Confidence is a strange thing. It feeds on itself. When everyone is gung-ho, the environment changes to make room for success. We had witnessed this during 2007-08 when record amounts of private equity capital were raised. However, more than the PE fund managers, it was really the benign environment that spelt success for them. By the same yardstick, widespread pessimism is a recipe for failure. For instance, the fundraising environment is challenging right now. Huge dry powder continues to frustrate in a market beset with intense competition. The rupee has plunged. And there is a policy paralysis in New Delhi. All these could add up to impact the current scenario.
But we should also remember that even if the GDP growth rate falls to 6.5 per cent, which is possibly a worst case scenario, we are still not doing too badly. The eurozone is tumbling and the recovery in the USA is painfully slow. Moreover, LPs, apparently, go behind the GDP. According to the findings of the VCCircle survey, which has collected responses from 60 Indian GPs – 2012-13 will turn out to be a good vintage year for PE/VC investments. In fact, both private equity and venture capital fund managers look set to outpace their deal-making levels of 2011. Much confidence is seen as far as exits are concerned, with fund managers expecting to deliver returns in excess of 25 per cent this year, which might well turn out to be the report card year for a host of these 2007-08 vintage funds as most of them had raised money during that period.
Certainly, things are not as bad as they seem.
2012-13 To Be A Good Vintage Year For PE Investments
There is a near-unanimity on how 2012-13 will turn out to be in terms of a vintage year for private equity investments. Around 40 GPs with whom VCCircle has spoken believe that 2012-13 will be a good vintage year for investing. In fact, some of them believe that this specific time span will prove to be a banner vintage. “I feel the 2012 vintage of funding will be much more rewarding than the 2008 vintage,” said a respondent, with more than $1 billion in assets under management and currently raising a $500 million fund. This is primarily being seen as the outcome of two factors – the difficult capital markets bringing in sensible entry valuations and the fact that there will be lesser number of funds participating for deals, as only a few PE funds will have the access to capital and the ability to invest against a backdrop of a difficult fundraising environment.
Ditto for VC fund managers who feel that the crazy valuation scenario is softening and coupled with strong growth fundamentals in near-term, it ensures a good vintage for this year.
Faster Pace Of Deal-making
In the wake of softening valuations, PE fund managers anticipate an increased pace of deal-making in 2012. The majority of respondents (51.4 per cent) essentially expect a higher deal flow, followed by 42.9 per cent who feel the deal pace will be the same as in 2011. Interestingly, no one expects the deal flow to come down. Such motivations by PE fund managers are best understood as more respondents (28.6 per cent) think entry valuations on transactions, measured by their EBITDA multiples, will decrease while 11.4 per cent respondents expect that entry valuations will increase. However, 60 per cent feel that entry valuations will remain stable.
On the early-stage side, VCs look set to continue the momentum of active deal-making. The year 2011 went down as a record year for early-stage or VC investment as there was a noticeable uptick in terms of quantity and quality. According to VCCEdge, a total of 197 investments amounted to $879 million, compared to 147 deals in 2010 worth $650 million. Around 53.3 per cent of the VCs polled expect to strike as many deals as they did in 2011 while 40 per cent professionals expect to outpace the deal flow seen last year.
Again, around 53.3 per cent of the VCs polled think entry valuations on transactions, measured by their EBITDA multiples, will decrease while 13.3 per cent respondents see it increasing. This only indicates VCs feel more strongly that entry valuations will shrink in 2012, compared to private equity fund managers.
“We see more discipline and a general approach towards capital efficiency at large,” responded a VC fund manager heading the India operations of a global VC fund. During last year, the euphoria around e-commerce deals was high and large cheque sizes were seen for companies operating across mobile, Internet and related verticals.
Huge Optimism: IRR Expectations In Excess of 25%
Ultimately, it is about generating quality exits and returns which has always been critical for private equity investors. But their overall significance is now even more crucial as holding periods have been stretched. Against the backdrop of difficult public markets, a sale to a strategic investor appears to be the preferred exit option as the near-majority (around 45.7 per cent of the respondents) believes. However, 28.6 per cent respondents anticipate a secondary sale to a private equity investor. This is in continuation of the trends seen last year as there had been more series B and series C funding than first-round institutional funding into companies. Such trends only suggest that GPs prefer companies where the initial risk is mitigated.
Also, there were some good exits in 2011. Mayfield Fund made 10x its original investment, with its portfolio company Fourcee Infrastructure raising a much larger round of $104 million from PE major General Atlantic Partners. Again, Standard Chartered PE made up to 3x on Endurance Technologies as it raised a larger round from Actis PE.
