November 9, 2015
Interviewed by: David Snow
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How PE Firms Can Adapt in LatAm Downturn

The effects of Brazil’s political and economic turmoil can be felt throughout Latin America. Experts from EY, Victoria Capital and Harbourvest Partners discuss how private equity firms should adjust their playbooks to take advantage of opportunities in the region and to avoid pitfalls.

The effects of Brazil’s political and economic turmoil can be felt throughout Latin America. Experts from EY, Victoria Capital and Harbourvest Partners discuss how private equity firms should adjust their playbooks to take advantage of opportunities in the region and to avoid pitfalls.

How PE Firms Can Adapt in LatAm Downturn
Investing in Latin America 2015

David Snow, Privcap: Today, we’re joined by Carlos Garcia of Victoria Capital, Scott Voss of Harbourvest, and Mike Rogers of EY. Gentlemen, welcome to Privcap. Thanks for being here.

All: Thanks for having us.

Snow: Certainly, the private equity experience in Latin America has not been a uniformly good one. There have been issues before. Do you think managers are better capable of navigating these challenges they’re facing now than perhaps in the ‘90s?

Scott Voss, Harbourvest Partners: The challenges that private equity had in the ‘90s were driven partially by the macro, but also by the fact that, [for] many of these private equity practitioners, it was their first time doing private equity deals. So, they had to learn lessons the hard way and that’s clearly not the case today. I don’t think the situation is nearly as dire today as it was in the ‘90s. I mean, this is a bump in the road, for the most part, in many of the Latin economies. There are some other emerging markets around the world where I think you could argue otherwise.

Carlos Garcia, Victoria Capital: To start with, if you look at the balance sheet of these countries, they are pretty much in very good shape. If you look at the debt, both public and private sector, across Latin America, it’s relatively low compared to the balance sheets these countries had in the ‘80s. So any crisis would be, I would say, much more benevolent than it was in the past.

Snow: Let’s dig a bit deeper into currency. That’s certainly something that a private econ manager simply can’t control for unless they buy maybe some expensive hedging products. How much does currency worry you, Scott? And how can investor like you even prepare your portfolio forth those kinds of fluctuations?

Voss: Yeah. It’s always interesting because the currency question comes up when currencies devalue. It never comes up with currencies are valued at a premium. In our portfolio over the long run, if you do the analysis over a 10-year fund cycle, currency tends to balance itself out. But, there are clearly periods of time where it might be undervalued or overvalued. So, the depreciation of currency has clearly had an impact on the holding values of assets that are in the ground, especially if the investments were done three or four years ago. But, it’s created an opportunity—if you’re a dollar investor, your dollar is buying a lot more today. So, that’s an attractive way to look at the cap currency. Over the long run, it tends to balance out.

Snow: Any other views on currency before we move on to another topic?

Garcia: No, I think the new economic reality globally indicates that we’re going to have depreciated currencies across the globe vis-à-vis the U.S. dollar for a while. So, we need to take that into consideration. As Scott said, I believe there are great opportunities if you are an investor. You have to deal with the products you have in your existing portfolio, of course, and the problem in your existing portfolio is two-fold. Number one is the fact that you invested dollars and now the businesses are at the different plateau you want in terms of currency. [Number] two is that many countries in Latin America had businesses with cost structures that were heavily dependent on the U.S. dollar—importers or industrial companies like that, foreign components. Therefore, your margins may be affected beyond the pure translation effect on currencies. So, [it’s] clearly a challenging time for the portfolios but I believe, as Scott said, that over the longterm, things tend to balance over time.

Mike Rogers, EY: Yeah. David I would just add on the currency front—obviously, in ’08 and that period postglobal crisis, there was a lot of money that moved off shore from the developed markets into emerging markets. It ran up, had a nice run for a few years and, obviously, with the threat of rising interest rates in the U.S. now a lot of that capital is repatriating back to the U.S. and other developed markets, which is putting that drag on the currencies around the world. It’s very rare globally that you see, as Scott mentioned, this balancing effect. Typically, that’s what a lot of global investors think—that they’ll get a balanced approach by having a portfolio of currencies and, on average, they’ll be up/down, but average. But, not very often in time have we seen the dollar, for example, just appreciate to almost about everything. It’s really depreciating values all over the world, so the interesting thing is, as Scott touched on as well, when does that challenge for assets you’ve already invested in, that decline in value trade off into the opportunity set that’s in front of you?

If you look at even Brazil, which it’s hard to make a bullish case for today, given that almost every economic indicator is going the wrong direction for Brazil. But with a currency that’s 30% or 40% down relative to the dollar, at some point, valuations will be attractive and capital will continue to flow back in there. In fact, we’ve actually seen pretty strong flows into Brazil despite the currency dropoff recently.

Snow: Let’s stick with Brazil a bit longer because it is the largest market in Latin America for private equity. Carlos, your firm is active in Brazil. What’s your analysis there?

Garcia: Clearly, Brazil is going through a very difficult period, not only because of macroeconomic conditions related to commodities and capital flows but, most importantly, because it’s going through some political turmoil or crisis. I think it’s very difficult to predict what is going to be the end of the story and when we are going to reach the end of the story. I think we’re going to see more volatility and, in my opinion, we’re going to see perhaps a bit more of decline in values in the assets in Brazil. Having said that, Brazil is such a large and diversified economy that it is impossible not to find good opportunities along the ride.

Rogers: It’s interesting—we’ve been looking at some of the LAFCA data that’s recently been produced in the first half. The amount of fundraising is about flat the last year—about $4.3 billion in the region. But, the amount of deal flow that was done and closed in the first half was about $3.6 billion. Interestingly, up to $2.2 billion of that was in Brazil. So, over 50% of the investment in Latin America was still being directed towards Brazil, despite all the challenges we’ve described. It’s just too big to ignore and the opportunities are the largest there, quite honestly.

Voss: This is more anecdotal, but when things were going really well in Brazil, we have a number of pan-regional funds in our program. And we found that the Brazilian team tended to be spending more time outside Brazil, looking at Mexico or Colombia to do deals because they felt that was where the better relative value was. But now, given the current state of the market actuallythe velocity in that Brazil portfolio or velocity of investment has really picked up. So, I think it’s that value orientation. The question is when do you step in and do the deal? Are asset prices going to fall further or is this a good point to enter, based on both sentiment and currency?

Snow: According to the anecdote, you suspect that your managers are doing exactly what they should be doing, which is getting busy when times are tough?

Voss: I think that’s right. I mean, there are different strategies. You have valueoriented managers who tend to hold investments longer. So, the entry is really critical. Then, there are managers that are more momentumdriven or growthoriented, where the whole period might be shorter. And when you’re more momentumdriven, I think you focus less on that value component or where are purchase-price multiples, where is currency, where is sentiment? So it’s a mix, but our value managers are deploying more money in Brazil right now.

Rogers: David, I think it’s interesting—private equity is only about 35 years old as an industry and Latin America is even younger, if you will, than that. But, if you look through the cycles we’ve experienced, oftentimes some of the best deals, as you might imagine, for private equity have been done in periods of downdraft. So, I think that if you have a longterm view like these two folks do—they’re going to be there forever. They want to have an investment platform there. It may not hit, you may not be able to catch the exact bottom, but you’re probably getting close to it.

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