Private Equity in India 2009

Private Equity in India 2009Year in review

In this issueForeword ....................................... 1

PE activity in 2009 ........................ 2

1.1. Investments ......................... 21.2. Exits ..................................101.3. Fund-raising .......................11

Key trends in 2009 ......................14

2.1. Rise in follow-on and co-investments ............142.2. Emerging sectors ...............142.3. Due diligence and risk management ...............172.4. Emergence of domestic LP class ...............17

The LP-GP equation: aligning interests ......................... 18

Regulatory and tax update ...........19

The way forward ..........................20

Global PE landscape .....................21

Foreword Signs of an early ‘off the block’ recovery; outlook cautiously optimistic

After a quiet first three quarters, macroeconomic fundamentals began to recover in India toward the end of the year. The general view is that the worst is behind us, but caution remains due to fears of a ripple effect from a possible global “double dip” in the latter part of 2010.

Aided by government stimulus and insulated by a lower dependency on exports (compared with other emerging markets), the Indian economy appears to be getting back on track with GDP for 2010 forecast to grow at 7.2% (up from 6.7% in 2009).

On the flip side, however, inflation has reached an all-time high of 8.5%. This, coupled with a recovery in economic growth, may put pressure on the Government to roll back some of its stimulus measures. India’s recently released 2010 budget, was well received by most as a well-balanced middle of the path budget focused on long-term growth. It was designed to reduce the fiscal deficit in a calibrated way from 6.9% to 5.5% of GDP, while restoring duties on crude oil, gasoline and other refined petroleum products. While some worry that these taxes will be inflationary in the short term, others believe they are necessary to wean consumers off unsustainable government subsidies. However, when combined with a rebounding economy, a stronger rupee, and a well-timed exit from fiscal stimuli, the proposed measures could support India’s continued growth.

Before the collapse of Lehman Brothers in September 2008, PE grew in India from USD2.5 billion in 2005 (across 151 deals) to a peak of USD17 billion (across 375 deals) in 2007. However, the global crisis took its toll toward the end of 2008 and 2009, as the crisis unfolded and global tremors impacted the Indian economy; 2009 has been the most challenging year for PE activity to date, with PE investment falling to a fifth of its historical peak. With liquidity scarce and PE houses taking a cautious approach, focus shifted from deal-making to preserving portfolio value as PE funds worked increasingly with management to improve operational performance and protect margins and cash.

Encouragingly, however, there are two important emerging trends that should augur well for the future. First, there are signs that PE is rebounding with fourth quarter deal activity and “big bang” deals (underscoring investor confidence) making a comeback. Second, the Indian PE environment is evolving to focus not on just investing but also on successful exits. There were 44 non-IPO exits in 2009 (up from 25 in 2008) worth USD1.2 billion.

Looking ahead, India should continue to see strong PE deal activity, with mainstay growth-stage minority interest deals continuing to dominate. Exits should pick up over the next few years, as firms look to realize profits on investments made between 2004 and 2006. Regulation is also likely to increase to meet global investor demand for more transparency, better risk management, and more sophisticated internal controls.

Draft

PE activity in 2009

1.1. InvestmentsSubdued activity in 2009, uptick seen in last quarter encouraging

2005–2007PE in India grew significantly from 2005 to 2007 as many global PE firms established offices in India, attracted by growth opportunities spread across various sectors. Factors such as a well-established corporate legal system, rich pool of entrepreneurial talent and liquid capital markets made India an attractive investment destination for PE. The country saw record deals of USD17 billion in 2007 — the highest in the Asia-Pacific region. Deal-making, fund-raising and exit opportunities, the three important indicators of any country’s PE health, saw a remarkable year-on-year increase during that period.

Figure 1: PE investments in India (2005–09)

Deal value

Source: Asian Venture Capital Journal and Ernst & Young research

2.4 17.4 10.5 3.57.5

335

180151

306

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02468

101214161820

2005 2006 2007 2008 2009

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Number of deals

After the global turmoilThe collapse of Lehman Brothers and the following global recession significantly impacted the PE environment in India in 2009. PE deal value plummeted 66% to USD3.5 billion from USD10.5 billion in 2008, making it the worst year after 2005. Similarly, deal volumes also saw a major decline to almost half of the 2008 deal volume levels.

However, after being significantly impacted by the global downturn during the fourth quarter of 2008 and the first quarter of 2009, PE deal flow improved from the second quarter, reflecting that India has not only shown the resilience to withstand the crisis, but the ability to emerge relatively unscathed from it. The last quarter saw the most number of PE deals — 51 — and this momentum carried forward into the first quarter of 2010 with 64 PE deals, worth USD2 billion.

Figure 2: PE investments in India (2008–09)

Deal value


Number of deals

4,705

513841

5053

119

79

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1,0001,5002,0002,5003,0003,5004,0004,5005,000

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950967974813 6452,759 2,243

Private Equity in India 2009: year in review2

Figure 3: Top 10 PE deals in 2009

The top 10 PE deals in 2009 accounted for a total deal value of USD1.4 billion, representing 40% of total PE deal value during the year.

Date Target Investor(s) Value (USDm) SectorSeptember 2009 Aricent Technologies Canada Pension Plan Investment

Board and Kohlberg Kravis Roberts & Company

255 Technology

January 2009 S Tel Bahrain Telecommunications and Millennium Private Equity

225 Telecommunications

August 2009 Quippo Telecom Infrastructure

IDFC Private Equity, Oman Investment Fund and SREI Infrastructure Finance


June 2009 National Stock Exchange of India

Caldwell Investment Management 130 Financial services

June 2009 Quippo Telecom Infrastructure

IDFC Private Equity and Oman Investment Fund


December 2009 Max India Goldman Sachs Capital Partners 115 Diversified group

November 2009 Dish TV India Apollo Management India 100 Media and entertainment

October 2009 Ind-Barath Power Infra BVP India Investors, Citigroup Venture Capital International and Sequoia Capital India

100 Infrastructure

September 2009 BP Energy India IDFC Private Equity 95 Infrastructure

March 2009 Essar Power IDFC Project Equity 68 Infrastructure


In India’s largest deal in 2009, the Canada Pension Plan Investment Board and Kohlberg Kravis Roberts & Co (KKR) announced an investment of USD255 million in Aricent Technologies, a communications software products and services provider. This was a follow-on investment, as KKR first acquired a majority stake in Aricent (formerly known as Flextronics Software Systems) in 2006 for USD900 million.

