The PE Hit

Caught between the devil and the deep blue sea, private equity (PE) funds in the country are facing trying times. Exit opportunities have narrowed with profit margins also dipping. A significant number of PE firms looking to exit investments made five to seven years ago are being forced to rethink the possibilities with the rupee going weak against the US dollar. A feeble rupee impacts potential returns on investments of a PE firm, which ideally expects an internal rate of return (IRR) of 20 to 25 per cent.

While the weakening rupee may have helped NRIs rethink their investment strategy in the Indian real-estate market, helping improve sales by opening up avenues, PE firms have been facing the brunt of adverse market conditions. Known to be the best allies of the real-estate sector, PE funds are stuck with investments made earlier and are unable to raise fresh funds. The rupee had plunged by 56 per cent to 64.31 from a high of 39 in 2007 making it tough for PEs to exit with profits. This plunge has almost wiped out foreign PE funds' meagre returns from real estate, and any exit in the current scenario will lead to at least 25-30 per cent loss in dollar value. Apart from the rupee, shares of PE-backed listed companies have been falling with the slowing economy, rising debt, and higher inflation and interest rates.

"The impact has been adverse as returns have eroded to a large extent" says Rajeev Bairathi, Executive Director  Capital Transactions Group and North India, Knight Frank India. "When the rupee goes below the 60 mark, erosion on your returns could be as high as 20-30 per cent." And Archana Hingorani, CEO & Executive Director, IL&FS Investment Managers, who has overseen investments with an aggregate capitalisation value in excess of $10 billion, says, "The currency depreciation has made returns meagre though in rupee terms the returns might appear to be healthy." Firms like IL&FS have been able to partially exit residential real estate as it gave the required cash flow. In FY13, the company made divestments worth Rs 540 crore and fresh investments worth Rs 770 crore.

What is also worrying for players is that the time risk for exits is becoming high and elongated. The waiting period for exits has grown from a three-to-five year norm earlier to a five-to-seven year hold period. According to an assessment by Anand Rathi Investment Banking, PE investments in some 630 companies are four or more years old and many of them are crying for exits.

Overseas Move
Ergo, top PE fund managers in India, faced with problems such as rupee depreciation and lack of return for their investment, are now eyeing the prospect of expanding their portfolio outside the country, to new investment hotspots in Southeast Asia like Singapore, Hong Kong, Indonesia and Vietnam that offer better valuations. The trend of global funds increasing their exposure outside India and combining the focus with the country is also owing to factors such as better utilisation of human resources and proximity from a time-zone perspective. Among those who have recently moved as part of the migration trend are Sameer Sain, Founder and Managing Partner of Everstone Capital, an India-focused fund which has over $1 billion invested in the country, Praneet Singh of Siguler Guff, a global fund with assets worth $10 billion under management, has shifted to New York as part of expanding the fund's investments in emerging market PE funds, and Naveen Wadhera, India Head of Boston-based private equity major TA Associates, has also moved to Hong Kong.

However, there are a few PE entrants who are exceptions, and are looking to make inward contributions. Bureaucrat-turned-entrepreneur Sanjay Gupta, for instance, has floated a private equity fund with the acronym LIFE or Let India Fly for Ever, which has its main focus on hospitality, healthcare and lifestyle businesses. Gupta, who resigned recently as executive chairman of the Rs 22,000-crore Metrolink Express for Gandhinagar and Ahmedabad (MEGA), is also the promoter and Chairman of business conglomerate Neesa Group, which has interests in a 1,200-room hotel chain, infrastructure, food and agritech, real estate, construction, IT and media business. He is initially looking to raise up to Rs 250-300 crore from India and overseas, which he plans to scale up to $1 billion over the next five years. "There is a huge need for capital solutions," says Gupta who hopes to acquire the necessary clearance from SEBI and achieve financial closure within the coming months. The fund could well be coming at the right time in view of the shortage of risk capital in the country.

