Ep. 8: The Abraaj Fiasco



I wanted to experiment with a different format for this episode and share my writings on the Abraaj fraud scandal as they were happening in real time a few years ago.

Now, for those who don’t know Abraaj, it was one of the largest — and probably the flashiest — private equity firms dedicated to investing in emerging markets. It was spearheading a big push into impact investing and was marketing a $6B fund when it collapsed in insolvency under allegations of fraud.

There are a few reasons why I wanted to revisit my articles:

  • First, the founder of Abraaj — a man named Arif Naqvi — had been fighting a battle in UK courts to avoid extradition to the United States. He lost that fight earlier this year.

  • Second, there’s a book coming out in July called The Key Man: The True Story of How the Global Elite Was Duped by a Capitalist Fairy Tale by two reporters at The Wall Street Journal — Simon Clark and Will Louch. I’m keen to bring them on the podcast to discuss the book and I wanted to provide some context in the hopes that one or both of them will join me in a few months’ time.

  • Third, the Abraaj story is a useful prism for seeing the world as it is — unvarnished. As you listen, I encourage you to think about how social capital, branding, and reputation are manufactured; how an industry that talks about due diligence did little to none; and the credulity that money buys.

So, there will be four parts to the story I share today. The first three were from the FebruaryMarch, and April 2018 editions of Portico’s much-beloved, monthly newsletter, Portico Perspectives.

The final part comes from the July 2018 edition.

As noted, this is an experiment, so please let me know what you think about the format and content. 

This podcast was recorded in April 2021.


Sign up for Portico Perspectives.

A CDO for Secondaries?

A year or so ago I floated the idea of an index fund for EM private assets.

What if there were an asset manager that could agglomerate a sufficient pool of capital through a publicly listed vehicle (e.g., a super-SPAC) to go out and purchase — in whole or in part — scores of PE-backed companies across EM?

Would a diversified portfolio — at scale — provide better risk-adjusted returns than existing public and private equity funds? 

My bias had been toward equity.

But what if the answer is debt? 

And not just any kind of debt, but securitized debt?

 * * *

Andrew Lo — Director of the MIT Laboratory for Financial Engineering — recently gave a fascinating lecture on new funding models for biomedical innovation as part of the Markus’ Academy series of webinars at Princeton’s Bendheim Center for Finance.

Lo argues that, whilst we’re living amidst a revolution in a variety of ‘omics’ (e.g., genomics, proteomics, microbiomics), to actualize and commercialize scientific and medical advancements, we need a revolution in economics — particularly in how we finance innovation.

At first glance it might seem like an odd proposition.

Even if U.S. venture is exhibiting a ‘diversity breakdown,’ biopharma companies are sitting on $1.5 trillion in ‘firepower’ to fund transactions.

Isn’t there enough funding available already?

Lo asks us to ponder whether it’s worth making a $200m investment in something with the profile of a single anti-cancer compound (i.e., 5% probability of a positive payoff after 10 years of R&D). If successful, annual profits would be $2B / year for 10 years (a present value of $12.3B).

At a 95% failure rate, investing makes little sense.

But Lo points out that if you could invest in 150 programs simultaneously (totaling $30B of capital), the probability of 3 successes out of 150 attempts is 98.18%, and the Sharpe ratio increases from 0.02 to 0.34.

* * *

What if we translate this idea to the EM private markets index?

Would we see:

  • A lower cost of capital for EM companies?
  • Longer runways for value creation?
  • Higher risk-adjusted returns for investors?
  • Lower fees?
  • Greater liquidity (e.g., coupons)?

I don’t know.

But I wonder: maybe — maybe — the solution for the artisanal industry of EM private markets is diversification and massive scale?

— Mike


Viktor Shvets on The Great Rupture

In the latest episode of the Portico Podcast, I speak with Viktor Shvets, a global strategist at Macquarie, and the author of the deeply thought-provoking book The Great Rupture, which investigates the past and interrogates current trends to probe the question: do we need to be free to be innovative, prosperous, or even happy?

