The year 2011 started with cautious optimism. The first signs of a slowdown surfaced in the last quarter of 2010, but there was hope that it was not serious enough to impact the deal-making activity. However, while the first half of the year remained largely unaffected, the shift in the momentum started from second half onwards. Falling stock market severely impacted the PIPE segment and the concerns on growth sustainability started impacting the PE deals as well.
A Look Back At 2011
2011 was the year that carried some expectations on exits for PE investors. With several of the 2006-2008 vintage investments getting mature enough for exits, the setting was just right for a flurry of deal-making. But with the capital markets being a big let-down, the IPO window just did not open up, nor were PE investors in any hurry to provide exit to their own fraternity members. And the cumulative effect was that ‘exit’ looked more like a mirage, except for a lucky few.
The year also promised a lot in the form of new fundraising. Several new funds were set up, some by seasoned professionals who had ventured on their own and were in the thick of action for fundraising. But a tough global environment, coupled with some disenchantment with the India story, meant that many of them are still work in progress. A pity, given that their presence would have added depth and variety to the PE market.
2011 has been a year that has posed severe last-mile issues for deal-closing. Due diligence has become more painstaking and intensive, and documentation has often taken an eternity. In a volatile environment, the longer a deal takes, the more vulnerable it becomes, testing the patience and temperament of all parties to the deal.
Despite all the headwinds, crossborder, inbound M&A continued to be reasonably strong, particularly in the mid-market segment and across a wide range of industries. The strong momentum on this front meant that at times, strategic investors were able to displace PE investors as more attractive options for entrepreneurs, particularly the ones who were less fussy about control.
Venture capital investments & exits
Internet and e-commerce staged a spectacular recovery, after almost a decade, and in style! Deal frenzy and valuations touched levels that reminded us of the dotcom boom in the late 90s. More importantly for the VC industry, there were also exits both for VC’s and angel investors that infused confidence and excitement in this segment and created a new wave of investments.
Looking Ahead To 2012
A challenging first half
The first half of 2012 has all the makings of being a very sluggish one. The real impact of the slowdown on corporate performance will actually manifest itself from the second half of FY2011-2012. A disappointing second half might rock the boat in several deals, especially the ones which are now close to term sheet or in the diligence phase. Investors will either renegotiate or even pull out and sellers will find it hard to reconcile to reality. In this climate, it is tough to expect investors to push the envelope to make a deal happen. So the ball will be in the court of the sellers. The ones who have delivered on performance or those who are quickly willing to reconcile their expectations in tune with the times will taste success. The rest will run the risk of staying out there much longer!
Advantage new funds
Some PE funds of recent vintage, without much baggage and with plenty of ammunition and time on hand, will exploit this situation to invest at attractive valuations. The panic in 2008-2009 was too short and the subsequent recovery was too quick for PE investors to react, but a slowdown as opposed to panic may just present a good opportunity, given that the long-term story is still intact. The ones who did this during the 2001-2003 slowdown were the first to laugh their way to the bank when markets revived from 2004 onwards and history could well repeat itself! Similarly, in tough times, deal activity sometimes tends to get concentrated in certain sectors. For example, microfinance and education ruled in 2008-2009 and ITeS ruled during 2001-2003. So which sectors will stand out during this slowdown will be interesting to watch. Will it be food and agri or healthcare perhaps?
Role of PE investors
The base of PE-funded companies is now much larger than ever before with many being ripe enough for exit. So in many cases, the destiny of these companies will be decided not just by the promoters but equally by the PE investors. Will these companies panic and transact in a hurry? Or will they have the stamina to wait and watch remains to be seen. Some are likely to stay put, not transact in a hurry and bide their time for better days. But there will be others who can neither support their portfolio companies any further nor wait any longer, and will not hesitate to bite the exit pill, howsoever bitter it is. There lies the opportunity for buyers too, be they strategic or PE investors.
Improvement from H2?
One can expect an improvement from the second half of the year. The possibility of inflation being under check, interest rates coming down, if not drastically, a stronger currency and hopefully, no further deterioration on the global front, might trigger positive sentiments in the markets from Q2 onwards. But for these developments to impact the deal-making environment, it might take another quarter or so. Even then, it will perhaps be too optimistic to predict a significant improvement. What one may end up seeing is a more even contest between bat and ball! Between buyers and sellers!
The Investment Banking Climate In 2012
Tough conditions for deal-making
2012 appears to have all it takes to really test the skills and patience of deal makers. New mandates will come in a trickle and that, too, after severe competition. Bankers will be sandwiched between buyers who will be nervous, unforgiving and at times, unreasonable, at one end and sellers who will neither drop their expectations nor be able to support with good performance. Extended diligence and documentation timelines will add to this frustration. So deal-making, at least in the first half of the year, might be a lot like batting on the first day of a moist and grassy Headingley wicket. It will be a real test of their skills and patience. And the Dravids and the Kallises among the deal-makers are more likely to succeed than the Sehwags!
Capital markets-focused players will compete aggressively
The Capital markets segment has been the worst hit during 2011. It’s a big let-down after the spectacular revival in 2009 and 2010. With no signs of immediate improvement, capital markets-focused players will have no option but to attempt inroads into the PE and M&A segments. Although their initial focus would be on the relatively larger mandates which are relatively more IPO ready, a prolonged slowdown in capital markets could mean that their presence in the PE and M&A segments could be a lot longer this time around.
Niche and regional players will weather this storm
Niche and regional players, consistently focused on the mid-market segment and with strong M&A credentials, should weather this crisis. While they may face the heat from the larger players in some larger mandates, typically, these players would have long-standing relationships, which coupled with their close-to-market presence, will hold them in good stead by delivering a consistent pipeline. History tells us that when deal-making climate turns tough, some of these firms are not as badly hit as the larger ones whereas when the climate is buoyant, the reverse happens – they don’t capitalise as much as the larger ones do.