Dim Outlook for Profit in Latin America –

As an asset class, private equity in Latin America is a mere youngster, less than a decade old. And yet, the nagging question remains: Will it ever mature into a viable, long-term investment area? For the most part, the rewards of private equity investing in Latin America have been unrealized. Therefore, sources are unclear as to whether investing there is worth the risk.

For example, of the $19 billion invested in roughly 270 Latin American companies and privatization deals between 1996 and 2000, only 15 have been exited. And the first generation of funds raised is close to the point where capital is supposed to be returned.

“Many firms can’t exit the companies they invested in,” says Eduardo Campiani, director, Latin America, of Advent International. “If you paid high prices and don’t sell your assets, you will see losses. This has brought bad publicity to Latin America and even doubt if private equity is a sustainable asset class here.”

Unsurprisingly, the doubt is weighing heavily on the minds of limited partners. Many have deemed the region too risky in which to invest, or re-invest, until it is demonstrated that profits can be made.

“Latin America is a part of the world we’re not enamored with right now,” says one LP, whose institution invested in a Latin American private equity fund between 1995 and 1998. “Europe and Asia are more compelling.”

This attitude has left even some veteran investors in Latin America feeling stuck as the dearth of exits makes raising money for new funds next to impossible at a time when many of the region’s first funds are close to fully invested. “These are gloomy times,” says Varel Freeman, a senior partner with Baring Private Equity Partners (BPEP). “The lack of liquidity has meant a lack of exciting stories.” Freeman knows because he has been fighting in the trenches. His firm went on the road last spring to try and attract third-party investors to its new fund, Latin America Partners I, which has a target amount of $300 million. As to the fund’s closing, Freeman says, “I wouldn’t put a date on it.”

In Their Dreams

In a recent survey by the Latin American Business Center of PricewaterhouseCoopers (LABC), many U.S. private equity investors said they intend to exit their current and/or future investments by selling to strategic buyers. The majority of respondents, 60% – which ranked strategic buyers as their most preferred form of exit – want to sell to a global strategic buyer, while the remainder, 40%, would rather sell to a domestic Latin American strategic buyer.

Survey respondents preferred international IPOs over domestic IPOs, which is not surprising because capital markets are virtually closed and Latin American markets, in particular, contracted in the late 90s.

In fact, success stories in the region are so hard to come by that one must look back to 1996, when Advent International purchased Aeroboutiques de Mexico SA de CV, for an example of a deal that actually concluded with an exit.

While Advent began its exiting process with an IPO on the Mexican stock exchange in 1997, the firm last May was able to completely exit the investment with a sale to a strategic buyer, despite the lack of opportunities in the region.

Based in Mexico City, Aeroboutiques operates duty-free stores and restaurants in Mexican airports and tourist areas. The company completed its IPO on the Mexican stock exchange in 1997, a year after Advent invested $3.7 million. Advent sold a portion of its position at the IPO, generating realized proceeds of $10.5 million. More recently, the company was sold to strategic investor Grupo Areas SA in May of 2001, releasing Advent from ownership completely. Advent’s total gain from the investment, including IPO, trade sale and dividends, was $65.3 million, according to the firm.

That Advent realized the full sale of Aeroboutiques through a strategic investor is instructive because it points to the near impossibility of taking Latin American companies public on local exchanges, where trading remains thin. The firm in fact shelved plans to take another portfolio company, Microsiga S.A., public over the new Brazilian stock exchange NovoMercado over the summer. Microsiga is a So Paulo-based producer of business planning software, and the planned IPO was to be the first on the new exchange. NovoMercado was created to make it easier for smaller Brazilian companies to become publicly listed and to provide more transparency to investors. Awhile back, a partner at Advent said he thought the timing was right for a Microsiga IPO, but no longer.

“We’re holding off on the IPO until the situation improves,” says Campiani of Advent. “And we might get better returns in the new market where there is greater transparency.” But Advent is in no rush to exit. After all, the investment in Microsiga is still relatively new since it closed in March 1999. Campiani estimates that Advent may take the company public in the second quarter next year.

Otherwise, Campiani said the firm would consider an exit to a strategic player if the public markets don’t impove. Advent does not invest in a company without an interested strategic buyer on hand – a policy many firms no doubt wish they had adopted along with Advent’s position of only taking majority stakes in Latin American companies.

“Exits are the first issue we address,” he says. “We therefore only take controlling stakes. To acquire control is to control the exit.”

