October 2011
INDUSTRY I N T E L L I G E N C E
Getting SMART on the Industry
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Contents Private Investment in Public Equity – India Focus: This article analyzes
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the global private equity space and the growth prospects of private investments in public equity (PIPE)... Read more
For-Profit Education in GCC: The market size of the
for-profit education sector in the Gulf Corporation Council... Read more
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Business Cycles and Entrepreneurial Activities: This article analyzes the correlation between entrepreneurship and business cycles and highlights the role of entrepreneurs in various economic...
Read more
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INDUSTRY INTELLIGENCE | October 2011
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Private Investment in Public Equity – India Focus – By TresVista Financial Services
This article analyzes the global private equity space and the growth prospects of private investments in public equity (PIPE) deals. Given the Indian PE market performance, PIPEs will continue to be an important part of the Indian markets that cannot be ignored. In correlation to the volatility of the market and the subsequent movement in valuations, PIPEs are here to stay. Since 2008, the global PE sector has experienced a significant downturn in activity given the Global PE economic slowdown. However, Market 2010 was seen as a year of recovery for PE worldwide, as the industry has been gradually recovering. PE continues to remain an important source of funds for startup and young firms, firms in financial distress and those seeking buyout financing. Nearly $180.0bn of PE was invested globally in 2010, up around 54.0% from the previous year but still down around 74.0% from the peak in 2006. However, activity in the industry has been showing positive signs to build on this recovery and is expected to top $200.0bn in 2011. With bank lending in short supply, the average cost of debt financing is well up on pre-crisis levels while leverage is down and PE firms are contributing a bigger proportion of equity into their deals. 4
In 2010, the epicenters of the global credit crisis, Europe and North America, recorded deal values up 160.0% and 192.0%, respectively, from the cyclical trough. A large and rapidly growing number of PE funds worldwide are said to be sitting on nearly $1.0tn in committed but un-invested “dry powder”, and they are looking across the globe for attractive investment opportunities. In line with the industry’s revival in developed markets in 2010, PE activity in India, China and other leading emerging markets also recovered quickly.
PE Market in India PE has established strong roots in India over the past decade, owing to the nation’s phenomenal growth, dynamic entrepreneurs and hunger for capital to finance opportunities in nearly every business sector. Over the past decade, its role increased in significance and PE began to shape itself to the contours of the Indian economy
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and unique business culture. Contrast to 2009, when Indian deal value saw the region’s biggest decline, India saw the largest increase in deal activity among the big Asia-Pacific markets in 2011. Total deal value more than doubled in 2010 to $8.2bn, and the number of deals rose to 362. Nearly every major sector of the Indian economy participated in the strong deal-making recovery, with the energy sector attracting the most capital. With financial crisis affecting the global economy and domestic concerns, industry participants have had to tackle with significant new challenges. With that, PE firms are now aware that they need to reassess their strategies and how they can continue to deliver superior returns especially when the traditional drivers of the past such as GDP growth, multiple expansions, and ready availability of capital, no longer provide the lift they once did; by increasing investments in India. PE firms invested $10,117.0mn over 441 deals in India during 2011, compared to $8,187.0mn across 362 deals during the previous year taking the total investments by PE firms over the past five years to about $47.0bn across 2,062 transactions.
Why PIPEs PE funds, which mostly invest in private companies, are buying stakes in listed companies trading at attractive prices, as the downturn in stock markets in the recent past has brought down valuations of companies offering significant investment opportunities for PE firms. PIPE is seen as one of the most attractive markets for qualified individual investors and accredited institutional funds. A PIPE deal is a directly negotiated transaction between an accredited investor and an issuer, a public listed company. PE firms prefer PIPEs as these allow the funds to sell their investments in just a year or two, compared with the average four-five year wait for exits in privately held firms. Also, PIPE investments are attractive as corporate governance, transparency and accountability of listed firms are perceived to be significantly better than privately held firms. PIPE deals, though, come at a premium of 20.0-30.0%. Since the late 1990s, PIPE transactions have been increasing dramatically, and have successfully raised $105.0bn in equity capital over the past two years. In 2010 alone, there were a total of 1,203 PIPE deals. As per the current trends, top Wall Street executives are increasingly becoming involved in PIPE transactions as placement agents. Also investors tend to consider PIPEs attractive due to the restrictive regulatory challenges in executing control investments
like PE or venture capital. In addition to this, since PIPEs do not involve public underwritten offerings, their relative time and cost efficiency make it attractive to public companies. During the credit crisis in September 2008, when the companies could not access equity markets, PIPE transactions have provided quick capital to the companies.
