Returns from Indian Private Equity

Will the industry deliver to expectations?

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© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Returns from Indian Private Equity
Will the industry deliver to expectations?

© 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

All rights reserved.Table of Contents Foreword Section 1 Section 2 Introduction Returns from Indian Private Equity How PE Funds Manage Exits and Create Value Influence of Capital Markets and Sectors Understanding the Type of Exit Influence of the Type of Entry Influence of Holding Period and Ownership Section 3 Section 4 Looking Ahead for 2012 Conclusion and Recommendations 03 05 10 13 16 19 21 25 27 © 2011 KPMG. a Swiss entity. . an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).

Foreword The turmoil in the global economy continues to damage value creation. India are in asset classes of their own rather than clubbed with other Asian countries – a reflection of their size. This motivates our present report. Within emerging Asia. The reader should note an unusual focus on PE exits in this report – causes. a Swiss entity. and confirmed by an EMPEA-Coller Capital survey in April 2011. and this is an important aspect of this report. Slow western economic growth followed the financial crisis of 2008 and 2009. We hope you find these insights interesting and useful. Emerging markets. type. In this report. Moreover. The returns ought to justify the risks. Earlier reports looked at the future of PE and its impact on corporate functioning and the economy. urbanization and workforce education – continue to attract investors. it puts a greater burden on delivering returns. We would like to extend our thanks to all the respondents for their time and contribution to this research. performance and potential. Many of these risks are more likely in India. which will continue into 2012. other components of emerging markets – the domestic growth released by reform. This prompted us to look more closely at a sample of PE exits and investments in India and undertake this study on the returns that these exits generate. scale and so on. timing. with nearly 78 percent of LPs expecting net annual returns of 16 percent or more. Unlike capital market investments. Many risks are common to all emerging markets – political and regulatory uncertainty and weak corporate governance among them. India shares the promise of unusual return and risk with many emerging markets. VIKRAM UTAMSINGH Head of Private Equity and Transactions and Restructuring KPMG in India RAFIQ DOSSANI Professor of International Relations and Senior Research Scholar Stanford University © 2011 KPMG. components of which are reliant on foreign capital and demand. the third in a series. we study returns. While ‘owning’ an asset class makes investment decisions by overseas investors less volatile than if India was a component of a broader allocation to emerging Asia. causing 2010’s sovereign debt crisis. Limited Partners' (LPs) appetite for emerging market private equity (PE) attained new highs in 2011. which persists to the present time. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). However. PE returns are precisely measured only by the value at exit. All rights reserved. even if they are not unique – such as working with familyowned businesses. Respondent LPs expect that PE allocated to emerging markets will increase from 13 percent at present to 18 percent in two years’ time. Not surprisingly then. . the LPs surveyed expect that Emerging Asia PE funds will earn the highest returns of any investment class. began to see the spillover in 2011. navigating IPO exits and compliance risks. now. first China and.

despite unsettled global conditions.397 600 500 400 Deal Volume 300 200 100 0 2004 2005 2006 2007 2008 2009 2010 9M 2011 359 8. 2011 Source: Venture Intelligence. UK. Deal value picked up only around 2004.000 12. The higher levels and lower volatility since 2009.1). an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).5% 29.975 14. the same as the lifespan of a typical PE fund.000 8.460 280 Period 1999-2003 2004-2010 CAGR (%) -1. The progression to a 2007 peak of USD 14 billion reflected both the global financial boom and the emergence of the ‘India story’. India now ranks sixth after the US. France and China in terms of PE deal value.160 937 78 591 56 470 90 1.607 1999 2000 2001 2002 2003 Amount (USD Mn) Note: 2004 till 9M 2011 from Venture Intelligence as of October 24.000 Deal Value (USD mn) 10. Dealogic © 2011 KPMG.737 186 2. All rights reserved. in 20101. though it overtook China briefly. Grant Thornton.000 0 107 500 110 1. when it crossed USD 1. it is worth remembering that they started in a high growth environment that later turned volatile due to the global downturn (See Exhibit 1.135 268 3.6% 358 7. Data does not include real estate deals Volume 1. Exhibit 1. marked India’s emergence as an asset class. a Swiss entity. Spain.004 489 465 10. AVCJ. .000 14.254 322 8. As the earliest funds wind down.03 1 Introduction The private equity (PE) industry in India is only about a decade old.000 6.1 Private Equity Investments in India 16.5 billion for the first time.000 4.000 2.

what percentage of the firm to invest in and how much to invest. do buyouts usually result in IPO exits or strategic sales? Our methodology is as follows: We first collected a sample of about USD 5 billion of investments which were invested over the period 1999 to 2010. However. what of the factors that can be controlled – choice of which sector to invest in. even though the returns might be lower? The key question of our study is what determines rates of return at exit? Some factors are systemic and uncontrollable: the global financial crisis of 2008-2009 tightened credit and narrowed the exit opportunities and returns for all firms. navigating IPO exits. the exits towards the end. Private equity is. cannot be construed as representing the actual exits and unrealized positions for private equity funds in India and should be considered as an 2 indicator only . invest. such as the life of the fund? Do the most popular sectors for investment also generate the highest returns? Which types of exits generate the best returns and why? Do promoter preferences on exit matter and. a Swiss entity. As the average holding period in India and globally is five years. PE investment also helped enhance a company’s reputation with bankers and the capital markets. monitoring is key. But. some of whose views are expressed herein. for the PE fund manager’s relationship with the portfolio company is constrained by the life of the PE fund. Many risks are common to emerging markets – political and regulatory uncertainty and weak corporate governance among them. For instance. and this is an important aspect of this report. of all the PE fund manager’s activities.04 In earlier reports. This begs the question: can a five-year engagement. and when to look for exit? From the answers to these questions. 2. the entry strategy. This comes under the category of factors that a PE fund cannot easily control. the relative immaturity of Indian industry as typified by the predominance of the family-run businesses and weak standards of corporate governance. However. we study returns. which is always limited (usually ten years). and today have either been realised or remain unrealised. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). bringing a company to exit requires significant governance and domain skills during the holding period. we would like to know how exit types match the preferences of fund managers or whether the type of exit is mostly out of their control. During those ten years. if so. their investors and portfolio companies. Our data analysis was then discussed through interviews with a representative sample of GPs and LPs. type of exit. These reports established the importance of PE in helping to transform mid market Indian companies to professional standards and deliver faster growth. The returns come from PE’s long-term. To what extent are exit type and timing influenced by the sector invested in and other factors. Many of these risks are more likely in India. The investments occur in the early years of a fund’s life. how are conflicts resolved? Is there a connection between the entry and exit types – for example. thus. This report therefore. Today. and compliance risks. See Important Notice to the Reader at the end of the report © 2011 KPMG. particularly. The returns ought to justify the risks. KPMG looked at the future of PE and its impact on industry and the economy. does the limited time available not constrain the PE manager to engage sub-optimally with the portfolio company and focus on operating strategies that will make exit possible in five years rather than for the long-term? Does it force him to choose certain types of exit over others – a strategic sale with a high probability of predicting the time of exit rather than an IPO with a much more unpredictable holding period. transformative impact: PE helps build companies that are designed to be future market leaders. hold and exit. . even if they are not unique – such as working with family-owned businesses. the PE fund manager fulfils four sequential tasks with respect to portfolio companies: find. This means that during the holding period. we felt that our sample size was adequate for the purpose of our analysis and the subject of this report. Indian companies find PE to be an alternate source of long term capital for funding new and innovative business models and growing businesses. corporate governance and professional talent management of portfolio companies. create a long-term market leader? In the Indian context. however intensive. There is an irony to this finding. All rights reserved. In this report. India shares the promise of unusual return and risk with many emerging markets. built around the philosophy that is possible to exit profitably over the holding period. We were unable to verify that our sample is representative of the industry’s exits and present unrealized positions. We found that the PE impact was most significant on business model changes. the fund must exert its transformative influences within this time frame. we can derive some lessons about exit strategies that should be useful to PE fund managers.

