LBO Market Still Quiet In Latin America –

With valuations still affordable and plenty of cash in their wallets, U.S. buyout firms have been putting their capital to work. In the third quarter alone, $11 billion of deals got done, and the fourth quarter thus far has shown no signs of letting up.

But despite this jump in activity, the purchasing party hasn’t moved south of the border. Market players say when it comes to LBOs, most of Latin America is still in siesta mode. At best, sources expect around $800 million worth of deals by the end of 2002-less than one-sixth the region’s high of $5 billion in 1998-with most of that coming in Mexico.

“It’s almost impossible to do any [deals] in Latin America, except for Mexico, because of the lack of access to debt, and availability of attractive assets for reasonable prices,” grumbled a managing director at a private equity firm focused on Latin America. “We just do not see an investor appetite for Latin America funding, and I can’t blame [the investors].”

The lack of enthusiasm isn’t surprising. The current global economic slowdown has been particularly hard on Latin America, while recent political turmoil in certain countries only introduces potential hazards at a time when most private equity firms have reduced or lost their appetite for risk.

Meanwhile, private equity in the region continues to be hampered by an aversion to cash-based lending. “Latin America has grown up in an asset-based lending environment,” said Ernest Bachrach, chief executive for Advent International’s Latin American business. “With the current volatility, inflation and exchange rates, it is hard to lend against cash flow.”

But despite those obstacles, Latin America is far from dead. Advent believed enough in the region to raise its Latin American Private Equity Fund II, which closed at $265 million this year and has already made some investments. “We closed a deal [equity investment] in Mexico in October and we are days away from closing another with a business services company in Brazil,” Bachrach said earlier this month.

And Advent isn’t alone. JP Morgan Partners has done one LBO in 2002-a management-led deal for Casa Marzam SA de CV, a wholesaler and retailer of pharmaceutical products-and invested in more than a dozen additional Latin American companies. Darby Overseas Investments Ltd., one of the first U.S.-based private equity firms to launch a fund focused solely on Latin America, is currently raising a new fund with BBBA, an investment bank headquartered in Spain.

But there’s no getting around the fact that Latin American private equity is moving at a snail’s pace right now. While the overall number of private equity investments is considerable, most deals are tiny transactions done locally between smaller banks and companies.

“The cyclical business we are in leads one to believe there will be a turnaround, but in this neck of the woods, that may not happen,” said an investor at a U.S.-based equity firm.

Distressed Opportunities

One category investors are watching closely in Latin America is distressed investments, of which there are several in the region. “What could potentially be interesting to investors is the distressed assets in Brazil and Argentina,” said Bruce Catania, managing director for CVC Latin America. “That is where you may possibly find significant assets at attractive prices.”

“We are cautiously optimistic, and are preparing for the upturn in Latin America,” said Dirk Donath, co-founder and managing partner at Pegasus Venture Capital, an investment firm in Latin America with offices in Boston, Buenos Aires and Sao Paulo. “We think we’ll see foreclosures on businesses due to large amounts of debt, enabling us to step in and take the assets off their hands.” Donath points to Argentina and Brazil as the two most likely sources for these kinds of deals.

Latin America is also a low-cost place to do business, which can help buyout firms establish platforms in the region. “Argentina is the cheapest place in the world for software programmers, call centers, data centers and programming centers,” said Donath, whose firm is investing $2.1 million in Marketec, an Argentine retail marketing company. “These relatively small deals are the platform for growth in this region.”

But not everyone ascribes to the notion that one man’s trash is another man’s treasure. “Even with all the distressed assets in Brazil and Argentina, there are too many negative factors to get [an investor] excited about doing deals down there,” said one partner. “The political issue alone is enough to scare away the smart money.”

Mighty Mexico

While most Latin American private equity funds are pan-regional, it’s common for them to keep their deals “strictly in the MBA,” meaning Mexico, Brazil and Argentina. At JPMP, for instance, 84% of its Latin American deals this year were done in Mexico and Brazil, while two deals were completed in Argentina.

“We are focused on Mexico…they are the exception,” said Timothy Purcell, a partner at JP Morgan Partners. “They have a relatively stable economy, and the already close link to the U.S. economy will get stronger going forward.”

According to the source, the firm is close to closing two deals, one in the $60 million to $70 million range, and the other worth more than $100 million. And some larger deals have been considered but failed to come to fruition. “We looked at two bids recently, in the $300 million to $400 million range, but the deal never materialized,” said Purcell.

JPMP currently has 20% of its $890 million Latin America fund invested, and claims 200 limited partners are included in this fund. While Purcell admitted 20% is a modest pace, “The LPs are happy we are conservative.”

And it’s clear the most conservative route these days goes through Mexico, where the lion’s share of investments are getting done. “We don’t even look at Mexico as being part of Latin America,” said an analyst familiar with the region. “We see Mexico as a 100 million-person extension to the 30 million Hispanics living in the U.S. and Canada.”

Mexican deals that have priced this year include the Banamex purchase of Malta Cleyton, a poultry and beef products company, and a $40 million deal for Pasa, a Mexican solid-waste management company, involving Washington-based Darby and Citicorp Venture Capital.

Exits have been prevalent in Mexico as well. JPMP’s Purcell said the firm’s last exit in Latin America was the 1996 sale of Cinemex, a Mexican chain of cinemas. “We realized a 24% IRR upon the sale, and it is a successful story,” he said.

Baring Latin America Partners completed four exits during 2002, including its investment in Mexico-based Absormex. Baring has invested all of the $45 million raised for its Baring Mexico Private Equity Growth Fund, started in 1999, and will start fundraising again in early 2003, as a follow-on to that fund, said Varel Freeman, a senior partner at Baring.

Looking Ahead

There’s no question that Latin America is sitting in the doghouse of private equity right now, and even those who have invested in the region expect it to stay firmly placed there for the near future. “Latin America is [currently] the least favorite marketplace for any sort of private equity investment,” said Baring’s Freeman. “The interest lies in the U.S., Asia and Europe, in that order.”

But all hope is not lost, market pros say. The International Monetary Fund’s impending decision on how to handle Argentina’s outstanding $800 million interest payment could help bring investment back to the region. If the IMF decides to roll over $14.5 billion in loans Argentina owes to international banks and the IMF, to the end of 2003, it would give the country more financial flexibility. “A favorable ruling by the IMF could tell people to get back in the water, it’s safe,'” said Donath.

And in the long term, the continued development of technology in this region bodes well for investors. Some private equity pros believe that in addition to the large countries like Mexico and Brazil, the smaller countries in Central America-including Costa Rica, El Salvador and Panama-that are making progress technologically will be a source of future, albeit small deals. “Some of the small economies are stepping up their integration in telecom, utilities and other sectors,” one pro said.

And one thing present even in negative comments is the fact that Latin America still offers significant opportunity. It’s the realization of that opportunity that’s unpredictable right now.

“It takes two to tango,” said Julio Lastres, managing director of private equity operations at Darby. “Asset values are very attractive in places, and there is a lot of interest on our side, but in a lot of cases [potential] sellers are shy to sell in this environment. With so little money made available by the banks…the number of deals done in Latin America is in no way reflective of the overall opportunity.”