Barings' Rahul Bhasin (L) and CDC's Donald Peck: Private equity's rainmakers

A booming stockmarket is not usually the best of times for venture capital investors. While it makes exits relatively easy, it makes investing incredibly hard. Valuations zoom, "promoters get greedy" (in the words of one VC) and the chances of ending up with a lame duck investment increase exponentially. Yet, come February or March, a gaggle of 20-odd VCs will board a flight from the US and put themselves through a near 24-hour journey, albeit in first or business class, to get a first-hand experience of what's turning out to be the industry's new El Dorado: India.

Sample this: Warburg Pincus, the country's largest private equity investor, puts in $300 million (Rs 1,380 crore) in Bharti Tele-Ventures in 2001, that is now worth at least $600 million (Rs 2,760 crore); Citibank Private Equity's seven-year-old investment in software product company i-flex is worth as much; Barings Private Equity has seen its $16.5 million (Rs 75.9 crore) staggered investment in software services firm MphasiS bfl (for a 35 per cent stake) appreciate to about $183 million (Rs 841.8 crore), General Atlantic Partners is all set to see its $100 million (Rs 460 crore) pre-IPO bet on Patni Computer Systems double, and CDC Capital Partners walked away with a net gain of about Rs 250 crore when it sold its stake in uti Bank in December last year to British banking giant HSBC. In fact, CDC's best-performing fund among the 50 countries where it invests is in India.

Last year, in particular, is being seen as a watershed year in the risk capital business in India. After two years of dot-bust induced lull-when the investor's investors such as pension funds, life insurance companies and high net worth individuals tightened purse strings-venture firms returned to make deals with a vengeance. At the fag end of the calendar, Newbridge Capital and Singapore government's Temasek coughed up a whopping Rs 1,500 per share, or Rs 607 crore, for a 14 per cent stake each in a relatively unknown Hyderbad-based pharma company, Matrix Laboratories. CDC broke the private equity mould to snap up 28 per cent of state government-owned Punjab Tractors for $57 million (Rs 262.2 crore). And Warburg forked out $50 million (Rs 230 crore) to buy into a quarter of Mumbai-based ethnic fastfood chain Radhakrishna Foodland.

Do the numbers and you find that at least 20 private equity deals in the $10-60 million (Rs 46-276 crore) range were struck last year, pumping in $500 million (Rs 2,300 crore) in direct investment in a wide variety of Indian companies. And these are just the mega-sized deals. Market estimates another $200-300 million (Rs 920-1,380 crore) to have come in by way of smaller deals, both domestic and foreign, putting the tally for last year at about $800 million (Rs 3,680 crore). As for 2004, if all the things that can go wrong don't go wrong, over a billion dollars of private equity money should flow into the country. By some estimates it could even be double of that, but it would be more realistic to expect between $1 billion (Rs 4,600 crore) and $1.5 billion (Rs 6,900 crore). Says Saurabh Srivastava, President of the Indian Venture Capital Association, and who also runs his own fund, Infinity Technology Investments: "Venture funds are just beginning to discover the India potential. I expect this momentum to go well beyond the $1-billion mark in 2004."

That means the secretive industry and its painfully low-profile dealmakers will make the headlines with greater frequency. For one, it appears that they aren't just getting more active, but bolder too. Take a look at last year's deal-making (in tech and pharma) in terms of quarterly numbers and deal sizes. Between January and March, according to data compiled by Bangalore-based monitoring agency TSJ Media, only four deals were done, totalling $26 million (Rs 119.6 crore). By the next quarter, the numbers had jumped to 10 and $35 million (Rs 161 crore), respectively, but by quarter ended September, there were 16 deals done worth $180 million (Rs 828 crore). While in the last quarter of 2003, the deal number fell to 10, the total amount soared to $304 million (Rs 1,398 crore). Says Donald Peck, Managing Director, CDC Capital Partners: "I expect deal sizes to grow, partly because larger deals seem to offer medium to higher returns." Notes Pradip Shah, Chairman, IndAsia Advisors: "They've all tasted blood, and now will want more."

