March 13, 2013
Interviewed by: David Snow
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ESG Case Studies and Cautionary Tales

Three emerging markets private equity veterans share stories about how ESG (environmental, social, governance) programs have protected and created value and, in cases where ESG has not been in place, how value has been put at risk. Jeremy Cleaver of CDC Group; Dushy Sivanithy of Pantheon Ventures, and  Sandile Hlophe of EY discuss how responsible manufacturing practices and community outreach helped one portfolio company complete a strong IPO, and more.

Three emerging markets private equity veterans share stories about how ESG (environmental, social, governance) programs have protected and created value and, in cases where ESG has not been in place, how value has been put at risk. Jeremy Cleaver of CDC Group; Dushy Sivanithy of Pantheon Ventures, and  Sandile Hlophe of EY discuss how responsible manufacturing practices and community outreach helped one portfolio company complete a strong IPO, and more.

DAVID SNOW, PRIVCAP: We are joined today by Sandile Hlophe of Ernst & Young, Dushy Sivanithy of Pantheon Ventures, and Jeremy Cleaver of CDC Group. Gentlemen, welcome to Privcap today. Thanks for being here.

We are talking today all about ESG in emerging markets. It’s a big topic. But I think it’s possible to spend a lot of time being very abstract in talking about responsible investing. It’s good. You can make money. But why don’t we tell some stories that actually illustrate the fact that you can actually preserve and create value by having ESG programs in place. I know all of you have a lot of stories, because you’re very active in the emerging markets in different ways.

Starting with Sandile… Have you seen examples of private equity firms investing, paying attention to ESG, and being able to either dodge bullets or create value because they have been so conscious?

SANDILE HLOPHE: Well, yes. One of our clients in Africa did an investment in about early 2006, just before the Africa World Cup. We focused on sporting equipment and sporting goods. It was quite a key focus from a labor production perspective, manufacturing, and also in terms of retail assets and focus on that. So they went in and bought a sporting goods retailer. And actually, they sort of picked it off of the back after a competition sort of ruling to prevent the merger of two similar-type companies.

In their diligence, one of the keys was to focus on saying, because they wanted to expand and increase their retail sales throughout the continent and so forth, there was a key focus around where and how those sporting goods are manufactured and how they’re driving local content in their products. And also, focusing on also how they’re addressing community and social investment around encouraging funding of development of soccer—the actual sport in itself—through schools and various sorts of sporting clinics. That in itself was quite a massive investment. So, one, they paid a premium—one, because they took over a business, and two, they invested significantly in driving out an ESG program throughout the portfolio investment. On the back of that, in about 2011 post–World Cup, they actually decided in their exit strategy to do an IPO. And actually, that IPO was actually oversubscribed. So they initially looked at doing a private sell. They thought, actually, “The number we’re looking for, we’re not quite getting.” And through an IPO, they actually get much more significant value in that exit. And that’s a very good example whereby paying attention to ESG during the investment strategy—making sure you follow through and execute on that—added real significant outside value in the exit.

SNOW: Dushy, as a firm, Pantheon, that backs managers around the world, and you—ESG in action, specifically in the emerging markets—can you think of any examples of, again, bullets dodged or value created as a result of paying attention to these issues?

DUSHY SIVANITHY, PANTHEON: Sure, I can think of an example where, actually from the secondaries side, we looked at a deal—a very interesting fund in Africa, very nice underlying investments, and a very steep discount available. Given it was an Africa fund, even further work was done around the ESG issues with each of those portfolio companies. And through our work, we found a co-investor in one of those deals that we were very uncomfortable with and discussed it with the general partner who hadn’t, we felt, managed the issue appropriately.

The co-investor was an individual. He was being indicted in the U.K. We felt very uncomfortable about his involvement and our capital being commingled. And even despite the significant discount and [the fact that] we quite liked the assets, we decided to walk away from that deal. And even despite the significant discount and our– we quite liked the assets, we decided to walk away from that deal. And we feel that was still the right decision. And actually that has resolved itself subsequently, but we weren’t willing to take that risk.

