How Limited Partners Are Reading The Sequoia Split Event

23 February, 2011

The big Sequoia India team split, that was announced last week when four of the founding partners Sumir Chadha, K P Balaraj, Sandeep Singhal and S K Jain quit to restart their own firm WestBridge Capital Partners, may be in line with the growing trend of  star general partners going their own way. But, it was no less surprising as it came after a record eventful year for Sequoia Capital India. And, the move has no doubt raised several questions, particularly from the LP (limited partners or investors in PE funds) quarters, on the overall climate of Indian private equity.

The WestBridge quartet, who are now back to resurrect their firm to invest in publicly traded companies, had, only in 2006, merged their firm Westbridge Capital Partners with the well-known tech investor Sequoia Capital.

Following this split, the questions many have begun to ask are: Are these signs of the Indian PE industry maturing? Did the team feel that they don’t need to leverage the Sequoia brand anymore? Are public equities indeed more attractive?

For most limited partners, the recent event (the Sequoia split) is being read as a need for

better alignment of economic interest, increased entrepreneurial energy in Indian PE and a desire to pursue an independent style of investing, in this particular instance, public equities.

What is triggering the spinout trend?

There have been a spate of spinouts  in the recent past with more and more private equity professionals launching their own funds.  While such events are not such happy news for the LPs who often question the motivation of the GPs in doing so, there is another school of thought which says that this is a sign of the industry maturing. Besides, some LPs even like such investopreneurs as they are more hungry for carry (share in profits) than management fee and often have more personal commitments to the fund.

“Overtime, we are seeing teams spinning out from global PE funds,” said Menka Sajnani, VP, Auda Investment Advisors. According to Sajnani, there is a trend in funds going local. She also added that the major drivers for such moves have often been a larger share of profits and greater control of independent strategy.

The Indian PE scene has seen several veterans going on the entrepreneurial path. For instance, Ajay Relan (ex-CVCI head) started CX Partners), Rajesh Khanna (former Warburg Pincus managing director and India head) quit to start a new private equity fund Arka Capital; former partner at Baring Private Equity Partners India N. ‘Subbu’ Subramaniam is also raising a new fund under MCap Fund Advisors; social venture fund Acumen India director Varun Sahni also started his own PE firm, Global Impact Investors, to specialise in critical service sectors in emerging markets.

While there is a clear trend in teams spinning out from global PE firms to establish their own, Sajnani was quick to add that there could be more spinouts in the local private equity market too. We have seen such action with firms like Ambit Pragma spinning out from homegrown India Value Fund. Spinouts are not only an Indian phenomena, such evidences are also seen in other emerging markets, she adds.

Public Vs Private: Which is Hot?

The Sequoia split has brought to the forefront a broader debate on the merits of public versus private investing. So, will the party last particularly when the markets have been choppy in the last six months? That is a question many are asking particularly following this move towards PE veterans opting for public equity style of investing.

In the past, there have been marquee investors like Pulak Prasad setting up Nalanda Capital or Ashish Dhawan of ChrysCapital returning money to LPs for a reportedly public markets play. When such players make these choices, it is safe to say that public equities could be equally attractive bet.

According to Praneet Singh, MD, Siguler Guff India Advisers Ltd, a leading fund of funds in India, “There is a huge amount of opacity in this space. Public markets offers a lot of opportunity.”

Both the asset classes are different bringing with themselves a different risk-reward profile and such events only draw attention to the challenges that the PE industry in India is currently facing.

“The private equity space is too crowded – too much money chasing too good deals.  With 800 firms doing private equity and venture capital, there may not be room for everyone to make money.  Public equity is a much more consolidated industry even between offshore funds, and domestic mutual funds and managed account managers.

The fund sizes are a major constraint, and with the median size being $350 million and the average investment size at $25 million, size is a problem in private equity,” said Radhika Gupta, a Founder Director with Forefront Capital Management, a SEBI registered portfolio manager, and India based  specialized quant manager.

Finding good deals in private markets at that size is a problem, and public markets probably offer the ability to do more mega deals as the companies are larger with visibility on liquidity.  At the same time, listed companies arguably come with better corporate governance, and if nothing else, with transparent financials, Gupta adds.

Apart from challenges in finding good deals, valuations have been a very big issue as India has always been an expensive market. Unlike other markets, which actually offer a discount to public market valuations to private equities, the latter has always been at a premium here, making the entry valuations into the companies for PE funds on the higher side.

“A second issue is that managers are likely to benefit from volatility in public markets and get better deals, valuation wise.  A round of volatility as we have recently seen will drive valuations of fundamentally good businesses to even 8-10 times earnings. Comparable businesses in the unlisted space are unlikely to come at such valuations.

Moreover, in private transactions between promoters and private equity investors that play out over a long period, managers are less likely to be able to take advantage of such opportunities,which are more short term in nature. Valuations in public markets are less likely to be driven by irrational exuberance or sheer despair.

Maybe this is why private equity track records in India have been questionable.  PE track record is more hazy, varies from fund to fund, and, with a few exceptions, is much shorter.  Risk adjusted, there is little convincing evidence that PE players are ahead,” adds Gupta.

According to Sumir Chadha, there will be more organized activity in public equities going forward. While it is difficult to draw a conclusion on which asset class is better based on a few precedents, one has to take cognizance of the fact that the Indian PE industry in just 10 years old with exits in the portfolios of most of the funds only beginning to show now.

“It is difficult to draw comparison and conclude which one is better, the reality is that there are a few funds which are showing good exits in the range of 3x- 4x in a 5-year time frame which is not bad,” adds Sajnani.

Echoes Kiran Rao – Principal, Grove Street Advisors LLC, a fund of funds having exposure to a dozen PE funds in India, “We have made good returns from early stage, growth PE portfolios from India and we continue to look at India very actively. ” Commenting on the Sequoia-Westbridge split, Rao said, one event is not reflective of the industry as a whole and that they are fairly optimistic about the private market investing in India going forward.


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How Limited Partners Are Reading The Sequoia Split Event

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