A Different World
As the US economy slows and globalization expands, PE firms try their luck in far-flung lands. Will it work?
By Kelly Holman July 28, 2008
The credit crunch and slowing domestic business growth have stalled buyout dealmaking in the US, but some domestic private equity firms are putting their money to work another way: investing in far-off lands. Businesses in Africa, China and India, as well as the Middle East, Central and Eastern European regions are drawing capital, as are funds that invest in emerging markets.
Whether those emerging market investments will prove to be the US private equity industry's next eureka moment or another elusive treasure hunt remains to be seen. The fallout from the subprime market meltdown, bank write-downs, as well as inflation, muted GDP growth and geopolitical concerns are all casting a pall over the global economy, though developing nation economies are looking a little more buoyant than those of mature nations.
The collapse of The Carlyle Group's planned investment in China construction equipment manufacturer Xugong Group Construction Machinery Co. this past week, though, which the acquirer and target said took place against the backdrop of "significant changes in the market environment," certainly isn't promising or insignificant.
It marked an end to a chase that began almost three years ago when the Washington investment firm sought to acquire a majority stake in Xugong for $375 million. Carlyle subsequently re-tooled the acquisition during that time into a minority stake growth-capital transaction to appease Chinese regulators but the deal still fell apart for unspecified reasons.
The economic incentive
The stumbling US economy is expected to contract somewhat in the second half of the year with GDP growth projected to top at 1.3%, according to the International Monetary Fund's latest World Economic Outlook Update.The report noted that the economic output in Europe and Japan is expected to slow while the GDP for emerging and developing markets--Africa, Brazil, Central and Eastern Europe, China, India, Mexico and the Middle East--will decline to about 7% through 2009, from 8% in 2007. More bad news for these emerging countries and regions is that their core inflation has increased 4.2%.
The incentive to invest in growing economies is a clear one given the far lower output of advanced economies, but shifting economic sands are clouding the investment picture in emerging countries.
The fund picture
Research earlier this summer from the Emerging Markets Private Equity Association, a Washington industry trade association, indicates institutional investors are bullish on emerging markets.
A survey of limited partners issued by the EMPEA in May estimated that emerging markets funds commanded $25 billion through the first four months of this year, compared with $59 billion raised by the funds last year. The survey noted that besides deeper commitments to China and India, 89% of respondents plan to invest in Asia-oriented funds within the next three to five years, while 75% plan to allocate capital to funds targeting Central and Eastern Europe, which actually marked a decline of 12% from the prior year. As for Africa and the Middle East, 52% and 35%, respectively, plan to put their capital to work in limited partnerships targeting the regions.
There were 222 emerging market private equity funds raised last year to the tune of $93.6 billion, compared with 209 or $69.3 billion in 2006, according to London private equity research firm Preqin.
For a number of private equity firms besides Carlyle, including Advent International, Emerging Capital Partners and Warburg Pincus, the idea of investing in developing markets is old hat. Boston-based Advent, for instance, put its capital to work in Central Europe in 1994 with an investment in Poland's Warsaw Distribution Park, a warehouse and distribution business. New York's Warburg Pincus also launched its investment business in 1994 in Asia, where it has put more than $2 billion to work.
Africa/Middle East
Africa is attracting high-profile investors like Carlyle, as well as steady investment from veteran investors in the continent such as Emerging Capital Partners, a Washington-based private equity firm that has invested exclusively in the continent for the last eight years. The Middle East is also drawing its share of heavyweights like GE and Mubadala Development Co., which announced a new $8 billion investment partnership that will seek investment opportunities in Africa and the Middle East.
Emerging Capital has been on a tear this year in Africa, which Hurley Doddy, its chief operating officer, says has grown faster economically than the world average for the last eight years. "For us, there is still very strong demand for capital and a lot of good compelling growth opportunities," he says.
Earlier this month, Emerging Capital invested $30 million in Djibouti-based salt producer Salt Investment from its $523 million ECP Africa Fund II.
"What's exciting about it for us is the use of salt in chemical plants like the kind they're trying to set up in the Middle East," says Doddy.
