Latin American Private Equity on the Rise
According to recent figures provided by the Latin American Private Equity and Venture Capital Association, 2013 was a record year for private equity in Latin America, with approximately $8.9 billion of total investments (a six-year high and a 13 percent increase over the previous year), $5.5 billion of funds raised and $3.7 billion in proceeds generated by exits. The data also show that the market is still dominated by Brazil (with 43 percent of funds raised and 68 percent of total amount invested), while Mexico, Colombia, Peru and Chile continue to experience increasing activity.
Despite the disappointing performance of some of the region’s economies in the last couple of years, Latin America continues to be an attractive market for private equity investors. During the past decade, robust economic growth in the region as a whole, civil stability and sound policy-making have created solid investment opportunities in Latin America, and strong macroeconomic fundamentals support the region’s continued growth prospects.
Population growth and increasing urbanization rates in the region continue to drive up demand for power and public infrastructure. At the same time, strategic reasons and the need to find effective hedges against inflation are still driving international investors towards Latin American markets, which can offer a steady supply of minerals and other raw materials. This growing demand for infrastructure, natural resources and power in the region has created substantial investment opportunities for private equity investors.
Additionally, a growing and young middleclass population in the region’s largest markets continues to fuel investors’ appetite for middle-market opportunities in industries such as consumer products, retail, health care and financial services.
A large presence of family-run businesses and fragmented industries in Latin American economies, as well as the fact that public markets in the region are still dominated by natural resource companies and banks, create a need and an opportunity for private equity, local and foreign, to fill in the investment gaps.
An Improving Regulatory Environment
The regulatory environment for private equity funds and investors in the major Latin American markets continues to improve. On the fundraising side, ongoing efforts by local regulators to ease the restrictions for institutional investors in private equity have resulted in increased private equity allocations by pension funds and insurance companies. However, there are still some challenges for fund managers trying to raise funds from institutional investors in these markets. For example, some large pension funds in Brazil still demand a seat on the investment committee as a condition for investing in a fund. Whereas, countries such as Chile and Mexico only allow their pension funds to invest in locally registered funds, forcing foreign fund managers to set up local feeders to attract investment from institutional investors. Despite recent efforts in some jurisdictions (most notably Mexico and Peru) to reduce the number and complexity of procedures to form new investment vehicles and to register local feeder funds with securities regulators, these processes are still more burdensome and time consuming than those in more developed markets.
Restrictions on foreign investments in the region are gradually disappearing. With the unfortunate exceptions of Argentina, Cuba and Venezuela (where tight exchange controls and reporting requirements continue to hinder foreign investment), all Latin American countries have eliminated exchange controls, as well as minimum stay and reserve requirements. Foreign investments in these countries are no longer subject to prior approval, although they must still be registered with the central banks in order to guarantee access to foreign currency for repatriation.
Capital markets in Latin America also continue to develop, thereby providing investors a greater supply of securities, larger sources of funding and a feasible exit strategy that were not available before (outside of Brazil and Mexico). The integration in 2011 of the stock exchanges of Chile, Colombia and Peru in what is called the Latin American Integrated Market has created the second biggest market of Latin America in market capitalization, behind Brazil’s BM&FBOVESPA. In 2013, the region saw eight private equity-backed initial public offerings in Brazil, Mexico and Chile, and the number is expected to increase in 2014.
Another favorable development in the region is the increasing adoption by major markets of international accounting standards. Chile, for example, has recently made International Financial Reporting Standards (IFRS) mandatory for both listed and private companies. Other countries, such as Argentina, Brazil, Mexico and Peru, require listed companies to use IFRS and, although they do not formally allow private companies to use these standards, they have been gradually incorporating international principles into their local accounting standards. On the other hand, Colombia, whose national accounting standards diverge significantly from IFRS and U.S. generally accepted accounting principles, is still lagging behind other counties in the adoption and implementation of international standards.
Despite enjoying an increasingly favorable regulatory environment in the region, private equity investors still face significant challenges in Latin America. For instance, weak record-keeping practices and inadequate internal reporting systems in some industries combined with deficient public records complicate investors’ due-diligence efforts; also, the prevalence of family-controlled companies where ownership and management are closely tied together can hamper post-acquisition integration in some cases.
With the notable exception of Chile and Uruguay, where the levels of perceived corruption (according to Transparency International) are comparable to those of developed countries such as the United States or Japan, rampant corruption is still a major concern for investors in Latin America in spite of recently enacted anticorruption legislation in Brazil, Mexico and Peru. Investors in regulated industries, as well as those who make use of local agents and consultants to secure government contracts or approvals, need to conduct serious pre-acquisition due diligence and be ready to implement robust post-acquisition compliance programs in order to mitigate their exposure in this regard.
Another important obstacle for foreign private equity investors is the prevalence of slow, inefficient and sometimes corrupt judicial systems in Latin America. While private contracts are generally upheld, judicial disputes are lengthy and cumbersome, which has promoted the use of international arbitration in cross-border transactions. Nevertheless, enforcing such arbitral decisions can be costly and problematic in some countries.
To be fair, these challenges are not different from, and in most cases not worse than, those encountered by investors in other emerging markets. But investors looking to enter Latin America would be well advised to seek the help of partners and advisors with specific experience in those countries in order to navigate the new landscape and to mitigate the risks involved.
Favorable macroeconomic trends and positive regulatory developments continue to make Latin America an attractive destination for private equity investors looking for acceptable returns in relatively stable emerging markets. Not surprisingly, some challenges remain for foreign private equity investors entering the region, but most of these risks should be manageable for investment teams and advisors with sufficient experience in those jurisdictions.