VZCZCXRO2384
PP RUEHAST RUEHCI RUEHDBU RUEHLH RUEHNEH RUEHPW
DE RUEHBI #0439/01 3230909
ZNR UUUUU ZZH
P 190909Z NOV 09
FM AMCONSUL MUMBAI
TO RUEHC/SECSTATE WASHDC PRIORITY 7560
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHNE/AMEMBASSY NEW DELHI PRIORITY 8774
RUEHCG/AMCONSUL CHENNAI PRIORITY 2148
RUEHBI/AMCONSUL MUMBAI PRIORITY 2792
RUEHCI/AMCONSUL KOLKATA PRIORITY 1936

UNCLAS SECTION 01 OF 03 MUMBAI 000439 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EIND EINV ENRG ELTN IN
SUBJECT: PRIVATE EQUITY FIRMS IN INDIA BELIEVE BETTER TIMES AHEAD 
 
MUMBAI 00000439  001.2 OF 003 
 
 
¶1.  SUMMARY:  Fund managers at private equity (PE) firms are 
expressing renewed confidence in high-growth opportunities in 
India, after a long hiatus.  While the market for private equity 
dried up from a high of $17.3 billion in FY2007 to $3 billion in 
year-to-date FY2009, PE investors report that deal activity has 
increased significantly in the last few months.  Buoyed by 
rising capital markets and increased economic activity, Indian 
companies sense a recovery, and are more amendable to growth 
capital equity investments.  PE fund managers note that 
investment challenges remain --- including a proposed capital 
gain tax - but feel that India offers a largely open investment 
field, with high potential rates of return.  Moreover, the 
requirements of institutional investors will drive greater 
portfolio investment in India overall.  We will continue to 
watch closely to see whether this new optimism is real or 
misplaced.  END SUMMARY 
 
 
 
Optimism Returns to PE Investors 
 
------------------------------------- 
 
 
 
¶2.  Despite a severe decline in private equity (PE) investments 
since 2007, fund managers have become optimistic that PE 
investments are on the rebound. At its height in FY2007, PE 
firms invested a total of $17.3 billion in India; investments 
declined to $10.7 billion in 2008, and only $3 billion 
year-to-date in 2009.  (Note:  Approximately 60 percent of all 
PE deals are in the real estate sector, and this decline clearly 
tracks the downturn in the real estate sector.  End Note.) 
Nevertheless, many Mumbai-based PE fund managers believe that 
India offers immense opportunities for future investments, 
report a significant pick-up in deal activity, and express 
confidence that India is already at the forefront of the global 
recovery.  Akhil Gupta, Managing Director of Blackstone, 
reported that in the six months up to the national elections in 
May 2009, they ceased pursuing any new deals due to political 
risk concerns, and tended to their portfolio.  Since then, he's 
looked at more deals than he did in all of 2008, and feels 
confident that he will make a number of investments in the 
coming months.  He also said the quality of deals is far better 
than those on offer in 2007.  Several other fund managers echoed 
these sentiments, and indicated that the current numbers did not 
yet reflect the amount of activity currently taking place. 
 
 
 
¶3.  Part of the increase in investment over the past several 
years is because India has opened new avenues for foreign 
capital investment, says Aluri Rao, Managing Director at Morgan 
Stanley.  Other than multi-brand retail, defense and a few other 
sectors where some equity caps or limits exist, investors can 
largely invest freely in most sectors.  In addition, fund 
managers point out that because India is still considered 
riskier than developed markets, investments can claim a much 
higher internal rate of return (IRR).  Darius Pandole, a partner 
at New Silk Route, an India-focused PE fund, claims that the 
average deal in India offers a 25-35 percent IRR, well above 
developed market returns. 
 
 
 
¶4.  Moreover, PE funds have put more emphasis on India due to 
institutional investor interest and global emerging markets 
potential despite the recent economic downturn.  Rakesh Khanna, 
Managing Director of PE firm Warburg Pincus, said his company 
has a 10 percent investment exposure to India, making it the 
largest single-country investment after the United States. 
Comparatively, China only carries a 7-8 percent weighting in his 
portfolio.  Khanna explained that while he had no specific 
requirement to invest in India or China, these two countries 
offered the most emerging market investment opportunities.  In 
addition, according to Pandole, the market for "secondaries" has 
become important to Indian PE fund managers.  As the global 
financial crisis hit institutional investors and hedge funds, 
many were not able to meet their financial commitments to PE 
funds, due to withdrawals and liquidity problems, or choose to 
limit PE or emerging markets risk.  Now that PE funds are again 
looking to make investments, they need to ensure that investors 
are able to provide their committed funding, when opportunities 
arise.  The buying and selling of these commitments is known as 
the "secondaries" market, and these exposures are often sold at 
steep discounts; in these cases, the new investors take over the 
previous investors' funding commitments, enabling the PE fund to 
maintain its momentum.  Although such deals are commonplace in 
 
MUMBAI 00000439  002.2 OF 003 
 
 
the U.S. and Europe, the practice is new for India-focused 
funds. 
 
 
 
Why the Optimism? 
 
