Private equity investment in Latin America fills local financing gaps
- Trade or secondary sales top PE exit strategy
- Consumer goods, financial services and healthcare are top sectors for investment
- PE ecosystem evolving into two-tier model
WASHINGTON, May 14, 2013 /PRNewswire/ -- Domestic and foreign private equity (PE) firms investing in Latin America over the last several years are generating returns above those available in local public equity markets. These returns have even surpassed what PE firms in developed countries have seen, according to Building vital partnerships: How do private equity investors create value?, a joint study conducted by the Emerging Markets Private Equity Association (EMPEA) and Ernst & Young. The study, now in its second year, examined the results and methods of over 70 PE exits between 2007 and 2012.
Sixty percent of transactions in the region were sourced through private channels or secondary sales, while just 25% came through corporate or listed markets. Similarly, private routes were favored as an exit strategy as 53% of PE investments exited through trade or secondary sales, although a small number of the deals were exited via IPO. Almost 95% of all the exits studied reported strong business performance and favorable market circumstances as principal drivers for exit.
"Increased investor interest and economic growth in Latin America has been astounding with region-wide GDP growth averages exceeding 4%," said Jeffrey Bunder, Global Private Equity Leader at Ernst & Young. "Despite a difficult commodity export market and continued challenges generating competitive industries, economies in the region power ahead, buoyed by the rapid growth of the region's emerging middle class. As we move forward, it will be crucial for PE to continue developing and maturing in the region as it will play a vital role in providing the necessary capital, discipline and expertise required to help the Latin American economy achieve its full potential."
While Latin America's importance as an investment destination continues to grow — capturing 21% of emerging markets PE investment in 2012 — there remains a sizable gap in these markets. PE accounts for less than 0.1% of GDP in Latin America, and a large majority of fast-growing companies remain undercapitalized.
"The good news is that investor interest in the region is still climbing," said Jennifer Choi, Acting CEO, Emerging Markets Private Equity Association. "According to EMPEA's Global Limited Partner Survey, 46% of institutional investors surveyed in 2013 plan to commit more capital to Latin America beyond Brazil."
Ecosystem development and growth
As the Latin American market continues to mature, there is a clear transition into a two-tier PE model that will resemble the multistate PE ecosystem in many developed markets. The large Brazilian and international buyout firms compete for deal flow at a very different level than traditional regional or domestic PE firms. With large funds now coming in to open up scale and globalization, small and mid-market firms can continue their focus to build better businesses, growing revenues and earnings before interest, tax, depreciation and amortization EBITDA.
This year's study confirms a key prediction from last year that Latin American companies have sought out PE to fill gaps that could not be addressed in local debt and equity markets. PE has played a crucial role in helping companies reach new customers, enter new markets and grow. In contrast to developed markets where cost reduction initiatives play an important role, focus on portfolio company growth is a main focus in Latin America. Across the entire sample, organic revenue growth accounted for 69% of earnings before EBITDA growth, while acquisitions accounted for more than 28% of growth and cost reduction accounted for less than 3% of total EBITDA growth.
Local market knowledge key
Whether through peer networks or though detailed sector experience, local market knowledge continues to be the primary source of deal flow. Many entrepreneurs favor these factors over bid price when making key business decisions.
This sentiment is also reflected in the decision making of local PE firms when taking control of a portfolio company. Only 44% of buyers replace the CEO because they are seen as critical to the company's strategy, success, and public leadership. The study revealed however that when larger deals are made, the CEO and CFO are both replaced, signaling that proper management is critical.
"Institutional investors continue to seek exposure to Latin America's attractive growth story fueled by the desire to build partnerships and foster the entrepreneurial spirit," said Michael Rogers, Global Deputy Sector Leader, Private Equity, Ernst & Young.
Middle class consumption and international expansion fuel growth
The key for PE firms was an ability to identify sub-sectors that would not only match Latin America's rapid growth rate, but exceed it by a significant margin. Targeting industries directly related to middle class consumption – consumer services, consumer goods, health care, and insurance – has proven to be a lucrative and scalable strategy for PE-backed businesses in the region. Financial services have seen significant PE interest and success over the past several years. An increase in access to banking products and consumer credit has been a powerful trend in Latin America and PE firms are right in the middle.
Increasingly, Latin American companies also have an eye toward international growth. For businesses with entry enterprise values EVs over US$100m, nearly half are pursuing international expansion alongside domestic expansion. While Brazil remains a target market for many companies based in smaller countries like Chile or Colombia, growing a Latin American business has gone beyond the former regional focus, and many have set their sights squarely on expansion in other emerging and developed markets.
"The PE Industry has proven to have a positive impact on the increasingly important region of Latin America and it now has to expand its strategies and reach as it manages through a more competitive environment and expected volatility in Latin America," concludes Bunder.
About the study
Building vital partnerships: How do private equity investors create value?, is a joint study on private equity exits in Latin American by EMPEA and Ernst & Young. The study examined the results and methods of PE exits between 2007 and 2012. Drawing upon confidential interviews with PE firms active in Latin America, and public documents and data sources, the study drew a sample from an initial population of over 70 exits. The aim of the study is to develop an understanding of the exit modalities and strategies in these markets and the underlying drivers of value creation. (www.ey.com/privateequity)
The Emerging Markets Private Equity Association (EMPEA) is an independent, global membership association whose mission is to catalyze private equity and venture capital investment in emerging markets. EMPEA's 300 member firms share the belief that private equity can provide superior returns to investors, while creating significant value for companies, economies and communities in emerging markets. Our members include the leading institutional investors and private equity and venture capital fund managers across developing and developed markets. EMPEA leverages an unparalleled global industry network to deliver authoritative intelligence, promote best practices, and provide unique networking opportunities, giving our members a competitive edge for raising funds, making good investments and managing exits to achieve superior returns. (www.empea.org).
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SOURCE Ernst & Young