This was followed closely by Bahrain Telecommunications and Millennium Private Equity’s investment of USD225 million in S Tel, a GSM service provider. S Tel has a license to operate in six Indian states — Bihar, Orissa, Jammu and Kashmir, Himachal Pradesh, North East and Assam.


Investment analysis by sector Core infrastructure and telecoms attract maximum capital; deal activity in technology most prolific

India’s infrastructure, telecommunications and technology sectors together accounted for 55% of total announced PE deal value in 2009. In terms of deal volume, technology, infrastructure and financial services were the major sectors with 42% of the total announced deal volume.

134Health care166Industrial products

747Infrastructure693Telecommunications

497Technology281Financial services

210Media and entertainment173Logistics

636Others

Figure 4: Composition of PE deal value by sector (2009)

0 100 200 300 400 500 600 700 800

Deal value (USDm)

31Technology

26Infrastructure

18Financial services

15Telecommunications

12Consumer products and retail

11Industrial products

11Media and entertainment56Others

Figure 5: Composition of PE deal volume by sector (2009)

0 10 20 30 40 50 60

Number of deals

Source: Asian Venture Capital Journal and Ernst & Young research Source: Asian Venture Capital Journal and Ernst & Young research


Infrastructure

Holding down the fort

Based on deal value, PE investment was highest in the infrastructure sector with USD747.5 million in deals accounting for 21% of the country’s total announced deal value in 2009. In the largest infrastructure deal during the year, a group of PE investors, including Bessemer Venture Partners, Sequoia Capital and Citigroup Venture Capital International, announced an investment of USD100 million in the Hyderabad-based power generation company, Ind-Barath Power Infra, for an 18% equity stake. The company plans to utilize these funds for expansion purposes. Currently, Ind-Barath Power Infra has five projects in Tamil Nadu, Maharashtra and Karnataka and is setting up approximately 3,000MW of capacity. Earlier, in 2007, Ind-Barath raised USD61.6 million from Citigroup Venture Capital International.1

Figure 6: Top five PE deals in infrastructure

Date Target Investor(s) Value (USDm)

October 2009 Ind-Barath Power Infra

BVP India Investor, Citigroup Venture Capital International and Sequoia Capital

100

September 2009 BP Energy India

IDFC Private Equity 95

March 2009 Essar Power IDFC Project Equity 68

April 2009 Ashoka Buildcon

IDFC Project Equity 50

October 2009 GMR Kamalanga Energy

IDFC Project Equity and Infrastructure Development Finance Co

48


During 2009, India’s power sector dominated overall PE deal activity within the country’s infrastructure sector and constituted 60% of its total deal value. Within the power sector, renewable energy was popular with PE investors. BP Energy India (a division of BP that holds wind energy assets of 100MW in India), Greenko PLC (a power-producer focused on renewable energy), Soham Renewable Energy and Shalivahana Green Energy were the prominent companies in the renewable energy space that attracted PE investment during 2009.

Trends in infrastructure

During the year, PE investments in infrastructure declined by 62% in terms of deal value and 51% in terms of deal volume from 2008 levels. The average deal size also fell 29% to USD31.1 million, compared with USD43.8 million in 2008. This was primarily due to the overall decline in PE activity in India.

1“Citigroup Venture Parks Funds with Infrastructure Cos.,” Asia Private Equity Review News Flash, 9 July 2007, via Dow Jones Factiva, © 2007 Centre for Asia Private Equity Research.

Figure 7: Trend in PE investments in infrastructure


1,192.6 1,968.8 747.52,265.6

26

48 53 53

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49.3 43.8 31.1 28.4

Average deal size for announced deals, in USDm


Indian PE infrastructure has generated significant interest from global PE firms during the past few years. Approximately USD6 billion has been invested in the Indian infrastructure sector in a total of 180 deals during 2006–09. However, with its underdeveloped and undercapitalized infrastructure, India requires significant impetus to accelerate its growth.

The Government has recognized this need and has already initiated an action plan, which calls for substantial investment in infrastructure and heightened private sector participation in the coming years. According to the Ernst & Young-ASSOCHAM (Associated Chambers of Commerce and Industry of India) survey, The Opportunity Framework, September 2009, the Indian infrastructure sector offers a significant investment opportunity for the PE community. The survey indicated that power, roads, highways and ports have attracted considerable investment-related interest from PE firms.

Going forward, numerous government policy measures, coupled with significant capacity additions by industry players, are expected to catalyze investments in the sector. As more private players enter the business, the sector is expected to evolve further and create attractive investment and exit opportunities for PE investors.

Telecommunications

Large-size deals rule

The telecommunications sector accounted for 20% of the total announced deal value during the year. The sector saw USD693 million of PE investments from 15 deals in 2009. In the largest telecoms deal of the year, Bahrain Telecommunications and Millennium Private Equity jointly acquired 49% stake in S Tel, a GSM service provider, for USD225 million. The deal provides an opportunity for Bahrain Telecommunications to expand its operations in one of the fastest growing mobile markets in the world.

