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Hedge Funds Muscle in on Private Equity Deals

Snigdha Sengupta and Rana Rosen

June 2007

Gridstone Research, an equity research start-up in Mumbai, had secured venture capital funding from three investors last March. The investors included Charles River Ventures, Helion Venture Partners and finally Maverick Capital, a US$10 billion (Rs41,000 crore) American hedge fund.

What appeared then to be a one-off has now become a bit of a trend. Hedge funds are fast penetrating India’s private equity market and, since mid-2005, have concluded 36 deals worth US$1.7 billion. And, this is just a partial estimate, based on deals that are publicly known. The actual numbers, industry experts say, is likely to be much higher.

In the past 18-24 months, several leading US hedge funds have made a beeline for India. DE Shaw & Co, one of the world’s top ten hedge funds with US$30 billion in capital under management, set up shop in Delhi last year to invest in private equity and distressed assets. Och-Ziff Capital Management, which has more than US$11 billion in assets under management, struck its first private equity deal this year with a US$51 million investment in Bangalore-based Nitesh Estates for a 25% stake. Old Lane, the New York-based hedge fund led by former Morgan Stanley executive Vikram Pandit and recently acquired by Citi, is investing out of a US$500 million India PE fund that will be fully invested in 18 months. Other heavy-hitters in the Indian private equity market now include New Vernon, Farallon Capital Management, Galleon Partners, Artis Capital and GLG Partners.

Private equity firms, by mandate, are long-term investors, seeking returns anywhere between 30% and 60% on capital invested. In a growth market such as India, many companies have required the patient capital of such investors, who have provided handholding to the relatively young Indian companies. Hedge funds typically seek above-market and short-term returns on their investments, but they are doing growth deals in India, sometimes even in unlisted firms.

Investment banking sources say that anywhere between 5% and 15% of private equity deals now go to hedge funds. Most private equity executives privately admit that it is beginning to hurt. Some of them have started collaborating with hedge funds on deals but don’t see it a long-term strategy.

Some of the hedge funds, including Maverick, that Mint spoke to declined to comment.

Industry experts say that in the past 18-24 months, hedge funds globally have been under increasing pressure to deliver above-market returns in their traditional markets.

This has been difficult since buoyancy in the capital markets has made listed securities expensive. Experts say growth markets, such as China and India have, therefore, become more attractive as listed securities here are still relatively cheaper. In addition, these longer-term investments are another way to diversify their portfolio, says Atul Mehta, partner in the transaction advisory services group at Ernst & Young, the accounting and consulting firm.

The other big draw in India has been private equity’s performance in this market. Warburg Pincus’ US$1.8 billion exit from Bharti Tele-ventures in 2006 proved that serious money could be made in this market. While Warburg had to wait nearly nine years for the exit, firms such as ChrysCapital have made money faster by investing in companies ahead of their initial public offer. Pune-based wind energy manufacturer Suzlon Energy Ltd, in which ChrysCapital invested in 2004, hit the bourse within a year with a Rs800 crore IPO.

Amrish Baliga, head of private capital practice at ICICI Securities Pvt Ltd, says most of the deals by hedge funds in India are in the pre-IPO category. He adds that with returns of 15-25% on listings and 25-30% on growth investments, there is no need to question the hedge funds’ motivation.

The list of 36 deals throws up investment strategies that mirror those pursued by their private equity counterparts. First, the sweet spot for deal sizes is in the mid-market US$30-80 million range. Second, the investments are sector-agnostic, real estate, IT-enabled services, media, telecom, financial services, hospitality, auto ancillaries and retail among others. Third, they buy minority stakes in companies, although even smaller slices than their private equity counterparts.

“One of the big problems is that hedge funds turn around on deals much faster. They hand out term sheets with amazing speed,” says Luis Miranda, president and CEO, IDFC Private Equity. This is something that investment bankers have no complaints about. Baliga of ICICI Securities says: “There is nothing they can’t do.”

For dealmakers, hedge funds can be a one-stop shop. Their shorter time horizon and focus on high return means bankers get higher fees that hit the bank account faster.

This also means that, unlike their private equity counterparts, hedge funds spend less time on due diligence – one reason they can close a transaction faster.

In the longer term, companies that get hedge funds on board may feel the pressure to provide exits to their investors faster than required. “The entrepreneur has to be very clear about what source of capital he wants and for what,” says Srivatsan Rajan, partner and head of private equity at Bain & Co.



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