Private Equity Needs Creativity to Deal in India

A Reuter’s report last Friday said the Asia head of a PE outfit was leaving within a year of joining. This firm apparently has had difficulty closing large buyouts amid high prices for deals and a dearth of sellers in markets like China and India. Compared with rivals such as The Carlyle Group and Warburg Pincus, this firm arrived late to Asia. The report says the firm found that competition for assets was fierce.

While not exactly at this degree, there are parallels to this story in India. The surge in Indian PE/VC deal market in the last 24 months has attracted many new foreign players.

Most PE or VC firms, which arrived in India in the last 12 months, are perhaps finding the going a little tough. There seem to be quite a few firms who have done no deals yet, or at best 1-2 deals in about 12 months of being active in India. In other words, many of these firms are still finding their way around the Indian markets.

A look at data would also give some indication. In the first quarter of 2008 (Jan-Mar), private equity firms invested about $3.3 billion in 97 deals according to Venture Intelligence. In Jan-Mar 2007, there were 101 deals. So while the number of PE firms is perhaps up 15-20% in the same period, the number of deals going around is roughly the same.

The learning here is simple – traditional PE models which apply in the US or Europe may not always work in India. For example, it is hard to do large deals in India, for more than one reason – supply remains low, consequently valuations are often an issue. Deals like buyouts are still harder.

In Jan-Mar’08, there were perhaps 5-6 deals greater than $100mn, if you ignore the real estate SPV kind of deals. There was perhaps only one buyout, if you count Paras, where Actis has reportedly upped its stake to 60%. So if you are a PE firm keen on large deals or majority ownership, what do you do?

One answer would simply be – bide your time, be content, do none or 1 deal a year if you don’t get the right deal and right valuations, and don’t bother opening a local office. The other may be to try a different route of ownership – incubate firms which can quickly grow to reasonable size. In an economy like India, which will grow in the range of 7-10% over 1-2 decades, it may be possible to build multi-billion dollar businesses from scratch. So if you can’t buy it, build it.

The recent IPL franchise auction was one area for PE funds to get in at startup and build a large operation ground up. Recent reports have indicated that winners of IPL franchises are being chased by PE funds. Some deals will surely be announced in the coming months. Yet, the price at which any investment will happen now will be vastly different. Consider this scenario – a PE investor puts together a team of operating types, and enters at bidding stage itself. The potential for wealth creation would be far greater in this route.

The recent auctioning for telecom licenses that saw groups like Videocon, Unitech and dozens of others apply, was another example. Many of the new applicants are essentially acting as investors – they are in it more for capital gains than to build and earn operating income. Their aim is – get the license, offload equity to actual operating companies, multiply valuations by getting PE investors in, and exit at some point with hefty capital gains. In the telecom infrastructure business, there is an example of a company being built ground up by a PE investor, with majority ownership.

An example of building rapid value in a short period of time is Lemon Tree Hotels, which was started by a first generation entrepreneur in 2002. Last week saw Shinsei Bank and Kotak’s PE arm pay $30mn for a 5.9% stake. This values the company at $500mn, or around Rs 2000 crore. This appears to makes Lemon Tree the third most valuable hotel company in India, behind only the Tata owned Indian Hotels, with a market cap of around 8000 cr or around $2000mn, and East India Hotels, with a market cap of Rs 5500 crore roughly $1350mn. Much older hotel chain Hotel Leela Venture is valued at $380mn and Asian Hotels at $280mn.

Warburg shows it remains the master of big ticket investing in India. It took a 27% stake in Lemon Tree in July ’06 for Rs 210 crore, or a valuation of Rs 800 crore. At that point Lemon Tree had only 2 properties actually operational. Warburg’s stake could now be worth Rs 540 crore, or more than double in less than 2 years, at an IRR of around 65%.

Comments

[AmesTiedeman]

What is all of this out sourcing information coming out of India? Where are the jobs going?