While the United States and Europe were hit hard in the global economic crisis, many emerging markets have fared better and private equity investors may be poised to benefit from new opportunities overseas. But these markets are in different stages of maturity and each has unique opportunities and potential pitfalls, according to panelists at the recent Wharton Private Equity and Venture Capital Conference.
The conference, titled “A New Dawn: Investing in the Post-Crisis World,” covered a number of topics, including a panel on the state of private equity in emerging markets. Wharton senior fellow and lecturer, Stephen Sammut, moderated the panel, asking the speakers what limited partners are looking for from private equity (PE) firms in their markets and if those demands have changed following the global economic crisis.
Veronica Lukito, co-founder and managing director of Ancora Capital fund in Singapore, said that Indonesia is a nascent market for PE. This form of financing began to evolve in Indonesia after the 1997 Asian financial crisis, she noted, adding that it took five years for the country to recover from that panic.
Natural resources are a key focus for the fund, she continued, with Indonesia a major exporter of coal, palm oil, gold, tin and nickel. The country is a net importer of oil and natural gas, but Indonesia has the potential to develop these resources internally in the future.
At the same time, she said, the fund also has new opportunities in the domestic market. With a population of 240 million, Indonesia is the fourth-largest country in the world. “Coming out of the 2008 crisis we have been more resilient because of our lack of dependence on exports compared to Malaysia or Singapore,” Lukito said. “Indonesians want to develop their exports, but also build new markets at home. We have the best of both worlds.”
Lukito also said limited partners are asking how a slowing Chinese economy would impact Indonesian investments because Indonesia is a major exporter of coal and natural gas to China. “All I can say is that Indonesia has room to grow,” she said, explaining that political reforms in Indonesia are stimulating internal growth such as the construction of power stations. “We expect that we will have internal consumption to rely on in the next few years.”
Brazil and Russia
Patrice Etlin, managing partner of Advent International in Brazil, described his market as “fashionable” at the moment. He recalled that American private equity investors surged into Brazil in the mid-1990s in part due to confidence in the nation’s currency after the real, and the peso in neighboring Argentina, were pegged to the dollar. “Of course nothing happened,” he said. “There were massive devaluations in Brazil and in Argentina,” and capital markets took 10 years to recover from related recessions. Limited partners, he said, turned their back on the region in favor of pursuing new opportunities in China and India. Only a few general partners remained Brazil.
Now the country is experiencing a new wave of interest from PE investors. However, Etlin pointed out that managers of large pension funds may be reluctant to rush back into Brazil. Pension fund managers tend to remain in their jobs much longer than hedge fund managers and other investors who quickly move in and out of capital markets, and who therefore may not have been in the industry in the 1990s. The pension fund manager, said Etlin, “will always remember he burned his fingers in the mid-90s in the region.”
While there is excitement about Brazil, few funds can show a track record in the region, Etlin noted. While that means his firm faces limited competition, he said it is still difficult to raise sizeable amounts of capital because of large investors’ past experiences in the region.
Dmitri Elkin, managing director UFG Capital Partners in Russia, said his market is viewed as one of the riskiest in the world for private equity investments. When the crisis hit global capital markets, many investment managers were suddenly seeking safety. Russia was the “first country that got crossed off the list,” according to Elkin. “It was a dramatic change.”
Now there are only about a half dozen specialized private equity firms operating in Russia. Those few remaining firms now enjoy better access to deals, but it is difficult to raise funds. Russia has returned to being a small private equity market with a few players and “reasonable valuations,” said Elkin. By contrast, he pointed to an incident in 2006 that jarred the traditional notion that returns in emerging markets were discounted because of the greater risk. He recalled his surprise at hearing a young banker in Russia’s then-hot investment climate refer to an “emerging market premium.”
India and China
Shifting the focus to India and China, Sammut questioned panelists about raising capital and how risk is perceived in those emerging markets. “Is it as easy as it sounds?” he asked. “Is it as hot as it is perceived?”
