Priyanka Bakaya, MBA ’11

Venture Capital in India: Waiting for Exits

India has a thriving entrepreneurial culture, high-single digits growth, strong talent, and is flush with money ready to put to work. Shouldn’t this naturally make it a venture capitalists’ heaven? Not necessarily.

The Playing Field

Venture Capital in India is still at a very nascent stage. The industry consists of roughly half a dozen active firms – most of which are U.S. based. The firms we met included Helion, DFJ, Accel, and I also separately met with Nexus. There are other firms we didn’t get to such as Sequoia, Canaan, and IDG Ventures (the latter which was interestingly co-founded by a Sloanie). Some other firms are present – but invest at a much later stage than pure venture – firms like Bessemer, Battery, Norwest and Matrix. Venture Capital has been around in India for a while, but roughly 10 years ago it morphed into PE. Various players such as ICICI Venture and Carlyle realized that with so much cash, PE was a much better model for them, so switched their strategy. The latest pure VCs to crop up have only done so in the past couple of years.

Are there Exits?

Since the firms have only been around for a few years, VC is still not a proven model in India. Until India gets its 20x’s, the main question on the lips of every firm we met with was ‘are there exits?’  This year should be an interesting year since there are about 100 IPOs lined up, including a sizeable number which are VC funded. However, until some major headline exits happen, VC lacks the reputation and still remains an unproven model in India.

Growth Garbed as Venture

Given its early stage as an industry, the VC happening in India tends to be more risk averse than traditional VC. There are still inhibitions around backing very young companies, so VCs prefer companies which are cash flow positive and use more PE-type criteria in evaluating companies - leading one firm to describe investments as “growth garbed as venture”. While this may be a less risky approach, on the flip-side, this also lowers the return potential. Since Indian VC investments tend to be oriented towards service companies rather than technology companies, while less capital is required and less risk is involved (since they don’t have to prove the technologies), there is also no exponential hockey stick growth that comes with tech plays. Service businesses are instead an execution play, and the time it takes to build out the business is a slower and more gradual process – which makes it tough to ensure that exits take place within a suitable horizon which is shorter than the 10-year fund life.

Where are the Angels?

There is still not much of an angel landscape in India – there are 2-3 well-known angels, but even these have a mixed reputation. However, fortunately the “friends & family” investing sphere is very significant – not surprising given India’s rich heritage of family-owned businesses. Hence, usually there is no trouble in getting early investments of around $100k to $200k. The only active VC making serious investments under $1 million is Accel, with the others mostly staying in the $2m - $10m investment range. Anything greater than $10m becomes very competitive, with companies with revenues to warrant large investment sizes automatically becoming hot property, sending valuations through the roof.

Sectors: Searching for Scalability

Most of the funds we spoke with had a sector agnostic view to their investments. The general theme we heard was there is rarely IP or new ideas coming out of India, and most start-ups are merely replicating and adapting foreign ideas for the Indian context. The one exception to this is mobile, where India is leading trends internationally largely because of the unique set of regulatory and socioeconomic conditions pushing this sector in India. Areas such as internet are still struggling in India, since it is hard to monetize websites if there is no E-commerce. E-commerce is still yet to take off in India since it requires logistics both through distribution and online payment, which are not yet in place. Cleantech is also a relatively new area, with only DFJ and Nexus seriously focusing on it, with some others starting to look at the space more closely. Generally the mantra on everyone’s lips when considering investments was ‘scalability’.

Where does this leave the Entrepreneur?

Interestingly, we heard that 95% of entrepreneurs in India are first-time entrepreneurs. Historically, businesses spawned out of family enterprises, so there was never a need for external funds, but now a new set of professionals is emerging. Other than the regular requisites of having a passion and stomach for start-ups, entrepreneurs in India also need to have a much longer time horizon. In the west, it is sometimes common to think in terms of a 3-4 year time horizon when make a decision to found a start-up, however we in India 10 rather than 5 years is the magic number.

