In February, the $174 billion Canadian Pension Plan Investment Board (CPPIB) announced that it was getting into a strategic alliance with India’s Piramal Enterprises to invest in residential projects across the country. The two partners will make an initial contribution of $250 million each. “India is a key long-term growth market for us,” says CPPIB spokesperson Linda Sims. “We will continue to pursue investment opportunities in the country, although there is no set allocation or timeline involved.”

CPPIB is part of the newest wave of international private equity (PE) players that have come to India over the years. “India is a key long-term growth market for us,” says company spokesperson Linda Sims. “We will continue to pursue investment opportunities in the country, although there is no set allocation or timeline involved.”

Back in 2006, at the height of the Indian investment boom, there were about 350 PE firms in the country. The numbers are estimates because the Securities and Exchange Board of India (SEBI) did not regulate the sector until 2012. According to the latest SEBI figures, there were 77 Alternative Investment Funds (under which PE and hedge funds are classified) and 180 venture capital funds registered with it as of September 30.

Venture Intelligence, a leading provider of data on private company financials, transactions and valuations, puts the number higher. “In our estimate, the number of serious PE-type investors — roughly defined as those that, on average, make more than one investment during a year or have a representative on the ground in the country – is closer to 250,” says managing director Arun Natarajan. Typically, funds that plan to raise money domestically tend to register with SEBI as a venture capital (VC) fund. A lot of others take the FII (foreign institutional investor) route or the FDI (foreign direct investment) route through Mauritius or Singapore.

The 250 figure itself may look like a substantial decline, and the truth is probably worse. Many PE players are waiting desperately for an exit opportunity. New York-based Blackstone invested in the listed Financial Technologies at Rs. 680 (around $10) a share in August 2012. It reached Rs. 140 and has gone up only now after Blackstone has increased its stake. Other problem investments include Monnet Ispat (down 85%) and Gokuldas Exports (down 82%). Warburg Pincus backed Punj Lloyd at Rs. 275 a share in August 2007. It is now less than Rs. 30. There have been just a couple of successful exits.

“The biggest challenge for private equity in India remains the question of exits.” –Arun Natarajan

The decline in the rupee is taking a further toll. According to one estimate, PE firms will have to book losses of up to $6 billion on this count alone.

No Exit

“The biggest challenge for private equity in India remains the question of exits — especially with such a large overhang of portfolio companies from the 2006-2008 period that are overdue for exits,” says Natarajan. “While the buoyant stock market, strong Inbound M&A interest and secondary transactions between PE firms have provided some good exits in recent months, the fact that the IPO market has not opened up for any sustained period is a key matter of concern.”

According to Wharton professor of operations and information management Kartik Hosanagar, “There have been several good PE investments in tech companies in India in the past five years. The challenge for the industry was the lack of exits. This in turn was because there are few acquirers in India — unlike in the U.S., where old dotcom successes like Google and Yahoo are big acquirers — and IPOs are harder for tech companies. So, the recent exits were much needed for the VC/PE industry. Many more are needed for the industry to bounce back nicely.”

The recent exits Hosanagar mentions were crowned by the January takeover of the Bangalore-based Little Eye Labs by the social media giant Facebook. The deal amount was not disclosed, although analysts estimate that it was probably less than $20 million. This was Facebook’s first takeover in India, and it was followed by speculation that the social networking giant was looking for other deals in the country, which sent tech valuations higher.

‘The Network Effect’

There have been other headline-hitting acquisitions. When Pearson, which owns the Financial Times, snapped up online tutoring company TutorVista in 2009, it was one swallow in an arid summer. The deal was consummated in 2013, with the acquisition of the last 20% at an equity valuation of $213 million. This gave an opportunity to Sequoia Capital and Lightspeed – both investors in TutorVista — to make an exit. “The TutorVista deal, because of the publicity it attracted, opened the doors for lucrative exits in India,” says K. Ganesh, who is co-promoter of TutorVista along with his wife, Meena Ganesh. “However, they dwindled to a trickle. It is only recently that high-valuation exits have started again.”

Last year, India’s largest online travel company, ibiboGroup, a joint venture between Naspers of South Africa and Tencent of China, bought bus ticketing company redBus for an estimated $100 million. The early investors were Seedfund, Inventus Capital Partners and Helion Venture Partners. Inventus, for one, got a return of more than 10 times its investment.

“For exits to happen, the buy-side local ecosystem needs to have scaled assets,” says Ashish Kashyap, group CEO of ibiboGroup, noting that he is talking specifically about the consumer Internet segment. “In the past, there were very few of these scaled assets in the Internet space. However, now we have emerging platforms such as ibiboGroup, Flipkart, the Naukri group and Justdial that are potential acquirers. As these buy-side assets increase in size, volume and scale, it drives more local innovations and startup activity. Think of this as a network effect between developers of assets and acquirers of these assets. I think this network effect is beginning to take off.”

In addition to the investment in redBus by his own company, Kashyap cites strategic investments by the Naukri group in Zomato and eBay in Snapdeal as “excellent indications of the network effect.”

