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An Indispensable Guide to Equity Investment in India

It is impossible to overlook the massive profits investors have earned in the Indian market over the past several years. However, beyond the tech-heavy activity that has driven much of these profits, there are many new and interesting areas that private equity and venture capital firms are now aggressively looking to take advantage of. The Indian market is certainly unique. A solid understanding of this market and some behavioural adjustments will be required from investment players who are new to India in order to maximise the returns for their investors. In addition to the required capital, proper research in a challenging market, subtle and savvy managerial skills, and a healthy dose of patience must also be invested to ensure success. In this article, Evalueserve’s analysis shows that those who manage the fundamentals and persevere stand to make significant gains in the years ahead. And, their impact will not only be felt in India, but will have a significant impact the global economy as well.

1. Introduction

Recent research conducted by the global research and analytics firm, Evalueserve, shows that if current trends continue, India will receive US$13.5 billion in private equity (PE) funding during 2007, ranking it among the top seven countries in the world. And, this funding could rise to almost US$20 billion in 2010. Our research also shows there are over 366 firms currently operating in India and another 69 have raised – or are in the process of raising – funds and are planning to start their operations soon.1 In total, these PE firms seem to have amassed US$48 billion earmarked for investment in India between July 2007 and December 2010. Several firms that we talked to also mentioned they would be willing to invest even more if they saw good investment opportunities. This situation stands in stark contrast to 1996, when Indian companies only received a total of US$20 million. Indeed, if Indian companies do receive US$20 billion in funding during 2010, this would represent a stunning thousand-fold increase over a period of just 14 years. Of course, the future is hard – if not impossible – to predict because PE investments are based on a complex combination of macroeconomic, microeconomic and financial policy-related factors that always affect the rational and emotional sentiments of the investor community. Indeed, a slowdown in growth of the Indian economy and a tightening of liquidity around the world are just two potential changes that could lead to substantially lower PE investment in India than those forecasted above.

From a demand-side perspective, assuming a real annual GDP growth of 8%, an annual inflation of 5% and a constant exchange rate of 40 Indian rupees to the US dollar2, our analysis shows that the Indian economy will grow in nominal terms from approximately US$1,030 billion in 2007 to approximately US$5,040 billion in 2020. Hence, it can easily absorb US$60 billion between 2007 and 2010 and as much as US$490 billion between 2007 and 2020. However, for such investment to be useful and wealth creating, it has to be invested in diverse sectors and not be limited only to information technology (IT) and IT enabled services (ITES) sectors.


Organisation of the Paper

This article consists of six sections. In Section 2, we trace the growth of private equity in India from 1996 to the first half of 2007, and also present our forecast for the next three and half years. Here, we also compare the PE investment in India with a few other countries, particularly the US, the UK and China. Section 3 discusses the breakdown of this investment across different sectors and the number of individual deals of at least US$10 million in value, as well as the total value of PE deals during the past few years. Here, we will also discuss the recent trend of hedge funds investing in India. Sections 4 and 5 discuss the reasons for this increased PE funding which include the rapidly growing Indian economy, the rise of the Indian stock market, liberalisation with respect to foreign direct investment into India, and the enormous potential for mergers and acquisitions that involve Indian companies. This section also discusses potential risks while investing in India. Finally, Section 6 discusses a few realities on the ground and best practices while investing in India.

2. Trends in Private Equity Investment in India since 1996

PE and venture capital (VC) firms usually raise capital from their limited partners (LPs) consisting of high net worth individuals and institutional investors such as insurance companies, investment banks, pension funds and university endowment funds. These firms then invest this capital in yet-to-be-formed companies, in newly-formed companies, in private companies not listed on stock exchanges, and in public companies that are listed on stock exchanges (wherein they make investments using “instruments” called PIPEs, ie, Private Investment in Public Equity or by simply buying equity shares in the stock market). Since most VC and PE funds have a hands-on management style and are motivated by the old adage, “if you want something done right, do it yourself,” very often, they place their own people on the boards of these companies and allow them to control the business more firmly. Since these PE funds are not always able to have a majority control (especially in public companies) some funds specialise in being “activist funds” and engage the companies’ boards and management in discussion, wage proxy battles, liquidate assets and even force the sale of some companies.

Venture Capitalists (VCs) usually invest in newly-formed start-ups that may not yet have revenues or even a well-developed product or service ready to sell. Hence, VCs usually bet on the founding or the executive teams, the total addressable market available for the product and deep domain expertise. In fact, since many VCs were themselves entrepreneurs in the past, they continue to be driven by a “start-up” mentality (ie, investing in a new innovation, developing a prototype product or service, and then making it robust enough for selling to bring in revenue) rather than a “growth via robust profits” mentality (ie, increase revenue and profits by performing additional research and development, marketing and sales, and by other means).

In contrast, PE firms usually invest in companies that already have some revenue and that can potentially be grown by restructuring, or by bringing new or improved products into existing or developing markets, or by otherwise unlocking some of the intrinsic value within these companies. Of course, the eventual aim of a PE firm is to either take the company public on a stock exchange or sell it so that the PE firm can free up its locked capital and return some of it to its limited partners. Further, since many PE managers come from diverse backgrounds such as strategy and operational consulting or investment banking, they are a bit more adept at investing in diverse sectors beyond only high-tech, biotech-pharmaceutical or a few other specific sectors.

Despite the key differences outlined above, at a broad level, the business model for both VC and PE firms is essentially the same. Typically, both groups charge their limited partners (LPs) a% as management fees for the assets under management (where “a%” is usually 2%) and retain an additional b% of the profit from the initial investment provided by their LPs (where “b%” is usually 20%).

Also, it is essentially the same group of limited partners that typically fund both VC and PE groups. In fact, many traditional VC firms based in the US and Europe are already investing US$10 million or more today in India, and hence the separation between VC and PE investment in India has become very blurred. Therefore, in this section, we consider the combined investment made by these two groups during the past few years. In Section 3, we will only discuss the India investments made by these firms that are at least US$10 million each.