So is it better to be an entrepreneur or investor in India? Chances are that in the early years at least, investors will get hurt more than entrepreneurs. It will take a few stellar exits to prove the model, but when it is proven, it could be the beginning of a very exciting era for Indian business.

Posted via web from PKClean Blog

Indian Cleantech: Set for Takeoff

Clean technology investments are still at a very nascent stage in India – with only two VCs really seriously involved in the space. I met with both of them during my trip – Nexus in Bombay and DFJ in Bangalore. Others are starting to look at the space, and in many of our meetings with other VC and PE firms, they mentioned trying to currently get their head around how best to deploy capital in the emerging Cleantech space.

In terms of the current Cleantech landscape, there is already a decent installed base of Wind and Hydro power, with more expected to come online in the future. Solar has received a good push from both industry and government, with literally everyone we met citing the 2020 solar …. There are also a decent number of waste-to-energy and biofuel companies, however the problem here is with scalability. Since these companies source locally, getting feedstock poses a challenge for scale. In order to avoid getting squeezed by suppliers of waste such as agriwaste, some companies have had to adopt a diversified strategy where 50% of their waste comes from the market, while the other 50% they need to grow captively.

Broadly speaking, start-ups in the Cleantech area are still in infancy. There still have been no dominant players emerge, which is a good thing if you are a start-up like PK Clean. Furthermore, in the Indian context these start-ups are not focused on the innovation side, but the deployment side. As Mohanjit Jolly explained to me - India is going from nothing to something, and not looking for “best of breed” innovations. The industry doesn’t have luxury to innovate, and just needs to put something in place in order to bring energy to the masses. Hence, from a venture capitalists perspective, Cleantech in India is more of an execution play than a technology play.

The following article from India’s Financial Express newspaper presents a great overview of the current state of Cleantech investment in India. http://www.financialexpress.com/news/2010cleantechgetspetraction/593431/0 Coincidentally, the article came out the same day as the start of our Trek, and since I had subscribed to Financial Express on my Kindle for my 2 weeks in India – I was excited to read this on the way to my first meeting. The photo below is of the article on my beloved Kindle:

Posted via email from PKClean Blog

Do You Have the Stomach for India?

As our group met with firms, some of the consistent questions we kept hearing were ‘how long have you been “outside”?’ and ‘do you have the stomach for India?’ The latter question was quite literal, as frequently it seemed like we were being tested through the type of water we requested to drink. (If my bizarre Australian/American accent wasn’t enough of a giveaway that I had been living outside, my preference for Bisleri certainly was). These questions quickly became a pet peeve for our group – we were all of Indian origin and felt a strong connection to our country of heritage.

I can understand why this was a concern for many firms, as understanding the Indian mentality is indeed important for conducting business. For me, while I’ve grown up outside India – the connection has always been strong through yearly trips to India, having many close ties through cousins and friends, and being heavily involved with my family’s business. Part of it has been my own fascination and love for India – during college I chose to spend 2 months in Bangalore researching growth and innovation in the tech sector for my senior honors thesis, and was also involved in social entrepreneurship start-up Vipani focused on the rural sector. On one end of the spectrum I’ve spent time in Kashmiri refugee camps, in villages, ashrams, training as a yoga teacher, and on the other end of the spectrum I covered major Indian IT services and BPO companies while working on Wall Street. In the year before coming to Sloan, I was living in India and working both on PK Clean as well as helping out with the family business – engaged in everything on the ground from property investment decisions, hiring & firing, managing vendors, training staff through series of classes, designing offices and logos, marketing and presenting to clients … really the whole gamut.

So what does it really mean to have a stomach for India? Perhaps there’s something more to it than the Bisleri test.

Posted via email from PKClean Blog

Private Equity in India: Knocking on Heaven’s Door

 

Several PE firms have cropped up in India over the past decade, each seeking to carve out its own strategy for generating returns in the unique Indian context. The operative word here is “unique” – India is unique because LBOs are not possible given government regulations around leverage. Despite lobbying, rules around leverage don’t look like they will change anytime in the foreseeable future. Since leverage is not an option, Private Equity in India remains a Growth Equity play.

