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Private equity: Destination India!

Apr 24, 2006

India has emerged as one of the fastest growing economies in the world, and is currently the world's fourth largest economy based on the Purchasing Power Parity (PPP) basis. With its liberalisation and globalisation led restructuring, the Indian corporate sector too is in great shape and hungry for faster growth in the future. A huge structural shift is taking place in the Indian economy leading to opening up of a lot of investment opportunities in different sectors and attracting large amounts of foreign and private capital, some in the form of private equity. The private equity way of investment in India commenced only in the early 90s, and the same has grown strongly over the last decade. The past 2-3 years have been especially good for investors, with improving profitability levels of Indian corporates, an enabling regulatory framework and improved investment climate all together contributing towards making India an attractive private equity destination. In India, private equity investments have grown from a mere US$ 500m in FY00 to US$ 1.8 bn in FY04 and in FY05, the contribution crossed the US$ 2 bn benchmark (see adjacent chart).

Growth of private equity in India has been driven by host of factors, which include:

Faster growing economy: India is the third largest economy in Asia (behind Japan and China), and also the second fastest growing in the region, next only to China. At an annual growth rate of 7% to 8%, it is surely ahead of many developing economies. A major contributor to this growth has been its buoyant services sector contributing to more than 50% of the GDP. Improvement in internal demand led by rising disposable incomes, which has been a consequence of better growth across sectors has led to the buoyancy in economic growth in the country. Higher credit offtake (both from the corporate and retail segments) from the banking system vindicates this point. All these factors, and many more, have improved the relative attractiveness of the Indian economy. This has, in turn, led to higher investments in the private equity segment.

Strong capital markets: Indian stock markets have been increasingly buoyant over the past three years. Optimal market capitalization, appealing relative valuations, strong earning growths, and transparent disclosure norms is attracting huge institutional money into the Indian markets, with a number of country funds being raised overseas.

Regulatory flexibility: Regulatory framework for private equity players has been liberalized futher by the Securities and Exchange Board of India (SEBI) thereby granting greater flexibility to this breed of investors. SEBI had made significant changes in the framework for private equity players, some of which include removal of the one-year lock in period for subscription in IPOs and increase in the limits on the quantum of funds that can be invested in the listed companies from 25% to 33%. All these measures have contributed to granting greater flexibility to private equity players, thereby leading to greater investments by them.

Easy exits: The exit options available are also an important factor encouraging private equity players in the Indian market. The exits had taken place through IPOs and mergers & acquisitions (M&As).

Deregulation in key sectors: The government of India has successfully undertaken deregulation in many key sectors like aviation, telecom and insurance. This has led to an increased pace of activity in these sectors with the foreign and private players eyeing a share of the growth pie.

With the strong rise in Indian equities witnessed in the past 2 years, overall valuations appear stretched even from a medium term perspective. The Sensex is, in fact trailing at nearly 17-18 times estimated FY07 earnings. However, with the changing mindset of mid and small size companies in the country and their increasing strides towards higher growth, there seems to be no dearth of ideas for private equity players.

However, we believe that retail investors should not base their investment decisions merely on the back of interest shown by private equity players on a particular company. Apart from the funding part, private equity is also supposed to bring in some business expertise in order for the invested company to take advantage of the deal (for examples, Warburg Pincus, apart from capital, helped Bharti Televentures in forming its business strategy and investor focus). We have seen some cases in India (like Punjab Tractors), where private equity participation had actually negatively affected the business of invested companies. Thus, on an overall basis, while private equity is likely to emerge as a source of critical funding for the 'needy' companies thus helping them in their growth path, small investors need to look carefully into the deal before making their investment calls.

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