You may want to grab a pen and some paper to take notes for this episode because Viktor is a polymath who will engage your brain in some important — and at times, unsettling — thought experiments.

Viktor and I discuss:

  • Why he wrote a book that looks for lessons in the 12th to 15th Centuries to guide us through the next two decades;
  • Whether the ‘operating system’ of open markets, property rights, and open minds that generated prosperity in the past is in retreat — and even if it were, would it matter;
  • The confluence of the information and financial revolutions, and how these two forces are hollowing out the core frameworks of society;
  • The state’s usurpation of the free market and what it means for capitalism and commercial banking;
  • The prospects for emerging markets in an era of de-globalization and the importance of EMs’ non-tradable sectors;
  • Whether universal basic income might liberate people from scarcity and empower them to live lives of their choosing.

But there is so, so much more.

Check it out on Apple Podcasts | Google Podcasts | Spotify


Does PE Investment in Healthcare Benefit Patients?

No.

  • “Our estimates show that PE ownership increases the short-term mortality of Medicare patients by 10%, implying 20,150 lives lost due to PE ownership over our twelve-year sample period. This is accompanied by declines in other measures of patient well-being, such as lower mobility, while taxpayer spending per patient episode increases by 11%.”
     
  • “We find that going to a PE-owned nursing home increases the probability of taking antipsychotic medications — discouraged in the elderly due to their association with greater mortality — by 50%.”
     
  • “We find that PE ownership leads to a 3% decline in hours per patient-day supplied by the frontline nursing assistants who provide the vast majority of caregiving hours and perform crucial well-being services such as mobility assistance, personal interaction, and cleaning to minimize infection risk and ensure sanitary conditions. Overall staffing declines by 1.4%.”
     
  • A puzzle is why nursing homes are attractive targets given their low and regulated profit margins, often cited at just 1-2%. Using CMS cost reports, we find that there is no effect of buyouts on net income, raising the question of how PE firms create value. There are three types of expenditures that are particularly associated with PE profits and tax strategies“monitoring fees” charged to portfolio companies, lease payments after real estate is sold to generate cash flows, andinterest payments reflecting the importance of leverage in the PE business model (Metrick and Yasuda, 2010; Phalippou et al., 2018). We find that all three types of expenditures increase after buyouts, with interest payments rising by over 300%. These results, along with the decline in nurse availability, suggest a systematic shift in operating costs away from patient care.”

Bain’s Global PE Report

A few highlights from the year in review:

  • Global buyout deal value reached $592m (up 8% yoy) whilst deal count declined by 24%;
     
  • ~70% of U.S. buyouts were priced above 11x EBITDA whilst ~80% of deals are leveraged 6x or greater; and,
     
  • The number of global buyout exits appears to have fallen below 1,000 — the worst year since 2009.

Hugh MacArthur and Mike McKay ask: Have classic buyout funds run their course?

When I look at the data points highlighted above, I think the answer will turn out to be a resounding ‘yes.’

MacArthur and McKay point to the rise of specialist funds, carving out space for a discussion on the evolution of Vista’s strategy, among other things.

Look. Buyout firms absolutely need a differentiated value proposition.

But in a world of capital superabundance, the average buyout firm offers declining utility as an allocator of capital.


Governance

Speaking of Vista.
 
By now you will have heard that Vista’s founder, Robert Smith, struck a non-prosecution deal with the U.S. government in which he admitted to evading taxes for 15 years.
 
There are some lawsuits alleging mismarked assets and self-dealing.
 
Amidst all the talk about ESG, do institutional LPs value good governance?
 
In the case of Vista, one seems to. Several don’t.
 
But it’s a much bigger question (Abraaj: Redux 👀).

Do institutional LPs actually do their homework on larger funds?
 
Or are the investment teams too cozy with their contractors?


