Bears force PEs to lower expectations

TRACKING THE DOWNTURN

Private equity (PE) funds are repeating only one line – “Past performance is no guarantee of future returns.”

In India, the stock market turmoil and weakening macro-economic scenario have compelled many PE funds to revise their return expectations to more realistic levels.

“The norm for a private investment in public equity (PIPE) deal was earlier 5 per cent above index returns. But it has now come down to 2-3 per cent over and above the index returns. For a deal in an unlisted company, the general target has come down to 20-25 per cent from 30-35 per cent,” said an industry analyst.

The euphoria of 2007 is over for now. UTI Ventures was among the earliest to smell an imminent slowdown. It exited Excel Soft Technologies with 50 times returns earlier this year.

Peaking interest rates and high inflation have squeezed the profit margins of companies. As evident by the first quarter results, many mid-cap companies have failed to beat analysts’ expectations. In such a scenario, private equity funds are expecting the exit period to be longer than normal. Since funds have to provide returns to their investors, who are HNIs and institutions, an exit may be difficult when the market is still in a recovery mode.

PE funds generally look for a gestation period of 3-5 years and exit thereafter either through IPO, or strategic sale. The timeframe is longer for venture capital funds.

“Though multiples will remain the same, the IRR (internal rate of return) will be lower because of sluggish market trend. The exit period will also become longer,” said Luis Miranda, President and CEO, IDFC Private Equity. A majority of PIPE deals that were clinched in 2007 have turned sour.

The value erosion has been severe in some cases where stocks are currently trading as much as 50 per cent below the deal price. ICICI Venture’s stake in Geometric Software and General Atlantic’s stake in Hexaware Technologies are examples.

Deepak Shahdadpuri, MD, Beacon India Advisors, advisor to Baer Capital Partner’s funds, said, “Exit periods will be longer. The IPO window is closed for many firms and exits will not be as easy as it used to be earlier. Entry prices are coming down to more realistic valuations.”