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Entries in Growth Equity (2)

Tuesday
Aug302011

Private Equity in Peru

I recently returned from a week-long class trip to Peru and so, as I’ve done in the past when I’ve visited other countries, I thought I’d share my thoughts about the private equity opportunity there. Aside from the requisite (and spectacular) visits to Machu Picchu and Lake Titicaca, our group spent a lot of time in the capital city of Lima, as well as a lot of time traveling via bus and making stops throughout the Peruvian countryside. The wide scope of our trip gave me a really good feel for the country. Right away, what struck me was that the overall growth in Peru has not yet trickled down to the more rural and localized areas of the country. Despite Peru’s strong GDP growth of nearly 9% in 2010 and a projected 7% in 2011, there is a stark difference between life in Lima and smaller cities and villages in the countryside.

While a similar story can be painted for other emerging countries, I thought in Peru the differences were larger and that there maybe was an overconcentration of growth and modernization in one metro area (Lima). As opposed to a lot of other emerging countries, people in rural areas did not at all seemed concerned with growth or with the outside world – the main thing that mattered to them was maintaining their way of life (It’s important to note that around 45% of Peru’s population is indigenous). It was a type of legit indifference that made me realize no matter what kind of shocks the worldwide macroeconomic environment undergoes, a significant portion of the Peruvian population would see no impact and might even be oblivious. I didn’t sense complacency though; rather it was that people seemed to take greater pride in social change as opposed to economic growth (even if economic growth was a byproduct). I realized that this is actually a good characteristic – it means that the economy is insulated. I also felt some of the same characteristics regarding change vs. growth in Lima and other larger cities which have larger foreign populations.  Insulation, on many levels, is attractive for emerging market private equity investors because it actually reduces risk and volatility while providing another line of diversification.

Peru has been a net exporter for over a decade, driven in large part by a vast set of natural resources. At first glance, natural resources might seem like a good way for PE firms to invest in Peru. However, I think that because of the insulation of the country’s growth, sectors addressing broader consumption such as banking, retail, construction and manufacturing might be more attractive. Further, apparently there have been tax issues with mining in the country and of course even if all is well, investing in natural resources and exporting them means investment returns would be more correlated to the worldwide macroeconomic environment.

Private equity in Peru is still in its nascence. Private equity penetration, as measured by PE/VC investment relative to GDP, was a mere 0.05% in 2011, compared to 0.27% for neighboring Brazil. I expect that most investment that has occurred thus far has been in the form of growth equity, not venture or buyouts. While the private equity industry is very young, I think it has be ability to grow very fast. Earlier this year, Peruvian private equity leader Nexus Group launched its first international institutional fund. The fund raised $320 million (well in excess of its $250 million target), to make “control or co-control” investments in “opportunities provided by the Peruvian macroeconomic landscape.” Industry focus thus far seems to be on consumer goods, services, finance, retail and education. Larger firms are also entering Peru. Carlyle, for example, recently announced plans to open an office in Lima via joint venture. What’s clear about this move (as well as with Nexus) is that local expertise is a prerequisite for private equity success in Peru, just as it is in just about every other emerging economy.

Overall, I was more impressed with the potential of Peru than I expected. The country possesses better infrastructure than many of its Latin American counterparts; there seems to be more political stability than other countries; the population is diverse and globally aware; accounting, legal and corporate governance systems seem to be fairly adequate; and while private equity-specifics such as tax treatment fund formation aren’t yet up to par, the country’s attractive growth profile is already attracting investors. While there are issues to be addressed, I fully expect Peru to emerge as one of the leading destinations of private capital in Latin America – the growth story and potential for uncorrelated returns are too important to ignore. 

Sunday
Mar072010

The Venture Capital / Growth Equity Opportunity in Brazil

Apologies for the brief hiatus from posting – I was in Brazil for a good part of last month, which actually provided a great opportunity to examine first-hand the opportunity for private equity there. Why private equity and not venture capital? In almost all emerging markets, venture capitalism as it is practiced in the U.S. simply does not work for a number of reasons, including weak intellectual property laws, infrastructure and markets as well as limited innovative and entrepreneurial spirit. Private equity investment, particularly growth equity (growth capital for mature companies) is most appropriate in emerging markets. Growth equity, which involves making minority investments in mature but growing companies, trumps even buyouts in emerging markets because of issues gaining control and limited availability of leverage. I’m not close to being an expert on the Brazilian economy, but the following is some of my thoughts on the growth equity opportunity in Brazil based on a few observations.

