December 1, 2011
Interviewed by: David Snow
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Corporate Governance in the Emerging Markets

A key value-driver of private companies in the emerging markets is a set of basic corporate-governance best practices, often instilled by private equity sponsors, as discussed in this Privcap program. “Corporate Governance in the Emerging Markets” is the second in a three-part series about value creation in emerging markets private equity, featuring experts Jeff Bunder of EY, David Creighton of Cordiant Capital, and Rob Petty of Clearwater Capital Partners. View Part 1, “Emerging Markets Value Creation,” here.

A key value-driver of private companies in the emerging markets is a set of basic corporate-governance best practices, often instilled by private equity sponsors, as discussed in this Privcap program. “Corporate Governance in the Emerging Markets” is the second in a three-part series about value creation in emerging markets private equity, featuring experts Jeff Bunder of EY, David Creighton of Cordiant Capital, and Rob Petty of Clearwater Capital Partners. View Part 1, “Emerging Markets Value Creation,” here.

David Snow, Privcap: Hello and welcome to Privcap.  I’m David Snow, Founder of Privcap.  Privcap brings you smart conversations about private capital.  Today, we’re talking about private equity in the emerging markets and our discussion is very important.  It’s all about corporate governance in the emerging markets and how private equity firms can transform their portfolio companies, thereby creating value for all involved.  Joining us today is a panel of experts.

We have with us Jeff Bunder from Ernst & Young, David Creighton, President and CEO of Cordiant Capital, Robert Petty, Co-Founder and Managing Partner of Clearwater Capital Partners.

This program is sponsored by Ernst & Young.

So, let’s talk about corporate governance, a very important topic in the emerging markets and something that private equity firms can, or at least should, bring to the table when they’re thinking about investing in a company.  How important is providing better corporate governance, better best practices around corporate governance in positioning a company in the emerging markets for growth?  Maybe we could start with David.

David Creighton, Cordiant Capital: It’s very simple.  It’s incredibly important.  That’s one of the key value drivers and one of the opportunities within the emerging market, so without a doubt, it’s something that you look at in potential investing companies.  You say, okay, so ideally, is the corporate governance structure in need of some repair, is management willing to accept the changes that you are going to suggest, and knowing that whatever the outcome is that any kind of progress is going to be positive for the company.

Snow: And just to follow up, David, when people say corporate governance, they might think of all kinds of things, so when you hear the term corporate governance what’s on top of the list of things to look into to make sure that they should be in place or things that you can bring to the table?

Creighton: We’re talking about family companies.  I mean, very basically, the number of meetings that the board has, who is on the board, is it all just the family getting around and having a cup of tea and a discussion about the business and whatever else is involved in it?  Do you have independent directors?  So, you want to start off with that; you want to look into the accounts and find out if they’re not arms-length relationships that are within the institution because that’s the type of thing that’s really going to potentially cause difficulties going forward.  So, it’s pretty high-level stuff at the outset, but then as you go through it, you can start to really look into best practices from a much more detailed perspective.

Rob Petty, Clearwater Capital Partners:  I don’t know if you’re going to jump in Jeff, but I couldn’t agree more.  It is what we are fundamentally empowered to do and should do, and it’s how you make the biggest single difference in making money.  The board is probably the most obvious place to do it and I think to sort of peel the onion a little bit, one of the places where we look first, and I think is the most indicative of where you can really have some of the hardest conversations even in due diligence, you know, as you think of it from the diligence perspective– is who has control of the bank accounts?

So, if you sit there and say what is my signatory authority and how do you release money? The minute you start talking about releasing controlled money and how many bank accounts you have, what are the rules going to be as private equity guys come in around control of those bank accounts, and how do you do it today.  When you get down to that level of cash, from there we think you can build up all the way to the board and the like, and so again, where we think about it, again, coming at most of these from, sort of, distress perspective, credit perspective, you go right to how do you run your cash and then from there you could sort of build the finance department and you could see how they work, and you can institute change such that there are better and better practices.

Absolutely at the board, and it comes as I often say, it comes up to how do you make sure the finance department is running and operating, therefore you can see decision-making from each financial decision and then put rules around those financial decisions and see what the current rules are.  That’s where we find day in day out that first 100-day plan is often about those things.  Or we don’t do a deal if we can’t get fundamental agreement with our potential partner around.

Creighton: Opening that up, as we were saying earlier, to the family companies, it’s a cash machine.  If they need a little extra cash on Friday afternoon they just go and pull whatever they need out and that’s something that has to change.

Snow: Rob, what’s one of the most unusual signatory situations you came across, without necessarily naming names as you’ve looked into buying companies in Asia?

Petty:  There are quite a number of companies that we’ve looked at, and I would say that still exist today, where the original founder and the controller still controls a substantial bank account.  Not necessarily thee substantial bank account, but different from operating accounts to a main bank account and that’s it.  One guy and all the keys to the kingdom, and that is, sort of, the most obvious example, but still something very real and very personal for a founder to give up the rights and often, or sometimes, the exclusive rights to control of a substantial bank account.

Welcome Best Practices

Snow: Jeff, I mean, it’s not the case that a lot of these companies in emerging markets are saying, ‘Oh geeze, these private equity firms came in and now they’re making us do our books different, or they’re making us change rules.’  They’re actually welcoming the transfer of knowledge that often comes with an investment, right?  Is that the case that you’ve discovered in the clients that you work with in the emerging markets?

Jeff Bunder, Ernst & Young: Yeah, sure, there’s a lot to offer, and it’s, in a lot of ways, a partnership in a minority interest situation.  I will say though that when we talk about corporate governance and instituting certain practices some of this that Rob has suggested, it’s basic.  It’s, you know, are you reconciling your bank accounts. Do you have control over your inventory?  In Asia– I know working with our Asia team, myriad of legal entities sprinkled around. There’s a question about whether there’s related parties in there and it tends to be under a larger umbrella trying to sort out really what the economics of the other businesses are is a bit challenging.

