Local Funds Help to Sustain Latin American Private Equity

Latin America’s private equity and venture capital industry, like its economy, has taken a few knocks lately. Growth has slowed sharply across much of the region; Brazil, the largest market, is suffering a serious recession with no end in sight, and foreign capital has been flowing out of the area recently, part of the global retreat from emerging markets.

Yet the industry is proving to have surprising staying power in places thanks to the rise of small and midmarket players in many countries and a boom in investment activity in Mexico, the region’s second-largest economy.

Mexico offers two big attractions, industry executives say. The liberalization of the energy sector by the government of President Enrique Peña Nieto is opening up new opportunities for investors. In January, Mexico Infrastructure Partners, a Mexico City–based private equity firm, said it would raise $42.8 million for energy investment by issuing a structured equity security.

In addition, Mexican pension funds are increasingly taking up the slack left by foreign investors and committing capital to private equity. That’s a positive development given that the funds — Administradoras de Fondos para el Retiro — manage a total of 2.5 trillion pesos ($140 billion) in assets.

“Whenever an international flight to quality has taken place in the past, it has been impossible for private equity managers in Latin America to continue fundraising,” says Fernando Lelo de Larrea y de Haro, managing partner at ALL Venture Partners, a Mexico City–based early stage private equity firm. “This time round things are different because local pension funds have a great deal of dry powder and are carrying on financing the industry, especially the local managers. The local industry has become much more resilient.”

Private equity and venture capital firms invested a record $2.3 billion in Mexico in 88 transactions in 2015, according to the Latin American Private Equity and Venture Capital Association (Lavca), a New York–based group. Those numbers were up 72 percent and 80 percent, respectively, from 2014. In Brazil, by contrast, investment fell by 31 percent, to $3.2 billion. Much of the decline simply reflected the weakness of the Brazilian real; in local currency terms, the fall was a more modest 11 percent.

“Emerging markets never grow in a straight line and Brazil is no exception, but I think the country’s problems are a bit exaggerated,” says Álvaro Gonçalves, CEO of São Paulo–based Stratus Group, one of Brazil’s biggest private equity managers. “For example, the cinema industry — a market in which we invest — grew by 25 percent last year. The whole country is still working hard. It is only a few big, state-owned companies that are suffering.”

Brazil’s economy contracted by 3.8 percent last year and analysts see little prospect of recovery as the so-called car wash corruption scandal continues to paralyze the government of President Dilma Rousseff and fuel speculation about her impeachment or resignation. The International Monetary Fund predicts the economy will decline by another 3.5 percent this year.

Yet the sharp decline of the real, which has plunged by nearly 30 percent against the dollar since the end of 2014, has a silver lining for the PE industry, making assets cheaper for foreign buyers. Deal flow may be down but London-based CVC Capital Partners opened a São Paulo office early this year, headed by Jean-Marc Etlin, the ex-CEO of investment bank Itaú BBA, to cover Brazil and Latin America. Canada Pension Plan Investment Board is looking to boost its exposure to Brazilian real estate and infrastructure, says Rodolfo Spielmann, head of Latin America for the pension fund.

Brazil’s economic difficulties are also creating opportunities for distressed investors. In December, Brasil Plural, a Brazilian structured finance specialist, raised a 150 million reais ($40 million) distressed fund.

Total fundraising in Latin America plummeted to $7.21 billion last year from $10.39 billion in 2014, according to Lavca. Brazil accounted for virtually all of the decline, raising only $2.58 billion last year compared with $5.56 billion in 2014, when three firms raised billion-dollar-plus funds. Advent International gathered $2.1 billion for investments mainly in Brazil, Mexico and Colombia; Pátria Investimentos, a Brazilian outfit owned 40 percent by Blackstone Group, raised a $1.8 billion buyout fund focused on Brazil, and Gávea Investimentos raised a $1.1 billion fund.

Last year most funds raised across the region were in the range of $100 million to $750 million. “We have seen an increased number of midmarket funds being raised by Latam managers in the last couple of years, indicating a growing community of local funds,” says Cate Ambrose, president of Lavca. “We have also witnessed a rise in co-investment, whereby an international firm with considerable financial firepower invests alongside a local manager, who has a strong network of local contacts.”

Private equity executives express growing optimism about the prospects for investment in Argentina following the election last year of President Mauricio Macri, the business-friendly politician who ended 14 years of Peronist rule. Activity is holding up well in Colombia and Peru, they say, while Chile suffers from a decline in investor confidence. For that reason Sembrador Capital de Riesgo, a Santiago-based firm that specializes in backing agribusiness start-ups, recently raised a $15 million fund in Colombia rather than Chile.

“In Chile not only are the international investors not backing the market because of concerns about emerging markets generally but local investors have become very reluctant to invest,” says CEO Jorge Karadima. “Colombia, on the other hand, is one of the fastest growing major economies in the region, along with Peru. A great deal of fresh capital is being invested, including from local pension funds.”

Firms invested $2.2 billion last year through 68 midmarket deals, down from $2.58 billion and 78 deals in 2014, according to Lavca. Almost half of the 2015 deals were in the information technology (IT) and consumer-related sectors. Venture capital firms boosted investment by 13 percent last year to $594 million, of which $500 million was devoted to the IT sector.

Notwithstanding the pockets of strength, the industry faces some notable headwinds, including subdued valuations. Many managers have decided to sit on assets rather than selling at today’s depressed prices and booking losses. Latin America’s private equity funds sold only $3 billion of holdings in 2015, the lowest level since 2009, according to Lavca. Sales will probably fall again this year, says Ambrose.

On the flip side, managers say the region’s economic difficulties are making it easier for firms to recruit talent. “The economic crisis means that more high-quality professionals are available to work for technology start-ups,” says Ariel Arrieta, founding partner at NXTP Labs, a Buenos Aires–based fund that has backed more than 160 technology start-ups in 15 countries. “Currently, there is no competition for talented staff coming from big corporations.” •