Smorgasbord of Financing Options

India is also unique given the wide range of opportunities available for companies to raise money. The IPO market is very active, and since the listing rules are relatively lax, this makes it easy for companies to raise money through IPO as an alternative to PE. However the downside here is that the company needs to be able to perform well otherwise it will be penalized by the market if it tries to raise money in the future (NSR shared with us a statistic that 70% of Indian companies are trading at a discount to their IPO price). Debt is also readily accessible for companies. External commercial borrowings are available since investors don’t mind Indian debt since it represents a relatively risk free investment for a high coupon payment. Finally, once public, companies have various other alternatives available for raising funds – such as QIPs, rights issues and follow-on preferential allotments.

The Holy Trinity of Investing in India

Interestingly, the holy grail of investing in India seemed to be consistent across all the firms we met. ICICI Venture, Actis, Blackstone and others all mentioned the same 3 themes driving their investments:

1.          Consumption

2.          Infrastructure

3.          Outsourcing

1.       Personal consumption includes areas such as hospitals and education, and is mainly driven by the fact that GDP per capita is expected to multiply at least 3 times in the next 12 years. We heard that the city of Bombay alone will be the 11^th largest GDP in the world by 2016. Not only is this important, but it’s encouraging to see that the wealth is percolating to B & C towns and villages. Opportunities in education specifically seem limited to either foreign universities coming to India or professional training institutions such as NIIT emerging. These make sense because they have the ability to scale, and in the case of NIIT, have a process-driven curriculum. K-12 is a tougher area since it’s regulated, and in the case of Pre-K it’s not regulated but it’s not a very scalable model since it tends to be more person-driven.

2.       The infrastructure story is pretty obvious when one looks around at the amount of construction happening across cities such as Bombay and Delhi. Infrastructure includes everything from roads to ports to power to telecom. The key driver of the need for road projects has been from traffic, which has been growing at a CAGR over 10%. However many challenges remain – IDFC spoke of the challenge of getting skilled labor; there is little incentive for contractors to skill their labor when they go to competitors, for instance. Power is another area where tremendous growth is expected – currently India has an energy shortage of 9.6% and a peak shortage of 12.6%.The government has an ambitious goal of getting the country to add 100,000MW between 2008-2012, requiring an investment of $155b; last year 15,000MW was added. IDFC spoke of money interesting opportunities across power generation, equipment manufacturing and transmission, however ICICI Venture warned of more distressed power companies emerging in 2-3 years since they have been built on forecasts of much higher prices that what they will get. Khazanah also noted how setting up the plants was the easy part, but challenges arise in execution – for instance getting land, coal, power grid access, etc. Telecom has seen explosive levels of growth at every level. At this point there are 11-12 major players and a lot of experts expect to see a lot of consolidation in the area in the coming years.

3.       Outsourcing not only includes services like BPO, but also includes manufacturing such as auto components, as well as more research & development which have recently been emerging.  Outsourcing is getting fairly commoditized now, particularly in the services domain. There is huge growth and a lot of scope for further manufacturing of auto components – even though this may be bad news for the western auto manufacturers. R&D is another area where India has a lot of technical talent that can be utilized at a much more attractive cost than the west, if companies know how to properly tap into this talent. (Effectively what PK Clean has been doing through our team in Pune).

Real Estate: Out of Vogue

Saying “real estate” to anyone in Private Equity in India is almost like saying a dirty word. We consistently heard from every firm about how out of favor Real Estate was right now. Basically if you invested before 2005 you’re in good shape, but if you invested post-2006 you’re probably in some serious pain right now (to put it mildly). A challenge for cities such as Bombay is the very limited supply of “good” real estate currently. We heard that office space in Ceejay House, which houses many investment firms in Worli, goes for $180/sq ft, which is more expensive than Midtown Manhattan. These exorbitant prices represent a challenge for any sectors which rely heavily on real estate, such as hotels and retail. For instance, it’s hard to justify expensive brands since not only is real estate expensive, but luxury demand is limited too. The more attractive businesses appear to be those using real estate in Tier 2 cities where there is still growth ahead, and where demand is stemming from the emerging classes.

