The Work

September is upon us, and Portico is marking the beginning of its third year in business. We’re not popping champagne bottles to mark the occasion, but it’s pretty dope to be here plugging away. After all, roughly one-third of U.S. businesses close within their first two years.

It’s not all peaches and cream, of course. EM PE is a hard-driving, competitive industry — and it’s one going through hard times.

During a recent discussion with a client, I shared my reservations about launching an advisory firm that caters to a shrinking industry.

“One of the challenges of managing a firm in this business,” he replied, “is that the downcycles are so brutal. Good people get discouraged waiting for the cycle to turn, and they walk.”

If the figures in this EM PE talent management survey are to be believed, fatigue with the industry explains more than 20% of staff turnover. Boy, do I feel that fatigue sometimes — and I’m not even working in an EM PE firm.

All that said, Portico’s still profitable with zero debt. We missed our (über-) aggressive revenue target, but that’s okay. It was at odds with two other goals I had for the year: launching a product (accomplished, but a serious time commitment) and making sure we had happy customers.

On the latter, we conducted a client survey over the summer to gauge our progress. The findings were favorable: all of our clients were “very satisfied” and our Net Promoter Score is maxed out at +100.

The other encouraging indicator is that all of our new clients have come through referrals.

Portico-Net-Promoter-Score

As for new targets, I experienced an epiphany last month. It came to me shortly after I’d achieved one of my personal goals for the year (attaining two stripes on my belt in BJJ). The epiphany was this: the stripes didn’t matter. I still get crushed, sometimes even by people with less experience. The value (and the pleasure) is in the work itself.

So, no hard targets for year three. I’m going to focus on doing the work and being helpful to others.

Entrepreneurship is way overhyped, but the liberty to chart one’s course makes for a gratifying odyssey.

Two closing thoughts:

First, I’m contemplating some content ideas for year three — a podcast (I know, saturated) and / or in-depth interviews with investors, thinkers, writers, etc.

Which of the following interests you most?

  • Podcast exclusively on EM private markets
  • Podcast on EM private markets + other topics
  • Transcripts of interviews exclusively on EM private markets
  • Transcripts of interviews on EM private markets + other topics

Second, I will be in London in October. Please drop me a line if you’d like to grab a coffee.

Alla prossima,
Mike

Advent + Walmart Brazil

Advent International completed its acquisition of 80% of Walmart Brazil, and it’s reportedly planning to invest an additional $485m across its existing stores. As we discussed in February (Always Low Prices), Walmart’s footprint of 471 stores generated revenues of $9.4B in 2016, but delivered seven straight years of operating losses. Why? “[P]oor locations, inefficient operations, labor troubles and uncompetitive prices,” apparently.

Advent purportedly plans to convert Walmart’s hypermarket formats into cash-and-carries, a format that is growing in popularity amongst local consumers. This should help the company improve one of the 5Ps — Price — by extending steeper discounts to customers.

But I’m curious as to how Advent will address another P — Place. Allegedly, Advent does not expect to roll out new stores; how will they address the so-called “poor locations”?

No clue, but it will be one of many interesting stories to watch in Brazil in the months to come.

African PE: Quo vadis?

Earlier this year, EMPEA released a report on The Road Ahead for African Private Equity. It’s quite good and it contains some refreshingly candid observations on the region.

There is a compelling exhibit that hits at one of our biggest frustrations: the concentration of capital in larger segments, and the relative scarcity of capital available for small and mid-size businesses (see below).

EMPEAAfrica

While the chart includes only a handful of countries (and excludes South Africa), I think it’s directionally accurate — the featured countries accounted for roughly half of the investments that took place in Sub-Saharan Africa between 2015-17.

Five additional findings jumped out at me:

  1. Growth equity deals have evaporated, declining by 45% from 2016 to 2017, reaching the lowest total since 2009.
  2. Managers need to bring more than money to the table — operational capabilities are required.
  3. Deal structuring needs to be more flexible and sophisticated. As one endowment representative lamented, “Many GPs are inclined to throw common equity into companies and call it a day.”
  4. Tech-enabled business models are appearing across verticals, creating a richer landscape for VC and PE alike.
  5. Permanent capital vehicles may be a better fit with the investable market than the traditional PE model.

