January 1, 2012
Interviewed by: David Snow
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Success and Hard Lessons in the Emerging Markets

Three veterans of the emerging markets private equity opportunity share real stories of success in the Privcap program, “Success and Hard Lessons in the Emerging Markets,” The third in a three-program series about value creation in emerging markets private equity includes three experts: Jeff Bunder, Global Private Equity Leader, EY; David Creighton, Founder, President & CEO, Cordiant Capital; and Rob Petty, Managing Principal & Co-Founder, Clearwater Capital Partners.

Three veterans of the emerging markets private equity opportunity share real stories of success in the Privcap program, “Success and Hard Lessons in the Emerging Markets,” The third in a three-program series about value creation in emerging markets private equity includes three experts: Jeff Bunder, Global Private Equity Leader, EY; David Creighton, Founder, President & CEO, Cordiant Capital; and Rob Petty, Managing Principal & Co-Founder, Clearwater Capital Partners.

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 have a very important topic: private equity in the emerging markets. Our discussion is all about stories of success. How have private equity general partners brought value to the portfolio companies in which they invest?

We have a very expert panel with us today. Joining us are Jeff Bunder from Ernst & Young; David Creighton, President and CEO of Cordiant Capital; and Robert Petty, Co-Founder and Managing Partner of Clearwater Capital Partners.

This program is sponsored by Ernst & Young.

Investing in private equity is challenging. Investing in private equity in the emerging markets is challenging, and yet there are success stories and all of you have been involved with or been directly responsible for some of these success stories.

I’m interested in your sharing with us maybe a couple of examples of how you went into a portfolio company. You brought something beyond just capital, whether it was corporate governance or you pulled some value add lever and saw success as a result. So maybe we could start with Rob. What’s a great example of your having brought value, brought corporate governance, to one of your portfolio companies?

Robert Petty, Clearwater Capital Partners: I probably cited our best example already, but it’s the Johore family and what we did with them together in a company called Jamna Auto Group where they had a classic case of three businesses: one they owned personally, one that they owned in two different listed vehicles. So we pulled all three of those businesses together, relisted them, and we were fortunate enough to have helped them through their transition.

So we lent them money and owned 30 percent of the business at the end of the day. Then when sort of that economic difficult pulled together, we helped them grow their business. And that was really around bringing on two members of the board and watching that public stock continue to perform as they lived through the global financial crisis.

And to think about living through an auto parts business in the global financial crisis, which is a pretty tough industry. But in India they did a phenomenal job in their finance department and I would say we were additive to that process by helping them really think about cash management. How do you make your tough decisions through a time when there were literally no waters and then evolving such that their board changed?  And they accepting and wanting board change so that additional members of the board including independents had led to substantial equity market value creation.

But also, the debt pay down so that their balance sheet structure is changed from being a five or six times levered business to now being a one times levered business. So that would be a case study of the finance department first and then working up through that to ultimately the board level.

Snow: Why was that important? Talk about the board level. Why was it important that you bring in two independent board members? Why couldn’t they have thought of that themselves, or why didn’t they have pressure to do that before?

Petty: I think they did, and what was exciting in terms of being aligned with the families they as an ownership group understood that the alignment of capital in terms of making money they wanted to implement that. And so no matter how much they do that themselves – and they did have other independent board members that were not brought in by Clearwater, but to have capital invested from a well-known private equity firm further enhanced that.

And then frankly, probably individuals joining the board who they may not have been able to find as a mid scale – they may be No. 1 in their industry, but that’s not necessarily sure that someone from Western Europe is going to come and join their board. So in terms of aperture one, but in terms of the real western people that want to come in and do that. So they understand that this helped them add value and they themselves were advocates of it as much as we were advocates of it.

Snow: David, your firm invests in a number of geographies around the world exclusively in the emerging markets. Can you think of a recent, really good example of your firm having brought more than just capital, brought some new ideas, some best practices that really transformed the company?

