PRIVATE EQUITY IN THE CONSTRUCTION INDUSTRY: AN ANALYSIS

INTRODUCTION
In layman’s terms Private Equity (hereinafter referred to as PE) can be referred to as an
alternative mode of investment which consists of ‘capital’ that is not listed on the stock
exchange. Here the capital is invested by a private set of investors, into a business in return for
equity in the company. It can be either in the form of a direct investment in a company or
acquiring public companies through funds and investors. It is a high-risk business because
companies may or may not perform. PE firms mitigate this by diversifying their investments and
hoping that their successful investment will compensate for their other losses. Recent trends
show that several foreign PE firms have started showing interest in India, especially in start-ups
as there can be a surfeit of venture capital money in early stages of the investment.
For a smooth transition of a developing country into a developed one, one of the most significant
steps is the need of development of physical assets i.e. infrastructure such as ports, airports,
bridges, roads, etc. Most of the developing nations including India lag because of their
underdeveloped infrastructure in terms of capacities, efficiencies, to deliver these basic services.
To achieve the desired economic growth rate, governments around the world have identified
infrastructure as a priority sector for the economy. The infrastructure projects are all capital
intensive; hence one of the most difficult aspects of an infrastructure project is the procurement
of such capital to fund the projects. History shows that infrastructure is that asset which is
expected from the government to be provided for and it is considered as a principal source for
the same. However, at the same time the government is also under the pressure to eliminate
public debt and at the same time improve and expand the public facilities, this creates a need for
the private sector to enter into long term contractual agreements for management as well as
construction of the infrastructure facilities. Therefore, private financing along with the
procurement of capital bring much needed efficiency and competency to infrastructure projects.
Improvements require continuous innovation on several fronts including technology, design,
construction, and operational processes. Several studies have indicated that private sector can
achieve more success comparatively for delivering such outcomes  . In India the private sector
at attracts PE investors to the
construction industry has been further elaborated in this article.

WHY CONSIDER PRIVATE EQUITY AS A SOURSE OF FUNDING?
Unlike other financial sources, Private Equity can be considered as a strategic source, in a
construction industry, there comes a threshold level beyond which a company cannot grow on its
own, this is where the Private Equity firms can bring substantial value to the table. PE firms not
only bring capital, but they also bring relationships in the market. It can be in any sort of form
like succession planning, partnership, business development as well as relationship with and
within the government. In the construction business, PE firms do bring a lot more than just
capital, they are able to understand the business models, project related nature of the construction
business, the competitive market, bidding cycle etc. One of the most important things to
understand is the value a Private Equity firm can bring to the table; one must realize that it is a
whole lot more than just money. Before investing in any sector, any PE firm does an industry
specialization regarding that sector, hence with the infrastructure sector they will have deep
industry specialization. They can understand the business models, the regulatory impacts, and the
overall market environments.
Unlike other sources of funding, PR investors are more active investors, apart from capital, they
also offer managerial inputs to the various upcoming projects of a construction company. A
study shows that firms with input of capital through Private Equity firms have performed much
better compared to the firms who have not.  Though there are also drawbacks to PE funding, the
most substantial one being the high cost of capital. Governments in countries like India or other
developing countries should consider attracting more PE investment, at least in the government
projects, so that the efficiency and performance of this sector can be enhanced.

