Indian private markets brace for correction

The writer is a managing director at BlackRock

For the private equity and venture capital firms of Bangalore, 2021 was a fine year. Inflows surged to record levels and a flurry of technology firms achieved “unicorn” status, with capital raisings that valued them at $1bn or higher.

As central bank largesse supported markets around the world, there were inflows of some $65bn into the Indian private equity and venture capital industry in 2020, according to data from Credit Suisse.

India added 43 “unicorns” during the year, raising the total in the country to 93 with a combined value of $330bn. That is almost 10 per cent of the 1,000 unicorns Credit Suisse estimates there are around the world.

However, it is clear that 2021 may be as good as it gets for a while for such young, private firms as tighter financial conditions emerge. Interest rates are now rising from the depressed levels that had lingered since the global financial crisis of 2008 faster than anyone expected just a few months ago. Investors are likely to be more demanding in both the terms and returns they are seeking as a result.

Bangalore is bracing itself for the eventual correction in valuations. The only question is how bad it will be and how far-ranging the second-round effects will prove.

The contribution of Indian unicorns to economic activity is significant. Their collective value is equivalent to 10 per cent of the market capitalisation of listed companies, compared with 4 per cent to 5 per cent in the US and China, according to Credit Suisse. New economy icons such as Ola, the ride-sharing company, and food delivery services create hundreds of thousands of jobs each year for younger people who are relatively unskilled.

The wealth effect was clear in India’s big cities as young tech entrepreneurs cashed in on their holdings to buy luxury residential homes — before their share prices could correct. Previously, only older tenants who had saved for decades to afford such opulence could afford to purchase in enclaves in Gurgaon and Bangalore.

In retrospect, many industry figures believe central bank liquidity created a bubble in areas of Digital India, just as it did in the US.

Until the end of last year, there was little differentiation between the stronger business models and the weaker. “We would see companies being valued on metrics such as price to vision,” one Mumbai investor said sarcastically.

Credit Suisse analysts also noted that “inflows exceeded the absorptive capacity of businesses”. Only a handful of those tech firms that went public last year are now above their initial public offering price.

“It feels like the US in 1995 right after the Netscape IPO. We’ve just had our first wave of tech IPOs in India in 2021 and there’s so much ahead of us in this decade,” said Rahul Khanna, Mumbai-based founder of Trifecta Capital, a firm that provides venture debt and growth equity to Indian start-ups.

But with pressure on valuations probable, some investors are wary of what came after Netscape. Firms such as General Atlantic and Lightspeed did virtually no new transactions in 2021, and focused instead on supporting their existing portfolio firms.

“We see the same opportunities as last year but now founders are no longer demanding decisions in two days, “ said Bejul Somaia, a partner at Lightspeed in Delhi. “We can get to know the entrepreneurs and build conviction. Last year, there was so much more anxiety.”

The correction has hit the public market harder than the private market. Thus food delivery service Swiggy remains private and is valued at $10.7bn compared with Zomato, which has seen its share price nearly halve from November peaks to a level that is only 5 per cent up from its IPO pricing last July.

That is partly because investors have far more latitude in marking their private portfolios than their public holdings. With the latter, accounting standards are clearer, making it easier to benchmark firms. But it is inevitable that today’s valuation gap between private and public markets will narrow.

In the longer run, stronger foundations and more differentiation mean that it may be possible for young firms to play a greater role in supporting the aspirations of India’s government to leapfrog both other emerging and developed markets in everything from artificial intelligence to decarbonisation.

But as in the US in 2001 and 2002, there might be a rocky period as some start-ups implode while tougher scrutiny exposes malfeasance in others. Coming down from dizzying highs is often painful in the short run.