1. India's growth story no longer needs to be sold to LPs but the lack of meaningful exits to date has been a cause of concern. 2010 3. even though most of the PE money . Asia Private Equity Review. All rights reserved. Nevertheless. Most of the volatility can be attributed to external economic events. As Exhibit 1. while exit volume too lagged behind and was only 53 percent of exit volume in 2010. a new cause for concern has arisen: India has fallen well behind China in exits. 2010 was a landmark year for exits in India as exit value touched USD 4. makes a significant multiple and returns the money to its limited partners (LPs).05 Returns from 2 Private EquityIndian India's economic growth has propelled PE investments in the country from USD 470 1 million in 2003 to USD 8. the true measure of success of a PE investment is when the fund exits.55 3 billion spread across 174 exits .7 billion in 2010. One should not deduce from this that India is a 'residual' destination for global PE money. Now. Data does not include real estate deals 2. however. it is expected to significantly decline post-crisis. .2 billion in 2010 . Exit value for 2011 (up to September 2011) was less than half of the PE exit value witnessed in 2010. Exit values were adjusted for PE investors’ share © 2011 KPMG. PE exits in 2011 have been less encouraging due to volatility in Indian capital markets and other economic challenges like high interest rates and inflation and a slowing GDP growth. Venture Intelligence accessed on October 24. 2011. While the volatility in PE flows into India will remain significant until the global financial crisis lasts. Exit value for 2 China was USD 8. Today and for the past decade. nearly twice the exit value for India in 2010. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). a Swiss entity. Although the increase in deal volume and value indicates the attractiveness of India as a PE destination. India is amongst the most important emerging market for PE after China and often competes favourably with it. highest volume of exits shows the close correlation between a vibrant capital market and PE exits. VCCEdge.1 showed.about 80 percent .does indeed come from overseas. It now occupies its own 'asset class'. The fact that 2007 2009 and 2010 have generated the . This was nearly two times the exit value in 2009 and about 56 percent of aggregate exit value during the preceding four years prior to 2010. In comparison. the size of PE investments can be quite volatile.

2 percent . fund managers will need to work harder with their portfolio companies in order to create value. Alternatively.1 Private Equity Exit Volume and Value 5000 4500 4000 3500 USD mn 3000 2500 2000 1500 1000 500 0 1482 93 5 152 1227 61 592 1029 92 32 1690 41 0 67 661 154 234 13 250 721 1486 334 82 1443 155 215 535 966 251 1516 241 632 1073 82 140 2005 Exit Volume 53 2006 64 2007 112 2008 60 2009 117 2010 174 9M 2011 93 Secondary Sale Open Market Strategic Sale IPO Buyback Note: Exit value has been adjusted for PE investors' share whereever applicable Source: VCCEdge For LPs. who tend to be global investors. Through our analysis and discussions with GPs. This could be a signalling effect to suggest outperformance.6 the median Sensex IRR of 14. Net of manager fees and other costs. 4. The large difference between realized and total returns seems to suggest that funds prefer to sell their performing assets first. this implies a required gross IRR of 25 percent). which is to earn a multiple of 3x on the typical investment (adjusted for the five year holding period. the IRR earned by LPs falls below the 14. the IRR jumps to 29. a Swiss entity.3 percent. . if one considers the returns only from the realized investments in our sample. All rights reserved.4 percent that investors would have earned if they had made the same investments in the Sensex. A look at our overall sample (realized and unrealized investments) shows that private equity in India has returned a gross IRR of 17 percent which is only .4 percent return for the Sensex mentioned above. Similarly. which in turn could make the GP's task of raising follow on funds easier. what also seems to emerge is that a significant number of unrealized investments that are held by funds are nearly valued at cost and have not generated any profit. capital flows are determined by return expectation across asset classes and geographies. It is also well below the benchmark of most LPs and funds. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). the median IRR for our sample of realized investments was 27 percent compared to . See Notes at the end of the report for a detailed description of returns calculation © 2011 KPMG. However.1 percent which is significantly higher than the corresponding 4 Sensex return of 16.9 slightly above the 14.06 Exhibit 2. In either case the high returns that our realized investments show will reduce as funds reach the end of their fund life and start to divest their positions. This means that funds will either need to continue to hold these investments in the hope of better returns in the future or will need to sell at cost or book their losses.

0x 25.120 Exit Amount (USD mn) 12.0x Deal by deal Return Sensex Return Top decile exits generate a multiple in excess of 4.0x 45.4 Private Equity Return Vs Market Return 55.0x 50.7% Cash Multiple 2.0% 10.0x 15. a Swiss entity. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).0% 15.5 percent while deals in the bottom quartile are likely to deliver a return of minus 3 percent or lower. deals are likely to return a satisfactory return of over 32. KPMG in India Analysis 29.0% Sensex Return Source: Bombay Stock Exchange.2% PE Return Exhibit 2. KPMG in India analysis Exhibit 2.2 PE Returns Snapshot PE Investments Total Sample Investment Amount (USD mn) 5. Similarly.0% 20.0x Cash Multiple 35.3 Sensex Return Vs PE Return for Sample of Realized Investments 35. KPMG in India Analysis A closer look at our returns data indicates that deals in the top decile are likely to return in excess of 58 percent IRR while deals in the lowest decile are likely to generate returns of minus 40 percent or lesser.193 Weighted IRR 17.0x 30.07 Returns from Indian Private Equity Exhibit 2.4 SENSEX IRR 14.4% Note: All IRR and cash multiples are presented on a gross basis Source: Bombay Stock Exchange.3x Source: Bombay Stock Exchange.0x 20.0x 40.0% Weighted IRR 25.9% Median IRR 7.1% 16.4x Average Holding Period (in years) 3. All rights reserved.0x 10. .0x 5.0% 30. when looking at the top quartile of exits.0x 0.0% 0.0% 5. © 2011 KPMG.

One of the respondents in our survey concurred with this thought. Further.5 IRR Distribution 80 70 60 Number of deals 50 40 30 20 10 0 Less than -60% -60% to -50% -50% to -40% -40% to -30% -30% to -20% -20% to -10% 90% to100% -10% to 0% 10% to 20% 20% to 30% 30% to 40% 40% to 50% 50% to 60% 60% to 70% 70% to 80% 80% to 90% 0% to 10% Over 100% 3 6 10 22 15 9 27 33 29 17 19 13 4 2 2 2 19 68 Represents a distribution with fatter tails. The overall IRR for China is 20. All rights reserved. as shown in Exhibit 2. © 2011 KPMG. returns for India lag behind on an overall basis as well as on a realized basis. Number of deals Source: KPMG in India Analysis . India also lags . over 50 percent of the investments tend to generate returns in the range of minus 10 percent to 30 percent. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).08 Exhibit 2.9 behind developed economies such as Australia and Japan both in terms of overall and realized returns. 30 percent of PE deals in India are likely to end up generating a negative return. So how do returns for PE in India compare to other Asian countries and emerging markets? When we compare returns for India to its closest competitor China. noting that “at least a third of the average PE fund portfolio is under water and remains in the portfolio” . deals delivering blockbuster returns (IRR>100 percent) and deals delivering significantly negative returns (IRR<60 percent) occur with relatively similar frequency. which shows a distribution with “fat tails” Nearly . Nearly 30% of PE investments end up giving negative returns Source: KPMG in India Analysis Exhibit 2.6 Distribution of Cash Multiple 120 100 80 60 40 20 0 0 to 1x 1x-2x 2x-3x 3x-5x 5x-7x 7x-10x Over 10x 42 27 11 5 8 111 96 This widespread IRR return suggests the existence of considerable outliers at both ends.7 . a Swiss entity.5. Moreover.4 percent as compared to an IRR of 17 percent for India. This is confirmed by the IRR distribution table shown in Exhibit 2.