Creador + Goldman Sachs on Asia

Brahmal Vasudevan — founder and CEO of Creador — recently shared some views on PE in Southeast Asia (where performance has been “quite poor”).

Of course, he’s talking his book at a time when Creador is marketing its fourth fund (which it will undoubtedly close at or above target).

Nevertheless, several observations jumped out at me, including:

  • The diversification benefits of regional funds;
  • The merits of maintaining discipline on fund size;
  • The relative scarcity of “high-quality companies that are growing rapidly and need private equity capital” in select markets; and,
  • The potential for adverse selection in control deals.

It’s an interesting contrast with this recent Exchanges at Goldman Sachs discussion about PE in Asia.

Goldman focuses on the “scale and sophistication” of managers, especially in China. But following all the bullishness and capital flooding into the region’s large / megacap funds, I wondered, “who’s the Muppet?”

Like, I don’t have any original insight on this. My rule #1 on China is: nobody knows anything about China — especially me.

But in my passive reading of the headlines from Zhongguo, I’m left with the impression that the winds of change are in the air. Maybe investors have grown complacent.

Mr. China Meets the Mekong

There are few laugh-out-loud books in the world of finance, but Tim Clissold’s Mr. China is one of them. So many instances of an investor being outwitted and outmaneuvered by a crafty operator.

One of the more memorable bits revolves around an acquisition of a Chinese brewery that (naturally) involved a joint venture partner tied to the central government. A few weeks after wiring $60 million to the JV, $58 million appeared to be missing.

Oops.

Missing funds are not at all the issue in this story about a deal-gone-wrong in Vietnam, but as I read the gossip piece, I couldn’t help but laugh.

I mean, it’s not funny … but it is.

Poultry firm Ba Huan JSC has sought the Prime Minister’s intervention in terminating its six-month-old investment partnership with Ho Chi Minh-based asset management firm VinaCapital. The firm said it agreed to investment terms it now claims to be unreasonable because they were initially stipulated in English.

In February, VinaCapital’s flagship fund Vietnam Opportunity Fund (VOF) had invested $32.5 million to acquire a significant minority stake in Ba Huan.

In its petition to the government, the poultry firm noted that VinaCapital is seeking an internal rate of return (IRR) of 22 per cent per year. It claims that the terms of the deal stipulate that in the event of the IRR not being met, Ba Huan will be fined or required to return the investment capital, along with a 22 per cent interest, or it must transfer to VinaCapital (or its partner) at least a 51 per cent stake in the company.

It also alleged that the partnership restricts it from engaging in any other business except chicken and eggs. Its litany of grievances includes what it claims is VinaCapital’s tendency to veto all board decisions, despite it being a minority shareholder.

So many layers.

I don’t know what’s true here … I don’t even have an opinion. I just take the chuckles when they come.

 

A Most Damning Indictment

Several years ago, I was in Marrakech for the UN African Development Forum. As I waited for a car to take me to the airport, a young man in a black suit was lingering nearby, and he was staring at me in a most uncomfortable way.

It got so awkward that I turned to him and asked:

Tatakallam engleezee?

Yes.

Hey man, how’s it going?

I am good, sir. Where are you from?

The United States.

America. I love the United States. I have applied for a fellowship there.

Where?

MIT.

MIT? Are you an engineer?

An economist. I have a master’s degree in applied economics.

Oh. Do you work for the UN here?

No. I am a volunteer. There are no jobs for applied economists in Morocco. Just with the government. I presented my thesis, which [something something labor market, econometrics, etc.]. But they don’t have any jobs. So, I want to go to America to get my PhD and find a job there. It is very nice there.

Have you been?

No.

[Chitchat about Atlanta and T.I. before car rolls up]

Now, as I rode to the airport, I thought about that young man and how frustrating it is to be underemployed — to have knowledge and skills that can be of value to companies and your country, and yet find yourself unwanted. And I thought about the fickle finger of fate that dictates the range of potential life outcomes based on where one’s born and to whom.

