Private equity as an asset class in the region: a multi-focal approach

Prof. Luc Nijs Founder & Chairman Horizon Ltd Istanbul April 27-28, 2009 Buy-outs & growth capital in the Balkans and emerging markets 2009

Where to start?

Why not fundraising!

Despite the market conditions EM PE raised $ 66,5 bio in 2008, a 12% rise Proportional share in total global PE fundraising raising for 5 years in a row now Relative decoupling & economic power shifting is reinforced by current recession Cyclical recession became a structural one and the risk of L-shape depression is looming (cf. Ponzi economy)

Source: EMPEA April 2009

Fundraising per region

Market outlook for fundraising

Market Outlook
A few conflicting data:

Preqin (April 2009):

US leads the way with 23 bio $ Europe 20,2 bio $ EM 2,7 bio$

Lot of funds postpone final closing Development finance will focus more on direct investing (FOM,) Force of consolidation coming in

Market outlook for EM fundraising

Market Outlook
Argumentation for EM proposition: Resilient growth Less use of leverage
Wider CEE massively impacted 20% of investors refer to increase EM risk

Investors stay committedbut

Some of the underlying fundamentals

What about the converts

Market Outlook
Argumentation for refusal of EM proposition: (Short-term) EM risk Lack of experience in EMs Only few quality GPs available in EMs
Quantitative easing and systemic risk?

Some of the underlying fundamentals

A (new) inconvenient truth about risk

Emerging Markets Risks
Political instability

Developed Markets Risks

Pre-crisis Thinking Developed Markets
Market fundamentals

Legal / Regulatory

Emerging Markets

High Risk High Growth

Low Risk Low Growth

Structural issues

Curreny (F/X)

Environmental

Market fundamentals

High Risk High Growth

High Risk Low Growth

Legal / Regulatory

Counterparty

Post-crisis Thinking

Av. risk premiums in EMs (%, 2008-2009)

Another inconvenience
Capital inflows to developing world

(Source: IFF, 27 January 2009)

Historic & projected EV/EBITDA

Source: Prop. Research, averages for the clusters

Market Outlook
Cheaper valuations (although some parties are still in denial)
Attractive deal flow to arrive (Q1 2010 onwards)

Capital constrained entrepreneurs & management

BRIC as a catalyst gone?

But major differentiators among emerging markets

Semi-globalization = procession of Echternach

Market Outlook
But major differentiators among emerging markets
CEE & CIS: Sovereign risk & currency management Debt-financed growth model is broke Euro and Nordic currency infrastructure has eroded fundamentals Mid/Long term catch-up dynamics still in place South-East Europe & Turkey still attractive Russia has a significant implied X-factor at present time MENA: Undeniable impact on economy SWFs are diverting capital flows back home Mid/Long term outlook still positive Valuations in region still need recalibration to new reality

Market Outlook
But major differentiators among emerging markets
Mena: Still growth but impact of the credit situation trickling down Commodity play Sector focus Sub-Saharan Africa: Limited effect of credit situation Tremendous improvement in investment environment Good risk-adjusted returns GDP growth & overall economic development decoupled from commodity play

Market Outlook
But major differentiators among emerging markets
Asia: China as a manufacturing hub Semi-globalization shows Global gross capital formation (cross-border at risk) Unrealistic valuations in India at present
Volume of investments dropped 38,5 % in 2008 to $ 10,7 bio and are expected to drop to $ 5 bio this year 3/4th of PE investments were done in listed entities

Can they become our customers of last resort? Social unrest might destabilize the vulnerable progress made South Korea, Singapore, Malaysia etc weak on their feet for the time to come

Something else that is inconvenient

Past performance & GP selection

Institutional investor views: EM versus developed (December 2008)

Institutional investor views: EM versus developed (April 2009)

Portfolio allocation

PE penetration as an asset class

Source: Goldman Sachs, EMPEA

Portfolio exposure

Reasons for expansion or continuation

Source: EMPEA 2008

EM Private Equity performance

Source: Cambridge Associates LLC & prop. research,: pooled end-to-end returns, net of fees, expenses and carried interest

Comparative end-to-end results 6/30/2008

(*) Statistical noise likely due to low sample distribution Source: Cambridge Associates LLC & prop. research,: pooled end-to-end returns, net of fees, expenses and carried interest

Impact on portfolio construction

In 2008 about 1/3 of the total pool of LPs had some kind of exposure to EMs Portfolio weighting somewhere between 10-30% Do or die for LPs the next couple of years Systemic risk in Western markets are not reflected in risk premiums

Source: Proprietary data

Smoke & mirrors

BVCA and E&Y 2008 performance study

A disaster waiting to happen

So now what
If PE is an activist shareholders position than why have these funds been managed as investment vehicles Demonstrate inept to manage companies Focus on financial engineering Models have to change Fund structure Terms & conditions Exit modeling Valuation and transparency

So now whatlife after leverage

Value creation/operational side Impact of average /holding periods Massive room for improvement of private capital formation Put capital to work But do they have the right human capital in place?

The 7 deadly sins of banking (Mike Mayo)

5 April 2009-more bad weather to come
Greedy loan growth Gluttony of real estate Lust for high yields Sloth-like risk management Pride of low capital Envy of exotic fees Anger of regulators

Each reflects a way that banks tried to compensate for lower natural rates of growth by taking more risk

The 7 deadly sins of banking (Mike Mayo)

Zombie banks versus complete recapitalization of system Relaxation of mark-to-market rules will impact balance sheets but the upswing will be largely out powered by the later downswing A potential artificial accounting-induced capital injection that does not change the economics

Is this time going to be different for EMs?

During previous booms and busts the developed and developing world evolved in a parallel fashion This time there is a (partly) contra-cyclical pattern Political & regulatory impact Global versus local teams: the best of both Business model rethinking & paradigm shift EM debt usage less or more prudent

Let gravity have its way

Darwinian tsunami & paradigm shifting

Where are you?

Contact
Riga Graduate School of Law Law & Finance Chair Strelnieku iela 4k-2 Riga LV-1010 LATVIA
luc.nijs@rgsl.edu.lv Tel. +37167039230