Over the past two decades, Spain has become one of the favorite markets for private equity (PE) firms. For example, global investment firm 3i, based in the U.K., has made Spain its second largest investment platform. Investment funds have focused on buying Spanish companies, especially those in the health care, distribution and telecommunications sectors.
Before 2008, investment players preferred to establish their portfolios in the United States and Europe, focusing on those regions and sectors that were growing the fastest. Latin America and other emerging regions were less appealing to private equity before the crisis. At the time, the philosophy was to pursue high profits when it was time to sell, but good returns are sometimes harder to achieve in those countries where capital markets are less developed.
More recently, the trend has moved in the opposite direction, and Latin America has become a favorite destination for private equity firms. According to Rafael Gonzalo, professor of finance at the IE Business School, three factors are responsible for the funds’ growing interest in the region: “a better macroeconomic environment, an emerging business structure, and less competition where they are operating.”
Gonzalo adds, “In absolute terms, Latin American companies are expanding at better rates, and that means a greater opportunity for making investments [in them]. On the other hand, in relative terms, the economic prospects, as well as national and corporate processes for deleveraging, in Europe offer them only a limited opportunity. What’s more, the private equity industry is very mature, and quite a few private equity firms are competing for those opportunities [in Europe].”
Obstacles and Limitations
Nevertheless, Gonzalo warns that there is still one condition that constrains the development of private equity in emerging regions such as Latin America. “There are limitations based on the mandate of the institutional investors” – that is, the funds, financial institutions and insurance companies that invest in the PE firms. “Whenever a fund is established, its shareholders impose a series of norms, clauses and conditions for the company that is going to manage their money and choose where to invest that money.”
On the one hand, Gonzalo notes, “these projects [for investing in emerging countries] are accompanied by greater risk on the political, macroeconomic and business level.” For example, last April’s news regarding the Argentine government’s expropriation of YPF, local affiliate of the Spanish oil company Repsol, is not going to help create the stable climate that international investors need.
On the other hand, managed funds are structured in such a way that they cannot make rapid changes in their strategy when it comes to the sorts of companies that they acquire. As Gonzalo points out, “A fund is created with an investment horizon of three to five years, plus another seven to nine years to sell.” Therefore, it can take more than ten years from the moment when the fund is created until the moment when it sells its shares and achieves the anticipated returns.
According to Gonzalo, there are two limitations to this long-term horizon. First, it means seeking stable geographical destinations for investing in order to guarantee the future of a project. Second, the specific investment criteria for various funds limit the type of companies that they can buy or the countries where those firms may be headquartered. However, some funds that anticipated investing in Latin America when they were founded have chosen to acquire Spanish companies that have a presence in Latin America, or to acquire other Spanish companies that have plans to expand into Latin America.
In one case, two Spanish private equity funds, N+1 and Mercapital, recently signed a merger agreement, and are focusing their geographical diversification strategy on the acquisition of Spanish companies that have a presence in Latin America. Another international firm, Permira, is also committed to pursuing a strategy of globalizing its shareholdings beyond Spain. Informed sources told Universia Knowledge at Wharton that Telepizza, a Spanish restaurant company, has halted further openings in Spain for the time being in order to begin its expansion in such countries as Peru and Chile.
It remains to be seen if firms will establish new funds that enable direct investments in companies in the region. Britain’s 3i is already studying the possibility of setting up a fund to acquire shares of other companies in Brazil, although this will not occur until 2013, which means that the first deals won’t be closed until 2014. Analysts say the most likely sectors for investments willbe distribution, telecommunications and possibly health care.
Already, it is apparent that major commitments are being made by Spanish private equity firms in Latin America. In 2011, the volume of Latin American private equity investments reached a historic high, as firms took in $10.3 billion, according to the Latin American Venture Capital Association. What’s more, Brazil continues to hold the lead, having almost totally eclipsed every other country in the region in previous years. Some other destinations stood out last year, including Mexico, Colombia, Chile, Peru and Argentina. Despite such progress, these levels of activity were quite far from the much bigger M&A deals achieved in European markets.