Zhou Xiaochuan and the eRMB

Caixin / Nikkei Asia published an important article from former PBOC governor Zhou Xiaochuan on the landscape for a digital renminbi. This is a space worth watching.


From the Bookshelf

Human history is indeed filled with endless possibilities; and the Renaissance saw this more clearly than either classicism, Catholicism or the Reformation. But it did not recognize that history is filled with endless possibilities of good and evil. It believed that the cumulations of knowledge and the extensions of reason, the progressive conquest of nature and (in its later developments) the technical extension of social cohesion, all of which inhere in the “progress” of history, were guarantees of the gradual conquest of chaos and evil by the force of reason and order. It did not recognize that every new human potency may be an instrument of chaos as well as of order; and that history, therefore, has no solution of its own problem.

— Reinhold Niebuhr, The Nature and Destiny of Man: Volume II. Human Destiny (Charles Scribner’s Sons: 1964)

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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 2021, all rights reserved.

Ep. 4: The Rise of Kleptocracy



In today’s episode I speak with Tom Burgis, an investigations correspondent with the Financial Times, and author of two courageous books: The Looting Machine: Warlords, Tycoons, Smugglers and the Systematic Theft of Africa’s Wealth and the recently released Kleptopia: How Dirty Money is Conquering the World.

I strongly encourage you to buy copies of Tom’s books, read them, and share them with others.

Why?

Because as you’ll hear in this podcast, the themes his books cover constitute an existential threat to democratic institutions and governance — and the rule of law — globally.

They’re absolutely riveting yarns, full of intrigue and consequences.

And my hope is that if more people read Tom’s work, then we’ll stand a better chance of resisting the precipitous slide into kleptocracy that endangers us all.

Courage is contagious.

My discussion with Tom covers:

  • The dots connecting The Looting Machine and Kleptopia.
  • The story of Mukhtar Ablyazov — a Kazakh billionaire whom some say is a freedom fighter, some say is a fraudster, and some say maybe he’s both.
  • The complicity of U.S. and UK professional services firms in facilitating the activities and laundering the funds and reputations of kleptocrats.
  • Some mistaken assumptions behind the ‘convergence’ thesis.
  • How citizens can keep Kleptopia in check and revivify democracy.
  • John Kenneth Galbraith’s notion of ‘the bezzle’ and where ‘the bezzle’ is biggest now.
  • And, what the rise of Substack and the proliferation of journalists going solo or direct-to-consumer imports for the future of investigative journalism.

I’m fired up about this episode, and I hope you will be, too.

If you enjoy the Portico Podcast, please share it with friends, colleagues, and / or your connections on social media. Thanks!

This podcast was recorded in November 2020.

Illusions and Delusions

Steve Jobs once said, “You can’t connect the dots looking forward; you can only connect them looking backwards.”

There’s a lot of wisdom in that nugget, whether applied to issues of a spiritual or temporal wavelength.

It’s also relevant to quotidian things, such as deciding which book to read. For instance, in the decade since I left SAIS, apart from a methodical reading of the Ancient Greek classics, I’ve approached my bookshelves with no real theme or objective in mind.

At least, that’s what I thought.

Whilst reading William Manchester’s droll book on the Medieval mind last week, however, I experienced an epiphany that revealed a pattern amongst the cornucopia of titles.

All these years, most of the most-enjoyable books have dealt with the theme of illusions and delusions.

They covered what Adda Bozeman, in her magisterial Politics and Culture in International History, refers to as the gap between image and reality.
(h/t Ben Welch for the recommendation).

Or, as Barbara Tuchman described it, the periods “when the gap between ideal and real becomes too wide, [and] the system breaks down.”
(See A Distant Mirror and The Proud Tower).

Basically, history is littered with episodes when the bottom falls out of everything. Foundational myths, religious and political institutions, social orders, scientific hypotheses — all have cratered in the face of discovery, new knowledge and shifting conditions. They prove to have been illusions and delusions.

