PE landscape getting better in India as investments fetch higher returns

Average returns on exited investments have risen from 8 per cent (2006-2008 vintage) to 22 percent (2012-2014 vintage)

The private equity (PE) landscape is getting better in India, with investments in the past five years fetching higher return than earlier vintages.

Average returns on exited investments have risen from an annual eight per cent (2006–2008 vintage) to 22 per cent (2012–2014 vintage), reveals a recent report by McKinsey & Company. The biggest challenge has usually been fewer exits and poor returns.

This is a huge positive for the sector, says Haigreve Khaitan, partner at Khaitan & Co. It will encourage Limited Partners (LPs, who invest in PE firms), to deploy more money in India. 

This also explains why large investors such as pension funds have become more active in this country. The returns have been gradually improving, with investments from 2009-11 vintage fetching 16 per cent annual return. These are weighted average gross dollar internal rate of return (IRR) by investment year, estimated for a sample of 654 exits on investments between 2003 and 2017, where both investment and exit values were disclosed.

What’s driving the improvement in return? ‘‘Over time, valuations have improved significantly, and businesses have performed. Investors have turned selective, investing only in good quality companies, after thorough due-diligence,’’ says Khaitan. Indian stock indices have gone up almost four times since January 2006, too.

Vivek Pandit, senior partner, McKinsey & Co, says: "We are finally seeing focus and discipline setting in with improvements in returns and exits, driven by control-oriented strategies, better sector and owner selection, faster and more purposeful interventions.”

Buyouts and minority deals have both done well, earning 25-plus per cent return each. Buyouts of $100 million or more in a deal size earned a 12 per cent IRR, while those between $25 million and $99 million earned more than 20 per cent, McKinsey said in its report. Returns have, until now, been better for small and midsize deals compared to larger ones.

In fact, median returns for deals less than $25 million were more than twice than deals of $50 million or more. Returns for deals of more than $100 million varied, depending on the sector.  Poor performance in this deal class size is primarily explained by some large investments in the infrastructure and telecommunications sectors, particularly from 2006 to 2008, McKinsey said.

The large deals in infra and telecom produced mixed results, with a median IRR of only one per cent, far below the other deal-size categories. However, deals of more than $100 million in other sectors have generated between seven and 19 per cent return, with a median figure of 10 per cent. 

Sectors such as financial services, pharmaceuticals & health care, information technology & business process outsourcing services, consumer goods, machinery & industrial goods, and telecom accounted for 83 per cent of investment between 2015 and 2017, up from 44 per cent between 2009 and 2011. Investments in these sectors have grown two to three-fold. 

Except for telecom, they have all delivered a median return of 15-19 per cent.