Business Standard

Making private equity work in India

India is becoming a powerful magnet for private equity investment. To realise its potential,...

By Sri Rajan and Ashish Singh

First published on Μαρτίου 19, 2007
min read


India is becoming a powerful magnet for private equity investment. To realise its potential, however, private equity investors and Indian companies must recognise what each brings to the table. By some measures, India is poised to become the next big market in private equity. There have been big deals, such as the $900 million paid in 2006 for Flextronics Software Systems (now called Aricent) by KKR, the US leveraged-buyout pioneer. There have been big successes, including the completion of the sale in 2005 by Warburg Pincus of its stake in Bharti Airtel for $1.6 billion. And there is certainly big interest: Well over 100 private equity funds are scouting for deals, making India the fastest-growing private equity market in Asia, with a 67 per cent compounded annual rate since 2002. Yet these numbers, while impressive, tell only part of the story. The full picture is more complex. Although it's growing fast, private equity (PE) in India has yet to show the scale of returns and deal volume that make PE a force in other global markets. When Bain & Company analysed nearly $15 billion in private equity investments between 2000 and 2006, most of the largest deals—more than 70 per cent-were less than $150 million. The average deal size was $21 million-less than one-third the size of the average PE investment elsewhere in Asia. Meanwhile, skepticism of private equity still runs deep among many Indian entrepreneurs as they weigh whether the potential advantages PE partners bring to the table justify diluting their financial interest and control. Can PE firms and the Indian companies they are courting bridge the gap? The answer, undoubtedly, is yes. The right question, in fact, is not whether private equity will blossom in India but when? Based on our experience, that will depend on the readiness of private equity firms to adjust their approach to India, and the willingness of Indian companies to see the opportunities in tapping the expertise of private equity partners. The challenge for Indian companies is to recognise that PE firms bring more than money to a deal—they also bring international networks that can help fill gaps in growth strategies, build alliances and add management depth. For their part, PE firms need to adapt their approach, picking targets carefully in industries where they can bring their distinctive skills to bear. Sizing up the opportunity The value of this approach was underscored by a recent survey conducted jointly by Bain & Company and Knowledge@Wharton, the online business journal of The Wharton School at the University of Pennsylvania. The survey gathered the opinions of nearly 150 global PE investors active in India, their local counterparts, and Indian entrepreneurs and executives. Among the highlights: Sixty per cent of survey respondents said the investment climate in India is more attractive than in Japan or South Korea, while 40 per cent agreed that India is more attractive than China. Over the coming three years, moreover, a majority anticipate that China and India will be on par as Asia's most attractive destinations for private equity investment. In general, India is perceived to be a friendlier investment environment than China, with survey respondents indicating that Indian businesses are less hamstrung by government regulations and have an easier time recruiting experienced managers. They also say it is easier to negotiate and close a deal in India compared with China. For example, 71 per cent told us that Chinese corporate accounts suffer from a lack of transparency, compared to just half as many who said Indian companies' finances are difficult to track. In one important area, however, respondents give China an edge over India: Valuations are more expensive in India. Nevertheless, private equity firms are rolling out plans that reflect their confidence that India presents attractive opportunities. Among firms in our survey sample, three-quarters anticipate at least doubling the amount they invest over the next three years. There was broad agreement among PE investors and Indian executives who responded to the survey about which sectors are most appealing. But there was also consensus about bottlenecks that may diminish India's attractiveness. Not surprisingly, poor infrastructure was the No 1 concern; 68 per cent of respondents described it as a "challenge" or "major challenge." More than 40 per cent thought that high asset values will continue to crimp opportunities for private equity. Also ranking high were worries about whether the supply of skilled workers can keep pace with the demand, as well as concerns that onerous government regulations could curb India's appeal. Whether India's young private equity market ultimately delivers on its promise will depend on how Indian companies and PE investors learn to capitalise on each other's strengths. Indian executives will have to discover what these deep-pocketed newcomers can do help their companies flourish. For their part, private equity firms should be willing to invest patience as well as cash in cultivating relationships. Indian companies: It's not just about the money Overwhelmingly, survey respondents said that access to capital was the principal advantage private equity firms bring to a potential relationship. Yet three out of five Indian executives said that they would prefer to finance their companies' growth through a public stock listing, and roughly two out of five prefer debt financing or a capital infusion from a strategic partner to the potential entanglements that come with a private equity investment. Private equity merits a closer look. Indian companies stand to benefit most in three areas: Fill gaps in long-term growth strategy. With their hands-on experience working with companies in a wide range of industries, private equity partners can help Indian companies accelerate their growth. In mid-2006, for example, managers at Claris Lifesciences, a leading pharmaceutical manufacturer based in Ahmedabad, accepted a $20 million investment from The Carlyle Group, the US private equity firm, to help fund its growth plans. Beyond the modest cash infusion, Claris anticipates getting a big operational boost from Carlyle's managerial input and connections that will enable Claris to speed up its penetration of key export markets. Carlyle's deep bench of US and European advisors will help Claris tailor the right strategies for each market and engage technical experts who can advise Claris on, among other things, how best to organise itself to meet US Food and Drug Administration standards. Another Carlyle unit in Japan, meanwhile, is working with Claris managers to line up reliable, cost-efficient offshore raw material