Lest we think that these gaps between myth and reality are confined to the distant past, consider this remark from Alan Greenspan in 2007 (as quoted in Adam Tooze’s Crashed):

[We] are fortunate that, thanks to globalization, policy decisions in the U.S. have been largely replaced by global market forces. National security aside, it hardly makes any difference who will be the next president. The world is governed by market forces.

Oops.

Or, consider the astonishing scale and duration of the fraud that was Theranos. John Carreyrou’s riveting Bad Blood, which deservedly won the 2018 FT / McKinsey & Co. Business Book of the Year award, is replete with illusions and delusional people — including a credulous board comprised of national security cognoscenti.

Or, revisit our January newsletter (“Bulls on Parade”) in which GMO’s Jeremy Grantham and KKR’s Henry McVey were bulled up on EM. I was too. Illusion! Delusion!

If it’s any consolation, an insight from Jobs’s quote is that it’s virtually impossible to measure the size of the gap between myth and reality in real time.

But man, secondo me, it really does feel like we’re living through a period when the gap between image and reality is wide and widening, and a trapdoor is beneath our feet.

I wonder, though. Which of the foundational beliefs in EM private markets will prove to have been illusions and delusions?

A few motions to debate with yourself and others:

  • There is an abundance of EM companies ripe for PE investment
    (h/t Nadiya Auerbach).
  • U.S. PE will outperform EM PE over the next decade.
  • LPs that have committed to mega-cap Asia / China venture will do well over the next decade.
  • “Impact investing” will continue to be a viable asset-gathering strategy for industrial-sized GPs if / when the yield on the U.S. 10 Year climbs north of 5%.

Anyway, our second son is arriving imminently, so this is Portico’s last newsletter for 2018.

A humble request: if you value our monthly(ish) dispatch, please share it with friends and colleagues. They may sign up for free at this link, and read previous editions here.

Once again, we’re going to make a charitable contribution for each new (human) subscriber we get between now and 30 December. We’ll be donating to Room to Read, a nonprofit active in Africa and Asia that focuses on literacy and gender equality in education.

Health and happiness to you and yours.

Alla prossima,
Mike

401(k)s — The Final Frontier

Private equity is one step closer to accessing the $5.3 trillion 401(k) market in the United States.

The Committee on Capital Markets Regulation has released Expanding Opportunities for Investors and Retirees: Private Equity, a study that provides the intellectual grist for legislative changes that would democratize access to direct investments in PE / VC funds.

I’m of two minds on this issue. Like, of course people should be able to invest in private investment funds. But on the other hand, there just aren’t that many great PE funds that merit one’s investment. Seems like a poor set-up for success.

Moreover, there are limits to PE’s absorptive capacity. For example, according to PitchBook, U.S. PE funds raised $275 billion in capital in 2017. If PE captured just 3% of the current 401(k) market, that’s an incremental $160 billion. Would a 60% increase in capital have a negative impact on returns?

Admittedly, this compares stocks to flows; but it’s worth asking just where all this capital would go. One thing is certain: it would generate a lot of fee income for managers.

It may have been my reading of it, but the study seems to pain itself on using historical performance data to make the case that private equity’s outperformance of public markets is akin to a law of nature. A tad overdone, in my opinion. Private equity is a market of managers; and recent research demonstrates that the persistence of fund managers’ performance is declining.

Honestly, how are retail investors going to select top-quartile managers when professional LPs fail to do so on a regular basis?

The reality is that they won’t. They’ll likely invest in the name-brand mega-cap firms that excel at gathering assets. The best-performing GPs don’t need — or want — Mom & Pop’s money.

Cui bono?

Future Fund

Steve Byrom — head of PE at Australia’s A$150 billion Future Fund — has something to say:

At a big picture level, this asset class is becoming less attractive … Business models aren’t sufficiently differentiated because of the number of GPs in the ecosystem and the amount of capital competing for a reasonably small number of bidders.