The Decline
Investments made in the Indian real-estate sector are estimated to be around $15 billion cumulatively since FDI was allowed in the sector in 2005. Around 20 per cent of this was expected to get an exit in the past two years, but seems a distinct possibility now. PE firms with offshore funds are in a state of flux not only because of their stuck investments and delay in project completions, but concern about raising fresh funds in the current scenario. Blackstone, IL&FS, HDFC, Redfort, Kotak and Xander Group Inc to name a few are among the bigger PE funds focused on real estate, having invested a total of $600 million of equity into the retail platform.

"Policy bottlenecks, lack of clarity on regulatory requirements, lack of speedy approvals along with the absence of a single-window clearance system are some of the major challenges posing a big threat to the existence of these funds," adds Bairathi. The value of a $150-million investment by Blackstone in Hyderabad-based infrastructure company Nagarjuna Constructions is now at $7.91 million now as shares tumbled by 92 per cent and the rupee by 56 per cent. The fund was invested in 2007. Blackstone, which had invested over $1 billion in India, has indicated that there are still opportunities to invest. According to India Private Equity Report 2013 by Bain & Company Inc, India saw deal activity fall from $14.8 billion in 2011 to $10.2 billion in 2012.

The number of deals, however, increased from 531 to 551 over this period, highlighting a fall in average deal size.

The report also highlights how limited partners (LPs) are showing increasing caution this year when allocating funds. The year 2012 saw 55 funds with a mandate to invest in India, but the total fund value allocated to India was only $3.5 billion, down from $6.8 billion in 2011. All this has been driven by the fact that 2012 was an uncertain year in India both politically and economically. Reported lapses in governance, coupled with a lack of clarity in regulation, raised considerable concerns about India's attractiveness as an investment destination.

"The PE funds that entered the Indian property market pre-2008 are struggling owing to the currency fluctuation," says Samir Jasuja, Founder and CEO, PropEquity.

"For some funds, currency has devalued as much as 50 per cent from the time they had invested, meaning lower repatriations. However, domestic funds have gained prominence, especially from 2011. Foreign PE investors are looking at income yielding assets, but given the risks and volatility in exchange rate, they have increased the cap rate expectations." He adds that the funds exiting are some that have reached the conclusion of their fund life and have to now return investors their money with whatever returns they can manage. "Some funds have exited owing to fluctuations in the market," Jasuja observes. "However, once the economy stabilises and a positive policy environment is built, there are good chances to see a comeback of PE funds."

How have PE funds performed? Ajay Gupta, Head, Infrastructure Finance, Investment Banking, HDFC Bank, remarks, "In terms of performance, some PE funds across asset classes, whether you take industry or real estate, have done well while some have not. It has been a mixed experience." Despite that incertitude, there has been a discernible drop in PE investment in Indian real estate in the first half of 2013. For the first six months this year, real-estate PE investments were recorded at $276 million (Rs 1,638 crore), 46 per cent lower than a year ago. PE funds invested $514 million (Rs 3,050 crore) in the first half of 2012, says a recent report of Cushman & Wakefield, an international property consulting firm. Experts do not expect significant foreign capital to flow into the country until the macro environment stabilises. Market experts believe it would take at least another two to three quarters and the upcoming general election might offer major triggers for the capital flow to resume. However, till that happens, it would be extremely difficult to raise fresh offshore funds or even plan exits till stability returns.

PE-rformance Hope According to Cushman and Wakefield's latest report on PE in real-estate investment, about $2 billion (Rs 11,854 crore) is available with PE firms ready to be deployed in real estate in the next one year, but PE funds want to put in money only in those projects with strong fundamentals.

So far in 2013, the highest value PE investment was $131.6 million in Pune, followed by $67.5 million in Mumbai, $38.8 million in the National Capital Region, and $16.9 million in Bengaluru. The total value of investments in the residential segment was recorded at $156 million (Rs 9.3 billion) in the first half of 2013, a drop of 48 per cent over last year. The total value of investments in the office segment was also lower in the first half 2013 at $118.1 million (around Rs 7 billion).