suppliers. Shankar Narayanan, Carlyle India's lead director, says that his firm's role is to "act as a catalyst to Claris's transformation into a major pharma player." Forge the right alliances. With the introductions that a private equity partner can provide, world-class Indian companies gain access to new customers, suppliers, and the opportunity to join forces with other enterprises in the PE firm's portfolio. Nimbus Communications, a diversified media company based in Mumbai, is harnessing its business goals to the network connections of 3i, the big London-based PE firm. Nimbus' founder and chief executive Harish Thawani acted to jump-start his company by selling 3i a 33 per cent stake in Nimbus for $45.5 million in August 2005. Nimbus is looking to 3i for introductions to potential partners from among its portfolio of 1,500 companies around the world, and is tapping the industry expertise of the firm's 300 investment professionals. Nimbus and 3i plan to deploy those resources to acquire broadcast rights, fund TV and feature-film production, and develop digital content for wireless distribution. Says Thawani: "We share a common belief in the global abilities of Nimbus, and that's where I believe 3i will add strategic value." Recruit strategic advisors. Talent, transparency and independent oversight—key attributes of good governance anywhere—are especially important in India, where company boards often operate through close personal ties. Having a PE partner can help strengthen those qualities. For example, it was just that need for seasoned judgment that initially drew Sunil Mittal, the founder of Bharti, to the investment offer by Warburg Pincus managing director Pulak Prasad, in 1999. As members of the company's board, Prasad (who left Warburg in late 2006) and his colleague Dalip Pathak, the head of Warburg Pincus' Indian funds, helped Bharti formulate an expansion strategy, bring aboard experienced senior managers and guide the company through an initial public stock offering in early 2002 that raised $172 million. Private equity investors: It's all about positioning Successful private equity firms know that capital is fungible. It is the unique skills they can bring to bear and the flexible, yet disciplined, approach they take to evaluating promising investment opportunities that matter most. Assemble the right team. In a reversal of how private equity works in the US or Europe, very few acquisitions in India result from an open auction process. Instead, word of the most promising investment opportunities circulates through tight networks of family relationships, well-placed government officials and other plugged-in confidants. Prominent senior directors who can command the respect of corporate insiders are themselves assets that can put a private equity firm at the top of a company's potential partners' list. Representative of this new breed of connected Indian-born business leaders is Ashish Dhawan, senior managing director at ChrysCapital, the domestic private equity firm he founded in Mumbai in 1999. The US-educated Dhawan held positions at prominent investment firms Goldman Sachs and Wasserstein Perella, financing technology and business outsourcing companies in the US and Latin America. Bringing that experience back to India, Dhawan raised a $1 billion war chest to provide growth capital to promising Indian outsourcing firms. ChrysCapital has been one of the most active investors in India's information technology and business services sector, backing 40 companies over the past eight years. Think "buy in" not "buy out". With low-cost sources of debt and public equity capital readily available, few Indian companies are looking for a big private equity investment that would require them to share control or give up a board seat. Moreover, some standard deal-financing techniques in the PE toolkit are off-limits in India. For example, government regulations restrict the dividend payouts shareholders can extract from their holdings. Successful private equity players adapt by acquiring minority holdings in target companies. Starting small can help PE investors get acquainted with management as the foundation for building a closer relationship down the road. A small stake need not be passive. Shortly after UK-based Actis took a minority position in Jyothy Laboratories, the Mumbai-based consumer products company, Actis introduced Jyothy management to outside advisers to evaluate the company's high advertising expenditures. The experts found that, while Jyothy's use of national media was efficient, the balance of spending among products needed to change. Inspired by these insights, Jyothy refocused advertising on several key products, repositioning some of them, and reduced spending on other brands, resulting in higher sales and profits. Parlay a firm's distinctive skills. India's economy offers appealing opportunities across many sectors. Yet in their eagerness to stake out early positions, some PE investors show an almost indiscriminate hunger to sample them all. Smart fund managers are beginning to recognise that they are better able to spot the best prospects-and bring more value to the companies with which they partner-by developing expertise that sets them apart from their peers. Over time, the most successful firms will likely be those who build reputations as specialists in a distinct sector of the Indian economy or who become masters at helping diverse Indian companies solve intricate business problems they share. The time for ambitious neophytes is fast coming to an end. Size up targets carefully. With plenty of private equity money chasing relatively few investment opportunities, even seasoned PE firms can be tempted to short-circuit their due diligence. That's a prescription for trouble. It's essential to look beyond the financial statements to take measure of the quality and capabilities of the management team and the company's broader opportunities. Alert private equity investors are adept at spotting ambitious entrepreneurs who know how to navigate fast-changing markets. Warburg Pincus found both a world-class opportunity and managers with the skill to exploit it at Radhakrishna Group, the food distribution company headquartered near Mumbai. It began by betting on chairman, Raju Sheté, who had piloted Radhakrishna's growth into India's largest food conglomerate. Investing $50 million for a 25 per cent stake in Radhakrishna in mid-2003, Warburg Pincus is working with Sheté to reorganise the country's food-supply chain and to expand the company's distribution network overseas. India offers some of the world's most fertile turf for the marriage of the talent and energy of ambitious entrepreneurs with the connections and capital of the savviest private equity investors. Trust and imagination are the necessary elements to fuse the two in a profitable relationship. Fortunately, Indian companies and PE firms are endowed with both.