VC-PE Investment during 1996-2006

Risk Capital Foundation seems to be the first VC-PE firm to start operations in India in 1975. During 1976-1995, domestic financial institutions like Industrial Finance Corporation of India (IFCI), Industrial Development Bank of India (IDBI) and Industrial Credit and Investment Corporation of India (ICICI Bank) were some of the few private organisations that provided any VC or PE capital, and the actual investment made by them was also negligible. During the period 1996-2000, several international and domestic VC and PE firms raised capital internationally and started investing tiny amounts in India. For example, the total investment in India made by these firms was only US$20 million in 1996 and US$80 million in 1997.

Even though PE-VC investment was only US$20 million in 1996 and $80 million in 1997, the pace of growth was very healthy largely due to the worldwide dot-com boom. Unfortunately, because this growth was driven by of the dot-com bubble, it came crashing down soon after NASDAQ lost 60% of its value in 2000 – for example, the total number of deals declined from 280 in 2000 to 110 in 2001 – and this investment reached its low point both in the number of deals and total value in 2003.

From 2003 onwards, India’s economy started growing at 8-9% annually in real terms and at 13-15% in nominal terms (including inflation), and since some sectors (eg, the services sector and the high-end manufacturing sector) started growing at 10-14% a year in real terms and 15-20% in nominal terms, VC-PE firms started investing again in 2004. For example, they invested US$1.65 billion in 2004, surpassing the investment of US$1.16 billion in 2000 by 42%. Table 1 shows the number and value of deals in India during the period from 1996 to 2006.

Table 1: Number and Value of Deals 1996–2006 (in US$m)

Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Number of Deals 5 18 60 107 280 110 78 56 71 146 299
Value of Deals $20 $80 $250 $500 $1,160 $937 $591 $470 $1,650 $2,183 $7,460
Source: Evalueserve, IVCA and Venture Intelligence India

In addition, the exit climate for PE investment in India improved significantly, and especially over the last two years, the market witnessed several large and well-publicised exits. In addition to public equity markets (eg, Genpact listing on NYSE and EXL on NASDAQ), PE firms have also used secondary buyouts or sale to other PE firms as exit.

Outlook for VC-PE Investment during 2007-2010

Table 2 given below shows both the number of deals and the total dollars invested in India H1-2007 as well as Evalueserve’s forecast for the number of deals and the total amount to be invested between H2-2007 and 2010. Our analysis shows that if the current trends continue, India would receive US$13.5 billion in PE funding during 2007, thereby becoming one of the top seven countries receiving such funding in 2007. Furthermore, this funding could rise to almost US$20 billion in 2010. Our research also shows there are more than 366 firms currently operating in India and another 69 are planning to start their operations soon. In total, they seem to have amassed US$48 billion earmarked for investment in India during the next three and a half years, ie, July 2007 – December 2010, and several firms we have spoken to mentioned they would be willing to invest even more if they saw good investment opportunities. Clearly, this is in stark contrast to 1996, when Indian companies only received US$20 million, and if indeed, Indian companies end up receiving US$20 billion in such funding then this would represent a thousand-fold increase between the 14 years of 1996 and 2010. Of course, the future is difficult to predict because PE investments are based on a complex combination of macroeconomic, microeconomic and financial policy-related factors, which affect the rational and emotional sentiments of the investor community. Indeed, a slowdown in the growth of the Indian economy and a tightening of liquidity around the world are just two examples of changes that could lead to substantially lower PE investment in India than forecasted.

Table 2: Number and Value of Deals 1996 – 2006 (in US$m)

Year H1-2007 H2-2007 (F) 2008 (F) 2009 (F) 2010 (F)
Number of Deals 173 277 510 560 620
Total Value of Deals $5,472 $8,028 $15,500 $17,500 $20,000
Source: Evalueserve

From a demand perspective, assuming an annual growth rate of 8%, annual inflation of 5% and a constant exchange rate of 40 Indian rupees to one US dollar, our analysis shows that the Indian economy will grow in nominal terms from approximately US$1,030 billion during the calendar year 2007 to approximately US$5,040 billion in 2020, and India can easily absorb US$60 billion during 2007-2010 and as much as US$490 billion during 2007-2020. However, for such investment to be valuable and wealth creating, it has to be broad-based and in diverse sectors and not limited only to IT, ITES or the healthcare sector. Interestingly, even though these sub-sectors seem to garner most of popular attention by many VC and PE firms, our analysis shows they are not the biggest contributors to the growth of the Indian economy, and there are several other sub-sectors, which we will highlight later in the article that might yield better returns. Finally, even though many VC-PE firms have been focused on the IT and the ITES (which includes business process outsourcing or the BPO sub-sector) sectors, a very important feature of the resurgence in the VC-PE activity in India since 2004 is that as a whole this community is no longer focusing only on these sectors. Figure 3 depicts the breakdown of these investments with respect to the number of deals in 2000, and 2006 in various sectors.

Figure 1: Expected Growth in Global BPO and KPO Markets (2003-2010)

Source: Evalueserve

Table 3 depicts the percentage of VC and PE investments as a percentage of the GDP in the US, UK, China and India for the year 2006. Interestingly, even after incorporating our forecast of US$20 billion of PE investments in India in 2010, since the Indian economy is likely to be US$1,490 billion during that year, this investment would represent approximately 1.35% of India’s GDP and hence on a percentage basis, it would be still be less than that of the US.

Table 3: Private Equity Investment as a Percentage of GDP of Some Benchmarked Countries (2006)

Countries GDP PE investment Percentage
United States of America $13,245 billion $191 billion 1.4%
United Kingdom $2,374 billion $42.3 billion 1.8%
China $2,630 billion $13 billion 0.5%
India $910 billion $7.5 billion 0.8%
Source: Evalueserve

3. Private Equity Firms and Hedge Funds Investing in India

In the US and Europe, the typical PE investment threshold is considered to be US$25 million. However, in India, since wages are between one-third and one-sixth of the US whereas most other costs like hardware, software, machinery, office furniture and real estate in the large cities are virtually the same, our analysis indicates that the comparative benchmark for PE investment in India should be US$10 million. Given this assumption, Table 5 provides a breakdown both by the number of deals and their total value for the period from 2005 to H1-2007; it is worth noting that during this period, only 10-20% of the total amount invested in India was from VCs while the remaining was PE investment; this is very similar to 14-18% VC investment versus 82-85% PE investment in the US.

