Passages

Happy new year. I hope you closed out 2018 with some respite and relaxation.

Our family welcomed the arrival of a new son / little brother shortly after Thanksgiving, so I’m thrilled to be starting the year refreshed and well-rested. 👀

One delightful discovery during the sleepless nights has been Patrick Leigh Fermor’s collection of travel writings. Bleary-eyed with baby strapped to my belly, I recited lines of exquisite prose to the bambino, evoking distant lands and daring adventures from a vanished world.

Whilst following the young Fermor’s trek along the Danube toward Constantinople, memories of my own youthful journeys through Mitteleuropa often materialized.

Visions of a glorious hike through the Berchtesgaden Alps; the enveloping warmth of eiderdown on a chilly summer evening; a call to my father from a payphone to wish him happy birthday, after imbibing zwei Maßkrügen of beer.

My dad would die within three years of that call, but I can still hear the mirth in his voice. How I wish he could have met his grandsons. May they forge paths of their own.

It could very well be the delirium, but I’m hoping that this year will be more constructive for EM private markets than 2018 was.

I wish I had something concrete to pin my hopes on, but the sheer degree of negative sentiment is all I’ve got.

Ain’t going to be an easy row to hoe, I’m afraid. So, we might as well get on with it.

Alla prossima,
Mike

P.S. Thanks to those of you who encouraged folks to subscribe to this newsletter. Portico made a donation to Room to Read for each new subscriber, so thanks for contributing to children’s literacy.

———

Profit from Purpose

So, the President of the World Bank Group unexpectedly resigned to join an infrastructure investment firm.

Par for the course. The writing was on the wall a year ago.

(“Jim has a lot of credibility with private equity firms,” said David Rubenstein.)

In an e-mail seen by the Wall Street Journal, Dr. Kim stated:

I’ve concluded that this is the path through which I will be able to make the largest impact on major global issues like climate change and the infrastructure deficit in emerging markets.

Look. I’m sure it stinks to be working with the Trump Administration. And it’s hard to make it in DC on a net-of-tax salary of $500,600 whilst enjoying world-class benefits. From a pecuniary perspective, it’s best to hop near the market top. Now’s better than three years from now.

But may we just pause and reflect on his statement?

What, pray tell, is the point of the World Bank anymore? Why did it need $13 billion in extra capital?

And what does Dr. Kim’s early departure tell us about the ability of the Bank to mobilize private funds?

Also. I am not questioning Dr. Kim’s sincerity regarding private capital’s role in solving development challenges — even if it led to a regrettable endorsement — but given the Bank’s role in financing climate solutions and infrastructure in developing economies, don’t the optics here look a bit Swampy?

Anyway, the Bank’s next President may need to come up with a new mission statement.

Thankfully, s/he likely won’t be Jeffrey Sachs. #huawei

———

Deals!

We kicked off last year with everyone getting bulled-up on EM, and this newsletter offered some cautious optimism about the prospects for exits:

Here’s hoping that we see sustained portfolio and direct investment flows, and GPs seizing the opportunity to distribute capital back to their LPs.

Well, we know how that story played out. #sadtrombone

According to data from Thomson Reuters Deals Intelligence, EM saw a 17% reduction in the volume of completed M&A transactions. The downdraft was most pronounced in Africa and Eastern Europe — which both experienced declines of 31% — but the slowdown hit each region (see below).

599e287f-c305-4fad-9210-87bbf61081ba

Fun fact: the Thomson Reuters data show that SoftBank paid out $894m in investment banking fees in 2018.

———

Tough Crowd

Private Equity International released its 2019 LP Perspectives survey. If the 101 respondents are a representative sample — an open question — then it looks like it’s going to be another tough year on the fundraising trail for managers ex-Asia (see below).

26ff7765-5808-4435-a4be-12e8c6fc825f

We’ve discussed LPs’ herd behavior driving a tsunami of capital toward (large-cap) Asia several times over the years. That shows no signs of abating.

Meanwhile, capital scarcity continues to define the rest of EM. History suggests that such conditions are conducive to strong performance, but — as ever — the contrarians seem to be few and far between.

