Finance: The Indian Venture Capital Industry – Interview with Pravin Khatau

image money small Mr Pravin Khatau, a native Indian and a former Executive Director with Goldman Sachs, has a distinguished track record in Venture Capital investing globally and particularly into the Indian markets. He was previously on the board of a well known VC firm in India and is currently also serving as a Board member of the MVCA in Europe.

Mr Pravin Khatau was kind enough to share his insights into the Venture Capital industry with Duvet-Dayz as part of our Venture Capital series.

After decades of massive growth of the VC industry in India this growth flatted out to the end of 2008. The year 2009 was pretty though for VC investments globally and India has also seen a substantial decline in VC investments during that time. Now since earlier this year VC investment is back on the rise with an increase around 30% over the last year. Do you believe this trend will continue?

Pravin Khatau:
I believe the trend will continue and even accelerate.

What we’ve seen the last 2 years, the BRIC countries have largely avoided the leverage related problems of the leading western countries. Now with QE2 launched in the U.S. and comments from Fed governors saying that QE investing will continue for many years, artificially low – near zero interest rates are resulting in cash seeking higher returns. A country like India with a GDP growth rate of 9%+ and forecasts seeing such growth to continue for many years to come, very favorable population demographics is and will obviously be one of the key recipients of these fund flows.

India has two very interesting dynamics. Firstly her growth is largely domestic driven and not so reliant on export and thus much less affected by sluggish economy growth in the West. India’s export oriented industries are clustered within the high-tech segment which is beneficial again – being higher up in the value chain. From a VC’s point of view this throws up some very interesting investment opportunities. For example a recent listing on the NASDAQ for an Indian travel site ( reaped enormous rewards for its VC backers. Overall FDI inflows into India that from 2007 to 2008 almost doubled remains strong and near its record level of 2008.

In the U.S. and Europe deals are getting smaller with more money provided to companies as seed capital. Do you see a similar trend in India?

Pravin Khatau:
Deal sizes and the number of VC transactions dropped significantly at the end of 2008 / beginning of 2009 as a consequence of the bursting leverage bubble. What India realized by mid 2009 was that she was far less affected than the Western economies and after the initial knee-jerk slowdown GDP growth quickly recovered as did the Indian stock markets. The VC and PE fund flows have also recovered though as one would expect with somewhat of a time lag.

However over the last several months PE players have become extremely aggressive in India and new players such as KKR have entered the Indian market. The urgency of PE investors is driven by their desperate need to use up their “dry powder” and their access to cheap funding based on extremely low interest rates in the West. A lot of bank proprietary money is also being invested in India for the same reasons. The growth and VC investing has increased but at a slower rate due to the fact that VCs had a much more difficult time in capital raising than the PE-firms.

Real estate investment historically one of the largest areas of PE / VC investment in India has been hit particularly hard the last years with the global recession. Do you see a come-back in this industry as well?

Pravin Khatau
With regards to real-estate investments – the second half of the first decade in the new millennium saw very aggressive investments in the real-estate sector in India not only in tier 1 cities like Delhi and Mumbai but also in tier 2 and tier 3 cities and into increasingly risky projects. This overinvestment wave climaxed with the London listings of real-estate funds such as Hirco which raised hundreds of millions U.S.$ for speculative future deals. Not surprisingly these speculative projects took a severe hit when the crisis evolved during the last years. Since then residential values in tier 1 cities have recovered smoothly but commercial property prices have been much slower to recover. For example in Mumbai at Nariman Point (note: the prime commercial center of Mumbai) prices are still 20-30% off their peak and I’m aware of several prime office locations there which are still unrented.

Adding to the problem is the large supply coming to the market with the development of the BKC (note: Bandra Kurla Complex). Under normal circumstances strong economic growth would quickly absorb this oversupply creating a healthy undertone. Unfortunately the enormous flow of funds, coming into India from overseas investors seeking higher returns as a consequence of QE & QE2, is once again manifesting in large amounts of new projects coming up in both the commercial and residential sector.

Frankly, I’m a bit concerned that this might lead to a new QE fueled bubble and a potential subsequent crash / bust. The scenario in Delhi is very similar to Mumbai and even more so in tier 2 & 3 cities that can even less absorb larger projects. Personally, I always feel when an ambitious developer announces / plans to build the tallest building in the world it is a huge red flag.

Is the VC landscape in India changing?

