Planting a flag

In all emerging markets, establishing an on-the-ground presence is crucial for originating good deals and managing local operations.

During the past few years, general partners seeking to capitalize on Latin American investment opportunities have raced to open offices in the region. Brazil has naturally been the most popular choice, with the likes of 3i Group, Apax Partners, The Carlyle Group, Kohlberg, Kravis Roberts, and TPG all establishing offices in the country.

The most recent example was the Canada Pension Plan Investment Board, which opened an office in São Paulo in February that will be operational in April. The office is staffed with three investment professionals, two of whom have relocated from Toronto, though CPPIB aims to grow the office to about a dozen individuals within the next year, according to a spokesperson. From São Paulo, CPPIB will focus primarily on five markets: Brazil, Chile, Colombia, Mexico and Peru. Prior to opening the office, CPPIB had invested about C$5 billion (€3.3 billion; $4.5 billion) in Latin America across private equity, real estate, infrastructure and public equity investments.

As any Latin American GP will tell you, São Paulo is the most logical city for a private equity firm to establish a first office in the region.

“Unless you are a more niche player, it makes little sense to have your first office in Latin America be in one of the smaller countries,” says Walter Piacsek, a partner at Apax Partners, which opened a São Paulo office last November. “Even Brazilian companies that are not based in São Paulo will do a lot of business in São Paulo.”

Piacsek joined Apax in 2012 to lead the firm’s efforts in South America. Though Apax has had a local presence in Brazil for only three months, the firm made its first investment in the country in 2010, acquiring Brazilian IT and business process outsourcing firm TIVIT for $1 billion. The deal marked the largest private equity transaction in the country at the time and was Brazil’s first ever take-private.

But regardless of whether a firm has experience investing in Latin America, all fund managers establishing a first office in the region are subject to the same risks that come with expanding into any new territory.

RUNNING THE RISK

“One of the main challenges for an investment firm is to successfully transplant the firm’s culture, values and standards into the new office,” says Alejandro Rodriguez, a director at PineBridge Investments in Mexico City. “In addition, there are the structuring challenges of legal and tax efficiencies for conducting business locally. [But] risks associated with operating in an emerging market [like] Latin America can be mitigated by taking the global standards of the firm and applying them locally.”

And even if firms get all this right, they may succumb to macroeconomic pressures that threaten long-term returns.

For instance, in 2011, 3i opened a São Paulo office, its first in Latin America, staffed with a four-person team hired from Standard Bank Private Equity. 3i planned to make investments of between $30 million and $100 million per transaction, targeting Brazilian businesses with enterprise values of up to $200 million.

In January, however, 3i finance director Julia Wilson said on a conference call that after making two investments in Brazil – sunglasses maker Oticas Carol and cable and broadband provider Blue Interactive – 3i’s now eight-person team would not be making any new investments in the country. The firm also scrapped plans to raise a Brazil-focused fund.

“Brazil remains a really interesting market, but conditions have changed over the last 12 months,” she said. “There’s much greater market and political uncertainty, and that’s also been reflected in currency volatility.”

Nonetheless, private equity interest in Brazil and other Latin American economies remains strong.

“There will be people who come into the region and stay for a while, and if they don’t get the returns maybe move on, but I don’t think it’s a fad,” says José Antonio Contreras, a managing partner at Mexico Coty-based WAMEX Private Equity. “I think there’s enough substance in terms of the size of the economies, and the number of companies that lack capital.”

FRESH COLOMBIAN INTEREST

While Brazil continues to attract the most interest, appetite for its neighboring economies is on the rise.

“Over the last few years, Peru and Colombia have shown a number of structural changes in their economies, so that there’s been fresh interest in those countries also,” Contreras says. “The other key market is of course Mexico, which is close enough to the US that for many years larger private equity managers have glanced over the border – and now their interest has significantly grown due to unprecedented reforms. Those would be the more substantive markets in [terms of] their population and GDP, and also because they share common themes – younger demographics and a growing middle class.”

US GPs are not the only fund managers looking at Mexico, either. “In a few cases we have had South American players look into Mexico and even open an office, with various degrees of success,” Contreras says.

Though interest in Colombia and Peru has grown considerably in recent years, Camilo Villaveces, president and chief executive officer of Andean private equity investment manager Ashmore Colombia, says he doesn’t expect a significant amount of new private equity firms to open offices in Bogotá and Lima. “I think the people who were going to come to Bogotá and Peru are basically here, and Mexico is now the place to expect openings of new offices,” he says.

If anything, he suggests, some firms will start scaling back their Latin American activities in the near future. “Managers that are not really emerging market managers, but who came opportunistically because of the problems of the rich countries will begin to go back to their comfort areas.”

That said, investors who stay the course should be able to benefit from a growing market.

“The opportunity set in Latin America has grown significantly over the last five years, but it’s still on average one of the most underpenetrated private equity markets in the world, [as] measured by private equity investments as a percentage of GDP,” says PineBridge’s Rodriguez. “More and more institutional quality managers are emerging, companies and entrepreneurs are experiencing the value of partnering up with private capital providers, and local institutional investors continue to grow their mandates locally and internationally – all signs of a healthy ecosystem developing for anyone looking to expand into a region.”

But fund managers be warned: if you expand into Latin America, you run the risk of jumping in too late.

“You have to be very nimble in hitting the right cycles,” says Contreras. “Even though the economies in the region have a lot of fundamental reasons to keep growing, there’s always the political side of presidents coming and going; maybe not the shocks that you used to have in the past, but there’s always changes and reforms. It’s a moving target.”