Moose Guen, CEO of MVision, provides a sobering outlook:

The interest in new markets like Latin America or Africa and even parts of Asia is extremely limited. Not because of lack of opportunity or experience, but due to local currency volatility relative to the US dollar and the net dollar returns … Over the next few years, GP headcount in those markets will be inhibited because it’s very difficult to finance them.

———

Risky Business

IFC SME Ventures teamed up with CrossBoundary LLC on a study that explores PE investing in fragile and conflict-affected situations (“FCS”) in Sub-Saharan Africa. The study reaches several conclusions that we’ve advanced in this newsletter — such as the merits of flexible mandates, financings, and fund structures — and it makes a convincing case not to invest in single-country funds in frontier geographies.

I found the most thought-provoking finding to be the determination that:

FCS funds with better net returns tend to either be highly active and in control positions on select investments or deploy standardized (but flexible) debt-like instruments to a larger group of investments … Small funds with a large array of minority equity positions can struggle to both realize liquidity and adequately manage their investments.

a03189d9-a9c4-4936-b738-8948efb3f50b
Source: IFC SME Ventures.

That said, later in the report, an analysis of 312 exits from IFC’s frontier markets PE portfolio reveals that “minority positions have performed almost as well as majority positions in terms of median gross IRR.” I wonder if the discrepancy boils down to geographies (frontier vs. FCS) or a comparison of deal-level vs. fund-level returns.

In any event, the report provides some good food for thought.

———

GP Stakes

In private equity the managers do better than the investors.

The FT recently reported on Dyal Capital and the growing business of firms investing in private equity fund management companies. In essence, the business entails taking a minority stake in the GP — providing the manager an injection of permanent capital — in return for a share of the management fees and carry.

I haven’t seen data on the volume of transactions in this space, but I observed with interest the launch of Meteor5, whose management team includes MVision’s Moose Guen. The firm invests in emerging GPs, and it strikes me that a firm like this can play an important role in seeding new managers and accelerating their time to close — all with the benefit of having visibility on the product that LPs demand.

Whilst I’ve seen EM GPs sell their franchises in whole or in part to other asset managers, I’ve not seen much along the lines of the Dyal / Petershill / Meteor5 / etc. approach.

And I think I know why.

EM PE’s industry-level performance and the harsh fundraising environment raise questions about the viability of firms raising follow-on funds and harvesting investments. How does one get comfortable estimating the terminal value of fee income + carry?

It’s all a bit of a shame, but I wonder if some enterprising, well-capitalized folks might come up with a solution.

———

From the Bookshelf

There are times when hours are more precious than diamonds.

— Patrick Leigh Fermor, Between the Woods and Water (NYRB Classics: 2005)

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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 2019, all rights reserved.

 

Liquefaction

Liquefaction | ˌlikwəˈfakSH(ə)n | noun
a process that creates a liquid from a solid (basically)

I’ve been wrestling with the idea of entropy in international affairs for the last five years or so. During my travels to London a couple weeks ago, Brexit peppered most every conversation, and I found myself thinking about political instability and its implications for investors.

The global landscape has transformed from solid to fluid, whether at the level of the international system, the state, or the individual. While the “decline of the liberal international order” has been debated ad nauseum, it’s fairly clear that we are transitioning from the post-World War II system to a new one. The problems seem to be that: (1) nobody knows what the new system should be; and, (2) no leaders are guiding us toward one.

That may be due to the fact that national leaders have more pressing priorities. How are leaders meant to identify principles of unity amongst nations when disunity and discord are ascendant at home — and, indeed, actively stoked to win at the polls?

Our populist and reactionary politics are a symptom, not the disease. At bottom, across developed and emerging markets alike, the social contract is broken.

As bleak as things are, it’s worth remembering that one of the benefits of democratic governance is that these fissures are out in the open. People are free to talk about them. The steam can be released. Society and institutions can adapt.

So, amidst all this political instability I’m beginning to think that the greatest risks in this brave new world come from the presumption of stability where none, in fact, exists.

And while I’m at it, I detect an astonishing degree of complacency toward one market in particular: China.

According to EMPEA’s Industry Statistics, $84B of capital has been raised for China-dedicated PE funds over the last five-and-a-half years, with scores of billions in regional funds that will invest in the country.

There seems to be a presumption that, since the country and its currency have been stable, this state of affairs will continue. That’s not how things work. Everyone’s legal disclaimers say as much (“Past performance is not indicative of future results …”).