” Secondly. 5. Further. and so are willing to wait for a higher bidder. 2009 © 2011 KPMG. the maturity of the capital markets raises entry valuations by providing alternative capital raising opportunities for private firms. Owners of such businesses tend to be financially sophisticated and secure.4x 2. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). China is different.1x 3.8x 1.5% 27. due to their understanding of the business risks and tolerance for illiquidity. PE fund managers tend to undertake extra due diligence of family-owned firms.5x 2.1% 35.5% 2. In subsequent sections of the report. it might mean that the books overstate revenues and profits.8x Overall Cash Multiple IRR Realized Cash Multiple Note: *Figure for India represents capital weighted IRR based on KPMG Analysis. leading to execution delays. “China's market is relatively immature and the quality of analysis is poorer than in India. the entry valuations tend to be higher than in China because of the relatively high proportion of family-owned businesses in Indian PE portfolios.6% 1. in India. We deal with one important factor here: the high cost of entry. Given the weaknesses that are evident in Indian corporate governance. a Swiss entity. which becomes tougher in the Indian scenario where entrepreneurs are unwilling to lose control and do not want to exit their positions either. KPMG Reshaping for future success. As a fund manager notes. we analyze the returns for Indian PE in detail and look at a host of factors that directly or indirectly affect returns.2x 1.9% 20.1% 12.0% 16.09 Returns from Indian Private Equity Exhibit 2.6x 1.5x 17. “We are very scared of the ‘lemons’ effect: if a family-owned business is keen to sell. As one of our respondents noted.7 PE Returns Across Asia and Other Countries Country IRR Developing Economies India* China Southeast Asia Developed Economies Australia Japan South Korea 24. private equity needs to compete with the primary market as a fund raising option. KPMG in India analysis Several India-specific factors account for the relative under performance. thus raising the entry costs. A third source of competition for deals are strategic investors.3x 2. Its key driver is one that we highlighted in our earlier report on the future of PE in India: the preponderance of intermediated deals relative to proprietary deals – only 40 percent5 of investments are proprietary or co-investment deals. As an LP pointed out to us.4% 3.9% 20.4% 2. Returns are presented on a gross basis Source: Asia PE Index. This usually means that new companies tend to be under-followed and undervalued.8x 47. it is possible to get deals at single digit (price/earnings) entry valuations.7x 1. . Intermediated deals are shopped around to the highest bidder. “In China. because of regulations. Indian capital markets allow private companies to raise capital early on in their life.2x 29. China's vibrant IPO market means that exit via the IPO route is easier than in India” In India. it is usually in the teens. All rights reserved.4% 4. Indian markets are also difficult to execute in.4% 32. Even for proprietary ” deals.

In 30 percent of the cases PE made money primarily due to multiple expansions (see Exhibit 2. During the typical holding period of five years. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). PE funds are typically structured as finite life funds with the philosophy that it is possible to invest and exit profitably across many companies over a period of 10 years. a Swiss entity..5% 3.8% 0% Helped in attracting talent Helped develop new business models Offered patient capital for company in growth phase Helped business to expand and access new markets Improved corporate governance in company Helped in building world class capability Helped access other sources of funding specifically debt Helped in efficiency improvement Enabled infrastructure capacity development Others Helped improve the perception of the quality of the company Note: Data represents percentage of responses Source: KPMG in India Survey. our survey indicated that organic growth was more important and is consistent with the overall picture that emerges of PE's transformative impact.10 How PE Funds Manage Exits and Create Value As noted earlier. besides providing patient capital for the company during its growth phase. Our survey indicated that EBITDA growth was the primary driver of value creation in 57 percent of the cases – driven primarily by organic growth. it becomes imperative for PE fund managers to manage the exit process well to generate the desired returns. obtaining an expansion in the multiple.0% 5.8% 7.3% 10% 5% 3.3% 8.3% 20% 15% 14. 2011 We also asked PE fund managers to identify the primary source of value creation in their portfolio company. the contribution of PE is partly due to timing the business cycle rightly. Our survey revealed that PE funds help in value creation in portfolio companies in a number of ways.5% 1. Thus. .8 PE Funds Contribution to Value Creation 25% 19.9).e.0% 12. improving corporate governance. helping the portfolio company to expand and access new markets.3% 12. i. PE funds besides providing capital to the portfolio company also provide transformative inputs which often take the portfolio company into the next level of growth. All rights reserved. assistance in developing new business models for the company. © 2011 KPMG.3% 12. While timing the cycle appears to be important. Exhibit 2. The most important areas relate to help in attracting the right talent. In other words.

4 Type of Exit 3.3 Timing 2.10). Overt disagreements with promoters on the type of exit are rare. a Swiss entity.7 0 1 2 3 4 5 Note: 5 being high disgreement and 1 being low disagreement Source: KPMG in India Survey. 'Company management' usually also means the majority owners. 2011 © 2011 KPMG. as our survey shows (Exhibit 2. since management are usually promoters who keep a controlling stake. The portfolio company's management needs to come on board with the exit process. Some parts of these processes are governancerelated: putting in place an independent board. This may lead to potential conflicts between fund managers and promoters on the type of exit. and testing the adequacy of corporate governance and financial systems to meet the buyers' requirements (for instance. Exhibit 2. the standards for listing the firm). Strategic sales thus become one of the least preferred option of promoters and the most preferred by the fund manager.11 How PE Firms Manage Exits and Create Value Exhibit 2. such as an IPO or a strategic sale. Even secondary sales are preferred to strategic sales by promoters for the same reason. entering new markets) Cost reduction through operating efficiencies Acquisitions by the portfolio company Note: Data represents percentage of responses Source: KPMG in India Survey. Most promoters prefer IPOs and open market sales to other types of exit. 2011 15% 30% 57% Note: Data represents percentage of responses Source: KPMG in India Survey. Other parts relate to the actual divestment process: negotiating with buyers and brokers. completing legal and compliance requirements. and so on.10 Portfolio Company Disagreement with PE Fund Valuations 3.9 Primary Source of Value Creation 4% Primary Source of EBITDA Growth 9% 12% Organic growth of the portfolio company 54% EBITDA Growth Multiple Expansion Other Leverage Reduction 19% Any other (changing product mix. although less preferred than public market options due to having to share control in the case of secondary sales with a new financial investor. as well as on timing and valuation. The disagreements may be significant. an exit process begins. . All rights reserved. since it allows them to retain control of the company. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). 2011 The exit process begins with an assessment of the likely type of exit.9 Partial or complete exit 1. Once the options are narrowed.

Exhibit 2. .5 1 1. negotiations on representation and warranties and structuring of transactions. 2011 Exhibit 2.11 How Much Control do Investors Exercise on Exit Type? 3.5 3 3. All rights reserved. 2011 The survey also indicated that it usually takes between six months to a year to actually exit after the decisions to exit the firm (including agreeing on the price with the buyer) is taken. The survey further highlighted that under most circumstances PE investors tend to influence the choice of exit. a Swiss entity. a few noted that such control is driven by the stake held in the portfolio company and the type of business. the highest disagreement between the promoter and the investor is on valuations and the type of exit. © 2011 KPMG.5 5 Note: 5 being complete control and 1 being least control Source: KPMG in India Survey.3 0 0. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).5 4 4.12 Our survey also indicated that during exit discussions. However. The most important challenges for the fund managers during the exit process were related to hurdles during execution and taxation issues.5 2 2. Other issues faced by funds included speed of execution.1 yr Over 1 yr Note: 5 being high disgreement and 1 being low disagreement Source: KPMG in India Survey.12 Time Taken to Exit 25% 20% 55% 3-6 months 6mths.

4% 3.4x Average Holding Period (in years) 6. This is due to the fact that rising markets support higher valuations and easier exits compared to a downward trend which makes exits difficult to come by as risk aversion replaces risk appetite.4% 5.4% 17.6% 14.13 Amongst the larger factors that influence exit activity. Hence.9x 4. KPMG in India Analysis Besides. Exit value represents total value of liquidity event Source: VCCEdge. KPMG in India analysis © 2011 KPMG.4 2. BSE Sensex Value and PE Exit Value 25000 20000 15000 10500 5000 0 31/Dec/03 31/Dec/04 31/Dec/05 31/Dec/06 31/Dec/07 31/Dec/08 31/Dec/09 31/Dec/10 31/Dec/11 Sensex hits peak of 21.3% 31.4% -0.3% 42.1% 22.7% Cash Multiple 4.0% 7.0% 19.13). an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). Bombay Stock Exchange.8 5. This is evident when one looks at the sample of returns for deals done at the peak of the market cycle in 2007 which have yielded an IRR of minus 0.5% -18. .6x 0. markets hit a bottom BSE Sensex Value PE Exit Value Note: Outliers have been omitted for ease of representation.14 Returns by Vintage Year Years 1999-2003 2004 2005 2006 2007 2008 2009 2010 Total Weighted IRR 33.8% 5.9% Median IRR 28. All rights reserved.206 on Jan 10. 2004 and 2005 were other good vintage years with returns of 42.6 3.6 1. a Swiss entity.0x 1.3% 86.0% 28.1% 19. Exhibit 2. being a key factor in determining the choice of exit and timing of exit. On the other hand deals done during the uncertainty of 2009 have generated the highest IRR of over 86 percent.9% 12. 2008 500 450 400 350 300 Sharp recovery post elections BSE Sensex PE Exit Value (USD mn) Sustained bull run in the Indian markets 250 200 150 100 50 0 Lehman crisis.4 0. Each dot represents PE exit.4% Note: All IRR and cash multiples are presented on a gross basis Source: Bombay Stock Exchange. company valuations are also a function of conditions in the capital markets which directly impact returns.4 Sensex IRR 20.3 percent on a capital weighted basis.4x 1.9x 2.1 3.1 percent respectively.4% 6. it’s not surprising that deals done at the top end of the market cycle are likely to yield lower returns compared to deals done at the bottom end of the market cycle.1% 26.3 percent and 31.9% 12.2x 1.3% 3.5% 0. capital markets bear a strong correlation with PE exit volume (see Exhibit 2.3% 6.13 Influence of Capital Markets and Sectors Exhibit 2.9% 44.1% 15.9x 2.0x 2.3 4.6 4.

