Deal of the Year: Emerging Markets –

With fund performance still in negative territory and the economy sputtering along, few private equity firms had an appetite for risk in 2002. Many chose to spend their cash on corporate divestitures-usually established, profit-generating units that were sold only to improve the selling company’s stock price. PIPEs were another favorite of gun-shy LBO funds last year.

Against that backdrop, and with a global economic slowdown to boot, the prospect of doing deals in emerging markets seemed unthinkable-especially in a volatile country like Brazil. Yet that’s exactly what Advent International did with its $10 million buyout of two Brazilian laundry companies last winter, a deal that looks to have tremendous upside.

Advent paid four times EBITDA for a 67% stake in Central de Lavagem e Processamento Textil Central Lav S/C Ltda and Aqualimp Higienizacao Textil Ltda, Brazilian companies with locations in Sao Paulo, Rio de Janeiro and Belo Horizonte. Both companies provide outsourced industrial laundering services and rental of linens and uniforms to hospitals, hotels and industrial companies. That business has been growing in Brazil, and there’s ample room for continued growth.

“The outsourced laundry and linen rental sector is growing at barely two or three percent each year in the U.S. and Europe, compared to 10% to 15% growth in Brazil,” said Erwin Russel, a partner with Advent, director of its San Paulo office and lead on the Central Lav/Aqua Limp deal. “We will see a significant jump in revenue simply by growing at the same pace as the entire market.”

The two launderers already have a head of steam. Each averaged annual growth of nearly 40% from 1997 through 2002. With combined revenue topping $20 million in 2002, the now-merged companies constitute the second-largest industrial launderer in Brazil, and its nearest privately-owned competitor is less than half its size.

A Deutsche Bank analyst said 70% of all industrial laundering in Brazil is done in-house, which means there’s plenty of upside potential for outsourced launderers such as Central Lav and Aqua Limp. Also, the need for clean sheets and creased uniforms is rising. “We are seeing six to eight percent organic growth in the hospitality sector alone,” the analyst said.

Looking Back

The deal was born February 2002 when Advent’s Brazil team decided to pursue buyouts in the laundry outsource sector, “and we soon learned Central Lav and Aqua Limp were the best companies [in the sector],” Russel said. Once word got out about the management team’s decision to listen to offers, a bidding war ensued.

“This was not a typical auction,” he said. “There were 13 separate owners to deal with – some wanted to sell and some wanted to stay involved. It was a strenuous situation, and our competitors basically threw their hands up in frustration and walked away.”

Meanwhile, Advent had the added challenge of Brazil’s fluctuating currency values. “During negotiations, the Brazilian Real moved frenetically between R$2.30 and R$4.00 compared to the U.S. dollar,” Russel said. Spreads on the country’s sovereign debt reached their highest level 2,700 basic points above Treasury’s level during this time, and according to Russel, Brazil gained the notorious distinction of being named the most financially risky country in the world.

But Advent and lender Bank of Boston helped mitigate this risk by using a currency hedge. “This deal was one of the rare occasions in Latin America in which the private equity fund sought a hedge to protect the investment against exchange rate exposure,” Russel explained. The hedge ensures that the funding provided by Advent and Bank of Boston is secure for the 10 months following the Brazilian election a time period in which “extreme volatility could occur due to the political transition,” he said.

In addition, Advent faced the obstacle of unreliable accounting practices at the target companies. Part-time number crunchers operated using basic ERP tools, without a CFO, a full-time controller or an international accounting firm to audit financial statements.

But Advent hurdled all those obstacles, and the firm kept its equity portion low when the owners that remained agreed to put up $1 million of their own money to be used as working capital, bringing the total amount of working capital to $3 million, and giving the owners a 33% stake in the new company.

Advent’s $265 million Latin American Private Equity Fund II paid just over $7.5 million in cash, while Bank of Boston contributed $2.5 million in debt. Of the total purchase price, $8 million went to the exiting owners, and the remaining $2 million is being used as working capital.

Exit Opportunities

An analyst at a European bank said Advent’s timing couldn’t have been better, based on the global interest in this industry. “Expansion into Latin American [by larger companies] should happen in the next three to five years,” he said. That means strategic buyers will likely be interested in the Brazilian pair.

Indeed, Russel said Advent plans to “roll up” enough small laundry shops this year throughout Brazil to become the largest company in its sector by 2004, a move that should make them a ripe target for some of the larger laundry and uniform companies, such as Cintas and Aramark.

“Our expectations are to grow the company to at least $50 million [in revenue] by 2006, and sell to a large strategic company based in the U.S. or Europe,” he said.