Figure 8: Top five PE deals in telecommunications


January 2009 S Tel Bahrain Telecommunications and Millennium Private Equity

225

August 2009 Quippo Telecom Infrastructure

IDFC Private Equity, Oman Investment Fund and SREI Infrastructure Finance

224

June 2009 Quippo Telecom Infrastructure

IDFC Private Equity and Oman Investment Fund

127

April 2009 Quippo Telecom Infrastructure

Axious Investment 40

March 2009 OnMobile Global Norwest Venture Partners

15


In addition to service providers, the telecoms infrastructure segment has also attracted the attention of PE deal-makers. This was demonstrated when Quippo Telecom Infrastructure, an independent tower rental company, successfully raised three rounds of funding from PE investors, including IDFC Private Equity, Oman Investment Fund and Axious Investment in 2009.

Trends in telecommunications

PE telecommunications deals during 2009 were nearly halved to USD693 million from USD1,412 million in 2008. However, deal volumes did not experience a significant decline, with 15 announced deals in 2009, compared with 18 deals in 2008. In fact, in terms of deal volume, the sector has seen an upward trend over the past four years.


Figure 9: Trend in PE investments in telecommunications


Deal value Number of deals

313.9 83.1 57.7 207.9


1,455.2 1,411.9 692.53,766.7

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2006 2007 2008 2009

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The Indian telecoms sector has witnessed several billion dollar plus PE deals, which have paved the way for large amounts of global PE capital to enter the country’s economy. Temasek Holdings Advisors’ USD2 billion investment in Bharti Airtel in 2007 was the largest PE deal in the Indian telecoms landscape during 2006–09.

Furthermore, large deals have dominated PE activity in the sector, and the average deal size for announced deals exceeded USD50 million during 2006–09. From tower companies, to ancillary providers to value-added service (VAS) providers, PE investors have invested across a range of companies in the Indian telecoms sector.

Going forward, the Indian telecoms sector presents a compelling investment opportunity for the global PE community. The expansion of telecommunications services in rural and semi-urban areas is expected to drive growth in the sector. In addition, the rollout of 3G services will boost growth prospects as 3G presents an opportunity to enhance revenues for VAS providers and other data services. In light of these factors, PE deal activity in the telecommunications space is likely to experience further growth in coming years.

Technology

High on deal count

With 31 deals totalling USD497 million, the technology sector experienced the highest deal volume of all sectors, comprising 17% of the total deal volume and ranking third in announced deal value with a 14% share during 2009. In the biggest technology deal of 2009, KKR and the Canada Pension Plan Investment Board, acquired an additional 15% stake in Aricent Technologies for USD255 million. KKR acquired Aricent Technologies in 2006 in the largest buyout PE deal in India to date.

During the year, smaller deals dominated the technology sector’s deal landscape, with almost 55% of the deals less than USD10 million in value. Barring the Aricent-KKR Canada Pension Plan Investment Board deal, the average deal size during 2009 was approximately USD9.7 million. This suggests that PE and VC firms go for smaller deals in companies operating in niche segments, including internet marketing companies, knowledge process outsourcing, business process outsourcing and internet portals.

Figure 10: Top five PE deals in technology


September 2009 Aricent Technologies

Canada Pension Plan Investment Board and KKR

255

August 2009 Financial Software and Systems

Jacob Ballas Capital and New Enterprise Associates

60

March 2009 MphasiS BFL Baring Private Equity Partners

25

November 2009 Manthan Software Services

ePlanet International Advisors, FIL Capital Advisors, Fidelity India Capital Partners, and IDG Ventures India Advisors

15

September 2009 RT Outsourcing Services

New Enterprise Associates

14



Trends in technology

Compared to the preceding years, 2009 was the worst year for PE activity in the technology sector. From a high of USD1.2 billion in 2006, PE deals reached an all-time low of USD497 million in 2009. Even in terms of deal volumes, activity was subdued, with only 31 announced deals during the year — the lowest in the previous four years. Declining PE activity in the sector over the years may be an indicator that PE investors have expanded their investments to other growing and emerging sectors.

Figure 12: Composition of PE investments bydeal stage (2009)



204 48 1,737 1,109 439

183 9

32

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PIPE Buyouts

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Figure 11: Trend in PE investments in technology




1,265.7 496.5981.4

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40.8 15.1 19.7 19.1

786.1

Investment analysis by stage Growth stage continues to be mainstay of PE activity; buy-out market nascent

Keeping with the trend of the past few years, 2009 was also characterized by a large number of growth-stage deals. Growth capital funding accounted for half of the announced deal value and 66% of the announced deal volume. This is likely to continue in the near future as Indian companies look for capital infusions to fund their expansion plans.

The preponderance of growth-stage deals was closely followed by private investment in public equity (PIPE) deals, which comprised 32% of the announced deal value and 18% of the announced deal volume in 2009. PIPE deals have attracted significant PE interest

as listed companies present a safer option than the majority of unlisted private companies. Notably, private companies are usually not easily accessible as they are either not of optimal size or they form a part of fragmented sectors.

PIPE deals declined 13% to USD1.1 billion during 2009 as compared with USD1.3 billion in 2008. This is primarily due to the overall decline in PE activity in 2009 from the global financial turmoil. Further, in the absence of robust PE participation, listed Indian companies looking for fund-raising opted for qualified institutional placements (QIPs) to fund their expansion plans, since Indian companies find them easier to execute and less risky in terms of price assurance. A total of USD8.6 billion was raised through QIPs in 54 deals through 2009.

However, the last quarter of 2009 witnessed a slight increase, with PIPE deal activity gaining momentum during this period. In some of the prominent PIPE deals in the fourth quarter of 2009, leading PE players such as Bain Capital, Goldman Sachs and Apollo Management acquired stakes in listed Indian companies.

Further, as India continues to be a fundamental growth capital market, buyouts have still not become important to those PE firms investing in the country. During 2009, a total of USD439 million was invested in nine deals. However, while minority deals are likely to continue to be the sector’s mainstay, in the long term, buyouts are expected to become more common.


