Questions of Leadership

“There is no global EM champion.”

IFC and EMPEA’s Global Private Equity Conference came and went in a blur, but that comment from Nicolas Rohatyn has remained lodged in my brain. There are many ways to read it.

One is to ask: qué? There are global champions that do well in EM. Warburg Pincus comes to mind.

Equally, there are well-known champions within specific markets. A sampling from the BRICs: Pátria in Brazil; Baring Vostok in Russia; Multiples and True North in India; CDH and Hony Capital in China.

Some are less well-known. Some are in other markets. Some are up-and-coming.

Another is to ask if the issue is the lack of a thought leader, like Jim O’Neill (“Mr. BRIC”), who can articulate a fresh vision for the attractions of emerging markets en masse. I’m a fan of Morgan Stanley’s Ruchir Sharma, though he’s a realist not an evangelist. (Maybe that’s why I like him).

Another is to ask if there can ever be a proper EM champion. Can one firm or individual credibly champion all markets at the same time? I think so, but it’s a tough task. Markets across Africa, Asia, Eastern Europe, and Latin America are often at different points in the cycle, with idiosyncratic risks that defy generalization.

Rohatyn’s comment came during a panel titled Global Private Equity Leaders on the State of the Industry. The panelists included a few traditional PE funds (Africa, India, global), but also an energy investor, an Asia credit specialist, and Rohatyn’s firm, an EM hedge fund that acquired a global PE firm (CVCI), as well as EM-focused infrastructure and real estate platforms.

If it’s an uphill battle selling the complexity of EM as a geography meriting investment, is it more so when a discussion with “private equity” leaders includes multiple asset classes?

In any event, if EM private markets are confronting a leadership void — and for all my quibbles it’s a view I share — then who will assume the mantle of leadership?

Alas, questions of — and questionable — leadership were top of mind last week, and they infused the four key themes that I took away from the conference:

  • Crises of Governance
  • Managers not Markets
  • Sustainability Now
  • DFIs and the Mid-Market

Before you jump to the write-ups, this is the last blast before the new General Data Protection Regulation (“GDPR”) goes live.

Our policy is simple: we will not send this newsletter to people who have not confirmed that they would like to receive it.

We hope that your find our content thought-provoking and entertaining.

If you’d like to continue receiving our monthly(ish) newsletter — and if you haven’t done so already — please update your subscription settings.

And remember, you may opt out / unsubscribe at any time.

Thanks for reading and sharing!

Alla prossima,
Mike

 

Crises of Governance

Piggybacking off of last month’s newsletter, governance — or the lack thereof — was the biggest theme I observed throughout the conference, and this was on display across three levels of analysis: the individual / firm, the state, and the international system.

At the individual / firm level, there were numerous discussions about corporate governance, alignment of interests, and deal / fund terms and structures. However, the most powerful comment came from Jim Yong Kim, who said to David Rubenstein, “The biggest problem is the explosion of aspirations around the world.” Relative deprivation amidst a global political awakening is a potent cocktail for radicalization and unrest.

Ellen Johnson Sirleaf and Mo Ibrahim provided some memorable commentary bridging the firm and state levels. Madame Sirleaf implored, “It is the responsibility of shareholders to use their boards to ensure transparency and accountability, and improve corporate governance.” Ibrahim quipped, “It’s really hard to improve public governance without improving corporate governance.”

At the international level, Ambassador Chas Freeman gave a rundown of the reasons why “risks are reallocating themselves for reasons that are structural,” and set the stage for numerous discussions about political risk.

Ambassador Freeman also introduced troglonomics to the lexicon — “knuckle-dragging mercantilism that emphasizes bilateral trade balances above all else.” It is a delightful, if depressing, addition for our times.

Freeman’s overarching thesis that “international law no longer protects the weak” evokes Thucydides — not only the Melian Dialogue (“the strong do what they can and the weak suffer what they must”), but also the “terrible chapter” on Corcyra’s civil war (see this month’s From the Bookshelf selection).

It’s hard to be constructive, and I’m generally dour on the world’s prospects in the near term. However, I am cautiously optimistic that we are on the cusp of a generational transition — from a culture of fear and anger at losing what was, to one with the confidence and energy to build what can be (h/t Sir Kenneth Clark).

Hopefully this translates to a revivification of a rules-based, harmonious international system.

🤞

Managers not Markets

In years past, much buzz would be made about the market du jour. Panels were populated with prospective private equity kingpins, and the audience would be serenaded with those sonorous words: structural drivers, rising middle class, boots on the ground.