PIPEs India During the height of the bull-run, one-fifth of the total PE investments made in India were seen to be in listed companies. But due to the financial crisis, the value of these investments was seen to drop lower, exhibiting a steep fall. In 2007, more than $3.0bn or 21.0% of all PE investments were of PIPE nature. Also, given that the markets continued to remain depressed below the highs seen in 2007, it was unlikely that PIPE investments would have recovered their cost. However, the increasing valuation of listed companies is reflected in the number of PIPE deals that took place in the last four years. As a percentage of overall value of PE investments, PIPE deals have fallen to 15.0% in 2011 and even in terms of the number of deals, the figure has fallen to 15.0% in 2011 as investors judged the valuations as excessive. PIPEs are expected to continue to be a very important part of the PE industry in India as in many segments similar businesses are often said to be valued far more reasonably in public markets than in private situations, especially in sectors where a lot of capital is chasing companies and entrepreneurs. In addition to this, PIPEs in India are expected to rise further after falling for the past 5 years, as lower valuations due to a decline in stocks are expected to present attractive investment opportunities to investors.
Returns and Risks Analysis
PIPE transactions are highly negotiated with widely differing terms of contract. Many a times such deals take place either at a discounted price as compared to the company’s market price or at a premium
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depending on the growth prospects. Most investors, who willingly pay a premium for the stock despite the market volatility, continue to remain bullish on the company’s growth potential and the respective sector. Often investors are offered a discounted price to compensate for the expected monitoring, services and expert advice, reduced/lack of liquidity, and/or the cost of due diligence. However, this is unlikely as PIPE investors remain passive and may not increase the firm value through monitoring; they might be facing certain resale restrictions, which may even be an incentive for investors to employ their specialized management and operational skills to increase the issuer’s public stock price and even incur expenses to assess the issuer’s future prospects. In fact,
PIPE investors generally face much shorter resale restrictions and also do not have access to material non-public information. Despite the current market fall which is expected to have an impact on recovery, PE investors remain willing to take long-term bets on the consumption driven India growth story, as strategies depend on a particular company and sector rather than performance of the overall market. Also if the investors have managed to identify companies that are expected to survive the present downturn and also have resources to bounce back when the market rebounds, investors can increase the stake in those companies whenever there is a good opportunity.
Outlook In the wake of softening valuations, PE fund managers anticipate an increased pace of dealmaking in 2012. Growth investments are expected to be the most attractive PE segment in the near future, followed by mid-buyouts, given that the Indian private investing market is maturing. PIPEs are expected to be next in preference list, as the market conditions in 2011 presented attractive opportunities for PE funds. After the bad performance of the equity market in the recent past, promoters are said to have become more realistic about valuations thereby expecting a higher number of PIPE deals in 2012. PIPE investors are expected to stick to the India consumption story and shy away from companies that have significant dependence on the US or the European markets or are export-oriented. Also, the new proposal by Security Exchange Board of India (SEBI) is expected to help expand private equity deal universe and effectively increase the potential deal sizes in the listed space by up to 89.0% without triggering the open offer. The change is considered to be good as it would not only lead to increased participation from PE players in terms of size and value of fresh investments, but also in their existing portfolio companies, where they would use the opportunity to increase their stake. The increasing competition in private space, as far as fundraising is concerned, also compelled the PE companies to change focus into the listed space. Increasing number of PIPE deals are expected to make the equity market cleaner and transparent, and trigger the currently missing shareholder activism. The recent exit of four managing directors of Sequoia Capital to form Westbridge Capital, an independent fund focusing on PIPE deals and raise $500.0mn in a span of three months, indicates a promising future for PIPEs in India. Other PE funds keen on PIPE deals in India include Norwest Venture Partners, Ascent Capital, LotusPool Capital, ChrysCapital and Warburg Pincus. Although the value and number of deals has slowed, PIPE is expected to pick up with several PE players betting on undervalued listed companies. 6
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For-Profit Education in GCC – By TresVista Financial Services
The market size of the for-profit education sector in the Gulf Corporation Council (GCC) countries is set to more than double by 2015 to USD 50.0 billion, driven by the increasing enrolment ratio of school age population. This, combined with the rising quality consciousness of an increasingly wealthy population, will lead to a larger share of for-profit institutions in a growing education sector pie. With primary and secondary enrolment ratios close to the peak in most countries, the tertiary enrolment market, which remains highly under-penetrated, offers a significant potential for growth.
to increasing wealth and infrastructure development in these countries. The last few years have seen an increased awareness in the region for the need to diversify the economies away from oil, leading to investments in physical and social infrastructure. The education sector has been a major beneficiary of this trend. Education has become a key spending and policy priority in most countries.
The education sector in GCC has shown tremendous growth in the last few years. We expect this trend to continue going forward for secondary and The GCC countries have recently witnessed high GDP especially for higher education, which remains highly growth rates, driven by increasing oil prices leading underpenetrated.