The result of the same study also showed that the volume of foreign PE investors in India was
higher than that of the domestic investors. Recently India moved up 14 places, i.e. to rank 63 in
the ease of doing business index, if the government is successful in creating an attractive
investment climate for foreign PE investors, then it can lead to an enhanced funding of the larger
infrastructure projects. This in turn means that things like bureaucracy and red tapism will be
reduced to a bare minimum, as the funding will be coming from private sector; PE organizations
and it will also lead to a timely completion of various projects. One of the other means to attract
foreign investors to India can be the participation of domestic investors in the infrastructure
industry. This very same study also revealed that the average investment made by a group of
foreign and domestic investors was significantly greater as compared to the average investment
sizes of a group of either domestic or foreign investors alone, hence this suggests that the foreign
players feel more comfortable having domestic firms around in the market. The inference which
can be drawn at this juncture is that the governments should not only look to attract foreign PE
investors, but they should also take bold steps to facilitate the domestic firms in the Indian
market. The strong foothold of domestic PE firms in the Indian market can act as a catalyst to
attract further foreign PE investment.
AN OVERVIEW OF THE PRIVATE EQUITY IN THE CONSTRUCTION SECTOR IN
THE USA
Private Equity groups have largely avoided the Construction Industry so far because of the
historical non convergence between these two particular sectors, a number of inherent risks,
cynical nature of the business itself and the largely unmet expectations attributed to the large
financial requirements. The lower middle market group per se is quite competitive. An
overabundance of capital coupled along with an influx of more sponsors, family offices and the
(PE) firms, has led to a dynamic being created where more players are going after degraded or
lesser quality deals. This has led to the competitive landscape becoming more competitive with
time.
The recent trends show that the Private Equity firms have started looking at Construction and
Engineering industry as an opportunity and not insecurity and for such opportunities the PE firms
are looking at a broader range of industry sectors such as environmental, heavy machinery , civil,
industrial, clean technology and energy services, construction materials and utility services etc.
Encore Capital Management can be taken as the most recent example for stepping out of its
conventional markets, as it is seeking to raise $400 million to build homes and buy land.  Private
Equity firms are not famous for “flipping homes” but recently in the US after the national
housing recession, quite a few PE firms invested in properties and purchased thousands of them,
with the intention of converting them to rental properties. According to one of industry’s oldest
and most respected publications “Engineering-News Records”, the PE firms have been executing
deals in the construction sector since the “Dot com bubble” in the early 2000s. This was an era
where there was a stock market bubble due to the excessive speculation of internet related
companies from 1995-2004. This is a time when the US economy was at its peak and with the
influx of investor cash, the PE firms started ramping up the investments which further helped the
industry firms to change corporate directions.
In India, in the last decade or so, PE has emerged as a significant source for capital funding of
infrastructure projects. Conventionally, equity for most of the infrastructure projects were
typically contributed by the sponsors and developers of a particular project. Debt financing was
used to obtain a major portion of the project investment, it accounted to around 60-70% of the
total investment required. This rise which has been noticed in India with regards to the PE
investments has led to a new pool of capital for the infrastructure and construction projects,
where anyway the demand for capital is more than substantial but the resources to fetch them are
very limited. As for the non-sponsor investments, they have been largely in the form of debt,
except in the case of public equity offerings.
APPEALING SEGMENTS OF THE CONSTRUCTION INDUSTRY TO THE PRIVATE
EQUITY INVESTORS.
The participation of the Private Equity firms in the construction industry largely depends on the
headlines, when the economy is in a slumber and is starting to recover the more traditional
discussions that happen at that point of time are mostly related to residential markets. When the news outlets are screaming about dilapidated bridges and the dismal state of infrastructure in the
country, there seems to be more discussion about the infrastructure market. For the PE investors,
the Public Private Partnership (PPP) model is one of the most interesting opportunities in the
construction industries, but these investors are also largely skeptical about it, since the PPP
comes with some real limitations and there are a lot of components attached to it. One of the
most significant components here is the non-operating component, meaning the financing and
concession component, it is something which cannot be called a private equity game in its strict
sense, certainly not a small-cap private equity game. Institutions that generally play at this level
are mostly seen in PPP ventures which are large firms with deep pockets and holding periods
which are measured in the 15 years plus range. This makes it virtually impossible for a middle
level private equity firm to enter a public-private partnership directly.
The solution for a middle market PE firm to enter into a PPP model would be to have leverage
over the relationship between the principals of the middle market operating company and the key
PPP developers and consortium leaders who also happen to be the “exclusively large cap
organizations”. The infrastructure and Industrial contractors; USA is one of the most appropriate
examples of an exclusively large cap organization running a middle market business. This
company took up a billion-dollar public private partnership project in Pennsylvania. The success
that they achieved was because of an executive that they hired who was able to leverage
relationships that led to such doors being opened which would not have opened in any prudent
course of a day.
In India, the total population of the workforce coupled with the demand and availability of the
cheap labor can prove as a decisive factor to attract more foreign Private Equity firms. As per a
report, 65% of the total population in India is below the age of 35, moreover the high demand for
good infrastructure in the country can make this country an El Dorado for the foreign private
equity investors to invest in the construction business in India. To substantiate this argument an
example can be given about the smart city plans which the current government has proposed.
Such high demands can yield greater profits for the firms; hence the government should use this
as an opportunity to attract more foreign players in the market but at the same time, taking care
of the domestic ones as well.
CONCLUSION
The overall characteristics of an operating environment play a huge role in attracting the Private
Equity investors. It has been discovered that regions with moderate or low level of economic and
industrial activity have lowest number of such deals. In India most of the eastern states suffer
from this, whereas the southern part of the country accounts for the greatest number of PE
investment deals. The reason for such high investment levels can be attributed to a favorable
investment climate which is indicated by a high PPP index value. The governments which are
desirous for improving the PE investment activity should aim for the creation of more investment
friendly policies and should try to improve investment climate for equity investors by reducing
corruption and ensuring better protection rights for private property. The Uttar Pradesh
government, in recent times has started promoting policies which would attract various
businesses to the state, for example its new start up policy of 2020 where all the 75 districts of
the state have been assigned a nodal officer who would promote startups and forge working
alliances with the financial, educational and technical institutions to promote new business
ventures. This can help in attracting the PE investors at a micro level.
Upon reading and comparisons of various project characteristics, it has been found that Private
Equity firms are prepared to invest in riskier environments than other investors are. This risk-
taking factor can be attributed to being one of the greatest contributions of the PE firms for
infrastructural development. While most of the traditional private investors may shy away from
investing in sectors with such high level of risk, PE investors seem to be more willing to
undertake such kind of investments. It is now time for India to facilitate an environment where
more Private Equity players can look forward to making investments in the construction segment
of the country. This will only lead to an enhanced efficiency and improvement in the
infrastructure of the country, more Private Equity would mean more capital, and as it is a capital
intensive business, availability of more capital in the market would mean more projects and more
tenders being passed, even for small time firms, this in-turn will create a demand for more labor
which will lead to a creation of more jobs, both at the skilled and non-skilled level.

By Mehul Shandilya and Ipshita Vedjna,
School of Law, Christ University Bangalore.

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