At a time when fresh investments are down to a trickle - new investment proposals in the 3rd quarter of 2017 were at the lowest levels since the September 2004 quarter - venture capital (VC) and private equity (PE) investors are going full throttle to make a point that India is a compelling investment case. In 2017, PE/VC investments touched $26.8 billion, a 37 per cent increase from the previous record in 2015, according to EY's PE Deal Tracker. On an year-on-year basis, the rise comes to 65 per cent; annual PE investments have risen 3.5 times over the last five years, an impressive show by all means.
"The year 2017 was a watershed for Indias PE/VC sector. Investments grew to a record high. Deals became larger and more complex. Growth capital deals accounted for the highest activity and investment," says Vivek Soni, Partner and Leader for PE Advisory, EY. Four growth capital deals worth more than $1 billion each made headlines as start-ups launched during the final years of the last decade came of age and looked for money to fund their next stage of growth. Three involved Softbank -Flipkart ($2.5 billion), PayTM ($1.4 billion) and ANI Technologies or Ola Cabs ($1.1 billion, along with Tencent). Apart from this, there was a $1.39 billion investment in DLF Cyber City Developers Ltd. by GIC (a big chunk of the proceeds will be used to reduce the developer's huge debt that is weighing on its financial performance).
Even exits rose as PE players took advantage of buoyant capital markets to book profit. The year saw exits worth $13 billion, nearly double the $6.67 billion seen in 2016.
PE funds have set an exciting pace for investments in India. But will it sustain? Broad trends such as dried-up bank lending, economic recovery, buoyant capital markets, fast growth in emerging sectors and the ongoing deleveraging by companies signal a bigger role for them in the coming years.
"The action is largely driven by big-ticket consolidation across sectors as companies divest assets to reduce debt," says Prashant Mehra, Partner at Grant Thornton India LLP (GTI). One such deal was a $956 million investment, led by KKR and Canada Pension Plan Investment Board, or CPPIB, in Bharti Infratel. Then, this January, Brookfield decided to buy Essar's Equinox office complex in Mumbai for $384 million. The Essar Group is reeling under heavy debt and struggling to save several of its former crown jewels from bankruptcy.
"Also, companies with strong balance sheets drove acquisitions to capture market share and increase competitiveness," he adds. The biggest deal in January this year involved a $1.7 billion investment in HDFC by institutional investors GIC, PE firm KKR & Co, CPPIB, Ontario Municipal Employees Retirement System and Premji Invest. The month saw investments worth $3.5 billion across 51 deals.
The roots of the current PE bull run lie in 2015 when VC investments peaked, with most of the money going into start-ups. Since then, VC funding has receded, and PE investments have picked up pace. The reason is simple. Banks typically don't lend for growth or mergers and acquisitions (M&As). Also, as bank lending further dried up due to rising non-performing assets, PE funds rushed in to fill the gap.
Meanwhile, technology and e-commerce companies are seeing their fortunes change after one-and-a-half years of lukewarm response from PE funds. There was an impression in 2016 that they were only 'cash burners' without profit visibility in the near future. However, this perception seems to have changed recently if one is to go by SoftBank's recent $2.5 billion investment in Flipkart. "Also, there is renewed euphoria in new tech/e-commerce segments, which were struggling to raise money for some time," says Nitish Poddar, National Leader, Private Equity, KPMG in India, attributing the heavy PE activity in August to "pipe being cleared for deals which were under negotiation for some time." In August, PE/VC investments, at $5.4 billion, were 5.4 times the same month in 2016, accounting for over one-fifth of the total in 2017, according to EY.
Two years back, PE funds were focused on commerce, e-commerce and technology companies. "Their focus has shifted to telecom, manufacturing, real estate, pharmaceutical and other consumer and retail sectors," says Mehra of Grant Thornton. The year 2017 was also the best for PE-backed initial public offerings, or IPOs, featuring the largest IPO exit ever with Fairfax selling its 12 per cent stake in ICICI Lombard for $558 million.
The IBC Impact
Following recent cases of high-profile debt default by companies, the government has tightened regulations for borrowers. The steps taken, including promulgation of the Insolvency and Bankruptcy Code, or IBC, are forcing companies to deleverage. "The companies want to pay off debt. And the only way they can do so is by selling their non-core businesses. The only buyers for good quality businesses are PE players and buyout funds," says EY's Soni. All bank debt restructuring schemes and restructuring proposals have been brought under the IBC.
"High interest rates, strong growth in chosen sectors, more and more buyouts by PEs given the strong macroeconomic fundamentals, are some of the things that are driving investments in India," says Poddar of KPMG.
Union Budget 2017/18 imposed long term capital gains tax on sale of public securities. This has come as a blessing for PE funds. "The convergence in taxation of gains from investments in listed and unlisted companies significantly reduces the historical tax arbitrage between these asset classes. The PE industry would hope this raises domestic capital allocation to PE/VC asset classes," says Subramaniam Krishnan, Tax Partner, Financial Services, EY India. On March 14, the government also extended indexation benefit for computing tax liability on sale of shares listed after January 31, though capital gains arising from such transactions will continue to be taxed at 20 per cent. This will help PE players, who usually invest in a company much before its gets listed on stock exchanges.
Mehra says the proposal to abolish the Foreign Investment Promotion Board would further liberalise FDI policy and encourage foreign investors. Also, the Budget's focus on uplifting the rural economy is expected to help the domestic consumption story and augurs well for PE/VC funds with exposure to sectors that cater to rural consumption.
Whenever economic growth in the US picks up, global investments fly out of emerging markets. However, India has bucked this trend, if one is to go by FDI inflows during the first nine months of 2017/18, raising confidence among domestic and international investors. The latest Department of Industrial Policy and Promotion data show FDI inflows of $48.20 billion in April-December 2017, raising hope that the inflows for the year will cross the last full year's figure of $60.08 billion. Though India's GDP growth slipped to 5.7 per cent in the April-June 2017 quarter, the July-September 2017 quarter numbers indicated strong recovery. Industrial growth of above 7 per cent for November and December also confirms that economic recovery is on course. Though fiscal slippage is a worry, improvement in bank credit offtake to 10 per cent, after 15 months of single-digit growth, supports the recovery story.
"US growth has been relatively strong. However, certain aggressive policy decisions there have given rise to uncertainty, and some of the macro-economic indicators in the past few quarters have not been very strong. This, coupled with the struggling Chinese economy, has put focus back on India," says Poddar of KPMG.
Experts are confident that the PE investment momentum will sustain for the next two years, except EY, which has put the timeline as 'the next one or two years'. Rising economic growth, low inflation and stable rupee are the positives, and though the fiscal deficit has risen, the situation is not alarming as of now. India is catching up on growth, and that is what PE funds are banking on. Mehra of Grant Thornton believes that IBC and PE investments will feed each other in the next few years.
Favourable policy environment, liberal monetary policy and faster FDI approvals will help growth in PE investments in the years to come, says Poddar of KPMG. Soni says in 2007 and 2008, PE deals were not happening because the promoters "did not want to sell", but now the promoters are being forced to sell if they fail to spruce up their operations. Mehra sees start-ups, banking/insurance, e-commerce, manufacturing, pharmaceutical, healthcare and biotech as the key areas expected to see action, apart from companies that gain from government spending, such as infrastructure.