“There have been several good PE investments in tech companies in India in the past five years.” –Kartik Hosanagar

Other numbers indicate that a somnolent sector is giving way to action. “Q4 (October through December 2013) proved to be an active quarter for PE investment with total flows exceeding US$2 billion, the first time since post-Q4 2007,” notes a report by PricewaterhouseCoopers (PwC). There were 76 deals involving PE investment of $2.12 billion. In deal value, there has been a 67% jump over the same quarter of 2012. The action was mainly in IT, IT-enabled services and health care.

From the industry’s point of view, those fourth-quarter results helped to shore-up a down year. “PE firms invested $7.5 billion (over 384 deals) in India during the 12 months ending December 2013,” notes Venture Intelligence. “The 2013 PE investment numbers, down 18.5% compared to the $9.2 billion (across 484 deals) invested in 2012, represent the lowest levels witnessed in the last four years in both value and volume terms.”

Yet there is a flurry of activity. The biggest deals last year were KKR’s $460 million investment in Alliance Tire Group, the Barings Asia $443 million buyout of publicly listed Hexaware Technologies and the $420 million purchase of GlobalLogic by Apax Partners.

Mixed Multiples

In the Alliance deal, Warburg Pincus got an exit at more than four times its investment; in Hexaware, it was General Atlantic recouping two times its investment. And GlobalLogic gave its PE investors — New Enterprise Associates, Sequoia Capital, Westbridge Capital, Goldman Sachs and New Atlantic Ventures – a five-times plus return.

In the past, there were better deals. In May 2009, ChrysCapital exited Shriram Transport Finance with a nine-times-investment return; TutorVista gave Sequoia Capital a six-times-plus return; and redBus delivered 14-times returns to Seedfund.

One big success is Justdial, a local search engine. It gave Saif Partners a 12-times-investment multiple. It is also one of the few recent IPOs. The May 2013 issue was at Rs. 530 per share. It ended the first day at Rs. 590 and is now around Rs. 1,600.

There is a rush today for the real estate space, where Canada Pensions is a key player. Kotak, in the financial sector, is targeting a US$200 million real estate fund. In the current calendar year, the ASK Group has raised $50 million (the first tranche of $200 million) and Indiareit $160 million. Brick Eagle (which focuses on affordable housing) is targeting $100 million, Indian Property Advisors $250 million and Milestone Capital around $100 million. Waiting in the wings, Qatar Investment Authority also is reportedly eyeing the real estate sector. Global real estate consultancy Cushman & Wakefield reports PE investment in real estate in 2013 at $1.1 billion, up 13% over 2012.

Why the flurry of new funds? First, there is a sense that the economic growth rate of below 5% in 2013-2014 is probably the low point. Second, it’s hoped that the April-May elections will deliver fresh government policies that could stimulate the economy. Third, inflation is at a nine-month low, which gives the Reserve Bank of India (RBI) the leeway to cut interest rates, which would likely kick-start investment. Acknowledging all this, the Bombay Stock Exchange Sensitive Index is at its all-time high.

“India has entered what we call the Looming Logjam phase.” –Sridhar Venkiteswaran

“India is a pretty good bet,” notes the Global Private Equity Report 2013-2014 by Grant Thornton, an accounting and advisory organization. “The U.S. will also stay solid. Europe is difficult, as is China, which has gone through a cycle. Brazil was interesting, but has cooled off a bit as its own growth has trailed off.”

How big will the exit problem be? “PE Exits in India have had two distinct phases in the past decade,” points out Sridhar Venkiteswaran, executive director of Avalon Consulting, an international management consulting firm. An Avalon report noted that the first was the India Shining Phase from 2004 to 2009. It saw faster exits (mostly less than three years), higher returns (30% to 60% internal rate of return, or IRR) and exits mainly through primary market sale or IPOs. The second phase – 2010 to 2013 – was the Melting Pot. It witnessed slower exits (mostly greater than four years) and lower returns (IRR less than 15%), and exits mainly through secondary sales and buybacks.

The ‘Looming Logjam’

“In 2014, India has entered what we call the Looming Logjam phase, in which we are opening with about Rs. 85,000 crore ($14 billion) of six-plus years invested capital that is waiting to exit,” says Venkiteswaran. “This is nearly equal to the cumulative value of exits over the past 10 years, and five times the total quantum exited in any year in the recent past. If you include four-plus year invested capital, this figure jumps to Rs. 125,000 crore ($20 billion). So if you think exiting was a problem in the past, you haven’t seen what is coming.”

Without action by a new government, “a large part of this capital will seek secondary exits or buybacks and will be at a significant [discount]. The price is being paid for the euphoria of investments in 2006 and 2007.”

Still, the PE market is maturing, according an EY report titled, “Asia-Pacific Private Equity Outlook 2014.” “Private equity is still developing a strategy for operating in India, but foreign and domestic firms are becoming more disciplined and sophisticated in terms of investing,” the report notes. “Many oversights, such as lack of adequate due diligence, are becoming things of the past.”