Private Equity in Emerging Markets: An Introduction

context, contribution, recent developments, and lessons learned

Michael Barth, CEO, Netherlands Development Finance Company (FMO)

Private Equity:What and Why?

Clarifying the terminology

PRIVATE EQUITY--medium to long-term financial commitment (equity or quasi-equity) in illiquid securities, with the expectation that future company performance will generate liquidity and opportunity to exit with substantial returns.

Private Equity is the Risk Capital “in Between”

Sponsor Financing- Start-up/ early stage- Absence of liquidity- High risk (no track

record)- Lack of information

base- No transparency- Family-run/ closely

held

Public Market

- At least 3 to 5 years’ track record

- Profitability

- Acceptable accounting standards

- Legal documentation

- Professional management

- Significant size

Who are prime PE candidates?

Annual Sales Publicly trade companies

Medium*-sizeCompanies, manyfamily-owned

Target for PrivateEquity

Small*, family-owned,informal economy

US $ 250 MM

$ 15 - $ 250 MM

< $ 15 MM

*Size definitions vary significantly depending on country’s size and level of economic development

Large*

Too small

The importance of private equity to emerging markets

Professionally managed Private Equity (PE) fills an important financing gapPE stands at the apex of development finance; it is not just about financing business, but about building businessesPE can have substantive effects on corporate professionalization, employment and export growth;support for the SME sectorPE is a potential building block for developing a stronger, more balanced financial sector

Context: Capital Mobilization Trends

Source: IIF, e=estimate

Financial flows to emerging markets has seen a downward trend in recent years

-50

0

50

100

150

200

250

300

350

400

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002e

US

$bn

Private flows Official flows

Only FDI has been a stable, growing component

Source: Global Development Finance, e= estimate

-20%

0%

20%

40%

60%

80%

100%

% o

f to

tal

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002e

Breakdown of aggregate net resource flows

FDI Portfolio equity Bonds Bank and trade related lending Official net resource f low s

Capital mobilization in most emerging equity markets has been depressed in recent years

Gross New Capital Raised by Domestic Companies

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

1997 1998 1999 2000 2001

% o

f m

arket c

ap

italizatio

n

Latin America Europe and Central Asia

Middle East East Asia and Pacific

Africa

Source: FIBV data for sample countries comprising Latin America -Mexico, Brazil, Chile, Argentina,Peru; Europe and Central Asia -Turkey,Poland. Hungary, Czech Republic,Estonia, Lithuania; Middle East -Egypt, Bahrain, Jordan, Oman, Kuwait; East Asia- Taiwan, Korea, Malaysia, Indonesia, Thailand, Philippines; Africa- South Africa, Mauritius, Ghana, Namibia, Swaziland

IPO markets have mirrored this downward trend

Number of New Firms Listed, Emerging stock markets, 1997-2001

0

50

100

150

200

250

300

350

1997 1998 1999 2000 2001

# o

f c

om

pa

nie

s

Latin America Europe and Central Asia Middle East East Asia and Pacific Africa

Source: FIBV data, New issue data for Nigeria in 2000-2001 and Kenya 1999 unavailable

Focus on private equity: funds raised and invested; performance

3.23.7

6.5

9.28.5

4.4

5.8

11.9 12.3

10.0

0

2

4

6

8

10

12

14

1997 1998 1999 2000 2001

(US$

b)

InvestmentFunds raised

ASIA (ex-Japan, Australia)

Sources: Compiled by Cambridge Associates from multiple sources including AVCJ, internal proprietary fund manager database, VE-LA Publications, and 3i/PWC.

2.7

0.7

3.7

1.3

3.43.7

1.8

2.6

0.6

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

1997 1998 1999 2000 2001

(US$

b)

LATIN AMERICA

Fund raising and investment trends

3.7

1.9

3.5

1.51.41.0

2.3

1.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

1998 1999 2000 2001

(US$

b)

Investment

Funds raised

MIDDLE EAST (Israel only) & AFRICA (South Africa only)

Sources: Compiled by Cambridge Associates from multiple sources including IVC, SAVCA/KPMG, EVCA, 3i/PWC and internal proprietary fund manager database.