The market size of the for-profit education sector in the GCC is set to more than double by 2015 to USD 50.0 billion 8
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Growth Drivers
The Demographic Dividend
GCC countries are currently experiencing a youth bulge, with 60.0% of the regional population under the age of 30
Migrants in the Population
The Gulf ’s construction boom and tax-free status has attracted many expatriate workers to the region, which has led to a rise in demand for private education
Rising Income Levels
Rise in income levels and improved standard of living in the region has influenced the attitude of people towards education
Private Education = Quality Education
Private education is generally perceived to be better quality due to its emphasis on English and exposure to expat students with diverse cultural backgrounds
Outbound Students
To be able to compete for jobs, regional students are moving overseas for seeking higher education, prompting governments in the region to encourage foreign universities to open their branches in an attempt to discourage students from going abroad
For-Profit Education Market Size We estimate the market size for the for-profit education industry in the GCC to more than double to USD 49.1 billion in 2015, growing 13.5% annually over 2009 2015. Within the industry, the for-profit education market for tertiary education will grow at a pace of 13.8% annually compared to 13.1% annual growth of for-profit primary and secondary education. Tertiary education will represent ~60.0% of the total for-profit education market size over 2009 to 2015.
Source: TresVista.
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Government Initiatives Recognizing the urgent need for expansion of the education space, governments across the region have launched various initiatives and reforms to help the sector grow to its potential. The governments have started taking steps to actively encourage private sector participation in the education space. Countries have established regulatory bodies to set standards for education, to monitor performance of institutes,
In a significant change from previous policies, governments have started taking steps to actively encourage private sector participation in the education space and for accreditation. Despite having a higher budget allocation to expenditure, the region still lags behind developed countries in terms of spending per student, which indicates that there is potential for private sector to contribute to reduce the funding gap. Government is also taking initiatives to address the education quality issue. The initiatives by GCC governments will be the prime movers for growth in the sector, since the countries have little private sector contribution across most industries. Government involvement becomes all the more important in the GCC, since the region is deeply conservative, and introducing education reforms involves managing a huge shift in the attitude and mindset of people.
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Private Equity Interest in GCC Education The education sector in the GCC presents an attractive opportunity for investment, as the sector is set for unprecedented growth. However, due to the limited number of education companies listed on regional exchanges, private equity becomes a favorable route for exposure to the industry. The region has witnessed an increasing number of private equity deals in the education space in the last few years. The growing interest evinced by private equity players is a further testimony to the high return potential of private education in the region.
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Challenges Despite the huge potential of the education sector, there still exist significant challenges to development of the sector:
Quality of Education Lack of qualified and skilled teachers and lower focus on English, Science, and Math due to high emphasis on humanities, hampers the quality of education
Lack of Job Opportunities after Education Governments provide employment to the nationals with minimum qualifications, tempting youths to choose government jobs over private jobs requiring higher education
CHALLENGES High Fees High fees charged by private players are major concern for expatriates, who usually send their children to private schools
Capital Intensive Nature of Investment A low number of students per school results in high cost and low revenue per student. Moreover, the industry has a high turnaround time, which acts as a setback for entry of investors
To conclude, though the GCC region offers an excellent mix of demographics, economics, and environment for the private education space. Its growing young population, increasingly a part of the globalized world, represents both an urgent challenge and an exceptional opportunity for countries in the region. Increasing wealth and the resultant quality consciousness in people is one of the key factors which will drive more and more of the population towards private education. While the sector is facing challenges to the realization of its true potential, governments across the region have taken various initiatives to reform education and improve quality. Recognizing the changing dynamics of the sector, various governments are also encouraging private sector participation in the sector. This has created conducive environment for the for-profit education sector, making it an attractive investment opportunity.
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Business Cycles and Entrepreneurial Activities – By TresVista Financial Services Business Cycle is the recurring and fluctuating levels of economic activity that an economy experiences over a long period of time. Entrepreneurship is more than simply starting a business. We understand entrepreneurship as a process through which individuals identify opportunities, allocate resources, and create value. This article analyzes the correlation between entrepreneurship and business cycles and highlights the role of entrepreneurs in various economic phases.
Business Cycle
The four stages of a business cycle are growth (expansion), peak, recession (contraction), and trough.
In other words, business cycles are recurrent periods during which the nation’s economy moves in and out of recession and recovery phases. There are short-term (2 to 3 years) to long-term (50
to 60 years) business cycles. These fluctuations are generally irregular, varying in frequency, magnitude, and duration and are often measured using the real GDP.