In July 2012, Mercapital signed its first deal in Latin America, acquiring 70% of Rubaiyat, a Brazilian restaurant chain, at a cost of 45 million euros. This chain is more than fifty years old, operating three high-end restaurants in Brazil and one in Madrid. Belarmino Fernández, president of Rubaiyat, notes that the arrival of private equity reflects his company’s need to access financial help in order to begin its international expansion, and to resolve the generational transition in its founding family. Belarmino Fernández Iglesias, patriarch and creator of the company’s initial restaurant, is selling his shares, as are two of his sons. His oldest son, with whom he shares his first name, has headed the company for years, and owns 30% of its shares.
“This deal with Spanish private equity is an opportunity to grow more rapidly and in a more professional way,” notes Belarmino Fernández. Over the next five years, his company will invest up to 25 million euros to open 10 new restaurants. The first step will be to increase its presence in Brazil, its country of origin. The cities chosen for that initiative will be Brasilia and Rio de Janeiro, where it has yet to open any restaurants. Beyond that, his goal is to jump from those locations into Mexico, Colombia and the United States – via Miami, Fla. Once this phase of his plan is completed, Fernández plans to revive his company’s development strategy for Europe. In 2006, the company opened a restaurant in Madrid, but its plans for the region were later thwarted by the financial crisis. He notes that his company’s top priority is Latin America, because it is a thriving market.
These will be Mercapital’s first operations on the other side of the Atlantic. Mercapital chose Rubaiyat as its private equity firm because “it is going to give us great visibility in the region, thanks to the prestige and recognition of its restaurants,” explains Javier Loizaga, president of Mercapital. What’s more, Mercapital is confident that this arrangement will open new doors for it in the Latin American business community. Once the merger between Mercapital and N+1 is finalized at the beginning of 2013, the goal of the new firm is to set up a 500 million-euro fund to invest in Spanish firms that have growth prospects in Latin America. The next step in this strategy, says the company, is to create local investment funds in various countries in order to buy Latin American companies. The main destinations will be Mexico, Colombia and Brazil.
Another Spanish firm that has focused on Latin America is GED, which looks to invest in small and midsize local firms that have a strong international presence. Until now, GED has focused on supporting the internationalization efforts of companies with European ownership. Now, says Enrique Centelles, president of GED, the company’s goals are focused on North Africa (because of its proximity to Spain) and on Latin America (because of its cultural ties).
“The most attractive countries are those that offer a greater potential for growth along with sufficient size,” notes Gonzalo. The list of such countries includes Brazil, Mexico, Peru and Colombia, and the Spanish funds are showing more interest in analyzing them. Nevertheless, Gonzalo adds, several key elements will determine if any specific investment takes place in one country or in another. These factors include the availability of financing; whether there are options for disinvestment when it is time to sell shares; and whether that [disinvestment] process, in capital markets, involves other private equity firms established in that country, or involves local industrial buyers. In that sense, Mexico and Brazil are the countries that best meet these requirements, according to top executives at private equity firms.
As a result of the global financial crisis, private equity funds have viewed geographical diversification as the best formula for establishing a presence in various markets with different economic cycles. This approach guarantees that the funds will be active in both rising and declining markets in different parts of the world at the same time. Nevertheless, notes Gonzalo, “It is not easy for institutional investors to accept when [a fund] manager expands his investment horizon to other locations where there is not the same level of [local] knowledge, and where there are local alternative investments.”
Adds Gonzalo, “In order to overcome this obstacle to attracting capital, Spanish private equity firms are looking to position themselves to institutional investors as experts in the transformational processes that have occurred in Spain over the last twenty years, and which they expect will occur in many of these other countries [in Latin America] as well. This way, they achieve the double objective of improving their investment expectations as well as their ability to attract funds.”