Realtors talk hybrid deals with PEs

Shailesh Menon & Ashish Rukhaiyar
MUMBAI
Oct 31, 2008

SOME real estate companies are trying to cut hybrid capital deals with private equity players, though the industry and deal makers are keeping their fingers crossed, given the turmoil in financial markets. Drying credit lines, non-availability of low-cost working capital and continuing downturn in equities have pushed cash-strapped promoters to work on new mezzanine structures with PE firms.

Mezzanine finance is a structured debt-like instrument consisting of cash income and an equitylinked component. It is sandwiched between debt and equity on a company’s balance sheet. Under mezzanine financing, the strategic investor (generally a private equity firm) funds a company through debt and equity.

According to private equity fund managers, the net cost of investments is 20-25%. Of this, 15-20% is paid as interest on debt and the remaining 5-10% is offered to the private equity investor as warrants exercisable at close of debt maturity at zero cost. The equity portion is valued on the basis of the company’s outlook, experts said.

“The current economic conditions are forcing companies to opt for quasi debt/quasi equity kind of financing. Several real estate companies are looking at this option to raise funds. A few are already negotiating with strategic investors,” said Noble Group’s Indian equities head Saurabh Mukherjea.

Mezzanine capital is typically used to finance acquisitions, product enhancement and plant expansion. Although it constitutes a small percentage of a company’s total available capital, mezzanine financing has become important for middle-market companies in recent months.

Some mezzanine deals already done

“TO MY knowledge, there has been no mezzanine financing deal in India lately. The segment is in a pause mode as of now. But I am sure that promoters are considering such fund-raising options,” said ICICI Ventures MD Renuka Ramanathan. ICICI Venture is in the process of closing the country’s first mezzanine fund. ICICI Venture’s ‘India Advantage Fund VII’ will offer $110 million in its first round of fund raising.

Mr Mukherjea said, “Private equity investors are not willing to finance companies without equity participation. Mezzanine financing offers promoters the flexibility to meet fund requirements without a significant dilution in ownership. Deal sizes should range between $15 million and $200 million in India.” The fees for raising money is about 1-2%of the transaction amount.

Mezzanine financing is a funding strategy that blooms when other forms of capital raising become unviable and impossible. Collaterised debt, zero-cost conversion of warrants and low investment tenures make mezzanine funding beneficial for the investor.

If analysts are to be believed, a few deals structured on the lines of mezzanine financing have already taken place over the past eight months. “These deals are not made public as they involve several regulatory bottlenecks,” an analyst said.