David Creighton, Cordiant Capital: Sure there is a lot. We’ve been talking a lot about governance.  Let’s just look at some other value drivers. We have a gold mine in Congo; pretty tough part of the world to do business. Artisanal miners just are running around the countryside chipping rocks. And while this gold mine development company is drilling and starting to come across some very significant reserves. So what they want to do is transform these artisanal miners into employees.

And so you’ve got the support of the government who are looking to sort of formalize the economy to a certain extent in the region. You’ve also got this – I mean, the mine is out in the middle of South Kivu a long way from anything. So what you want to do is be able to engage the local community and get them not only just as employees, but also as supporters of the business because they’re really what’s driving the whole thing.

If they are unhappy with the dynamics of their environment, you’re going to know about it; and that’s going to affect the business.  So what we did is one of the – the Cordiant board member who is on the company engaged with Cara Canada, brought them in. I think this was the first time that they had ever actually aligned themselves with a specific company.

Cara came in as an advisor working with the local community, doing the things that you hear about. But this is actually very specific examples on the ground building a school, engaging with local community, getting the buy-in of all these people, making sure that the women are all happy because the men are the guys who are going to work. And if the women are not happy, the men are going to work or not going to work.

So the whole dynamic that’s going on there, is in order to essentially make the investment that much more robust and it’s been very successful. You’ve got total buy in from the community. There is real support. There’s a foundation that’s being setup, which means that even if the company sells out to a major, that that foundation will continue to be in existence.

So it’s endowed, and it will continue to work with the community. So I mean, it’s a very basic thing. You sort of sit there and say well, of course. But the fact is, to actually get in there and do it and see the effects this actually had from a value perspective, is very satisfying.

Snow: That’s definitely a very, as you say, foundational way to add value. You’re creating a community around this business.

Creighton: Yeah, basic stuff. But it’s in the execution where the difficulty can be.

Snow: Jeff, obviously, you’ve been involved in a number of transactions with your clients. And without necessarily naming names, what’s been among the more impressive examples of a private equity firm pulling some levers of value creation where it’s really made a big impact in the emerging markets?

Jeff Bunder, Ernst & Young: I think we see quite a bit. What’s interesting is where they’re occurring and not just one geography. Across the emerging markets in names you haven’t heard of before things that are – businesses that are being built in Turkey and Indonesia and Malaysia, clearly South Africa and other parts of Africa. But the fact of the matter is, we talked about you going into a due diligence exercise where there’s a lot of risk.

You spend a lot of time focused on whether or not there is any form of fraud in the business or payments going outside the company. You’re questioning where they’re going to and maybe ethical violations. Watching that sort of transition into focused on value creation and adding sales marketing and distribution help or helping some of these retailers in places like China expand and figure out how to assess market opportunities.

Some of this is really around about data. Pulling data in and then analyzing the data to permit the company to actually capitalize on opportunities that are in the local markets. The surprise to me is how many situations you’ll see and it could end up being a relatively small company that evolves into an IPO candidate or it could be just a basic investment minority interest where there’s a partner and they work together and build up the community around it, adding jobs.

Where private equity is seen as a very positive force and compared to the sort of developed model, very different in terms of value creation and levers where it’s much more specialized. And you’ll bring in folks to drill down our working capital to release cash into the business and bring in operational improvement and price cost reduction folks and a lot more specialized operational improvement in contrast to emerging markets where again, you’re trying to help in many ways, a family owned business evolve and compete not only in their local markets but beyond that.  To see that sort of evolution is pretty neat and you see quite a bit of it in a lot of geographies and private equity is driving these situations.

Snow: Private equity in the emerging markets is not only good stories.  There are some bad ones and I’m sure Rob and David your firms have only done good deals, but I’m wondering if you can talk about bullets dodged or situations where despite your best efforts, there was resistance or an inability to bring to bear the kinds of practices that you would have hoped. And I’ll let anyone start.

