High profile success stories spark investor interest in a developing private equity market like India, although in reality hefty returns on the big investments are not really expected to outshine the country’s growing mid-market, which is where most buyout activity is expected. However, Warburg Pincus’ US$1.616bn total realisation or over 5.5 times its US$292m minority investment in Bharti Tele-Ventures, has really put the Indian market on the map with the big international funds moving in to find similar successes.
Between September 1999 and July 2001, Warburg Pincus invested US$292m in Bharti Tele-Ventures in return for a 19% stake. Bharti went public in early 2002 and saw its IPO 2.5 times oversubscribed in just over a week, with strong interest from institutional investors in Asia and Europe and high net worth individuals.
Warburg Pincus’ exit process started in August 2004 when it sold a 3.35% stake for about US$208m, valuing Bharti at around US$6.2bn. In March 2005, Warburg Pincus sold a further 6% stake for US$560m, making history as the largest ever equity deal in a single scrip on an Indian stock exchange. And one of the fastest also with the trade completed in less than 30 minutes, observers say. At this stage, Bharti was valued at US$9.333bn. Then in October 2005, Warburg Pincus sold its remaining 5.65% stake to Vodafone of the UK for US$847.5m, valuing the company at approximately US$15bn or a whopping 10 times the value since Warburg Pincus first invested.
Bharti Tele-Ventures is one of India’s contemporary growth story legends and reflects just how rapidly a well-conceived and well-managed company can grow in a country of 1.1 billion people.
As this story demonstrates, a very hot equity market in India might be competing with private equity but it is also offering a buoyant exit option, which is another reason why India’s private equity market is set for considerable growth. Exits in 2005 remained constant both via M&A and IPOs. The largest M&A exit totalled a massive US$1bn (for a 64% stake) in mobile telecom services company BPL sold by Actis and AIG to Essar Group.
Many private equity-backed companies across a range of sectors IPO’d in 2005. The size of each IPO, typically ranging from US$30m to US$80m, suggestive of pre-exit strategies in many cases.
India is the third largest Asian economy, and with an annual growth rate of 7% to 8%, it is second only to China in the region. India has a Gross Domestic Product (GDP) of US$600bn, when Purchasing Power Parity adjusted this is equal to US$3.1trn. A major contributor to India’s growth is the services sectors, which contributes more than 50% of GDP. Domestic consumption, at 65%, forms the bedrock of growth.
In the first four months of 2006 the amount of private equity investments in India is estimated to have topped US$2.5bn, surpassing the US$2.3bn of investments made in 2005. But for a country that attracted little over US$20m in private equity funds for the first time 10 years ago, investors are split over whether India is ready for much buyout activity beyond a handful of deals each year. Buyouts are expected to account for between 5% and 10% of the market this year, investors say.
“It’s a fairly new concept as far as India is concerned. However, we as an organisation are very bullish about buyouts in India,” says Sumit Chandwani, director of investments and buyouts at ICICI Venture in Mumbai. ICICI Venture has completed four leveraged buyouts in the last couple of years, says Chandwani. A pre-cursor to ICICI Venture’s lion share of the buyouts market in India was the March 2004 US$13.8m MBO completed by Actis of Nitrex, the former nitrocellulose manufacturing and trading division of ICI India.
The creation of Nitrex by Actis and the management team was a landmark deal in the Indian private equity market. The MBO of Nitrex is among India’s first wave of such buyouts and follows Actis’ completion in 2003 of India’s first private equity-backed privatisation of Punjab Tractors. “We tend to be the lead investor. All of the transactions we have done have been on a lead basis,” says Chandwani. ICICI Venture, a subsidiary of India’s largest bank ICICI Bank, has in excess of US$650m in funds invested in India.
