VCCircle

(This guest column is written by Arun Duggal. He is the Vice Chairman of International Asset Reconstruction, a company that manages non-performing assets. He has earlier held the position of CEO of Bank of America in India. He is currently on the board of about a dozen companies like Patni Computers, LNG Petronet, Matrix Labs, Info Edge, and Fidelity Fund Management in India. He was also involved in a few large private equity deals in India such as the $125-million investment by Temasek and NewBridge Capital in Matrix Labs and ChrysCapital's investment in Shriram Group, among others.)

After growing rapidly from around $1 billion in 2004, private equity flows into India grew to $7 billion in 2006 and will probably exceed $10 billion this year. In addition to its traditional functions of providing smart capital to fuel the entrepreneurship of non-traditional businessmen and boosting managerial efficiency, PE is slated to enter into new areas such as leveraged buy-outs, distressed assets and infrastructure. We could also witness some public offers from PE firms.

At present, there are over 100 PE firms seeking to deploy $20 billion in India. The PE Industry has been able to attract talented professionals from major consulting firms, investment banks and industry in India and overseas. Some of the large deals have been KKR’s investment of $900 million in Flextronics, and the recent Carlyle investment of $600 million in HDFC.

Globally, PE has seen an unprecedented boom, drawing in increasing amounts of institutional investment and private wealth by delivering superior returns. There are several global PE firms with over $50 billion of invested capital and a new fund size of $10 billion or more is not uncommon. Beijing’s $3 billion investment in Blackstone has created a new landmark. Sale of Chrysler to US PE fund Cerberus posits PE firms as a major force in the global market for corporate control. However, globally, PE investment is less than 4% of the total public market investments. In India, this figure is probably closer to 2%. There is still a lot of potential for growth of this alternative form of corporate ownership.

Thanks to its fast growth, the PE industry has attracted serious criticism in Europe and the US: they take on excessive leverage, restructure managements, slash jobs, strip assets, fail to invest for the long term and still enjoy unfair tax advantages.

PE supporters contend that it creates more value as compared to public ownership. The British PE and Venture Capital Association research has demonstrated that PE-backed companies have grown faster in sales and employment than others. What happens in India?

Contributing To The Economy

PE has contributed to economic growth by both providing smart capital and improving capital efficiency. In addition, it has encouraged entrepreneurship by supporting new ventures and promoting new industries such as BPOs. It was Warburg Pincus, a major PE firm, which gave Sunil Mittal early stage capital for Bharti Airtel and supported Mittal’s entrepreneurship, leadership and management skills to create one of the most successful companies in India. Of course in the process, Warburg Pincus delivered outstanding returns to its own investors.

More than two-thirds of the capital for the sunrise BPO sector came from PE firms. The young professionals who led Warburg Pincus, ChrysCapital, Actis, General Atlantic, Oakhill Partners, CVC, etc saw the potential of the sector and funded companies such as Spectramind, EXL, Daksh, WNS and Genpact, promoted by educated entrepreneurs who did not come from traditional business families. BPO firms supported by PE Investors have been far more successful both financially and in job creation than other BPOs.

PE investors have struck gold in financial services, pharmaceuticals, IT, construction, consumer products, engineering and even traditional industries such as textiles. Their success stories include Suzlon. According to a survey by Four-S, a research firm, the PE backed companies have shown compound annual growth of 37.1 per cent as compared to 19.1 per cent for other companies.

PE has, in short, made a major contribution to the growth of jobs, revenue and profits of their investee companies, and therefore, of India’s over all economic growth. Their superior returns attract much larger pools of capital to India.

Increasing Efficiency

What makes PE tick? PE firms have a clear Investment Thesis as to how they will create value — by additional capital, change of ownership/capital structure, strategy shift in terms of international markets, technology, manufacturing, etc. They also incentivise the management teams by giving them ownership stakes. PE investors then undertake detailed due diligence to confirm their thesis and have an appropriate investment contractual framework.

PE investors get involved, more or less, depending upon the scale of ownership, in operationalising their original investment thesis and ensuring proper corporate governance. Such active investment is superior to passive investing by mutual funds, etc. This is also more committed ownership as compared to hedge funds and other short-term investors. Since PE investors are sharply focused on value creation, the managements get challenged constructively and prune inefficiencies and outmoded practices. In some cases, some jobs are eliminated, but new jobs are created as well.

Even the public markets recognize the superior inputs of PE investors: generally, a listed company receiving funds from a major PE gets re-rated and stock price increase by 20%-30%.

The Outlook for India

So what is the outlook for PE Industry in India?

1. More venture fund flows into IT products, Telecom, particularly Mobile Telephony, Internet, Biotechnology, etc targeting domestic as well as global markets.

2. Larger PE firms will provide vital partnership, in terms of finance, strategy and other expertise, to Indian companies seeking large overseas acquisitions.

3. We could see large Infrastructure investments by PE firms in Roads, Ports, Airports, Power, Telecom infrastructure, etc.

4. Regulation is likely to turn more permissive vis-à-vis leveraged buyouts. After all, how long will we applaud the Tatas, Birlas, etc acquiring large firms abroad on the strength of debt finance, while denying international or Indian firms loans in India for making acquisitions in India? Perhaps, experienced foreign banks could take the lead in providing buyout credit Indian banks could follow.

5. We could see some Indian PE firms go public in India, and also tap Indian Institutional and High Net Worth capital.

6. Finally the distressed asset market in India will develop and the PE Industry will participate in that.

(This article first appeared in The Economic Times of July 25, 2007, and is republished here with permission.)