1% 111.8% 26.6% Cash Multiple 4. a Swiss entity. This is particularly true for exits in 2007 which yielded an abnormally high return of 77 . the reverse should be true for exits as bullish markets are likely to yield higher returns compared to bearish markets.8 4. .6 2. As one fund manager noted.1x 3. 2011 © 2011 KPMG. Thus.4% 27. eg.2% 0.5% 22.6 3. regardless of the cycle.3 4. This underscores the fact that timing the exit is a crucial aspect which determines the likely return the investor will make.1% Median IRR 36.1% 27.5x 3.2% Note: All IRR and cash multiples are presented on a gross basis Source: Bombay Stock Exchange. “One reason for the five year holding period in India is that we can catch the business cycle on the upswing. we expect to exit profitably on average – provided we are disciplined about exiting during the upturn. buyback. Exhibit 2. KPMG in India analysis The survey respondents indicated support for the above findings.16.9% 15.16 Factors Influencing Timing of Exit Decision State of capital market environment Portfolio company performance State of domestic business cycle Status of fund / Remaining fund life Preferences of portfolio company management Type of industry/sector that the portfolio company belongs to State of global business cycle Contractual agreements with promoters of the portfolio company. If we invest during a downturn.1x Average Holding Period (in years) 3.8 2.1% 32.8x 1. Another good year for exits was 2010 which returned a decent 30 percent IRR. we will make a large profit during the subsequent upturn.8 Note: 5 being highly significant and 1 being least significant Source: KPMG in India Survey.3 3. As shown in Exhibit 2. If we invest at a high prior to a downturn.0% 9.1% 20.0% 37. we expect that we will exit during the next upturn without a loss and.0 Sensex IRR 22.0% 29.5 3.14 Further.5 percent on capital weighted basis as PE funds were able to cash in on the upsurge in capital markets and earn ‘supernormal’ returns.6x 2.5 2.8% 29..7% 16. in the process. hopefully.9 4.2x 3. some profit from organic growth. the state of capital market environment and portfolio company performance are amongst the most crucial factors impacting the decision to time the exit and affecting.0x 3. Other important factors impacting the exit decision include state of the domestic business cycle and status of remaining fund life.7 2.1% 77. ” Exhibit 2.1% 16. All rights reserved. the holding period.6 2.3% 6. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”)..0% 7..4 3.15 Returns by Exit Year (Only for realized investments) Years 2004-06 2007 2008 2009 2010 2011 Total Weighted IRR 36.5 2 3 4 5 1. Time to exit and related transactions costs 0 1 1.3 3.

the pace at which it is growing and most importantly the entry valuation .3% 11. retail and apparel. Unlike public equity funds.1x 2. on average.4x Note: Transportation. All IRR and cash multiples are presented on a gross basis Source: KPMG in India Analysis Notwithstanding the diversity of sectors for investment.9% 0.4x 1. Consumer and retail includes gems and jewellery.17 PE Returns Across Sectors Sector Agri & Food Auto & Auto Components BFSI Consumer & Retail E-commerce & Online Services Energy & Energy Equipment Engineering & Construction Healthcare & Pharmaceuticals Hotels..2% 7.9% Median IRR 4.2x 1. the lowest performing sectors based on weighted average IRR were auto & auto components and consumer & retail. Shipping and Logistics includes logistics infrastructure.8% 7. it may also reflect poor underlying performance relative to investor expectations.4x 1. Our survey indicated that the sector returns tend to be driven by the nature of the sector – whether it is capital intensive in nature.9x 2. If so.8% 27.6x 0.5% -8. specialized retail etc. On the other hand.0% 11. Shipping & Logistics Overall Weighted IRR 16.9x 4. The lack of deals means that it is not possible for a GP to find enough investments to justify sector specialisation. . PE funds tend to be generalists. since waiting may be viewed as a costless option by the fund manager. This was followed by engineering & construction which returned an IRR of 38 percent while healthcare & pharmaceuticals and manufacturing gave returns of around 27 percent each.6% 41.8x 1. Until the fund exits from an investment. availability of a large number of deals. Others include real estate.9x 2.7% Cash Multiple 2. But.4% 10.whether you are the first to identify the sectors potential before competition drives up valuation.7% 6. though this is changing as India acquires its own asset-class status.9% 21.4x 2.2% 28. in most sectors. It is quite likely that underperforming investments will be held for as long as possible.8% 24. A second factor is the lack of depth. as noted.4x 1.0x 0. They include some LPs’ preference for a general emerging market-like portfolio in India. i.8% 4. The reasons are several.0% -1.6% 37.2% 9.6% 17. unprocessed foods. the case of private equity funds lies with the fund manager. All rights reserved.7x 1. processed foods and restaurants. than realized investments. a Swiss entity.e.8% 20. Does the choice of sector selection also influence returns? Our study indicates that the top performing sector in our sample based on capital weighted IRR was energy & energy equipment that returned 42 percent.2% 25.9% 15.5% 12. where the option to disinvest (exit) lies with the LP the option in .0% 2.6x 2.6% 0. Resorts & Leisure IT & ITES Manufacturing Media & Entertainment Other Services Others Telecom Transport.6% 1.0% 6. Agri and Food includes agri inputs. we would expect that unrealized investments would be valued less.1% 6. both of which have eroded capital for investors.. the LPs must wait.9x 2.9% 29.3x 5.2% -7.6% 9.6% 16. education.15 Influence of Capital Markets and Sectors The difficulty in exit may reflect the capital market environment. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). Exhibit 2. © 2011 KPMG.6% 27.

we examine which exits would be most preferred by a PE fund manager. we seek to understand: do certain types of exits yield higher returns? What kind of exit will be preferred by a PE firm under what conditions and why? As noted in Exhibit 2. This can be attributed to the fact that once a company is listed on a stock exchange. the most common type of exit in India is the open market sale.19 Ease of Exit Options in India Open Market 1. a Swiss entity. Open market exits accounted for nearly 38 percent of total PE exit volume over the period January 2005September 2011. Strategic sales were considered difficult due to the lack of strategic buyers while buybacks are hampered by the lack of enforceability. for obvious reasons are considered the option of last resort.18 Exit Volume by Type Secondary Sale 12% Buyback 10% IPO 8% Total exit volume (2005-9M 2011): 673 Open Market 38% Strategic Sale 32% Source: VCCEdge The survey respondents considered open market exits as the easiest to do in India. . Exhibit 2. Specifically. Next in popularity were strategic sales that accounted for 32 percent of total PE exit volume over the mentioned period. buybacks or put options as they are called. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).4 0 1 2 3 4 5 Note: 5 being most difficult and 1 being easiest Source: KPMG in India Survey. to be tried only in the worst case scenario after all other options have been exhausted. Exhibit 2. M&A transactions are less impacted by conditions in capital market due to their strategic nature. 2011 © 2011 KPMG. Also.3 Secondary Sale 2. other exit options such as an IPO and open market sales are market dependent and also face regulatory restrictions in the form of lock in periods restricting the sale of shares. while open market sales are directly related to sentiments in the capital market. All rights reserved.6 IPO 2.16 Understanding the Type of Exit In this section. Interestingly. it is fairly easy for a PE investor to sell off in one shot or dribble its stake.5 Buyback 3.3 Strategic Sale 3.18. depending on the liquidity in the company’s stock. Moreover. Strategic sales and buybacks were considered to be the most difficult despite the fact that nearly 32 percent of exits have been through strategic sales.