----------------- 
 
 
 
¶5.  Much of the optimism stems from the recent rally in equity 
markets - the SENSEX, India's main stock index, has risen 73 
percent since March - and the increase in overall economic 
activity in India.  The vast majority of PE investments in India 
are growth capital injections, either as equity in a 
publicly-traded company, or private placements in unlisted 
firms.  In India, almost all companies are controlled by 
families who are reluctant to cede management control to outside 
investors, but will shed some equity if the right relationship 
develops, at the right price; hostile takeovers or buyouts are 
non-existent.  Rao estimates that 90 percent of private equity 
funds have bought minority rights in Indian companies.  When 
Indian capital markets were depressed, few company owners wanted 
to sell equity at prices below what they believed they were 
worth.  Even those firms who needed funds, explained Pandole, 
preferred to suffer a decline in business rather than sell at 
the current valuations.  Moreover, PE funds were also cautious 
about the health of individual Indian companies, and preferred 
to wait until the recovery to see how these firms - as well as 
global economic conditions - had weathered the crisis. 
 
 
 
Challenges of Investing in India 
 
-------------------------------- 
 
 
 
¶6.  According to PE fund managers, one of the biggest challenges 
faced by current and potential investors is the proposed new 
Direct Tax Code Bill of 2009.  This bill will increase the 
capital gains tax to a uniform rate of 30 percent, dramatically 
increasing the tax burden on PE investments and reducing capital 
flow into India.  (Note:  Currently, the long term capital gain 
tax on listed securities is zero percent and unlisted securities 
is 20 percent.  End Note.)  Since most PE investments are made 
through equity markets, a 30 percent capital gains tax will make 
many of these investments unviable.  In addition, PE players 
would no longer be able to take advantage of the beneficial 
treatment under different tax treaties and shall have to pay 
taxes as per the provisions of the new tax code.  PE fund 
managers also expressed frustration that PE investments are 
classified as "short term" by regulators, and receive the same 
treatment as foreign institutional investors (FIIs) or hedge 
funds, instead of foreign direct investment (FDI).  Since most 
of their investments are in the five to seven year range, PE 
fund managers believed they should be treated as long term 
investors.  Pandole noted that "non-disclosure" agreements - 
where an investor evaluating a company prior to an investment 
would pledge to not mis-use proprietary information -- are not 
permitted under Indian capital market regulations.  Therefore, a 
potential investor cannot look closely at the financials of an 
Indian company prior to an investment, without fear of being 
targeted under inside trading statutes.  Pandole recommended 
that the main capital markets regulators, the Securities and 
Exchange Board of India (SEBI) develop rules for using 
non-disclosure agreements so that investors can avoid making 
leaps of faith in determining the viability of an investee 
company. 
 
 
 
Power Sector Attractive, Some Infrastructure Sectors Are Not 
 
--------------------------------------------- --------------- 
 
 
 
¶7.   Many PE firms are looking at the power sector as a 
potential source of growth because there are a large number of 
new projects in the pipeline.  According to the research firm 
Venture Intelligence, investment in the power sector increased 
from $122 million in 2006 to $495 million in 2007, and to $902 
million in 2008.  This growth was due to continued capacity 
expansion plans and growing demand in the domestic market. 
However, investment in the power generation sector dropped 80 
 
MUMBAI 00000439  003.2 OF 003 
 
 
percent in 2009, to $157 million year-to-date.  Despite this 
dismal figure, most PE firms appear to be confident investment 
growth will pick up in the energy sector. 
 
 
 
¶8.  PE firms are less confident about investments elsewhere in 
the infrastructure sector.  For instance, Sreekumar Chatra, 
manager of Macquarie Capital's $500 million infrastructure fund 
(in partnership with State Bank of India), explained that most 
foreign investors are not able to participate in road projects, 
due to their low rates of return by international standards. 
Most road projects offer annual IRRs in the 14-16 percent range, 
while foreign investment funds require annual IRRs of 22-25 
percent in order to meet investment return requirements, 
particularly institutional investors who support funds like 
Macquarie's.  However, these kinds of projects are attractive to 
Indian construction companies with financing arms because they 
earn contractual fees on the construction, as well as returns on 
the investment.  Foreign funds would like to participate in 
financing these projects, but could only do so if they acquire 
construction companies, or if IRRs were raised on the project. 
(Comment:  Indian interlocutors, however, have suggested that 
foreign investors lower their return expectations to take 
advantage of the huge potential volume of investments in India. 
End Comment.) 
 
 
 
¶9. Comment:  In a series of recent conversations, the excitement 
and optimism among India-based PE fund managers was real and 
vibrant, especially after a long, dreary run over the last 18 
months.  Their enthusiasm is shared by many in the India-based 
business and investor community, as people smell the signs of a 
recovery.  Many expect that the buoyant capital markets are 
indeed the harbingers of more years of high growth for India. 
While these fund managers alluded to a large numbers of deals in 
the making, the numbers still tell a different story; since 
2007, data shows that the market for private equity investments 
largely dried up, reduced by 84 percent over the last two years. 
 And should the new capital gains tax become law, PE funds will 
find the potential profitability of their investments quickly 
eroded.  As the end of FY2009 approaches, we will see whether 
this optimism has been realized.  End Comment. 
FOLMSBEE