Table 4: Number and Total Value of Deals (each over US$10m) between 2005 and H1-2007

Year 2005 2006 H1-2007
Number of Deals 65 169 95
Total Value of Deals 1,731 6,941 4,976
Source: Evalueserve

Similarly, if we only consider only those investments that are US$10 million or more and made in 2006 or H1-2007, then Table 5 shows that these investments were even more broad-based than those in Figure 3.

Table 5: Percentage of the Total Deals by Value in Various Sectors; Deal-size at least US$10m

Sectors 2006 H1-2007
IT & ITES 22.3 14.3
Financial Services 12.0 28.5
Manufacturing 10.6 3.3
Medical & Healthcare 1.6 1.4
Others 53.5 52.5
Total 100.0 100.0
Source: Evalueserve

List of PE Firms Investing in India

Although PE firms like Baring Private Equity Partners, Warburg Pincus, CDC Capital, Draper International, HSBC Private Equity, Chrys Capital (formerly known as Chrysalis Capital) and Westbridge Capital (now a part of Sequoia Capital) were investing in India during 1996-2000, some of these firms, eg, Westbridge Capital and Chrys Capital, changed their strategy between 2003 and 2006 and moved from only venture investing to both venture and private equity investing. Today, many traditional VC firms based in the US and Europe are investing US$10 million or more in India, and hence the separation between VC and PE investment in India has become very blurred. Evalueserve’s research shows there are 366 such firms claiming to be operating in India and another 69 that are raising capital with plans to be operating soon.

Current Status of Hedge Fund Investing in India3

Usually, a hedge fund’s strategy is to “hedge” its bets, for example, by going “long” with respect to some of its investments and “short” with respect to others. Given this strategy, most hedge funds typically buy and sell a set of shares/equities or other instruments and constantly trade these to generate returns over a 6- to 18-month period. Furthermore, because of their hedging strategy, usually these funds have a fairly high threshold for high-risk opportunities, and by taking such risks they are often able to generate fairly high returns for their limited partners. According to our analysis, currently there are more than 10,200 hedge funds worldwide, which cumulatively have more than US$1,800 billion under management. Interestingly, of this amount, US$1,200 billion is being managed by only the top 250 hedge funds. Since VC, PE and other alternative investment-related firms also have approximately US$1,800 billion under management, together these two groups currently manage approximately 6% of all assets under management worldwide. Consequently, the “law of large numbers” seems to be gradually creeping up and it is becoming harder for many hedge funds to find good opportunities. Hence many hedge funds are beginning to act like PE firms investing with a “longer time horizon”, especially in India. Some well-known hedge funds investing in India include D E Shaw Group, Farallon Capital Management, Old Lane Management (now a part of Citi-Alternative Investments), Galleon Group, Monsoon Capital and Tiger Global Management. A few other hedge funds operating in India can be found at

Most hedge funds investing in India are not registered as Foreign Institutional Investors (FIIs) and are therefore not allowed to trade Indian stocks directly. Hence they get exposure to Indian stocks (by using equity swaps, contract for differences or CFDs, promissory notes or P-Notes, etc) through large global brokers and custodians like Merrill Lynch, Morgan Stanley, Goldman Sachs, Bear Sterns and Citibank. Furthermore, their trading costs through these brokers and custodians in India are quite high since these costs involve those related to brokerage fees, statutory charges and commissions. Although some of these costs have come down lately, the commissions alone are still 50-60bps (ie, 0.5-0.6% of the tradeable value) as compared with 3-4bps in the US. Furthermore, the financing cost for short positions in Indian stocks is much higher than for long positions. Finally, the Indian stock market, which is represented by the Sensex (see Section 4 for more details), has quadrupled during the last four years giving very little incentive to “short” most stocks that are available with these custodians. Hence, unlike the US, where these hedge funds buy and sell continuously, most hedge funds in India do not participate in short movements related to any major indices or stocks, and to that extent do not create volatility in the Indian stock market.

Given this backdrop, at least for now, most hedge funds have decided to go “long” only with respect to the Indian public markets and some of them have even taken substantial equity in some private companies in India, thereby, following a strategy almost identical to typical PE groups. Of course, this strategy could easily change because such a large rise eventually increases the incentive to short, thereby benefiting from a correction if the Indian stock market becomes stagnant for some time or fluctuates wildly as it did between 1992 and 2002.

4. The Growing Indian Economy and Its Stock Market

Since its independence in 1947 and until 1991, the Indian government largely pursued socialistic economic policies that severely restricted economic freedom and trade – both domestically and globally. Hence, it is not surprising that the Indian economy grew at an average of 3.5% annually during this period. However, in 1991, the government started liberalising the Indian economy and the country’s annual growth rate began rising substantially. It reached 9% in 2005 and crossed 9.2% in 2006. Evalueserve’s analysis shows that, given the current environment and macroeconomic factors and barring any major calamity (eg a natural disaster or a war), India’s annual growth rate of 8% is likely to continue until 2020. On the other hand, during the last 17 years, ie, 1991–2006, annual inflation – as measured by the average wholesale price index (WPI) price index – has been approximately 6.67%, and given the savings rate and liquidity in the system, our analysis also shows that the annual inflation in India is likely to hover around 5% over the next 14 years. So, assuming a constant exchange rate where one US dollar equals 40 Indian rupees, the Indian economy that was approximately US$800 billion in 2005 and US$910 billion in 2006 is likely to be US$1,030 billion in 2007, US$1,490 billion in 2010 and around US$5,040 billion in 2020 (all in nominal terms). This implies that including inflation, there will be more than a five-fold increase in India’s economy between 2007 and 20204.

During 2006, the services sector accounted for approximately 55% of the economy, the manufacturing and industries’ sector contributed about 26% and agriculture about 19%. Furthermore, both the services and the industries sectors have been growing at approximately 10% annually during the last three years, which after including inflation (of 5%) implies an average annual growth of 15%. Given this backdrop, we briefly mention three groups of industry verticals below that are likely to be lucrative for the VC, PE and HF communities, especially because cumulatively, they are likely to contribute approximately 6.5% of the growth or about half of the total nominal growth of 13% per year.