Not because it’s necessarily being hidden, but these are different types of structures in place for, at times, serving different purposes for the family.  So, some of that is getting under the business and looking at some more basic functions that don’t exist with the company, but I can contrast that to 20 years ago in the US when we had similar situations where you talked to an owner of a business and say, okay, where are you making money?  They said, I don’t know, but there’s cash in the bank account.  So, that’s the way I evaluate it.  So, it’s not dissimilar to that; we just don’t – you know, a lot of these jurisdictions don’t have the customs in place where there’s this rigid internal control structure in place.

It’s a volley and I think to your point, these businesses want – they desire to get there. It’s just they’re pretty far back from a current developed situation.  They realize they have to progress up to it and you’ve got to train some of the people around accounting and finance, et cetera, to get there.

Creighton: It’s kind of like the joke of how many psychologists does it take to change a light bulb.  Only one, but the light bulb has to want to change.

Snow: That’s excellent.  Do you have a better joke?

Petty:  No, I do not.

Consultants vs. GPs

Snow: Can’t a lot of these companies just go hire a consultant, hire a corporate governance consultant to come in and tell them how to do things a certain way?  What is special about the private equity approach to instilling corporate governance?

Petty:  I think some of them are.  I would say that that is not a bad solution in some of these cases, and I would, again, go back to the delineation. There are very large businesses and whole sort of scale of emerged businesses and emerging businesses to remember that, you can go across Asia and find some world-class examples of good boards and good governance. So, it’s not that they don’t have that role model, at least in some of the markets in Asia.  They can always get better.  Outside parties are a real plus in that regard.  The alignment of interest and having us both make money is the quick and obvious answer to that question.

When we are aligned with the owner of the business and our goal is to mutually grow the enterprise value of this business- that’s the difference.  It’s one thing to come and say nice things; it’s another thing to say did that help your bottom line?  Did we both make money because of the change you’re instituting rather than a checklist approach? A checklist approach is valuable; it’s not that you shouldn’t do that. I would say it’s not the only thing you should do and it’s easy to walk away as a consultant without having helped the business make money.

Preparing for an IPO

Snow: What I often hear is that companies seek out world-class corporate governance and world-class best practices in preparation for an IPO either in their own market or in the west.  How important is that as a selling point for private equity? Have either of you, David or Rob, come across situations where they say we really want to do an IPO and we hear that you guys might be able to build a bridge for us to get there?

Creighton: Oh, without a doubt.  Absolutely, yeah, and in particular– I’ll mention the country, China, there are a number of companies that we have worked with where they figure that by engaging with groups like us that that’s going to give some sort of seal of western approval and that that’s going to create some value when they go to an IPO.  So, without doubt, they are looking for anything to be able to create that slightly higher multiple when they actually go to the market.

Petty: Unquestionably. Modestly different. So a minorities stake example, in one of our public companies, a company called Jamna Auto Group in India, our largest investment there. We brought onto the board Pierre Everaert who has been CEO of multiple businesses across Europe, including InBev, so a world-class corporate governance expert who has done it. The family, the Jahur family, clearly wants to build enterprise value, is doing it successfully, and has sought somebody out who is ten years older, who has really done it, and respects and wants that value add to be part of their business as they themselves go from more of a family run business, though already publicly listed, to putting independence on the board.

So, there’s no question that they, again, understand that enterprise value when you can trade at a multiple is worth more than just the cash flow of this year’s business.

Creighton: And that’s the carrot.  That’s what they all of a sudden understand is that if they tidy themselves up, they can value their company at not just one time cash flow, but at a multiple. That’s where you’re able to get them motivated.

Snow: Jeff, your firm Ernst & Young has done a lot of work around IPOs and, of course, including IPOs in Asia which are even more robust than one finds in the US right now.  To what extent has private equity played a role in creating that pipeline in Asia?

Bunder: I think in two ways.  As we talked about here, the pre-IPO model is certainly one that has quite a bit of activity, particularly in Asia. Part of it is getting that seal of approval, bringing in a western PE shop, and what invariably happens during the process is they appreciate, from a corporate governance standpoint, et cetera, what they don’t have.

But I think it’s also an emphasis around what we used to find in the US as well, which is a scramble to get to the finish line to go public only to then realize you actually have to do something in a public company, you actually have to report, you actually have to prepare financial information, particularly for the companies in China that are listing in the US or in other geographies that the requirements are not necessarily known to them and requires a lot of back office support and help.

I think you see private equity get involved and bring that expertise.  And then there’s also just the growth capital stories, the businesses that are small and local in China that then expand through the help of private equity that then become great stories built around an entrepreneur and businesses that have great growth prospects and go public. So, you have sort of two different models that I’ve seen in Asia; both successful, but both with challenges, again, around things like corporate governance and financial reporting.

Petty: And I might just sort of add to that in Asia and say that it’s interestingly not just Western capital they’re seeking out anymore.  There are best in class lead investors that are 100 percent, if you will, domestic Chinese private equity firms, or let’s mention some of the sovereign wealth funds.  So, I think, being aligned as it’s not just Western capital, but it’s also local capital, I think increasingly in some of these markets is a phenomenon that is worth mentioning and watching.  They also care about the corporate governance point when you talk about the large, world-class sovereign wealth funds, whether they’re Asian or not.

Snow: Well, this has been a fascinating conversation, corporate governance in emerging markets, private equity.  We’re going to pause here, but gentlemen, thank you so much for joining us today.

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