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PE May Have Missed Out on PIPEs at Attractive Valuations

13 May, 2009

The currently market rally has seen the Sensex going up by more than 20% since the beginning of last month. The rally has caught many napping, as the markets were not expected to recover till end of the year. Many dealmakers were expecting valuations to remain at January-February levels through most of the year, which would force promoters to do deals at those valuations.

VCCircle caught up with Praveen Chakravarty, Chief Operating Officer & Head of Institutional Equities Sales, BNP Paribas India. Chakravarty says that risk in Indian markets has fallen, which has led to foreign inflows (estimated to be $1 billion in net inflows) into the market. He also says that markets are unlikely to go down as there are lots of investors waiting on the sidelines to enter at these levels and support it. Chakravarty also talks about impact of market rally on private equity, valuations, and the IPO markets. Excerpts:

Q. How are you viewing the current rally?

It’s confusing. Earlier people were asking me when is a recovery, now everyone is asking why there’s a recovery. Clearly, not everyone has been able to make sense of the rally. In my opinion, the rally has been driven by some amount of inflows coming in, not really based on any fundamentals. It is a sentimental rally but there is nothing to say that it has to stop anytime soon.

Q. So do you think we can categorise this as a bull or bear rally?

I think people have tried to give all sorts of names. The reality is there is a lot of money that has been waiting on the sidelines, and waited for a long long time. And now, finally, people have started to deploy some of that into markets like India.

Generally the perception is that emerging markets are riskier than developed markets. Typically risk is measured in terms of volatility. Over a 10-15 year time frame, the volatility in the NIFTY was 800 basis points higher than the volatility in the S&P. In the post Lehman era, volatility in the S&P is the same as that of NIFTY. Which means the perceived risk, or risk differential between developed and emerging markets is actually compressing. A lot of money on the sidelines, which would have gone to developed markets, is now coming to emerging markets like India because the perceived risk is the same now.

Q. As the risk is coming down, do you expect the current rally to sustain?

The other way to answer that would be what can stop or reverse the rally. A month and a half ago the worst fear was political uncertainty, the election risk. Within that the worst fear was a new

third front government whose policies no one really knows. Now after four phases of polling, the markets beginning to recognise that the likelihood of third, fourth front are remote. So the surprise element on 16 May is not going to be as high as expected.

Secondly, what if liquidity suddenly vanishes? Again if we look at that argument, what has happened is that net inflows into the country have only been a billion dollars which has pushed the markets up. It’s not as if a flood of money has come in and pushed the markets up. To put that in perspective, in 2007, the country saw close to a $20 billion of inflows.

So I don’t think a lot of money has come in for it to go away and markets to tank. The election risk is diminishing; the fear of liquidity drying up is unwarranted in my opinion, so I don’t see what

could be the catalyst to bring the markets suddenly down.

Q. Do you think markets will hover around this area of 11,00 to 12,000?

It could remain higher. There are a lot of investors that you speak to saying they have not participated in the rally. And what was before a fear that markets may go down is now becoming a hope, so that these people can enter. But the fact that there are so many saying that they will enter when markets go down, just says that it will not go down.

Q. So have investors who have been waiting for lower valuations missed the bus?

Yes, because there are too many of them waiting on the sidelines. So at every drop, there will be money coming in which will push it back up.

Q. What kind of high do you see going into the year?

BNP Strategist Call has a Sensex target of 15,000 by end of this year.

Q. Do you see markets responding more to global cues going into the year?

To answer that analytically, if you look at the correlation between Nifty and the S&P over the last 10-12 years, it has touched a high of 80%. Right now the correlation is about 80%, which is at an all time high. I do expect that correlation to come down going into the future.

Q. How are the valuations in India?

In terms of valuations, if you look at our strategist call, at 15,000 we would be at 3.2 times price-to-book ratio, which is in line with India’s long term average. There is nothing to suggest that markets are expensive right now. Really the problem is right now nobody knows how the fundamentals are shaping up so we have to look at corporate earnings very closely before we say whether its cheap or not.

Q. What are you telling your clients right now?

We are telling clients that we do not see the catalyst for a downside. The BNP Strategist has upgraded India as a fairly bullish Sensex target. Even if you have to take the view that markets will correct, we are unable to point out catalyst that will pull it down.

Q. Do you see IPO markets coming back?

I hope so, but we don’t know. I think the valuation gap between what management wants and what investors are willing to pay is still high. But with markets going up, I am hoping that gap will come down, on what is called the bid-ask spread. IPOs may come back starting third quarter calendar year. Clearly, Unitech’s QIP did indicate there is an investor appetite for beaten down stock. The book was oversubscribed and funds were raised despite the fears of bankruptcy. That itself shows there is an appetite at right valuations for both secondary market raises which would translate into primary market raises.

Q. Estimates peg the amount to be raised by firms in next few months between $6-9 billion through QIPs, rights issues. Do markets have the appetite?

Why not? It’s not as if a lot of money has come into the market, its only $1 billion. So clearly there is a lot of headroom. I don’t see $6-9 billion very large number for a market like India to take. At the right price and valuations, I think there is an appetite right now.

What kind of impact will rising markets have on private equity space?

I am pretty sure it’s not entirely good news for them. Private equity deals tend to use public equity markets as valuation benchmark. So with rising markets, valuations for private equity deals will

understandably go up. Another reason is that just when PE funds started to look at public market to do some PIPE deals, or secondary market purchases, the markets have started to run again.

I don’t have enough evidence to say that PE guys have come in and that’s why markets have gone up, I don’t believe that is the case. So there would be a lot more people who would be left out because not only will expected PE valuations will go up, but they have also missed out on opportunity to do PIPE or secondary market deals.

Q. Do you think many might have missed out on an opportunity to do deals?

From a private equity perspective, IRRs tend to be very high as compared to a public equity investor. To meet their IRRs they should have gotten in at a very attractive, lower valuation than what it is right now. So I think this rally has impacted private equity more than public equity asset managers.

I think PE still has opportunity in the small and midcap space, which is what PE guys do when they invest in listed space. I think the small and mid-cap names have not participated in the rally as much, and they still may have opportunity on a one-off basis. But clearly the markets are running ahead.


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PE May Have Missed Out on PIPEs at Attractive Valuations

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