Wrong stocks and wrong timing have earned poor returns for supposedly smart private equity investors, find Debashis Basu & Jason Monteiro

Private equity (PE) companies come in with billions of dollars of cash, pick up significant stakes in firms, often work with managements to improve performance and exit at a profit. That’s the theory. A key area of their interest is private investments in public equity (PIPE). Under such deals, PE firms invest in companies listed on the stock exchanges. PIPE deals focus on small- and medium-sized companies that are generally undervalued. PE firms are supposed to have expert knowledge of companies, sectors and markets; they are supposed to be selective and do detailed research before pouring large amounts of money into companies that have great potential. They make bigger, more concentrated and longer-term bets on companies than any other kind of investor. Fortunately, when smart PE companies pick up large stakes in mid-sized, fast-growing companies, the public gets to know of it—unlike investments by foreign portfolio investors. Since they are supposed to be the smartest among smart investors, should we follow PIPE deals to make superior investments?

To understand that, we have to examine whether PE firms have pulled off great returns in PIPE deals, so far. Unfortunately, comprehensive data is not available on how PIPE deals have done. A KPMG report says that they have made some 15% over 2009-11 (a bull market); it is impossible that PE funds will be able to exit from their 2006-08 investments over the next two years. In short, PIPE investors won’t make much money.

This article looks at anecdotal evidence; and the evidence is not very encouraging so far. This could partly be because many investments were made over the past few years when the market has been choppy and the Indian economy is now facing severe headwinds. But it is also because PE funds—like most investors—find it difficult to make money when the market is not on a bull run. This is one of the lessons to keep in mind about ‘smart investors’. Let’s review the PE investments with the caveat that most of the information about secretive PE funds has been pieced together from secondary sources. The information is believed to be accurate; but it is anecdotal and not comprehensive.

Let’s start with one of the most spectacular blow-ups of PIPE deals which was KS Oils. On 16th August 2011, KS Oils’ share price, which was down for most of the year, crashed by a whopping 32% on the Bombay Stock Exchange (BSE). Its biggest lender, Sicom Ltd, sold around 23.84 lakh shares which were pledged by the company. On that day, Edelweiss Finance and Investment Ltd sold around 44.50 lakh shares on the BSE at Rs9.13 a share. Earlier, on 12th August, Sicom had sold 25.78 lakh shares of KS Oils at Rs12.96 on the National Stock Exchange (NSE). Why were they in a rush to sell? The company had pledged around 80% of its shares against loans and could not pay back. There are stories of gross mismanagement. Moneylife had reported that, in December 2010, the Intelligence Bureau noted massive price-rigging and insider trading in KS Oils.

The company has also been accused of tax evasion. KS Oils, whose scrip has plunged by 90% since January 2010, had received investments from some large PE funds. In May 2009, Rajat Gupta-promoted Asia-focused New Silk Route (NSR) invested around Rs135 crore through preferential equity shares. Also, Citigroup Venture Capital and Baring Private Equity Partners Asia invested Rs49 crore each through subscription to convertible warrants. The crash of KS Oils is a glaring example of the Indian corporate sector being a minefield of poor corporate governance and PE funds are often not well-informed about the quality of management.

In October 2010, ChrysCapital invested Rs100 crore in Pratibha Industries Ltd, a company focused on water management and urban infrastructure. The investment was done through a mix of preferential equity shares and compulsorily convertible participatory preference shares at a share price of Rs92. This investment of ChrysCapital has done rather badly. Pratibha is now trading at just Rs32.50 per share, down 65% from the purchase price. Another infrastructure stock that has left an equally large hole in ChrysCapital’s portfolio is NCC Ltd (formerly Nagarjuna Construction Company Ltd) in which it holds 8.8%, just a tad lesser than the holding of the Norwegian sovereign wealth fund which held 7.63% as of 30 September 2011. ChrysCapital’s total investment is pegged at around Rs170 crore, according to industry estimates. The private equity firm had started buying into the company when its price was around Rs98 a share. The latest stake was bought at a price of Rs53.42 which means ChrysCapital is averaging its high cost of initial investment. The stock is now trading at Rs38, down 29% from its latest stock purchase.

