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September 03, 2005

Making merry until the IPO party lasts

In an article for the Financial Express, I highlight how late-stage companies are tapping Private Equity investments just a few months before filing for an IPO.
October 2004: HT Media raises private equity capital from Citicorp International Finance Corporation, following an earlier investment from Henderson.

August 2005: HT Media's IPO is oversubscribed.

May 2005: ABG Shipyard raises funds from Merlion India Fund and IL&FS VC.

August 2005: ABG Shipyard files for IPO.

May 2005: Telecom R&D firm Sasken raises a reported $9 million from US-based VC firm, NEA, and files for an IPO almost simultaneously.

See a pattern here? Welcome to the world of pre-IPO Private Equity deals. As long as the IPO window in India is wide open we can expect the pre-IPO PE financing to gather momentum. (After all, right now, the only difference between one IPO and another is how many times each one is oversubscribed). Investing in mature companies just before their IPO – which sets a nice healthy valuation benchmark for the company - and exiting at a nice profit either at the IPO or over a couple of years, is a nice formula indeed. As long as the party lasts.

Investing in mature companies just before their IPO – which sets a nice healthy valuation benchmark for the company - and exiting at a nice profit either at the IPO or over a couple of years, is a nice formula indeed. As long as the party lasts.

I personally do not have too much of a problem with this phenomenon. Over the last 18 months, one of the most significant trends in the Private Equity world has been the emergence of a clear stratification within the industry - i.e., a clear demarcation of who specializes in what, in terms of stage and size of financing. This is good since it lends depth to the market and can be expected to have a “trickle-down” effect on start-up financing as well. Angel investors and early-stage Venture Capital firms (which are a sub-set of Private Equity firms) can now invest in the confidence that their investee companies have multiple players to go to for follow-on financing at various stages of their growth.

...To their credit, PE firms have kick-started investments across a range of industries. (Until mid-2003, companies outside the IT and BPO industry rarely got as much as a dekko from VCs.) And it is not just export-led industries like textiles, pharmaceuticals and auto-components that are attracting PE investments. Companies focused on the domestic economy - like Retail and Media firms - are getting a decent share of the money as well. This again augurs well for the long-term.

So, what’s next? As the IPO fever heats up and more and more PE firms rush in to make their first investments – keen to report an “early success” back to headquarters - we can expect a supply-demand mismatch. As more money chases fewer quality companies, the result is inevitable: Prices - that the promoters will demand from PE firms - will go up. As long as the markets head northwards, the deals will continue to get done at higher and higher valuations. But the IPO window will - inevitably - close at some point. And, when the music stops, some PE firms - who have just paid fancy premiums in their latest pre-IPO deal - will be left stranded.

...They will have to bide their time until the next IPO season. Or sell at a discount. After all, as the Americans say: No pain, no gain.


Arun Natarajan is the Editor of TSJ Media, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of TSJ Media's Venture Intelligence India newsletters and reports.