Three Groups of Rapidly Growing Sectors

The first group that is likely to exhibit rapid growth consists of hi-tech services and products, most of which are currently being exported but some of which are also being consumed domestically. These hi-tech services and products include IT and application development, business process outsourcing (BPO), knowledge process outsourcing (KPO), drug research and clinical research outsourcing (CRO), engineering services outsourcing (ESO), software and solutions related to the consumer Internet, software as a service (SAAS), open source, software-cum-services, and telecommunications (both wireless and wire-line) products and related services. This combined group of products and services is expected to grow at approximately 22% per year during the next five years, and it is likely to contribute about 1.3% out of a total growth of 13% per year, ie, approximately 10% of the total growth of the Indian economy. Furthermore, from a PE investment perspective, it is worth noting that this group only constitutes approximately 1.3/6.5, or 20%, of the growth of these three groups combined.

The second group consists of services that are mainly geared towards the Indian domestic market although in almost all cases, people visiting India can also benefit from them. These sectors include the retail sector, travel and hospitality sector (eg, airlines, hotels, theme parks), the healthcare sector (including medical tourism, alternative medicinal centres and spas, hospitals, pharmacies and laboratories), the entertainment sector (including the Indian movie and the TV industry) and the private education sector. Not surprisingly, this combined group of services and productised services is likely to grow at approximately 19% per year during the next five years, and is likely to contribute about 2.7% out of a total nominal growth of 13% per year (including 5% annual inflation).

Finally, the third group consists of products and services related to high-end manufacturing and infrastructure and it includes automobiles, automotive components, electrical and electronic components, speciality chemicals, pharmaceuticals, gems and jewellery, textiles, and sectors related to construction, real estate and infrastructure. This combined group of products and services is likely to grow at approximately 19% per year during the next five years, and is likely to contribute about 2.5% out of a total nominal growth of 13% per year.

The Growth of the Indian Stock Market

As of 30 June  2007, there were 23 government-recognised, stock exchanges in India and there were more than 9,700 companies listed on these exchanges. Among these, the Bombay Stock Exchange (BSE) has 4,842 listed companies, and this exchange happens to be the oldest exchange in Asia having been established as "The Native Share & Stock Brokers Association" in 1875. Since BSE has the most well known indices within the Indian stock market, we focus on a few of these indices in this article.

Figure 2 depicts three indices, Sensex or “Sensitive Index” (with a base of 100 in 1979 and comprises of the 30 companies listed on BSE), BSE-100 (with a base of 100 in 1984 and comprises of 100 stocks listed at five major stock exchanges in Mumbai, Calcutta, Delhi, Ahmedabad and Chennai), and BSE-500 (with a base of 1,000 in 1999 and comprises of 500 listed companies in various Indian stock exchanges). Ignoring dividends, both Sensex and BSE-100 have grown by 12.5% annually in US dollar terms between June 1990 and June 2007, although they have fluctuated fairly wildly during this period.5

Figure 2: Comparison of US$-adjusted Price Return of Sensex, BSE-100, Dow Jones, NYSE-100 and FTSE

Source: Evalueserve, Thomson One Banker

The 12.5% annual growth rate for Sensex and BSE-100 during the last 17 years (in US dollar terms) consists of the following two sub-components:

  1. The companies comprising Sensex and BSE-100 have individually grown at an average of 9% or more on an annual basis.
  2.  Because of the consistent and substantial growth of these companies, their Price/Earnings ratios have grown from approximately 13 in June 1991 to approximately 21 in June 2007, which accounts for an additional growth of 3.5% per year.

Given that most of the companies comprising the Sensex, BSE-100 and BSE-500 are likely to grow at an average annual rate of 11-12% during the next 4-5 years, these three indices may grow by at least 11-12% on an annual basis. On the other hand, since the average P/E ratio of the corresponding companies is substantially more than those in several other emerging markets (where the P/E ratios have generally continued to hover around 12-13 for the past two decades), it is quite possible that the Indian companies listed in these three indices are overpriced and they may not grow at all or may even drop precipitously. Finally, given the past history of these indices, especially during 1992-2002, it is also possible that these indices would continue to fluctuate in the near future (especially if the Indian government curbs the liberalising of the economy or if the global economy cools down.)

Although the eight-year period of June 1999 to June 2007 is a rather short duration for the Indian stock market, it is still worth noting that during this period, the annual price return in US dollar terms for Sensex, BSE-100 and BSE-500 was 18%, 21% and 25%, respectively, which implies that the 400 companies in the BSE-500 but not in the BSE-100 grew much faster, and on an average these companies became more productive and/or grew more rapidly than those in the Sensex or BSE-100.

Table 6 depicts the number of companies listed on the BSE between June 1999 and June 2007. Not surprisingly, the number of IPOs on the BSE went down dramatically during the 2001-2003 period because of the dot-com bust and the NASDAQ crash of 2000. However, this number has been growing again since 2004 and is expected to touch a new record in 2007. Despite the fact that almost 250 companies were listed on BSE during this period, 1,250 companies were de-listed because of performance and the legacy of the dot-com era. Finally, although US$10 million or less was being raised during a typical IPO in 2000 and 2001, this amount has been increasing steadily, which indicates that earlier companies were using BSE as an alternative for raising VC funding, but now many of them are using it as an alternative for raising PE funding. Indeed, many smaller Indian companies are going to the other 22 stock exchanges in India to raise smaller amounts and using those exchanges as alternate means for raising capital.

Table 6: Initial Public Offerings & Price/Earnings’ Ratios for Bombay Stock Exchange (2000–07)

Year IPOs IPOs Year Sensex BSE-100 Listed Companies
  Number Average Value (US$m)   P/E P/E Number
1999-2000 40 7 Jun-00 29.39 25.96 5,886
2000-2001 45 8 Jun-01 17.49 16.92 5,962
2001-2002 5 52 Jun-02 15.92 13.92 5,786
2002-2003 5 76 Jun-03 14.61 12.73 5,641
2003-2004 26 443 Jun-04 14.76 13.01 5,270
2004-2005 38 112 Jun-05 15.75 13.58 4,738
2005-2006 92 73 Jun-06 17.9 16.67 4,793
2006-2007 97 102 Jun-07 20.67 20.16 4,842
Source: Evalueserve, Bombay Stock Exchange Website

