Private equity fuelling healthy growth

The health sciences sector has been witnessing a spike in private equity (PE) activity, which is expected to get stronger. A review of deals so far and factors to be considered by pharma companies while choosing a PE firm Navroz Mahudawala

Private equity (PE) in India has established itself as a successful approach of raising capital. While in the earlier years, the concept was nascent with majority of transactions being in early stage ventures, in the last few years PE has emerged as a recognised mode for late stage companies seeking expansion capital. The year 2006 witnessed growth in PE, with around 296 deals totaling $7.4 billion. However, 2007 broke all past records and saw PE deals of $17.1 billion value. (Source: AVCJ)

The health sciences sector has historically been one of the favoured sectors for PE firms in India and globally. In the former years, there were early stage investments in firms like Ajanta Pharma, Medicorp, Gland Pharma, Neuland, Biocon etc. Majority of these were led by Indian Venture Capital (VC) firms and were done in the late nineties. As the sector grew dramatically and Indian firms achieved perceivable success in the global generics arena, the size of deals and stage of investment changed. While there have been large deals such as Matrix, Emcure, Jubilant, Apollo, they have been comparatively fewer and majority of the deals average on/at $15-20 million range. As per industry estimates, PE statistics of 2007 show that the health sciences sector accounted for only two percent of the total PE market in India.

Major PE Deals

Funds which have been active in the health sciences sector are ICICI Ventures, CVC, Chrys Capital, IFC, Actis and Schroders.

While formulations and Active Pharmaceutical Ingredients (API) were the key areas of interest earlier, outsourcing Contract Research and Manufacturing Services, (CRAMS) and healthcare has been the dominant investment themes in recent times. Outsourcing/CRAMS continues to be a favourite with three major investments this year (Sai Advantium, GVK Biosciences, Siro) focusing on this theme. Two large deals (Max/IFC and Apollo/Apax Partners) this year in healthcare reiterated the importance of healthcare in the portfolio of large, global funds. Though much debated, most entrepreneurs (who have received PE money) believe that funds add value to the company through various strategic inputs which helped the company in its growth strategy. Most funds are known to provide good industry insights and strategic planning; besides active board representation. Majority of funds are focused on assisting the management in a few select areas and never interfere with the day-to-day operations.

Following are the areas wherein PE funds have added value to their investee companies:

Attracting talent: Today most HR heads of companies in India accept the challenges before them in attracting mid and senior level talent. Through their relationships both in domestic and international market, PE firms have been able to attract talent for their investee companies. This factor is in fact the most crucial value add that PE firms offer to biotech investee companies.

Business generation and development: Expansion into new geographies and helping investee companies win new customer contracts.

Financial advisory support: While Indian corporates have excellent skillsets in financial accounting; they lack in M&A planning and execution capabilities. The pharma sector has seen among the largest number of outbound transactions in recent times and having the support of PE has helped some of these companies tremendously. These funds have also advised companies in acquisition financing.

Corporate governance: Managements find that there is a huge gap between corporate governance followed in their existing state (ie. privately held) and a listed status. PE helps bridge this gap by creating systems and procedures wherein board level controls could be exercised. Also, they help in recruiting independent directors on the board.

Fund raising capabilities: This largely involves capital market expertise during the Initial Public Offer (IPO) process. With their relationships with Investment banking and Foreign Institutional Investors (FII), PE funds are best poised to run an effective IPO process for their investee companies. Many PE funds have also helped their companies to raise External Commercial Borrowings (ECBs) at competitive rates.

Systems and risk management: Most entrepreneurial and high growth companies lack the requisite management expertise in choosing the right kind of systems and vendors for their MIS, ERP, forex risk management and supply chain. Funds through their experience in other investee companies have been able to identify appropriate vendors and negotiate better.

The benefits of PE for health sciences companies is immense, however it is important for companies to evaluate PE funds. Just as management styles differ, similarly fund management styles also differ. While some are more passive investors, others follow an active ‘hands on’ approach. Hence, managements need to be extremely careful and evaluate various factors before choosing a correct fund. Some key factors which a pharma company should evaluate comprise:

Global presence: This is a critical factor, especially for CRAMS companies, as global funds can add a lot of value in generating new business through their business relationships.

Experience in India in creating successful companies: While managements of many pharma companies are experienced, tie-up of such companies with young PE teams with limited experience could be disastrous.

Knowledge and maturity of the fund manager: The experience profile of the person who is leading the investment from the fund side is critical. Pharma and its dynamics can be complicated, it is important to give a board seat to a person who understands the sector in detail.

Risk appetite: It is important to align with a fund that has a similar perception of risk of the business plan as the Management.

Speed to move: The investment process highlights a lot of factors related to the fund; especially its internal decision making capacity and timelines. Hierarchical funds with limited decision making capabilities in India are best avoided.

Industry focus/experience: A fund with global life sciences focus can add a lot of value to the investee company. The strategic guidance provided by such funds could be invaluable as these funds understand global industry dynamics and can guide managements in their global forays.

Brand: A marquee name as an investor helps on various fronts including at the stage of IPO.

Chemistry between principals: Often underestimated; a crucial factor during the troughs of business. The promoters and management need to substantially interact with the fund managers even socially to develop a rapport.

Valuation: Perhaps the most important factor from a promoter's mindset. However, history has proved consistently that the best of funds typically are conservative in their valuations.

The health sciences sector has been witnessing a spike in private equity activity, which is expected to get stronger. With a huge potential for innovative business models and novel service areas in sectors like healthcare, private equity companies provide the much needed funding along with brainpower and expertise, helping companies realise their optimal potential. Increasing availability of private equity funding would help transform innovative technology and business ideas into tangible products and services, thus unlocking substantial inherent value of various businesses in the sector.

(The author is Associate Director, Healthsciences Practice, Ernst & Young. The views expressed herein are the personal views of the author and do not necessarily represent the views of Ernst & Young Global or any of its member firms)