portfolio company performance and the preferences of promoters – are as expected. .20 for our sample. if the investment has not done outstandingly well. Exhibit 2. “Given the shortage of buyouts in India. IPO and open market sales on a weighted average basis). All IRR and cash multiples are presented on a gross basis Source: KPMG in India Survey.0x 0. Third. This gives promoters a lot of options. 2011 The returns from strategic sales can be explained from the fact that strategic buyers are willing to pay a higher premium to enter into an established business due to operational synergies or to get a head start into a new market.0% 30.0% 35.0% 20.17 Understanding the Type of Exit But does the ease of exit option also translate into higher returns? As shown in Exhibit 2. This allows the portfolio firm to be positioned appropriately over a period of years by building relationships with desired acquirers several years in advance. the stake being sold might be too small to justify an IPO. For one thing. The remainder had strategic sales at the top of the list followed by public market sales (IPO/open market).0% 15. this will not continue.0x 37. Going forward. Also if a majority stake is on offer it is possible for the seller to get a high control premium.0% 10. it is unusual for secondary sales to generate the highest return due to high levels of buyer sophistication. whereas strategic buyers tend to be open to a wide range of investment sizes. Secondary sales offer an ” additional advantage: they enable a maturing investment to continue to remain under PE guidance for some more time than may be possible within a single fund’s lifespan. Half the PE fund managers' that we surveyed did not have a preferred choice of exit with most calling it opportunistic and preferring with the one that delivers the highest return for that particular divestment. a Swiss entity.0% 5. a lot of capital is being reinvested in the portfolio companies of other PE funds.4% 3. Since stock market activity is influenced by the business cycle of the economy. Strategic buyers. as the preferred modes of exit. this suggests that fund managers have managed to invest within a disciplined framework that accounts for the time it takes to exit and the costs involved – this is a sign of the increasing maturity of the PE industry in India.20 Returns by Exit Type 45. While most of the important factors – such as the state of capital market and state of the domestic business cycle. exit via IPO requires a vibrant stock market.5x 2.7% 3.1x 5. and perhaps the most important.3% 30. it is interesting that fund life and transactions costs associated with exits are relatively unimportant. there is not much difference between returns from different types of exits.1% Buyback 1.0% 40.5x 0.21 shows the importance that PE fund managers attach to different factors influencing the exit type.0% 25. think long-term and are less influenced by short-term market swings. As one of our respondents noted.9x 24. Second.8x 4. While the low return on buyback may be explained – these are underperforming deals that are sold back to promoters – it is interesting that secondary sales earned the highest return (followed by strategic sales.4x 35. a strategic sale is still possible at some valuation while an IPO might be unlikely. All rights reserved.0x 1. Exhibit 2.0x 2.9% 3. with the exception of buybacks. From a global perspective. There are several reasons why a strategic sale is preferred.1% 29. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).5% 35.3% 2.4% 39.0% Open Market Strategic Sale Weighted IRR Secondary Sale Median IRR IPO Cash Multiple 2.0x 3. the timing of an uptick in markets may not match the time when a portfolio company is ready for exit. Given our earlier discussion on how fund life critically affects every portfolio decision. © 2011 KPMG.0% 0. on the other hand.6x Note: Data pertains to realised deals only.5x 32.5x 1.7% 2.

a Swiss entity.7 3.1 2. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). allows the fund to participate in further upside and get the fund manager’s ‘carry meter’ ticking. partial exits are important in cases where the fund owns large stakes.0 3.0 1. All rights reserved.3 4 5 Note: 5 being highly significant and 1 being least significant Source: KPMG in India Survey. 2011 4. Further. Partial exits can also be a result of changes in regulatory factors which lower the attractiveness of the industry.2 4.9 2. which might be difficult to sell especially in new/unique industries given that capital markets may not know the appropriate valuation.22 Factors Influencing Partial vs Full Exit Tendency to book partial profits 3. Status of fund / Remaining fund life Time to exit and related transactions costs Others 0 Note: 5 being highly significant and 1 being least significant Source: KPMG in India Survey.21 Factors Determining Choice of Exit Type State of capital market environment Portfolio company performance Preferences of portfolio company management State of domestic business cycle Type of industry/sector that the portfolio company belongs to State of global business cycle Contractual agreements with promoters of the … portfolio company. . buyback clauses. 2011 © 2011 KPMG.8 1.1 2.8 2. eg. Taking the cost out when valuations are high.9 1 2 3 4 5 We also asked fund managers to identify factors which influence their decision to partially exit from a portfolio company against a complete exit from such company.9 2.5 Liquidity Requirements Signaling effect to market Availability of options Regulatory factors Other Expectation of significant upside 0 0. The tendency to book partial profits and take some money off the table is the most important factor that affects the decision to make a partial exit. Exhibit 2.5 3.7 1.18 Exhibit 2..3 1 2 3 0.7 0.

0% 35.0% 20.24 Returns by Deal Stage 40.1% 1.6x 25. it participates at the growth stage.3% 2.0x 15. Hence.6% 9. Growth stage deals comprised nearly 58 percent of all PE deal value in India and over 51 percent of all PE deal volume in India over the period January 2004. might start to give higher returns in the future. One attributed it to the immaturity of the industry. The Indian PE market is unusual in that.0% Early Growth Weighted IRR Note: All IRR and cash multiples are presented on a gross basis Source: KPMG in India analysis © 2011 KPMG. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).23 In this section.0x 24. our study indicates that returns for early stage deals are significantly lower at 4.0x 2. Our survey indicated that fund managers were also surprised at this finding. Another factor that can perhaps ” explain the low returns include the lack of an entrepreneurial eco-system in India.7x 19.0% 0. All rights reserved. businesses take longer to cross the ‘proofof-concept’ stage. noting that: “In India funds don’t add enough value.9x 36.7% 2.0% 25.0x . Early stage deals which were about 21 percent of the PE deal volume over the mentioned period comprised only 3 percent of deal value in the country.0% 11. unlike most countries. a Swiss entity.3% 4. buyout deals represented 8 percent of total PE deal value.0x 1.2% 3.6 percent for growth stage deals on a weighted average basis.0% 5.0x 0.5x 3. Early stage investing needs an eye for quality and since it is fairly new in India. However. 35.1 percent compared to 19. we would expect the highest risks to be found in the earliest stage deals. PE Deal Volume by Entry Type 600 500 400 27 90 11 64 12 4 65 12 77 8 24 2005 Buyout Early 190 18 Number of deals 20 60 8 300 200 100 0 6 1 30 3 36 17 2004 11 42 12 15 39 6 134 261 259 9 45 10 149 200 64 18 2006 77 18 2007 Growth 106 13 2008 Pre-IPO 64 12 2009 PIPE 86 9 2010 Others 94 17 9M2011 Note: Growth stage deals include growth as well as late stage deals Source: Venture Intelligence.5x 0. By contrast.2% 1.0% 15. increasing the time period it takes to turn profitable.6% Pre-IPO Median IRR PIPE Cash Multiple Buyout 2. That’s why there is a mismatch in returns and stages.5x 1.0% 10. KPMG in India analysis Normally.6% 2.September 2011. we explore the relationship between entry and exit. as well as the highest potential to make a difference.0% 30.19 Influence of the Type of Entry Exhibit 2. Exhibit 2. with very few early and buyout deals.5x 2.