There was an energy and excitement about the prospects of [pick your market]. Never mind that this frequently happened just as the market was topping. It was fun. Remember Mongolia?

Yes, there were regional panels this year (and even one on blockchain), but that invigorating splash of euphoria gave way to more measured discussions around the evolution of the industry (from private equity to private markets), the need for new metrics (on impact), and more practical issues of managing funds and investments.

All of this may be an indicator of a more institutionalized asset class; but it seems to me a subtle endorsement of the idea that it’s managers that make money for investors, not market timing.

One wonders whether it was ever sensible to hype up specific markets, particularly when there are managers that consistently do well in out-of-favor geographies. I’m reminded of a recent interview with the famed short-seller Jim Chanos:

Barry Ritholtz: The last time you and I sat down for a conversation, about three years ago, you mentioned that back in the day there were a few hundred hedge funds, and out of those, 20 or 30 were reliable alpha generators. Today, there’s 11,000 or so hedge funds …

Chanos: And probably 20 or 30 reliable alpha generators.

Sustainability Now

There has been a palpable shift in investor sentiment toward the importance of sustainable investing. The Sustainable Development Goals (“SDGs”) permeated many speakers’ comments, and there seems to be an effort afoot to segment “impact investing” from mainline PE, with the latter being viewed as key partners for attaining the SDGs.

Most allocators are not keen to sacrifice financial returns for “impact” — define the term as you will — but they are looking for managers that deliver responsible, sustainable alpha.

The irony is that some of these managers may very well be “impact investors!”

Nevertheless, the SDGs seem to offer the biggest tent for the array of investors seeking to do well while doing good, and it is manifestly the direction in which large institutional capital is heading.

DFIs and the Mid-Market

Trillions of dollars of private capital will be needed to meet the SDGs. IFC’s CEO, Philippe Le Houérou, spoke about the organization’s new strategy for mobilizing private capital, which includes working with governments to unlock investable projects, and de-risking investments for private capital.

Presumably this was the rationale behind the “DFI Leaders Panel: Moving from Billions to Trillions” — a chance to proselytize about the benefits of investing in emerging / frontier markets before a quasi-captive audience of institutional investors.

And yet, about 15 minutes into an abyss of DFI navel-gazing, a delegate from a university endowment turned to me and asked, “What’s a DFI?”

🤣

The DFIs do amazing work. But I do worry that the emphasis on mobilizing large volumes of private capital will exacerbate the financing gap for mid-market funds and businesses.

To wit, there’s scuttlebutt that some DFIs may be spending less energy on fund investments going forward. Who will intermediate capital flows to smaller companies?

We’ll see; but these discussions brought to mind two of the findings from our July 2017 report The Mid-Market Squeeze.

Basically, are DFIs catalyzing private capital into EM PE funds if: (1) their preferred ticket size is in the sweet spot of commercial investors; and, (2) most commercial LPs would not be more likely to commit to a fund < $250m in size if its investors include DFIs?

No sé.

CrowdinginoroutVertical

From the Bookshelf

Certainly it was in Corcyra that there occurred the first examples of the breakdown of law and order. There was the revenge taken in their hour of triumph by those who had in the past been arrogantly oppressed instead of wisely governed; there were the wicked resolutions taken by those who, particularly under the pressure of misfortune, wished to escape from their usual poverty and coveted the property of their neighbours; there were the savage and pitiless actions into which men were carried not so much for the sake of gain as because they were swept away into an internecine struggle by their ungovernable passions. Then, with the ordinary conventions of civilized life thrown into confusion, human nature, always ready to offend even where laws exist, showed itself proudly in its true colours, as something incapable of controlling passion, insubordinate to the idea of justice; the enemy to anything superior to itself; for, if it had not been for the pernicious power of envy, men would not so have exalted vengeance above innocence and profit above justice. Indeed, it is true that in these acts of revenge on others men take it upon themselves to begin the process of repealing those general laws of humanity which are there to give a hope of salvation to all who are in distress, instead of leaving those laws in existence, remembering that there may come a time when they, too, will be in danger and will need their protection.

— Thucydides, History of the Peloponnesian War (Penguin Classics: 1972).

# # #

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.

Transparency & Governance

I’ve been meditating on transparency and governance rather frequently of late. Not out of a sense of righteousness, mind you, but largely because they are inescapable in my morning reading of the newspaper: Abraaj, Norway (both discussed below), FacebookMartin SorrellSean Hannity, &c.