Investment analysis by deal size Cautious wait and watch approach through most part of 2009; mid-sized deals continue to dominate

After reaching an all-time high of USD53 million in 2007, the average PE deal size in India has experienced consistent decline. In 2009, the average PE deal size fell nearly 40% from 2008 and 57% from 2007.

Figure 13: Trend in average deal size of announced deals (USDm)


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38.7

23.1

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2006 2007 2008 2009

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Deals amounting to less than USD10 million accounted for the lion’s share of total announced deal volume during 2009. Notably, deals in this range comprised 52% of the total announced deal volume, the highest in the last four years (39% in 2008, 34% in 2007 and 46% in 2006). Among a total of 17 deals, large-size deals (more than USD50 million) accounted for 11% of deal volume, a significant decline when compared with 2008. (Such deals were close to 20% of the total announced deal volume in 2008.)

Figure 14: Composition of total deal volume by deal-size category


119

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Less than USD10m

USD11-20m

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1.2. ExitsMore exits with smaller deal values; PE-backed IPO activity lowest in past four years, due to meltdown of capital markets

There were 44 PE-backed exits that occurred outside of the normal IPO route in 2009. This was considerably higher than the 25 non-IPO exits that PE firms performed in 2008. The increase was primarily due to increased buoyancy in the Indian stock markets, which witnessed a more than 80% increase from 2008

2006 2007 2008 2009

Figure 15: Trend in non-IPO exits

Trend in non-IPO exits Composition of non-IPO exits (2009) (in %)

59

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13,787 20,287 9,647

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Number of exits Sensex

Infrastructure Real estate, hospitality and construction

Industrial products Others

Financial services Technology

Media and entertainment


30

1816

11

11

7

717,465

lows. From a sectoral point of view, the infrastructure sector was the most active, with 30% of the total non-IPO exits obtained by PE firms (as PE invests heavily in the infrastructure sector.)

In the largest non-IPO exit, D.E. Shaw India Advisory Services exited from DLF Assets in a deal valued at USD500 million. Other prominent non-IPO exits included ICICI Venture Funds Management’s USD79.7 million exit from Vetnex Animal Health (one of the leading players in the Indian animal healthcare market) and ChrysCapital’s USD60.7 million exit from Shriram Transport Finance (a truck finance firm). Notably, PE players such as ChrysCapital, Citigroup Venture Capital International, IL&FS Investment Managers and Sequoia Capital executed multiple non-IPO exits during 2009.

10

Figure 16: Trend in non-IPO exits


2,163 1,933 3,168 1,232

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PE-backed IPOs

A total of USD1.3 billion was raised by PE-backed companies through just seven IPOs in 2009, the lowest number of PE-backed IPOs in the last four years. In the largest PE-backed IPO, Adani Power, backed by 3i Group, raised USD625.8 million in August 2009. In another IPO, Farallon Capital Management and LNM Internet Ventures-backed Indiabulls Power raised USD329.3 million in October 2009. Interestingly, power sector companies dominated the PE-backed IPO space and accounted for roughly 72% of the total funds raised through IPOs during 2009.

Figure 17: Trend in PE-backed IPOs — for the year 2008


Value (USDm) Number of IPOs

3,051 2,657 1,332

21

28

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1.3. Fund-raisingIndia increasingly becoming an integral part of the Asia fund-raising story

PE fund-raising in India declined by 62% to USD3 billion from USD9 billion in 2008 as investors became selective and limited partners (LPs) as well as general partners (GPs) realigned their interests. However, since 2005, fund-raising activity has been on the rise in India compared with the rest of Asia — from just 9% in 2005 to 21% in 2009, indicating India’s increasing attractiveness for PE investments compared to the other developing Asian countries.

Figure 18: Total PE funds raised

Source: Asian Venture Capital Journal

2,6837,085 6,644 8,753

3,345

29,304 47,306 58,210 50,582 16,235

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During the year, EMPEA/Coller Capital Emerging Markets Private Equity Survey, 2009 reinforced India’s position as an attractive investment destination for global PE investors. The survey captured the views of 156 PE investors worldwide on investments in emerging economies. According to the survey, India was ranked third among developing economies in terms of attractiveness for investment over the next 12 months. .

On the back of strong underlying fundamentals and economic growth, coupled with signs of improving liquidity globally, LPs are expected to gradually increase their allocations to the PE asset class. For them, India is becoming a favored investment destination over other emerging markets.

Figure 19: Announced plans of new PE funds in 2009

Fund name Focus sector Target fund size (USDm)

Multiples Alternate Asset Management

Sector agnostic 400

Akansa Capital Sector agnostic 300-400

Principle Europa Indian Infrastructure Fund

Infrastructure 300

Avendus NA 220

Aditya Birla PE Sector agnostic 200

Catamaran Investment Health care, retail and technology

130

Advent International Sector agnostic NA

OrbiMed Health care NA

Sources: Dow Jones Factiva, ISI Emerging Markets and Ernst & Young research

Domestic funds were on the increase in 2009 as several corporate entities set up their own PE funds:

fi Aditya Birla Private Equity, the PE arm of the Aditya Birla • Group, raised USD100 million of the targeted USD250 million at the end of 2009. It also plans to launch at least four more PE funds, each amounting to USD400–500 million over a period of five years.

Vivek Paul, the former Vice Chairman of Wipro and former • partner at TPG Capital, has launched his own fund, Akansa Capital, with a fund-raising target of USD300–400 million.

fi N R Narayana Murthy, Chief Mentor of Infosys Technologies, • has launched a new venture capital fund, Catamaran Investment, which has capital of approximately USD130 million and will invest in health care, retail and technology companies in India.

Key new funds have entered India

During the year, several global and domestic PE firms set up shop in India. These include renowned firms including Advent International (a fund with approximately USD24 billion under management), OrbiMed (a US-based health care-focused global PE fund with approximately USD5 billion in assets under management) and PE Indian Infrastructure Fund (a fund sponsored by two Europe-based financial groups, Principle and Europa).