Petty:  Maybe I’ll take a different tack on that because again, we’re turnaround and special situations guys. So we deal with companies that are going through stress and distress.

I guess part of our fundamental belief and how we make money as a firm, is really over the past 12 years since the Asian financial crisis you think about what to take to turnaround a business. And there really is a practice across Asia of doing that, so it doesn’t always have to be a downside story. But let’s use Gajah Tunggal in Indonesia which is the largest tire manufacturer; 60 percent market share of sort of the domestic local tire.

So you think of motorbikes in Indonesia. 60 percent of those tires are coming from Gajah Tunggal. Michelin only owns 10 percent of it. This is a real business, a real manufacturing business. You think about rubber. Obviously, very – rubber is right there in Indonesia. This is a world class manufacturing facility; but during the global financial crisis, they had a large public bond deal coming due that clearly was something that was going to be problematic.

And so we became the single largest bond holder in that case, at substantial discount to par value; and worked and led with our restructuring team, with management such that we termed out that public bond to be an eight year deal. So a restructuring where a real business got a breath of fresh air, you need to sit down with the banks and say guys we’re not going to par back tomorrow. But we could get par back in eight years. Let’s work together, give the company a lower interest rate, ask them for some more cash sweep. So there really is, across the emerging markets now, people that have had lessons learned.

And so trying to take the positive side of lessons learned, Gajah Tunggal’s today thriving, and that debt is being comfortably repaid and trading at a substantial discount. They just had their 60th company meeting and invite their largest bond holder who was sitting across the table from leading a restructuring because you can actually do this collaboratively such that distressed and problems – boy, a lot of businesses go through them.

And there are cycles in the industry, and they don’t always have to be such downside stories.  But you do have to sit down and sort of work through those.

Snow: Speaking of lessons learned, David, any lessons learned the hard way in your portfolio?

Creighton: We’ve got one common denominator and that is that natural resources like water, which you consider to be just a give in but that are often integral to the success of a business, the access to water.

We’ve had a couple of situations in China where all of the sudden the taps have been turned off because it’s being diverted by the local government because the business that we were in was generating a certain amount of income and employment. But if it was diverted to another source or another area, it would create more. So when you go into the business, we looked at the whole selection of potential risks that would be coming out of there; but we didn’t think of water. We just said that’s a give in, so we won’t do that again.

And I think going around the world, that is a theme that we’re all going to be thinking of, across all geographies, is that water is something that we all take for granted and is not going to be around long. Or at least is not going to be around in the quantities and allocations that we’ve had in the past.

Snow: So that becomes a systematized part of the due diligence is you look at corporate ownership, who’s coming to the board meetings, who’s got control of the bank accounts, and who’s in charge of the water and the electricity.

Creighton: Yeah, I mean, it’s basic stuff.  I mean, usually a lot of the businesses are kind of sausage factories. You go and just check and see what the inputs are and what the outputs are, and make sure that you have access to all those things. But you don’t often think about the fact that water is one of the inputs, and we should.

Snow: Jeff, on the theme of kind of sad stories, bad stories, where have you seen recurring themes as far as failure or as far as disappointing results when private equity firms have tried to effect change in a corporate governance way?

Bunder: You end up with a number of situations where the PE Fund can’t get along with the partner. And as a partnership with a minority interest investment and ultimately just make a decision that they can no longer work with the founder/owner or the other partner at the end of the day and just decide it’s time to get out.

Snow: Are these always personality driven, is it resistance on the part of the founder to changes?

Bunder: You get in many ways two strong personalities at the table. The PE Funds are as difficult in certain cases as the founders and have different visions and different direction and ultimately are used to more of a control model in many cases and end up with sort of irreconcilable differences and decide to split.  I’ve seen situations where that has occurred, and other private equity has come in and done incredibly well post the initial private equity investor.

So some of it’s personality. Some of it’s circumstances, but it kind of goes back to there’s quite a bit of risk in the minority interest model in the seeing that that’s potentially a downside. I think we also see the consequence of not doing enough diligence.  It always comes back to haunt a lot of the PE funds.