Bribery: A Tax You Pay to “Save Time”

Another topic that came up in our discussion with firms was the relationship with government. For some firms, government appeared a bed partner of sorts. IDFC was one example where the firm maintains close ties with government and policy makers. It was not surprising when they spoke about having been “coincidentally” correct on many government calls in their investments. Although the government plays less of a role in IDFC now (in 1997 the government had a 40% stake) – the government’s equity ownership still represents 18-19% of the company.

Views on government were mixed – some felt that the general governance of the country was deteriorating. On the topic of corruption, it was unfortunate to hear from one major fund that it’s getting worse rather than better. While the funds would never engage in making bribes themselves, it was generally accepted that most portfolio companies would be making bribes to conduct business. Without some level of bribery things take too long – and one fund manager noted that the key challenge for companies wasn’t Return on Investment but ‘Return on Time’. Some interesting euphemisms we heard for this type of corruption included “it’s a facilitation payment” or “it’s a tax you pay to save time”.

Show me the Money

So given this landscape for PE players, where is the money to be made? Broadly speaking, we know that PE can make money three ways: (i) leverage, (ii) multiple arbitrage, and (iii) fixing businesses. Leverage is not possible in the Indian context, multiple arbitrage is just taking a bet on market movements, and fixing businesses is difficult if funds don’t have a controlling stake.

To get around this, different funds are adopting varied approaches. Carlyle has adopted the approach of focusing on high growth rate companies with low ROE where they can gradually increase leverage across several years. This could mean, for instance, industrial sectors which are capital intensive such as manufacturing and family-owned businesses. Actis meanwhile prefers to make investments in the $50m-$300m range where it can take a controlling stake in the company – the fund noted that 50% of its transactions have been control transactions. IVFA also generally takes a majority or controlling stake of companies, and essentially takes over and runs a portfolio company. While it may not always be easy to take a controlling stake, others such as Blackstone, Khazanah and New Silk Route spoke of how their relationship with promoters and CEOs is the most key thing when making an investment since they don’t have the luxury of being able to make hiring and firing decisions. At least the solid relationship ensures that even though they may only have a minority stake in the company, they still feel a certain level of control over and comfort in management to fix the business as needed. It will be interesting to see how each of these slightly varied strategies plays out for these firms.

 

Posted via web from PKClean Blog

Trekking Around the World with MIT

By far one of my favorite experiences since arriving in Cambridge has been …leaving Cambridge! Coming to MIT Sloan, I had 3 primary goals (i) build skills to make me a better entrepreneur (ii) develop an understanding of the latest technologies in Cleantech (as well as broadly in other areas, such as digital media) and (iii) understand the VC landscape better. Fortunately there are enough stellar classes and extracurricular activities which have helped me make great strides in the first two areas (let me know if you’d like pointers), but for achieving the third objective I’ve spent a lot of time off campus trying to get my head around venture capital.

Since the start of the school year I’ve been on treks to meet Venture Capital (and Private Equity) firms in London, Silicon Valley, New York, Boston, and India. If there was an award for going on the most VC/PE treks ...I would definitely be the top contender. Not something to be particularly proud of since this basically means that I’ve used every break and long weekend being a nerd and meeting with firms rather than lying on a beach somewhere. I also spent the month of January interning at a VC firm in Boston, while many other classmates traveled the world. Although the exotic photos from classmates do look enticing, I definitely have no regrets since I feel that these treks present once-in-a-lifetime opportunities to hear insights about business trends around the world from industry leaders. I not only understand the Venture Capitalists perspective better, but also understand the business landscape in different regions better. Fortunately the nature of venture capital is so tight-knit, that once you have a few connections in any region it makes it easier to connect with others. Since I wanted to be a little selfless and share some of the insights I’ve been learning with others, the next few blog posts are dedicated to my takeaways from my most recent India VC/PE Trek over Spring Break. Hope these allow you to relive the experience a little – Enjoy!

 Group Picture from London VC/PE Trek – Thanksgiving 2009

Posted via email from PKClean Blog