Deal makers have traditionally steered clear of investing heavily in emerging markets. A combination of poor management, state-ownership, opaque business practices and financial accounting, as well as burdensome regulation, have ensured that the closest some of the world’s biggest private equity players have come to looking at developing nations is on a kid’s globe. But attitudes are changing – as are the financial fortunes of some of the world’s biggest developing economies.
According to the Emerging Markets Private Equity Association (EMPEA), a global body that promotes private equity investment in developing countries, a robust recovery is underway in emerging market’s private equity as investment pace is picking up significantly post-crisis, and appears on track to beat 2009 totals. In the first half of this year, investment totals stood at $13bn versus $8bn at this time last year, an increase of 55 percent. The total value of private equity investments made in the first two quarters of 2010 was $4.5bn more than that invested through the same period last year, led by an investment surge in Latin America and continued strong activity levels in China and India.
“Investment conditions in emerging markets private equity are revitalising,” says Sarah Alexander, EMPEA’s president and CEO. “There are more and better quality deals in the pipelines. The continued easing of price expectations among sellers means managers have been more successful in closing transactions. Emerging market fund managers are increasingly bullish in light of stabilising markets and lower valuations,” she adds.
EMPEA has also found that fundraising levels are showing signs of rebounding, with $11bn raised in the first half of 2010 versus $9bn raised in the same period last year. EMPEA says that Asian funds continue to account for more than half of the total (55 percent), with China continuing as the leading destination for new capital. China-dedicated funds accounted for two-thirds of the 46 Asian funds that raised capital through mid-year, 60 percent of total capital raised for Asia, and one-third of the total capital raised for emerging markets during that period.
EMPEA’s analysis has found that 90 percent of the rise in both transaction volume and in total investment can be attributed to increased investment activity in China, India and Latin America. It also found that there were 44 percent more deals completed, with 402 deals done this year to date versus 280 deals this time last year. Furthermore, its research points out that there has been an increase in large transactions, pushing average deal sizes up 27 percent (from $40m to $51m), driven by 28 deals topping $100m versus only 17 of similar size in the first half of 2009.
Deal volume in Latin America continues to be small, but private equity firms are seeing promise in the region’s untapped potential. So far much of the attention has been on Brazil, which accounted for 62 percent of total deal volume in Latin America in 2009, according to the Latin American Venture Capital Association.
In September emerging markets buyout firm Actis carried out its first investment in Brazil, having been active in Latin American for more than 30 years. The firm, the former direct investment arm of UK government-backed investor CDC Group, has bought supermarket chain operator Companhia Sulamericana de Distribuicao. The $58m acquisition marks Actis’s first Brazilian deal. Actis wants to expand the group and take advantage of Brazil’s steadily increasing consumer wealth. Paul Fletcher, a senior partner at Actis, said: “This is a highly auspicious time for Brazil with rising income and increasing access to credit; over 20 million Brazilians have entered the middle class over the last five years.”
“Relatively welcome”
The deal is the latest example of private equity companies taking an interest in the country. In July, David Rubenstein, co-founder of US buyout firm Carlyle Group, touted Brazil as one of the most attractive countries for private equity investment. Speaking in an interview with Dow Jones Newswires, he said: “China, India, Brazil, South Korea, Taiwan, Saudi Arabia, South Africa, among other countries, are places where your growth rates are going to be 5-10 percent, where private equity is relatively welcomed, and where there’s a culture that foreign capital is being sought. The comment followed Carlyle’s first Brazilian deal, an acquisition of tour operator CVC Brasil Operadora e Agência de Viagens.
Since then, the group has bought Brazilian health services provider Grupo Qualicorp, as well as a 51 percent stake in Brazil’s Scalina, the owner of a pantyhose maker, with the funds for the $159.7m deal coming from South America Buyout, a Carlyle fund, and a fund Carlyle has in partnership with state-run Banco do Brasil. The aim is also to increase the company’s participation in international markets.
Other private equity firms have been quick to seize investment opportunities in Brazil. In May, UK buyout firm Apax Partners also made its first Latin American investment, with an acquisition of a listed Brazilian information technology and outsourcing services company from a local venture capital firm. The deal was worth €383m, according to data provider Dealogic. In July, Swiss private equity manager Partners Group was preparing to open a Brazilian office while rival Capital Dynamics said it had already opened an office in Rio de Janeiro.
No middle ground
Elsewhere, the Middle East is showing signs of recovery with attractive investment opportunities which will help the private equity industry to grow significantly over the next three to five years, even though its investor base may remain mostly niche, according to research carried out by consultancy Booz & Company and leading French business school Insead. Called Private Equity in the Middle East: A Rising Contender in Emerging Markets, the research has found that as governments, particularly in the Gulf Co-operation Countries (GCC), seek to diversify their economies and shift some of the burden of funding to the private sector, opportunities for private equity will grow. The report adds that the number of funds operating in the market has continued to grow and by May this year there were 150 funds identified in the region.