"India is hot in the international markets, so 2004 should see a fair amount of fund raising for India" Ajay Relan/India Head, Citigroup venture capital international

Welcome, New Funds (and Old)

Predictably, there are new funds making a beeline to India. A random enquiry among people in the know reveals that funds like Mobius Venture Capital (erstwhile Softbank Ventures) is currently scouting for deals in the country. Technology sector investor Battery Ventures is currently evaluating a few deals too. And then there is the Silicon Valley Bank-led delegation of 20 VCs that flew in to "check out" opportunities last November, besides another group of 20 that the Indus Enterprise (TIE) plans to bring in February this year.

Besides the newbies, there are several others putting their money where their mouth is. Temasek Group, a Singapore government-promoted fund, has already committed to an India fund, Merlion, in association with Standard Chartered, and is now looking to commit more in partnership with other heavyweights like HDFC. Then, there's buzz about others such as Trinity Ventures and Trident Capital upping India investment, on the back of initial bets in tech companies like Outsource Partners (Trident) and Ephinay (Trinity). Another new entrant, the Silicon Valley-based Artiman Ventures, has firmer plans of investing anything between $70 million (Rs 322 core) and $200 million (Rs 920 crore) in India.

"We see a lot of buyouts happening in India. We ourselves are identifying people who can form good management teams" Rajesh Khanna/MD, Warburg Pincus	"We will definitely see more turnaround transactions this year... say, about five to 10" Renuka Ramnath/MD & CEO, ICICI Ventures

But it's the funds that have already tasted blood that are baying for more. Warburg, for example, hopes to truck in another $400-500 million (Rs 1,840-2,300 crore) in the next four-to-five years, and Newbridge hopes to strike more Matrix-like deals in the $50-100 million (Rs 230-460 crore) range this year. cdc-where the management is in the process of buying out the British government's stake, besides changing the firm's name to Actis-will be bringing in $250 million (Rs 1,150 crore) of its own over the next three years, besides raising another $100 million from other investors by June this year.

Barings hit the international investor circuit starting middle January, with ports of call in the Middle East, Europe, and the US, to raise between $120-150 million (Rs 550-690 crore). Tech investor Carlyle expects to deploy a total of $125 million (Rs 575 crore), of which $40 million (Rs 184 crore) is already invested. GW Capital Partners, a largely India-specific fund, has also pumped Rs 120 crore so far, and has another Rs 80 crore to go. Then there is IFC. A World Bank arm, it invested $345 million (Rs 1,587 crore) between July 2002 and June 2003, and $100 million (Rs 460 crore) in the six months to December 2003, but sees greater opportunities for investment. Says Neil Gregory, Manager (Strategy, South Asia), IFC: "We are starting to see more opportunities in infrastructure, banking and finance, manufacturing, and oil and gas."

"We haven't formally closed the India fund but are already looking at transactions" Girish Kulkarni/Head (India), TDA Capital	"The deal-makers have all tasted blood, and are now going to want more of it" Pradip Shah/Chairman, IndAsia Advisors

There is also a bunch of Indian investors
that, possibly inspired by Merlion's closure of its $100 million fund late last year, expects to close India-specific funds this year. Industry players such as TDA Capital and IL&Fs that have been in the market for a while now to raise funds for India are optimistic of closure this year. "We haven't formally closed the India fund but are already looking at transactions," says Girish Kulkarni, who heads TDA Capital in India. Adds Ajay Relan, India Head of Citigroup Venture Capital International: "India is hot in the international markets, so 2004 should see a fair amount of fund raising for India." Relan expects anywhere between half-a-billion to a billion dollars worth of India-specific funds to be raised.

New New Deals

A big reason why there is a surge in risk capital is the spread of growth outside the information technology sector. Why, two of the three biggest deals of last year had nothing to do with technology. One was CDC's $57 million (Rs 262.2 crore) investment in Punjab Tractors and the other was Warburg's $50 million (Rs 230 crore) deal with Radhakrishna Foodland. Says Pulak Prasad, Managing Director, Warburg Pincus: "If you had asked me in 2001 if I would look at a food company, chances are I would not have shown a lot of enthusiasm since it is a non-obvious sector." Now, though, investors like Warburg aren't just looking at food, but retail, banking and finance, FMCG, automotive, disinvestment, infrastructure, healthcare, hospitality, media and even the commodity sectors of steel and cement. Relan's Citigroup, for example, bought into Jindal Iron & Steel at Rs 121 per share in May 2003, and the stock is now quoting at Rs 280 or so.