an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).e. the market will worry that there is something wrong with the company. if a fund can spot a company where the market does not capture the full value of the company? There would be more PIPEs if the 15 percent threshold was higher. since the stake may sometimes be large enough to justify a board seat. a way to invest spare funds in liquid. but mostly. “PIPES are ok to do . Still. VCCircle.7 percent.0 percent. Under the new Takeover Code which ” came into effect on October 22.25). one survey respondent noted: “It is natural that buyouts will exit through strategic sales because the investors control the company. yet several PE firms and LPs do not look on them as 'true' PE investments. Venture Intelligence..why not. . a Swiss entity. as one fund manager noted in our survey. This is unexpected because of the perception that promoters demand a 'control premium' to sell out. Exhibit 2. All rights reserved. with an ability to make a quick rather than a substantial return. Our study indicates that PIPE returns are more or less in line with the public market at 15. the investment is passive. Some respondents of this survey noted that the scope for adding value might exist in PIPES. they are viewed as 'balancing investments'. 6. the promoter will have a say in the type of exit. while other entry types are more diversified in exit types. i. undervalued stocks. despite the ” higher entry valuation that this implies. In a buyout. Adding a signalling dimension. They accounted for nearly 17 percent of total PE deal volume over the period January 2004 to September 20116. there appear to be some opportunities in buyouts. Data does not include real estate deals 7 . PIPE deals are an unusually large phenomenon.25 Relationship Between Entry and Exit Type Entry/Exit Buyout Early Growth PIPE Pre-IPO Buyback 0% 0% 18% 3% 0% IPO 0% 33% 16% 0% 0% Open Market 13% 17% 25% 88% 100% Secondary Sale 13% 17% 25% 3% 0% Strategic Sale 74% 33% 16% 6% 0% Note: Data pertains only to our sample of realized deals Source: KPMG in India Analysis An analysis of the relationship between entry and exit types indicates that buyouts in India mostly get exited via strategic sales (see exhibit 2. “Promoters run a lifestyle business and don't usually want to sell out. October 2011 © 2011 KPMG. At best. 2011 the initial threshold for trigger of an open offer has been raised from 15 percent to 25 percent7. This is likely to provide an impetus for PE investment in small and mid cap companies. the decision maker on exit type is solely the fund manager. whereas in other types of investments. Yet. PIPE ” deals and pre-IPO deals are expectantly realized through open market sales. As one of the survey respondents noted. If the PE funds own a majority and exit through IPO.20 Another unexpected finding is that buyouts have returned 24.com.

2011 © 2011 KPMG. longer holding periods appear to yield substantially higher returns.8% As the chart above shows. such investments could grow to be a substantial share of the portfolio’s total value.6% 9.6% 1.5 0 1 2 3 4 5 Note: 5 being highly significant and 1 being least significant Other includes view of future potential. A PE fund would also like to hold on to highperforming investments. we would expect that longer holding periods and larger ownership/deal sizes would yield higher returns. The first is a reward for holding period risk.0x 5. interesting and only partially explicable.2% 2. Exhibit 2.21 Influence of Holding Period and Ownership Exhibit 2.0% 1. These arguments suggest that – though constrained by fund life – fund managers hold on to both ‘dogs’ and ‘stars’.7x 8.1% 5. Returns by Holding Period 35% 30% 25% 20% 15% 1.8x 10% 5% 0% Less than 2 years 2-3 years Weighted IRR Note: All IRR and cash multiples are presented on a gross basis Source: KPMG in India analysis 6.0x 1.5% 14.27 below. Source: KPMG in India Survey.6% 10. All rights reserved. .2 State of capital markets 3.0x 4. Apart from intrinsic factors such as the portfolio company performance.3x 3.0x 0. as discussed earlier. the second because it improves access to better deals and allows for more fund control.9x 5. as shown in Exhibit 2. ownership percentage and size of the deal.0x 3-4 years Median IRR 4-5 years Cash Multiple Greater than 5 years 24.0x 29.27 Factors Influencing Holding Period Portfolio company performance 4.6 State of sector's business cycle 4. Over time. a Swiss entity. That returns rise with holding period is. This is supported by survey respondents.0% 1. underperforming investments tend to be held on to in the hope of doing well down the road.3% 4. Intuitively.26 The final factors that we consider as influencing exits are holding period. a longer holding period also depends on the state of capital markets and the stage of the industry and economy’s business cycle.0x 18. However.9 Other 0. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). This appears to be consistent with the argument that an investor ought to earn greater reward for the greater liquidity risk implied by longer holding periods.0x 2. there are two more factors at work. therefore. First. incremental IRR. etc.

All rights reserved. It depends on the business cycle. “ five year holding period enables A one to catch at least one business cycle” . It takes twice as much time to manage control deals compared to minority deals.22 As one of the respondents of this survey noted. our findings surprised several fund managers.28 Returns by Stake Acquired 50% 3.4x 1. In our sample.5x 0.8% 2. you may miss the opportunity. 2011 © 2011 KPMG.5x 1.9 percent as compared to 17 percent for the total sample. Exhibit 2.5x 3. taking control required more fund manager time than might be worth it.9 Exhibit 2.0x 0. the ” sweet spot was deemed by survey respondents to be between 20 percent and 30 percent . In addition.6x 11. deals in which stake acquired was between 20 percent and 30 percent returned 26.5% 28.8% 1. ” Turning to the influence of ownership and size effects. If you don’t sell at the peak (of the business cycle). As one of the respondents of this survey noted.6x 26.0x 40% 2.6% 15.6% 18. . while another cautioned that merely holding on longer in order to add more value might not work. as expected. a Swiss entity. noting that.29 Sweet Spot for Investor Ownership 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 0% to 10% 10% to 20% 20% to 30% 30% to 40% 40% to 50% 50% to 60% 60% to 70% 70% to 80% 80% to 90% 90% to 100% 8% 6% 8% 8% 6% 6% 14% 14% 11% 19% Note: Data represents percentage of responses Source: KPMG in India Survey. we find that. Returns were highest for deals where more than 50 percent of the stake was acquired. “Long holding periods are not intrinsically superior.0x 2. who felt that a holding beyond 50 percent but less than 100 percent would rob the promoter of the incentive to perform.0x 12.9% 17. .0x Between 30% and 40% Median IRR Between 40% and 50% Cash Multiple Greater than 50% Nevertheless. In fact.5x 30% 20% 10% 0% -0.5x 2. larger stakes yield higher returns. “There are huge bandwidth issues with control deals.5% 1.4% 3.8% 7. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).an ownership stake that assures adequate influence without creating incentive issues and which allows the promoter to be substantial even after subsequent rounds of funding. This can partly be attributed to the fact that a controlling stake allows investors to operate the company in a determined way and deliver superior results.1% -10% Less than 20% Between 20% and 30% Weighted IRR Note: All IRR and cash multiples are presented on a gross basis Source: KPMG in India analysis 3.

larger commitments of capital and entail greater fund manager commitment.1% 14. © 2011 KPMG.8x 14. a Swiss entity.0x 10% 1. As Exhibit 2. However since companies of this size are more mature. is for deals between USD 20 million and USD 50 million at a cash multiple of 2.0x $10 mn to $20 mn Weighted IRR $20 mn to $50 mn Median IRR $50 mn to $100 mn Greater than $100 mn 0% Less than $10 mn Cash Multiple Note: All IRR and cash multiples are presented on a gross basis Source: KPMG in India analysis The highest return.9x 20% 2.30 When it comes to return by deal size.9x 32. especially the risk that the promoters might not be able to execute well enough. The reasons appear to be several.2% 3. typically. arguing that a deal size beyond USD 10 million imposed significant risk.0x 6. the number of funds in that space reduces which allows investment at reasonable valuations. a deal size between USD 10 million and USD 50 million allows the company to cross an important inflexion point and takes the company into the next (higher) level of valuations. In fact.0% 0. that returns would increase by deal size since larger ownership would require.0 percent).7x.7x 30% 1.1% 1.7 percent. the effect is not as marked.7% 2.1 percent. . All rights reserved. A reason for this could be that as deals get larger.3% 8. Returns by Deal Size 50% 4. However. we notice that deals above USD 100 million return an acceptable 20. we expected.0x 40% 2. deals of this size would not deliver abnormally high returns. Another respondent noted that ” this size of deal also is significant enough for an IPO or a strategic sale. Returns from deals in the range of USD 10 million to 20 million are also relatively high at 19.1% 20. some respondents were cautious.23 Influence of Holding Period and Ownership Exhibit 2.0% 4.1 percent. beyond USD 50 million in size. were viewed as imposing too much risk. This reiterates the attractiveness of India’s mid market opportunity. whereas smaller deals allowed better diversification. On the other hand deals below USD 10 million earn the least (6.0x 23. As one fund manager noted.1% 2. However. about 23.0x 19. when one takes into account median IRR such deals have earned the greatest return.1% 16. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). Large deals.30 shows.

a Swiss entity.24 © 2011 KPMG. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). All rights reserved. .