I shared my rule #1 on China last month (“nobody knows anything about China — especially me”), but China’s fragilities are increasing. And a certain someone in the White House seems to smell it.

Will the country’s political system be able to respond to current and future challenges? In a manner that’s aligned with the interests of international capital?

I have my doubts.

At the very least, confidence intervals should be adjusted.

My conclusion: the most valuable attribute in EM private markets going forward is a flexible mandate.

There will always be a place for focused specialists, especially managers who bring bona fide operational expertise and can genuinely build businesses. However, in a fluid global landscape, flexibility is key — whether geographic, along the capital stack, or even across asset classes.

It’s time to think different.

Anyway, Portico has been busy in all corners during this harvest season, but particularly in Latin America, which remains a manifestly underappreciated region (see below).

Things are also a tad hectic on a personal level, as our family’s expecting the arrival of our second son / first little brother next month. If there’s no newsletter in November, well … entropy.

Alla prossima,
Mike

Herd Behavior

EMPEA released its 1H 2018 industry statistics and the concentration of capital in Emerging Asia is astonishing. Across private equity strategies (i.e., buyout, growth, and VC) Emerging Asia captured $24B — 93%! — of EM fundraising in the first six months of the year (that’s up from 77% in full-year 2015).

Only $1.85B was earmarked for PE managers active in Africa, Central & Eastern Europe, Latin America, and Pan-EM.

As usual, it’s worse than it appears.

That $1.85B figure overstates the volume of U.S. dollar investors committing capital to EM managers. Consider that the largest PE funds achieving a close in each region ex-Asia raised only $382m in USD, but $1.1B in local currency vehicles (see below).

Screen Shot 2018-10-24 at 11.36.46 AM

I get that political uncertainty has stalled many Latin American managers’ fundraising plans, but $24m in USD? WTF?

Meanwhile, the forward calendar in Emerging Asia (inclusive of closes in Q3) has over $50B of USD-denominated funds in market (e.g., Hillhouse, Baring Asia, CVC, PAG, TPG, etc.).

I’ve disclosed Portico’s interest, but if ever there were a contrarian play in EM PE …

KYC

Fred Wilson of Union Square Ventures put out a heat-seeking missile of a blog post on Sunday (Who Are My Investors?). You should read it.

Fred’s musings were prompted by a note from one of USV’s portfolio company CEOs, who said:

I need to know if any of your LPs include ……….  entities/interests.

This is a super interesting and welcome development, and I think Fred’s right to conclude that the quality of a fund’s LPs will impact deal flow … at least in U.S. venture.

A few quick reactions:

  • The cynic in me wonders if this sentiment is a luxury of a world awash in capital. But then, maybe founders with vision are the scarcest thing around.
  • For all the asset managers clamoring after Millennial money with impact strategies, it’s notable that founders are saying they want to partner with ethical investors who share their values.
  • We’ve talked a lot about transparency and governance in this newsletter this year, and it’s intriguing to see a dialogue emerge about information flowing down to the portfolio company, and not just up to the fund.

Anyway, in case you don’t click through to Fred’s post, his bold conclusion follows:

It is time for all of us in the startup and VC sector to do a deep dive on our investor base and ask the question that the CEO asked me. Who are our investors and can we be proud of them? And do we want to work for them?

Not all money is the same. The people that come with it and who are behind it matter. That has always been the case and remains the case and we are reminded of it from time to time. Like right now.

Add-Backs

The thing about dealing with leveraged buyout firms is that you always know who the Muppet isn’t.

Let’s say you’re a leveraged lender. A Patrick Bateman clone shows up and presents his bone-colored business card along with pro forma financials showing “adjusted EBITDA” for a company they’d like to lever at 6x.

You ask some questions about his revenue growth and efficiency gain assumptions, which seem slightly … optimistic.

But also, you don’t want to get fired for turning away business from a Very Important Client Who Always Gets What He Wants.

Meh, it’s not your money.

So the loan gets funded, and some teachers’ pension in Dubuque or wherever ends up holding the paper.

A couple years later, as you’re clearing out your desk, you find Bateman’s business card and you remember the discussions about the adjusted EBITDA. And since you’ve just been fired, you have time to look up what happened to that company. Did they grow revenues? Did they capture those efficiencies?

