Private equity inflow into smes drops by 32 per cent

The number of deals came down to 80 in 2009, from 127 in 2008.

The flow of private equity (PE) investment into India’s small and medium enterprises (SMEs) dropped by 32 per cent to $654.5 million (Rs 3,010.7 crore) between January and November 2009, compared with $962.5 million (Rs 4,427.5 crore) in the corresponding period of 2008.

The number of deals came down by 37 per cent, to 80 deals in January-November 2009, from 127 deals in the year-ago period.

Industry experts say that this is a temporary phenomenon and that PE funds are poised to invest an estimated $5 billion (Rs 23,000 crore) in SMEs — largely in those based in tier II cities.

Data compiled by Venture Intelligence, a Chennai-based research firm that focuses on private equity and mergers and aquisitions deals, shows that IT/ITeS industry continues to be the favourite of PE investors.

As much as $191 million (Rs 878.6 crore) of the total PE investment of $654.5 million in January-November 2009 was invested in the IT/ITeS sector, compared with $388 million (Rs (Rs 1784.8 crore) in the year-ago period. The number of deals in this sector dropped from 61 to 32.

Telecom attracted $111 million (Rs 510.6 crore) in January-November 2009, compared to just $7 million (Rs 32.2 crore)in January-November 2008. The number of deals increased to four from three last year.

The research firm’s calculation is based on companies which attracted less than $50 million (Rs 230 crore) in PE investments and are unlisted, and which it has classified as SMEs. These are typically promoter-or individual-driven and, in many cases, are led by first-generation entrepreneurs.

Arun Natarajan, chief executive officer of Venture Intelligence, said that SMEs rather than big companies would lead future PE investments into the country, especially enterprises operating in tier II cities. In 2009 investments in big companies almost dried up, while there was some action in sub-$50 million investments, he added.

Sectors that would drive growth include microfinance and agriculture in tier II and III cities and infrastructure as well as consumer-facing sectors — including education, health care and food and beverages — he added.

Pankaj Dhandaria, a partner at Ernst & Young, said that the drop in PE investments, which was mainly due to volatility in valuations, would be temporary. Manufacturing activities like industry, oil and gas, power equipment and other infrastructure would drive investments.

“IT/ITeS will continue to attract investment, but the weightage may drop,” he said, adding that global PE funds were attracted by India’s entrepreneur-driven economy, which offered lots of opportunity.

“It is also good for SMEs to have PE investments rather than go to the capital market, which was the source until seven or eight years ago, apart from banks. PE firms, apart from money, also bring good governance and experience in financial management,” he said.

According to a World Bank report, one of the greatest challenges for India’s 13 million SMEs is the current credit crunch. The sector has traditionally depended on bank loans, but bankers curtailed lending to SMEs last year due to the greater risk of non-performing assets (NPAs) in a downturn.

Moreover, large firms that raise funds through both the capital market and banks have turned increasingly to banks, since the capital market crashed at the beginning of 2008. This offered banks a line of business that is more lucrative than lending to SMEs, according to the World Bank report.

“Their (SMEs’) access to funding has been constrained, which is affecting their ability to invest in capital goods, environmentally friendly technologies, and job creation,” the report added. The bank recently provided additional financing of $400 million (Rs 1,840 crore) to India’s SMEs.

PE funds started investing in Indian firms in the late 1990s. Some of the early entrants built companies, arousing the interest of entrepreneurs in private equity as a source of capital and establishing India as a strong PE destination. PE investors have shown a preference for sectors with a domestic focus, and expect a three-fold return on investment, Natarajan said.