Great time for retail to jump in!

Norway on Governance

Norges Bank Investment Management made a couple appearances in the newsletter this year, most notably for calling out private equity’s lack of transparency as a principal reason for their decision not to invest in it.

And since governance has been a key theme this year (and will be at least through Q1 ‘19), I was pleased to see that Norges Bank has released three position papers on key governance issues:

Social Capital

Chamath Palihapitiya — Founder and CEO of Social Capital + Owner of the Golden State Warriors — is an outspoken guy whom I’ve enjoyed listening to and reading over the last few years.

There was a bunch of hubbub in recent months about the exodus of employees from his firm, as well as his decision to transition from a fund structure to a holding company that will invest from its own balance sheet. I don’t know what’s fact or fiction. I don’t really care.

But since the firm is now a holding company, Palihapitiya is emulating Warren Buffett and releasing annual letters. His first letter provides a dour view on U.S. venture capital as an industry, which he colorfully describes as a “multilevel marketing scheme.” It’s worth reading. His cynicism is crisp, refreshing, and effervescent, like a chilled flute of pignoletto.

In the letter, he asserts that “the demands of innovation are going up;” it’s a conclusion that I’m inclined to believe. As I wondered aloud last month, “maybe founders with vision are the scarcest thing around.”

Palihapitiya closes with a cheeky comparison of Social Capital’s performance over its first seven years vis-à-vis Berkshire Hathaway’s. The devil’s in the footnotes, but I must say: hubris is not a good look.

From the Bookshelf

[T]he political and philosophic history of the West during the past 150 years can be understood as a series of attempts — more or less conscious, more or less systematic, more or less violent — to fill the central emptiness left by the erosion of theology … the decay of a comprehensive Christian doctrine had left in disorder, or had left blank, essential perceptions of social justice, of the meaning of human history, of the relations between mind and body, of the place of knowledge in our moral conduct …

[This] nostalgia [for the absolute] — so profound, I think, in most of us — was directly provoked by the decline of Western man and society, of the ancient and magnificent architecture of religious certitude … Today at this point in the twentieth century, we hunger for myths, for total explanation: we are starving for guaranteed prophecy …

It was a deeply optimistic belief, held by classical Greek thought and certainly by rationalism in Europe, that the truth was somehow a friend to man, that whatever you discovered would finally benefit the species. It might take a very long time. Much of research clearly had nothing to do with immediate economic or social benefits. But wait long enough, think hard enough, be disinterested enough in your pursuit, and between you and the truth which you had discovered there will be a profound harmony. I wonder whether this is so, or whether this was itself our greatest romantic illusion?

— George Steiner, Nostalgia for the Absolute (Anansi Press: 2004)

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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.

 

An Extractive Industry

I remember it like it was yesterday.

30 years ago, my father — God rest his soul — dragged me to the hardware store, with the promise that yet another of my boyhood weekends would be spent “building character.”

But this weekend was different.

Instead of heading home after securing the lumber and dirt, we stopped by a Toys “R” Us.

Dad told me to look around while he spoke with a manager, and when I sauntered back to the front of the store, the manager was retrieving — ever so delicately — a Nintendo Entertainment System from a locked display case. My Dad’s outstretched hands rose to the ceiling, as if offering a prayer, ready to catch the box should the manager tumble from the ladder.

Nintendo. Humankind’s third-greatest invention (after the wheel and the Gutenberg press).

That trip to Toys “R” Us was one of the most joyful moments of my childhood. I am certain that I am not alone — Toys “R” Us was an iconic company that enriched the lives of millions of children.

And private equity destroyed it.

Let’s not mince words: leveraged buyouts (LBOs) constitute an extractive industry.

In the case of Toys “R” Us, Bain Capital, KKR, and Vornado took the company private in a $6.6B LBO in 2005. It is now bankrupt and closing all of its stores — without paying employees any severance.