If your research reveals anything like a recent analysis by S&P Global Ratings, you’re likely to find that Bateman’s adjusted EBITDA turned out to be slightly … optimistic.

Says Institutional Investor:

In an analysis of companies involved in deal making in 2015, S&P found that the earnings projections were unrealistically high on average across leveraged buyouts and mergers due to so-called “add-backs” — adjustments made to account for expected cost savings or an anticipated rise in revenue … Compared to companies’ projections, EBITDA … turned out to be 29 percent lower in 2016 and 34 percent lower last year.

The good news is: (1) tallboys of Tecate come with a shot of Fidencio at El Rey’s tonight; and, (2) your mom’s pension invested in the LBO fund.

So when Bateman & Co. jammed through the inevitable dividend recap, the probability of your mom living on cat food declined by a few basis points. Unlike those sad souls in Des Moines or wherever.

Every cloud has a silver lining.

¡Salud!

Public Companies and Short-Termism

The U.S. Federal Reserve Board conducted a study to investigate the investment tendencies of public and private firms. Using corporate tax returns, the economists determined that — contrary to popular belief — “public firms invest substantially more than private firms.”

Says the study:

Relative to physical assets, publicly-listed firms invest approximately 48.1 percentage points more than privately-held firms … predominantly driven by long-term assets: public firms invest 6.5 percentage points more in short-term assets, and 46.1 percentage points more in long-term assets than their private firm counterparts … The access to capital investment and the ability to spread risks among many small shareholders appears to facilitate heavier investments in R&D, arguably the riskiest of asset classes.

You learn something every day.

And who knew R&D was an asset class?

Impact Investing

I don’t know about you, but I find it a bit difficult to wrap my head around “impact investing.” The term is as slippery as a greased pig.

IFC has stepped into the breach and developed, in consultation with asset managers and investors, a set of Operating Principles for Impact Management. The draft document establishes nine principles across the following five elements:

  • Strategic Intent
  • Origination & Structuring
  • Portfolio Management
  • Impact at Exit
  • Independent Verification

IFC is inviting reviews from stakeholders through the end of the year, so if you have an opinion, please share it. With IFC.

From the Bookshelf

Thus they were able to recall the past in the hope of finding new wisdom rather than in awe of its immutable commands; they could think of the future as a time of promise rather than of certainty; and they could use the present as an opportunity for the exercise of choices rather than for compliance with preordained patterns of life.

— Adda Bozeman, Politics and Culture in International History (Princeton University Press: 1960)

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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.

 

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)

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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.

 

The White Stripe

A small print of Jody Clark’s “Keep Treading” hangs on a wall in my office. It’s a picture that I first saw at the Brazilian Jiu Jitsu (“BJJ”) gym where I started training last fall. It shows a man in a gi trying to stay afloat in the ocean. An eel is wrapping around his legs and pulling him asunder, while a collection of sea nettles threatens to sting him if he reaches out his arms.

It’s an apt metaphor for the travails of a white belt in BJJ. As Sam Harris describes it, “The experience … is akin to falling into deep water without knowing how to swim. You will make a furious effort to stay afloat—and you will fail.”

That is an accurate one-word summation of my first five months in BJJ: failure. Relentless, unmitigated failure. Soul- and ego-crushing failure.

Consider this dispatch from my BJJ journal:

2/10 – Open Mat

Performed poorly. Got smashed. Decent defense but too passive. Need to be more aggressive. Neck got crushed while in turtle. Honestly I just feel dejected.

There are days when the hardest thing is showing up to class or open mat. The certainty of being smashed, submitted, and in pain makes it all seem like a futile exercise. It’s so tempting to quit in the face of near-certain failure.

But, you have to keep treading. It’s all a bit of a metaphor for life as a whole.

Last week, I received my first stripe on my white belt. I know it’s foolish to place much stock in outward signs of progress, but this promotion—this piece of tape—was one of the more hard-earned accomplishments in my life. And yet, it’s merely the first rung on the ladder. Progress. One aching, small step at a time.

In other news, I’m looking forward to joining some folks from General Atlantic next month for a conversation with students at UVA’s McIntire School of Commerce. Should be fun!

