The Deal

Private equity, the new mantra for PE in India

India beckons private equity investors as a land of beguiling opportunity wrapped in mind-boggling complexity.

By Srivatsan Rajan, Ashish Singh and Hugh MacArthur

First published on junio 19, 2006
min read


India beckons private equity investors as a land of beguiling opportunity wrapped in mind-boggling complexity. Today, more than 30 funds totaling $4 billion are scouring the country for deals—and landing some big ones. In April, for example, Kohlberg Kravis Roberts & Co., the pioneer of buyouts, announced its Indian debut, paying $900 million for an 85% stake in an Indian software developer. Other prominent newcomers include Blackstone Group LP, which has earmarked $1 billion for Indian acquisitions, and Carlyle Group, which has created three Asian funds totaling $1 billion and opened a Mumbai office in late 2005. These arrivals are joining a cadre of homegrown firms, such as UTI Venture Funds, ICICI Venture and ChrysCapital, for one simple reason: While representing only a small portion of Asia's more than $100 billion in private equity capital, India's growth trajectory is the region's steepest, increasing at a 51% compounded annual rate since 1998. Using the benchmark of deal value as a percentage of gross domestic product, Bain & Co. estimates that India's private equity market has the potential to expand fourfold. But while the economics are elementary, the task is not. Indeed, for all of the new capital and energy flowing into India, new deal activity actually went dormant in late 2005. The chief reason: The Bombay Stock Exchange—India's leading public equities market—nearly doubled during a 12-month period. Although they have recently fallen off their recent highs, elevated stock prices have driven up the value of potential target companies. Another complicating factor has been government rules. Indian regulators cap the amount of debt foreign private equity investors can use to finance their acquisitions. Instead of taking a controlling stake in a target company with just a sliver of equity that helps boost their leveraged returns, non-Indian private equity acquirers must typically commit 75% to 90% of the purchase price from their own capital. With so much capital chasing a limited number of high-quality companies, smart private equity firms are taking pains to differentiate themselves. They begin by nurturing relationships with local enterprises, then offering a proposition that goes beyond just capital infusions to include knowledge of global markets and access to deep management expertise. Our analysis shows that successful investors are navigating this enormously complex market by honing four skills: 1) Choose wisely. Private equity players have always started with a clear thesis of how value is created. In India today, there are three particularly promising investment hypotheses. The first involves capitalizing on the underpinnings of the global outsourcing phenomenon: India's talented, low-cost labor force in software applications development, business services, engineering and technical design. The second targets those dynamic new sectors benefiting from the rise of a consumer class, including for-profit healthcare, real estate, and retail banking and credit. The last recognizes that selected industry niches—pharmaceuticals, automotive components and metal forging—are becoming globally competitive players. General Atlantic LLC and Oak Hill Capital Partners took a stake in India's global back office in 2004 by paying $500 million for a 60% stake in General Electric Capital International Services, or Gecis. General Electric Co. established Gecis in 1997 as a captive offshore business and technology center, and it blossomed into a 17,000-employee unit serving nearly 1,000 GE operations worldwide. The deal allowed GE to continue to outsource its IT and business processes to Gecis, while harvesting the value it had built in the company. The new private equity owners quickly marketed its services to companies wanting a state-of-the-art service provider in India, but reluctant to entrust sensitive data to a captive GE unit. Since acquiring Gecis (now renamed Genpact), the new owners have locked in contracts with non-GE clients and made the company India's largest business process outsourcer. 2) Exercise quiet influence. Among the 25 largest deals in 2005, some 80% were made to acquire minority stakes in publicly traded companies. Here, private equity investors have limited ability to influence the way the companies in which they've invested are managed. Smart private equity fund managers find ways to add value unobtrusively. Even when they lack effective control, fund managers put their know-how and range of contacts to use with quiet authority, as was the case with Baring Private Equity Partners, the London-based buyout firm. Shortly after Baring India acquired a stake in Jyothy Laboratories Ltd., a Mumbai-based manufacturer and distributor of consumer products, the firm 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 company wasn't able to reach its potential market through existing sales channels. These Baring-inspired insights enabled Jyothy to extend its distribution network, significantly boosting sales and profits. 3) Bet on the right people. Assembling the right management team has always been key to success for private equity funds. But because India's economy is largely being built by closely held family businesses, minority private equity investors have less scope to hire and fire. That's why funds are maneuvering to forge partnerships with experienced Indian entrepreneurs and managers who know how to navigate fast-changing markets. Warburg Pincus found both a world-class opportunity and managers with the skill to seize it at Radhakrishna Group, a privately held food distribution and logistics services company headquartered near Mumbai. It began by betting on Chairman Raju Sheté, who had managed Radhakrishna's growth from a startup provisioning ships into India's largest food conglomerate, with interests in supermarkets, catering and fast-food franchising. Investing $50 million for a 25% stake in Radhakrishna in mid-2003, Warburg Pincus is working with Sheté to implement a farm-to-plate reorganization of the country's food-supply chain. The aim: to overcome the fragmentation and public health barriers hampering India's development of a modern food-processing and distribution system. The private equity partners are also collaborating with Sheté and his team to expand Radhakrishna's commercial food service and distribution network into southern Africa and the Middle East. 4) Stay nimble. U.S.-based PE firms usually think in terms of a three- to five-year holding period for the companies in their portfolios. But the Asian currency crisis in 1997 and any number of local financial rumbles have proved that the markets seldom let investors choose when to sell. Shrewd fund managers will anticipate sharp market swings and formulate flexible exit strategies. Baring recently discovered the importance of patience when it was forced to postpone a plan to sell off a 35% stake it had in Mphasis BFL Ltd., a business process outsourcing firm it purchased in 1998. However, Mphasis was forced to lower its earnings forecast in 2004, weakening interest among prospective buyers and jeopardizing Baring's goal of selling its stake within four to seven years. Baring and Mphasis remained confident that revenues and earnings would increase 25% and 30%, respectively, in 2005 and 2006, and held on. In early June, Baring sold its Mphasis stake to Electronic Data Systems Corp., the information technology services firm, for a handsome $255 million—more than 25 times its original investment. No single key will unlock success in India's complex economy. Private equity investors will need yoga-like flexibility to prevail. But buyout firms that learn to exercise the disciplines of building relationships, spotting emergent opportunities, quietly influencing outcomes and betting on the right human capital will be those best able to reap the rewards of a market where East and West are meeting for mutual benefit. Sri Rajan is a partner with Bain & Co. and leads the firm's private equity practice in India. Ashish Singh is a Bain partner and leads the firm's New Delhi office. Bain partner Hugh MacArthur, a partner in the firm's Boston office, leads Bain's global private equity practice.