I thought about the PE firms pursuing higher education deals in Africa and across the emerging markets. And I thought about all these students (and their parents) paying tuition to get a handhold on the ladder to a better life, and the risk that new graduates might end up like this young man, with a degree that the market doesn’t value.

In development economics, increases in human capital are vital to long-term economic growth. But what happens if the gap between expectations and reality for newly minted college graduates becomes a yawning chasm? I think we know the answer …

Anyway, these musings came to mind recently after I read a most damning indictment of PE investments in for-profit universities. The academic study, When Investor Incentives and Consumer Interests Diverge: Private Equity in Higher Education, explored 88 investments in U.S. for-profit colleges.

What did they find? In summary, following the buyout:

  • Profits↑ by upwards of 3.3x, driven by higher enrollments (↑ 48%) and tuition increases (↑ 17% relative to mean);
  • Graduation rates↓ by 6%;
  • Earnings of graduates↓ by 5.8% relative to a mean across all schools of ~$31k;
  • Per-student debt↑ 12% relative to mean;
  • Educational inputs↓ in absolute number of faculty, with 3% ↓ in share of expenditures devoted to instruction; and,
  • Rent seeking: revenue from public sources (e.g., federal grants and loans) ↑ from 60-70% prior to the transaction to 80%+.

Basically, students end up paying higher prices for inferior products and shittier prospects. Presumably agriculture isn’t a popular field of study, otherwise customers would know where to find the pitchforks.

There are many interesting findings in the paper, such as the nugget that “the returns to for-profit education [for the consumer] are zero or negative relative to community college education.” So, dig in. The online appendix with even more data is available here.

Or, you can look at slides 2, 10-15, and 20 in this presentation to the NY Fed.

From the Bookshelf

In every venture the bold man comes off best, even the wanderer, bound from distant shores.

— Athena in Homer, The Odyssey (Robert Fagles, trans.; Penguin: 1996)

# # #

Haven’t signed up for our newsletter yet? Sign up now.

# # #

The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

Copyright © by Portico Advisers, LLC 2018, all rights reserved.

 

Veritas

Last month, the New York Times published a fascinating article about the market for followers on Twitter. (Disclosure: shareholder of NYT and TWTR). The manufacture of social capital is something that I hadn’t really thought about before, but now that my eyes have been opened, it’s hard not to notice it.

For example, it’s always been nauseating when someone namedrops to inflate his or her reputation, but I hadn’t considered companies leveraging the brand equity of established firms to magnify their own. Think of all the conferences and august fora where firms’ logos are on display. (Yours, too, could be featured amongst the great and the good for a modest sum).

Or, consider this: have you ever read a profile of a firm or entrepreneur and, en passant, your nose turned up in a visceral reaction? Something just smelled about it? Me too. The article was probably placed. By a PR firm that doesn’t do nuance. Occasionally, these articles include character references from individuals who are compensated by the company being profiled, and yet the credulous journalist didn’t care to ask about potential conflicts.

The currency of currency is all a bit exhausting. I’m reminded of Diogenes the Cynic’s apocryphal confrontation with Plato:

On seeing [Diogenes] washing vegetables, Plato came up to him and quietly remarked, “If you paid court to Dionysius, you wouldn’t need to be washing vegetables,” to which he replied in the same calm tone, “Yes, and if you washed vegetables, you wouldn’t need to be paying court to Dionysius.”

Anyway. Next month, I’ll be at the UNC Alternative Investments Conference, where I will be leading a teach-in session on the role of EM PE in LPs’ portfolios. I’m planning to cover the evolution of emerging markets and explore whether investors are being presented with a richer landscape of opportunities than was available in the past. I’m really looking forward to it. Click here to learn more about the event, and please reach out if you’re planning to attend.

Alla prossima,
Mike

Abraaj

The New York Times and Wall Street Journal report that the Bill and Melinda Gates Foundation, CDC Group plc, IFC, and PROPARCO have hired forensic accountants to probe the books of the Abraaj Group. The investigation is focused on the use of funds within the $1 billion Abraaj Growth Markets Health Fund.

