November 25, 2013
Interviewed by: David Snow
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Latin American Exit Markets

All about the private equity exit markets in Latin America, including insight into the IPO markets of Brazil and the smaller national markets like Peru and Colombia; the appetites of Latin American family groups to do deals; and the acquisition plans of local an international strategic buyers.

All about the private equity exit markets in Latin America, including insight into the IPO markets of Brazil and the smaller national markets like Peru and Colombia; the appetites of Latin American family groups to do deals; and the acquisition plans of local an international strategic buyers.

Latin American Exit Markets

Value Creation and Exits in Latin America

David Snow, Privcap: Today we’re joined by Michael Rodgers of EY, Rodrigo Galvao of 3I, and Hector Martinez from The Abraaj Group. Gentlemen welcome to Privcap today, thanks for being here. We are talking about a hot topic, that is value creation in Latin American private equity. All of you are involved in that market, and so I am fascinated to hear your views. In particular I’d like to understand a, the most critical aspect of value creation, which is the ability to realize and to monetize that value. And that happens via a private equity exit, why don’t’ we learn about the state of the exit markets in Latin America? Conveniently both of the GPs here are focused on different parts of Latin America, Rodrigo you are primarily focused on Brazil, and, and Hector you are focused on mostly X-Brazil. So why don’t we start with Rodrigo, what are the opportunities that private equity firms have to monetize their investments in the Brazilian market right now?

Rodrigo Galvao, 3i: Right, the way we like to think about exit alternatives as building optionality from the moment we come into our businesses. So when, when we come in we like to know how much strategic value this asset has. We like assets that have very strong strategic value where you could see the potential it acquires, be they from inside of Brazil or outside of Brazil. That’s something that’s actually changed over time in Brazil since I started doing private equity in the country. In the beginning, the late 90s what you’d see is that we would, we would rely very heavily on exits to foreign strategic buyers. And then over time you saw the rise of local strategic buyers, local groups that then became very inquisitive. So we really like to have that pillar very strong. We also look at the potential for IPO of the businesses we are investing in.

The IPO market in Brazil, perhaps more so than in other places, is cyclical. It becomes very selective to shut at times because we are in a facet of focus on the mid market, not always we can rely on the IPO as a potential exit alternative for our investments. So that why the first pillar is very important, but if the conditions are right, and our businesses grow significantly that’s an avenue that we like to explore. I think the third avenue that you see becoming stronger and stronger in, in Latin America, in particular in Brazil for mid cap funds would be secondary opportunities. That is situations where you sell your stake to another financial sponsor. As operators in the, in the mid market we can look at funds that buy larger businesses, so after a say three, four, five year period of growth and value creation you can see there is a potential avenue of exit to another private equity firm. That’s something that’s already quite common for example in other places like Europe, and I think we will be seeing a lot more of that in Brazil in the years to come.

Snow: And Hector brief, briefly can you give an overview of the exit options that you would have in your market? Which of course has much smaller countries with Brazil being by far the biggest market in Latin America.

Hector Martinez, The Abraaj Group: Absolutely, but, but even though it’s kind of similar because you, you said it, our countries are, are midsize markets. Our stock markets are not so deep, you know, and sophisticated, so even though there is a stock market, an active one, mid, midsize companies are very difficult for them to, to tap those markets. So basically what we do, and do, when we do a deal, an investment on, and obviously the exit is, is one of the top issues that we analyze when, when we go to an investment committee. It’s basically we try to invest in companies that can build regional, who have the regional role out strategy so that we can get scale and be attractive for strategic investors coming into the region. Because it’s quite different that a company coming from the US, from Europe or, or even though from the same region looking for a company that has presence in one single country that, that even if that, if they have it in three or four countries.

So it’s already a regional in just one transaction they can, they can access, have access to a much larger base of, a much larger market. Just to give you an example if we combine the Mexican, the Colombian, the Peruvian and the Chilean market it’s almost equivalent to Brazil. It’s one Brazil, so that’s the size of that, and that’s why we always look for regional companies. So, but that’s not the only alternative that we are currently seeing. There is also as Rodrigo mentioned a secondary market of private equity funds, large built funds that see our investment as potential companies for them. Because these are companies that we’re, they still have ample room for growth, and so it’s not uncommon that they are usually knocking our doors to see, hey, and they have their calendars there. You’re already in your fourth year you should be thinking about exiting. No it’s, it’s kind of funny, but it is, because a lot of large funds are, are, are looking Peru and they’re, and, and the region also is very attractive.