5. Opportunities and Risks for PE Investing in India

Most VC and PE firms have a time horizon of five to seven years in the US and Europe, and they expect to provide an average net annual return of 13-15%, ie, double the investment of their limited partners in approximately five years. However, the PE firms currently operating in India seem to have a time horizon of three to five years and their expectation of an average net annual return is between 25% and 27%, ie, double the investment of their limited partners in three years. These elevated expectations can be attributed to the following key factors:

  1. In many respects, the maturity of VC and PE investments in India today is probably similar to that in the US in the early 1970s, and hence, by and large investors are likely to take more risks (with respect to finding the right companies, their financial transparency, etc) and hence would expect higher returns in return for the greater risk.
  2. There are broader risks associated with India as an emerging market, which include the possible depreciation of the Indian rupee, high inflation and the Indian government not liberalising the economy any further.
  3. High volatility in the Indian stock markets, and hence the corresponding expectation of high returns.
  4. The rise of the Indian stock market, which is epitomised by the growth of the following indices between June 1999 and 2007 (adjusted in US dollar terms): Sensex at an average annual rate of 18%; BSE-100 at 21%; and BSE-500 at 25%.
  5. A fairly impressive set of PE firms as role models, eg, Chrys Capital, Francisco Partners, General Atlantic, Oakhill Capital Partners and Warburg Pincus, who have realised at least 30% in annual return during the last 3-4 years for their limited partners.

However, given that so many VC, PE and HFs are beginning to invest actively in India, good investment opportunities will become more difficult to find, and hence, an annual return that is 7-9% more than that of Sensex or BSE-100 (ie, 18-20% per year assuming Sensex and BSE-100 continue to grow at 10-12% per year) seems to be a more likely scenario, in which case the principal amount is likely to be doubled in four years (and not three). In light of this analysis, Evalueserve believes there are some key opportunities and short-term risks while investing in India.

Playing the Indian Stock Market

As discussed in Section 4, the Indian stock market, which is epitomised by the Sensex, BSE-100 and BSE-500, has been growing at approximately 42% annually in nominal terms since June 2003, and has thus more than quadrupled in four years. Although this growth rate is likely to slow to a more reasonable level, there will still be substantial opportunities for VC, PE and HF firms to do substantial research and cherry-pick companies that are growing annually at 25% or more (including the 5% inflation). Incidentally, when it comes to cherry-picking such opportunities, Chrys Capital has done an excellent job between 2003 and 2007. Before 2003, Chrys Capital used to mainly provide VC financing to start-ups and smaller companies. However, it changed its strategy and started investing between US$20 million and US$200 million in 2003. Furthermore, it became an activist fund (see Section 2 for definition), started providing growth investment to medium and large private companies, and its average annual return on investments during the past four-year period has been over 50% per year.

Public Sector Undertakings (PSUs)

The Indian economy was a socialistic economy between 1947 and 1991. As a result, the Indian government owned many companies – called Public Sector Undertakings (PSUs) – especially in the following sectors that were considered critical to the Indian economy: financial services (eg, those in banking and insurance), utilities (eg, those in electricity, oil, gas, telecommunications), capital goods (eg, those related to earth movers, electronics, heavy electrical), transport services (eg, those related to airports, railroad, containers, shipping), and metals and mining (eg, those in aluminium, steel, and copper). However, gradually the Indian government has been reducing its stake in many PSUs and now owns only 51% in some of them. In fact many of these are currently listed on the Indian stock market and the enterprise value of just the top 42 PSUs listed on BSE, which constitute a BSE-PSU index with a datum of 1,000 on 1 February 1999, currently exceeds US$210 billion.

Not surprisingly, these PSUs were quite inefficient before the Indian government privatised them (at least partially). However, just like the BSE-500, the 42 PSUs comprising the BSE-PSU index have become significantly more efficient and productive as indicated by the data given below:

  1. On a US dollar-adjusted basis, the BSE-PSU index has grown at approximately 23.5% per year during June 1999 and June 2007. This is only slightly less than the 25% annual growth of BSE-500 but more than the annual growth of BSE-100 and Sensex of 21% and 18% respectively (during the same eight-year period).
  2.  Since 1991, the average, annual net profit per employee in the PSUs in the BSE-PSU index has improved by approximately 16 times and gone from approximately US$1,000 per employee to US$16,000 per employee. Similarly, the average, annual revenue per employee has gone up by approximately ten times during June 1991 and June 2007. Indeed, some PSUs have done better than others. For example, India’s largest retail bank, State Bank of India, which also happens to have the largest number of branches and offices of all the retail banks in the world, has seen its profit go up 25 times with only 89% of the workforce that was employed in 1991, thereby, resulting in productivity improvement of 28 times.

Although these productivity and efficiency improvements seem very impressive, there is still room for further improvement – according to Evalueserve’s estimates by as much as 60% – within these 42 PSUs, and even more within the other PSUs that do not constitute to the BSE-PSU index. Furthermore, since the Indian government is planning on opening the banking sector completely to foreign competition (by 2009) and is also planning on further liberalising other sectors – eg, metals and mining, utilities and capital goods’ sectors – these PSUs do not have any choice but to become more productive, efficient and aggressive with respect to both organic growth and acquisitions. Hence, these PSUs provide a good opportunity especially for the activist PE and HF firms that can help these PSUs grow to the next level. Of course, since most of these PSUs are still quite hierarchical, bureaucratic and stodgy, and usually have a disdain for taking any advice or being influenced by third parties, the PE firms would have to patiently “weave” their way into them to effect appropriate change.

The following examples show that at least some PE firms are beginning to get interested in this sector:

  1. In 2003, Actis paid US$60 million for a 29% stake in state-owned Punjab Tractors, India's most profitable maker of farm tractors and forklifts (in 2003), which demonstrated 20% quarter-on-quarter growth in revenues and 26% in profits shortly after this investment. Later on, Mahindra and Mahindra acquired Punjab Tractors.
  2. US-based hedge fund, DE Shaw with assets worth over US$30 billion, is believed to have put in a bid in response to IFCI’s (Industrial Finance Corporation of India’s) decision to sell a 26% stake to strategic investors. US-based private equity group, Blackstone, may also join the race to acquire a 26% stake in this oldest state-owned financial institution.