Last September, ICICI Venture acquired Ranbaxy Laboratories Limited’s Allied Business portfolio comprising fine chemicals, animal health care and part of the diagnostics business. ICICI Venture also completed a buyout of Infomedia India, the printing and publishing arm of Tata Group, making the investor the key shareholder in the listed business process outsourcing company that since the buyout has completed trade acquisitions in India and the UK as part of its growth strategy.
The fund also acquired the Indian business of VA Tech WABAG, which is engaged in the field of industrial water and waste water treatment. The management team plans to grow the business three-fold over the next four years.
ICICI Venture’s largest buyout so far is its most recent. Associated Cement Companies (ACC) sold its refractory business, ACE Refactories, to ICICI Venture in a US$60m transaction. The deal came about following ACC’s decision to exit its non-core businesses. The deal was structured as common equity and preference capital.
For ICICI the investment thesis was based on ACE Refactories’ well-diversified end-user base showing strong growth across the country. The refactories industry in India is also fragmented, offering good consolidation prospects through the company’s growth acquisition programme. The company’s management aims to be the second monolithic refactories business worldwide within three years, it has stated.
The buyout was structured as a business sale allowing banks to participate in the leverage. Bank loans were issued against cash flows as the company’s net assets were valued well below the loan value. An IPO of ACE Refactories is planned for later in the year with an expected valuation in the range of 3.5 times to four times the acquisition cost. And a strategic sale had been slated for two to three years’ time.
For the US$40m-equivalent debt element in the deal, Chandwani says ICICI Venture received commitments totalling US$80m, from a group of banks and non-banks (NBFCs) in India. ICICI Venture has worked with around 10 banks and financial institution in its leveraged buyouts. “We don’t lever up businesses as much as they do in Europe or the US. We would apply leverage at one to three times. All of the companies have strong growth characteristics,” says Chandwani. “Our approach is more business building and not squeezing out cash flow.”
There is a debate also about just how much of a company an investor needs to invest in to secure full managerial control. So while buyouts may be an all-or-nothing approach in many developed economies, in India it is important to understand the corporate nuances. “More often that not you can say that a financial investor will look to take anything from 51% to 100%,” says Rajeev Agrawal, a fund manager at India Value Fund Advisors in Mumbai. In India, management control is highly correlated with shareholder control. It is widely perceived that where you have shareholder control you also have management control,” he explains.
Although there has been some suggestion valuations have been inflated in recent months, the typical valuation range is enterprise values of between 5x and 7x EBITDA. For early stage capital this will be higher normally.
“Leverage buyout is still a concept that has not really caught on in India. We’ve only seen leveraged transactions in the last 18 months or so,” says Agrawal. His company has set up a US$100m credit line, led by HDFC Bank. “Which we intend to use for leverage buyouts in the future,” he says.
It appears unclear in India if the Reserve Bank of India (India’s central bank) will allow shares in companies to be financed by banks and financial institutions in leveraged buyouts. “This is possible by an NBFC,” says Gagan Kapur, associate vice president at Ernst & Young in New Delhi. “For a bank you need to make an application to the Reserve Bank of India and on the merit of the case it is allowed. This was done for the buyouts done by ICICI Ventures.”
“Against assets and cash flow it is a lot easier to raise finance; against shares it is another issue,” says Rajiv Memani, national head of private equity and managing partner at Ernst & Young in New Delhi.
“Buyout financing aspects are still a little challenging,” says Chandwani. “The Reserve Bank of India does not always allow banks to finance shares in companies. In some cases we have not bought shares but we have bought assets and have had to be creative in financing them.”
The participation of private equity investors in Indian companies is also encouraging banks. Banks generally look at deals after companies have received two or three rounds of private equity funding and leveraging subsequent equity injections is typically done in the range of 2.5 times to three times. However, in time, this could increase to as much as three times to five times. “Banks are becoming more and more progressive. They are increasingly more willing to engage with companies that are backed by private equity investors because this backing gives them added confidence,” says Agrawal. “There are still no real established principles in India.”