In my travels I was able to explore second and third-tier cities and even some semi-rural areas of the country, which I think provided a better sense of the country’s potential than if I had just visited larger cities such as Rio or Sao Paulo. Compared to rural areas of fellow large emerging market (and BRIC) countries India and China, the more rural parts of Brazil seemed further developed, or more ready for development. Large infrastructure investment is not as necessary as a precursor for growth as it may be in India and China. But it is still needed, particularly in the northern part of the country which is growing faster than the south. I think the government and private investors realize this, and it was evident in the many roads and bridges under construction as I traveled through parts of the north. In many ways, investing in Brazil seemed like less risky of an endeavor than investing in India or China. There’s probably less of an upside to growth investments, but also that there’s less risk and more immediate potential, a tradeoff that is probably attractive to many investors.

Brazilian consumers seem ready for growth but I did notice that the aspiration factor was lacking, or it was at least not evident, especially when compared to Indian consumers. Examples include consumers shying away from higher quality goods even if they are priced the same, or diners shying away from nicer restaurants simply base on the aesthetics (assuming it would be too expensive). I made this observation much more in the north than in the south, which brings up another point – the country’s diverse culture. The population is not as homogenous as other emerging markets and investors will have to adjust for this, especially when it comes to investing in consumer goods and service companies.

Another thing I noticed was that there were few signs of recession or that there had even been a recession – Brazil was relatively insulated from trouble in the broader world economy. The country’s quick recovery had a lot to do with government policy (which has after many decades seems properly aligned for economic growth) but a lot of is also has to do with the fact that Brazil’s domestic growth is so resilient. It may not be as fast growing as India or China, but it’s strong and also somewhat sheltered because the country is not reliant on trade with the rest of the world, even though Brazil has been expanding international trade in recent years, particularly with the U.S., China and Europe (driven mostly by natural resource demand). Growth equity investment decoupled from the world economy provides true diversification for limited partners investing in a private equity fund - which gives Brazil a leg up on many other emerging markets.  

When it comes to private equity investment, Brazil consistently ranks behind China and India in terms of amount of capital deployed and number of deals. But in recent LP survey’s I’ve seen, interest in Brazil is growing and is often higher the level of interest in India or China. In Brazil, local pensions are a huge source of capital. They’re now allowed to invest up to 20% of assets in local private equity funds, but most only invest 1-2%, which still accounts for a little less than 20% of all commitments to brazil-focused private equity funds, according to the Emerging Markets Private Equity Association. Even though there’s currently plenty of dry private equity capital in Brazil, I’d expect to commitments to increase in the coming years. Expect investment to remain heavy in the energy/natural resources sector, but other sectors will see growth for sure.

Infrastructure investment in Brazil, both private and public, will probably see increase over the next few years, driven by the need for infrastructure improvement ahead of the 2014 World Cup and 2016 Olympic games. As I had mentioned though, the infrastructure need is not as great in Brazil as it is in other emerging countries. As such, other areas, particularly industrials, manufacturing and consumer goods and services will surpass infrastructure as a destination for private equity. What about technology and more venture-type investments? Despite what I mentioned at the onset about emerging markets not being ideal for venture investment, I actually think Brazil has promise - perhaps more near-term promise for venture capital than India and China. We’ve seen so many venture capital funds fail or pull out of India and the environment in China is too murky for venture to be attractive there. But in Brazil, the regulatory, legal (intellectual property), tax and corporate governance environment is advanced, stable and reliable enough to harbor venture investment. Furthermore, I get the sense that there is a growing entrepreneurial spirit, aided in part by government programs supporting innovation and developing technologies from universities.

There should be plenty of opportunity in the internet, and mobile sectors. Both have a lot of potential for expansion in Brazil, both from an adoption and evolution point of view. Increased broadband and mobile adoption will be a basic driver, which means me-too copies of successful internet and mobile technologies from the U.S. will do well, but also expect there to be innovation from within Brazil. Still, growth equity investment remains more attractive now (especially in the manufacturing and consumer goods/services sectors). Brazil is primed for it from many angles and it should be one of the least risky emerging markets. Investors will need to be careful they are in tune to cultural and operations nuances, which means experience is key to success, as it is in almost any emerging market. It should be interesting to monitor Brazil’s growth in the coming years and as the environment for venture capital improves, look for more innovative technologies coming out of Brazil.