These will join the domestic PE community, which includes PE firms established by the Indian corporate houses such as Wipro Chairman Azim Premji, Anil Ambani, the TVS family, the Future Group and the Tata Group. These domestic funds are attracting the interest of a number of financial institutions (FIs), as these FIs have legacy relationships and significant exposure to their parent corporate business.

Top PE funds raised during 2009

Although 2009 was a challenging year for PE organizations, proven funds with a successful track record were able to raise capital. Furthermore, with several infrastructure-focused funds created, the sector was in favor among several PE firms. Well-known global PE organizations that successfully raised funds during the year include TA Associates, Norwest Venture Partners, Actis, India Value Fund Advisors, IL&FS Investment Managers, NYLIM Jacob Ballas and ICICI Ventures.

Figure 20: Top PE funds raised during 2009

Name Focus sector Geography Fund size (USDm)

TA Associates Health care, media, technology

Global (with focus on India)

4,000

Norwest Venture Partners

NA India, China 1,200

Actis Infrastructure Emerging markets including India

750

India Value Fund Advisors

NA India 725

StanChart-ILFS Infra Fund

Infrastructure India, China 640

NYLIM Jacob Ballas India Fund III

NA India 440

ICICI Venture (IAF III)

Infrastructure India 350

Sources: Dow Jones Factiva, ISI Emerging Markets and Ernst & Young research


Key trends in 2009

Marked with a changed macroeconomic environment, PE activity in India went through several interesting trends through 2009. From a rise in co-investments to increasing focus towards due diligence and risk management, 2009 saw new themes emerging as PE firms adapted to the aftermath of the global turmoil. Furthermore, relatively recession-proof sectors such as education and health care garnered significant PE interest.

2.1 Rise in follow-on and co-investmentsFollow-on investments, coupled with co-investment, were the key themes observed during 2009. The increasing trend of follow on investments, specifically after the credit crisis, has been driven by PE firms working to help their portfolio companies withstand the downturn and gain an advantage from the fall in valuations. Leading PE houses such as Blackstone, KKR, 3i, ICICI Ventures and Kotak Private Equity announced their follow-on deals in 2009. In addition, co-investments became popular as a risk-mitigation strategy in 2009, even in the case of medium-sized deals. Shrinking risk appetite, coupled with capital preservation as the primary motive, resulted in PE players coming together and joining hands to pick up stakes in companies.

2.2 Emerging sectorsSeveral sectors, such as education, health care, cleantech and microfinance garnered PE attention in 2009 due to their relatively immunity to the economic downturn, as well as their high-growth potential. Other emerging sectors include power and roads and highways, which are high on the government agenda and consumption-focused sector, which is correlated with Indian economic growth.

Education: on the learning curve

From USD12 million in PE funding in 2008, the education sector attracted close to USD120 million, with an average deal size of USD15 million, in eight deals during 2009. PE players invested in technology-based education infrastructure companies and training institutions or coaching classes. Some notable deals

during 2009 include Navis Advisors’ USD30 million investment in Edutech and Matrix India Asset Advisors’ USD20.5 million investment in FIITJEE. The increasing interest of PE players towards the sector is primarily driven by the significant demand-supply gap that exists in it. Currently, India has an undercapitalized education sector. A burgeoning middle class and a large young population have resulted in an increasing need for professional educational services (coaching classes, IT training and e-learning). This imbalance between the number of people

to be educated and provision of education services has created significant opportunities for investment in education companies in India.

Going forward, the sector has the potential to attract investment of around USD100 billion over the next five years,2 and PE investors are expected to play a key role in this expansion. According to Ernst & Young’s Private enterprise in Indian higher education report, the sector’s ability to withstand a downturn in the economy, predictability of cash flows and low dependence on working capital makes it attractive for potential investors.

2 “USD100 billion of investment potential in Indian education sector,” Asia Pulse, 12 January 2010, via Dow Jones Factiva, © 2010 Asia Pulse.


Health care: scaling new heights

As the demand for quality health care services increases, PE investors are also looking to acquire interests in hospital chains and diagnostic centers. The sector experienced a total of USD134 million of investment, comprising an average deal size of USD17 million in nine deals in 2009. Hospitals and hospital chains have been the primary beneficiaries of PE funding and companies such as Nova Medical Centers, Max India and Kavery Medical Center and Hospital successfully raised PE funding in 2009.

Currently, the health care space in India is characterized by its inadequate infrastructure, a significant rural-urban divide and private spend of 80%. This calls for a massive increase in the participation of private sector players. Going forward, India’s health care services market is expected to grow from INR1,513 billion in 2007 to INR2,654 billion by 2012. Of this, the private health care sector is expected to contribute INR1,560 billion from INR690 billion at present.3

Cleantech: lighting India

The year 2009 has also seen the rising interest of PE houses in the renewable energy space. PE firms have invested close to USD185 million in a total of five deals in the renewable segment during 2009, with an average deal size of USD37 million. A substantial shortfall in power supply, the depletion of fossil fuels and concerns related to energy security have been the key factors responsible for driving PE investors toward this sector. Several PE firms, such as Wolfensohn Clean Energy Fund, South Asia Clean Energy Fund, IDFC Private Equity, Global Technology Investment Group, Ashmore Climate Change Capital and FE Clean Energy are looking at deals in the renewable energy space in India. In addition, various sector-agnostic funds such as Morgan Stanley, Citigroup Venture Capital International, Axis Private Equity and 3i Group have also made investments in Indian renewable companies in the past.

3 “Healthcare Services,” Centrum Research, June 2009, via Thomson Research.

