A lot of private equity exits will happen by second half of 2012, says Archana Hingorani

This Q&A first appeared in DNA Money edition on Monday March 12, 2012.

After seeing a huge traction till the first half of 2011, the private equity (PE) market turned lacklustre in the second half. While the number of deals has gone down, the sizes too have shrunk. Archana Hingorani, chief executive officer and executive director of the BSE-listed IL&FS Investment Managers Ltd (IIML), one of the largest PE funds in India, with over $3.2 billion under management, spoke about the overall business environment for PE firms and developments within her company. Excerpts from the interview:

Q: PE exits have significantly slowed in 2011. Do you see the momentum picking up in 2012?
A: There certainly has been a slowdown in PE exits, which were looking very promising till the first half of 2011. That’s also because the market was looking very buoyant and stable between second half of 2010 and first six months of 2011. In fact, most of the exits that have happened in the last fiscal or are about to happen in the next fiscal, are all because of negotiations done in that period of 2010-11.

While some deals have already been concluded, many will happen in 2012. This is because in the second half of 2011, there was no expectation or ability to convert the exit discussions into a meaningful transaction. Having said that, the funds would have exited but most of the transactions wouldn’t have probably given the real value to the investors.

Q: IL&FS Investment Managers also made a few exits...
A: Yes. Our earliest exit in the last fiscal I can remember was Continental, which we sold to Warburg. But that was based on the work done in the first quarter of 2011. Everything takes time and it really is an amalgamation of a lot of work that has gone into negotiations prior to the deal getting announced. Even from this fiscal perspective, while we have done some partial exits, many of them are related to our real estate projects that have seen sales happening, with cash flow coming back into the business. Other than that, I don’t think there has been any significant full exit in 2011. I think a lot of that (full exits) will likely happen in the first six months of 2012 because a lot of work has already been done on them.

Q: Has the increased timeframe for concluding transactions impacted the size of the deals being discussed over a period of time?
A: I think post-2008 investment sizes have shrunk primarily on the real estate side. While we had a very large, fund and it would have been ideal to put in, maybe, 15 investments overall. That would have made the per-investment size way too large from an opportunity perspective. I’m not saying we are putting less in a transaction and asking other people to support it.

We are just doing smaller transactions because I don’t think in the real estate space - at least from a risk-return perspective - it makes any sense to put in $100 million pieces. While real estate per se needs a lot of money, the kind of transactions we are comfortable with are ideally in the $20 million to $50 million bracket. Based on our learning from the previous fund in 2006-07, we made smaller investments from the second fund, primarily because of the investment cycle; the amount of time taken for project completion is too long. The impact hasn’t been much in the growth capital (PE) side, especially because we are operating in the mid-market space and not putting $50 million or $100 million in a transaction.

Q: Is that the reason you always invest in special purpose vehicles (SPVs) and not at entity level?
A: We have never done entity-level investments and are biased to SPVs because one has a lot of clarity on the kind of the project, the cash flows, timelines and the exit pattern. This is not the case with entity-level investments because of the diversity of projects, and one is not able to understand how each underlying entity is doing. Besides, one has to significantly rely on public markets for an exit — which has timing-related issues.

There may be just one entity-level investment in Fund I while Fund II is entirely SPV investments. Besides, even at the SPV level, we are only focusing on smaller investments and will not go beyond $50 million a piece. We took a conscious call that the portfolio will become bigger and will require more management bandwidth.

Q: Among the three verticals— private equity, real estate and infrastructure — which one will see a lot of activity in 2012?
A: We see opportunities across and would happily and readily invest from all the three verticals if we have investible corpus. While there is an economic slowdown, assuming that interest rates are likely to come down, we do expect businesses to start coming back to growth stage. Now whether infrastructure investing will be slower than private equity or real estate will largely depend on what opportunities are being looked at.

The market isn’t expecting significant changes, but if the companies already have projects that were bagged 2-3 years ago, these are still under implementation and a lot of such investment opportunities are available. We would certainly be looking at investments across the sectors, and in infrastructure we see a lot of potential in waste management, ports and logistics.