According to the WSJ, which claims to have reviewed the fund’s quarterly reports to investors, Abraaj called $545 million between October 2016 and April 2017, but had invested $266 million by September 2017. In October 2017, the four LPs are said to have asked for bank statements to show what—if anything—was done with the balance of the funds. Abraaj is said not to have provided them. In December, Abraaj is said to have returned $140 million to the fund’s investors.

A reading of the two articles together suggests that there may be some disagreements over the obligation to return called capital—and the time window for doing so—when projects are delayed rather than canceled. Two hospital projects—one in Karachi and one in Lagos—are said to have been delayed.

The WSJ notes that “construction in Karachi was delayed by a ban on new buildings more than two floors high. The planned hospital had 17 floors.” Local media sources report that the ban went into effect in May 2017 due to water shortages and inadequate civil infrastructure in Karachi. Last month, Pakistan’s Supreme Court approved construction for buildings up to seven-storeys high.

Abraaj released a statement on 4 February saying, “recent media reports … are inaccurate and misleading.” The firm states that it appointed KPMG in January 2018 “to verify all receipts and payments made by the Fund,” and that as of 7 February, “KPMG has now completed its findings and reported that all such payments and receipts have been verified, in line with the agreed upon procedures performed, and that unused capital was returned to investors.”

The forensic accountants’ investigation has either not yet been completed, or the findings have not been disclosed publicly.

To an outsider, this looks quite bad. The investor syndicate that hired the forensic accountants isn’t comprised of neophytes to EM PE and impact investing. On the contrary, they’re the most experienced LPs in the industry. IFC alone has invested in over 200 EM funds over the last decade, while CDC is an active investor in 164 funds in 74 countries—including other Abraaj vehicles. These investors have mainstreamed EM PE as an institutionalized investment strategy. If their concerns are in the newspapers, then it’s worth paying attention.

More broadly, this could have knock-on effects across the broader EM private markets landscape. Integrity and transparency are vital, particularly in an opaque industry and in markets where investors confront information asymmetries. To the extent this story encourages managers to improve their operations and reporting, this is a good thing. However, with one of the largest and most visible EM firms coming under scrutiny regarding its use of funds, there is a risk that more investors will just walk away from EM altogether.

The industry will not thrive without trust, transparency, and quality corporate governance.

Abraaj is currently in the market for a $6 billion mega fund. The WSJ’s sources suggest that the firm has collected $3 billion toward its target. I find that incredible; not only because there have been several senior departures from Abraaj of late, but also because it’s hard for me to make the math work from both a top-down and a bottom-up perspective.

  • From a top-down perspective, we explored the absorptive capacity of EM PE in our latest research piece, which, based on an analysis of exits and M&A volumes, suggests that annual flows to traditional fund strategies may need to shrink to $16 billion per year. Can one firm collect a third of that and invest it well? I have my doubts.
  • From a bottom-up perspective, Abraaj built its global platform through the acquisition of Aureos, an SME-focused investor that was writing $10 million checks. In recent years, Abraaj has been securing deals through auctions—outbidding established large-cap firms such as Carlyle and TPG—and secondary buyouts from the likes of Actis, Advent International, ECP, and Metier. It seems reasonable to ask about pricing pressures and style drift.
  • Finally, the firm has raised an estimated $3B across five funds since 2015 and appears to be in the market for upwards of $7.1B across four funds (see exhibit below). Where are they going to put it all?

Of course, all this may just speak to my failure of imagination.

Several institutional investors have read Hamilton Lane’s reports and clearly disagree with the previous assessments. Washington State Investment Board (approved unanimously, up to $250 million) and Teachers’ Retirement System of Louisiana (approved 6-3, up to $50 million) have committed to the mega fund, while PEI reports that Teacher Retirement System of Texas is on board as well.

Scale has its advantages.

Abraaj2

Private Debt in Africa

Runa Alam of Development Partners International co-authored an intriguing article on the prospects for private debt in Africa. There’s clearly demand for more flexible capital solutions amongst local businesses, and my understanding is that some early suppliers of credit / mezzanine solutions on the continent, such as Amethis and Vantage Capital, have done well. As one would expect given the supply-demand imbalance, new entrants emerged:

  • Helios Investment Partners launched Helios Credit, its direct lending platform, in 2015.
  • Ethos acquired Mezzanine Partners in July 2016 and launched Ethos Mezzanine Partners 3 with a target of $150 million.
  • Syntaxis Capital, a Central and Eastern Europe-focused private debt investor launched an Africa strategy in 2016, establishing a presence in Lagos.

