November 14, 2013
Interviewed by: David Snow
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How PE Helps Latin American Businesses Grow

Hear insights from three experts into how private equity firms partner with Latin American businesses to change and grow. You will learn about the LatAm strategies of major PE firms 3i and The Abraaj Group; how PE sponsors can exert influence, even from a minority position; the frequency and importance of management change; and how business growth in Brazil is very different from other LatAm regions.

Hear insights from three experts into how private equity firms partner with Latin American businesses to change and grow. You will learn about the LatAm strategies of major PE firms 3i and The Abraaj Group; how PE sponsors can exert influence, even from a minority position; the frequency and importance of management change; and how business growth in Brazil is very different from other LatAm regions.

How PE Helps Latin American Business Grow

Value Creation and Exits in Latin America

David Snow, Privcap: We are joined today by Michael Rogers of EY, Rodrigo Galvao of 3i, and Hector Martinez from the Abraaj Group. Gentlemen, welcome to Privcap. Thank you for being here.

We are talking about private equity in Latin America, and, specifically, how value is created. With all your different market perspectives, I am fascinated to hear about what you’re seeing in Latin America—clearly, a topic of interest to investors around the world, as more capital goes into Latin American private equity. Why don’t we start by understanding the respective investment approaches of the two GPs sitting at the table? Hector, from the Abraaj group, can you talk about how your firm approaches value creation in Latin American private equity?

Hector Martinez, Abraaj Group: Sure. A brief introduction to the Abraaj Group: we are a global private-equity firm with a specific focus on growth markets. Over 10 years we manage to $7.5 billion and our model combines local expertise in more than 30 offices in every market where we invest. But also we combine that with international standards of investing. We have a very detailed anda very good investment process where we have captured all the international standards that any global international private equity firm has developed. We have implemented a strategy where we have a specific team coming from companies like Coca-Cola, Kraft, Pepsi Co. that are on our hops; we do have regional hops. And, before we do any deal, they help us build and develop what we call a value-creation plan, which has two components: a 100-day plan and a value-creation plan throughout the three or four years of our investment horizon.

Snow: For the record, what is the geographical footprint you target?

Martinez: Of course, we raise regional funds, so we have a fund in Latin America and in Africa and Asia. In Latin America, we launched our first fund in 2007 with a specific concentration in Mexico, Columbia, Central America and Peru. Moving forward, things will remain the same. We will probably adopt one more country like Chile, but our strategy will remain the same.

Snow: That’s interesting. Now, let’s move to Rodrigo, because you have a different geographic focus. I’m interested in hearing about your geographic focus and your general investment approach.

Rodrigo Galvao, 3i: Thank you, David. 3i is a global firm, focused on the mid-market throughout the world and, in Brazil, it’s no different. We focus on the Brazilian mid-market—typically, companies with an enterprise value between $50 and $300 million. We are typically deploying equity checks between $30 and $75 million, both in control and minority situations focused on the Brazilian midcap market. There are several ways we add value to the businesses in which we invest. We are mostly looking at companies that will have had a tremendous period of growth before we come in. These are typically successful businesses where the entrepreneurs and shareholders are saying, “OK, how do I take this business to the next step, the next level? How do I build growth with quality?” We typically bring in governance and systems and try to make the decision-making process that much more robust. Often, you see companies that are approaching a stage where the entrepreneur has typically taken decisions based on intuition, on his knowledge of the market. So, how do you institutionalize that knowledge and create an institution that can be built for the long term?

Snow: Mike, as someone who is in close contact with private-equity GPs throughout the emerging markets, including a big practice in Latin America, and recognizing that every firm is different, do you see some commonalities in the ways private-equity firms in Latin America have structured themselves to be successful?

Michael Rogers, EY: Yes, in fact, we just finished our Latin America private-equity exit study for the year. It is the second year we have done this, and a couple of themes are emerging: (1) It’s about an equal split between minority and majority investment. That’s an interesting concept—there was not a big difference in terms of how folks are investing there. (2) We found a lot more co-investing strategies going on. So, many funds are partnering together on some of these activities, which was another unique concept we found in doing this study. Ultimately, we felt three or four themes were important coming out of the study this year. The database is growing; we have about 70 companies in it. This is a study of exits from 2007 to 2012, and the professionalism that private equity brings to the table was very important. You are bringing financial savvy; you are bringing the professional management to bear. The other thing we have seen is the “two-tiered strategy,” which is the bigger, more global funds.

Lastly, Dave, the key to all of this is returns: the returns that the analysis we’ve done, we do studies in Africa, in Europe, EMEA, the U.S., and one for Latin America we’ve been discussing, and the returns for the last couple of years have been highest in Latin America.

Snow: Throughout the emerging markets?

Rogers: Yes. So, folks who do this for a living are ultimately looking to monetize those returns. We have seen the highest set of returns from the Latin American exits we’ve studied.

Snow: That will draw even more capital into the region, which will be good news for you. A follow-up question, Rodrigo: what are some resources, ideas, and help that many entrepreneurs and corporate divisions you come in contact with need? What are some recurring themes, as you talk to groups you might want to partner with?

Galvao: One recurring theme I have mentioned is growth and consolidation. These businesses typically look at ways to consolidate the industries in which they operate, so bringing in that expertise for them is critical. Many groups are also looking at help through thinking in their strategic plans. So, how do you grow your business going forward? What are the key push buttons, in terms of value creation? How do you prioritize that? You often see us assisting a company, setting up a project management office, for example, so the value-creation process can be tracked carefully.

