MEXICO CITY – Aside from economic volatility, investors say the two biggest problems with private equity investing in Latin America are the lack of access to other capital markets and difficulty in exiting investments.
Indeed, despite what appears to be a resurgent market for Latin American initial public offerings, investors are calling exits the single biggest issue in Latin American private equity right now, as the time has come to begin to exit their initial investments that were made three to six years ago.
“Exits are already a significant concern [for us in Latin America], although with our investments it’s too early to tell [what will happen],” says Larry Rusoff, a portfolio manager at New York-based General Motors Investment Management.
Investors certainly felt that concern last year, when the initial public offering market in Latin America was virtually comatose, due to Brazil’s devaluation and widespread recession in the region, among other factors.
And while some Wall Street bankers are projecting a big year for Latin IPOs – their definition includes United States-domiciled companies with a Latin focus – its revival hinges primarily on technology and telecommunications plays, and thus isn’t reflective of appetite across all sectors.
“You’re going to be discouraged if you think the only way to exit is to go public,” says Diego Serebrisky, a principal with Advent International, in Mexico City. “You can’t rely on an IPO with private equity investing in general. Whether or not you’re [cynical about exiting right now] depends on how you analyze your investments.”
Advent has a $265 million fund dedicated to Latin America, the Latin America Private Equity Fund LP, which is 75% invested in 11 companies in Argentina, Brazil and Mexico.
Interestingly enough, participants of a recent Economist Intelligence Unit survey seemed to show confidence in Latin America’s domestic markets, as 62% said they had exited investments through a local sale, and 15% said they had exited through an initial public offering.
Restrictions Curb IPO Volume
That said, there are still a host of reasons why exits are difficult in Latin America. Indeed, they vary between countries, although each nation in the region retains a few common characteristics. To begin with, because many of these exits are considered high risk, there has to be a sufficient number of high-risk investors for the deals to work. But having recently recovered from recession, investors these days have a very low tolerance for risk in Latin America.
Moreover, most of the stock markets – except in Argentina – are nascent, due to the absence of long-term economic stability in the region. In other words, having shares in a company is not necessarily good protection against the kinds of risks these economies have historically posed. Big investors want liquidity, and unlike the U.S., buying shares is still expensive south of the border.
“The markets are a lot more restrictive on the types of companies that can go public,” says Everett Santos, chief executive of Emerging Markets Partnership (EMP), which manages the $1.013 billion AIG/GE Capital Latin American Infrastructure Fund LP. “[For example], they might have to be in existence for a minimum of five years.”
The issue of profitability is also different in Latin America than it is in the States. “Some of the local markets have laws [that require] you have to be profitable before going public,” Serebrisky says. “These laws were created to protect investors by banning companies with losses. But Internet companies are by definition unprofitable. So they have no choice but to use Nasdaq.”
However, Santos and other local sources say that won’t be the case for long. “It’s just a matter of time before that changes,” Santos predicts. “Those regulations are a little antiquated, and [generally] there’s a lack of sophistication in many securities markets in Latin America. It’s important to go cautiously as to what you allow to go public. You don’t want to get into a situation where the whole [system] is called into question.”
In Mexico, where Advent has seven of its 11 investments, Serebrisky says, the IPO window is cyclical. It was open from 1996 to 1997, closed in 1998, and made a small comeback last year. Share performance is more a result of liquidity in Mexico, and the stock market also depends on the U.S. stock market.
Advent’s last IPO in Latin America was with Latinamericana Duty Free, a Mexican company that Advent took public in December 1997. Serebrisky went on to say he believes there’s a large opportunity for well-timed IPOs in Brazil. Indeed, that’s where bankers expect much of this year’s Latin IPO activity to come from. “Because of the size of the market, Brazil eventually has to turn around,” he says.
Of course, there are still many roadblocks when it comes to IPOs. Susan Segal, a general partner at Chase Capital Partners, cautions, “There can’t be an IPO until you can prove there’s a revenue stream. And the market is a brutal place to perform.”
EMP’s Santos adds that government policies will have to address deficiencies before the possibility of more exits through IPOs takes hold.
At the same time, that doesn’t mean IPOs can’t get done. “We think IPOs will be possible,” Segal says. “At least in the context of our portfolio, 35% of which is in telecom, all are prime candidates for IPOs, albeit most are technology-related right now. But with communication changes, access to capital will be as open as it is to trade now. There will be a lot of flows a lot faster vis-a-vis the Internet. Private companies themselves are creating demand.”
Rick Schifter, a partner with Newbridge Latin America, has a slightly different take on the situation. “Remember,” he said, “an IPO is not an exit. At best it’s a partial exit. It’s a slow process you have to sell down over time. In the U.S., you can feel reasonable when you take a company public you’re reducing your stake in it. The problem in Latin America is there’s no investor appetite [for public markets].”
In every country, private equity investors cite the advantage of the medium- to long-term window to harvest investments, which enables firms to ride out troughs.
But for many firms, the time to cash in is now, and the most likely way to do that is through the public market. “To some extent we’re dependent on public markets to exit,” Serebrisky says. “Especially in some sectors, the best exit we can have is an IPO, because the public market is going to pay higher value than [a] private [placement].”
Pre-Planning the Exit
“Every time we analyze a deal, we analyze an exit strategy,” Serebrisky said. “In some cases, it’s ideal to go public, but we try to think of alternative exits, [such as] international major players, what type of acquisitions they have done. We have a contingency plan.”
Nevertheless, while it’s true that no private equity investor wants to be stuck without an exit, not everyone agrees that planning an exit strategy before investing is possible. Indeed, Rodrigo Andrade, a CVC/Opportunity partner, says planning exits as part of an overall strategy – at least in Brazilian companies – is impossible.
But he said growth will happen with good assets. “We will have our growth, our exits,” he said, “[but] not through IPOs. There’s no selling control in the stock market, there’s no such thing [in Brazil].”
Instead, CVC buys control, which Andrade described as “the only asset in Latin America. Having scale allows you to deal with the volatility of the region, [as well as] buying established franchises, like a soccer team. And having control over management is vital. We always select a CEO and CFO.”
Having more control from the outset is also part of the PCFG Advisory’s strategy, says Jorge Duran, managing director at the firm, who recommends having a local market presence for sourcing deals and ultimately for more opportune exits.
“You get more access to information, [and therefore] more control,” he says. “The facility to hire people is crucial. You can build better relationships, so it doesn’t matter if you’re going to sell the company in five years. [The executive you have hired] will know he’ll have another opportunity.”