And last but not least there is a very important family office market, you know, our countries have seen many families selling their, their, their mining, fishing, and a lot of natural resources companies that have sold their, their, their, their assets to, to Europeans, to Chinese, to American companies and they’ve paid a lot of money to them. And they don’t know what to do with their cash, so wisely they have replicated what has been done many years ago in, in Chile for instance, that the family office are there more than 20 years ago. And they are hiring the professionals to, to manage their portfolio, and one of the alternatives they are looking at is, is like investing as, as, as in, in, in, as a private equity investor. And they are also looking at our companies as potential ways to, to jump into an industry that they are attracted to.

Snow: Mike, EY recently did a value creation study focused on Latin America, what did you learn about the state of the exit markets in Latin America from that effort?

Michael Rogers, EY: Actually overall, David it’s thriving compared to some of the other markets around the world, and the opportunities to exit are much higher than they, in Latin America than they have been historically or recently. In developed markets like Europe as well as China has had its own issue with getting exits out in the IPO market being essentially closed for some period of time now beginning to open.

So you see the window as being very very positive in Latin America, but there is really three avenues that people responded to us and told us you know, where they really spend the bulk of their time on exit. First on the trade sale side, that’s by far the majority still, and if you think about that it makes a lot of sense for these companies that are being taken and professionalized, and taken to another level. And what we’re finding is that there is still a number of multinationals out there that want to have a Latin American strategy.

In many cases it’s these types of entities that they find attractive that private equity has gone in, put professional management into, and it maybe changed in some ways for the better. So that they can come along and, and actually assimilate it into their business and use it as a platform of operation. And in many ways you might imagine for the, at least the US multinationals Latin America is like their backyard in some ways, same time zones, and things of that nature. So you do get some natural play between the multinationals on the trade sales side. The other avenue that’s’ been touched on is the IPO side, and we actually have seen good IPO activity. And I think both my colleagues are, are correct here in saying that if, if the company can be absorbed in the local markets that’s sometimes the most positive aspect. Because it has name brand recognition etc., and there are thriving markets, IPO markets in these respected countries. But also I think a lot of the entities they’re looking at, trying to figure out can we do an IPO on a cross border basis.

And what I heard from a lot of investors is we’d love to go locally, but we also want to go to the deepest and richest and best valuation market we could go to as well. So if that happens to be local we’ll take that first choice, but if it happens to be a market in the US or someplace else in the world we’re not going to shy away from that because we do want deep liquidity and good valuation levels. So the IPO market is pretty strong locally, and then the cross border has, has worked out pretty well as well. And then lastly the comment that was made around the secondaries, and we too see that, that theme of a two tiered environment where smaller maybe sometimes local funds are growing these businesses up to a level that, just about where they can max out the contribution they can make and selling them on to some of the bigger more global funds that focused ether on emerging markets, or you know, some of the bigger funds there based in, in Europe or the Americas. And that model I think will continue to grow because as a sophistication level of the, the funds there continue to, to build. They, they’re creating more and more attractive assets for some of the worldwide players.

Snow: I’m interested in digging in a big deeper into what you think the most attractive or robust exit opportunities are right now? Obviously it sounds like there are a lot of potential options, but where are you sensing the most interest? Is it from these local family groups that are seeking to diversify their wealth into private equity style investments and see your portfolio companies as being attractive purchases or is it something else?

Galvao: Well what we are seeing in Brazil is that strategic groups continue to be very inquisitive.

Snow: And by that you mean the local strategic groups.

Galvao: Both local and foreign strategic, these strategics are very inquisitive at the moment. They have retained an interest, I think they’re seeing the softness for example in the Brazil area, or in the case of the foreigners there is a potential opportunity to be coming into the country at a better dollar valuation than it was a year or two ago. I think people are keeping the medium and long term in mind, and say okay, where can I put my capital to work and get access to the Brazilian market, which still presents a very good opportunity. What we have seen typically in our investments throughout our careers has been that when we come into a, a business it’s quite often that strategics will already have sniffed around a little bit even before we come in. And then as Hector was implying you know, they kind of you know, stay around and, and keep probing until it’s, it’s the right time for them to come in.

Snow: And of course they must be happy to the extent that the private equity sponsor has made improvements to governance, and, and upgraded the talent, and done kind of the hard work that makes it easier for them?

Martinez: And they are willing to pay for that job, right. It’s like the dirtier job. You’ve done the job for them, you know, and, and but still there is as I told you before plenty of room for, for, for continued growing and adding value to a company. But you have, you have set the basis of the future growth of the company.

Snow: And Hector what, in your part of the market, sort of Latin America Ex-Brazil, what seems right now to be the, where is the most interest coming from? Is it strategics generally or is it local groups?

