Having grappled with low growth rates in the recent past, PE firms are changing the rules of the investment game. The traditional model of silent investor no longer works for them. To ensure high returns and profitable exits, they are playing a more nuanced role in the companies they have a stake in
In September 2013, private equity (PE) firm TPG Growth invested nearly Rs 150 crore in the medical consumables company, Sutures India, for a 22 percent stake. This was after months of deliberation and discussion, and clearances from the Foreign Investment Promotion Board (FIPB). At first glance, it appeared to be another run-of-the-mill deal: Sutures India would use the investment to expand, and TPG would sit quietly with its minority stake, waiting to exit the company on a high. This is a well-traversed route for PE companies globally, and one that they have been following for years.
The TPG-Sutures transaction, however, is far from the ordinary. In the nine months since TPG got a toehold in Sutures, it has put in place a new CEO, mapped a clear path to growth, evaluated more than 15 acquisition targets and is in talks with 3-4 companies for potential buyouts. And, now, the hands-on TPG plans to acquire a majority stake in the company.
Out-of-the-ordinary, though, is increasingly becoming the new normal in the Indian PE industry which has been combating low growth rates in the recent past. The country’s FDI inflow between April 2000 and December 2013 stood at $209.8 billion, according to ‘PE in 2025’, a PwC report released in June; of this PEs have invested $80 billion, and nearly 65 percent of these transactions are yet to offer returns. This has forced PE firms to rethink the way they create, tailor, manage and exit deals.
“Lack of returns due to various reasons has put the industry on the edge [where it has] to seek the next big opportunity to make that alpha [returns upward of 25 percent],” says Renuka Ramnath, founder of Multiples Alternate Asset Management. “Modest returns don’t satisfy PE investors; if we don’t give back 30 percent, it’s a job not done well.”
The experiences of the recent past have made PEs more cautious in their approach toward new deals. Rigour and diligence on prospective transactions have intensified. For instance, six years ago, a deal would take 6-8 months to be sealed. Today, it takes as long as a year to 18 months. “The search for Shangri-La [perfection] is on. Investors are still trying and testing out various approaches to find the winning formula,” says Bala Deshpande, senior managing director of venture capital (VC) firm New Enterprise Associates (NEA) India. (Deshpande has earlier overseen deals ranging from Rs 6 crore to Rs 300 crore at ICICI Venture.)
And this quest for the “winning formula” has led the Indian PE industry to defy traditional business models that work in other countries.
The Big Hunt
India’s PE industry is just over a decade old, but it has seen a full investment cycle, which includes infusion of capital, gestation (scaling up) and exit. Typically, the investment horizon is of 5-7 years, by the end of which a PE firm needs to give back returns to its Limited Partners or LPs (investors in funds created by VC and PE firms.) Exit routes usually take the form of a public offering, a secondary transaction when another PE firm buys from an existing investor, or when a promoter re-acquires the stake. In emerging markets, LPs usually expect returns that are 3-4 times the capital invested.
This tried-and-tested formula, however, falls through in India. In the first cycle 2004 onward—we are currently in the second cycle—the PE industry failed to offer successful exits and returns despite the fact that the period from 2005 to 2007 was touted as the golden years of private equity in India. Global investors—attracted by the country’s 8 percent GDP growth—thronged the private investment sector. They bet on large-ticket deals assuming India’s growth (coupled with the aspirations of Indian promoters to crack new markets) would automatically generate returns of 15-20 percent. And with a little push from them, returns could go up to 25-30 percent. But investors have been proved wrong.
India’s performance when compared to China’s adds insult to injury. PE investment in both countries started at the same time. India’s grew at a moderate pace reaching $2.6 billion by 2005. China’s started slow but, between 2004 and 2005, reached $9.6 billion. The Lehman bankruptcy in 2008 applied temporary brakes on investments in all emerging markets including Brazil. By 2010, however, China and Brazil regained momentum, leaving India behind. No one was prepared for the slowdown that hit the country from 2008.
“In 2003 we were protected; the economy had not opened its doors to FDI,” says Vishakha Mulye, managing director and CEO of ICICI Venture. “Today, that’s not the case. In 2014, most of the companies are directly exposed to global markets and the associated volatility, which can be high. I can’t sit on my chair and expect India’s growth to grow my company.”
Everstone is an established player in the food and beverage (F&B) space. In 2008, it invested in Pan India Food Solutions (Blue Foods) which owns Noodle Bar, Bombay Blue and Copper Chimney. Later in 2011, it invested in New Delhi-based restaurant chain Pind Balluchi. Both these companies are a part of Cuisine Asia, a Mauritius-based holding company founded by Everstone Capital Advisors. With the Burger King deal, though, Everstone is experimenting with a JV format.
Rule #4: Find profit in debt
Investors have also started planning about exits at the time of signing the deal, and not as they reach the end of the investment period (which is usually five years; in India, this may extend to even 10 years.) If an exit route is not clear, the deal will not happen, says Sanjeev Krishnan, leader, private equity, PwC India, adding that investors no longer trust the current IPO market. “They [investors] don’t want to time the market. They are now starting talks with strategic investors for potential exits through mergers and acquisitions within a year of an investment,” says Krishnan.
(This story appears in the 08 August, 2014 issue of Forbes India. To visit our Archives, click here.)