Allen Wagner May 19, 2014
Standing at the precipice of a major shift in global investment, the largest U.S.-based private equity firms have recently made the leap into emerging and frontier markets, where deal sourcing and opportunities will be increasingly abundant in the coming years. The Carlyle Group leads the way with region-specific funds, but KKR and The Blackstone Group aren’t far behind, as the biggest players in PE begin to make the leap into Africa, Southeast Asia and Latin America.
The largest U.S.-based PE firms will increasingly be looking for opportunities in frontier markets in the coming years as investment opportunities dwindle in the United States and Europe continues to remain in constant crisis-mode. In fact, we’ve already begun to see this shift. Carlyle now completes more than 25% of its PE deals outside of North America and Europe, while KKR, Blackstone and TPG closed roughly 15% of their transactions in emerging markets in 2013, PitchBook data show.
One common theme across the board for five of the biggest U.S. firms (Apollo, Blackstone, Carlyle, KKR and TPG) is that they began to invest more heavily outside of North America and Europe in the immediate aftermath the financial crisis, as developing economies and frontier markets were generally viewed as uncoupled from the financial system that sent the United States, Europe and select Asian economies into a tailspin. For example, prior to 2009, Carlyle only once made more than 20% of its PE investments outside of North America and Europe (in 2007). But the firm completed nearly 30% of its deals outside those two regions in 2009, and has generally averaged 25% since then.
While those percentages for all the major firms have gone down somewhat in the last two to three years, the firms are still leading the way in emerging- and frontier-market investing, and we should see a growing share of their deal-making outside of North America and Europe in the coming years.
What will be the main drivers of this shift?
First off, deal-sourcing conditions in the United States will play a major part. Increasing competition due to an abundance of cash and available debt, as well as an overall improvement in market conditions, has driven investment multiples up in the U.S. PE firms are finding it more expensive than ever to buy the few desirable companies they want to acquire and have begun shifting their investment philosophies to include more growth deals and add-ons. But they will also likely look to emerging markets, where investment opportunities are abundant and can be had with less competition among PE firms and corporate acquirers.
Secondly, emerging markets represent a massive long-term growth opportunity for private equity firms. Middle-class growth and stabilizing economic and political systems make these frontier markets attractive on many levels; and the PE firms that take advantage early can compound their success by gaining a foothold and helping to build companies that grow along with the overall economy. For example, Carlyle’s recently closed $700 million Sub-Saharan Africa Fund won’t be making many deals for mining or natural resources projects—what many investors previously focused on in Africa. Instead, the fund, which has already completed transactions for two logistics companies in the region, is set up to invest how it normally would in the United States or Europe.
The fund will focus “on industries in which Carlyle has an established investment track record and in which the team has expertise. These include financial services, fast-moving consumer goods, agribusiness, transportation & logistics and energy.”
Many emerging countries still have to do much in order to improve security, infrastructure and stability. But it’s clear that there are opportunities for PE firms to invest in frontier markets, as improved infrastructure opens new avenues of commerce and as the energy and commodities boom in many such countries generates jobs, which, in turn, helps transform local economies and grow the middle class.
“It is not for the faint of heart, and it is not easy to do deals there,” Carlyle Group co-founder David Rubenstein recently said about Africa. “But it is an opportunity where I think over the next 10 years you are going to see a lot of private equity firms going there.”
It seems limited partners want them to as well. A 2013 survey of LPs, conducted by EMPEA, showed that one-third of LPs plan to increase the share of their PE allocations in emerging markets. And U.S.-based PE firms are obliging with region-specific funds. Several emerging-market funds from Carlyle, KKR and TPG have closed in recent years, with additional vehicles focused on Brazil, Asian real estate and more expected to close in the next few years. The performance of some mid-decade region-specific funds leaves a lot to be desired, with PitchBook data showing that most such vehicles from the big-five U.S. firms have not made their LPs whole (DPIs less than 1.0x). But that hasn’t dampened LP or GP enthusiasm for what could be great opportunities abroad.
How and where will deals get done?
Most investors are focusing their attention on Latin America, Africa and Southeast Asia—all locations where the middle class is growing, citizens have more disposable income than before and governments are working to provide stable environments to do business. This shows through in many of the region-specific vehicles being closed by the big-five U.S. PE firms, as they raise Africa and Latin America focused funds, in addition to more commonly seen Asia- and China-focused vehicles.
PE firms, by and large, make more growth equity investments in emerging markets than in North America and Europe. But there’s reason to believe this may shift in the coming years, as many GPs “are no longer willing to settle for the purchase of passive minority stakes in companies whose entrepreneur owners are reluctant to cede control.” It’s likely growth equity deals will remain popular in emerging markets, but with added terms and conditions that allow GPs on the ground to manage their portfolio company more actively to ensure success.
And success now will no doubt beget more success, as LPs gain confidence in PE firms’ abilities to invest overseas and provide more capital for the unique opportunity that emerging and frontier markets represent.
Featured image courtesy of Flickr user Zouzou Wizman.
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