Martinez: Our countries are growing at, at five, six percent per year, so we are right now at the spotlight of many, of many investors. So the interest is coming from all the, I mean there is no one single you know, specific alternative. I think strategics are, are going around. There is a lot of M&A activity moving on. Large private equity international, large international private equity funds are also either based locally or based outside. Going around, traveling I’ve met several of them in the recent years. And the family offices as well, this is new, I mean the family office concept is rather new, but those are groups that are willing to pay you, you know, very very nice premiums. You know, because they don’t have the, as opposed to the private equity firms that you have very defined limits and, and, and restrictions. I mean if they really want to buy any strategic company that it’s important for them they will do it. As long as there is an upside, right?

Snow: They don’t have to exit too, right? They don’t have to exit in five to seven years.

Martinez: They don’t have to exit. They don’t have a time horizon, they are there for the, for the long term, no. So that’s a big change that is what’s happening in our markets.

Snow: Are you seeing Brazilian groups come to your part of Latin America and vice versa or are they still fairly distinct markets?

Martinez: Large Brazilian companies in several, in sectors such as construction or, and, and so on and on, and oil and gas, but not, not yet in the mainstream of the, of like retail or, or consumer products. Not yet, I think they have a lot of room still to grow in Brazil.

Galvao: I think that’s right, for us before taking a company internationally there is often still so much room to grow locally why bring in the added complexity while there is so many low hanging fruits locally. But we, we are starting to see companies moving the other way around, companies moving from some of the Andean countries into Brazil looking for the additional growth that the Brazilian market brings.

Mike: Just to, to add this David, that when we see some of the funds, some of the strategics that are trying to make investments into Latin America they, they, they look at a couple different dimensions. I mean first of all does the company need a lot more capital, and so you start talking about not just a little bit of capital to, to kind of operate from but really big growth capital that, that they might need. Do they have really a talent shortage? Is there something that this acquirer could do to really add value to the business by bringing in some sort of leadership? And I’d say another issue that pops up quite a bit is capital expenditures, and, and you know, is there a big need to make a big investment that, that somebody doesn’t have, or the technology quite honestly to do that.

Maybe it’s acquisitions, we touched on that earlier in terms of bringing that network together, and lastly it’s new markets. If they, if an entity really sees the opportunity to exploit that product, not only within its own country, within Latin America, and then ultimately internationally then that’s going to drive acquisition behavior. And so when companies or entities around the world are looking at acquisition opportunities those are the things that they’re going to look at and see, is there a void? Is there some value to be added by us getting involved, maybe making a preemptive offer, things of that nature, that’s what we think is going to drive a lot of that activity from the strategics around the world.

Expert Q&A with Mike Rogers, ‎Global Deputy Private Equity Leader at EY

Can you describe the range of services EY provides to private equity firms investing in the emerging markets?

Rogers: The hunt for higher returns continues. On a global basis, all private equity funds are diversifying along different service lines, capabilities, and geographies.

They’re looking into the emerging markets more seriously. The focus used to largely be on China. Now they’re thinking: What’s our Latin American strategy? What’s our African strategy? And do we need to be in India? Then they realize there are private equity funds that have already been there for a long time.

Many of the larger, name-brand funds that operate very successfully in the Americas and Europe suddenly find themselves playing catch-up in the emerging markets.

Once the funds recruit a team and seek transactions in the new geography, they instantly want their service providers to follow them and remain by their side in every deal they do. EY positions itself to meet the needs of our clients as they expand around the globe.

Clients expect our work to be on par with what they get in New York, Hong Kong or London. We handle issues in transactions and transaction support, the diligence process, and tax structuring. Tax work becomes critical because of very complex jurisdictions. The diligence of financials goes hand in hand with tax work. We’re also engaged in valuation work and human-capital decisions. Once they make successful investments, they seek other traditional services, such as audits

How does competition drive the need to expand into new global markets? 

Rogers: Once one of the bigger firms learns that a competitor is charting new territory, it’s not very long before someone from the operating board starts asking, “Firm X is there—why aren’t we there?” Or “What’s our strategy to enter that market?”  They get very, very competitive.

We have received urgent calls from clients seeking to enter Africa, Latin America, and countries outside of China in the Asia-Pacific. Many of those markets are evolving very, very quickly. And it’s not just the traditional U.S. or European buyout-capital deals that are being employed in these locations. In many cases, growth capital is used to build these businesses out. In many parts of the world, the traditional senior bank lending market just doesn’t exist. They don’t have access to a local bank, bond market, or capital market to fund growth. They’re literally relying on family, friends, and other resources.

So the opportunity for private equity is to use growth capital to join the foundation of these entities. It is an opportunity to make nice returns from the exit. It’s also an opportunity to help these emerging societies advance in some way. Private equity can make money and at the same time deliver socially responsible components to these countries.

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