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PE Funds: Exits, The Only Measure Of Value

Private Equity has been a catchphrase in India for the last 10 years and has played a critical role in creating value for investee companies. However, due to a lack of good exit opportunities with the drying up of IPOs and stalled M&A activities, investments by PE Funds have dropped significantly in the recent past. Sumeet Mehta, Managing Director, Paradigm Advisors tells us about the challenges PE Funds will need to tackle to revive themselves, like deploying uninvested capital, asset management and multiple exit routes.

When capital markets participants hear about Private Equity (PE) and value creation for PE Funds in listed companies, the first thing that flashes across their minds is Warburg Pincus having exited Bharti in March 2005. This exit happened through open market sales in two block deals totalling 112 million equity shares. This represented 6.04 per cent of the equity capital of the company valued at Rs 24.67 billion. Warburg had invested USD 288 million in five stages of fund raising between September 1999 to July 2001 in Bharti. Between February 2002 and October 2005, it exited Bharti in five deals aggregating to USD 2 billion. This was one of the biggest success stories in value creation by PE Funds in India.

Private equity has been a buzzword ever since it picked up pace in 2004. In the recent past, the markets have witnessed many IPOs of companies backed by PE Funds and open market sales by PE Funds. PE Funds have been a critical catalyst in creating value in their investee companies.

Exhibit 1 gives a quick snapshot of investments by PE investors in India, showing that PE Funds have invested around USD 83 billion in 3539 deals since 1999.

Exhibit 1: PE Investments in India

Year Investment (USD Bn) Deals (No.)
1999 0.50 107
2000 1.16 280
2001 0.94 110
2002 0.59 78
2003 0.47 56
2004 1.74 90
2005 2.60 185
2006 7.40 296
2007 17.10 494
2008 14.10 448
2009 4.50 216
2010 9.50 380
2011 14.80 531
2012 7.60 268
Source: Industry and Media Reports

However, it has been observed that investments by PE Funds have dropped significantly in 2012 after it bounced back in 2010. This can be attributed to falling investor confidence and interest in India funds. Lack of investor interest resulted in India funds raising a meagre USD 2.5 billion in 2010 and USD 2 billion each in 2011 and 2012. Also, the money available for investing in India fell from USD 25 billion in 2010 to USD 17 billion in late 2012. This is a critical indicator of falling investor interest in and allocation for India.

This is mainly due to the lack of good exits and quantifiable performance by India funds and lesser liquidity chasing the emerging markets in general and India in particular. The only measure and yardstick of value creation by PE Funds Investment is exits. No wonder then, that while investments are news, exits are much bigger news. As is evident from Exhibit 2, PE Funds in India have managed to book exits of USD 23 billion in 840 transactions since 2005.
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Exhibit 2: Total Exits Since 2005

Year Exits (USD Bn) Deals (No.)
2005 2.96 53
2006 1.81 64
2007 2.70 112
2008 1.13 60
2009 2.43 117
2010 4.55 174
2011 2.95 123
2012 4.43 137
Source: Industry and Media Reports
Accelerating this concern is the overall regulatory and economic environment, coupled with corporate governance issues arising in many investee companies and the inability of PE investors to manage such issues.

The bulk of PE investments in India have happened in 2005-2007, and most of those funds have been under pressure to generate returns, book profits and return capital to investors. This process has been slow since 2008 and has caused concerns among investors, impacting the ability of existing fund houses to raise capital in their new funds.

Indian PE Funds surged ahead in concluding exits in 2012, addressing the concerns of investors. While 2011 witnessed 123 deals aggregating to USD 3 billion, PE Funds clicked 137 deals generating USD 4.4 billion in 2012. This shows that exits have jumped by around 47 per cent year-on-year.

Exhibit 3: Exit Routes in 2011 and 2012

Exit Type20112012

Value (USD Mn) Deals (No.) Value (USD Mn) Deals (No.)
Buyback 22 317 17 109
IPO 13 115 4 194
M&A 30 1089 47 466
Open Market Sale 41 861 49 2445
Secondary Sale 17 571 20 1219
Total 123 2953 137 4433
Source: VCC Edge

What is evident from Exhibit 3 is that the exits through IPOs have fallen significantly in numbers. This would mainly be due to sluggish primary markets. This is also a challenge in disguise, because when investments were made nearly all funds had anticipated IPOs as an exit route for nearly all the deals.
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The Indian capital markets have seen investor interest in PE-backed IPOs and performance of PE-backed listed companies over the last decade. PE investors entering into investee companies not only bring equity capital, but also enhance the strength of investee companies to raise debt and equity in follow-on rounds of fund raising. Beyond that, PE funds also act as catalysts in creating value by various other means.

Big Four firm KPMG’s survey of fund managers in 2011 provides many interesting insights on the measure of value creation. The study explores various responses to understand the source of value creation in companies. It shows that PE fund managers believe that value creation was in the form of more tangible and measurable parameters like EBIDTA growth and multiples expansion. They attribute EBIDTA growth to organic growth of companies, changing product mix and new markets and efforts towards cost reduction by achieving operating efficiencies.

The major value creating contributions of PE Funds are attracting talent, developing new business models, helping to access new markets, improved corporate governance, building capability, raising capital, enabling efficiency improvement and last and the most important, improving perceptions of the quality of the company.

Exits by way of mergers and acquisitions (M&A) remain a challenge because PE Funds, being minority investors, may not be able to convince all promoters to sell a controlling stake to other companies. However, promoters can certainly create greater value by aligning with PE investors and seeking support and leads from them in case they want to exit together through the M&A route.

The outlook on PE Funds remains challenging in 2013. Three critical areas which would garner maximum mindspace of investment teams of PE Funds would be – deploying un-invested capital, asset management and exits. Amid mixed reports on the economic front, PE Funds will have to stick to a bottom-up approach in evaluating opportunities while deploying capital.

On their part, PE Funds would have to focus on higher asset-management skill sets, along with aligning with managements to create value for investors and promoters. This would require investors to evolve from being mere funders to partners and to forge a symbiotic relationship with promoters. In existing portfolio companies, investors and managements would have to align with each other to create a common vision and jointly formulate a strategy to achieve the vision. PE Funds are now focussing more on operating partners with industry expertise to assist managements of portfolio companies to improve performance and create value. However, they face the critical challenge of tackling sticky issues like non-transparency by promoters and company managements after the investment is received.

The other key result area for all funds is exits. However, there is the probability that the returns generated by PE Funds could be moderate. This could be due to exit multiples not being in line with the anticipated valuations based on which PE Funds entered investee companies. However, completion of the entire investing cycle would generate higher investor confidence. This can attract existing and new investors investing in follow-on fund offerings of successful fund managers.

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