In the year of the acquisition, the company generated $11.2B in annual sales, and the linked article says their biggest competitors at the time were the discount retailers Wal-Mart and Target. (Amazon’s shares were ~$35, fwiw).

Revenue was never a problem. Net sales never dipped below $11.3B (in fact they exceeded $13B between 2007-13). However, according to SEC filings, Toys “R” Us’s debt burden jumped from $1.86B at acquisition to $5.5B in the fiscal year after the deal, and annual interest expense climbed from $130m in the year of the acquisition to $400m+ beginning in 2006 (see charts). Optimizing capital structures for whom, one might ask.

ToysRUs2

The LBO firms were on the take from the get-go. According to SEC filings, “upon consummation of the Merger, [Toys “R” Us] paid the Sponsors a fee in the aggregate amount of $81 million for services rendered and out-of-pocket expenses.”

In addition, SEC filings show that between 2005-17, Toys “R” Us paid out aggregate “Sponsor management and advisory fees” of $204m. An analysis in The Atlantic suggests there may have been $128m in (incremental?) transaction fees as the company bought up KB Toys (another Bain Capital bankruptcy special) and other toy retailers.

Consider that between 2014-16, when Toys “R” Us was posting losses of $867m, $256m, and $48m, the company paid out advisory fees of $22m, $18m, and $6m. In other words, in the three years that the private equity sponsors were overseeing losses before taxes of nearly $1.2B, they still drew fees of $46m.

That giant sucking sound you hear is LBO firms hoovering out the value from a cash-generating company. One that likely could have remained a going concern, had the LBO firms not forced down such an onerous debt burden.

Again, 30,000 employees were fired without receiving severance. This is Dickensian villainy at its finest. It evokes The Ghost of Tom Joad.

The FT reports that some of KKR’s pension fund clients “are re-examining their relationship with the investment group amid anger over the treatment of workers at the bankrupt retailer.” They should.

But they shouldn’t stop there — they should re-evaluate their investments in LBOs altogether.

Here’s the dirty little secret: when pensions invest in LBO funds, they are fueling inequality.

The entire LBO model is predicated on bogging down cash-generating businesses with debt, and compelling managements’ hands to create efficiency gains (i.e., layoffs). In other words, thousands of people must lose their jobs and benefits, and be plunged into a state of precarity, in order for pensioners to remain secure in their stipends. It is absolutely zero-sum.

One of the most rigorous takedowns of the LBO model is Eileen Applebaum and Rosemary Batt’s Private at Equity Work. I highly recommend it.

Notably, one of their conclusions is that, unlike LBOs, private equity investments in small and midsize companies can drive meaningful business growth and innovation. I — and others — would argue that the opportunities for shared value creation are even greater in emerging and frontier markets.

When I came up with Portico’s ethos, I jotted down the following:

Value creation > value extraction
Build something that increases the general welfare. While there are riches to be made in value extraction, we do not believe in doing well at the expense of others. Spread dignity.

The fate of Toys “R” Us is precisely the type of BS I had in mind when I wrote those lines.

I would encourage all investors to consider the long-term consequences of the LBO model, and to eschew such extractive forms of investment.

Alla prossima,
Mike

P.S. The newsletter is taking a hiatus in August. See you in September.

Raising a Fund

At Portico, we believe in fund managers who are trying to build businesses and increase prosperity across the world.

In a sense, Portico was founded as an anti-gatekeeper. We believe that too many service providers in this industry operate in a black box, and that this lack of transparency ultimately hurts everyone.

With that in mind, we created the Informal Guide to Raising Your First Fund. Our goal with this product is to empower fund managers with the knowledge they need to develop an institutional-quality pitchbook. We’ve bundled it with a 27-page sample pitchbook to maximize its practical utility, and the feedback we’ve received tells us it’s equally relevant for managers raising funds III, IV, and beyond.

Given the exceedingly difficult fundraising environment, we’re pleased to announce that we are now offering it for only $149. It’s more important to us that a greater number of firms succeed — and that the industry develop — than that we sit on useful knowledge.

