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Private equity value creation in Latin America: exit study highlights

Private equity (PE) investors have come out of the recession with a renewed focus on organic revenue growth, applying a more entrepreneurial mindset to working with their portfolio companies.

To uncover how value creation is achieved in the emerging markets, we teamed with Emerging Markets Private Equity Association (EMPEA) to produce this inaugural emerging markets study. What we discovered is that private equity in the rest of the world is evolving to better resemble the model in the emerging markets.

PE firms are focused on growth and hands-on partnerships
In the Latin American exits we studied, PE firms are focused on growth and hands-on partnerships with entrepreneurs to transform companies into market leaders, and this approach is yielding strong results. While styles and strategies varied, what the exits nearly all had in common was that organic revenue growth was the primary driver of EBITDA (earnings before interest, tax, depreciation and amortization) growth and returns.

In every deal analyzed, taking advantage of Latin America's impressive macroeconomic growth was a key feature of the investment thesis. Buying well in such an environment is key — leveraging local teams and proprietary channels to find future market leaders in fast growing but often highly fragmented industries.

Nearly three quarters of the deals we analyzed were sourced from private sellers, and two-thirds came either through the network or via active tracking of the sector. Just 20% were acquired through auctions. In finding the next market leader, PE buyers seek companies that can take advantage of demographic trends, such as rising consumer spending, or address bottlenecks to growth, such as infrastructure.

Value creation approaches in Latin America
Entrepreneurial approaches are another defining characteristic of value creation approaches in Latin America deals. In many cases, the investment thesis hinges just as much on the potential for close alignment with incumbent management and the opportunity to transform the business model.

Unlike in the North American and European markets, PE buyers in Latin America place more emphasis on improving the core business and preparing and strengthening management to ready companies for exit than on optimizing the capital structure. Enhanced financial discipline and corporate governance is the baseline in every deal, achieved through the installation of CFOs and controls and board-level engagement.

Partnering with management
Even where the PE buyer is a minority investor (in the majority of deals), these are the key areas through which influence is vital, achieved through incentives and rights negotiated in the term sheet. This approach to partnering with management to drive growth and professionalize the business nearly always includes a value creation roadmap, always of at least 100 days, and often longer.

Implementation of these plans draws on the GP's network to tap new or cheaper sources of finance and strategic advisors to set direction and implement strategies. PE buyers make use of their own teams to complement the bench strength of their investees.

This may take the form of a senior PE partner or deal team member acting as interim CEO, or even as CFO for the life of the investment. In other cases, senior PE partners engage solely at the Board level, but do so intensely.

Strong alignment with management from the outset befits the current exit modalities in the region. Most exits are sales through private channels, often a buyer identified on entry or attracted by enhancements made through the PE partnership.

IPOs typically play a very specific role in the investee's growth trajectory and were often identified at the outset as the preferred mode of exit.

PE in Latin America shows continued growth
Continued growth of private equity in Latin America will naturally stress this growth-focused, hands-on model and create some opportunities for innovation and evolution. Robust economic growth and the overall good health of their portfolios have enabled PE firms to be highly effective with lean, generalist teams.

There are few examples of firms with dedicated portfolio staff or operating partner networks, practices that have recently emerged among US and European PE firms preparing for future downturns. As flows of new capital to the Latin American markets put more pressure on valuations even as growth rates begin to slow, it will be critical for PE buyers to shore up their advantages and in some cases reposition to other market segments as a defensive measure.

Finally, our sample points to a gap in the Latin American market today, with secondary sales to PE buyers comprising only 5% of exits. With investor interest in Latin America showing no signs of slowing, there is a need to build towards a more cohesive ecosystem in which the middle market and the buyout segment not only coexist but enhance the overall scale and quality of the investable universe.

PE has yet a larger role to play in supporting economic and entrepreneurial growth in Latin America.

To download 16-page report, please click here.

Source: Ernst & Young - GAI

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