Snow: Hector, picking up on what you said about the ability to expand beyond borders: obviously, the countries you are targeting are much smaller than Brazil. So, you can see the appeal of moving beyond Peru or some other countries. Why can’t these companies do it themselves? Why do they believe that having a private equity partner can assist them in making the move to connect with other markets?

Martinez: Basically, a private equity brings to them a strategic thinking. Sit down and plan. Many of the companies we invest with have already started their expansion plan, but they are experimenting. We can accelerate that educational part of the internationalization because we have local resources. We can provide all that market intelligence for them to accelerate their growth and expansion. Otherwise, and it happened with one of our firms that went to Chile—they believed the way to go was one and when they realized it, they were doing wrong. It took them two or three years to find the right way. A firm like us—who has already a presence in the countries, plus expertise with similar companies not in Latin America but in Africa or Asia—that has experienced the same issues can help them to accelerate that learning curve. We will both win in that association.

Snow: Mike, you nodded when Rodrigo talked about consolidation. Is that a common theme as you look at the kinds of resources and ideas emerging markets companies look to private equity to get?

Rogers: Yeah. The other aspect, in terms of the internationalization component that I spoke to earlier, is the new markets, the network component. Because you asked the question, why do you need private equity to do this? In many cases, it’s the network that once these organizations get involved with these companies, they bring new ideas to say, “We know a company over here that would be another nice acquisition target.” So, let’s try to build this platform up, take it and build it even further. It’s not only the new-market activity and the interest in going to new markets; it’s bringing that powerful network to bear, that their Rolodex of other companies or investment bankers or people might come forward with ideas.

Snow: Mike, you mentioned that about half of investments in Latin America are now majority investments. People traditionally think of emerging markets as being dominated by minority investments, yet there are still a number of minority investments, especially when you’re dealing with family groups. Rodrigo, what are some challenges of executing on a plan of value creation when you are not necessarily in the control position?

Galvao: In both situations—where we are a minority and where we are controlling of that service—we always look to partner with very strong management teams. A critical part of our investment thesis is backing the right people. These management teams often need to be complimented. Hector mentioned perhaps bringing in a CFO, which sometimes you don’t see in midsize businesses, to help strengthen the financial and control function. But, typically, we look for a core of people that are experts in the sector where they operate as in the business they manage. We usually look to support these teams. The way we actually work on a day-to-day perspective is similar situations where we are minority and in situations where we are control operators. Where things differ is if you need to make changes. It is critical when you are doing a minority transaction to retain flexibility to be able to make changes should things deviate from plan. What we have seen is that the entrepreneurs or shareholders that are looking toward the long term are happy to give away that flexibility. That allows us to make changes to the management team if things deviate from plan by a certain degree.

Snow: So, would that be written into the terms of the transaction?

Galvao: Yes, it typically would be. The reason for that is most of the time they know what they can deliver, so they are confident about their plans. It’s a way for them to send a strong message to the investors, to say, “We are fully behind this plan.” And it’s often the case that most of their wealth is also tied into the company that they operate. So, they say, “If I’m not delivering, then I want to bring in somebody who can. Because that would create the most value for me.”

Snow: And they want you to make that decision?

Galvao: Typically, this would be a joint decision by consensus. We do not envision ourselves going through the legal course to try to enforce something like this. It is more an act of the partnership, a sign of the partnership acting together.

Snow: Hector, what are your views on the challenges of investing in a minority situation and still getting the kinds of performance results you hope for?

Martinez: What Rodrigo has just said is very true. It’s a matter of alignment of interest. If they win, we win. We come together. We try to make decisions together, so it’s basically a matter of trust. We spend a lot of time with them before and after—it’s like a marriage. But, if things don’t go wrong, you have to change things, and Rodrigo was perfectly right. We try to look for entrepreneurs from companies where this investment, the company, is their life. If they lose that, they lose everything, so they will do anything at good times or bad times to move up and create value. To give you an example, it’s what we mean by “skin in the game.”

We did an NVO in a company in the tourism sector in Peru, and our partner mortgaged his house and put 10% of the value of the transaction to buy part of the control of the company with us. That’s alignment of interest. It’s our guarantee that if things go wrong, he will be first to come and say, “What do we have to do? Do I have to move aside? Yes, I’ll do it because this is my patrimony, this is my network. If I lose it, I will lose it everything. I will lose my house.” So, that’s the best way we can secure that. Having a minority position, we have something to say at the moment.

Rogers: Interestingly, from the study we saw, that 44% of the companies have replaced the CEO in the process of an acquisition. But, as you mentioned on the finance side, 89% replace the CFO. So, you can see that difference—if the CEO were strategic to the company, had a vision, had a name brand in the market, there was some branding associated with that CEO that they tended to stay in the business a bit longer. The challenge on the financial side is part of the professionalism and trying to improve the business. Often, the finance area is one place that comes to bear. We see that often.

Galvao: Yes, those changes must be taken, at least in the first two years. Otherwise, you are losing time.

Martinez: Yes, and in some situations where we have come in, we have started to implement the change even before we came in, so that from the moment we showed up with our equity stake, things were already in place and the wheels could start turning.

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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