This is almost twice the maximum amount of PE investment (USD 14 billion in 2007) received in India in any year. Another 8 percent believed that exit volume will decline by more than 20 percent. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). instead.1 Outlook for Exit Deal Volume in India 35% 30% 25% 20% 15.1 billion in exit value realized over 2009-2011 (till September 2011)2 assuming that these exits are for vintage years 2006 and beyond.7% 23.8% Note: Data represents percentage of respondents Source: KPMG in India Survey.1% 23. 2011 1.5 billion was invested by PE funds in India from 2006 to 20081. On the other hand 46 percent believed that exit volume would increase by more than 10 percent while 15 percent expected it to remain stable.1% 30. Further. Assuming a five year holding period and if funds are expecting to get back 3x on their investment which translates into a 25 percent IRR.10 percent) Increase somewhat (10-20 percent) Increase significantly (>20 percent) 7. Such a large amount of divestment appears unlikely and we. More than USD 31. expect returns to reduce going forward owing to the legacy of underperforming investments that will be carried to maturity.25 Looking 3 for 2012 Ahead The exit environment is expected to be difficult over the next two years. Venture Intelligence. nearly another USD 85 billion will need to be realized over the next three years to 2014. with capital markets remaining choppy on the overhang of high inflation and the global sovereign debt crisis. exits through IPOs and public market sales may remain low until the markets revive. VCCEdge. a Swiss entity. . Data does not include real estate deals 2. Exhibit 3. which was a blockbuster year for exits.4% 15% 10% 5% 0% Decrease significantly (> 20 percent) Decrease somewhat (10-20 percent) Remain stable (+/. All rights reserved. In such a scenario. Nearly one third of this survey respondents also believed exit volume would decrease somewhat (between 10 percent and 20 percent) in 2011 and 2012 as compared to 2010. PE funds will need to explore alternate methods of exit. that is nearly USD 95 billion in exit value that needs to take place over the next three years. Even when one considers USD 9. This translates to about USD 28 billion of exit value per year over the next three years. Exit value includes only the PE investors share © 2011 KPMG.

3% 43. Exhibit 3. 2011 Volatile capital markets. However. which is viewed to be the factor most likely to influence exit. The state of capital markets has a much wider influence than on IPO exits and is likely to influence all types of exits. Liquidity to exit large stakes will continue to remain a challenge and act as an impediment to large deals. All rights reserved. Most fund managers interviewed in the survey believed that taking a company public would be the most popular exit route followed by open market sales. this might change in the future as pointed out by one of our respondents “as promoters are now building businesses to sell out” This would enable . this depends on the state of capital markets.3% 6.2 Most Popular Exit Route 15% 33% 19% IPO Open market sale M&A (sale to strategic investor) Secondary Sale (to financial investor) 33% Note: Data represents percentage of responses Source: KPMG in India Survey.8% Note: Data represents percentage of responses Source: KPMG in India Survey. Disagreements between promoters and the fund and the lack of strategic buyers may also hamper the growth of exits. Hence. 2011 © 2011 KPMG.8% 15. although to a lesser extent. Exhibit 3.6% 9. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). regulatory hurdles and mismatch in valuations are likely to be some of the biggest challenges for exits in India over the next two years. Liquidity can create a challenge even while exiting mid market investments because even if the IPO is successful.3 Biggest Challenge for Exits 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Volatile capital markets Valuation mismatch Regulatory hurdles Management and promoter disagreement Lack of strategic buyers Others 18. the fund might not be able to offload its stake without the risk of negatively affecting the stock price. .4% 6. Delays in regulatory clearances and uncertainty of tax laws can further act as a dampener even if other things seem to be working out well and going according to plan. there might not be enough liquidity or interest in the stock. more strategic sales to take place.26 Of course. a Swiss entity.

Further. and between a decision to exit and actual exit. they should support their fund manager’s efforts to invest and exit through at least one. Such an environment also protects promoters and investors better. as our report shows. While the short-term cost may be higher valuations. as did exits during the buoyant months of 2007 For LPs. Bain India Private Equity Report.27 Conclusion and 4 Recommendations This report highlights many valid reasons to be worried about returns in today’s PE environment in India: the depressed global economic environment and its spillover effects on India and other emerging markets. focus on organic growth Organic growth drives return in about 60 percent of investments. October 2011 © 2011 KPMG. also matter. rapid changes in investment and exit opportunities. and given the rapid economic swings. if not two. lack of sector depth. complete business cycles. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). and with PE investors looking for opportunities (“dry powder” is estimated at USD 20 billion1 and new fund-raising by an estimated 60 PE/VC firms may add another USD 13 billion2). and returns. while timing the business cycle is the key driver in 30 percent of investments. both on when to enter and when to exit. What our respondent probably does not appreciate is that such efficiency comes with other advantages that make the fund manager’s functioning far easier: more predictable rules. the presence of return outliers that raise the probability of large negative returns. More than one fund manager has bemoaned this situation and wished that he operated in a less efficient environment. . A second invalid reason is sometimes offered by LPs and it concerns China. with fewer dealmakers and less savvy promoters. one should discount the invalid reasons sometimes offered. investment and ownership decisions. In fact. better protection of intellectual property and more efficient capital markets.com. They point to China’s superior performance and note that its more vibrant IPO environment is the driver of better performance. On timing. the sophistication of India’s deal environment relative to China is a reason why entry valuations are relatively high in India. the long-term. but do not be obsessed by it. All rights reserved. a Swiss entity. other factors. Given the many valid reasons for concern. Chinese capital markets are today where India was in the 1980s: an immature secondary market within a growing economy created opportunities for bankers and brokers to profit from investor ignorance through IPOs. what should be done? ? Manage timing. the challenges of sharing control with promoters on exit type. such as high entry valuations. timing is also clear: given the long time-lags between fund closure and full investment. These factors adversely affect holding periods. high entry valuations. timing and valuations. Instead. Equally. VCCircle. India’s mature secondary market of today is an important reason why its IPO market is difficult: retail investors are well-informed about today’s weak global and domestic growth environment and are reluctant to invest. transactions made during the uncertain months of 2009 yielded abnormally high returns. For instance. while timing is important. 1. and a weak IPO market. the evidence suggests that a simple strategy of investing in uncertain times and exiting after a period of capital market buoyancy will lead to better performance than trying to call the cycle of particular sectors or other factors. So. transformative outcome of a more efficient deal environment is that it forces fund managers to focus on organic growth to achieve returns. 2011 2. For instance. over-allocating resources to calling the business cycle wastes resources that may be better used in monitoring. the message on .