India beckons private equity investors as a land of beguiling opportunity wrapped in mind-boggling complexity.

Today, more than 30 funds totaling $4 billion are scouring the country for deals—and landing some big ones. In April, for example, Kohlberg Kravis Roberts & Co., the pioneer of buyouts, announced its Indian debut, paying $900 million for an 85% stake in an Indian software developer. Other prominent newcomers include Blackstone Group LP, which has earmarked $1 billion for Indian acquisitions, and Carlyle Group, which has created three Asian funds totaling $1 billion and opened a Mumbai office in late 2005.

These arrivals are joining a cadre of homegrown firms, such as UTI Venture Funds, ICICI Venture and ChrysCapital, for one simple reason: While representing only a small portion of Asia's more than $100 billion in private equity capital, India's growth trajectory is the region's steepest, increasing at a 51% compounded annual rate since 1998. Using the benchmark of deal value as a percentage of gross domestic product, Bain & Co. estimates that India's private equity market has the potential to expand fourfold.

But while the economics are elementary, the task is not. Indeed, for all of the new capital and energy flowing into India, new deal activity actually went dormant in late 2005. The chief reason: The Bombay Stock Exchange—India's leading public equities market—nearly doubled during a 12-month period. Although they have recently fallen off their recent highs, elevated stock prices have driven up the value of potential target companies.

Another complicating factor has been government rules. Indian regulators cap the amount of debt foreign private equity investors can use to finance their acquisitions. Instead of taking a controlling stake in a target company with just a sliver of equity that helps boost their leveraged returns, non-Indian private equity acquirers must typically commit 75% to 90% of the purchase price from their own capital.

With so much capital chasing a limited number of high-quality companies, smart private equity firms are taking pains to differentiate themselves. They begin by nurturing relationships with local enterprises, then offering a proposition that goes beyond just capital infusions to include knowledge of global markets and access to deep management expertise. Our analysis shows that successful investors are navigating this enormously complex market by honing four skills:

1) Choose wisely. Private equity players have always started with a clear thesis of how value is created. In India today, there are three particularly promising investment hypotheses. The first involves capitalizing on the underpinnings of the global outsourcing phenomenon: India's talented, low-cost labor force in software applications development, business services, engineering and technical design. The second targets those dynamic new sectors benefiting from the rise of a consumer class, including for-profit healthcare, real estate, and retail banking and credit. The last recognizes that selected industry niches—pharmaceuticals, automotive components and metal forging—are becoming globally competitive players.

