A private affair
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Emerging Markets

A private affair

A surge in private equity flows to Latin America brings with it a more cautious approach to risk management


Buoyed by low inflation and an abundance of global liquidity, the private equity funds that fled Latin America just under a decade ago are staging a formidable return. Once again, investors are discovering an appetite for Latin risk, though this time in the hope of more stable returns. “Investors that weathered the storm and stayed proved to be most successful,” says Lucas de Beaufort, senior associate with EMP Latin America, a private equity firm. “But investors have short memories: so many left and for those that have come back, there is not much trauma.” In 2004, $714 million in funds was raised, climbing to $1.3 million in 2005, while the first quarter of 2006 alone matched this activity, with analysts expecting a significant increase beyond this.


According to the Emerging Markets Private Equity Association (EMPEA), $3.7 billion in funds was raised in 1998, collapsing to $407 million in 2002. This was largely the result of the turmoil that beset the region for many of those years: the Mexican banking crisis in the mid-90s, widespread currency devaluation and the Argentine financial crisis of 2001. These episodes, together with high expectations but poor fund performance, meant funds went bust, focused their attention to Asia with its abundant capital or went back to Europe and North America. To many regional specialists, the gradual return of private equity to Latin America reflects an improvement in the region’s macroeconomic fundamentals.


“Local markets were very expensive, and the devaluation of currencies in the region caused massive blows to those companies that had leveraged in dollars,” says Julio Lastres, managing director at Darby Overseas Investments. Lastres believes flexible exchange rates have helped combat lower inflation, while better governance has notched up credit ratings and helped the development of local capital markets across the region. One of the developments he finds most promising is the rise of institutional players: “With low interest rates in Brazil, pension funds now have an incentive to play outside the bond market.” The consolidation of local capital markets will encourage investors to believe they can exit successfully through public offerings, he says.


Ownership change


New management strategies are a further sign that investors are increasingly willing to take a bet on the region. According to Alyssa Grikscheit, a partner at law firm Goodwin Procter, investors have changed their attitude towards corporate governance since the Argentine crisis: “Many of the first generation funds were content with minority positions, but investors are now seeking either majority control or de facto control through creative minority protections.” Shifting the ownership structures maximizes investors’ legal protection while granting local companies the benefit of experience and a fresh perspective. In general, this new wave in private equity flows represents a more cautious approach to risk management.


But this does not mean new investors are being timid. Advent International’s acquisition of Controladora Milano, a Mexican clothing retailer, from an investor group under Newbridge International’s stewardship, is one such example. The deal, which leveraged on equity flows of $110 million against $90 million in debt, is a significant move. “It reflects our confidence in the consumer market due to demographic and investment opportunities in Mexico, and retail gets aggressive financing,” says Santiago Castillo, principal at Advent’s Latin America buyout team.

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