Private equity scours the Andes
by Leticia Lozano
Economic growth, stability, market reform and liberalization have led to Latin American investors into Chile, Colombia and Peru. Leticia Lozano reports.
November 2007 – THE ANDES HAVE rarely been at the forefront of international investors’ minds, instead conjuring up images of poverty, guerrilla groups and presidents who survive in office for just a few years. In Latin American business and politics, the might of Brazil and Mexico dominate, and the region’s private equity growth has been no exception. But just as tourists have begun to flock to Peru’s famed Inca citadel of Machu Picchu, so teams of private equity specialists are beginning to scour the Andean region’s capitals of Lima, Bogotá and Santiago, as well as nearby Buenos Aires, for buyout opportunities and the chance to develop funds.
Political stability, more open trade, a surge in commodity prices, low inflation and interest rates, fiscal discipline, pension fund reform and strong consumer demand are all leading to unprecedented growth rates in Peru and Colombia. Chile is knocking on the door of developed-country status and Argentina is recovering from its 2001 crisis with red-hot 8% annual economic growth rates. As a result, private equity has huge potential in a largely untapped region, especially in the fast-growing oil, gas and mining sectors of Peru and Colombia.
The depth of capital markets, banking regulation, the rule of law, protection of minority shareholder rights and government corruption are still issues in the Andes but the feeling among investors is that things are rapidly changing for the better. “Colombia and Peru are two of the countries that have a recent track record of very strong economic growth and very stable macroeconomics. That is clearly something that differentiates them from the rest of the region,” says Julio Lastres, senior managing director for the Americas at Darby Overseas Investments, which has invested in the Peruvian and Colombian banking sectors, in fuel distribution and in telecoms, and owns a power station in the two countries.
“There is a renewed interest for private equity in Latin America and it will start spilling over from Brazil and Mexico into other areas like Colombia and Peru,” adds Lastres. According to the Latin American Venture Capital Association (Lavca), Chile offers the best conditions for private equity in Latin America – still a long way from the top environments of the UK, Spain and Israel but ahead of Brazil and Mexico. Colombia is not far behind in the Latin American rankings, and is ahead of Argentina despite lower private equity inflows, with Peru bringing up the rear.
The increase in interest in Andean private equity is only possible because of the huge revival in the business in Latin America as a whole and indeed globally.
Some 107 private equity funds worldwide raised $21.5 billion in capital commitments in the first six months of 2007, compared with $33.2 billion by 162 funds in the whole of 2006, according to the Emerging Markets Private Equity Association (Empea), which has 152 members in more than 35 countries with more than $135 billion in assets under management. Latin American funds, which lag Asia and eastern Europe in terms of investor interest but are ahead of the Middle East and Africa, raised $1.4 billion in the first six months of 2007. With the addition of two $1 billion-plus closes in July, funds in the region are poised to match fundraising levels not seen since the 1990s, and this time around with a wider range of countries involved and more sophisticated investments.
“Brazil has had most of the attention, the capital and deals to date. But we’ve seen a pick-up in deals, a pick-up in funds being raised for Peru and Colombia,” says Jennifer Choi, director of research at Empea. In a new Empea survey, the association found that limited partnerships in general expect their Latin American private equity commitments to produce returns 4.4% higher than their US buyout commitments this year.
According to Cate Ambrose, executive director at Lavca, although it might seem that private equity is only returning to past levels, a lot has changed since the first private equity investments were made in the mid-1990s, with the macroeconomic and regulatory environment much improved in Latin America and the gains unlikely to be reversed.
“Overall, I see positive momentum, and the fact that the region has not been affected significantly by the sub-prime crisis in the US is a sign that we might not go back to the very difficult years of 2002-03, when private equity activity in Latin America came to a virtual halt,” says Ambrose. Many of the managers who gained experience in the late 1990s are returning. “They are now starting new funds and applying the lessons learnt from that first round of investing,” says Ambrose.
Back then, the Brazilian and Argentine devaluations chased investors out of the region and smaller economies like that of Peru registered zero economic growth. Now the longer-term outlook is much stronger and Latin American markets, although today lagging emerging Asia and Eastern Europe, show some of the best potential for increased investment. Latin America is not yet a “must have” part of institutions’ investment strategies, according to Empea, but the number of limited partnerships that expect to invest in Latin America in five years’ time is more than double those that are investing this year, as private equity players look beyond India and China towards Brazil, Mexico, central America and the Andes.
“Colombia and Peru are on the horizon for many institutional investors,” says Ambrose. “At Lavca we have heard consistent expressions of interest in recent months. The challenge for those markets is that they are comparatively smaller, so it is particularly critical that the investment environment be attractive from a regulatory perspective. The capital markets are doing very well and the local pension funds are quite active in Peru.”