Pravin Khatau
India’s Venture Capital industry has seen substantial change since the formation of the TDICI and regional funds in the 1980s and 1990s. After the entry of foreign Venture Capital funds since about 1995 and the emergence of domestic and India-centric VC firms we now see more and more global VCs and private equity firms actively investing in India. Until 2006 the PE /VC industry is estimated to have invested about USD 7.5 Billion.

Venture capital investment in India demonstrated massive growth over these years until 2008 when it reached its peak and growth flatted out. Based on data from Dow Jones VentureSource, India saw about US$864 million VC investments in 2008 up only 3% from 2007 VC activity.

In difference to China with more established business infrastructures, in India much of VC investment went into its business and financial service companies. Investments into India’s IT industry that was in earlier years the biggest segment, has recently slowed down while investments into the energy and utility sector has almost doubled. This could also be related to the maturity of the Indian IT industry gained over the last decade and we have by now already seen some quite substantial investments of Indian IT firms abroad. Some of the Indian IT firms are now amongst the largest IT service companies worldwide. Overall money inflows (DFI) into India remained strong and close to record levels during the last years and is now also complemented by more and more Indian companies investing abroad via M&A or other strategic investments.

During the last 12 months we’ve noticed much more aggressive activity by private equity firms and proprietary investment arms of international banks and investment banks. Due to the fact that Indian companies frequently get listed on stock markets at a very early stage, the private equity model in India is quite differentiated with these players often doing PIPE transactions and waiting for the stock market to rally to get their returns. This trend has been associated with the recent enormous inflow of FII (note: Foreign Institutional Investment) money which may well lead to an unhealthy bubble being formed. Similarly in the real-estate space – as mentioned before – a lot of foreign money is going to fund increasingly overambitious projects. FII inflows in the month of October for example was the second highest ever seen in India. This unhealthy trend seems to cross the boundaries of various institutional players regardless of strategy who invest in Indian asset markets because of its perceived attractiveness and with seeming disregard for their communicated strategies (e.g. private equity firms being involved in PIPE / buyouts). There’s an increasing risk of a policy response to prevent Western style bubbles taking place in India as well. Already the government has raised interest rates at least 6 times this year to head off inflation. Thus far they have not enacted any capital controls as for example Brazil has done, but they remain vigilant.

What is the most common exit strategy for VCs in India and their average time frames for investment?

Pravin Khatau:
There are basically 3 types of exits common with VC investments in India. First there are trade sales, the second is listing on the Indian stock markets and the third are listings on international stock exchanges abroad.

We are not seeing any extraordinary pickup in trade sales although with the strong growth in the economy continuing successful Indian companies are growing quite well. The competitive landscape in India has always been tough as there seems to be no shortage of talented entrepreneurs who are willing to jump on attractive looking opportunities. Throughout this year the IPO window with regards to domestic listings has been rather lukewarm.

The Indian investors have largely been out of the market and the IPO valuations this year have been too aggressive leading to very poor aftermarket performance. This is an unusual phenomenon particularly given the strong performance of the market index which would normally bring the retail investors back into the market but with market valuations being further pushed up by strong FII inflows, domestic investors largely remained on the sidelines.

2010 has seen a tremendous spurt in Chinese companies listing in the U.S. and Russian companies listing in Hong Kong. Indian companies have been much less aggressive in following this model though there are some examples of large and successful IPOs by Indian companies on overseas stock exchanges. I do expect that more Indian companies might follow along this avenue in the next years.

Is their a secondary market in PE/VC investments in India?

Pravin Khatau:
No, not to my knowledge.

A few last words and a general outlook for the VC industry in India?

Pravin Khatau:
The general outlook for the Indian economy is very strong and should continue like that for the foreseeable future, the strong monsoon should keep domestic spending high.

Infrastructure spending continues to be very strong therefor most people expect GDP growth rate to remain at the the 9%+ level. The concerns lies in signs that inflation is picking up and the government has been raising interest rates to counter this. Asset prices are being pushed rapidly by foreign investors fueled by QE2 fund flows and the U.S. weak dollar policy. This penalizes countries like India where exchange rates are trade related and therefor appreciating vs. the US$ and other linked currencies like the Chinese RMB thereby making Indian exports more expensive.

The overall business climate is very optimistic but there’s a high risk of destabilizing foreign fund flows creating problems down the road.

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