Like retail investors and FIIs (foreign institutional investors), often, PE investors too move in a herd. Blackstone, a big PE investor, had originally invested over Rs400 crore in NCC Ltd. As of September 2011, Blackstone owns 9.9% in NCC Ltd. Other prominent investors in the company include Rakesh Jhunjhunwala who, along with his wife, holds 5.85%. Promoter holding in the infrastructure firm stood at just 19.5%, over a quarter of which is pledged with financial institutions. NCC Ltd is down 90% from its peak price of Rs388 in January 2008.

 

Venture and growth capital investing firm, Sequoia Capital India, through its investment entity Ironwood Investment Holdings, has a stake of more than 6.8% in Ess Dee Aluminium which makes packaging materials used by pharmaceutical companies. The stake has been increased over time. In January 2011, the PE firm picked up 1.87% stake at Rs448 per share. In June, it increased its stake to 4.88% and, as of 30th September, it was the largest institutional shareholder. In its latest acquisition, the firm picked up the shares at Rs240. Sequoia, too, seems to be averaging its costly initial investment. The stock is now trading around Rs140, down 42% from its first purchase. How many years will it take for Sequoia to break even? Sequoia was also a big investor in SKS Microfinance, a stock that is down 94% from the peak of Rs1,491 it made in September 2010. Having ousted Vikram Akula, PE investors will now have to ensure that SKS survives or write off their investments.

Mauritius-based Kaup Capital’s Infrastructure India Holdings Fund LLC, in March 2011, acquired 6.35% stake in Aegis Logistics Ltd for Rs68.27 crore, by acquiring 21 .2 lakh equity shares at Rs322 per share—at a premium of 12%. The share is now trading at Rs139, down 60%.

ChrysCapital, in November 2005, picked up a 30% stake in JMT Auto Ltd through its Indian subsidiary Bach Ltd at Rs100 per share. The stock is now trading at Rs65, down 54%. ChrysCapital has not yet reduced its stake. As on September 2011, ChrysCapital holds 9.59% in Balkrishna Industries, a company which manufactures off-highway tyres for agricultural, construction and earthmoving segments. ChyrsCapital initially invested in the company, in July 2005, at Rs1,000 per share, giving it a 6.69% stake in the company. The stock has grown at around 4% annually since then, a far cry from the 25% rate of return most investors want.

In another deal done in February 2006, ChrysCapital acquired around 5% stake in Bajaj Auto Finance (now Bajaj Finance Ltd) via private placement possibly at Rs450 apiece. The PE firm increased its stake to 9% by September 2007. In September 2010, when the stock was near its peak, ChrysCapital sold its entire holding in the company in the open market for around Rs241 crore. This has been a good investment but may have netted only about 12% compounded annual return in rupee terms. In July 2007, Carlyle picked up around 5% stake in publicly-listed offshore oilfield services provider, Great Offshore, for about Rs165 crore at Rs860 a share. The share is now trading at Rs99, down 88%. Carlyle is still holding on to its 5% stake.

In December 2006, Citigroup Venture invested $23 million in Himadri Chemicals, which is into manufacturing of coal tar pitch, carbon black, chemical oils and several other by-products. In May 2008, the company further invested $4.5 million. In April 2010, Bain Capital invested $35 million in Himadri. As of September 2011, Citigroup holds 12% and Bain Capital holds 27%. The stock has given a return of 16% annually since December 2006 and a 6% annualised return since April 2010. These older deals have yielded slightly better results because of proper timing—when the market was at a low and the holding period long—where the stocks have been held for three to five years.

