A V Rajwade: Smell the coffee

WORLD MONEY

Private equity investments have risen significantly in the past year and are beginning to attract political attention.

Private equity investors have become increasingly active in the Indian market. Some of the sectors which seem to be attracting them include cement, hotels, real estate and financial services. Infrastructure Development Finance Corporation (IDFC) is putting in place a $1-billion private equity fund for investment in infrastructure projects. Again, several IPOs are being preceded by placements with private equity investors. This serves two purposes: first, a benchmark for the pricing of the IPO, and second, the credibility which a well-known private equity investor conveys. Private equity investments, including venture capital, attracted about $1 billion of foreign money last year and the number is expected to grow rapidly. Temasek of Singapore is probably the largest single investor. Last year was also successful for exits, with several investors making bumper profits on disinvestment "" either public issues or sale to other private investors. In the process, some Indian fund managers have reportedly earned tens of crores in bonuses. One major domestic player is also emerging: Anil Ambani.

If, so far, the activities of foreign private equity funds in India have not attracted much political attention, in Korea and Germany, they are finding themselves in the eye of political storms. It may be recalled that Korea was engulfed in the balance of payments crisis in east Asia which began in Thailand in 1997. As in other affected countries, a large number of businesses, and many of their banks, came into difficulties. Private equity funds have been active in bank rescues all over Asia, including in Japan.

The typical process has been for the government to take over troubled banks and carve out non-performing assets into a separate vehicle, before selling the "good bank" to private investors. (In some cases, while not all bad assets were taken off the books, the government guaranteed to make good losses in excess of agreed thresholds). In many cases, the buyers of the "good bank" were foreign private equity investors. Some of them have already exited, but the case which is currently attracting maximum attention is that of Lone Star, a US private equity fund.

It is expected to make a profit of $3 billion from its investment in the rescue of the Korea Exchange Bank. And, the way the transaction was structured, Lone Star would not pay any Korean taxes at all on the profit. With elections in Korea due in a couple of months, the huge tax-free profit has become a political hot potato, with calls for changing the tax laws with retrospective effect. Other private equity investors such as the Carlyle Group, Newbridge Capital, Goldman Sachs, and so on, also had attracted similar adverse publicity earlier. But the proximity of the elections has meant that anger against Lone Star is particularly virulent, fed also by an earlier transaction where too the company did not pay any taxes on the profit.

Another case which is attracting a lot of attention in Korea is of a private equity investor's bid to take over KT&G, the former government-owned tobacco and ginseng monopoly. Here too, the bid has become controversial as it is being seen more as a tool to force major corporate restructuring on the company. In fact, shareholder activism is gathering momentum in Korea with one fund, the Korea Corporate Governance Fund (KCGF) "" currently under floatation "" aimed at investing in undervalued companies with weak corporate governance in order to force major corporate restructurings. Such shareholder activism is particularly strong in major Korean companies such as Samsung Electronics, Posco and Hyundai Motor, which have large foreign shareholdings. ICICI and HDFC, beware!

The activities of private equity funds had attracted political flak in Germany as well: during the last year's election campaign, one major politician compared them to swarms of locusts who destroy everything that stands in their way. Germany, with its strong manufacturing culture and faith in "stakeholder capitalism", has always been suspicious of Anglo-Saxon "finance capital", which gives little consideration to other stakeholders such as employees. Yet, in Germany, after the elections were out of the way, private equity seems to have become more acceptable, increasingly seen also as a positive feature for the economy. Private equity investments have rescued a number of sick businesses, and helped in the recapitalisation of Germany's famed, middle-sized mittelstand companies. One recent survey evidenced that businesses bought out by private equity funds have created more jobs, in percentage terms, than the European economy as whole.

The fact remains, however, that private equity funds have become huge, attracting investments of $250 billion a year in the last couple of years, and are very active in leveraged buyouts. Fund managers such as KKR and Blackstone control so many large businesses that they have become conglomerates employing hundreds of thousands of workers, and with consolidated turnover putting them in the top 20 of the Fortune 500 list. And, the sheer size means that with every success, political attention comes nearer.

Email: avrco@vsnl.com