Private equity and emerging markets

I was able to catch today’s morning sessions at the Global Private Equity Conference and will link to the presentation when they go online next week. Comments on the event below the fold for those that are interested.

First of all, I was shocked at the turnout! Last year’s event here at the IFC had about 150 attendees. I’ve been to two similar events in NYC, neither passed 100. Today there where over 600 external guests, from over 60 different countries, almost all practitioners (mostly general or limited partners), and a huge percentage had flown in from overseas. Congrats to whoever promoted this. Or was this really more a sign of the surging interest in emerging market private equity?

Did you know that Queen Isabel of Castille was the world’s first emerging market venture capitalist? Yes, at least according to Carlyle’s David Rubenstein. The company she invested in… Christopher Columbus. Columbus had been trying to raise the $10,000 he needed for seven years, after three years of due diligence the Queen finally caved in. The sweet deal negotiated by Columbus promised him 10% of the profits, 5% of the gold and reimbursement for all expenses in advance - negotiated like a true VC! Now if only he had found the route to India as promised.

Beyond a history lesson, Rubenstein also took the time to differentiate between ‘emerged’ and ‘emerging’ markets. A very important distinction in my view. He made the argument that these two groups of countries need to be treated differently and that the best investors will go beyond just ‘emerged’ markets (ie China, India) and look to truly emerging economies that are slowly turning the corner and where returns will be maximized. Which countries is he talking about? Well, if it is impossible to find a hotel room in Shangai you should take the hint that maybe you’re not at the cutting edge. Look for countries without four star business hotels and multiple international airports. If you do have the courage to move into one of these countries, patience is a must. It took Marco Polo 22 years to leave China with a profit.

Sarah Alexander of EMPEA presented their latest survey on institutional investor views towards emerging market private equity. The findings show that the average emerging market investor demands a premium of 7.1% to invest. Being that the average rate of return in the US is around 16.9%, this means that they only consider deals that promise a staggering 24+% return, net of fees. Now the survey is not perfect, but it shines light on the perceived risks that are still involved in these type of deals.

One of the issues with the sector is that so many new funds are popping up. The challenge with this is that many institutional investors are hesitant to invest with new managers. Especially since the management role of the private equity investor is so important in these countries, due to the challenges in finding viable exits and that investors do more ‘managing’ as apposed to just the ‘deal-making’ activities common in the US and Europe. On the other hand, it has also been shown that local knowledge and experience is key in these countries; and that many of those taking the risk there are entrepreneurial-types that have left larger firms to branch-out on their own. In this vein, Chihtsung Lam (who recently started Axiom Asia Private Capital) brought up a Chinese saying: “I would rather be the head of a chicken then the tail of a phoenix.”

Lots of people brought up Sub-Saharan Africa, and the lack of attention it has been receiving (besides South Africa). Justin Loasby of EIB was optimistic. He admitted that few African deals can currently promise the 25% return being sought, but that is why government and institutions like the IFC have a role. What he likes about Africa: the enormous untapped potential – what he called “a glass half-full that is filling-up” – and the recent success stories that are emerging from the region. What he doesn’t like: the often poor macroeconomic and legal environment, corruption worries and the small national markets which have forced many investors to take a regional or sectoral approach.

In the end, the three messages that were constantly repeated where:

1. There is a lot more out there than just China, India and Russia. Do you have what it takes?
2. You can’t just group countries by regions. Market characteristics differ immensely between countries in Africa, the Middle East, and Latin America. We need to talk more about specific country markets and conditions, not just Africa’s market as a whole. Don’t let a continent’s cloudy past darken the future of the rising bright spots.
3. We need better data on recent trends and performance. This last point is likely a challenge that the IFC or EMPEA may have to tackle. For example, a better methodology for comparing emerging market performance with US and EU markets – because we may not be comparing apples to apples.

I missed out on the evening events, but Rachel was chairing a session – so hopefully she will chime in. In the meantime, you may want to check out the research over at EMPEA or Wharton’s Private Equity Review. The first chapter looks at the long-term investment attractiveness of India and China. Chapter two looks at venture capital and alternative energy.

Update: video and presentations from the conference now available.