General Atlantic LLC and Oak Hill Capital Partners took a stake in India's global back office in 2004 by paying $500 million for a 60% stake in General Electric Capital International Services, or Gecis. General Electric Co. established Gecis in 1997 as a captive offshore business and technology center, and it blossomed into a 17,000-employee unit serving nearly 1,000 GE operations worldwide. The deal allowed GE to continue to outsource its IT and business processes to Gecis, while harvesting the value it had built in the company. The new private equity owners quickly marketed its services to companies wanting a state-of-the-art service provider in India, but reluctant to entrust sensitive data to a captive GE unit. Since acquiring Gecis (now renamed Genpact), the new owners have locked in contracts with non-GE clients and made the company India's largest business process outsourcer.

2) Exercise quiet influence. Among the 25 largest deals in 2005, some 80% were made to acquire minority stakes in publicly traded companies. Here, private equity investors have limited ability to influence the way the companies in which they've invested are managed.

Smart private equity fund managers find ways to add value unobtrusively. Even when they lack effective control, fund managers put their know-how and range of contacts to use with quiet authority, as was the case with Baring Private Equity Partners, the London-based buyout firm. Shortly after Baring India acquired a stake in Jyothy Laboratories Ltd., a Mumbai-based manufacturer and distributor of consumer products, the firm 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 company wasn't able to reach its potential market through existing sales channels. These Baring-inspired insights enabled Jyothy to extend its distribution network, significantly boosting sales and profits.

3) Bet on the right people. Assembling the right management team has always been key to success for private equity funds. But because India's economy is largely being built by closely held family businesses, minority private equity investors have less scope to hire and fire. That's why funds are maneuvering to forge partnerships with experienced Indian entrepreneurs and managers who know how to navigate fast-changing markets.

Warburg Pincus found both a world-class opportunity and managers with the skill to seize it at Radhakrishna Group, a privately held food distribution and logistics services company headquartered near Mumbai. It began by betting on Chairman Raju Sheté, who had managed Radhakrishna's growth from a startup provisioning ships into India's largest food conglomerate, with interests in supermarkets, catering and fast-food franchising. Investing $50 million for a 25% stake in Radhakrishna in mid-2003, Warburg Pincus is working with Sheté to implement a farm-to-plate reorganization of the country's food-supply chain. The aim: to overcome the fragmentation and public health barriers hampering India's development of a modern food-processing and distribution system. The private equity partners are also collaborating with Sheté and his team to expand Radhakrishna's commercial food service and distribution network into southern Africa and the Middle East.

4) Stay nimble. U.S.-based PE firms usually think in terms of a three- to five-year holding period for the companies in their portfolios. But the Asian currency crisis in 1997 and any number of local financial rumbles have proved that the markets seldom let investors choose when to sell. Shrewd fund managers will anticipate sharp market swings and formulate flexible exit strategies.

Baring recently discovered the importance of patience when it was forced to postpone a plan to sell off a 35% stake it had in Mphasis BFL Ltd., a business process outsourcing firm it purchased in 1998. However, Mphasis was forced to lower its earnings forecast in 2004, weakening interest among prospective buyers and jeopardizing Baring's goal of selling its stake within four to seven years. Baring and Mphasis remained confident that revenues and earnings would increase 25% and 30%, respectively, in 2005 and 2006, and held on. In early June, Baring sold its Mphasis stake to Electronic Data Systems Corp., the information technology services firm, for a handsome $255 million—more than 25 times its original investment.

No single key will unlock success in India's complex economy. Private equity investors will need yoga-like flexibility to prevail. But buyout firms that learn to exercise the disciplines of building relationships, spotting emergent opportunities, quietly influencing outcomes and betting on the right human capital will be those best able to reap the rewards of a market where East and West are meeting for mutual benefit.

Sri Rajan is a partner with Bain & Co. and leads the firm's private equity practice in India. Ashish Singh is a Bain partner and leads the firm's New Delhi office. Bain partner Hugh MacArthur, a partner in the firm's Boston office, leads Bain's global private equity practice.