JEREMY CLEAVER, CDC GROUP: I think it’s important to say that there’s a lot of hidden value in ESG, particularly on the governance side, but also very broadly. So in terms of the issue that Dushy mentioned, but really across our investees, there are a number of areas where you may not actually be able to put your finger on the value, but there is huge value to be created; there’s huge efficiency gains to be made. One example is reducing corruption and bribery. So from our perspective, the value is sort of underlying and sometimes difficult to put your finger on, but is there.

HLOPHE: I think that’s the challenge with ESG. It’s easy to quantify the cost of implementing and complying with it. It’s sometimes very difficult to put your hand on value, but the activity studies have shown that it’s better to have it in place than not to have it, because it’s like insurance. So, all of us know that we should have insurance; we should wear our seat belt. But if the insurance is actually not in place, then you wouldn’t be able to achieve that.

CLEAVER: It’s a good point. And in fact, there’s a consumer goods business—in fact, a lingerie business—in East Africa that we invested in that realized who their target market was and worked very closely with the local breast cancer and women’s health initiative. And through that process, they saw a marked increase in footfall in their stores. And it’s very difficult to put your finger on what the actual increase in revenue from that particular activity is, but from our perspective, if that’s able to kind of bring more women into their stores and increase footfall at the same time as improving women’s health, then that’s a great benefit.

HLOPHE: So we find that a lot of the clients that we advise, we always say it’s about protecting your brand and growing the affinity and position of how that brand is perceived, whether that be through a product or actually through the organization. So it’s as intangible as that. But it actually goes directly to the brand of your company and of your products, if correctly implemented.

SIVANITHY: And even with regards to dodging bullets in terms of our strategy with emerging-market managers, we tend to prefer those that have either B2B investments or B2C, and just avoid B2G. Because it’s an unnecessarily…another level of complexity. And the chances are, you’re going to put yourself at risk in terms of there is an element of corruption there where you’re exposing yourself to unnecessarily. So just by avoiding that from a strategy perspective can reduce your risk.

SNOW: We actually have a lot of Africa expertise sitting at the table here, so I’d like to take advantage of that. One major investment theme across Africa is, of course, mining, natural resources, and energy. I’m wondering if you can give some very concrete examples of ESG really making a big difference in that strategy, given the complexities and some of the very specific risks that all of those activities entail.

CLEAVER: Yeah, CDC actually invests at the expiration stage. So we don’t invest in the extraction-stage businesses. But what we find is, the exits for those expiration-stage businesses are to the large global mining companies like BHP or Rio Tinto, or, indeed, to list on stock exchanges. And so for both of those exit routes, ESG…clear and functioning ESG policies and systems are absolutely critical.

So from our perspective, making sure that we’re dealing with the environmental and social issues, but also the governance issues within mining. Because those are businesses which change very quickly once a resource is discovered. So it changes from a couple of guys with a spade and a pan to a very large operation which is looking to identify and establish a resource—and then, very quickly again, to an extraction of a resource. So from a governance perspective, there needs to be quite a fast and significant change a couple of different times over the period of expiration.

SNOW: I wonder if there are any cautionary tales that any of you can share—again, without necessarily naming names of firms, investors that have neglected important ESG safeguards or items of due diligence and actually lost money.

CLEAVER: Sure. We have an investment in East Africa in a consumer goods, manufacturing and distribution business. It was a family business. And the GP brought in really quite strong ESG policies. But the buy-in and the cultural change was a real problem, and so the sort of on-the-ground implementation was not as strong as we would have liked to have seen, and the company fell foul of the local regulator. And that cost them dearly.

SNOW: So in that case, it was a regulatory penalty that was imposed on them?

CLEAVER: Yes, it was.

SNOW: As a result of failing to pay attention to that.

HLOPHE: We’ve also seen a case study in Africa where an investment into a waste-disposal company in Africa was actually done. And obviously, clearly being a waste-disposal company, ESG diligence up front was very good and thorough and focused. And there were good, clear plans and policies to be implemented during the introduction to the company. And as the company grew, part of the capital-raising involved getting the company listed on the stock exchange. It performed very well and strongly.