On the growth (PE) side, we are looking at consumer-oriented businesses that are focusing on domestic consumption, while for the real estate vertical it will be largely the residential developments in the metros. That has been our investments theme and it hasn’t really changed in the last 2-3 years.

Q: What is the extent of investible corpus with the company as of now?
A: There is money left to be deployed in the infrastructure vertical (Standard Chartered IL&FS Asia Infrastructure Growth Fund — $658 million) to the extent of $250 million to $300 million. So around 40% of the original corpus we raised in 2008 is still available for investments. We are fully committed in the real estate fund, so there is no investible capital available. On the PE side, we were fully committed last year and have kick-started an exercise to raise a new fund. The growth fund is expected to be $300 million and we are very far away from that number as of now.

Q: When do you expect to do another fundraise for the infrastructure vertical?
A: We will do a fundraise as soon the corpus starts dwindling; this is a vertical where we will be deploying money this fiscal. While in normal circumstances, investment firms start new fundraise as soon as they have invested 70% of the overall corpus. However, the market has changed and the investor’s (limited partners) focus is more on the fund’s past performance and how well the underlying portfolio is really doing. I think that’s a right thing to do from the investor perspective, and our view is that the scenario is completely different in terms of when we want to start the fundraising cycle.

Q: Is the scenario indicating a possible change in the overall fundraising approach by PE firms in India?
A: If you look at our real estate vertical, we are 100% committed, but we have not yet gone out because we want to be fully invested. And because it is a new sector for India in terms of performance, track record, return on investor capital, it is more important to show operating / financial performance on the portfolios before going back to the LPs (limited partners) for another fundraise.

Q: By when will the next round of real estate fundraise happen?
A: We will start around June or so this year once we are fully invested. The corpus for our new real estate fund will be half the size of what the earlier fund was. This is because we have halved our investment size. If you have a large fund, portfolio management becomes a big challenge. The overall figure for this fund will probably be around $500 million vis-a-vis the $900 million we did in the earlier fund.

Q: Will the fundraise be largely from international markets or will you look at a mix of domestic and international markets?
A: We have done both in the past, but clearly the dollar approach is looking much better, especially looking at the rupee conversion rate; so we will do a 90:10 ratio in our funds.

Q: Which international markets are you looking to tap for the new fundraise?
A: It depends on the sectors largely. For instance, in real estate, the US investors have been ahead of the curve while it is the European investors when it comes to infrastructure. As we raise only $200 million-$300 million at a time, the set of investors in growth (PE) is pretty small. While there are institutions from across the world, a lot of family offices from Europe, Asia and the Middle East form part of investors in the growth fund.

Q: You think domestic high networth individuals (HNIs) are a good source when it comes to raising funds?
A: Internationally, family offices are largely HNIs to a great extent. As for Indian HNIs, the domestic market hasn’t matured to an extent that we can boast of having a family-office concept. There are a handful of them (like Azim Premji’s) currently which will morph into what are traditional family offices over time. But from a risk-return profile, is an individual investor putting Rs5-10 lakh in a PE fund the right candidate? The answer is no. This set of investors doesn’t understand how the PE business functions and the lack of awareness continues in the market. They are more appropriate for product-oriented or yield funds because that makes more sense for such investors.

Q: Could you take us through the performance of IL&FS Investment Managers’ portfolio of investee companies? Has the slowdown impacted their performances as well?
A: It will be very difficult to discuss each company. All I can say is that despite difficult times, many of our companies are growing at over 25% and there are a lot of them in the portfolio. There has been a slowdown significantly with investee companies from the older portfolio.

Q: Is any of them likely to do a fresh round of fundraise or go in for an initial public offering?
A: There are no new rounds of fundraising. However, some of them (in the waste management and infrastructure sectors) will certainly get ready for a public offering in the upcoming fiscal. Work is in the initial stages but some of them will hit the markets in the next 12 months. I feel if you have the right company which is doing well and expected to sustain future growth with a reasonable approach to valuations, then there certainly is room, and we have seen that happen with a few companies in the last few quarters.