India is becoming a powerful magnet for private equity investment. To realise its potential, however, private equity investors and Indian companies must recognise what each brings to the table.

By some measures, India is poised to become the next big market in private equity. There have been big deals, such as the $900 million paid in 2006 for Flextronics Software Systems (now called Aricent) by KKR, the US leveraged-buyout pioneer.

There have been big successes, including the completion of the sale in 2005 by Warburg Pincus of its stake in Bharti Airtel for $1.6 billion. And there is certainly big interest: Well over 100 private equity funds are scouting for deals, making India the fastest-growing private equity market in Asia, with a 67 per cent compounded annual rate since 2002.

Yet these numbers, while impressive, tell only part of the story. The full picture is more complex. Although it's growing fast, private equity (PE) in India has yet to show the scale of returns and deal volume that make PE a force in other global markets.

When Bain & Company analysed nearly $15 billion in private equity investments between 2000 and 2006, most of the largest deals—more than 70 per cent-were less than $150 million. The average deal size was $21 million-less than one-third the size of the average PE investment elsewhere in Asia.

Meanwhile, skepticism of private equity still runs deep among many Indian entrepreneurs as they weigh whether the potential advantages PE partners bring to the table justify diluting their financial interest and control.

Can PE firms and the Indian companies they are courting bridge the gap? The answer, undoubtedly, is yes. The right question, in fact, is not whether private equity will blossom in India but when? Based on our experience, that will depend on the readiness of private equity firms to adjust their approach to India, and the willingness of Indian companies to see the opportunities in tapping the expertise of private equity partners.

The challenge for Indian companies is to recognise that PE firms bring more than money to a deal—they also bring international networks that can help fill gaps in growth strategies, build alliances and add management depth. For their part, PE firms need to adapt their approach, picking targets carefully in industries where they can bring their distinctive skills to bear.

Sizing up the opportunity
The value of this approach was underscored by a recent survey conducted jointly by Bain & Company and Knowledge@Wharton, the online business journal of The Wharton School at the University of Pennsylvania. The survey gathered the opinions of nearly 150 global PE investors active in India, their local counterparts, and Indian entrepreneurs and executives. Among the highlights:

Sixty per cent of survey respondents said the investment climate in India is more attractive than in Japan or South Korea, while 40 per cent agreed that India is more attractive than China.