Naveen Wadhera, who heads TA Associates’ Mumbai office, said that like Brazil, India is a “very sexy story.” She explained that the market in India is well understood by limited partners who know about positive demographic and consumer trends in the country along with deregulation that is improving business conditions. “India is an exciting story and limited partners get it,” said Wadhera. “Capital is very available for India.”
However, limited partners also are struggling to find investment firms with a track record in the country. While India’s capital markets are mature for Asia, they are still just emerging when compared to the rest of the world. “Only a handful of firms have seen a full investing cycle in India,” Wadhera said. Finally, she noted that companies go public much earlier in India than in other countries so there is more competition between private equity and public markets. There are a lot of opportunities for investment firms “that are nimble enough to play both,” she added.
As for China, Richard Zhang, managing director of Apax Partners and head of its Greater China business, called it a “gigantic paradox.”
He focused in on two words in Sammut’s question: “hot” and “emerging.” He said the paradox is that both describe private equity markets in China. First, he confirmed that China is “red hot,” even “iron hot.” Everybody is rushing to China and India. “All limited partners want to increase their exposure. Liquidity is abundant,” he said.
At the same time, Zhang emphasized that China is still an emerging market. Many entrepreneurial companies are in the very early stages of development and while the volume of firms starting up is high, each company is quite small. The average deal size in China, he noted, is only $50 million. He observed that a wide range of types of funds are doing business in China, including Asia funds, venture capital, and larger buyout funds. Corporate entities are operating in China as if they were private equity funds.
“I think the question on risk perception is extraordinarily important,” Zhang continued. “The good news is that there is significant money in China and I think it is clearly a market that will remain very big and will continue to grow. The jury is still out on what investment model will be most successful, but probably [more than one] will coexist.”
Zhang added that he is neither completely optimistic nor pessimistic about the market. “The truth is there is a lot of complexity, a lot of nuance. The devil is in the details in China — to identify where the real risks, upsides, and price are to make the risk adjustment work.”
Sammut noted that he recently spent a month in China and sensed that the government is growing increasingly uncomfortable with the structure of offshore investments and the prevalence of dollar-denominated funds. He asked Zhang if he thinks the government might begin to push for investments through renminbi (RMB) funds.
Although he isn’t certain that the government is advocating RMB funds, Zhang pointed out that China is selective in attracting foreign funds and funds denominated in dollars and other foreign currencies are subject to certain limitations in China, which are no different than any other foreign investment in the country. .”The emergence of the RMB fund as a phenomenon will continue to grow,” he said, but added that he does not think that continued growth of RMB and dollar-denominated funds in China are mutually exclusive. “Doing both raises some conflict-of-interest and coordination and governance issues, but in general the rise of the RMB fund is a long-term trend,” Zhang predicted.
Kosmo Kalliarekos, who manages Baring Private Equity Asia in Hong Kong, a pan-Asian private equity investment fund, said the bulk of the firm’s investments are in India and China. He agreed with other panelists that while limited partners are eager to take positions in the region, there are not many experienced funds in operation. Of approximately 250 funds currently active in Asia, two-thirds are first-time funds that started after 2005. The funds also tend to be small, he said, noting that no more than 10 pure Asia funds have assets of more than $1 billion.
While limited partners are eager to invest in Asia, Kalliarekos commented that they have a difficult time choosing which fund to use. Since most funds now in operation were established between 2006 and 2008 — and have not yet made distributions — there is not much of a track record on which to judge fund managers. “Investors are coming and they are excited,” he said, “but the limited partners in particular do not have the infrastructure to cover Asia although they are building it out.”
So far, he added, a significant amount of recent PE investment in Asia was through hedge funds and the proprietary trading desks at Wall Street firms, which has largely exited the market. “If you have returns you will be able to attract funding. It’s there. They want to invest. It will be interesting to see how it plays out over the next three years,” he said.