Saturday, September 19, 2009

PE in India - time for consolidation

It has truly been a long time since I posted. I have avowed to myself that I shall post at least once a week. It has been a truly enriching experience over the last three years being a part of what hopefully, is still a sunrise (and not enroute to a sunset !) industry.

Wanted to bounce off a thought that has been gnawing my mind for the last six months. Having met different constituents of this spectrum - LPs, Investment Bankers, Promoters and fellow PE funds, I tend to believe that the PE industry in India is on the cusp of a large shake-out. Listed below are top reasons why :

Gap in skill sets : There are just way too many funds focussed on "passive capital". I would have thought this would have changed post the financial melt down. Truth is, the ones who missed the India bus earlier, seem to have gotten even more aggressive in deploying cash. All my dear investment banking contacts tell me that with all the free money sloshing around in the Western markets getting directed to "Emerging Markets" (what else !). I seriously think the time has come for BRICS -II. Goldman, where art thou ? May be a SMAT (Srilanka, Mexico, Argentina, Taiwan). Takers, anyone ?

Lack of focus/segmentation: I am yet to see more than 6-8 funds that pridethemselves on their focus - geography, verticals or deal types (venture, growth, buy-out, restructuring). Everyone's favourite sector seems education, healthcare and all else where India's per capita consumption is woeful. Where are the proprietary deal flows, where is the ability to construct a deal (and not study an IM for its pros and cons), where is the network of relationships ?


Impending battle for exits: This is going to be fun to watch. All the excesses from 2007 and 2008 have resulted in PE invested companies being valued at astronomical valuations (favourite whipping boys being retail, education, aviation where there is no evident route to a profitable scale-up with the exception of a honourable few). Case in point, a company that was invested into by a PE fund was valued at Rs. X in Jan '09 when the PE fund sold their stake to a counterpart. Now, I hear the going value is Rs. 2 X with hardly a change in fundamentals. Basic laws of economics point to the fact that in any free market arbitrage opportunities vanish fairly quickly. Hopefully, it would happen here as well.


Forward integration by LPs: if your friendly Mutual Fund told you that he did nothing with your money all year long and knocks off 2% off the corpus as ostensible "management fee", would'nt you be mad at him ? Ironically in an immature market like India, it does not take one too much of an effort to hire a couple of smart traders and generate a return of 15-20% from public markets. If so, what is the big deal in getting a 25% IRR from an illiquid asset class over a 5-7 year time period.

Ever increasing fund sizes : Funds are doubling their corpus every three years. Surely, the economy is not growing at 25% to justify doubling of deal sizes in the same segment(s) all else being equal; or is it ? This game has to stop - I have not seen Mutual Funds being proud of their corpuses - as far as I remember, they have been proud of their performance (historical returns). Why should it be any differnet in the PE industry.

Would love to read from others their thoughts and moot points.

~Varadha

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