Figure 21: Investment drivers for PE investments in health care

Transitioning demographics

Demand-supply imbalance

Need for private sector players

• Growing population• Rising income levels• Rising lifestyle-related diseases

• Inadequate health care infrastructure

• Lack of skilled manpower

• Under penetration• Low health care expenditure• Need for quality health care• Medical tourism also an

emerging business segment

Private equity investment opportunity


According to an Ernst & Young report in 2009, Cleantech in India: tapping the potential, India has emerged as a global hotspot for cleantech activity over the past few years, primarily due to the country’s growing energy needs and the escalating cost of conventional energy sources. Furthermore, technological advancements, coupled with favorable government policies, are driving both domestic and international private sector investments in cleantech.

The sector is poised for robust growth, given the Government’s ambitious capacity expansion and investment plans. The Government has proposed capacity additions of 15,000MW in the renewables segment during the Eleventh Five Year Plan period (FY07–FY12), with an investment requirement of around INR104.6 billion. Carbon trading may emerge as another potential growth driver for the sector in the near future.

Microfinance: Tapping the bottom of the pyramid

India’s microfinance sector has witnessed substantial growth in the past few years, aided by two underlying factors. The first is the expanded reach of microfinance institutions (MFIs) and the establishment of a pan-India presence. The second is the increased participation of PE funds and banks. As these entities brought in more funds, the microfinance sector integrated further with capital markets worldwide. PE firms such as Aavishkaar-Goodwell, Lok Capital, Unitus Equity Fund, Bellwether and Grammen Capital India have been active and have invested in the country’s microfinance space. During 2009, MFIs including Asmitha Microfin, Asirvad Microfinance and Bhartiya Samruddhi Finance also raised PE funding.

The low penetration level of financial services provides tremendous growth opportunities. Recent statistics4 support the increasing need for financial services to penetrate into rural India.

Sixty-five percent of the Indian population • does not have a bank account.

Twenty-seven percent , or 300 million people in India live • below the poverty line (earn less than USD1 per day).

Eighty-seven percent of the country’s poorest households do • not have access to easy credit.

Seventy percent of the rural poor do not have a • savings account.

This is likely to increase the investment potential of the microfinance sector for PE investments in India.

Power

A significant demand-supply gap is expected to continue until 2017 in the Indian power sector. The Government has initiated various reforms to meet this rising demand and address the acute power shortage in the country. Furthermore, the private sector is also increasing its involvement to address India’s chronic power shortage issues. Driven by the significant investment opportunities offered by the sector, PE investors are expected to add in additional funds, thereby feeding the expansion plans of private players. In addition, players in the cleantech and renewable energy segment are also expected to benefit from the enhanced interest of the PE community. Factors such as rising energy demand, technological improvements, depleting fossil fuel reserves and global warming concerns are driving the development and usage of renewable sources for power generation, boosting the investment potential of the sector.

Roads and highways

Although India has a widespread road network, spanning around 3.3 million km, there is still a shortage of good quality roads, primarily due to the lack of funds and low standards of construction. There is a compelling argument for increasing investment in the sector, specifically through public-private partnerships. Furthermore, the Government has undertaken several initiatives such as the launch of the National Highway Development Programme and the Pradhan Mantri Gram Sadak Yojana to improve and maintain roads in the country.

4 “Guide to Microfinance- India,” Research on India — Netscribes, July 2009, accessed via ISI emerging markets.


PE firms have been substantial investors in the Indian road sector. This momentum is likely to be maintained as PE players continue to provide growth capital funding to companies for expansion in the sector. There are a large number of opportunities relating to construction companies, highway holding companies and individual road special purpose vehicles. The Government is also encouraging private participation as indicated by the Road Transport and Highway Minister Kamal Nath who initiated a global campaign to attract global investment in the Indian road sector in 2009.

Domestic consumption-focused sectors

There have been two primary drivers for the PE community to invest in domestic consumption-focused sectors. First, these sectors have been relatively insulated from the shocks of the economic crisis, and provided a cushion for PE investors during tough times. Second, growth in these sectors is directly linked to economic development and the country’s favorable demographics. As the economy charts higher growth paths, the demand for consumer products, consisting of personal care products, soaps and detergents and food, is expected to increase. In addition, on the back of a burgeoning middle class and higher disposable incomes, the demand for consumer services such as beauty salons, centralized cab services and restaurants, and entertainment businesses such as multiplex chains and amusement parks is expected to grow.

5 “Domestic investors emerge as show-stoppers,” Mint, 29 September 2009, via Dow Jones Factiva, (c) 2009. HT Media Limited.

2.3 Due diligence and risk managementIn 2009, PE firms began to focus more on risk management while making new investments. The due diligence process became more rigorous, substantially increasing deal closure times. Further, PEs worked more closely with investee companies to improve their operational performance and enhance their value to reduce the adverse effect of the global downturn. Consequently, PE players began hiring industry experts with operational experience as “operating partners” to help them achieve this objective. In fact, 2009 saw PE firms looking to industries such as manufacturing and services for CEOs, managing directors and other senior executives.

In addition, due diligence assumed more importance during the year as PE firms were focused on robust risk management functions, while evaluating PE investment decisions. Going forward, risk management will continue to be an area of focus as PE firms become more careful in their approach after learning from the ramifications of the credit crisis.

2.4 Emergence of domestic LPs as a source of capital The PE industry in India has been primarily dominated by foreign LPs, but tight global liquidity conditions during 2009 made these investors cautious about new commitments to Indian funds. 2009 saw the rise of Indian LPs comprising banks, insurance companies, pension funds and high net worth individuals as important sources of capital. In addition, PE firms including ICICI Venture, Reliance Private Equity, Milestone Religare Investment Advisors, HDFC Property Ventures, IL&FS Investment Managers, Kotak Realty Fund, Tata Capital and Piramal Real Estate Fund announced their plans to raise domestic capital.5


The LP-GP equation: aligning interests

The economic downturn of 2008 did not just affect the global PE industry, but also LPs that invest in PE funds and GPs that manage these funds. The downturn has resulted in a rebalancing of the relationship between LPs and GPs, with LPs becoming more selective in their approach when choosing GPs.