A firm with 25 investment professionals and six offices across Africa, Emerging Capital has garnered the support of well-capitalized limited partners like the European Investment Bank, African Development Bank and the International Finance Corp., the private sector arm of the World Bank. Emerging Capital invests across a variety of industries including agribusiness, financial services, natural resources, power, telecommunications and transportation.
The private equity firm realized the fruits of its investment in region with an exit from Nigerian wireless phone company Starcomms, Nigeria's fourth largest telecommunications business, this past week, generating a 2.9 times return, or $99.1 million from its $34.3 million investment in the wireless company three years ago alongside London emerging markets private equity firm Actis.
Emerging Capital chief executive Thomas Gibian says of Africa: "We are optimistic about the private equity space in Africa. The best is yet to come."
Carlyle's Middle East and North Africa-focused investment group (known as MENA), meanwhile, recently pulled off its first investment in Turkey. Established two years ago under the stewardship of former Abu Dhabi Investment Co. chief executive Walid Musallam, Carlyle's MENA group announced its 50% stake purchase in Turkish chemical ship tanker manufacturer TVK Shipyard on July 17 for an undisclosed sum.
The Middle East offers good demographic and economic growth prospects, according Carlyle MENA's Musallam. "The population growth exceeds the global average, and economic growth exceeds the global average. We are making investments where, 10 years down the line, those two parameters will be very important to us."
MENA looks for investment opportunities in a broad range of sectors including telecommunications, energy, banking, manufacturing, healthcare and logistics.
Investcorp, a New York-and London-based private equity firm, is also interested in the area. It has finished amassing more than $1 billion for its Gulf Opportunity Fund to tap into the oil-wealthy Arabian Gulf, a region expected to generate $6 trillion in cumulative revenues by 2020 as a result of soaring oil prices. The Investcorp fund, which will also invest in North Africa and Turkey, has made a $100 million investment in an unidentified Arabian Gulf-based distribution services firm. (Investcorp owns SourceMedia, the parent company of IDD).
Central Europe
The area comprising the nations of Bulgaria, Czech and Slovak Republics, Hungary, Poland, Romania and Ukraine isn't new when it comes to the inflow of private equity capital. Advent has made at least 35 investments alone in the area since 1994, when it launched its investment program there. In April, Advent raised its fourth Central and Eastern Europe investment fund with the support of investors AlpInvest Partners, California State Teachers' Retirement System, European Bank for Reconstruction and Development and GIC Special Investments, raising €1 billion for investments of €30 million to €100 million per deal.
"We don't have a vision that is centered on one country. We've always had a regional approach to take advantage of a broader set of opportunities and diversify risk," says Chris Mruck, managing partner and co-head of Advent International's Central and Eastern Europe investment group.
The assimilation of the Czech and Slovak Republics, Hungary and Poland into the European Union in 2004 helped ease political volatility in region, says Mruck, noting growth rates in the region have hovered around 5% to 6% as of the late 1990s. "The macro appeal of Central Europe and Eastern Europe is basically growth. These economies were freed from the Soviet System in 1990 and then collapsed. From the second half of the 1990s onward the dust settled and the region's growth phase started."
The Advent dealmaker says the region's composition of highly-educated people with a desire "to catch up to Western Europe" is one factor underpinning the region's growth in coming years. Advent's debt-lite approach to investing, or leveraging its investments in the region at three times Ebitda instead of five to six times Ebitda, leaves cash flow for growth instead of debt service, Mruck says, adding the market is also more attractive because the number of competent managers from chief financial officers to marketing professionals to chief executives has multiplied.
China
Growth in the Middle Kingdom is modulating too with its GDP expected to peak at 9.7%, according to the IMF. Yet, China's home-grown private equity business has taken off and major investment banks, US private equity firms and law firms have rushed en masse to establish offices and relationships with Chinese financial and government officials. The nation is expected to attract more growth capital investment, largely because of the Chinese government's legal restrictions that make borrowing for leveraged acquisitions almost impossible, according to law firm Paul Hastings, which held an executive briefing on China's business landscape recently.
China's investment profile was raised considerably last year when The Blackstone Group agreed to sell a 9.4% stake in its general partnership for $3 billion to Chinese sovereign wealth fund China Investment Corporate. Blackstone subsequently invested $600 million in Beijing specialty chemicals company China National BlueStar Group.