GP Investments, the top private equity firm in Latin America, with more than 50 investors in its funds, is a leading investor showing interest in the Andes, although things are at an early stage. “We do find Peru and Colombia very interesting because these are countries that have undertaken significant reforms in recent years,” says Antonio Bonchristiano, co-chairman and co-CEO of GP Investments. “Colombia has solved the violence and guerrilla problem that it had and the country is growing at an amazing rate with very able local investment managers, and I believe there are a lot of opportunities there.”
GP has moved into Argentina and Colombia with its August purchase of Pride International’s drilling rigs in Latin America for $1 billion in cash, the first entry by the company into the oil services industry. The asset stretches across eight countries in the region and generated sales of $824 million in 2006 and should provide more growth from US, European and Chinese companies operating in Latin America and needing oil services. “The attraction is that by buying a business that provides services to oil and gas companies, you end up getting indirect exposure to the growth of the oil and gas business without having to get into the exploration business, which is fairly risky and very capital intensive,” says Bonchristiano. “It is an indirect play on the high growth of the energy market in Latin America.”
GP Investments’ biggest limitation in the Andes is size because the company has to look for relatively large deals, investing at least $50 million in a transaction.
“That really limits the number of deals you can pursue because there are not many large deals in these markets,” says Bonchristiano. Another issue for GP is its strategy to acquire control, or shared control, of its companies, which limits the number of opportunities it can pursue. “Very often you find owners or entrepreneurs who are willing to sell 20% or 30% stakes but not 50% or more of their respective companies, so that’s an issue we have to tackle,” he adds.
Chile is also a tricky play, because prices are high, driven by the private pension funds, which are not allowed to invest outside the country, meaning that a lot of capital is pushing up prices in the local stock market. “In turn, this ends up having a ripple effect as prices in the private market are also pushed up very high. Price is an important factor for us and as a firm we always look to make acquisitions at reasonable value,” says Bonchristiano. Still, GP is not giving up on the Andes, and sectors that can be out of fashion one day can prove to be excellent investments the next, while investor interest is strong. “We see a lot of new investors interested in Latin America who have not looked at the region before, which I think is a very positive sign,” he adds.
Boston-based Advent International is another leading Latin American player that is keen on new opportunities and has a strong presence in Argentina and Chile.
It is also just beginning to look at Colombia and does not rule out getting into Peru, particularly via companies that have a regional presence. Having invested in some 30 companies across Latin America over the past 11 years and by launching the largest ever private equity fund for the region in July at $1.3 billion, Advent boasts the first private equity-backed buyout of a commercial bank in Latin America, Uruguay’s Nuevo Banco Commercial, and the first mid-market transaction in Mexico to use cashflow-based debt, with clothing retailer Milano.
“We are looking at some of the countries in the Andean region,” says Juan Pablo Zucchini, a partner in Advent’s Buenos Aires office. “Colombia is attracting our attention and we are looking at some assets and analysing some businesses.
Right now, we are not active in Peru.”
Argentina has been a boon for Advent, which sees the local energy sector as a key area. However, the company faces challenges with Chile. “There is a lot of enthusiasm to invest but competition is extremely strong. The combination of strong investor interest and a smaller economy makes deals in Chile highly competitive,” says Zucchini.
One company that is very keen on the Andean region is Aureos Capital, which focuses on small-cap to mid-cap companies in emerging markets. It is setting up offices in Colombia and Peru. “We are in the process of setting up the Aureos Latin America fund and expect to have a first closing towards the end of this month,” says Erik Peterson, Aureos’s regional managing partner for Latin America. “Our target size is $300 million and we expect to have a first closing at $150 million. We’ve been actively generating a pipeline in the region for quite some time and we see attractive opportunities in both Peru and Colombia.”
Peterson says Aureos is focusing on the development of family-owned businesses, which are growing and often need management help and make up 90% of the companies that Aureos looks at. “We focus particularly on change of control transactions where we back management teams, as well as expansion opportunities. Both types of transactions can appear at the time of a generational transition, where there isn’t a clear successor to the founder or else there is a second generation that is more open to bringing in outside investors that can create value in the business,” says Peterson.
The Aureos management model is based on senior local teams that build relationships and do research and reference checks, backed by the firm’s global infrastructure. “We are in the process of setting up the Colombia office, it will be ready in November and we are in the process of incorporating a fund in Colombia that will be Aureos Colombia,” says Victor Hoyos, a partner responsible for Colombia at Aureos. The target for the Colombia fund is between $50 million and $100 million, and Aureos sees plenty of investment opportunities. Hoyos adds: “I think there are very many interesting areas in medium-sized companies with sales of between $25 million and $100 million across a range of sectors from education to companies that offer services to bigger firms, such as big oil and telecoms companies. There are also opportunities in service companies to construction and health.”