Family-run Businesses

Some of the most profitable, efficient and productive companies in India – eg, those run by the Tatas, Ambanis, Premjis (Wipro), Birlas, Singhs (Ranbaxy) and Bajajs – are family-run businesses. As shown in Table 7, 47 of the BSE-100 companies are partially or wholly family-run businesses and had a total market capitalisation of US$345 billion as of June 2007. Despite such impressive statistics, our analysis shows that the examples above seem to be noteworthy exceptions. By and large, a majority of family-run businesses do not succeed. In fact, over the last 50 years, more than 70% of for-profit organisations in India were started as family-run businesses and corporations, but less than two-thirds survived the first five years and only one-third survived the next 20. This is because these businesses suffer from a lack of effective corporate governance, lack of management structure and often a lack of vision to expand domestically or globally. Consequently, an investment in such companies could be a win-win for them as well as for the PE firms. However, for this strategy to really succeed, the PE managers should be able to bring not only capital but also their strategy and operational expertise to bear, and they may have to work in “deep and dirty trenches” along with these business families and their management teams.

Table 7: Composition of BSE-100

As of June 30, 2007 Percentage by Number Percentage by Market Capitalisation
Public Sector Undertakings 16 24
Family-run companies 47 46
Subsidiaries of Multi-National Companies 23 20
Others 14 9
Source: Evalueserve, Bombay Stock Exchange Website

Merger and Acquisition Opportunities, Especially Spin-offs from Larger Companies

As mentioned in Section 2, the eventual aim of a PE firm is to either take the company public  or sell it so the PE firm can free up its locked capital and provide a return to its limited partners. Given the rapid growth of PE investments and the rapid consolidation of some of the more maturing industries (eg, IT and ITES), the M&A activity within India is already growing quite substantially. Furthermore, since Indian companies are now becoming more confident of acquiring and successfully integrating non-Indian companies, this M&A activity is likely to grow even faster. Clearly, since many PE managers have investment banking and consulting backgrounds, they can certainly help their portfolio companies during this process.

For the year 2006, Table 8 compares the total value of deals in India as a percentage of India’s GDP to those in the US, UK, Japan and China. On a percentage basis, Indian companies are ahead in M&A when compared to China and Japan but they still have some distance to go to catch up with the US or the UK.

Table 8: Total M&A Deal Value in Different Countries (2006), US$bn

Country GDP in US Dollars M&A Percentage
US 13,245 1,390 10.5%
UK 2,374 379 16.0%
Japan 4,367 113 2.6%
China 2,630 30 1.1%
India 910 39 4.3%
Source: Evalueserve, Thomson One Banker

Another opportunity for the PE industry is in either buying – or helping their portfolio companies to buy – captive units of multinational or domestic companies that are likely to be spun off from their parent companies. British Airways started this trend in 2002 when it decided to sell a majority stake of its ITES captive unit in India called WNS Global Services to PE firm, Warburg Pincus. General Electric followed suit two years later by selling its captive unit (now called Genpact) to General Atlantic and Oakhill Capital Partners. These two companies, WNS and Genpact, recently went public on the New York Stock Exchange and currently have a market valuation of more than US$700 million and US$3 billion, respectively. More recently, The Netherlands-based company, Philips, sold its ITES unit to Infosys and currently Citigroup is negotiating with several firms to sell its ITES captive unit, eServe. Indeed, it is not surprising that several PE firms are involved in negotiations with Citigroup in buying eServe wholly or partially for one of their portfolio companies or to create an entirely new company. At Evalueserve, we believe that during the next three to four years, between 20 to 30 multinational companies are likely to sell – partially or wholly – their captive units since the main tasks performed within such captive units seem to be proper hiring, training, retaining of personnel and providing high-quality processes and services, which these multinationals do not consider as their “core” business6.

Short-term Risks while Investing in India

Since the Indian economy has been growing at a fairly rapid pace, particularly between July 2003 and June 2007, this growth may be overheating its economy. The following are several short-term risks worth investigating:

  1. In several sectors (eg, IT and ITES, telecom services, airline services, high-end construction services), demand is beginning to exceed supply – especially for skilled workers and equipment. These severe skill shortages are causing wages to balloon, thereby causing inflation and attrition.
  2. During the last year, bank lending for commercial property rose 75% and residential property increased 35%. Furthermore, the prices of commercial property in some – but not all – cities have increased five-fold during the last four years and prices for residential property in a few other cities have quadrupled. Since wages have not risen by even half that much, the real-estate bubble in these cities can burst, thereby, leaving some investors with substantial losses and debt. (See Section 6.3 also.)
  3. As mentioned in Section 4, the P/E ratio for Sensex and BSE-100 is close to 21, which is significantly higher than the corresponding ratio of 12 for similar indices in other emerging countries. Even though the companies comprising the Sensex, BSE-100 and BSE-500 are growing rapidly, much of this increase seems to be speculative and fuelled by FIIs, especially foreign mutual funds. Since in the past (eg, 1992-2002), the Indian stock market has exhibited wild fluctuations, it could easily repeat this behaviour again.
  4.  India is heavily dependent on short-term FIIs, who have bought equities and other securities, rather than the longer-term FDI. During the last four years, there has been more than US$40 billion of FII investment in India compared to US$23 billion of FDI investment. Most of the FII investments can be recalled very quickly in a crisis. Clearly, rapid influx of this money has driven the Indian stock market to dizzying heights, but our analysis shows that a quick flight of this money (out of India) is likely to harm the Indian economy significantly by depreciating the Indian rupee by as much as 25% and by depressing the Indian stock market by as much as 40%.
  5. Since January 2007, the Indian rupee has appreciated with respect to the US dollar by more than 10%, and with respect to British pounds, euros and the yen, it has risen by 8%, 7% and 11%, respectively. This appreciation is a double-edged sword for the Indian economy. On one hand, this appreciation has benefited the economy by making imports – particularly crude oil – cheaper and has also helped in controlling inflation. On the other hand, this appreciation is beginning to hurt Indian exports and may end up decimating some of the low-margin export sectors because they have to compete with Chinese goods. (Here, it is interesting to note that the Chinese yuan has only appreciated by 3% with respect to the US dollar and even less with respect to other currencies.)