"For sometime now, Shah's firm has been trying to raise an India-specific fund, but now is confident of closing one this year." Rahul Shah/Director, IL&FS Ventures

What's behind the sudden diversification of opportunities? Blame it on India's happy growth story-the economy is clipping at 7 per cent-plus and could possibly gather more steam. On the one hand, outsourcing has become a major movement across sectors-from it to BPO to automotive to textiles to pharmaceuticals-and on the other, smaller but savvier companies, especially in FMCG, are racking up stunning growth thanks to their low-cost, high-quality strategy. CDC and Credit Lyonnais, for instance, bought Barings' stake in Mumbai-based Jyothy Laboratories in 2002 for $7.5 million (Rs 34.5 crore), which was double of what Barings had put in. Warburg's Matrix deal is in many ways a testimony to foreign investors' confidence in the pharma sector, where companies are tapping newer growth areas like basic research, clinical research, and complete outsourcing of manufacture.

In other industries like textiles, the end of quotas could mean boom time for the more aggressive players-especially companies that have the capability to offer everything from design to yarn to readymades. According to IndAsia's Shah, India is ahead of China when it comes to complex processes requiring multiple skills. "Productivity gains and cost reduction have made India very competitive in the manufacturing sector," he says. Agrees Rahul Bhasin, Managing Partner, Barings Private Equity (India): "Don't forget that Indian industry has been through a big cleansing in the Nineties; the ones that survive now are the stronger ones."

That also explains why pipe (private investment in public enterprises) deals have suddenly become so popular. In fact, a majority of deals in the private equity space in recent times have been in listed companies. Industry expects more such deals in the future simply because, according to one investor, almost half of the listed companies are still ripe for private equity deals. "There has been a shift of investments into companies that are potential market leaders and India traditionally has had these market leaders listed for a while," explains Relan. And why do listed companies prefer private equity over IPO or debt? While the latter comes at a cost, the former does not offer the advantage a private equity investor does: skills and a global network. Says Nimmagadda Prasad, Chairman and CEO, Matrix Labs: "(For Matrix), raising money itself was not the issue. Rather, we wanted to get access to a global network, which Newbridge and Temasek now make possible."

Restructuring and the government's own disinvestment programme have also thrown up opportunities that did not exist until recently for private equity firms. Schroder Ventures, for example, picked up Lodhi Hotel in a privatisation bid in 2002, and icici Ventures shelled out about $22 million (Rs 101.2 crore) last year to buy half of Tata Infomedia from the Tatas. Banking is another area where VCs will head once some of the public sector banks (there are some 25-odd) go under the hammer.

Then, a totally new class of investors is waiting in the wings: those who buy distressed assets (read non-performing assets). Already two asset reconstruction companies have obtained licences, and a third is awaiting one. Inevitably, private equity firms will tie up (some braver ones may go solo) with these companies, bring in money for the clean-up and turnaround. Once the turnaround has happened, they may either take it public or sell it to a strategic investor. Add to that leveraged buyouts and management buyouts, and you are looking at a totally new deal-making landscape.

In fact, some of it is already happening. Remember UDV's Deepak Roy buying out Gilbey's range of India whiskies? That was a management buy-out, made possible by a consortium of investors comprising individuals, banks and financial institutions. Also, when Warburg bought out British Airways' BPO subsidiary WNS, it did a similar deal, putting its own management team in place. Says Rajesh Khanna, Managing Director, Warburg Pincus "Going forward we see a lot of buyouts happening in India. We ourselves are identifying people who can form good management teams." Leveraged buyouts-where a fund borrows to finance the purchase-in particular could become fashionable, since the real rate of interest in India is less than 5 per cent. Agrees Renuka Ramnath, MD & CEO, ICICI Ventures: "We will definitely see more turnaround transactions this year...say, about five to 10." Her firm will look at deals over Rs 100 crore in the case of leveraged buy-outs.