The report also indicates a growing trend towards investments in ready office space. The growing stability of the market is reflected by the continuous growth of the core investors (number and value) with over $1.3 billion (Rs 7,705 crore) invested in ready office space during the past three years.

While the unstable rupee and other factors weren't enough to create a cautious sentiment running in the market, according to VCCEdge, which tracks investment activity in the country, there are only 219 active funds in the country and 41 funds have become æzombie'ùinvestment funds that have become inactive and are not expected to make a profit on the investments they made. "Probably 10-15 of the 50-60 odd PE funds with real-estate investments have turned zombie funds," says Anuj Nangpal, Managing Director - Investor Services, DTZ India. "It's hard to pinpoint as some of them could have dry powder and could be waiting to deploy once the opportunity arises. There is no major implication for zombie funds; they could even be highly profitable for investors if they have made the right investments when they were active."

About $18 billion in Asia-focused PE assets are held in so-called zombie funds, which are effectively inactive but continue to collect management fees from investors, according to data provider Preqin. Of the $116 billion in total zombie assets that are collectively held by 1,200 vehicles globally, Asia accounts for about 10 per cent of the Assets Under Management (AUM), indicates a new report by Preqin. It is attributable to 109 inactive Asia-focussed funds that have passed their typical holding period, with general partners (GPs) having no clear plans to raise a successor fund. Experts believe that a combination of tax guideline changes, a difficult exit market and rupee depreciation in India has turned the market from a pre-crisis PE hotspot in Asia into a zombie zone.

Despite the carnage witnessed in the wake of the rupee's downslide, there are those who are wont to see positives in the current turmoil. With the depreciation of the rupee, valuations have become cheaper by 30 per cent and therefore more attractive for foreign funds. Further, according to Sanjeev Krishnan, Leader, Private Equity & Transaction Services, PricewaterhouseCoopers (PwC), high interest rates and the ongoing liquidity crunch have served to create a perfect opportunity for PE funds to contribute to the long-term India growth story.

To get India back on the radar of foreign investors, policymakers and SEBI are working on a regulatory framework for Real Estate Investment Trust or REITS ù an asset class that buys income-generating, real-estate assets and passes on the yield to investors. REITs are a big hit with investors in countries such as Singapore, the US, Hong Kong, Australia among others. "If and when implemented, they provide a viable exit mechanism to commercial investments in India," says Anuj Nangpal, Managing Director - Investor Services, DTZ India. "REITS have been highly successful in other Asian economies such as Singapore and Australia where the markets are so deep they even have different asset classes in REITS such as office, residential, industrial, etc. They provide retail investors a way to gain exposure to otherwise inaccessible asset classes and hence make the price discovery of these assets possible."

However, industry players say the Indian property market is not ready for REITs yet. SEBI first laid out draft regulations for REITS in 2008. But nothing moved. Further, SEBI allowed asset management companies to launch real-estate mutual funds. In other countries, REITs are required to distribute at least 90 per cent of their annual profits to investors as dividends. The basis of taxation for dividends or capital appreciation from real-estate funds was not stated last time around, deterring investors. According to sources, SEBI is now considering reviving REITs on the Alternative Investment Fund (AIF) platform. Under this, REITs would allow investors to invest directly in real-estate assets. The industry is hoping that the issues of valuation, taxation and transaction costs will be addressed in the new guidelines. "REITs will give the general public a better chance to get into real estate," says Gaurav Karnik, Partner, Infrastructure, Industrial & Consumer, Ernst & Young. Maybe the amendments will make it third-time lucky.

Highest value of PE investments in 2013

• Pune: $131.6 million (`7.8 billion)
• Mumbai: $67.5 million (`4 billion)
• NCR: $38.8 million (`2.3 billion)
• Bengaluru: $16.9 million (`1 billion)