6. On-the-Ground Realities and Best Practices for PE Investing in India

This section advocates a number of best practices and highlights some of the key differences between private equity investing in India versus the US or Europe.7

6.1 Find “Diamonds in the Rough” and then Help Polish Them

The 500 companies comprising the BSE-500 are likely to have revenues of approximately US$360 billion in 2007. Furthermore, as mentioned in Section 4, since June 1999, these companies have been performing better than the 100 companies comprising BSE-100 or the 30 companies comprising Sensex. In some ways, these companies do not have much choice if they want to emerge as winners during the liberalisation of the Indian economy.

In addition to the BSE-500, our analysis shows there are another 22,000 for-profit organisations (ie, companies, partnerships and family-run businesses) that would earn approximately US$135 billion in revenue in 2007 and most of these are facing the same challenges with respect to growth, productivity and efficiency. However, at least one-fourth (or 5,500) of these companies either have good processes or unique intellectual property that is likely to make them winners but they are “diamonds in the rough” and suffer from the following drawbacks:

  1. Since PE investing in India is still a nascent phenomenon, PE firms that may be well known in the US, Europe or Asia, do not yet have significant brand recognition in India. In fact, the executive management in many of these companies may not even understand how PE firms work. Consequently, it will be up to PE managers to find and convince the management of these firms of the benefits of PE investment. However, once these PE managers find good companies, in many cases, they are likely to agree upon more realistic valuations (eg, 10 to 12 times earnings) as compared to those prevalent in the IT and ITES sectors.
  2.  Since the executive management of these companies is very resistant to giving up control and dislike even the notion of bringing in external directors, it would be up to the PE managers to convince the executive management of their value proposition, of course, in addition to providing capital.
  3. Many of these companies are very regional in nature (eg, they may only produce and/or only sell in Northern India) and hence would need advice with respect to strategy and operational expertise in marketing and sales within India and abroad. In addition, most of them would require guidance and help with sales and acquiring and integrating non-Indian companies.

Clearly, finding such companies and doing due diligence on them is more challenging in India as compared to the US or Europe markets because there is very little market research available and because these companies and even the corresponding sub-sectors may not be very transparent. Furthermore, since most of these companies may not appear on the “radar screens” of the big strategy and management consulting firms (eg, McKinsey and Company, Bain & Company, etc), the PE managers would have to either perform this research themselves or employ global research firms with a strong presence and experience in India (eg, Evalueserve) to do this research. Finally, these PE firms would also have to find senior and experienced professionals in India, who may have worked in the corresponding sub-sectors capable of conducting thorough SWOT analyses. We believe that such India-based on the ground analysis may cost a PE firm between US$25,000 and US$50,000 for a specific sub-sector and/or a specific company – but with investments likely to be US$10 million or more, this should be money well spent.

6.2 Diversify, Diversify, and then Diversify a Bit More

Given that many managers in the VC and PE firms come from science and technology backgrounds, they are instinctively attracted to the high-tech industry. However, as mentioned in Section 4, this area is likely to contribute only 10% of the overall growth of the Indian economy, and will contribute only 20% to the growth of the three fast-growing areas mentioned in Section 4. On the other hand, even though deals in the IT and ITES sector dropped from 65.5% in 2000 to 28.8% in 2006 (see Table 3), IT and ITES constitutes only a sub-sector of the overall high-tech sector, and this sub-sector is getting overheated with valuations of many – if not most – companies running at 30 to 50 times their earnings. In contrast to this, the Sensex is only trading at 21 times earnings. Furthermore, because of the availability of cheap capital, many “lemming” companies have started during the last four years in the IT and ITES sector, but most may not survive the next three years. Incidentally, even within the IT and ITES sub-sector, there are sub-sectors (eg, open source, robotics related to machine tools and animation) that have largely remained untouched so far by the PE industry in India.

6.3 New Sub-sectors are Emerging in the Indian Economy

As the disposable income for the middle and rich classes is increasing, their changing habits and tastes are leading to the creation of new sub-sectors, eco-systems and supply chains. For example:

  1. India currently has 325 airplanes that fly domestically but this number will exceed 750 by 2010, thereby, generating US$12 billion in annual revenue (in 2010). Of this US$12 billion, approximately US$2 billion will be used for maintaining these airplanes. However, there are hardly any airline maintenance companies today and this sub-sector is likely to grow exponentially in the near future. Similarly, there are almost no airplane certification companies in India that can audit and certify that airplanes have complied with all maintenance requirements. Currently, most of this work is being outsourced to companies in the US and Europe.
  2.  Traditionally, Indians have consumed liquor mainly to get intoxicated. Those who could afford it drank branded beer, rum and whisky, whereas those who could not lived and died by the “hooch” (illicit/country liquor). As the disposable income of the middle and rich classes has increased and as they have become more aware of European and American tastes, Indians have begun to acquire a taste for fine wine. Consequently, two wine companies in India – Sula Wines and Champagne Indage – are growing at 40-50% a year and have recently received capital from GEM India Advisors, Arisaig Partners and Indivision Capital.
  3. The Indian automotive industry (for both domestic and export purposes) is likely to quadruple in revenue and achieve US$165 billion in 2016, but in this process is likely to face a shortage of 2.5 million skilled personnel (that include mechanics, maintenance professionals, assemblers and specialised IT professionals). Hence, a learning services company, Adayana, which has been building e-learning courses for specialised sectors in the US market, has turned its attention to the Indian market. It will be working with the Society of Indian Automobile Manufacturers and 38 automotive companies in India to create a curriculum and then provide a low-cost solution to train a million or more professionals – both on a generic basis and on a more customised basis for these 38 companies. Incidentally, Adayana has recently received funding from Kubera Partners, a PE group, and has been doubling every year for the past three years with half of its workforce based in the US and the other half in India.
  4. Although the real estate and hospitality (hotels) sectors are not new to the Indian economy, thanks to the booming Indian economy and the Indian middle class, the demand in these sectors has been growing very rapidly. Indeed, during the past four years, these sectors have provided average annual returns of around 30% and although these returns are likely to come down, these sectors are still likely to be fairly lucrative for the PE and HF communities. Hence, it is not surprising that during the first half of 2007, PE and HF community invested US$1.8 billion in these two sectors and they seemed to have raised more than US$9 billion (out of a total of US$48 billion) for investment during the next three and half years; Morgan Stanley, D E Shaw, Avenue Capital, Starwood Capital and Walton Street Capital are only some of the funds currently investing in these sectors. Interestingly, although these sectors are growing fairly rapidly, there are hardly any title insurance companies currently providing insurance with respect to the titles and the deeds of commercial or residential properties. Finally, as mentioned in Section 5.5, some cities and regions in India may be already overpriced with respect to real estate (although even these cities have a demand-supply gap with respect to hotels) and hence the investing community would need to do its research before investing in this sector.

