Latin America Private Equity and Venture Capital: A New Priority for Global Investors

Speakers:

• Patrice Etlin, Managing Partner, Advent International
• Susan Segal, President and CEO, Americas Society/Council of the Americas
• Ken Tidwell, Partner, The Carlyle Group
• Miguel Zurita, Partner, Mercapital
• Cate Ambrose, President and Executive Director, Latin American Venture Capital Association (Moderator)

Summary

On December 14, 2010, the Americas Society/Council of the Americas hosted its second panel on the current investment climate for private equity (PE) in Latin America, held in partnership with the Latin American Venture Capital Association (LAVCA). Cate Ambrose, LAVCA’s president and executive director, moderated a discussion with partners from leading private investment firms with significant presence throughout the Americas. Panelists gave brief overviews of their respective regional portfolios and discussed attractive markets, potential risks, and the growth of entrepreneurship. Overall, panelists agreed that PE investment is new and relatively risky, but essential to the continued growth of emerging business in the region.

The year in Latin American investment

Although PE investment peaked in 2007 at over $9 billion, 2008 and 2009 saw a dramatic slump due to the economic crisis, dropping down to $4.6 billion and $3.3 billion, respectively. However, 2010 showed promise with a slight increase of about half a billion dollars. The reemerging interest in PE investment is overwhelming, despite recent setbacks; as Ambrose noted: “There is a wall of capital looking at Latin America right now.” But the question is how to use it.

So where to invest?

Ambrose began the discussion by asking panelists where their main investments are located. Patrice Etlin of Advent International stated that the firm does not tie itself to a specific location, but has 80 percent of its investments in Brazil and Mexico. Ken Tidwell of the Carlyle Group noted that, like Advent, Carlyle is not country specific and enters a country based on the following three criteria: a stable political and economic environment; growing domestic market; and underpenetrated and developed private equity market.

Panelists agreed that building relationships is essential for regional and international expansion. Once a firm has its portfolios well established in one country, it becomes easier for them to reach out to its regional neighbors. Advent, for one, was able to expand its portfolio from Mexico to the Caribbean, specifically Puerto Rico and the Dominican Republic. From Argentina, the firm has successfully moved into Chile and Uruguay.

Across the board, panelists agreed that the majority of their activity focuses on Brazil. This comes as no surprise, seeing that Brazil has had an annual average growth rate of 4.2 percent since 2003 and an estimated rate of 5.8 percent for the next four years, according to the Brazilian Ministry of Finance. Americas Society/Council of the Americas’ Susan Segal noted that during Lula’s administration, “28 million people moved into the ranks of middle class,” cultivating unprecedented potential for entrepreneurship and venture capital investment.

Although investments in Colombia, Peru, and Chile are relatively smaller than those in Brazil, panelists expressed their overall satisfaction with the recent success of their portfolios in these three growing markets. In terms of the Latin American countries where the regulatory environment for PE investment continues to improve, Chile and Brazil remain at the top while Colombia has shown a strong and steady improvement since 2006. Ambrose indicated that Colombia has continued to grow with the election of Juan Manuel Santos in August of 2010, supporting competitiveness and free market policies.

Segal acknowledged that “macroeconomic stability in Latin America is vastly different than it was ten years ago,” allowing for international investors to look past the region’s history of economic instability and begin investing dollars into the growing market. Tidwell agreed with Segal, stating that “an Indian buyer would never have ventured into Latin America ten years ago.” Miguel Zurita of Mercapital, a Madrid-based private equity firm, stated that the initial investment in Latin American portfolios will eventually pay off in the long run.

Assessing and addressing risk

Ambrose shifted the conversation to the potential risks of entering the PE market in Latin America. About 52 percent of global investors see the political risk of private capital markets in Latin America as positive or neutral. Tidwell pointed out that the primary fear that PE investors have is that “it’s a process.” In other words, PE investors must commit to long-term partnerships that not only require investment dollars, but time, patience, and development of management and expertise in a market that is not well-established in Latin America.

Another investor preoccupation is the negative outlays for the first three or four years when investing in private equity. There is also a general lack of liquidity and high taxes (up to 60 percent in Brazil) in PE markets that Etlin sees as problematic since “investors are looking for liquidity especially after the 2009 crisis.”

Ambrose introduced the topic of the exit market environment, which panelists addressed with rational optimism. Since transactions between funds are growing in Latin America, it is only inevitable that portfolios will eventually be sold, which Etlin said is a “sign of the maturity of the industry.” Yet the size of the PE market has a direct effect on the success of an exit. For example, exits in Brazil are less complicated than Mexico because there is a deeper stock market in Brazil. Also, Zurita used Peru as an example of a country with fantastic growth, but with a relatively small market. Because there is little experience with exits in the Peru, there is higher risk to investing in PE. It is for this reason that firms must continue to improve exit strategies in Peru and other countries in Latin America that have seen rapid growth in a short amount of time.

Although Brazil is an attractive site for PE investors, according to Ambrose, many claim that “Brazil is overheated.” Etlin agreed, but said that that is not reason for Advent to lose momentum in the Brazilian market. There is also little availability of financing for PE investment, which is relatively more sophisticated in Mexico. Regardless, Etlin pointed out that there is about $5 billion to 6 billion in dry powder and substantial dollars still chasing pension funds in Brazil. Segal noted that Brazil has reached a certain level of macroeconomic stability, but needs to further develop its fiscal and microeconomic reforms in order to further enhance its success. Yet all of these risks must be addressed and not avoided because the region has come too far in its international market development to turn back.

Getting into the entrepreneurial spirit

On the topic of entrepreneurship in Latin America, Segal acknowledged the presence of angel investment, but also noted that there is little venture capital beyond this initial period of support. Brazil, Colombia, and Peru have an emerging entrepreneurial sector, but Segal considers Argentina to be the best in the region in terms of resourcefulness and “surviving adverse economic conditions.” For example, MercadoLibre is the only company to survive an entire economic cycle in Argentina and is now the largest online trading platform in Latin America.

What is meant by “entrepreneurial spirit” can be demonstrated by the privatization process of Mexican businesses over the past three decades. International institutions such as the International Monetary Fund and World Bank condition their loans to businesses in Mexico based on privatization. Ambrose noted that Mexico’s largest industries used to be almost entirely run by family businesses, with little transaction transparency. Now some investors are using their connections to conduct more transparent investments with smaller companies. By encouraging entrepreneurship, new technological innovations continue to invigorate the competition in Mexico. With the proper government framework and support from PE investors, entrepreneurs will be the key to the continued success of the growing middle class in Latin America.