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January 14, 2007

"Danger lurks around the corner": Ashish Dhawan

Ashish Dhawan, founder of ChrysCapital, has written an interesting article for the Corporate Dossier section of Economic Times on why he is bearish in the near-term about returns from Private Equity investing in India. (Unfortunately, no online link is available. Emphasis on the "Real Estate is India's dotcom" (!) para is mine.)

India's P/E multiple is a reflection of the fact that risk aversion is at a cyclical low. Fast money can easily leave the public markets to create a buying opportunity. However, private equity money has a long lockin and therefore the supply of capital is unlikely to diminish, leading to an imbalance that gets perpertuated much longer than in the public markets.

Margin decline: in aggregate, the top 500 listed companies have grown revenues and net profits at 14% and 24% CAGR respectively over the past five years. We all know that in the long term, revenues and profits grow in line with nominal GDP. But margins are now likely to decline as new entrants attack fat profit pools and as existing players expand capacities. I dont believe that 20+% earnings growth will continue despite real GDP growth at 8 to 9%. History shows us that EPS growth is always much lower than anticipated as the business cycle turns.

Financial shenanigans: Real estate is India's dotcom. Both sectors are poised for growth. But the valuation metrics are insane. In the dotcom craze we forgot about earnings and valued companies on eyeballs. Today Indian real estate companies are valued on landbank. Cushman & Wakefield's landbank valuations are no different from Henry Blodget's infamous Amazon valuation. The state of affairs in real estate doesnt suggest a lot of prudence out there, meaning it's time for us to apply our own.

All of us in the private equity industry are aware of these risks and yet our incentives will prioritise quantity over quality in portfolio construction. The recent successes have erased from collective consciousness the ability of risk to turn into loss in the last few years. Private equity is now here to stay in India and will only grow over the long term. However, danger lurks around the corner.

Arun Natarajan is the Founder of Venture Intelligence, the leading provider of information and networking services to the private equity and venture capital ecosystem in India. View free samples of Venture Intelligence newsletters and reports.