The only firm conclusion I’ve reached is that quality governance — corporate or otherwise — is the most underappreciated necessity. A world awash in capital is also a world awash in unaccountable bullshit. People just don’t seem keen to ask — let alone field — questions when the money’s rolling in. Plus ça change …

Say what you will about younger generations, but they’re pretty quick to raise the BS flag and ask uncomfortable questions (so much so that it has become a meme, apparently). I was reminded of this recently while giving a guest lecture at UVA’s McIntire School of Commerce. The students were super sharp, and they asked hard-hitting questions … including one that made me ponder some life choices.

In short, they’re awesome. They rekindled my belief that the future is going to be amazing. Hopefully their incessant questioning will continue as they assume positions of leadership, thus contributing to more transparent and accountable governance. On verra bien …

Speaking of the future, Portico’s first product launch is in the works. We’re making it easier than ever for first- (and second-, and third-, &c.) time funds to produce institutional-quality marketing materials, at a price point that delivers enormous value. Stay tuned!

Finally, I’m really looking forward to IFC’s Global Private Equity Conference next month (hosted in association with EMPEA). It’s the 20th anniversary of the event and it should be a good one. I’m excited to reconnect with friends and make new connections. Drop me a line if you’re planning to attend.

If you haven’t registered, you may learn more about the event at this link. Hope to see you there!

Alla prossima,
Mike

GPEC Banner

Abraaj: Fin?

[This is the third — and final — in a series; see Part I and Part Deux]

“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.”

So read the conclusion to my take on the drama at Abraaj in last month’s newsletter.

I don’t know whether the investors drove the process, but Houlihan Lokey was brought in to find a solution to the Abraaj Growth Markets Health Fund debacle, and the FT reports that Abraaj subsequently offered to step down as manager of the fund. An interim manager is reportedly in the cards until a permanent replacement / solution is found.

A few thoughts / observations:

  • Key Person Provisions — More senior departures were reported over the last month, including those of Sev Vettivetpillai and Mustafa Abdel-Wadood, both of whom reportedly attempted to resign late last year but were asked to stay. The Wall Street Journal reports that “the firm now has lost half its managing partners and a third of its partners in the past year.” At this point, given the flood of senior departures, it stands to reason that Key Person termination provisions likely have been triggered across several Abraaj funds. If so, then I imagine investors will be looking for (a) new GP(s) to manage out the assets.
  • Sharks Circling — The firm is reportedly considering a sale of its private equity business to raise cash, and reducing headcount by 15% to cut costs. It is also moving forward with its planned listing of the South African FMCG company Libstar.
    Kenyan sources report that the firm is evaluating a sale of its stake in Nairobi Java House, which it acquired from ECP last year. (I talked about the deal here). The same article reports that sales of Avenue Hospital, Brookside Dairies, and Seven Seas Technologies may be under consideration as well. With all these headlines, management teams and fund managers may be sensing an opportune moment to scoop up shares at a discount from a stressed seller.
  • Exit Closed — In recent years, Abraaj had become an active buyer of PE-backed companies, particularly in Africa (e.g., Java House, Libstar, Mouka). Had its $6 billion mega fund come to market, I imagine Abraaj would have become a sought-after exit channel for GPs. In a way, it could have become to EM private markets what the SoftBank Vision Fund is to venture investors: a deus ex machina of liquidity.
  • &c. — Its portfolio company Stanford Marine has reportedly breached covenants and is seeking to restructure $325 million in debt. Reuters reports that it is seeking repayment of $12.4 million in loans to Nigeria’s C&I Leasing. Deloitte has been called in to look into its governance and control issues. &c.

I’m tired of writing about Abraaj. I don’t plan on including anything about the firm in next month’s newsletter.

The news articles are likely to keep coming, though, and the developments over the last month suggest that it will take a long time to clean up the detritus from this unfortunate turn of events. Here’s hoping that it doesn’t contribute to investors’ exodus from EM private markets altogether.

Norway: Part Deux

In January’s newsletter, we mentioned that Norway’s sovereign wealth fund had submitted a recommendation to the finance ministry that it be allowed to invest in and alongside private equity funds. At the time, we held out a grandiose vision of a world in which the fund might build a genuinely differentiated approach to EM private markets.

Well, the finance ministry has issued its report, and fund managers’ hopes for a veritable tsunami of cash have been put on hold.

Indefinitely.

