September 18, 2009
By Beina Xu
Dow Jones
As much as emerging markets have been the tortoise in the race to rebound from the recession, investors in the sector still have to tread carefully about what they invest in, and where.
Markets like India and China have come back with relative resilience; capital markets in both countries have shown upside with increased IPO sightings. But many risk profiles still remain challenging for investors to grapple with, including pricing, regulation, corruption worries, and as always, cultural differences, according to a panel at the Dow Jones Private Equity Analyst Conference in New York on Thursday.
“It pays to be highly selective in emerging markets,” said Jonathon Bond, a partner with London-based Actis.
But it also pays to be an emerging market company. Pricing has become increasingly competitive – a premium that many private equity investors seem more willing to pay for entry into the market. Bond cited a deal Actis closed in Egypt for a 10% stake in a top bank for which it paid a little over two times book value.
“Most thoughtful investors are beginning to say that since it’s about growth, perhaps it’s appropriate to pay higher prices for smaller returns,” he said, although Shailesh Dash, managing partner at Global Capital Management, said not all emerging markets were necessarily trading at that level.
What investors need to look for is inefficiencies in pricing, rather than chasing the efficiencies, according to Cartesian Capital Group’s Peter Yu. The firm had funded an airline after 9-11, bought assets from Enron and Worldcom and most recently purchased shares in Citibank.
And the best niches are still the most expensive. Bond said his firm “still likes the Chinese consumer story,” as well as the Indian consumer market, but that both were very fully priced. North Africa and Brazil were also selectively attractive.
“Now we’re trying to recognize that we’re living in a world of permanently higher pricing,” Bond said. “Although the heat map may guide you on the macro level, it’s now down to the GP to really build on sector expertise, location expertise. The growth is there, it’s just about what price you’re getting to pay to get on the escalator.”
Overall, minority investments are the preferred path for myriad reasons, most notably regulation and cultural gaps, according to panelists. Out of the past 70 deals Actis has done in the last 10 years, around two-thirds have been minority, according to Bond. Yu said Cartesian has always preferred minority control with 40% to 45% ownership and a “strong alignment in interest” with the company.
“Soft power in emerging markets in PE is the preferred path,” he said. But for Dash, soft power can only go so far in countries where regulation makes leveraged buyouts nearly impossible.
Being slow helps. Cartesian has a “gestation” period per deal of around 11 months, which it spends building relationships with sellers that oftentimes back out by month three, Yu said.
“In some ways the phrase ’emerging markets’ is a little out of date,” Yu said. “There’s no one who’d rather land in JFK Terminal Three than Beijing Terminal One. The world has globalized – and the companies we select will be based on whether they’re globally competitive.”