0.77

0.63

0.48

0.37

0.85

0.56

0.57

0.47

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

1998 1999 2000 2001

(US$

b)

CENTRAL & EASTERN EUROPE (incl. Russia)

Fund raising and investment trends

Emerging markets private equity investments by region

Latin America

Central & Eastern Europe 2%

Russia/NIS

Africa (S. Africa only)

Russia/NIS

Central & Eastern Europe

Middle East (Israel only)

13%Africa3%

0%

3%

Latin America

11% Emerging Asia (ex. Japan,)

70%

Emerging Asia (ex. Japan)

59%

18%

3%

4%

Middle East (Israel only)14%

Cumulative 1998-2001 2001

Sources: Compiled by Cambridge Associates from multiple sources including EVCA, AVCJ, MITI/Japan, VE-LA Publications, SAVCA/KPMG, IVC, 3i/PWC and internal proprietary fund manager database.

Returns on VC and PE funds (%)

Note: Pooled end to end return, net of fees, expenses and carried interestSource: Cambridge Associates, LLC

As of September 30, 2002

Preliminary Emerging

Markets VC and PE index

US Venture Capital Index

US Private Equity Index

1 Qtr (6.0) (9.1) (5.2)

1 Year (13.1) (29.4) (9.2)

3 Year (5.3) 25.1 (4.0)

5 Year (1.6) 46.7 3.7

10 Year 0.2 35.9 11.4

A broader look at returns - Public Markets

*Commenced November 1, 1984, **Returns of the one year period ending September 30, 2002. Source: Bloomberg, Venture economics

Annualized returns as of Dec 31 2002 (%)

1 year 3 year 5 year 10 year 20 year

Public equity

S&P 500 (22.1) (14.6) (0.6) 9.3 12.7

NASDAQ (30.2) (30.2) (2.4) 8.2 10.6

EAFE (15.9) (17.2) (2.9) 4.0 10.2

FTSE* (13.9) (15.1) (3.2) 7.3 6.5

Private equity

Venture capital** (22.1) 15.0 26.7 26.0 16.5

Buyouts (8.2) (4.2) 1.6 9.1 12.6

Total private equity (12.1) 1.2 8.4 15.2 14.5

Performance: “Management matters”US 1980-95 US

Private equity

(%)

US Listed Equity

(%)

US Fixed Income

(%)

Upper 25% 21.9 17.0 12.6

Median 14.0 15.9 12.0

Lower 25% 6.9 14.8 11.5

Spread between top and bottom

15.0 2.3 1.1

European PE 1993-1999

Spread between top and bottom 25%

25.2

Source:Teresa Barger, International Finance Corporation "What is a Private Equity fund?”

Some of the important “lessons learned”

Private equity in Emerging Markets- Lessons Learned

Apparent critical need to adapt PE operations to the local environmentManagement x 3; private equity is a craft, not a commodity; focus on additionalityIssues of critical mass, incentivesDeal flow, timing, acquisition pricesIssues of instrumentation, exit planningEnvironmental issues, esp. those related to poor investor protection/corporate governance, basic domestic capital markets

A Closer Look: Different Perspectives on Private Equity

Analytical perspectiveDr. Roger Leeds, Johns Hopkins University School of Advanced International Studies

Practitioner’s perspectiveMr. Alejandro Schwedhelm, Managing Director, Darby Overseas Investments, Ltd.

Domestic/policy perspective Mr. Alvaro Gonçalves, Managing Partner of Stratus (Brazil), Board Member, Venture Capital Association of Brazil

Investor’s perspective Dr. Patricia Dinneen, Consultant, Cambridge Associates