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PEs Caught Off-Guard

BW Online Bureau Nov 08, 2014

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[One of the offshoots of a faling rupee has been that global private equity funds, which poured tens of billions of dollars into India investments when the economy and currency were flying high, may be stuck with those holdings much longer than planned as the rupee's plunge plays havoc with their exit options. The sharp fall in rupee against the US dollar has prompted many foreign private equity funds to up their return expectations in rupee terms for new investments in India. The rupee is now down by nearly 20 per cent against the dollar from a year ago, adding to the several previously unforeseen challenges for the PE investors. For every investor realising a 15-per cent return on equity investment, the gains will be nullified if rupee slides 15 per cent. For investment made one year back, the return in such a case will be negative due to 20 per cent fall in rupee. Returns on funds raised in dollars have shrunk with the currency's tumble to record lows, compounding the effects of a weak stock market and slowing growth, and threatening to further dampen private equity interest in Asia's third-largest economy. Srinivas Chidambaram, managing director at Jacob Ballas Capital India, of the rupee's steep slide since August says "this has simply shaved off nearly a year's implied return." "The depreciation is clearly a matter of concern in the medium term as it impacts exit realisations and existing portfolios," he said. His company, an offshore fund backed by New York Life Insurance Co, manages $600 million in India. However, that does not mean the global PE funds have gone dry on India. While Asian private equity is set to see a boost in allocations from North America and Europe in the next few years, Australia is seen as the most attractive market for buyout deals, as indicated by about 39 per cent of LPs across all regions, followed by China with 30 per cent. Indonesia and India were deemed appealing by about 25 pwer cent of investors. The currency risk could dampen private equity investments in India which, including venture capital deals and stakes in listed companies, rebounded to $13.5 billion last year, up 64.3 per cent from 2010,  according to KPMG. The peak year for private equity investment in India was 2007, at $14.1 billion. Last year, exits were down 38 per cent from a year earlier, at $2.8 billion, the KPMG data showed. "Most funds are not keen to exit their investments now," said Jacob Mathew, managing director of Mape Advisory Group, an Indian investment bank that handles private equity deals. Investor Optimism A latest survey by Bank of America Merrill Lynch (BofA-ML) show fund managers have pared their underweight positions on India in June, even as they have reduced their overall exposure to emerging markets to the lowest level since October 2011. India, the third least-preferred among the emerging markets, has seen its underweight position coming down to 35 per cent in June from 55 per cent last month, according to the latest survey of fund managers by Bank of America Merrill Lynch (BofA-ML). However, India hasn't seen any improvement in fund allocation by global investors, as they have gone underweight on emerging market equities in June for the first time in seven months. For Asia-Pacific LPs, India is in the bottom three for buyout investments over the next two years. For venture and growth capital investments, India is the second most favoured destination after China. For global LPs, China, India and Indonesia are the most attractive destinations for venture or growth investments in the region. There is an interesting discrepancy between views of LPs in different regions about India, It seems India's neighbours are less optimistic about the country's PE industry than those farther away, he said, adding that it is a reflection of what is happening in the local PE market, pointed out a report in Business Standard. The desire for greater Asian PE exposure is in line with investor optimism for the region, in contrast with dampened sentiment towards the West. Also, the tumble in the rupee comes on top of a slump in share prices, with the BSE Sensex sliding 25 per cent last year, although it has recaptured some of those losses with a gain of about 9 percent so far this year. And while the outlook for protracted weakness will give many investors pause, Mape Advisory Group's Mathew said it also makes Indian assets attractively cheap. "If the rupee remains at these levels, we will see more fresh investments than exits," he said. How Did Things Change? As JM Trivedi, Partner and Head of South Asia, Actis, writes in Business Standard, the world was a different place in early 2008. The mood was bullish in India — over 2005-08, private equity (PE) investments in India had grown 10 times. Nearly $50 billion was raised during this period for investment in India, of which $20 billion was yet to be invested at the end of 2009, as the global recession took hold and investment activity froze. So, what went wrong? In the past, the PE industry relied on earnings growth led by strong revenue expansion and multiple arbitrage to deliver returns. After the financial crisis, the earnings growth declined and multiple arbitrage (between entry and exit multiple) vanished. In fact, in many deals done before the financial crisis, the arbitrage is likely to be negative. The Rupee Conundrum Coming back to the curse of falling rupee, it is Asia's worst-performing currency over the past 12 months, shedding more than one-fifth of its value to hit a record low last Friday at 57.32 to the dollar. In November 2007, at the height of a boom in private equity investment, it marked a decade high of 39.03. India has proven a tough market for global private equity companies once captivated by its growth potential. Fierce competition for deals, few willing sellers, a regulatory ban on leverage and a fickle market for exits through IPOs meant many private equity firms have had to content themselves with minority stakes,  often in listed companies. KPMG figures $31.5 billion was invested in India by private equity funds during the boom period of 2006 to 2008, with less than 10 per cent of that having exited as of the end of 2011. Typically, private equity investors look to sell off their investments in roughly five years. "There is at least one year extra time required for portfolio companies to now deliver the returns,"  said Subbu Subramaniam, founding partner of M Cap Fund Advisors, which has invested in consumer products maker Jyothy Laboratories Ltd and City Union Bank. In one boom-time deal whose paper loss has been exacerbated by the drop in the currency, US private equity fund Warburg Pincus, one of the most active India investors, in August 2007 paid $98.5 million for a small stake in Indian engineering firm Punj Lloyd at Rs 275 a share. Since then, the rupee is down 27 per cent and Punj Lloyd stock is down nearly 83 per cent, and the stake is worth just $12 million. Caught Off-Guard The rupee has been under pressure as India's economy weakens and investors worry about a widening current account deficit. Ratings agencies Fitch and Standard & Poor's, citing fiscal policy woes and risks to growth, have cut their outlook on India's credit rating, threatening its investment grade status. The Reserve Bank of India, which has stepped into the market to sell dollars, on Monday announced a rise in foreign investment limits in government bonds and other steps to bolster the rupee, but the currency drew little support as the market had hoped for more aggressive measures. The sharp drop in the rupee late last year, and again since March, caught companies, investors, and policymakers off-guard. "The speed and magnitude have been significant. It adds to the risk profile of our investments," said Devinjit Singh, managing director of the India buyout fund at Washington-based private equity giant Carlyle Group, which has invested $800 million in India, according to its website. Traders and economists expect the rupee to remain weak as Europe's protracted debt crisis steers investors away from risky assets and India's economy sputters at its slowest in nine years, growing at 5.3 per cent in the March quarter. (With Agencies)