And whether it be because an asset’s been out there and it felt, like, everyone’s been sort of through a diligence process with it, some big names included and there’s a thought that okay, they’ve already sort of – everyone else has gone through it, so it should be fine only to find out that everyone else has gone through it and backed out. And you’re the one left with the sort of prize if you will. And at times you end up with bad news at the end of the day.

I think the last thing is just as we’ve seen in the developed economies, we’ve come through a pretty tough recession. Some of these businesses operate differently under stress; and as Rob can attest to, it’s a different situation and essentially can lead to a company just falling off the path. I think what we’ve seen in the U.S. is the private equity funds that tend to do better are ones that continue to stay on the path, do whatever it takes to keep the business on plan even when you’ve gone through sort of the worst recession in recent history.

You end up sort of getting everyone back in the boat and directing. And then someone with the rudder pointing – and point the ship forward and move forward. Even in emerging economies you can get off track, and there they continue to spiral. And it’s at times irreparable.

Snow: Well, Jeff, you mentioned sort of interpersonal issues. Why don’t we end on a quick discussion about maybe the least scientific topic that we’ve discussed today and that just assessing people? Is there any different at all in the emerging markets versus the developed markets about you’re about to go into a deal. You want to bring some changes to the company; and you just feel, like, the management team, the CEO, the founder, is just not someone who’s going to be a good partner to be with. Is there any different at all in assessing that?

Bunder: Without doubt. If you cannot connect, what I will do is I’ll step aside and get one of the other guys in the operation to see whether they connect. And if you go through the whole operation and there’s no seeing eye-to-eye on very basic things, about just partnering, going forward, understanding that everybody’s going to do well by working together. But if you don’t have that, then you really just shouldn’t pursue it.

Petty: Yeah, I would put that exactly right and maybe put it in I as a western male am often not necessarily the right person to be sitting on the board. And indeed if you look at the rest of our organization, you’ll see many of those board seats or many of those deal leaders are local. So when we talked about what it take in terms of team earlier, team really does mean the ability to lead a transaction and leading a transaction means building an interpersonal relationship with the founder of a business or the son of the founder of the business or some senior person on that board that is driving that.

And so it is fundamental to being able to get comfortable in our case when you have an equity position. If you’re doing a debt position, we may come to a different conclusion. And again, two-thirds of our positions are debt positions. But when you’re equity and aligned in that regard, it is imperative and often we find something- they may not be articulate in English. They may be a great manager and a great leader and the like and making sure that you see that and make sure that you take advantage of that opportunity is, a fundamental key to be good in emerging markets and having the team that can do that.

Bunder: Which you hear quite a bit about. Don’t excuse the fact somebody can speak English with the fact that they know how to run a business in the emerging markets. And I think a lot of funds have sort of fallen into that trap in particular. Again, if you can trust it to developed markets where you go in and evaluate management and in a lot of cases you end up doing background checks and a fair amount of due diligence. This is a clearly different animal at the end of the day, and puts a lot more pressure on the situation if it’s a minority investment as well. There has to be that sort of chemistry with the management team that it ultimately is of a different culture. So it goes back to, I think from a private equity perspective, trying to figure out how you can be as local as possible but still essentially stick to your values.

The other part I’d say also is to communicate expectations. I’ve also heard of expectations where it’s not communicated. PE Funds have not communicated expectations to a manager just thinking they were like any other manager in any other part of the world. We talk about things like providing ethical standards or corporate governance or those types of things that you’re adding to the equation. Those should be out on the table in terms of discussion, in terms of expectation, so it’s not just,  “Okay. You should have expected this.” This is what always happens when a PE shop comes in and makes an investment in a company.

Snow: Well, this is a fascinating topic. I think we’re going to pause for now.  Gentlemen, thank you very much for speaking with Privcap today.

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