Investing in India's defence sector

We talk to the founder of the India Rizing Fund, the first fund set up to invest exclusively in defence companies in India.

Rajesh Narayan, founder and managing trustee of the India Rizing Fund, talks about why the time is ripe for a fund focused on investments in India's defence sector and what makes him confident that his fund will deliver.

What is unique about the India Rizing Fund?
We are the first venture capital fund dedicated to investing in India's defence sector. The Indian defence market is one of the largest in the world with an annual outlay of around $30 billion. The government recently introduced a procurement policy in which international suppliers to India must source at least 30% of the invoice value of orders locally. This is a big boost for Indian companies as the government's defence procurement from international companies over the next decade is projected at around $100 billion.

India's domestic production capacity, which in revenue terms currently stands at around $4 billion annually, is owned by the state with the private sector accounting for less than 10% of the total turnover. These revenue numbers are set for quantum growth and over the next decade as local production is forecast to reach $13 billion annually. The growth potential coupled with the procurement policy creates a multi-billion dollar opportunity for Indian private sector defence companies.

International defence firms under pressure to contain costs are exploring outsourcing to achieve this aim. India's history of operating as a democracy, the country's record on non-proliferation and manufacturing expertise make it an attractive destination for international defence companies to outsource production. The offset requirement of the international defence companies will act as a catalyst for outsourcing from India. As the first fund in this historically recession-proof industry, we hope to cherry pick the best investment opportunities and generate significant returns for our investors.

Why have there been no similar offerings in India to date?
Private ownership was allowed in the defence sector as recently as 2001. Indian defence companies hitherto catered to only one buyer - the government. New defence procurement policies in 2006 and 2008 changed that due to the mandatory offset clause. Also, the sector is at an early stage and it is difficult to see visible exits in three to five years - which is what a typical venture capital investor seeks.

Finally, investors need expertise in the defence industry both to identify investments and help to create value in investee companies, which is not easy to do.

What are your target assets under management and who are your anchor investors?
The fund has a 10-year term which we can extend, with consent of the investors by two two-year periods. We are looking at a minimum Rs1 billion ($20 million) commitment from an anchor/strategic investor and Rs250 million for other investors.

We recently received approval from the Securities and Exchange Board of India and the Foreign Investment Promotion Board and have embarked on a Rs7.5 billion fundraising exercise. We are targeting three categories of investors: international defence companies interested in the Indian defence market; strategic international government or quasi-government organisations; and Indian financial institutions.

What is the background of your team?
Our team blends defence industry expertise with finance knowledge. Team members have experience spanning the defence industry from research and development to production and supply chain, based on operating experience working in the kind of companies that we plan to invest in. Early stage investments in the defence sector require operational support, which we intend to bring to the table. We also have corporate finance and investment banking experience to help structure deals both for the fund and for our investee companies. I lead the team and report to an advisory board comprising industry stalwarts in both defence and banking.

How do you intend to monetise the investments?
We expect traditional exits through both initial public offerings and trade sales. We are seeking companies with niche expertise and capabilities, which have high growth potential. The incremental offset business that will be contracted by the Indian defence sector during the next five years is around $20 billion. Currently, there is no Indian company in this sector with a turnover greater than $100 million. This gap is large.

So the opportunity to identify and back companies which have the potential to be emerging champions in this sector is huge. We will also consider selling our stake in portfolio companies to international and Indian defence companies.

What makes you confident there is an opportunity to add value in this space?
We have a deep understanding of this sector. India's threat perceptions are not going to go down in a hurry considering its neighbourhood in the west, northwest, south and east is pretty volatile. The Indian defence forces need to completely overhaul its machinery and fire power to maintain its strategic position in the region (the 34% increase in the country's defence budget in this, a bad year, is a reflection of this).

Global defence companies are looking to outsource production to reduce costs and India's defence offset policy will act as a catalyst to this. Indian defence companies not only need money but support in managing the growth and business scaling. We are sitting in the middle of this and plan to invest the fund in the next three years. We have the best team in India to execute this huge opportunity.

This story was initially published in the May issue of FinanceAsia magazine.

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