One way or another, the private equity landscape is in for a big change. In undergoing a transformation, it will also mark the coming of age of the Indian market. Deals will get bigger, bolder, and more innovative. No doubt, some of them will go belly up. But the rest should more than make up for it. At least, that's what the bulls in the private equity business in India seem to think. Stand aside, please, let the real investors in.

-additional reporting by Alokesh Bhattacharyya in New Delhi and E. Kumar Sharma in Hyderabad

The Coming of Age of Indian Private Equity By Ashish Dhawan, Senior Managing Director/Chryscapital

Back in 1990s, the value of private equity had not been clearly established in the minds of entrepreneurs and promoters. After all, "private equity" and "venture capital" were new terms in the Indian business lexicon. The success of venture-backed companies in the recent past has demonstrated the valuable role of private equity. Take, for example, the BPO sector. All the leading players-SpectraMind, Daksh and MSource-have been created with private equity capital. Even Infosys and Satyam have chosen to raise venture capital to provide greater impetus to their BPO efforts. I firmly believe that with the respectability that private equity has garnered, 2004 will usher in a new era for our industry. Specialisation. The flavour of venture investments has evolved substantially, to the point where the adventure of venture capital has been substituted with the rigour and discipline of private equity capital. In the current environment in India, venture capital rarely fills the void between an entrepreneur's dream and the first trickle of revenues. The private equity sector itself has rapidly evolved towards further segmentation with funds focussed on specific niches. So while JumpStartup focuses on cross-border technology deals, GW Capital invests in emerging domestic service businesses and CDC is pioneering management buyouts and corporate carve-outs. The increased specialisation translates into accumulated expertise that funds can bring to their investments and prevents lemming-like behaviour. Wider Opportunity Set. The smattering of private equity investments in the 1990s lacked the perspective of hindsight available to investors in the current environment. Most venture capitalists are now sharply focussed on growth capital investments with the glaring insight that organic growth is the single biggest driver of investor returns. Several funds also talk about the upcoming boom in turnarounds. Although a couple of seminal LBO transactions will be consummated in 2004, I remain sceptical about the prospects of operational turnaround situations. Why deal with "brain damage" when the sector dynamics can do the work for you? Aligned with Macro Trend. "The myth is that venture capitalists invest in good people and good ideas. The reality is that they invest in good industries." (Harvard Business Review, How Venture Capital Works). With the Indian economy firing on all cylinders in 2004, private equity capital will get absorbed across a wide spectrum of export-led sectors (pharmaceuticals, technology, BPO, light engineering) and domestic consumer-led areas (financial services, healthcare, media, education, retail/distribution). In an era of accelerated growth, private equity is a well-aligned participant in the ecosystem. First sign of exits. When a stock triples or quadruples, investment pros start eyeing the exits, unless, of course, the pro works as a sell-side analyst. In that case, he may invent new arguments to urge investors to even higher targets. The disciplined investor will take "chips off the table" in 2004. For example, venture-backed companies such as Patni and Daksh are already slated for IPOs this year. This first wave of private equity exits will solidify the track records of selected blue-chip funds. Value of patient capital. Above all, the venture capitalist with solid experience and proven skill is a true long-term partner. FIIs and mutual fund managers are fair-weather friends who will run for the exit at the first sign of trouble. Our investment in MphasiS is a classic example. ChrysCapital's initial preferential allotment was at Rs 175 per share (adjusted for splits) and we continued to support the company and increase our exposure as traditional public market investors abandoned the stock at below Rs 50 per share. We had the courage and the conviction to take a contrarian view given our time-horizon. In 2004 and beyond, the role of "patient capital" will be recognised. While private equity is clearly coming of age, I want to sound a note of caution. The boundless hope and optimism embodied in India Shining will lead some private equity investors (including ourselves, potentially) to display "cowboy-like" behaviour in their deployment of capital. The greatest asset of the financier is his discerning, suspicious eye and meticulous nature. However, the booming stockmarket has its designs for concentrating the speculative energies of the investor on effortless riches leading to serious errors of judgement. Most of you are cheering at the hero of 2003, the ever-rising Sensex. For private equity investors, aggressive entry valuations will pose the most significant challenge in 2004.