Invest in yourself. As our next story demonstrates, it’s only going to get tougher for EM managers to raise capital.

Abraaj: Redux

(For background, read parts III, and III)

This is way bigger an exposure than anyone expected … What is shocking is that the company invested almost 10 percent of its total assets and all their investment book with one company.

I am surprised that the company had more than 70 percent of its 1.5 billion-dirham investment portfolio exposed to a single fund and this was never flagged by the auditors or questioned by the shareholders.

These two quotes come from a Bloomberg article on Air Arabia’s disclosure that it faces a $336m exposure to funds managed by Abraaj.

That is a lot of granola. But it’s only part of the story.

Abraaj executed a pre-IPO investment in Air Arabia in 2007, and it secured two board seats in the process. Arif Naqvi retained his position on the board through 2017 (though he didn’t show up to the first three meetings in 2017).

Somehow, nobody seemed to see a conflict of interest in Air Arabia directing “all their investment book” to a board member’s firm?

It gets worse. The Wall Street Journal reports that, “Money originating from Air Arabia was used to replenish the [Abraaj Growth Markets Health Fund], according to people familiar with the situation. KPMG’s review of the fund didn’t mention this, one of those people said.”

KPMG, you may recall, was the firm Abraaj selected to examine the books of its healthcare fund after this whole imbroglio erupted in the press. KPMG is also the auditor of Air Arabia (among other Abraaj portfolio companies).

And then there’s the bombshell.

A separate Wall Street Journal article reveals that PricewaterhouseCoopers, a provisional liquidator for Abraaj Holdings, “have ‘been unable to obtain standalone annual financial statements or management accounts’ for the holding company, a situation they described as ‘highly irregular.’”

Absolutely extraordinary. It’s a sentence worth reading again.

According to the Journal, the PwC report goes on to say:

This lack of financial record-keeping raises the question of how the company’s directors were able to ensure the company was solvent and being effectively managed.

Investment management fees revenue had, for some years, been insufficient to meet its operating costs.

Any liquidity shortfall was largely funded through new borrowings.

Reuters reporting adds that “Abraaj’s total debt stood at $1.07 billion … including $501.4 million in unsecured debt and $572.4 million [in] secured debt.”

The launch of the $6B mega-fund may be viewed in a new light.

The whole situation stinks.

And the stink is on many hands.

Who was doing due diligence? With what documents? Where was the fund administrator?

Institutions were throwing money at Abraaj. Washington State Investment Board, for example, unanimously approved an investment of up to $250m, plus fees and expenses, in the mega-fund, “based on Abraaj’s solid overall investment performance, large, institutionalized team … [and] a consistent investment and risk underwriting process applied globally.”

During the preceding Private Markets Committee meeting, Hamilton Lane “discussed [Abraaj’s] approach to investing, reputation, culture, track record, and currency risk” and supported the staff’s recommendation to invest in the fund.

They’re not the only ones. It’s just that their minutes are public.

Consider, for example, the long list of third parties that provided Abraaj the equivalent of a Good Housekeeping Seal of approval:

  • Abraaj reportedly received its third A+ rating from the UN Principles for Responsible Investment last year.
  • Arif Naqvi was on the Board of the UN Global Compact and a Founding Commissioner of the Business and Sustainable Development Commission
  • He is also a member of “The B Team” — a self-appointed group of business leaders that seeks to advance ESG, etc. Literally the first challenge on their website is, “Drive full transparency: be open, transparent and free from corruption, with good governance and accountability at all levels of our organizations.”
  • The Harvard Business School and Kennedy School connections.
  • The World Economic Forum.
  • Gatekeepers.
  • Auditors.
  • PR firms and the press.
  • Etc.

If there is one lesson from this fiasco, it is that it pays to do your own work.

Also, don’t chase shiny objects.

Fin.