Page Share this article:

 

Submit your comments

Name * :
Email Id * :
Author Url:
Comment*:
	alert me when new comment is posted on this article
Security Code:	Not readable? Change text.

4 Comments

Pcchacko 4 months ago

Stock market is a playground of good and bad promoters and brokers and speculators. n ordinary investors are fooled by the clever promotors,brokers ,merchant bankers and investment advisors. Before liberalisation most of the IPOs and FPOs have given reasonable returns toinvestors long term and shortterm Then there was controll of theController of Capital issues and ROC for IPOS and FPOs and Most of the Merchant bankers wre honest and prudent.After liberalisation cruel,cheating and greedy promotors charge exhoritant premium .Evenbefore acquiing an office or land for factory or business actvities they charge premoums ranging from Rs.25 to 200. Out of 120 IPOs 98 have given negative retirns vrying from 25% to 95% on an average the IPOs/FPOs reduced the capital of the investors by 50% (minus) .Check the chittorgarh.com and they have given a link IPO tracker look at it you can see yourself. NOW ONWARDS DONOT SUBSCRIBE TO ANY IPOS EVEN IF IT COMES FROM BIG INDUSTRIAL HOUSES. WAIT FOR THE LISTING ANDSEE THE PERFORMANCE FOR 6 MONTHS AND THEN DECIDE AFTER CHECKING PE RATIOS DIVIDEND HISTORY RETURN ON CAPITAL ETC. ALL IPOS SHOULD BE MAADE FAILURE BOYCOTT IT COMPLETELY TO TEACH THE WICKED PROMOTORS WHO ARE OUT TO LOOT THE INVESTORS

http://www.moneylife » Reply » Link » Report abuse

In reply to: Pcchacko                                                               Close Name* :           Email Id* :        Author Url :      Comment* :             alert me when new comment is posted on this article Security Code : Not readable? Change text.

Narendra Doshi 4 months ago

Please give full details on eClerx -Sequoia PIPE

http://www.moneylife » Reply » Link » Report abuse

In reply to: Narendra Doshi                                                               Close Name* :           Email Id* :        Author Url :      Comment* :             alert me when new comment is posted on this article Security Code : Not readable? Change text.

Jagadees 4 months ago

Very nice article. But i felt you guys should also have included some of success of PIPE deals... Anyway the jest is, as a portfolio if it gives similar returns to benchmark net of fees does not sound PE fund managers as great investors with strong domain knowledge.. Regards

http://www.moneylife » Reply » Link » Report abuse

In reply to: Jagadees                                                               Close Name* :           Email Id* :        Author Url :      Comment* :             alert me when new comment is posted on this article Security Code : Not readable? Change text.

Dhirubhai 4 months ago

Some investments like eclerx for Sequoia have been stupendously successful.

http://www.moneylife » Reply » Link » Report abuse

In reply to: Dhirubhai                                                               Close Name* :           Email Id* :        Author Url :      Comment* :             alert me when new comment is posted on this article Security Code : Not readable? Change text.

What's Hot
From this section

• S&P 500 index futures volumes in collapses by 85% on the National
  The S&P futures derivative product launched by the NSE is finally paying for its inherent limitations. Volumes have collapsed as investors and brokers shun a product which can only be traded when the US market is closed, creating uncontrollable risk
• Vikas WSP: Operators continue to play their games while SEBI sleeps?
  A recent research report reveals a possible attempt to push the price of Vikas WSP. SEBI which should have the institutional memory of rampant price rigging in this scrip by a scam-tainted top broking house in the late ‘90s, remains unconcerned
• Varun Industries stock price tanks 84% in 2 months
  Selling of pledged shares, along with resignation of 4 directors within a month has prompted fears that something is deeply amiss with the company
• E-Gold: 1gm gold coins from e-Gold units
  
• Markets shrug off S&P’s negative outlook
  Sensex rallied from day’s low after S&P issued a negative outlook on India; shows declining influence of ratings agencies on a beaten down market