According to Ernst & Young’s 2009 report, Shifting sands: Limited partners’ perspectives on the future of private equity, it is likely that LPs are interested in partnering with a smaller number of GPs with strong investment strategies, unlike their previous approach of “more is better.” In terms of management fees, even the best GPs in the industry are likely to face pressure on the traditional 2% management fee/20% carried interest fee model. Furthermore, management fees are expected to experience downward pressure and are likely to go below the 2% mark.

The past few years have seen a distortion in the way GPs and LPs have been aligned, resulting in disparity between the risk exposure and returns enjoyed by GPs compared with LPs. After the credit crisis, LPs are expected to realign this gap and are likely to formulate partnership agreements that equalize their treatment of LPs and GPs. Furthermore, communication between LPs and GPs is expected to improve. Moreover, as an after effect of the crisis, LPs are likely to keep a close watch on information flows to closely monitor their portfolio performance

ILPA principlesThe Institutional Limited Partners Association (ILPA), a global organization dedicated to the interests of institutional limited partners in PE, has published a set of principles and best practices in PE partnerships known as the ILPA principles. These principles are intended to promote leading practices and unified terms. According to these principles, several terms and conditions that that have been in place for quite some time now require renewed attention in PE partnership agreements. The principles revolve around three major guidelines — alignment of interest, governance and transparency.

Alignment of interest:• Management fees should cover the normal operating costs of the firm and these costs should not be excessive. GPs should have a substantial equity interest in capital commitment, with a higher percentage in cash, and there should be tighter provisions to avoid profit distribution imbalances between GPs and LPs.

Governance: • LPs should have stronger rights. Partners should have the ability to elect to dissolve a fund or remove a GP without cause. The auditor of a fund should be independent, and the meetings, processes and procedures of limited partner advisory committees should be standardized across the industry.

Transparency:• GPs should be transparent while providing details to investors about fees and carried interest calculations as well as detailed valuation, and financial information related to portfolio companies should be made available, as requested, on a quarterly basis.

As a result, in future, LPs will expect GPs to form closer relationships with them (to enhance information flow and transparency). The former require increased communication and detailed information to monitor their portfolio performance. Most importantly, LPs seeking increased communication is an indication of their desire for enhanced transparency and closer alignment of their objectives with that of GPs.


Tax updateThe significant tax-related development was the release of Direct Tax Code (the code). The code is proposed to come into effect from 1 April 2011 and it would replace the Income Tax Act of 1961. Key provisions from the code are:

Companies (including foreign companies) will be taxed at 25%. At present, • Indian companies are taxed at 30% and foreign companies are taxed at 40%

Companies having even partial control or management in India would be • considered as resident in India

Income arising from indirect transfer of capital assets situated in India is • deemed to accrue or arise in India

Neither the code nor the tax treaty will have a preferential status. And in the • case of a conflict between the two, the latter in point of time shall prevail

Regulatory updateSeveral regulatory developments were initiated by the Government of India. Key updates related to foreign investments include:

Increase in cumulative debt investment limit by USD9 billion (from • USD6 billion to USD15 billion) for foreign institutional investor (FII) investments in corporate debt

Firm commitment requirement for registration as foreign venture capital • investors

Modification in the reporting mechanism for foreign direct investment • in India — transfer of shares/preference shares/convertible debentures (together called equity instruments) — by way of sale

Other regulatory developments include:

Notification from Stock Exchange Board of India (SEBI) regarding delisting of • equity shares

Amendment of SEBI Takeover code for application of open-offer obligations • in case of American Depository Receipts (ADR) and Global Depository Receipts (GDR)

Notification from SEBI for issue of capital and disclosure requirements • regulations 2009 (ICDR Regulations), which rescinded the SEBI disclosure and investor protection guidelines 2000 (DIP guidelines)

Reserve Bank of India released guidelines for issue of Indian • depository receipts

External commercial borrowing (ECB) policy also modified and there has • been a withdrawal of relaxation in all-in-cost ceilings for ECBs

Regulatory and tax update


The consistent improvement in the macroeconomic environment of the country during the latter half of 2009 suggests that the process of recovery is slowly but surely gaining ground. Corporate earnings reports are sending out a positive message, stock markets are regaining their 2007 levels and GDP numbers are steadily climbing. Other growth indicators, including industrial production, exports and core sector growth signal that the economy is doing better than expected. FIIs are also, after their flight last year, coming back and investing in India. FIIs have invested a total of USD16.8 billion in domestic equities in India in 2009, the highest-ever inflow into the country in rupee terms in a single year.6

As we move into 2010, the sanguine outlook for India’s economic environment is likely to be reflected in the country’s PE deal landscape. The optimism stemming from India Inc.’s ability to withstand the economic crisis is expected to further fortify the investment in PE as an asset class. Fund-raising activity is also expected to gather pace as investor confidence rebuilds and liquidity increases. PE deal flow is expected to improve further as many global PE firms, sitting on dry powder (money ready to invest), will actively invest to multiply their portfolios.

Deal-making will be more prevalent in the traditional middle market (i.e., deals from USD10–30 million). In 2010 we expect to see PE firms attracted to infrastructure enablers and domestic growth sectors. An increase in domestic consumption, primarily on account of a burgeoning middle class and a growing population, is expected to drive cross-sector growth rates in the country. Thus, domestic consumption, core infrastructure sectors (power and roads), financial services including microfinance, and underserviced sectors (e.g., health care and education) are expected to see higher PE activity.

On the exit side, the momentum seen throughout 2009 is likely to be maintained in 2010. Given the recent rallying around the country’s capital markets, PE investors are expected to make the most of this opportunity and make some meaningful exits.

