Private equity finds new ways to protect downside risks

Risk aversion leads to innovative structured deals.

Large private equity (PE) players are back at the deal-making table. However, they are also focused on protecting their investment against downside risk. This is true even for late-stage funding that has seen a pick-up recently.

Take the instance of Singapore-based Temasek. Recently, when it invested in GMR Energy, it did so through a structured paper, compulsorily convertible into equity. It invested $200 million (Rs 935 crore) in GMR through its wholly-owned subsidiary, Claymore Investments.
 

“Structured deals always work best when there is a mismatch in valuation. A lot of funds are now looking at principal protection as the basic guarantee, with some upside. People are becoming more risk-averse and most large deals are being structured,” said Ritesh Chandra, executive director, Avendus Capital Pvt Ltd.

HEDGING THE BETS TOP PE LATE STAGE INVESTMENTS OF 2010
Company	Investors	Amount (In USD mn)	Date
Shriram Capital	TPG Capital	217	Apr-10
Coffee Day  Resorts	New Silk Route, StanChart PE, KKR	217	Mar-10
NSE	Temasek	175	May-10
Avnija Properties	KKR	167	May-10
Lilliput Kidswear	Bain Capital, TPG Growth	86	Apr-10
Metropolis Healthcare	Warburg Pincus	85	Jun-10
Monnet Power	Blackstone	60	Jul-10
Integreon Managed Solutions	Actis	50	Feb-10
Financial Software & Systems	NEA, NYLIM India	50	Mar-10
Famy Care	AIF Capital	50	Apr-10
Source: Venture Intelligence

“It is the overall environment. When times are bad, deals will be scrutinised and will be stringent, while at other times, PEs are ready to go for straight equity deals, which we did see in many cases before the slowdown set in. What is also happening is that PEs have moved to late-stage investments, where they are investing in the range of $25-200 million,” said a PE player.

In the convertible structure, the most popular route, a PE fund keeps getting the coupon for two-three years and then converts it into equity at a pre-decided price. There are exit structures under which the PE fund’s stake is bought out by the promoters.

In the case of Coffee Day Resorts, industry sources note the promoters have assured 18 per cent return to a clutch of PE firms that include New Silk Route, Standard Chartered PE and KKR. The three have collectively put in $217 million (Rs 1,009.05 crore) in the company, promoted by V G Siddhartha.

PEs also prefer to get into structured deals when they are not comfortable with the promoters’ return projection. This is how the downside gets protected. Another route to protect the downside is a built-in clause which mandates that the stake goes up if the company does not perform as promised.

Earlier, Shriram City Union allotted warrants to a clutch of PE funds, including ChrysCapital, Bessemer and India Advantage Fund. The investors later raised their holding through conversion of warrants, resulting in fresh fund infusion.

“In 2007-08, the number of assets compared to the number of buyers was very different, so most deals were auctioned. Now, a PE player has the ability to negotiate. Most PE funds in larger deals are not doing straight deals, as they are able to negotiate with the market. It is all because of the market and the variability,” said Vikram Hosangady, executive director-advisory transaction services, KPMG.

PE players are looking at various convertibles, based on profitability. There are claw-back situations. There are also earn-out structures, where a PE investor agrees to share the upside of any return the company earns over and above a minimum targeted internal rate of return.

“The nature of structuring is always specific to the peculiarity of the deal. PEs looks to structure deals that protect the downside without compromising the upside,” said Darius Pandole, partner, New Silk Route.