Indian investors frustrated by red tape

Economic growth rates of near 9 per cent in India are reviving interest in Asia’s third-largest economy among private equity groups. However, they warn that delays in project execution and high valuations are hobbling investment in a market dominated by family-owned companies.

Venture capital and private equity fund flows are forecast to reach as much as $17bn this year in India, Asia’s most volatile market for this investment class.

That would be near the pre-financial crisis high-water mark of $19bn in 2007 and more than four times 2009 levels, according to a study by Bain & Co, the consultancy. In two years, private equity market growth could exceed 25 per cent as investments flow into badly needed infrastructure development.

One of the latest signs of this trend was the decision by 3i, the UK private equity group, to set up a £1.5bn ($2.3bn) infrastructure fund for India next year, targeting investments in ports, roads and power.

However, the bulk of private equity money is coming from the US.

In the five years to 2009, close to $50bn in private equity investment was made in 1,400 Indian companies, with high-profile deals and divestments involving the likes of KKR, Singapore’s Temasek, Providence Capital, TPG Capital and WL Ross & Co.

The growth of Bharti Airtel, Idea Cellular, infrastructure group GMR and SKS Microfinance enjoyed considerable support from mainly foreign private equity investors. Successive investments in Bharti Airtel helped it become India’s largest mobile network: Warburg Pincus invested $290m in 1999, CVC International $210m in 2004, and Temasek $2bn three years ago.

Real estate and pharmaceuticals have traditionally attracted private equity but power and energy, automotive, textiles and entertainment and hospitality are now drawing interest.

But although a fast-growing economy is providing momentum, execution risks and a lack of skills particularly at the middle management level have weighed on private equity transactions.

Though India became the largest market for private equity in Asia in 2007 and 2008, activity there has been far more erratic than in China. In contrast to China’s state-dominated economy, India has a fluid small-business culture that responds quickly to booms but is more precarious when growth falters.

Deal activity in India was the most volatile in Asia in 2004 to 2009, reflecting a turbulent entrepreneurial business environment.

According to Bain, private equity in China grew at a 39 per cent rate compounded between 2004 and 2008, about half the pace of India’s private equity growth rate. But the 68 per cent drop in the value of private equity deals in India during the 2008-09 global financial crisis stands in stark contrast to the 12 per cent decline seen in China.

Grant Thornton, the auditors, believes private equity is back. Last week, its survey of 100 Indian companies showed that merger and acquisition values had risen to more than $45bn from January to November this year. Of these, private equity deals reflected an “improving climate,” totalling $5.27bn in the first 11 months of 2010.

“Indian entrepreneurs are realising the benefits of accessing risk capital from external investors,” says Siddhartha Nigam, a partner at Grant Thornton India. “Private equity is emerging as a logical step before accessing capital markets to not only invest for scale but also get the ‘house in order’ [ahead of a public listing].”

Sanjay Nayar, chief executive of KKR India Advisors, says rising valuations have made it “tough to find obvious value” and that worse, getting things done in India has become harder partly due to greater interference from the state.

Joseph Massey, chief executive of India’s MCX Stock Exchange, also blames much of the execution delay on red tape.