There is no one set view on the Indian market. Conflicting interpretations of how private equity will be used there is probably more reflective of individual investor perspective and strategy than any absolute market forecast.
Private equity was mainly focused on growth capital until 2002 in India, dipping in 2003 by more than half from investment levels of around US$1.8bn in 2001. It is only in the last couple of years that large funds have moved into India but many of their investments to date have been minority growth capital plays.
Families, multinationals and the government have traditionally owned Indian businesses. “It’s a relatively new concept, but investors are becoming more comfortable with selling to financial investors and management seems to be at ease working with financial investors,” says Chandwani.
“I don’t see that there will be a spectacular growth in the buyouts market but there will be more activity, especially in the US$25m to US$100m range,” says Memani. “About 80% of transactions in India are growth transactions.”
“We’ve seen a sea change over the last couple of years where the business community has shown increased confidence in financial investors,” says Agrawal. “Competition has generally increased and all barriers for international players are gradually falling. Existing companies in India have had to restructure to compete in the global economy,” he says. “Conglomerates that are very diversified are divesting their non-core assets but that is something that is at the very start of the process. People are beginning to accept that they can divest controlling stakes to financial investors.”
Corporates in India are generally expanding rather than consolidating and this includes many Indian corporates looking overseas for acquisition targets. There is also the view that there needs to be more generational change in the corporate world. “The breadth of activity will remain in the minority private equity space rather than buyouts. There is huge potential, however, hence the renewed interest from all of the buyout funds,” says Stephane Delatte, managing director of MezzAsia Capital, the buyout and mezzanine fund under the CLSA Capital Partners umbrella, in Singapore.
Carlyle, Newbridge Capital, Blackstone and Apax Partners are among the big guns looking to the Indian buyouts market. Yet none has so far clinched a big buyout deal that would even dent their sizable and dedicated India funds.
“The pre-requisite for buyouts is that you need restructuring because of corporate distress and slow growth conditions,” says Jean Salata, managing partner at Baring Private Equity Partners, Asia in Hong Kong. “India and China are high growth economies and don’t have the underlying rationale for buyouts,” “Would anyone have asked Henry Ford to sell Ford soon after he had set up the company?” asks Salata.
Financial investors may be more widely accepted now by the corporate world in India, but this does not mean that they are able to hover up deals. As many companies across industry sectors look to build their groups, trade sales are a competing force.
Last year, one example where trade beat private equity was when Shaw Wallace was taken over by The UB Group, which has a 60% domestic market share of the liquor market in India. There were a number of concerted efforts by some of the international funds, which were overshadowed by the UB Group offer, not only on price but because of its managerial clout in the drinks industry in India.
Recent headlines have also indicated the Indian market may be running before it can walk. Kohlberg Kravis Roberts announced in mid April that one of its affiliates signed a definitive agreement to acquire the software development and solutions business of Flextronics International Ltd in a transaction valued at approximately US$900m. Flextronics (which will be renamed post closing) will retain a 15% equity stake in the software business and continue as an important business partner and customer.
While the software company does have large operations in India, most people on the Indian private equity scene are viewing this deal as a US seller and US buyer deal. If it were an Indian deal it would have been the first to be financed with overseas debt, which in this case will be fully underwritten by joint bookrunners and joint lead arrangers Citigroup Global Markets (Asia) and Merrill Lynch.
For the time being, those active in the Indian market stress the need to understand the myriad of nuances in this very individual economy. There is an expectation that a US$100m buyout will close this year or next (US$60m is the record). The long-term view on India could mean US$100m buyouts are more commonplace, but long-term could mean decades, not years.
“The differences between India and China are huge. When you look at India for the first time you see the culture and the environment and you’re shocked, but after a while you become more comfortable. In China, it is completely the opposite reaction. India is so much more western,” says one investor who has recently set up shop in India. “The new giants will come out of India,” he says. “The investment banks are employing the best of talent in India. That said, I don’t think India will be a classic buyout market.”