However, the research adds that the market remains highly concentrated with three fund managers controlling about 79 percent or $4.8bn of the total value of closed funds. Nonetheless, around 120 firms have survived the recent economic turbulence in the region and these will most likely opt for increased specialisation, greater emphasis on earlier stage investing and small and medium enterprises (SMEs), improved economics for investors and more operationally focused sector-specific teams.
Given the operational expertise required to succeed in a more challenging environment, and more clear streams of growth in the region, a growing number of firms are focusing on very specific sectors, mainly infrastructure, consumption, healthcare and agriculture, says the report. But it also adds that the number of exits recorded by private equity in the Middle East is still small. This is due to a combination of the recent financial crisis, the relative young age of the Middle Eastern private equity industry, and the limited data availability on private placements.
But other experts are less enthusiastic about the attractiveness of the region for buyout firms. Bankers say that private equity is falling behind other rival asset classes in the Middle East in the competition to attract Islamic money. Head of Middle East structuring at Deutsche Bank Hussein A Hassan says many Islamic banks will not commit capital due to the long-term and illiquid nature of many of the region’s private equity funds and their levels of debt liability.
“Islamic banks cannot invest in private equity funds in a meaningful way even though private equity is as close as one can get to pure or real Islamic finance,” says Hassan.
The total value of private equity funds raised fell to $1.06bn last year, down from $5.4bn in 2008, while the number of fund closings dropped to six in 2009, from 17 a year earlier, a report by the Gulf Venture Capital Association (GVCA) says. Less than five percent of this money, it is thought, was committed by Islamic investors. Bankers say that Islamic focused private equity has failed to take off largely due to Shariah regulations that prohibit too much debt and investments in companies that trade in non-compliant goods and services.
Yet while investor appetite in the Middle East may be cooling, there are signs that investor interest may be picking up in what have until now been regarded as the most unlikely places. EMPEA has found that “notable up-ticks” in Sub-Saharan Africa have accounted for a significant portion of the overall increase in capital raised in emerging markets. “African funds raised through June already exceeded the full year 2009 total, and some sizeable funds being raised point to a return to pre-crisis levels,” says EMPEA’s Alexander.
In September, anti-poverty campaigner Bob Geldof announced he is to become the frontman for a new $750m (£487m) private equity fund that will invest in Africa. The influential rock star has teamed up with Mark Florman, a former executive at Doughty Hanson, and Gordon Moore, formerly of Cinven. The former private equity duo will run the fund – named 8 Miles, the distance between the southern tip of Europe and northern Africa – with the aim of making it one of the biggest private equity investors in Africa.
Geldof says that he has been planning to launch the fund for several years but his efforts were delayed by the onset of the financial crisis. He is expected to use his knowledge of African development to source deals for the fund, even though the venture will be entirely commercial rather than charitable. The team have already secured backing from the African Development Bank and the International Finance Corporation. Several other investors are set to sign up.
Geldof’s foray into private equity follows in the footsteps of U2’s Bono who co-founded Elevation Partners in 2005.
More widely, confidence may be being restored in Africa by the ongoing work of the World Bank on the continent. Its private-sector lending arm is leading large government-owned wealth and state pension groups into frontier markets in Africa and elsewhere where few big investors have sought to venture. The hope is that by investing money on behalf of these deep-pocketed funds in regions they would normally shun as too volatile, they will learn to appreciate the long-term profit potential.
Over the past few months, the International Finance Corp’s Asset Management Company (AMC) has made investments using capital from the Korea Investment Corporation, Azerbaijan’s state oil fund, Dutch pension fund manager PGGM, and an unnamed fund investor in Saudi Arabia. The first investments by AMC’s Africa, Latin America and Caribbean “ALAC” fund have gone into HeidelbergCement, the world’s fourth largest cement maker, which has expansion plans in west and central Africa, and Ecobank Transnational, a leading pan-African bank group seeking to boost lending.
While the investors do not have a say in where the money is invested, the initial choices appear to be conservative, focusing on segments likely to be in hot demand. “The investments we have made so far show there is a strong pipeline out there,” says Gavin Wilson, AMC chief executive.
World Bank President Robert Zoellick first pitched the idea of using money from powerful sovereign wealth funds of Asia and the Middle East in 2008, challenging them to invest one percent of their assets in Africa. The funds have amassed nearly $3trn in assets, and a one percent investment of their assets could add up to $30bn a year in private investment for Africa. “We are seen as a safe pair of hands by those who have previously not done much investing in emerging markets,” says Wilson. “They recognise we’re not going to take foolish risks, or try to invest the funds too quickly and move on to the next thing.”