Further down the line, it actually turned out that they were not following those very good policies and procedures that had been put in place in terms of caring and actually managing some of the solid waste. So the issues of waste dumping actually then became prevalent, which actually knocked the share price quite significantly—which actually meant, by that time, that those investors actually exited, that lost value significantly. So that’s a study in terms of it’s more about the monitoring and implementation versus the diligence and policies being in place.

SNOW: Dushy, I would imagine that there have been a number of teachable moments in the history of your forming relationship as managers, whether it’s in the developed or the emerging markets.

SIVANITHY: Yeah. I think talking about the issues up front when people are investing in companies, and just things that the GPs may just not have identified. And given the breadth of our portfolio, we’ve often seen it before. So we can actually give people lessons that have been learned painfully by other GPs, particularly around social and governance issues.

I think the environmental issues are much more tangible. There’s very good technical advice; good external consultants are available. Around the social and governance issues, people just miss some of the softer points—and they can have as much of an impact, if not more. So I think those are the things we try to get GPs to really think about, because they often are just overlooked just because they’re so intangible.

SNOW: Final question, and that is, agriculture—certainly in the emerging markets, and in Africa in particular—that is a big investment theme, anything having to do with agriculture or agribusiness. Are there ESG issues specific to agriculture that loom large right now?

HLOPHE: So I mean, I think we’ve seen that it’s more around depending which part of the value chain do you invest in. So, similar to mining exploration, the up-front sort of piece where you’re involved in the actual production—land projects production—the diligence around land ownership and governance is much more important. And in emerging markets, the history of land ownership has not ever really been that much clear. So there’s normally challenges around the production side. But we have seen better practice wherein working with the community and government being part of that land-production mechanism actually helps. So it’s really about making sure you’ve got the right stakeholders involved in that part of the production piece.

When you move into the processing, it’s less prevalent in having issues around diligence. But that’s more, really, on the normal ESG types. But we find that in the up-front, you have to have a focus more around the land ownership and also the participants and users of that land. So social-giveback benefits become much more prevalent. But we’re finding some very innovative DFIs coming forward and actually assisting in better investing and educating sort of private investors around how to operate in that front-end bit.

And also, the challenges: We’ve seen a lot of funds, have massive amount of funds, focusing on trying to get access to investments in the agriculture sector. But unless you’ve got a meaningful way and mechanism of unlocking the project… So, some people think that when I get involved in the distribution side and the processing side, but to be honest, without the input in the projects, there is no value chain business.[OK as written?] So that’s why you’re finding, for a very long time, funds find it hard to disperse investments into the agri sector.

Expert Q&A with Sandile Hlophe, E&Y

Privcap: What investment framework is required for successful private equity investing in Africa?

Hlophe: The ability to understand the social governance issues related to a particular sector and the drivers of growth and drivers of value in the particular sector become important. And these you learn, and improve your understanding of the sector, as you do more portfolio-company investments in that particular sector and as you evolve. So we found that PE firms that focus particularly between three and five specific sectors are quite successful.

And then, number two, having a good understanding in terms of which parts of the African continent are you going to invest in. There’s always a perception that Africa is just one big country. It’s actually 54 different countries and with probably about five different regional and economic zones. So having good sector focus, good understanding of which countries and which regions—and as to what the returns expected for that sector will be—gives you a better understanding of your investment horizon.

Privcap: What is the importance of local knowledge when investing across Africa?

Hlophe: Africa’s become quite a big investment destination. So a lot of companies are finding that that there are a lot of suitors out there, so it’s become quite competitive. So unless you have a local partner to assist you in focusing and engaging in almost exclusive discussions with particular targets, it can be quite difficult in actually doing an investment. You might find the premium is actually much more significant.

Number two, Africa growth is driven by a lot of family-owned small to medium-sized businesses that are not traditionally listed that have grown exponentially, that have the ability and power to grow across various countries and regions. Those aren’t publicly listed. There’s very little information available in public around them. And that is the way we’re finding that a lot of PE firms are leveraging our footprint and network.

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