VC-Magazin: How would you describe the current state of the Indian economy?
Meghraj: Growth rates remain high, which is giving corporate India a widespread sense of confidence across most sectors. The middle class is constantly growing in size and disposable income, and the economy in general is still in a very strong condition. The changes that have taken place over the last few years are fundamental and would be hard to reverse; the momentum that India now has is robust.
VC-Magazin: What are the main growth drivers in India?
Kohli: Mostly consumer demand, the emergence of a very large middle class and the young population, which has helped India to grow very rapidly. I don’t know if India will continue to grow at 8, 9, 10% annually, but its growth will continue to be very rapid.
VC-Magazin: Which obstacles do you see that could hamper further economic development in the future?
Kohli: There are two big things. One is obviously infrastructure, which is still very poor in large parts of the country. Secondly macroeconomic factors could impact growth because India is still running a current account deficit and political uncertainties do still exist.
VC-Magazin: How far developed is private equity in India?
Meghraj: Private equity is well developed in India. There is a visible market of domestic funds as well as a strong presence of larger foreign funds. It is absolutely usual for Indian companies to be knowledgeable about this asset class and to use it as an alternative to going public or as a step before an IPO. I am convinced that in the future we will see a growing number of Indian funds investing overseas, which so far has only happened in very few cases.
VC-Magazin: How does a private equity transaction typically proceed in India?
Meghraj: Indian companies tend not to like auctions, whether it is an M&A-transaction or a private equity deal. They are more comfortable with one on one negotiations. The process, which usually takes between four and nine months, typically begins with talking to a few funds. Companies will look for a fund where there is a high comfort level between the people involved as well as a sympathy and understanding of the strategy for the company. What sellers are increasingly looking for is an added value other than just money, which is becoming a commodity due to the high interest in India. This could be in terms of industry experience, overseas relationships, or the ability to bring in new clients or partners.
VC-Magazin: Which steps should an international private equity firm take before investing in India for the first time?
Meghraj: It is much better to actually have your own people on the ground, or to work with somebody who is based in India and understands the market. It is quite difficult to come in cold and assess an opportunity correctly. I would recommend several trips to India and to meet as many companies as possible to get a feeling of local idiosyncrasies and how managements think and operate.
VC-Magazin: Company valuations in India have risen sharply. Is the risk-/return-profile still reasonable?
Kohli: In many cases it is not the right time to buy at the moment. However, there are still certain attractive sectors. Export oriented companies and businesses with good franchise-values and high consumer demand are still worthwhile looking at. Financial services have also seen very rapid growth. Demand for consumer credit and financial products increases exponentially in India, which provides an excellent opportunity for investors. A typical price-earnings-ratio for a financial institution in India at the moment would be 15. This ratio has gone up four to five multiple points over the last couple of years.
Meghraj: Some companies are trading at very high multiples, which seem hard to justify. Whether the risk/return profile is reasonable from an investment perspective will depend on the plans and motivation of the buyer. In very broad terms, some indications of the valuations at which M&A transactions are taking place are: manufacturing industry: 6-8x EBITDA for mature businesses, and 9-11x EBITDA for growing businesses. In the service industry: 8-10x EBITDA for mature businesses, and 11-13x EBITDA for growing businesses. However, transactions are sometimes taking place at much higher valuations, and we can conclude that beauty is in the eye of the beholder: Sometimes higher valuations are acceptable if a buyer finds a way of creating value which other firms cannot take advantage of, for example using an existing infrastructure to introduce new products, bringing in new clients, or integrating with an existing business. Some of the large international corporations see a strategic value in getting into India as quickly as possible. They are for example prepared to pay a high price for a distribution network in India which would take very long to build from scratch.
VC-Magazin: Which rate of return should be achievable for a 2007 vintage year growth capital fund in India?
Kohli: 20%.
VC-Magazin: Is it easy to buy a majority stake in Indian companies?
Kohli: Indian companies grow at a very high rate of often more than 30% per year, thus most entrepreneurs do not want to sell their businesses. 90 to 95% of the time private equity firms are taking a minority stake when they invest in a company in India. This makes India an unattractive market for buyout-funds, but rather attractive for growth capital.
Meghraj: In my experience, nowadays Indian owners are much more open than earlier to selling their businesses. The social stigma that used to be attached to selling a business no longer remains and business owners are becoming more pragmatic and less sentimental. A common occurrence is to have a staged sale if the seller understands the value an acquirer can bring to the business. They may sell a majority of the business initially, and remain as a minority shareholder, selling down their remaining shares in a pre-agreed manner.
VC-Magazin: What is your outlook for the Indian M&Amarket in 2008?
Meghraj: Our overall view is fairly optimistic. The growth of the Indian M&A-market – both inbound and outbound – has been enormous over the last couple of years and is likely to continue. The number of transactions, for example, has grown from 467 in 2005 to 480 in 2006 and 460 in the first 8 months of 2007. Deal value, which was about USD 20 billion in 2006, had already reached USD 48 billion in the first eight months of 2007. Due to the subprime crisis in the US there might be a slowdown at the large end of the market where sizeable external funding is required, but a lot of Indian M&A in midsized companies is driven by the strength of the Indian economy and the profitability of those companies. We therefore expect both Indian companies to continue to buy overseas, in particular in Europe and the US, and for overseas companies to continue to buy into India, because for many such companies not being in India is no longer an option.
VC-Magazin: Thank you for sharing your views on India!
Editorial remark: Both interviews have been conducted separately.
The dialogue partners
Gulpreet Kohli is Principal at ChrysCapital, New Delhi, India. ChrysCapital manages USD 2.25 billion across five funds and typically invests USD 30 to 300 million in equity per deal across all growth sectors in India.
Binoy R V Meghraj is Chairman of Meghraj SP Corporate Finance (Private) Limited. The firm is an investment banking boutique servicing clients across India. It is headquartered in Mumbai and maintains a regional office in Ahmedabad.
