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Millennium Post

The double-edged sword

When it comes to Private Equity (PE), there can be numerous schools of thought. You have the group that would completely go gaga over PE. You have another that would simply want to wipe off this infactuation. There is also one that would hold PE responsible for failed, inefficient and weak government policies. In India unfortunately, what we have (mostly) seen so far is the havoc that PE has caused. It is one key reason that has snowballed into the economic crisis that we face today.  
It was back in 1946 when PE emerged in the American market in its true sense. The era between 1960s to 1980s saw the Vanderbilts, Whitneys, Rockefellers and Warburgs build fortunes in businesses ranging from real estate construction projects to airlines, banking to whatever moved on the streets of Silicon Valley. Running parallel and equally fast was Warren Buffet, who through Leverage Buy-Outs (LBOs) acquired one corporation after another.

The US Congress then opposed every change in tax policy that could have made life more difficult for PE firms (the Carter Tax Plan of 1977 was the first of such acts that failed to be enacted). What followed up until 1990 was quite understandable (given the quick, sweet success PE had witnessed in its early years). Thousands of PE labels mushroomed across the globe. Cracks on the PE wall first became visible in the first half of the 1990s. Ills related to the massive rise in leveraged buyouts that were financed by junk bonds led to the-then collapse of the LBO industry.

The ‘true’ global effect of PE became more publicised in the early 21st century. It began with the dot-com bubble bursting. It shook the very belief in PE. In the quick years that followed this early 2000s disaster, more than half of PE firms were forced to throw in their towels. Many IT firms were wiped off clean. And the biggest reason for such an unwanted outcome was that those very PE firms that had promised to fuel their dreams ran out of fuel themselves. By end-2000, globally, the count of PE firms fell by 50 per cent. India too felt the impact of the dot-com bubble slap. The Indian IT industry came under huge pressures – returns vapourised for some time. There are apprehensions still that have spread to other verticals. Private equity dealings in the first decade of the 21st century has left us in ruins. Worse, during this period, PE entered one sector after another and that resulted in excess supply being created. PE has ruined organisations far and wide.

Take for instance the case of the much-hyped industry (in India) called Real Estate. Real estate was once considered a non-volatile sector. Then came PE intervention, and left the industry in a shambles. Back in the 1997-2003 period, withdrawal of funds by PE led to a crash in Mumbai region’s real estate business. The same was repeated in the 2011-2012 period when prices fell by 20 per cent (and higher) in Delhi and Mumbai. The fundamentals of the entire sector have seen a paradigm shift after the SEZ Act of 2005. Most concrete jungles that were built post-2005 were aimed towards investors who wished to park their money in such properties. Ghost towns were built around metros and bigger cities, and sold at prices that were headed for the moon. The present scenario?

When PE investors decided to stop the inflow of funds, the expected came to pass. Empty malls, half-completed high rises and incompletely dug up construction sites – you know the story! Holistically stated, the purely economical repercussions of PE’s entry and exit across sectors and markets have also led to several socio-economic crises. In a 2011 study by the University of Chicago, Harvard and the US Census Bureau, it was proved that ‘companies tend to terminate more employees after a buyout compared to competitors in the same sector.’

But PE investments always offer higher returns given the risks. Right? Actually, no! In a 2005 study by Prof. Steven Kaplan of the University of Chicago and Prof. Antoinette Schoar of MIT, covering the period ranging from 1980 to 2001, it was revealed that, ‘Investors actually made slightly less on PE deals than they could have by investing in an S&P 500 Index fund.’ All in all, PE funding not only degrades and makes a sector volatile but also injects malpractices into companies. Today, PE funding worldwide is headed southwards. And that is good news. It implies greater stability for the global economy as a whole.

Going back where I started, when it comes to PE funding, there are several schools of thought, but when it comes to India, the thought that PE can and will leave you in ruins appears most logical. The Indian government has to be very careful going forward about the manner in which it allows PE to enter any given sector. PE is a double-edged sword. Popular perception is that it makes you stronger – but only until you measure the blood you have lost. Period!

The author is a management guru and director of IIPM Think tank

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