I’ve also created a video of the presentation that I delivered at the UNC Alternative Investments Conference last week (some of the slides are featured below). If you’re keen to see a 30-minute overview of EM PE, check it out on YouTube!

Alla prossima,
Mike

Abraaj: Part Deux

In last month’s newsletter we discussed the drama at Abraaj following revelations that four LPs had hired forensic accountants to probe the books of the Abraaj Growth Markets Health Fund.

The situation is serious, indeed:

  • Abraaj’s fund management business is being split off into a separate entity with an independent board “to which internal audit and compliance will directly report.”
  • Abraaj’s founder, Arif Naqvi, relinquished management of the funds business, though he is expected to serve on its investment committee.
  • The firm announced a halt to investment activities.
  • Private Equity News reports that Themis, the energy team that Abraaj acquired in March 2016, sought to end its partnership with the firm as early as mid-2017. Denham Capital announced a new platform agreement with Themis earlier this month.
  • The WSJ reports that the firm is weighing job cuts as its fundraising is put on hold; existing investors in its $6B target mega fund are asking for their money back; investors in other funds are considering selling their stakes; and, lenders are reviewing credit lines for their capital call facilities.
  • The FT reports that the firm’s CFO departed.

Meanwhile, the firm is still unable to secure an exit from K-Electric, a divestiture it announced in October 2016. Abraaj was slated to receive a consideration of $1.77B from Shanghai Electric Power, a subsidiary of the State Power Investment Corporation of China; however, the transaction has been dogged by delays.

According to a local news report dated 9 March, the Pakistani government still had not cleared the sale, in part because it has not received a copy of the sale-purchase agreement, in part on national security grounds, and in part because the company is alleged to owe “dues” upwards of PKR139 billion (~$1.25B). Arif Naqvi is reported to have met with government ministers this week in an attempt to accelerate the sale.

What a mess. I’m left wondering if investors in the firm’s funds will seek (a) new GP(s) to manage out the assets.

EM Fundraising: Coming Full Circle?

 

giphy2

“Coming Full Circle.” So reads the adulatory headline from EMPEA’s year-end 2017 statistics, which show $61 billion in EM fundraising across PE, private credit, and infrastructure and real assets—the highest level since 2008. Break out the champagne glasses and lace up those dancing shoes. EM PE is back!

Or not.

Looking at fundraising for buyout and growth equity funds, the volumes remain stagnant since 2011 (see below). Though 2017 shows a rebound, the aggregate figure is deceptive: KKR Asia III clocked in at $9.3B and Affinity Asia closed on $6B, which means these two funds account for 40% of the capital raised for buyout and growth strategies. That leaves about $20B for the rest of EM. It’s peanuts!

FRchartv2

The trends we highlighted in November 2016 are continuing apace, with only 75 growth equity funds achieving a close in 2017—a 44% decline since 2010. In addition, new entrants are struggling to get traction. EMPEA’s own analyses show that first-time growth equity funds have declined from 30% of the capital raised for the strategy in 2008-09 to less than 10% over the last four years.

At issue is a lack of distributions and a lost decade for LPs in EM buyout and growth equity funds (see below). There is a sharp drop-off in distributions beginning in 2007 / 08 when fundraising exploded. It’s a decade later, and the breakpoint for top-quartile funds beginning in 2008 hasn’t returned investors’ capital.

lostdecade

These performance indicators from Cambridge Associates are damning, and it’s no surprise why LPs have been walking away from “traditional” EM PE in greater numbers.

But there’s something about this exhibit that bothers me. I know many established managers that refuse to provide their performance figures to Cambridge. One global manager was befuddled when I presented these figures; s/he noted that their EM deals generated IRRs well north of 30%.

It’s worth asking whether Cambridge’s benchmarks are a worthy benchmark in EM. I have my doubts.

For example, a quick sketch comparing the universe of EM buyout and growth equity funds—as collected by EMPEA—to those in Cambridge Associates’ database show that CA has between 4% and 21% of the total number of funds by count, and between 29% and 60% by total capitalization (excluding 2011; see below).

cambridge

The industry is poorly served by these benchmarks. I should probably stop using them, but there is no credible alternative.

