India is booming. The economy is growing, albeit at a slightly slower rate compared to the unprecedented highs of a couple of years ago. Against the backdrop of continued global uncertainty, Moody's has predicted a drop for the current period to slightly under 7 per cent compared to 8.5 per cent a year ago. Nonetheless, confidence remains high and the landscape for Indian investors across all sectors is promising and dynamic. India's share of the regional investment market - nearly 15 per cent - is at its highest levels since 2007 and 2008(Asian Venture Capital Journal November 2011) and the domestic fund management industry is buoyant.
A vibrant economy, strong capital inflows, a flourishing private equity industry
: a great way to start 2012. But dig below the surface and there are some warning signs for private equity fund managers. LPs are looking for reassurance that private equity managers can deliver returns in a changing landscape. Investors would like to be convinced that managers are adapting to succeed.
The fundraising environment is tough. Securing the backing of investors is growing more challenging. Although the deal pipeline still looks strong and good investment opportunities are visible, competition for deals is high. Making investments at the right price has to be a priority. At the same time, exits are getting harder to achieve, so identifying the proposed realisation route is becoming more important for managers. Investors and LPs are watching carefully, with their attention firmly focused on the end game: good returns.
The market is a long way from the heady days of 2007 when private equity funds raised hit a high of $8.1bn. Quantum decreased by around 50 per cent to $3.8bn in 2009 and stayed flat throughout 2010. Capital was harder to come by in 2011 and the picture looks set to stay that way in 2012. For an industry that has been used to a particular investment climate, this presents a challenge. Gone are the days when managers returned to the market with second and third successor funds, having successfully invested all fund capital within a few years of closing.
Coupled with this, there are important trends and developments on exits. For Indian managers, the public market platform has been the main route for realisations. In 2010 72 per cent of divestments were through the stock market(Asian Private Equity Review). While the IPO route remains the main exit option, the picture is changing. Trade sales are growing in importance. In 2010, figures for trade sales rose to $994 mn from $147 mn the previous year(Ibid). The IPO market is falling away. The strong managers are moving away from their over-reliance on IPOs and are adapting to the changing environment. LPs are encouraging their managers to pay more attention to identifying the optimum exit route early in the fund life, demonstrating a clear strategy to achieve that goal. GPs are increasingly realigning their focus to pay proper consideration to matters such as the type of potential buyers; are these targets international or domestic; what sectors are most attractive to these buyers; what systems must be put in place that a potential buyer could adapt to fit their own business model. Managing assets for future trade or strategic sales requires a different set of skills compared to the IPO route. Managers are thinking ahead, adapting their mindset and tailoring their strategies to deliver the identified exit route. This kind of approach requires active management and diligent monitoring. And crucially, managers are working to reassure their own investors that these vital steps are being taken.
The environment is particularly challenging for the Indian private equity market. We are seeing many out there fundraising in the market but these are often sector-agnostic, generalist funds. Often teams are second-tier teams with limited track records. LPs would like to see more focused funds with distinct investment and exit strategies; funds that differentiate themselves. At CDC we've seen limited exits from our Indian portfolio over the last five years and that concerns us. There is a great deal of unrealized value out there and investors need to see this being addressed.
The growing diversity of sectors receiving private equity investment in India is good news for managers. Sectors such as consumer goods and services, healthcare, media, financial services and construction are all receiving capital allocations, reflecting improving living standards in India. Not only does this open up the prospects for investment opportunities and deal origination, it also brings wider possibilities for identifying potential future trade and strategic buyers, thus deepening the potential for exits.
Indian private equity firms are making a step change in the way they approach their investments. They know they need to keep a weather eye on the wider strategic picture because some important pieces of the private equity jigsaw are moving. Smart managers will stay focused on the end game : a good exit and a good return on capital.
Private equity investing is about the long term. Managers must remember that the job is not done when the deal is done. That's just the beginning. There is more to private equity investing than simply putting the money to work. Private equity is about nurturing portfolio businesses, identifying market opportunities, improving efficiency and standards - and having a clear exit strategy. The job of private equity is building value in portfolio businesses across the fund and delivering to investors the returns they seek. And that has to be done across all the fund's investments.
Indian private equity managers still have much to prove to their investors and many LPs feel this is a waiting game. Making investment is one thing; bringing businesses to a successful exit is quite another.
In short, the message to private equity managers, is simple: remember your investors.