Aureos is also upbeat about Colombia’s long-term outlook, with expectations of a smooth transition from the two terms of president Alvaro Uribe to a new leader. It also sees progress on the regulatory front, with clear rules to help foreign investment, better protection of shareholders’ rights and rules allowing institutional investors to get more involved in private equity. “I believe that Colombia has evolved from a relatively closed environment to one that is quite open,” says Hoyos.
Peterson also sees a need for Andean firms to do their part to understand how private equity works, so as to get the most from the tie-ups. Openness is also an issue that can be difficult for family-owned companies long used to doing things their own way. Peterson says: “We provide value to our partners by bringing financial and industry expertise, as well as local, regional and global contacts.
But the transition from a family-run firm to a professionally managed business comes with increased accountability and transparency that local businesses have to be willing to adapt to. It also has implications from a legal and regulatory perspective, where we need to ensure that we are working together to properly structure private equity transactions in the local market.”
Given Colombia’s geographical proximity to central America and a host of business ties in the region, Aureos also has a presence there, with the Aureos Central America fund set up in 2002, and uses the experience it has garnered there in the Andes. In Central America, Aureos has five investors and aims to close a new fund with seven investors.
Although Peru is not yet such a hot spot, economists predict growing private equity interest. “In the medium term, what we will be seeing is investment in sectors away from the traditional mining and construction sectors, and that is very positive given the need for diversification in the Peruvian economy,” says Juan Carlos Odar, senior analyst at Peru’s top bank, Banco de Crédito.
Washington-based investment firm SEAF also predicts that it will not be long before investors start seeing Peru in a new light and that Peruvian businesses themselves begin to attract private equity firms. “Peruvian pension funds need to diversify and find new investment instruments, while companies need to grow and consolidate because of the growth of the internal market and the free-trade agreements that create the need for companies to be more competitive,” says José García, SEAF’s vice-president for Latin America.
Space to grow
He adds that there is an initial development of private equity in Peru, and although there are few funds, there is space to grow. “This year has been very interesting,” he says, “with the creation of some funds. But 2008 will be even more interesting and there are many different profiles that private equity can follow, with some focusing on big companies, others on infrastructure, a range of sectors.” SEAF sees retail, construction and service sectors that link with domestic consumption as the places to be for private equity in the Andes. SEAF started its first Peruvian fund three years ago at the beginning of Peru’s economic boom and now has $15 million in the Transandino Peru fund. The Colombian fund, Transandino Colombia, has $17 million.
“In total we have $32 million, but we hope that by the end of the year to increase the amount under management to up to $120 million because we are launching a new fund,” says García. SEAF is looking to pension funds to step up with resources to invest. It has six investors in Peru and two in Colombia, ranging from European financial development agencies, pension funds and insurance companies.
Aside from all-important economic growth and stability, the increase in successful exits is also helping private equity to grow in Latin America and the Andes. “The IPO markets have reopened and that is very good news for the private equity industry,” says Darby’s Lastres. Latin American equity capital markets volume so far this year is about $30 billion, more than 50% higher than last year’s record levels, and the region has seen $22 billion in IPOs in the same period, nearly double those of last year. Much of that has been in Brazil but private equity firms say there is nothing to stop them exiting an Andean venture on the Bovespa.
Given the volatility of financial markets in general, finding a strategic buyer is also a desirable exit and something that many still favour. “We will always seek to exit through IPOs on an opportunistic basis, but our primary focus is on building mid-market companies that would be attractive to a strategic buyer looking to enter the Latin American region,” says Peterson of Aureos. In an encouraging sign, he adds that his firm has begun to see more locals coming to buy companies, rather than just US and European businesses. “We’ve seen a lot more interest from local players wanting to do cross-border transactions within the Latin American region,” says Peterson, adding that, for example, Aureos sold its investment in the consolidation of Xerox’s operations in central America to a Caribbean company.
Finding buyers is now a lot easier than just a few years ago, as the outlook for increased economic growth promises high long-term returns. But Latin America’s shallow debt markets need to continue to deepen to give private equity firms a chance for leverage, and the Andean region in particular needs more local players such as Chile’s Southern Cross to come in and add the value and expertise in companies that might be too small for firms such as Advent and GP.
Stricter regulation and more economic and labour reforms would also be welcomed. “Above all, what is really needed is a more intensive development of capital and debt markets so that private equity firms can float companies on the stock exchange, recapitalize companies and do leveraged buyouts. That is one of the most important things to develop the industry,” says Advent’s Zucchini.