If only there were an organization that could serve as a utility for the industry—one that provided impartial data on private capital performance … 🤔

In any event, as bearish as I’ve been about the prospects for the EM PE industry, I am cautiously optimistic that we’re close to reaching a bottom. If flows to EM public equities continue, then the exit windows should stay open, managers should distribute cash to their LPs, and then capital can be recycled to new commitments.

While I don’t expect EM-dedicated growth equity and buyout funds to come “full circle” to the $58 billion they raised in 2007 anytime soon, the scarcity of capital allocated to the sub-$1 billion segment portends well for the performance of current vintages. And if history is any guide, LPs will herd back into these markets after the “easy” money has been made.

giphy1

Private Equity: Overvalued and Overrated?

Dan Rasmussen of Verdad is not making friends with many people in private equity. His former colleagues at Bain Capital must wish he’d stop talking. Like him or hate him, Dan puts out thought-provoking, empirically driven takes on the myths and realities of U.S. buyouts (see last December’s newsletter for an example).

In his latest piece, “Private Equity Overvalued and Overrated?”, Dan probes three premises about which there is “near-complete consensus:”

  • PE firms make money by creating value in portfolio companies;
  • PE is less volatile / risky than public equity; and,
  • PE will significantly outperform other investments.

Rasmussen’s most interesting conclusion pertains to the first bullet: the myth of value creation. Verdad constructed a database of 390 deals—representing more than $700 billion in enterprise value—for which the PE firm issued debt to finance the acquisition. This enabled Verdad to compare underlying companies’ financial performance both pre- and post-acquisition. What did they find?

In 54 percent of the transactions we examined, revenue growth slowed. In 45 percent, margins contracted. And in 55 percent, capex spending as a percentage of sales declined. Most private equity firms are cutting long-term investments, not increasing them, resulting in slower growth, not faster growth.

If PE firms are not growing businesses faster, investing more in growth, or gaining much operational efficiency, just what are they doing?

In 70 percent of cases, PE firms are leveraging up the businesses they buy. PE firms typically double the amount of debt on the balance sheet, from 2.5x EBITDA to 5x EBITDA—the biggest financial change apparent from our study.

With $1.7 trillion in dry powder, rising rates, and average U.S. LBO entry multiples hitting 11.2x EBITDA, this just does not seem like an attractive value proposition.

Persistence in Private Equity

McKinsey’s Global Private Markets Review has a fascinating finding on the decline of persistence in private equity performance. Notably, “follow-on performance is converging towards the 25 percent mark—that is, random distribution.”

At a time when capital is flooding to mega-cap funds and, at least in emerging markets, established GPs with a track record, I wonder whether new techniques are needed for manager selection. Perhaps the winning LPs will be those with the liberty to chase a variant perception of value; those less hamstrung by rigid asset allocation buckets and / or institutional constraints.

Je ne sais pas.

From the Bookshelf

A man is born gentle and weak.
At his death he is hard and stiff.
Green plants are tender and filled with sap.
At their death they are withered and dry.

Therefore the stiff and unbending is the disciple of death.
The gentle and yielding is the disciple of life.

Thus an army without flexibility never wins a battle.
A tree that is unbending is easily broken.

The hard and strong will fall.
The soft and weak will overcome.

— Lao Tsu, Tao Te Ching (Vintage: 1989).

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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.

Dumb Money

In last month’s newsletter, I mentioned that I would be speaking at a conference with a bunch of LPs on the topic of “Global Markets for Buyouts and VC”. I closed saying, “Here’s hoping for an interactive, no-holds-barred session.”

Suffice it to say that my hopes materialized. While discussing the performance of EM PE, one LP said:

The issue with emerging markets is these funds have often been growth equity with minority stakes. The teams have been heavy on investment bankers who don’t know how to do deals. In emerging markets, private equity is the dumb money.

Dang.

Another discussion revolved around whether EM PE is in a cyclical downturn or a structural one. LPs’ commitments are generally pro-cyclical and many herd into markets / strategies at the same time, with predictable results. If so, then—ceteris paribus—the trickle of capital flowing to EMs (apart from mega-cap Asia … more on that below) may well signal a cyclical bottoming. As one conference delegate argued, now would present an optimal time to adopt a contrarian strategy and lean into EM PE.

