THE NEXT FIVE YEARS FOR BUSINESS (5) PRIVATE EQUITY
Bullish No More
Despite long-term growth trend,
India will continue to be an extremely volatile market
Private equity (PE) is inherently a
cyclical business that is highly correlated with the public markets. The period
from 2002-07 was the Golden Age of PE in India. The economy was growing at 9%,
the stock market was on steroids, and competition was limited during the early
part of the cycle. The Bharti exit by Warburg Pincus was a landmark event - it
was a wakeup call for the investing world that there was money to be made in
India. And so, within a couple of years, every major fund was looking at India.
All of us were seduced by the macro, but forgot one fundamental investing tenet
- that GDP growth does not always translate into investment returns.
Consequently, the period from 2007-12 has been challenging for PE. Aside from the heated competition that drove asset prices into the stratosphere, there are three major structural problems:
Procyclicality - Entrepreneurs are smart and so raise money when valuations are high and defer the capital raise when valuations are low (i.e. attractive for PE funds).
Sector skew - The most attractive sectors (pharma, FMCG, IT) grow through internal accruals and so PE funds have been overweight 'capital hungry' sectors (infra, real estate) where the returns are lower and the risks are higher.
Exit mindset - Investors in emerging markets don't want to let go of a high growth asset and often forget that the exit window only opens up for a limited period.
I would dare to say that the asset class has generated zero to negative returns (in dollar terms) over the past five years. And, all the scams, regulatory and tax uncertainties, and corporate governance issues have only accentuated the risks. It is but natural for the international investors in PE funds to be asking the question: Should I even bother with India?
This is precisely why I am more sanguine about the future of PE over the next five years. The Golden Age will not return but we should start to see normal returns of 15%. The supply of capital is shrinking as only those who survived the last down cycle are able to raise another fund and the global funds are reducing their India allocation. But India is not for the faint of heart-despite the long-term growth trend, ours will continue to be an extremely volatile market. Only those who know how to navigate the cycle, dodge the unscrupulous entrepreneur, and time the exits, will create alpha and generate over 20% annual returns.
By ASHISH DHAWAN , one of India's most successful private equity investors, co-founded ChrysCapital, a private equity firm, in 1999 CDET130104
Consequently, the period from 2007-12 has been challenging for PE. Aside from the heated competition that drove asset prices into the stratosphere, there are three major structural problems:
Procyclicality - Entrepreneurs are smart and so raise money when valuations are high and defer the capital raise when valuations are low (i.e. attractive for PE funds).
Sector skew - The most attractive sectors (pharma, FMCG, IT) grow through internal accruals and so PE funds have been overweight 'capital hungry' sectors (infra, real estate) where the returns are lower and the risks are higher.
Exit mindset - Investors in emerging markets don't want to let go of a high growth asset and often forget that the exit window only opens up for a limited period.
I would dare to say that the asset class has generated zero to negative returns (in dollar terms) over the past five years. And, all the scams, regulatory and tax uncertainties, and corporate governance issues have only accentuated the risks. It is but natural for the international investors in PE funds to be asking the question: Should I even bother with India?
This is precisely why I am more sanguine about the future of PE over the next five years. The Golden Age will not return but we should start to see normal returns of 15%. The supply of capital is shrinking as only those who survived the last down cycle are able to raise another fund and the global funds are reducing their India allocation. But India is not for the faint of heart-despite the long-term growth trend, ours will continue to be an extremely volatile market. Only those who know how to navigate the cycle, dodge the unscrupulous entrepreneur, and time the exits, will create alpha and generate over 20% annual returns.
By ASHISH DHAWAN , one of India's most successful private equity investors, co-founded ChrysCapital, a private equity firm, in 1999 CDET130104
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