Over the coming three years, moreover, a majority anticipate that China and India will be on par as Asia's most attractive destinations for private equity investment.

In general, India is perceived to be a friendlier investment environment than China, with survey respondents indicating that Indian businesses are less hamstrung by government regulations and have an easier time recruiting experienced managers.

They also say it is easier to negotiate and close a deal in India compared with China. For example, 71 per cent told us that Chinese corporate accounts suffer from a lack of transparency, compared to just half as many who said Indian companies' finances are difficult to track.

In one important area, however, respondents give China an edge over India: Valuations are more expensive in India. Nevertheless, private equity firms are rolling out plans that reflect their confidence that India presents attractive opportunities. Among firms in our survey sample, three-quarters anticipate at least doubling the amount they invest over the next three years.

There was broad agreement among PE investors and Indian executives who responded to the survey about which sectors are most appealing. But there was also consensus about bottlenecks that may diminish India's attractiveness.

Not surprisingly, poor infrastructure was the No 1 concern; 68 per cent of respondents described it as a "challenge" or "major challenge." More than 40 per cent thought that high asset values will continue to crimp opportunities for private equity.

Also ranking high were worries about whether the supply of skilled workers can keep pace with the demand, as well as concerns that onerous government regulations could curb India's appeal.

Whether India's young private equity market ultimately delivers on its promise will depend on how Indian companies and PE investors learn to capitalise on each other's strengths. Indian executives will have to discover what these deep-pocketed newcomers can do help their companies flourish. For their part, private equity firms should be willing to invest patience as well as cash in cultivating relationships.

Indian companies:

It's not just about the money
Overwhelmingly, survey respondents said that access to capital was the principal advantage private equity firms bring to a potential relationship.

Yet three out of five Indian executives said that they would prefer to finance their companies' growth through a public stock listing, and roughly two out of five prefer debt financing or a capital infusion from a strategic partner to the potential entanglements that come with a private equity investment. Private equity merits a closer look. Indian companies stand to benefit most in three areas:

Fill gaps in long-term growth strategy. With their hands-on experience working with companies in a wide range of industries, private equity partners can help Indian companies accelerate their growth.

In mid-2006, for example, managers at Claris Lifesciences, a leading pharmaceutical manufacturer based in Ahmedabad, accepted a $20 million investment from The Carlyle Group, the US private equity firm, to help fund its growth plans.

Beyond the modest cash infusion, Claris anticipates getting a big operational boost from Carlyle's managerial input and connections that will enable Claris to speed up its penetration of key export markets. Carlyle's deep bench of US and European advisors will help Claris tailor the right strategies for each market and engage technical experts who can advise Claris on, among other things, how best to organise itself to meet US Food and Drug Administration standards.

Another Carlyle unit in Japan, meanwhile, is working with Claris managers to line up reliable, cost-efficient offshore raw material suppliers. Shankar Narayanan, Carlyle India's lead director, says that his firm's role is to "act as a catalyst to Claris's transformation into a major pharma player."

Forge the right alliances. With the introductions that a private equity partner can provide, world-class Indian companies gain access to new customers, suppliers, and the opportunity to join forces with other enterprises in the PE firm's portfolio.

Nimbus Communications, a diversified media company based in Mumbai, is harnessing its business goals to the network connections of 3i, the big London-based PE firm. Nimbus' founder and chief executive Harish Thawani acted to jump-start his company by selling 3i a 33 per cent stake in Nimbus for $45.5 million in August 2005.

Nimbus is looking to 3i for introductions to potential partners from among its portfolio of 1,500 companies around the world, and is tapping the industry expertise of the firm's 300 investment professionals. Nimbus and 3i plan to deploy those resources to acquire broadcast rights, fund TV and feature-film production, and develop digital content for wireless distribution.

Says Thawani: "We share a common belief in the global abilities of Nimbus, and that's where I believe 3i will add strategic value."