The preliminary, unofficial translation of the report provided a fairly damning assessment of the asset class’s fees and opacity:

Low costs are characteristic of the GPFG. External equity management costs in the listed market are about 0.5 percent … measured relative to assets under management. In comparison, the annual cost of investing in private equity funds can be estimated at about 6 percent of assets under management …

Transparency is an important prerequisite for broad support for, and confidence in, the management of the GPFG. Many private equity funds disclose little information about their activities …

High prospective returns aren’t a sufficient argument for new money to come into the asset class — especially when its citizens’ savings. We’ve said it before and we’ll say it again: the industry will not thrive without trust, transparency, and quality corporate governance.

Bain & Co.

Two findings jumped out at me from Bain & Co.’s Global Private Equity Report 2018:

  1. Entry pricing is … inauspicious.As of year-end 2016, the percentage of deals priced at <7x EBITDA (~10%) was the lowest it had been since at least 2007, while 54% of deals were done for >11x EBITDA (compared to ~35% in 2007). “Our presumption is that we’ll be exiting at smaller multiples,” says Alan Jones of Morgan Stanley Global Private Equity. Agree
  2. Long-hold funds can outperform. Bain ran an analysis comparing a theoretical long-hold fund selling an investment after 24 years against a buyout fund selling four successive companies over the same period. Their finding: “By eliminating transaction fees, deferring capital gains taxation and keeping capital fully invested, the long-hold fund outperforms the short-duration fund by almost two times on an after-tax basis.” [emphasis added]

At Portico, we’re privileged to work with firms that are pursuing non-traditional and longer hold strategies. We think it’s only a matter of time before more investors come to see the benefits of these approaches.

Grab Bag

  • Into Africa—The FT reports that the EBRD is considering an expansion into Sub-Saharan Africa. The politics of getting this approved might be tricky, but EBRD could do a lot of good on the continent. 🤞
  • India — IFC’s Ralph Keitel gives a masterclass on PE in India in this interview.
  • Management Fees— Dave Richards of Capria has an interesting view on how GPs should be determining their management fees. Hint: they should be predictable and budgeted, rather than a percentage of committed / invested capital.
  • Theranos— “It has been pretty obvious for a few years now that Theranos Inc. was a huge fraud.” Matt Levine’s take on the Blood Unicorn, Elasmotherium haimatos. And, its solicitation for cash after its CEO settled fraud charges?

From the Bookshelf

Make friends with those who are good and true, not those who are bad and false.

— Eknath Easwaran (trans.), The Dhammapada (Nilgiri Press: 2007).

# # #

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.

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).

# # #

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.

First Move

It has been five months since we released our first research piece, Is Emerging Markets Private Equity Dying?, and though Portico is still in its infancy, we’re excited about the doors this study continues to open, and the conversations we’ve been having with firms across geographic and market cap segments.

Two recent developments suggest that the trends highlighted in Is EM PE Dying? are unlikely to reverse anytime soon:

  • Fundraising data from EMPEA show that the number of final closes for funds <$250m in size continues to decline; meanwhile, capital raised for EM VC and private credit funds has reached all-time highs.
  • Apparently IFC is looking to commit up to $25m to Carlyle’s fifth Asia growth fund, underlining the trend of DFIs supporting established fund managers (that probably should have graduated from DFI capital).

Keep your eyes peeled for Portico’s forthcoming Middle Market Survey. We’d truly value your input. For those suffering survey fatigue, there will be a prize drawing for a Year in Books Subscription from the delightful booksellers at Heywood Hill in Mayfair.

Best wishes,
Mike

⎯⎯⎯

Coming to Southeast Asia in May

I’ll be traveling through Southeast Asia next month, with stops planned for Singapore, Jakarta, and HCMC. I’m looking forward to (re-)connecting with several firms, and to kicking the tires on a hypothesis that the region presents a qualitatively different opportunity set than was on offer five years ago. Back then, investors got bulled up on the region, but had questions about the investable market. Have things changed? (It’s a small sample, but Cambridge Associates Benchmark data show TVPI of 1.07 for 2010-13 vintage Southeast Asia funds).

I’m particularly excited about the visit to Vietnam, where there have been some big deals taking place, including:

  • KKR’s $150m transaction in Masan Nutri-Science, continuing the firm’s quality food thesis (seen with its Modern Dairy and COFCO Meat deals in China);
  • VinaCapital’s joint venture with Warburg Pincus to create a hospitality JV (valued at up to $300m); and,
  • TPG’s intention to acquire a stake in Vietnam Australia International School, providing a potential liquidity event for Mekong Capital.