While Campiani sees holding a minority stake as risky, that did not keep others away – investors stormed the region in the mid-90s, taking whatever stakes they could get. Of 123 investments made in Latin America between 1996 and 1998 (the years private equity investing in Latin America peaked) only 52 represented majority stakes. Furthermore, among pan-regional investments, which became popular during this period and account for nearly $1 billion worth of deals, only 30% were done for majority stakes.

Because the average Latin American company owner prefers to retain control of the company, many GPs conceded to deploying capital in the region through minority stakes. In many cases, there were no partners working on the ground who truly understand the diverse cultures and economies of Latin America. This was especially true during the Internet craze that hit Latin America in late 1998 and lasted through the Nasdaq crash in the spring of 2000. Early stage Internet-related investments shot up from 3% to 20% of investment dollars spent in the region in 1999-2000. The top Internet investors during this time were Chase Capital Partners (before it merged with J.P. Morgan), Brazilian firm GP Investimentos, CVC Latin America and Warburg Pincus. Chase made 19 total first- and second-round Internet and Internet-related investments beginning in 1998, many of them business-to-consumer dotcoms, all of them for minority stakes.

The one that garnered Chase the most attention was Internet portal StarMedia Network. Its successful IPO on Nasdaq – the first of venture-backed Latin American start-ups to go public in the U.S. in May 1999 also laid the groundwork for others like Softbank to create Internet funds for Latin America. It also encouraged traditional buyout firms already heavily invested in Latin America to act as venture capitalists in the region. Among them were Hicks, Muse, Tate & Furst, and Buenos Aires-based Exxel – firms better known for their investments in more stable areas prior to 1999.

Chase made a splash with the successful IPO of StarMedia (Chase was the original investor in the company and invested $3.5 million for a 30% stake in the company in 1997 in a first round). However, Gary Nusbaum, managing director and head of the Latin American group at Warburg Pincus & Co., says his firm was the only one to make money on that IPO as the others retained their shares. Warburg Pincus came in on a third round in 1998, which garnered StarMedia $80 million for that round, and nearly $100 million in total financing.

“For us it was a major exit,” Nusbaum says. “We were the only financial investor in StarMedia to take out a material amount of cash. We sold $41 million in stock six months after the IPO, in November 1999, which was two times the cost.”

Warburg Pincus has invested in eight deals in Latin America, seven of which are Internet or technology related. One portfolio company, Submarino.com, an online retailer, postponed plans to go public last year.

Despite the excitement StarMedia and other successful IPOs on Nasdaq including those of start-up El Sitio, an ISP and portal, and Terra Networks, the Internet subsidiary of Telefonica of Spain, clearly Nasdaq is not going to sustain the dozens of venture-backed Internet-related start-ups coming out of Latin America. In fact, in 2000, only 18 million computers were in use in Latin America. Comparatively, in East Asia, that number was 116 million.

Finally, Good News

Latin America does not represent all bad news, however. The main path has been laid for investors in the region. While the average annual GDP growth between 1980 and 1990 was 2.6%, it grew to 3.7% between 1990 and 2000 and is expected to grow to 4.5% between 2000 and 2005.

Advent’s Latin America fund made a second exit. It sold a winery and plans to sell six more companies before the end of the first quarter of 2002, says Campiani.

In its latest realization, Advent sold Bodegas y Vinedos Santiago Graffigna SA of Buenos Aires, a company that comprises Bodegas Graffigna (one of the oldest wineries in Argentina, founded in 1870) and Bodegas Sainte Sylvie. Advent invested $26 million ($9.1 million in equity) to acquire 100% of the company in May 1999, and sold the company to Allied Domenq Spirits & Wines USA Inc. in July 2001 for eight-and-a-half times trailing Ebitda. It gained $8.4 million on the investment.

“We liked its market share and the industrial dynamics,” says Campiani about what attracted Advent to acquire the company. “Spirit sales are decreasing globally while they’re increasing for premium wines.”

During the 25-month ownership period, the company improved management and systems, provided a stock option plan, expanded production capacities and added 140 new acres of vineyards. The production of all vineyards is up 56% after four years. Advent increased the company’s Ebitda by 24% a year, and experienced revenue increases of $18.5 million the first year.

Difference of Opinion

A few investors, however, are not as panicked as others about the state of their Latin American investments, claiming that the time is not right to be selling. “We obviously would be selling if it were the right market now,” said Sam Santos, managing director of Emerging Markets Partnership, which runs the $1 billion AIG-GE Latin American Infrastructure Fund (LAIF), which is 90% invested.

“Latin America is more adversely affected by the U.S. downturn than it would be in a less globalized world,” says Santos. “We need recovery before sales can happen. [And] we have to prove we can exit before we can raise a second fund. It’ll probably be awhile before we do so. It’s a hard game to play right now.”