While Carlyle, a firm that has invested $1.3 billion in more than 30 Chinese companies, couldn't consummate its deal with Xugong, it reiterated its commitment to the country last week: "Carlyle has a long-term commitment to China and values the relationships it has developed with the many government agencies it has worked with throughout the years. Carlyle looks forward to furthering these relationships, which are built on mutual trust and good faith, and to broadening its contribution to China."
Two weeks ago, Carlyle illustrated that commitment when its Carlyle Asia Partners unit announced an $87 million investment in Shanghai-based rubber antioxidant chemical supplier Sinorgchem Group.
And, despite dealmaking regulatory challenges, new China-focused investment funds keep sprouting up.
In the second quarter 10 new private equity funds secured $12.02 billion in commitments and 37 Chinese businesses received $2.56 billion of equity from more than 30 private equity firms, according to data from Zero2IPO Group, a provider of China venture capital and private equity data.
The research organization's latest China Private Equity Report Q2 2008 projects that more than $50 billion in capital will be raised by China-focused funds in 2008, whereas companies in China will secure more than $10 billion of equity investments by year end.
"China has become a more important destination for private equity and there's a fair amount of interest there because it's growing," says Kelly DePonte, a partner in the San Francisco office of alternative investment advisory firm Probitas Partners.
The country's exit environment is in the doldrums, however, which Zero2IPO attributes to "continued worsening of international capital markets, the sharp plummeting of the domestic stock market and the new strict regulations published by the regulatory organs."
India
A nation noted for its highly-educated work force and infrastructure needs, India's economic outlook is still strong with 8% GDP growth projected for 2008, though it's a decline from the country's previous 9% GDP rate for 2007, according to the IMF.
"With rising consumer spending and infrastructure investments, Indian companies are expanding rapidly," says Arun Natarajan, CEO of Venture Intelligence, a Chennai, India-based private equity and venture capital research organization. "In the last few years they have found an ideal partner in PE firms for fueling their growth plans and which obviates the need to tap public funds prematurely."
Private equity firms invested roughly $2.8 billion in 77 Indian companies in the second quarter, compared to 74 deals totaling $1.9 billion in the second quarter of 2007, according to Venture Intelligence's July 10 report.
For the first half of the year private equity investors put $6.3 billion to work for the first half of the year, the report said.
The largest reported investment in the second quarter was the $640 million deal sponsored by Providence Equity Partners in Aditya Birla Telecom, a subsidiary of the publicly-traded mobile telecommunication services provider Idea Cellular, which is a portfolio company of Boston's TA Associates.
Venture Intelligence found that telecommunications and power companies are continuing to draw capital, while healthcare and life sciences have gained a higher profile among investors. Conversely, investment in India's banking, financial services and insurance as well as construction and engineering businesses have declined since last year.
Financial sponsors aren't the only class of investors interested in India. Last Tuesday, UK emerging markets fund of funds manager CDC Group announced its $185 million commitment to six India-specific private equity funds. A day earlier, Rabobank Group said it was launching a $100 million India private equity fund with a pair of co-investors.
Natarajan, who says US-based PE firms constitute about 60% of PE activity in India by value and volume, notes that in recent years Indian companies have found an ideal partner in private equity firms, which help companies fuel growth plans and avoid getting involved with the capital markets prematurely.
High-profile deals in the country of late include Kohlberg Kravis Roberts' $250 million investment in India wireless telecom services company Bharti Infratel and Warburg Pincus' $65 million commitment to India advertising services company Laqshya Media.
The success of deals like Warburg Pincus' profitable exit from in Bharti Tele-Ventures three years ago helps explain the prospector-style rush to invest in India.
Venture capitalists invested $158 million in 26 deals in India in the second quarter, a joint study by Venture Intelligence and the US-India Venture Capital Association reported.
The attraction of India and other exotic developing nations is apparent enough and there's no question that private equity firms need to put capital to work, but a watchful approach on where money is invested is also part of the investment process. Given the macroeconomic fluctuations, global inflationary pressures and housing-related concerns in America's financial system, which seem to be rippling across the world like an unbridled tsunami, employing greater restraint when investing in nascent economies might not be such a bad idea. A little discipline, after all, goes a long way.
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Hurley Doddy
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