Two brief rejoinders: First, this is not what LPs are saying they’ll do:

LP Sentiment

Second, this just isn’t how private markets work. Even if you wanted to do so, you can’t buy the index. You have to choose a manager.

Industry cycles and macro need to be disentangled. With that in mind, my view is that the quality of the managers in the market at a given time drives flows more than macro. The nuance is that fundraising is a bit of a coincident indicator: the managers with whom LPs wish to invest frequently come to market (a) at the same time; and, (b) when investor sentiment toward the jurisdiction in question is hot.

Alas, I’m still in the camp of this being a structural downturn. A few reasons I’ve pondered this week include:

  1. “Dumb Money”!
  2. David Swensen’s recent remark that “the breadth of emerging markets that we were interested in 20 years ago has narrowed dramatically.”
  3. DFIs, which historically have supported the development of the industry, are increasingly committing to later, larger funds.
  4. The ongoing emergence of local, non-PE investors that don’t face the same return hurdles / horizons creates greater competition for quality deals.
  5. Tech is disrupting everything; in markets with fewer, ephemeral exit channels, this is a big problem.

More importantly, Happy Thanksgiving to you and yours. One of the great bits of having a toddler is that I’m reminded daily that I have a blessed life. Thank you for being a part of it, and for welcoming this newsletter into your busy day!

Alla prossima,
Mike

The Great Wall of Capital

Fundraising for buyouts in Asia is robusto:

Seven funds. $34 billion. There are others.

That is a lot of granola; it’s on par with the aggregate hauls for EM PE funds in each of the last two years.

In other news, KKR inked a deal this month with Great Wall International to bring leveraged loans to China. There’s a joke in here about Barbarians at the Gate, but I’ll stop.

LP Views on Latin America

LAVCA teamed up with Cambridge Associates for the second time on their annual LP opinion survey. There are some interesting findings the study, such as the discovery that 53% of LPs considering a first investment in Latin America view currency volatility as the biggest impediment to investing in the region. (Recency bias?)

My favorite exhibit explores LPs’ preferred means of accessing LatAm:

LAVCA.jpeg

  • Most LPs plan to access LatAm via pan-regional funds
  • Brazil is the country of the future …
  • Proportionally, more Latin American LPs expect to access LatAm PE via global funds than international LPs (statistically insignificant, but the fact that they’re close strikes me as interesting)

Facebank

The societal parasite that is Facebook is entering the small business lending space, starting with merchant cash advances. This is a fairly fascinating development. The company has already effectively become the Internet for a large number of people; will it become a lender of first resort for small businesses? Given the vast swathes of data that Facebook collects, one might surmise that they could develop an edge in credit scoring that could benefit businesses with lower rates and Facebook with a large loan book. My interest is piqued.

In related news, EMPEA’s Q3 data show that capital invested in fintech companies through September ($416M) has already exceeded last year’s total ($379M). Aggregate fintech deal value is on track to match or exceed those for 2014 ($470M) and 2015 ($509M).

Turkey Resurgent?

Every so often, a leader steps up and makes a bold pronouncement, and market sentiment shifts. Think of Warren Buffet going long Goldman in the depths of the crisis, or Jamie Dimon plunking $26 million of his own cash on JPM shares in February 2016 (now up ~70%).

Has Seymur Tari of Turkven made a gambit to shift opinion in Turkey? Following a summer IPO of jeans retailer Mavi, Tari appears to be getting bulled-up on the market. Last month, Tari announced that the firm plans to list Medical Park Group in an offering that could fetch $1B. (Maybe?) Moreover, Turkven is planning to execute “three to four acquisitions of $50-400 million each in 2018 … and to start a new fund of more than $1 billion in one or two years,” according to Reuters.

I admire the verve. Turkey has been in the doldrums, and local business and consumer sentiment has been in a downtrend for seven years (see below). Is the tide turning?

Turkey2

From the Bookshelf

The quality of ideas seems to play a minor role in mass movement leadership. What counts is the arrogant gesture, the complete disregard of the opinion of others, the singlehanded defiance of the world.

Charlatanism of some degree is indispensable to effective leadership. There can be no mass movement without some deliberate misrepresentation of facts.

— Eric Hoffer, The True Believer (Perennial: 1966).

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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 2017, all rights reserved.