If you’re in the region, I’d love to meet with you. Drop me a line and I’ll try to find a time that works for you!

⎯⎯⎯

Deal Flow in Africa

AVCA and EY released their latest study on exits in Africa, and the data point that jumps off the screen is the rapid growth of secondary buyouts as an exit channel, which hit *17* last year. There haven’t been more than 7 secondary buyouts / year going back to 2007.

The other dynamic at play—and I haven’t pulled data on this, so it’s just an impression—is a steady drumbeat of GPs co-investing in deals on the continent. Taken together, these two dynamics suggest that deal flow may very well be an issue in Africa (at least for firms managing traditional 10-year, closed-end structures).

But at the same time, the clear growth in secondary buyouts and (suspected) increase in GP co-invests may not necessarily be a bad thing. We could be witnessing a phenomenon similar to tier one PE / VC in the United States, where sequences / consortia of private capital investors scale up winner-take-most (if not all) platforms, or build out category leaders with decent moats. Time will tell!

⎯⎯⎯

The Gift that Keeps on Giving in Eastern Europe 

Speaking of secondary buyouts and private capital building category leaders, Zabka Polska—operator of convenience stores, Freshmarkets, and supermarkets—has been sold to a PE buyer once again. Over the last 17 years, Zabka has changed hands from:

PineBridge Investments Penta Investments Mid Europa CVC

The company’s growth over the last two decades is truly astonishing. For its part, Mid Europa reportedly fetched €1.1B after growing Zabka’s top- and bottom-lines 3x and 4x, respectively, and opening 500 stores / year. Na zdrowie!

⎯⎯⎯

Consumer Sentiment in Latin America

It’s not a good idea to try to call tops or bottoms—so I won’t—but one of the data streams I’ve been monitoring with interest is consumer sentiment in Brazil and Mexico. Given the political and economic turmoil in the former, and the fact that average manufacturing wages have been flat for a decade in the latter, it’s little surprise that consumers in these countries have been gloomy for five years running.

And yet, since the beginning of 2015, there has been a marked divergence in retail sales volumes across these two markets. Brazilian retail sales have declined in line with a contraction in consumer lending. By contrast, Mexican retail sales have been on a tear, fueled, in part, by a rapid expansion in household credit.

Brazilian consumer confidence is recovering, as are retail sales, and consumer credit growth remains restrained. Though the politics are slippery, it appears like a bottoming process is at hand. Mexico’s debt-fueled consumption binge, however, gives one pause. It’s hard to look at the chart below without contemplating a parallel to the morning after a night out in La Condesa, having imbibed too much mezcal and consumed too few tacos.

LatAmConsumer

⎯⎯⎯

From the Bookshelf

Earlier this year, I read Carroll Quigley’s Evolution of Civilizations (1961). One of Quigley’s core arguments is that societies create instruments to meet basic human needs (e.g., security, the accumulation of wealth and savings, etc.), but these instruments evolve into institutions, which over time become less effective at achieving their original purposes.

When discussing the interwar period (1919-39), Quigley makes an insightful point about the evolution of the economic system that seems germane to today’s debates about secular stagnation.

The purpose of any economic system is to produce, distribute, and consume goods … As [the economic system] became institutionalized, profits became an end in themselves to the jeopardy of production, distribution, and consumption.

The rub is that the expansion of profit margins through higher prices and lower costs of production ultimately reduced consumption, and increased wealth inequality. Quigley continues:

Such an inequitable distribution of wealth was a very excellent thing as long as lack of capital was prevalent in the economic system, but such a maldistribution of income ceases to be an advantage as soon as the productive system has developed out of all proportion to the processes of distribution and of consumption.To some extent this situation was made worse by the growing separation … between ownership and control of corporations, since this led to an increased accumulation of undistributed profits held by the corporations in control of the management rather than distributed as dividends to the owners. Such undistributed profits became savings with no possibility of serving as consumer purchasing powerIncreasing proportions of the national income were going to those persons in the community who would be likely to save and decreasing proportions were going to those persons in the community who would spend their incomes for consumers’ goods.

As someone who genuinely believes in long-term investment, the passage above left me wondering whether this world awash in capital—one in which U.S. after-tax corporate profits (net dividends) amount to $982 billion (see below) and the pension assets of 22 countries total $36.4 trillion—is one that consigns us all to Keynes’s paradox of thrift.

USCorpProfits

# # #

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 2017, all rights reserved.