Presumably DPI will be joining them.

It’s important to remember, though, as one seasoned private credit manager once put it to me, “leverage is not your friend in emerging markets.” Private credit is more than just a position in the capital stack. It requires a different skillset than growth equity, and a deep understanding of volatility’s impact on balance sheets and cash flows. Choose your partners wisely.

Taking a step back, it’s great to see a broader set of financing options being made available to entrepreneurs on the continent. For LPs willing to look, there are some very interesting managers with vehicles that expand Africa’s investable market. (Drop us a line if you’d like to know more).

Always Low Prices

Walmart, the world’s largest company by revenue, is reportedly shopping around their Brazilian operations. ACON Investments, Advent International, and GP Investments are said to have been pitched.

According to Thomson Reuters, the company’s 471 local stores generated revenues of $9.4 billion in 2016. However, the company “posted operating losses for seven years in a row after an aggressive, decade-long expansion left it with poor locations, inefficient operations, labor troubles and uncompetitive prices.” In short, apart from the labor troubles, they weren’t Walmart.

Apparently, several retailers took a look at Walmart’s assets in the country, but took a pass on them after concluding the suco ain’t worth the squeeze. A consequence, it seems, of Walmart’s poor customer understanding and a bungled expansion strategy.

It will be interesting to see if a private equity buyer can turn things around, but it’s pretty clear they won’t be paying up for the privilege to do so. In that sense, Walmart’s finally operating true to form: offering bric-a-brac at the deeply discounted prices that shoppers have grown to love.

Currency Risk in Emerging Markets

Sarona Asset Management released the final report of its nearly year-long initiative, “Expanding Institutional Investment into Emerging Markets via Currency Risk Mitigation.”

Sponsored by USAID’s Office of Private Capital and Microenterprise, and in partnership with EMPEA and Crystalus Inc., the initiative sought to develop innovative, practicable solutions to FX risk management in EM PE. The final report contains a wealth of data and information on FX hedging in EM, as well as three new “solution pathways” that the project tested with practitioners:

  • New direct currency hedges (i.e., covertures and supported range forwards);
  • Proxy hedges (i.e., baskets of liquid, low-cost interest rate, equity, and commodity options); and,
  • Insurance.

The proxy hedge was piloted through simulated back tests against two EM PE portfolios over 20 years, and the product shows promise. However, as always with hedging, the devil is in the details.

USAID and Sarona have kindly made the report available to the public. Click here to download it.

From the Bookshelf

Recurrent descent into insanity is not a wholly attractive feature of capitalism …

The only remedy, in fact, is an enhanced skepticism that would resolutely associate too evident optimism with probable foolishness and that would not associate intelligence with the acquisition, the deployment, or, for that matter, the administration of large sums of money. Let the following be one of the unfailing rules by which the individual investor and, needless to say, the pension and other institutional-fund manager are guided: there is the possibility, even the likelihood, of self-approving and extravagantly error-prone behavior on the part of those closely associated with money …

A further rule is that when a mood of excitement pervades a market or surrounds an investment prospect, when there is a claim of a unique opportunity based on special foresight, all sensible people should circle the wagons; it is the time for caution. Perhaps, indeed, there is opportunity … A rich history provides proof, however, that, as often or more often, there is only delusion and self-delusion.

— John Kenneth Galbraith, A Short History of Financial Euphoria (Penguin: 1993).

# # #

Haven’t signed up for our newsletter yet? Sign up now.

# # #

The information presented in this newsletter is for informational purposes only. Portico Advisers does not undertake to update this material and the opinions and conclusions contained herein may change without notice. Portico Advisers does not make any warranty that the information in this newsletter is error-free, omission-free, complete, accurate, or reliable. Nothing contained in this newsletter should be construed as legal, tax, securities, or investment advice.

Copyright © by Portico Advisers, LLC 2018, all rights reserved.