Expectations are also high regarding returns, to be made over the next 12 months. The majority of respondents (65.7 per cent) hope to deliver an IRR in excess of 25 per cent. This comes in the wake of a difficult fundraising environment where GPs need to exhibit handsome exits to LPs in order to raise money. Also, 2012-13 might well be the report card time for a host of these 2007-08 vintage funds as most of them had raised money during that period.
Similarly, on the VC side, 80 per cent of the respondents anticipate a sale to a strategic investor, followed by 20 per cent who anticipate a secondary sale to a PE fund manager. In terms of expectations, again the majority (60 per cent) expects IRR in excess of 25 per cent from their investments. That venture investing is finally taking off is also shown by the way of exits. SAIF Partners’ multibagger part exit from MakeMyTrip is being touted as the poster deal for the domestic venture industry. With the likes of JustDial, One97 Communications and others lining up over the coming months, more data points are likely to emerge. On the non-tech front, companies like MedPlus and Orient Green are examples of recent successes for investors and entrepreneurs.
Who Will Get What
In terms of sectoral preferences, consumer products/services clearly lead the pack, as indicated by the majority (51.4 per cent). However, 14.3 per cent respondents have voted for healthcare services and manufacturing, followed by financial services (11.4 per cent) and infrastructure (5.7 per cent).
On the early-stage side, consumer Internet continues to lead the pack. Fifty per cent of the professionals surveyed have zeroed in on consumer Internet as their first choice, followed by healthcare, IT services and media & communications. “The valuations of consumer Internet companies, particularly e-commerce companies, are showing signs of softening,” said a respondent.
Cautiously Optimistic About Fundraising
The survey highlights the fact that the fundraising climate is especially challenging at present, with a record number of funds currently on road, competing for capital commitments from an investor community who remains cautious about making new PE investments. Consequently, PE fund managers are none too optimistic when it comes to expectations about fundraising. About 37.1 per cent of the respondents believe that the allocations of LPs/institutional investors towards Indian private equity will increase, but with a caution. This is closely followed by 31.4 per cent people surveyed who have chosen to disagree and expect a decline.
Such reactions from the PE fraternity come for a reason. As many as 60 India-based private equity firms are out on road to raise money for their first or follow-up funds, expecting to mop up over $13 billion, according to VCCEdge, the financial research platform of VCCircle, and not many of them have met with success. However, all is not doom and gloom in terms of fundraising and quite a few have been successful. For instance, Tano Capital has raised $111.3 million for the final close of Tano India Private Equity Fund II; Somerset Indus Capital Partners is raising $25 million from institutional investors for its first close and ChrysCapital is also making a first close.
“The appetite for Asia as a market remains strong,” said a Singapore-based LP, commenting on the survey results. However, that does not necessarily translate into good news for Indian PE fund managers as they are competing with a lot many players here – a great wave of returning global GPs, other Asia targeting non-India funds, as well as fellow-competing funds. China’s outperformance, a lack of experienced fund managers in India and the country’s below-par performance by way of exits or generating distributions have been a few of the concerns of the LPs. However, with private equity portfolios maturing and some of them delivering good exits, those with a good track record should be able to raise money.
Thanks to some meaningful exits, the VCs seem more confident. About 60 per cent of the VC fund managers believe that the allocations of institutional investors will increase, but with a caution, over the next 12 months. However, it is not all that easy for them on the fundraising front, either. In an interesting response, a GP managing an early-stage fund north of $50 million responded, “Earlier, the macro-economic scene and the government were seen as positives while this sector was unproven. But now, the opposite is true. Just as the sector shows promises of exits and returns, the government apathy is taking its toll in terms of global perceptions. It is hard to win the perception war with the LPs, with China out there.”
Growth Equity, Mid-Buyouts & Pipe – In That Order
The survey also suggests that there won’t be a drastic shift from the strategies that the private equity fund managers are currently pursuing. The Indian PE market will continue to be dominated by mid-market growth equity investments. Around 57.1 per cent of respondents believe that making ‘growth investments’ is the most attractive PE segment. That the Indian private investing market is maturing is well reflected with about 17.1 per cent opting for mid-buyouts as key strategy. One can already see such trends with funds like India Equity Partners and Multiples PE taking this route.
The next in the preference list is definitely PIPE – Private Equity Investing In Public Enterprise – and investors have increased their activity in PIPE deals as the choppy capital markets in 2011 have presented attractive opportunities for PE funds. The recent departure of four managing directors from Sequoia Capital India, to form Westbridge Capital – an independent fund that will focus on PIPE deals and raise $500 million in a short span of three months – also points to the fact that PIPEs are here to stay. Meanwhile, Pulak Prasad’s Nalanda Capital has also been successful in raising money for the second time.