Why promoters of cos keeping PE investors at bay

For the past few months, private equity (PE) investors have been making a beeline to the offices of Karbonn Mobile, a mobile handset maker. The five-year old firm has been growing rapidly, cornering some 15% of the market. Now, Karbonn is thinking big — international expansion, a larger R&D unit and a more robust sales and after-sales set-up.
But, surprise surprise, managing director Pardeep Jain is keeping eager investors at bay.His rationale: he's waiting for the right fund to come by and, until then, he will fund expansion plans with internal accruals and debt.
However, with the whiff of an economic turnaround in the air, Jain and other promoters can't keep eager investors at bay for ever. They need to stock up on capital to fuel their growth (and PE investors have some $10 billion in dry powder waiting to be deployed), but are wary of dealing with a sector that has had a spotty record in India.
"We have been very careful [in making a choice of an investor]," says Jain. "Our expertise and resources are limited, so we want an investor who can add some value to our business and lift it to the next level." Karbonn operates in a competitive mobile handset market, which is growing at some 13% annually, according to technology researcher Gartner, which predicts over 326 million phones will be sold in 2016.
PE gets the thumbs up
Jain wants a bigger bite of this fast-evolving market, which is getting more crowded and competitive, with the arrival of a raft of Chinese makers looking to attack domestic firms such as Karbonn and Micromax. "We do want an investor eventually, but we don't want to take one on board for the sake of it, like some of our rivals have, and allow them a seat on our board," he says. Promoters like Jain are wary of aggressive investors meddling too much with the functioning of their companies, leading to spats over future strategy and exits for investors.
PE funds have badly bruised in the past. Investments made based on inflated valuations when the economy boomed between 2004 and 2007 saw PE funds struggle with returns. According to data from Bain, a consultancy, since 2000, PE firms have invested some $85 billion in India and nearly twothirds of these investments are yet to turn a profit. Investments in India have so far returned just $30 billion of this capital, Bain's 2013 report stated. Added to this, controversies related to investee companies like Lilliput Kidswear — whose investors accused it of fudging accounts — are only making promoters more wary of seeking out this set of investors, even if they will soon require their monies.
According to Bain's 2014 PE report, country-focused funds for five countries, including India, declined by 40%, even though there is enough capital from Asia Pacific and global pools to invest in the country. "Fund-raising for India has become more difficult as LPs [limited partnerships, which is how PE funds are structured] have intensified their scrutiny of who they trust with their fund commitments. They are now looking much more closely at factors like team stability, GP [general partner, who typically raises funds from cash-rich institutional investors], track record and investment philosophy," this report observes.
Despite these challenges, PE remains the preferred go-to option for growing firms to raise capital. While debt-financing may be one option, many firms want to avoid a repeat of 2008-09, when companies rapidly raised debt to fuel their expansion, only to be tripped up by the global financial crisis. Going public is also an option for some promoters, but it requires some scale (Rs 300-350 crore or more in annual revenues) and plenty of stamina to adhere to increasingly rigorous compliance norms.
In this context, promoters tend to gravitate towards PE. For one, the route is shorter — a public listing is a relatively long-drawn process and firms in emerging businesses without collateral can lean on the instincts of PE fund heads to raise capital.
Stepping up the pace
Narendra Modi's arrival as prime minister and the new optimism in business sentiment seems to be attracting stronger investor interest. According to the Bain report, over a third of GPs surveyed expected growth of 10-25% in terms of investments made. The bullishness in investments may be catalyzed by an improving exit landscape—the past year saw a 43% increase in exits, even if the total value stayed flat at around $6.8 billion. The worst may not be over for PE funds. According to data from Venture Intelligence, a tracker of data for this sector, investments by PE funds dropped by 28% for the quarter ended June 2014, compared to a year ago. It also dropped by a fifth compared to the preceding quarter.
Promoters, then, find themselves in a curious position.
In Mumbai, Tanuja Gomes, cofounder of Furtado's Music School, is closely watching the action, even as she and her three siblings plot to take their family-run business to the next level—expanding the intake and reach of their school and network of stores selling music gear.
As market sentiment has improved, Gomes has become acutely aware of the need to consider an external investor, but is worried about how perceptions may cloud her judgment. "We don't want someone with their finger on the exit button when they invest," she says.
The business, started way back in 1865 as a single music store in Mumbai, has ambitious plans.
"We train around 4,000 students in music and we have 350 dealers for our products and 20 branches nationwide."
Gomes and the other founders want an investor who can push the business in new directions— how to expand online, setting up stores for high-value products such as pianos (costing upwards of Rs1 crore) and reaching tier II and III towns.