6.4 India is neither the US nor China

Although it is fashionable these days to compare India and China, actually the two countries are quite different. Indeed, a lot of progress in China happened because of the government whereas in India it happened despite the government. For example, the communist government in China can easily plan projects in a very structured and systematic manner without worrying about the courts or public opinion, whereas most projects in India get delayed because of Indian courts and strong public opinion. Similarly, although India and the US share democracy as one of their fundamental tenets, India is a poor country with a severely underdeveloped infrastructure, whereas the US is one of the wealthiest countries with a very well developed infrastructure. Because of these reasons, it behoves VC and PE firms to consider investing in Indian companies “in their own right” rather than pursuing the following strategy: “if it has worked in the US or China, it will work in India too.” Given below are examples of three companies that are likely to cater only to countries like India:

  1. Because of the unreliable supply of electricity throughout India and the Indian government clamping down on the use of diesel generators in many large and medium-sized cities (due to immense pollution), a set of universal power supplies called “inverters” have already become quite popular and are expected to become more so during the next few years. According to Evalueserve, the market size of these inverters (and the associated batteries) would grow from approximately US$1.2 billion in 2007 to US$3 billion in 2010. Hence, it is quite likely that by 2010, there would be at least two or three companies with combined annual revenue of US$1 billion and these companies are likely to have unique intellectual property with respect to products, processes and sales networks. Furthermore, given their unique intellectual property, these companies are also likely to export to other countries in Africa and Southeast Asia.
  2. Because of poverty, low education and the tropical climate, diseases like malaria and dengue, which are spread by mosquitoes, are quite common in India (and also in parts of Africa and Southeast Asia). Hence, the market size of mosquito repellents in India was already US$400 million in 2006 and is likely to grow to US$1 billion by 2010. Again, it is quite likely that at least one company would emerge with US$250 million or more in revenue and will begin exporting in a big way to other regions in Africa and Southeast Asia.
  3. Castrol India produces many different kinds of engine oils and lubricants in India (eg, those for motorcycles, two-wheeler scooters, cars, trucks, tractors and pumps) and is likely to have revenues of US$500 million in 2007. Since the requirements of consumers in large cities are quite different from those in villages, Castrol India has designed unique products for each market segment, eg, engine-oil pouches for 10 cents each that can be sold in villages and small towns. One of its unique features is its distribution network that consists of almost 100,000 outlets throughout India. According to Evalueserve’s estimates, there are at least 20 companies in a variety of sectors that could become as big as Castrol India, if they could receive proper advice and operational consulting especially with respect to building a similar distribution network.

Note:This article is largely focused on private equity investment, ie investments in companies already generating revenue and perhaps profit. A related article dated 21 August 2006 and titled “Is the Indian VC Market Getting Overheated?” can be downloaded from and another article titled “Investments by Hedge Funds and Related Institutions in India” is scheduled to be published in December 2007.

To get an appendix of key PE Firms that have invested in India during 2004 and the first half of 2007, please visit the following link:

About the Author

Dr Alok Aggarwal is the Chairman and Founder of Evalueserve. He earned his PhD in electrical engineering and computer science from Johns Hopkins University in 1984, and “founded” IBM’s Research Laboratory in New Delhi, India during his 16 years at the IBM Thomas Watson Research Center.

About Evalueserve

Evalueserve provides the following custom research and analytics services to companies worldwide – emerging markets and regions, intellectual property and legal process services, market research, business research, financial/investment research, data analytics and modelling. Evalueserve was founded by IBM and McKinsey alumni, and has completed over 12,000 client engagements on behalf of global clients. Several hundred of these research engagements have focused on emerging markets and regions including China, India, South America and Eastern Europe. Nitron Circle of Experts, a recently acquired subsidiary, is an independent research firm which provides institutional investors with direct access to a network of senior industry executives in a wide range of industries. The firm currently has over 2,100 professionals located in research centres in India, China and Chile. Additionally, Evalueserve’s 45 client engagement managers are located in the major business and financial centres globally – from Silicon Valley to Sydney. For more details, please visit


Although the information contained in this article has been obtained from sources believed to be reliable, the author and Evalueserve disclaim all warranties as to the accuracy, completeness or adequacy of such information. Evalueserve shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof.


1 The following web-link, provides:
  • A list of approximately 160 venture capital firms, private equity groups and hedge funds, along with their key portfolio managers and some investments that they have made during the last four years.
  • A list of approximately 40 firms who are either in the process of raising capital or have raised capital (for investing in India); others have requested that their names remain confidential for the time being.

2  The current exchange rate is 40 Indian rupees equals approximately one US dollar. Many economists believe that in the future the Indian rupee is likely to appreciate because of the rapid growth of the Indian economy, which is similar to what happened with Japanese and South Korean currencies during 1960s, 70s and 80s. On the other hand, many economists believe that the Indian rupee may actually depreciate with respect to the US dollar because of the substantially higher inflation in India as compared to that in the US. Since this debate is hard to resolve, for simplicity, we have assumed a constant exchange rate of 40 Indian rupees to one US dollar for the period 2007-2020.

3 Evalueserve is planning on publishing an article on the status of hedge fund industry in India in December 2007.

4 Most tables with respect to the Indian economy – including those provided by the Indian government – are provided for the financial year, ie, from 1 April of one year to 31 March of the next. However, to keep our analysis uniform, we have converted these tables so that they conform to the individual calendar years.

5 Since the data for BSE-500 is available only for the last eight years, it is harder to make a proper evaluation.

6 For more information regarding the various issues involved with multinationals running their captive units, interested readers can read our article, “The Future of Knowledge Process Outsourcing: Make or Buy in KPO” available at:

7Since many best practices and ground realities have been already discussed in our previous article, “Is the VC Market in India Getting Overheated?” (please see to download the full-text) dated August 21, 2006, we only discuss those factors that have not been discussed earlier.