Recruit strategic advisors. Talent, transparency and independent oversight—key attributes of good governance anywhere—are especially important in India, where company boards often operate through close personal ties. Having a PE partner can help strengthen those qualities. For example, it was just that need for seasoned judgment that initially drew Sunil Mittal, the founder of Bharti, to the investment offer by Warburg Pincus managing director Pulak Prasad, in 1999.

As members of the company's board, Prasad (who left Warburg in late 2006) and his colleague Dalip Pathak, the head of Warburg Pincus' Indian funds, helped Bharti formulate an expansion strategy, bring aboard experienced senior managers and guide the company through an initial public stock offering in early 2002 that raised $172 million.

Private equity investors:

It's all about positioning
Successful private equity firms know that capital is fungible. It is the unique skills they can bring to bear and the flexible, yet disciplined, approach they take to evaluating promising investment opportunities that matter most.

Assemble the right team. In a reversal of how private equity works in the US or Europe, very few acquisitions in India result from an open auction process.

Instead, word of the most promising investment opportunities circulates through tight networks of family relationships, well-placed government officials and other plugged-in confidants. Prominent senior directors who can command the respect of corporate insiders are themselves assets that can put a private equity firm at the top of a company's potential partners' list.

Representative of this new breed of connected Indian-born business leaders is Ashish Dhawan, senior managing director at ChrysCapital, the domestic private equity firm he founded in Mumbai in 1999.

The US-educated Dhawan held positions at prominent investment firms Goldman Sachs and Wasserstein Perella, financing technology and business outsourcing companies in the US and Latin America.

Bringing that experience back to India, Dhawan raised a $1 billion war chest to provide growth capital to promising Indian outsourcing firms. ChrysCapital has been one of the most active investors in India's information technology and business services sector, backing 40 companies over the past eight years.

Think "buy in" not "buy out". With low-cost sources of debt and public equity capital readily available, few Indian companies are looking for a big private equity investment that would require them to share control or give up a board seat. Moreover, some standard deal-financing techniques in the PE toolkit are off-limits in India. For example, government regulations restrict the dividend payouts shareholders can extract from their holdings.

Successful private equity players adapt by acquiring minority holdings in target companies. Starting small can help PE investors get acquainted with management as the foundation for building a closer relationship down the road. A small stake need not be passive.

Shortly after UK-based Actis took a minority position in Jyothy Laboratories, the Mumbai-based consumer products company, Actis introduced Jyothy management to outside advisers to evaluate the company's high advertising expenditures.

The experts found that, while Jyothy's use of national media was efficient, the balance of spending among products needed to change. Inspired by these insights, Jyothy refocused advertising on several key products, repositioning some of them, and reduced spending on other brands, resulting in higher sales and profits.

Parlay a firm's distinctive skills. India's economy offers appealing opportunities across many sectors. Yet in their eagerness to stake out early positions, some PE investors show an almost indiscriminate hunger to sample them all.

Smart fund managers are beginning to recognise that they are better able to spot the best prospects-and bring more value to the companies with which they partner-by developing expertise that sets them apart from their peers.

Over time, the most successful firms will likely be those who build reputations as specialists in a distinct sector of the Indian economy or who become masters at helping diverse Indian companies solve intricate business problems they share. The time for ambitious neophytes is fast coming to an end.

Size up targets carefully. With plenty of private equity money chasing relatively few investment opportunities, even seasoned PE firms can be tempted to short-circuit their due diligence. That's a prescription for trouble. It's essential to look beyond the financial statements to take measure of the quality and capabilities of the management team and the company's broader opportunities.

Alert private equity investors are adept at spotting ambitious entrepreneurs who know how to navigate fast-changing markets. Warburg Pincus found both a world-class opportunity and managers with the skill to exploit it at Radhakrishna Group, the food distribution company headquartered near Mumbai.

It began by betting on chairman, Raju Sheté, who had piloted Radhakrishna's growth into India's largest food conglomerate. Investing $50 million for a 25 per cent stake in Radhakrishna in mid-2003, Warburg Pincus is working with Sheté to reorganise the country's food-supply chain and to expand the company's distribution network overseas.

India offers some of the world's most fertile turf for the marriage of the talent and energy of ambitious entrepreneurs with the connections and capital of the savviest private equity investors. Trust and imagination are the necessary elements to fuse the two in a profitable relationship. Fortunately, Indian companies and PE firms are endowed with both.