most funds are not specialised by sector.e. On the other hand. considerable fund manager time can be saved by selecting the most rational exit option without worrying about its effect on return. Since already owned by a PE fund. . However. A buyout. ?on Focus with promoters on type. the incidence of such transactions is bound to go up. ” ? 3x in 5 the average deal. are several. The median time just for the negotiation and structuring work is 6 months. especially the latter two are. Given the low likelihood of positive outliers – only 9 percent of deals earned an IRR of 60 percent or higher – it makes sense to seek a risk profile that focuses on deals whose return is expected to be close to the average. i. a 3x return is required if investors are to get a fair return after accounting for costs and risk. ? Narrow years still makes sense.. limited sector specialisation may be worthwhile. as in China. and avoiding intrinsically short-term deals like PIPES that returned funds with high IRR to LPs whose options to invest the funds may be limited. As competition for quality deals increases. as we noted earlier. can rarely be fully exited through an IPO. “Indian fund managers operate funds that are too large for the number of partners. involving changes in governance and financial processes. but save the resource that is most valuable to their LPs: time spent in monitoring losers. not on outliers The “fat-tails” distribution of Indian PE shows that investments do not distribute themselves smoothly across the return spectrum. Partial exits are always possible. This is true for India as well. which are usually a fallback option for exiting underperforming investments. a typical stake of 20-30 percent ownership in a growth stage investment may be divested in many ways. a secondary sale should not be viewed as a forbidden option. such underperformers would indeed be hard to exit. value and timing of exit. an important source of liquidity for underperforming investments. As the PE industry matures in India. managing conflicts Despite the inability to earn this widelyadopted benchmark. These companies might have significant unrealized value which a PE player might not have been able to harness fully due to a limited fund life. All rights reserved. Second. but the evidence is publicly hidden by many fund managers’ decisions not to divest underperformers. a Swiss entity. By realizing losses quickly. Third. negotiations with bankers and acquirers on structuring and representations. M&A (strategic sales) and buybacks. There is scope for expanding their professional base. fund managers will not only reduce the risk of massive losses later. PE investors have generally been reluctant to exit via secondary sales as indicated by the low exit volume for such deals. Secondary sales. as a full exit sends the wrong message to public investors. As we have seen in this report. but Sectoral will require greater resource commitment by GPs. with the exception of buybacks. However. the Indian environment offers a greater diversity of exit options. including the advantage of preparing for this very early on in the investment cycle. However. ? specialisation is possible. for instance. A second factor is the lack of depth. more and more PE funded companies will come up for sale. the company would have in place adequate systems and processes along with satisfactory corporate governance. outliers are significant contributors to average return. Some strategies to get there: focusing on organic growth. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). As one LP told us. lack of a large number of deals in most sectors. So. there is not much difference in return between different exit types. secondary transactions offer relatively high returns. Given the advantages of a strategic sale. it will require GPs to expand staff. the addressable issues – such as bringing in independent directors – should be addressed as soon as possible to avoid losing windows of opportunity. globally. this should be considered as a first option. which may then be shifted to more promising investments. In an exit environment driven by IPOs. Hence.28 ? Consider realizing underperforming investments About a third of PE investments are currently losing money. as our study shows. given the relatively low costs of Indian professionals. They include some LPs’ preference for a general emerging market-like portfolio in India. as it sometimes is. although this depends on the type of entry and exit. though this is changing as India acquires its own asset-class status. Still. Instead. © 2011 KPMG. and so on. the range of possible exit strategies early and rationally The exit process is often tortuous. The reasons.

growth stage deals when investing GPs perhaps need to look beyond growth deals and make investments in often neglected deal types like buyouts. In turn. a Swiss entity. Undoubtedly. As the Indian PE market matures. . There is an increasing need to focus on business risk. investors need to tread cautiously and build in the risks involved to demonstrate PE capital as ‘smart money’. Various scandals and litigation between investors and promoters can often significantly impact returns and highlight the need for greater focus on these areas of corporate governance. Outperformance will call for GPs to build on the experience of the earlier cycle and to address the risks involved while making such investments.29 Conclusion and recommendations ? between Invest USD 20 million and USD 50 million and own between 20 percent and 30 percent India is a mid-market opportunity. as it optimally blends the PE manager’s ability to monitor without dis-incentivizing management. Although buyouts in India are difficult to execute as promoters of Indian businesses are averse to selling out their business. ?on Focus risk assessment GPs would be advised to focus more on risk assessment and fraud risk management. India offers immense opportunities for PE investments. returns are likely to moderate. As such. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). if properly executed. conduct extensive due diligence and build in all such scenarios while evaluating transactions. Hence. with its strong economic growth and entrepreneurial ability. the entry value. should be about USD 80 million.7 percent IRR for the firms in our study. ? Look beyond generate significantly high returns. The ownership of majority stake in the company does entitle PE investor to define the company’s growth strategy as well as garner any ‘control premium’ that may be there on its exit. it is important to invest a sufficient amount in companies that will make them attractive to the IPO market and strategic buyers – this means that exit values need to be at least USD 250 million. assuming a 3x multiple. may © 2011 KPMG. All rights reserved. Our report shows that taking a stake between of about 20 percent to 30 percent yields the best returns for investors. they returned 24. however. the optimal investment range should begin at USD 20 million for an ownership stake of at least 20 percent. Recent PE exits in Paras Pharmaceuticals and VA Tech Wabag demonstrate that such transactions.

All rights reserved. partners. press releases. managers. transaction costs and other expenses All available cash flows have been used to calculate exit returns k) Dividends if any have been ignored. All such parties and entities expressly disclaim any and all liability for. reasonableness or completeness of the information contained in the report. shareholders. or errors in or omissions from. a Swiss entity. KPMG. DRHP annual reports of the . underwrite or purchase securities nor shall it or any part of it form the basis to be relied upon in any way in connection with any contract relating to any securities ? The information contained in this report is selective and is subject to updating. company. expansion. this report or based on or relating to the readers use of the report. The report is based on a sample of PE returns in India and should not be considered representative of the entire industry. makes any representation or warranty. employees or agents of any of them. news articles and ROC filings ? This report is not a prospectus nor does it constitute or form any part of any offer or invitation to subscribe for. carried interest. express or implied.e. or based on or relating to any such information contained in. as to the accuracy. which may become apparent. © 2011 KPMG. nor any affiliated partnerships or bodies corporate. they do not reflect management fees.30 Notes a) The data for this study has been collected by KPMG b) Our sample consists of returns data for about USD 5 billion of investments which were invested over the period 1999 to 2010. It does not purport to contain all the information available on this subject. and today have either been realized or remain unrealized c) The sample consists of a mix of full exits. stock market announcements. nor We have the directors. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). but should be considered as indicative only ? not independently verified any of the information contained herein. revision and amendment. Important Notice to the Reader ? The information used in this report is from various sources including but not limited to various databases. partial exits and unrealized returns d) In case of partial exits the investment amount has been proportionately reduced to account for only the stake exited e) All aggregate IRRs are capital weighted average IRRs unless otherwise mentioned f) IRRs for public market indices are calculated by investing the equivalent cash flows that were invested in private equity into the public market index g) Index returns for each exit has been calculated using date of first private equity investment and date of last exit as the entry and exit dates h) The index refers to the Sensex unless otherwise stated i) j) All IRR and cash multiples are presented on a “gross” basis i. No obligation is accepted to provide readers with access to any additional information or to correct any inaccuracies. taxes. .

31 Contact our Private Equity Team Vikram Utamsingh Partner and Head Private Equity Advisory & Transactions and Restructuring +91 22 3090 2320 vutamsingh@kpmg.com Nandini Chopra Partner Corporate Finance +91 22 3090 2603 nandinichopra@kpmg.com Dinesh Anand Partner Forensic and Integrity Services +91 124 307 4704 dineshanand@kpmg.com Punit Shah Partner Fund Structuring and M&A Tax +91 22 3090 2681 punitshah@kpmg. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).com © 2011 KPMG. All rights reserved. a Swiss entity.com Nikhil Bedi Director Forensic and Integrity Services + 91 22 3090 1966 nikhilbedi@kpmg.com Rohit Madan Associate Director Research and Market Intelligence – Private Equity +91 124 334 5448 rohitmadan@kpmg.com Tushar Sachade Partner Fund Structuring and M&A Tax +91 22 3090 2683 tushars@kpmg. .com Bhavin Shah Partner Fund Structuring and M&A Tax + 91 22 3090 2701 bhavins@kpmg.com Nishesh Dalal Partner Transactions Services +91 22 3090 2659 nishesh@kpmg.

We would also like to express our gratitude to the Brand and Design team of KPMG. All rights reserved. © 2011 KPMG. a Swiss entity. we interviewed various General Partners and Limited Partners whom we would like to thank for their time and insights. .32 Acknowledgement In order to provide a broad-ranging industry view in the study. We would like to acknowledge the commitment and contribution of our core team comprising of Rohit Madan and Gaurav Aggarwal without whom this report would not have been possible. an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”).

All rights reserved. . No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. The KPMG name. logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. a Swiss entity.com Rajesh Jain Partner and Head Markets T: +91 22 3090 2370 E: rcjain@kpmg. an Indian Partnership and a member fi rm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”). © 2011 KPMG.com Rohit Madan Associate Director Private Equity T: + 91 124 334 5448 E: rohitmadan@kpmg.Contacts Vikram Utamsingh Partner and Head Private Equity Advisory and Transactions & Restructuring T: +91 22 3090 2320 E: vutamsingh@kpmg. Although we endeavour to provide accurate and timely information.com Nishesh Dalal Partner Transaction Services T: +91 22 3090 2659 E: nishesh@kpmg.com/in The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity.com kpmg. there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. Printed in India.

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