P.S. As we suggested in March, it appears that LPs in the Africa fund are looking for a new GP to manage out the assets.

Small Is Beautiful in CEE

EMPEA recently released a report on private markets in CEE and it’s really quite good. My fundamental takeaway from the report is that the region attracts little capital — between $500m and $1.5B annually between 2009-17 — but this lack of capital is why (a handful of) investors like it.

Consider that, according to the PitchBook data in the study, the median Eastern European buyout multiple between 2006-17 was 5.8x — the lowest multiple globally.

Admittedly, there were few transactions that provided data points for PitchBook, so let’s look at the other end of the spectrum: as of December 2016, EBRD’s portfolio of CEE funds — which is, like, every CEE fund ever — has delivered roughly 7.5% net across all vintages. It’s not an exceptional number, but private equity’s not about investing in an index.

Moreover, it’s not like pension funds — which aren’t pursuing EBRD’s development mandate — are doing much better. According to the American Investment Council’s 2018 Public Pension Study, the median U.S. pension fund’s private equity portfolio delivered a 10-year annualized net return of 8.6%.

Anyway, as I read the briefing, I reflected upon Portico’s thought piece from last December — Does EM PE Scale? — and decided that what’s happening in CEE is a beautiful outcome. The GPs and LPs interviewed for EMPEA’s piece seemed happy with the status quo: most investors have mistaken perceptions of the region’s risks, so they don’t invest in it; and those LPs that do invest in the region have found manager relationships they value across cycles.

Maybe EM PE is an artisanal industry.

Insomnolent in India

Bain & Co. released the 2018 edition of their India Private Equity Report. Lots of charts. Lots of things moving up and to the right.

Bain asked respondents to its survey, “What keeps you awake at night?”

The top three responses:

  • Mismatch in valuation expectations (~75% of respondents)
  • Challenges to maintain high level of returns (~55% of respondents)
  • Lack of attractive deal opportunities (~50% of respondents)

Those seem like … the core elements of running a PE business? No wonder so many Indian GPs are happy to take my calls at 2am IST — they’re not sleeping!

Funnily enough, respondents were least concerned about, “Approaching end of fund life with unliquidated assets” (~3% of respondents).

Now, Bain’s survey had 39 respondents out of a universe of active investors they estimate at 491. But I wonder, would the percentage be much different if the sample size quadrupled?

Zombie4

Turkey: Value Trap?

Last November, we asked if Turkven’s Seymur Tari was precipitating a market turn in Turkey. After seven years of declining business and consumer confidence, was the country on the cusp of a resurgence?

Well. After the latest round of elections, the president’s appointment of his son-in-law as the head of the country’s treasury and finance ministry, and changes to the rules for appointing the central bank governor, one wonders if all those assets trading at a discount might constitute a value trap.

The IMF forecasts gross external financing requirements of ~25% of GDP (equal to ~$200B) each year through 2023.

Turkey’s policymakers confront a delicate dance, indeed.

From the Bookshelf

There is a crime here that goes beyond denunciation. There is a sorrow here that weeping cannot symbolize. There is a failure here that topples all our success. The fertile earth, the straight tree rows, the sturdy trunks, and the ripe fruit. And children dying of pellagra must die because a profit cannot be taken from an orange. And coroners must fill in the certificate — died of malnutrition — because the food must rot, must be forced to rot.

The people come with nets to fish for potatoes in the river, and the guards hold them back; they come in rattling cars to get the dumped oranges, but the kerosene is sprayed. And they stand still and watch the potatoes float by, listen to the screaming pigs being killed in a ditch and covered with quick-lime, watch the mountains of oranges slop down to a putrefying ooze; and in the eyes of the people there is the failure; and in the eyes of the hungry there is a growing wrath. In the souls of the people the grapes of wrath are filling and growing heavy, growing heavy for the vintage.

— John Steinbeck, The Grapes of Wrath (Bantam Books: 1970)

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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.

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