public markets with a $340-million (Rs 1,496-crore) offer. Investors Citicorp and ChrysCapital who had entered Suzlon at Rs 21.6 a share and Rs 27.1 a share for 9.6 per cent and 7.1 per cent stakes, respectively, made a killing when Suzlon made its debut on the bourses at Rs 510 per share. Warburg Pincus sold its remaining 5.65 per cent stake in Bharti Tele-Ventures to Vodafone for $847.5 million. Warburg had invested $300 million in 1999.


Much of the PE action in India has happened in case of early stage deals. PE investors have come in after angel investors have got the start up going. But PE can also be used in case of established firms. PE in case of early stage buyouts goes often by the name of venture capital. In case of established firms, it is called Leveraged Buy Outs (LBOs).

PE funds often attract media attention because of the spectacular returns they generate. But PE is not merely about deal making, financial engineering or smart investment. Indeed, the big contribution of PC is the discipline and focus which comes into the bought out firm. There are management strategies and techniques that PE firms use to produce remarkable results that most publicly traded companies and private companies under conventional ownership cannot match. A recent Fortune article by Ram Charan and Geoffrey Colvin provides rich insights in this regard.

PE investors typically buy companies for their portfolio, fix them, grow them, and sell them to a company in the industry, another PE firm, or the public. The holding period may range from less than a year to as long as ten years. But always the goal from the inception is to sell the company at a profit. Executives quickly realize that they gain nothing by resisting change.

Pay is a wholly different concept in PE-owned companies. While public companies talk a lot about aligning executive pay with performance, they typically award stock options and restricted stock on top of already substantial pay packages, giving executives lots to gain but little to lose. In PE firms, the stakes are much higher for the managers.

PE investors often prefer to buy a company with strong management in place. But if they choose, they can attract talented outside managers using highly attractive pay packages. Here, they hold a valuable advantage over public companies. They are not under compulsion to make any disclosures.

Acting quickly often produces volatile quarterly earnings, which stock markets and analysts do not like. Many public companies hesitate to take drastic actions such as making a big new investment or taking a write-off for a plant closing. PE-owned firms don't have to worry about it. They spend little time trying to placate the capital markets, unlike public firms which spend a lot of time communicating to shareholders, analysts, and the media. In a PE-owned firm, those distractions disappear, and the CEO can spend virtually 100% of his time focused on the business.
PE-owned companies also bring in the necessary business focus. Several of these companies were initially parts of much larger outfits where they did not get adequate attention. After the PE deal, the spun off company gets the required attention and resources.
PE-owned companies also get excellent support from their board. Compared to listed companies, the board of a PE company is typically smaller and consists only of representatives of the PE fund plus industry experts whose explicit job is to help management formulate and implement strategy. Many directors fulfill both roles.
PE-owned companies have no confusion about the role of the board, who's ultimately in charge and the eventual goal. They are especially disciplined about how to reach their cash flow targets.
In short, PE firms have figured out how to attract and keep talented managers, provide strong incentives, free them from distractions, give them necessary support and let them free to complete the tasks at hand, while keeping them focused on quick results. No wonder these companies tend to be outstanding performers.

A fundamental question analysts are asking is, why can't public companies do all these things themselves? In theory, they can. Indeed, PE’s success is built on advantages that public firms just haven't figured out how to adopt yet. But markets have a rewards and punishment mechanism that forces public companies to learn over a period of time, if not immediately. When they do, their returns should rise, slowly eroding the advantage PE enjoys today. But that would certainly augur well for the economy. For what better news can there be for any economy, than the efficient use of capital?

References
“The New World of Private Equity” Businessworld, 14th August 2006, pp 30-32.
“The India Opportunity – I” Businessworld, 14th August 2006, pp 36-39.
Colvin, Geoffrey, Charan, Ram, “PRIVATE LIVES,” Fortune 27th November 2006, pp 80-88.
“Private Equity Funds Catching up in India” Business Standard, 9-10th December 2006.


[1] “The India Opportunity – I” Businessworld, 14th August 2006, pp 36-39.

[2] According to Venture Intelligence, a research service focused on private equity (PE) and venture capital activity.
[3] Survey done by Deloitte & Touche and the US National Venture Capital Association (NVCA), in June 2005.