Home > Entrepreneurship, India, Venture Capital / Private Equity > India: are unlisted equity markets overheating?

India: are unlisted equity markets overheating?

September 1, 2010 Leave a comment Go to comments

[Apologies for a long hiatus – work gets in the way sometimes.]

Back when I was in New York at the height of the dot-com bubble, a stranger once advised me that it is time to get out of the stock market when cab drivers start offering stock tips.   Ever since, I have looked for leading indicators to time my exits.   Today, I am wondering if it is time to stop investing in the Indian private equity markets (for a while) based on two reasons.

First, the fundamentals:  earlier this year, I was lamenting the rise of the Sensex (the Mumbai stock exchange index) as it was pushing up valuations in the unlisted market.   Even as fears of a double-dip recession in the West have held back global markets, the Indian stock markets have broken away.

A recent analysis indicated that the Indian listed stock market as a whole  (which is dominated by a few large caps) is trading at about 16x forward earnings.  Further,  a large number of high quality mid-caps are trading at half of that.   Meanwhile, the private market deals I see nowadays are getting priced at 20x and 25x forward earnings ( for the uninitiated, please recall my note on valuations here).   As per Investment-Theory-101 it is absurd to pay that much more for significantly smaller businesses with all their attendant risks.

Second, the signs on the street are many and real that we are in the middle of a bubble in private market valuations:

  • Any quality deal sees no less than 10 bids; the auctions are on.
  • Recent high-profile IPOs like SKS Microfinance, MakeMyTrip, etc., have raised expectations among promoters and investors alike.
  • We have seen businesses list with less than $30M in annual revenue and/or less than $8M in profits.  The IPO market presents a real alternative for companies that would otherwise have sought private equity.  This puts a scarcity premium on good deals in play today.
  • We saw a deal close in less than 6 weeks from the time we first saw it.  All indicators are that the investor skipped diligence almost completely.
  • A banker said to me last week “20 is the new 10,” by which he means it’s the norm to pay 20x forward earnings for a business you would have paid 10x for a six months ago.
  • Deals are not closing as entrepreneurs change their minds about fund-raising – why sell now when their stock is rising so quickly?

These are fast growing businesses but their  valuations are front-running the underlying fundamentals of their business.   The smart money will now be looking for the door or stop entering the market or at the very least enter the market very selectively.   There is of course the other smart money that believes you can buy high and sell higher.

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  1. Shyam Kamadolli
    September 22, 2010 at 2:18 am

    Ugh… as of Sep 21st, 2010, the Sensex breached the 20,000 mark and is fast approaching the all time high of ~22,000. The markets are trading at PE ratios of 25 and trending higher.

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