Business Cycles are recurrent periods during which the nation’s economy moves in and out of recession and recovery phases October 2011 | INDUSTRY INTELLIGENCE
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Entrepreneurship Entrepreneurial success is a function of the ability of an entrepreneur to see opportunities in the market place, initiate change, and create value through solutions. There are two main classes of entrepreneurs: Growthbacked Entrepreneurs and Recession-backed Entrepreneurs. Growth-backed entrepreneurs are innovative, opportunistic and risk-appetite entrepreneurs, whereas, Recession-backed entrepreneurs are mainly necessitybased entrepreneurs.
The GEM Conceptual Framework for Entrepreneurship A number of researchers and experts have conducted studies on the relation between macroeconomics, business cycles, and entrepreneurial activity. We refer to the entrepreneurship framework developed by Global Entrepreneurship Monitor (GEM) to establish the inherent interdependence between entrepreneurship and business cycles.
Basic Requirements
Institutions Infrastructure Macroeconomic Stability
Established Firms (Primary Economy)
New Branches, Firm Growth
Efficiency Enhancers
Higher Education & Training
Social, Cultural, Political Context
Goods Market Efficiency Labor Market Efficiency Financial Market Sophistication
Technological Readiness Innovation & Entrepreneurship
Entrepreneurial Finance Government Policies Government Entrepreneurship Programs
Entrepreneurship Education
R & D Transfer Commercial, Legal
Entrepreneurship Attitudes: Perceived Opportunities Perceived Capacity Activity: Early-Stage Persistence Exits
National Economic Growth (Jobs & Technical Innovation)
Aspirations: Growth Innovation Social Value Creation
Infrastructure for Entrepreneurship
Source: Global Entrepreneurship Monitor 2009 Global Report.
GEM model illustrates that macroeconomics is correlated to entrepreneurial activity at every phase: boom or recession The top portion of the framework focuses on established and developed firms. These firms explore newer markets, innovate newer products, and increase their risk appetite. These expansion activities provide
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additional employment in the economy which leads to growth of entrepreneurial activities. The lower half of the model details the pre-conditions and ambience necessary to promote entrepreneurship.
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GEM considers three major components of 2. Recession: A recession is marked by a fall in the entrepreneurship: attitudes, activity and aspirations. real GDP of an economy. It is usually initiated by The new entrepreneurs, with the right attitude and a macroeconomic shock – collapse of an industry aspirations help improve the market conditions by (banking, real estate), mounting fiscal debt, developing their firms and providing opportunities to collapse of the government, etc. There are fewer others. opportunities in the markets leading to stagnation in the growth of the economy. People tend to be We believe that the GEM model illustrates that macroeconomics is correlated to entrepreneurial activity at every phase: boom or recession.
Correlation between business cycles and entrepreneurial activity in an economy
People tend to be more risk averse in economic downturns
1. Growth: Under this phase an economy witnesses more risk averse in economic downturns. The a boom and increased activity. There is macrobusiness world sees job cuts leading to a decline in level stability in the economy. Opportunities are the disposable income of consumers. People spend plenty and people are willing to take more risks. less and thus demand declines. As spending drops, The labor market is strong and banks are willing to returns for enterprises drop further, leading to lend money at competitive rates. The growth phase further unemployment. is marked by increase in innovations, opening up of new market opportunities, and a generally high 3. Trough: The lowest point of the economy in the business cycle is called the trough. National income risk-appetite. declines substantially, bankruptcy increases, As the growth phase evolves, entrepreneurial expenditure declines and economic activity activity picks up such that it becomes the driving slows down; leading to further increase in the force behind growth. unemployment. National inflation borders around
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Necessity entrepreneurship tends to be proportionately higher in low and medium income countries than in high income countries
zero and often results in deflation. While conventional entrepreneurs take a hit by either closing their ventures or delaying its start for a much favorable time, there are few individuals who bring in a slight growth in the economy by starting their own businesses, as a measure of last resort triggered by high job cuts. These types of entrepreneurs increase activity in markets by creating jobs, increasing disposable income and thereby, affecting demand in the economy. This, along with concentrated efforts by the government and established firms, kick-starts the economy leading to a shift from trough to growth. In a way, necessitybased entrepreneurs help the economy attain the troughstage and start the recovery/growth-stage.
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We find that, entrepreneurship and economic growth complement each other at every phase of a business cycle. At growth stage, the motive is to take advantage of the market opportunities while at trough, the motive is to survive. We conclude that, as a leading indicator of business cycle, entrepreneurial activity governs, limits and stimulates the growth and recessionary phases of an economy.
About TresVista Financial Services TresVista is a leading provider of high-end research, analytics and other customized Âfinancial services. Our clients include corporates, consulting firms, asset managers, hedge funds, and several of the most recognized financial institutions around the world including leading private equity firms and investment banks. We provide a range of services for our clients, ranging from investment screening, valuation analysis, and financial modeling to advisory work, research, and due diligence.
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