Global private equity hot on the heels of Indian start-ups

PE players are looking at companies and sectors with export orientation with less import component, such as IT/ITeS, pharma and mining

India's information technology services has not witnessed any slowdown as far as mergers and acquisitions are concerned. In fact, even as overall volumes and value of deals declined between July and September, inbound deals in the technology sector have increased sharply. Typically, outbound activity has been higher than inbound activity. However, the story has been different this year (2013). Investment bankers believe that inbound interest will continue to rise.

According to the merger and acquisition data by Venture Intelligence, for the year 2013 (year to date), inbound activity has surpassed outbound activity (excluding e-commerce deals). Total investment in Indian assets by private equity investors and strategic players has touched $1.32 billion, compared to $154.7 million spend by Indian firms to invest in assets outside of the country. The sector saw 20 deals both in outbound and inbound, but the value of inbound activity was significantly higher than outbound activity.

Among the macro-economic reasons, points out Amit Singh, executive director, head technology and outsourcing investment banking, Avendus Capital, investors are looking for risk-free sectors. "PE players who have set up funds dedicated to India are in a dilemma on when and where to invest. Add to this, an uncertain economic environment has impacted the rupee and also partly clouded political environment. They are hence looking at investing in companies and sectors with export orientation with less import component. IT/ITeS, and to some extent pharma and mining (though it has regulatory challenges) are the only industry that fit into this,” he explains. Baring’s investment in Hexaware Technologies is a case in point. Also, the financial metrics of this sector are superior than many others. Singh says there are few industries that can boast of EBIDTA (earnings before interest, depreciation, taxes and amortisation) to cash ratio of over 50 per cent and RoI and RoC (pre-tax) of over 20 per cent.

Samiron Ghoshal, Partner & IT Advisory Leader, Ernst & Young explains that investors have been looking at Indian assets for three reasons. First, when companies are looking to scale and assets that have niche capabilities. Finally foreign companies are looking at assets that have business across regions, but have back-end in India. “We see activity in all the three areas. India's technology sector is undergoing a shift. The 90s was all about body shopping kind of work, Y2K and the period after that saw players beefing up their offshoring presence. The next five years will be about a handful of companies emerging and becoming big players in niche segment,” added Ghoshal.

WHY START-UPS ARE IN DEMAND

After the IT/ITeS companies, technology start-ups in India, especially those focused on the enterprise segment, are also started to see deal traction. Though the e-commerce story has managed to capture interest of venture capitalists, start-ups providing technology in the enterprise segment have also managed to get funding.

Indian technology start-ups have become a hot bed of niche ideas that are getting picked up by large multinationals, as they fill the technology gap. Some instances include, Gluster, an open source storage software company that was acquired by Red Hat. PE player Silver Lake made its first India investment by backing Bangalore-based Eka Software Solutions. Druva that has its office in Pune managed to raise $25 million in a seris C round of funding.

Sandeep Singhal, co-founder Nexus Venture Partners agrees that foreign investors are looking at Indian technology companies both from an investment and M&A perspective although the activity is still significantly lower than the US or Israel.   “The IT space grown in recent years on the back of mid to senior level engineers leaving MNC global development centers to start companies, either alone or in partnership with colleagues from the US. There has also been some transition of founders from the US to India, but it has been less of a factor," he further adds.

Most of the MNC outsourcing in India is around either infrastructure technologies (OS, storage, networking, security, cloud) or around productivity applications (ERP, SCM, etc) and since this is the source of start-up talent it is natural to see companies in these spaces.

“We see traction in either niche space like cloud and analytics, or even in traditional areas like generic BPO and IT services. Even in traditional area like call centre nearly two-third of business is done in-house. Hence significant headroom for growth exists in these areas,” said Singh. For some sectors, there's no such thing as a slowdown.