The outlook for PE activity in India is favorable. With the strong fundamentals of the economy, coupled with recent indicators of recovery, PE activity in India is expected to have an upward trend, and PE firms will become increasingly more active in their investee companies, in order to unlock the value of their investments.

6 Jitendra Sanghvi, “Optimism in the air,” Corporate India, 15 January 2010, via ISI Emerging Markets.

The way forwardOutlook cautiously positive after encouraging macroeconomic fundamentals and investor sentiment


Globally, PE firms made 1,612 acquisitions in 2009, a 36% decrease from 2008. The average size of an acquisition in 2009 was smaller — USD100 million versus USD158 million in 2008 — as total deal value fell 56% to USD95.5 billion. While there were fewer buyout deals during 2009, minority investments as a percentage of total acquisitions rose from 45% to 50%, even as the value of such transactions fell from USD57.7 billion to USD21.9 billion.

However, annual data masks the real story of 2009. The long retreat that began in the summer of 2007 ended as a comeback that began in the third quarter and gained strength as larger deals were announced toward year-end. Globally, transactions worth USD39 billion were announced in the fourth quarter, up from USD24 billion in the third quarter, and more than double the USD18 billion announced in the fourth quarter of 2008.

Driving this recovery is the renewed willingness of banks to underwrite debt. Bloomberg reported that global high-yield debt issuance nearly tripled last year to USD210 billion, from USD74 billion in 2008. PE firms, particularly those in the US, used their share of new issues to replace existing portfolio company debt, gaining critical debt extensions in the process. The use of newly issued high-yield bonds to refinance leveraged loans is expected to continue through 2010 as interest rates on government bonds are expected to remain low, causing investors to seek higher yields.

Leveraged loans used to finance new acquisitions bounced back in the fourth quarter. While Thomson Reuters reports that new issues in the US totaled USD80 billion in 2009, nearly half of that total — USD37 billion — was issued in the fourth quarter, up from just USD14 billion in the third quarter and USD21 billion in the fourth quarter of 2008. Financing for new acquisitions should increase gradually in 2010, barring major banks being hit with defaults on government and commercial debt in Greece and, possibly, Spain. Liquidity also returned on the sell side.

The recovery of worldwide stock markets restored the IPO as a viable exit strategy in the US and Asia. PE sponsors brought 53 new companies to market in 2009, raising proceeds of USD16 billion, compared with USD11 billion in 2008. Only three of these IPOs occurred in Europe, while 25 took place in both the Americas and in the Asia-Pacific region. While trade sales fell sharply last year to USD65 billion from USD140 billion, they have increased steadily since bottoming out in the first quarter of 2009, as bid-ask spreads between buyers and sellers narrowed.

PE firms continued to focus on preserving portfolio company value as operating excellence replaced financial engineering. Over the last few years, larger firms have concentrated on hiring operating partners and managers to focus on improving their portfolio companies. They have also tapped former executives of global Fortune 500 and other multinational companies, along with a coterie of ex-management consultants, to serve as senior advisors. These executives, who have years of strategic and operating experience, have been invaluable in helping struggling companies streamline operations, improve their working capital, ease their financial situation and position themselves for growth.

Fund-raising will continue to be a challenge for the next 12 to 18 months. With Preqin reporting that PE firms had USD500 billion in uncommitted capital waiting to be deployed at the end of 2009, one of the biggest challenges may be finding quality targets. That said, firms closed USD234.9 billion worth of funds, 60% less than in 2008. As limited partners continue to demand better returns and more transparency, competition among general partners will heat up, even as investors — who sat on the sidelines last year — prepare to commit more capital, according to a recent Preqin study. Mid-sized buyout, distressed debt, secondary, and emerging market funds focused on China, India and Brazil may garner increased interest.

While 2010 should be a better year than 2009 on all fronts, regulatory reform is a major uncertainty that could slow the industry’s recovery. The EU’s proposed directive on alternative investment fund managers (AIFM) will dramatically affect both European and foreign firms operating in the EU. Increased capital requirements in many markets could adversely affect lending, as could the “Volcker Rule” in the US, which would force banks to sell their PE operations and the income streams they provide. Evolving tax rules in many jurisdictions could affect returns, as deficit-ridden governments seek to increase their tax revenue.

During the first three months of 2010, global PE firms have announced 358 transactions valued at USD27.0 billion, compared with 415 transactions priced at USD17.0 billion for the same period in 2009. While the average deal size, where the value was disclosed, for those three months rose to USD157 million from USD70 million last year, it remains far below the pre-recession high of USD706 million in the second quarter of 2007. This year is looking to be an intriguing year with global PE activity on the rise.

Global PE landscapeNew horizons emerge

While 2009 was a challenging year for PE on all fronts, it has offered a window into the industry’s flexibility in adapting to a changing economic environment. The year 2010 is already exhibiting more robust global PE activity as funds look to invest and divest in a more stable economic setting, according to our report, 2010 global private equity watch: new horizons emerge. The following is an extract from this report.The full report is available online: http://www.ey.com/GL/en/Services/Specialty-Services/ Private-Equity/2010-global-private-equity-watch--new-horizons-emerge.


• Private Equity in India 2009 : year in review is based on Ernst & Young’s analysis of announced PE deals and other PE-related news and information reported in secondary sources and the Asian Venture Capital Journal (AVCJ).

• Deal values used in this document are as provided by AVCJ.

• The deals have been reclassified, wherever required, based on Ernst & Young’s sector classification policy.

• “PE-backed IPO” represents an unlisted PE investee that has become publicly listed subsequent to the investment by the PE fund.

• Non-IPO exits include: public market sales, secondary sales (sale by one PE fund to another PE fund), strategic sales (sales by one PE fund to a strategic investor) and buybacks.

Methodology

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EYG no. FR0007 Private Equity in India 2009 year in review

Artwork by Deepti Khatri.

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

Private Equity in India 2009

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