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PEs need to create deals

Posted by fairval on January 5, 2008

Fund managers will have create deals and bring value to stay ahead in the overcrowding PE/VC market in 2008

2007 will end as a remarkable year for the PE business in India. Recent reports have suggested that PE business may have crossed $17bn for the year, more than double of $7.5 bn done in 2006. India has also reportedly overtaken China in PE stakes. According to media reports, till Oct’07, India had seen around $5bn more of deals as compared to China.

PE fund raising has matched or exceeded the public market – IPO/FPO – route in recent years. In 2006, fund raising from PEs had exceeded domestic IPOs and FPOs by around 50%. In 2007, IPO/FPO route almost tripled to over Rs 73,000 crore ($18bn). So while PE could not exceed domestic public markets, it still nearly matched it. PE has clearly emerged a credible alternative to IPOs/FPOs for late stage and listed companies.

After all these big and excellent numbers, where do we go in 2008?
First point – clearly no one expects any slowdowns. These numbers can only grow. “Investors are very bullish on the India story. More money is clearly headed India’s way” says Sarath Naru, managing partner, Venture East. “New funds are still entering, and India allocations of global funds continue to increase” says Srini Vudayagiri, managing director, Lightspeed Venture Partners.

A recent report by Evalueserve had indicated, there are around 400 PE funds in India now, which already have commitment of close to $50bn to invest in India. While fund managers think active funds are less, the consensus seems to be – active funds and moneys available will go up in 2008. So is there enough for everyone?

In 2007, around 400 deals happened, from around 300 in 2006, a growth of 33%. Everyone agrees there will be more deals in 2008. Let’s work some numbers. Most funds will do atleast 3-4 deals a year. So even if number of deals grows 50% to say 600 in 2007, and each fund does 3 on an average, that’s enough space for 200 funds.
“Overcrowding is already happening” says Naru. “This is more so in late stage deals, where ticket sizes are $15 or more” says Nilesh Mehta, managing partner, Aureos India Advisors. This has two consequences – valuation will go up, and questionable deals will get done.

There will be various ways to deal with this. If you do deals through intermediaries, and all you bring to the table is money, then you are going to have to bid up the price and sacrifice returns. “One way to have proprietary deal flow is to create deals” says Naru. Can you for example bring two companies together and fund the acquisition? Funds will have to have deep sector or local knowledge and networking for this. “Intermediaries won’t normally think of such deals” says Naru.
“You will have to be able to bring value to deals” says Mehta. This can be either through opening doors for new business, or synergies with a similar company in your global portfolio. Blackstone, when it bought Intelenet last year, reportedly promised to give business to it as well. Global funds also fund it easier to deals when they have done a similar deal in US or China.

Funds may have to specialize and build sector focus, agree most PEs. That would be the only way to bring added value to deals.

There is less competition in early and seed stage. “Less than 10 crore deal size is a different market altogether” says Rajesh Jain, founder of Emergic Venture Capital. Rajesh, who has perhaps the most well rounded portfolio of early stage digital plays says while there are less players in VC and angel space, quality, fundable deals are the issue here. “Entrepreneurs need to be more creative to build scale” he says. In both the internet and mobile space, entrepreneurs aren’t coming up with credible businesses which will gel with Indian customers.

Among sectors, infrastructure and real estate will perhaps see a lot of flows. “Power, water and waste management could see large deals” says Srini. In mid size deals, scalable consumer plays remain the hottest area in mid size deals, while outsourcing led businesses have lost some luster. In consumer plays, healthcare, education, media and entertainment are top of the list. “Healthcare is a huge opportunity. Preventive healthcare does not exist in India” says Srini. In IT, now the focus is more on domestic plays. Funds are keen on companies trying to cater to Indian SMEs, preferably using software as a service (SaaS) concept.

An Indian fund may break into the league of top 50 global funds in 2008. An AUM of around $4bn can achieve that goal, and ICICI Ventures could get there in 2008. It has over $2bn under management currently, and wants to reach an AUM of $10bn by 2010
And finally, funds will have to work harder. Doing deals through intermediaries will clearly not work. The smart fund managers will get out of their offices and meet more companies, if they are to close deals in 2008.

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