Doing Well by Doing Good? Private Equity Investing in Emerging Markets

On Tuesday 30 April at the London School of Economics and Political Science the Department of Finance organized a private equity event entitled 'Doing Well by Doing Good? Private Equity Investing in Emerging Markets'.

The theme of the event was private equity’s role in the transformation of the world economy. As Western economies battle to restructure their economies and re-launch growth, South-South investment flows have been steadily growing over the last decade. Vast and exciting investment opportunities are opening up in these global growth markets, but is it really true that best in class returns and socially transformational investments can go hand in hand?

The event was introduced by Dr Ulf Axelson (Abraaj Group Chair in Finance and Private Equity, LSE). Arif Naqvi (CEO and founder, Abraaj Group) gave a keynote speech entitled ‘Global Growth Markets: Transforming our world, our businesses, our communities’.  The lecture was followed by a panel discussion led by Felda Hardymon (Professor of Management Practice at Harvard Business School and Senior Partner at Bessemer Venture Capital), entitled ‘Doing well by doing good? Private Equity Investing in Emerging Markets’. The panel featured the following leading practitioners: Tsega Gebreyses (Managing Partner, Satya Capital), Arif Naqvi (CEO and founder, Abraaj Capital; Abraaj Capital currently has around 10 billion of assets under management with offices all around the world, the biggest emerging markets private equity fund) and Diana Noble (CEO, CDC).

Dr. Axelson opened the event by thanking Abraaj Group for funding LSE’s private equity research program and helping to foster research in this relatively nascent investment area. Private equity started around 30 years ago in developed economies. Relative to a private firm model private equity solves some of the common problems, e.g. succession. On the other hand public companies are great for risk-sharing but problems exist with management-shareholders agency problem for which private equity offers a solution. It is not clear whether private equity works in emerging markets since there is not much data. Nonetheless, private equity in emerging markets has grown quite fast. In 2012 alone it invested around 40 billion USD, however it is not clear what future returns will be had on these investments.

Arif Naqvi started his presentation by describing private equity industry. Private equity as an industry has gone through three stages. The first stage was about maximizing returns by taking as high leverage as possible; the second stage was about asset aggregation; the third, current stage, is about defending the business model, e.g. talking a lot about sustainability. Private equity is about long-term thinking, its largest investors are pension funds, sovereign and institutional investors etc. Private equity has a strong future as an equity investment given that most Western pension funds have unfunded liability and in search for returns they will invest in private equity given that absolute return is higher than on public markets. Most private equity money goes to Western firms that invest in global growth markets; however there is a need for local presence. Private equity needs to invest in economic opportunities, governance, etc to make the ecosystem sustainable. Abraaj Group invested 5% of its top line back to the communities. It has 150 firms in its portfolio and all of them are expected to be socially responsible.

Arif Naqvi’s lecture focussed on future economic opportunities around the world. He stressed that emerging markets should be termed “global growth markets” given their current role in the world’s economy, i.e. they will define growth in the 21st century. Africa has a buzzer and it is not just a resource story; over the next decades Africa will have around 350 million middle-class people. Today’s Africa resembles the Middle East 10 years ago in which Western private equity funds required high returns on capital (IRR around 60-70% and 3-4 times return on invested capital). Investors talk about slowing growth in China and India but it is impossible to have double-digit growth in such big economies forever. Growth in global growth markets is three times higher than in developed economies. A lot of growth comes from outside China and India. There is an axial shift in society and growth opportunities. Today, Africa’s growth rate is higher than East Asia’s. The rise of urbanized middle class will shape the world. In 2008 50% of the world’s population was urban, and currently the urbanized population is growing by one million per week. Most of the 1m+ cities are located in global growth markets. In Africa and Asia a lot of urbanization creates affluent communities but at the same time it creates a disconnection in society. Cities achieve economies of scale that are not easy to apply in rural areas and this is one reason why cities are the center of economic life. Typically, capital cities have growth rates around two times higher than their country growth. In the next 30 years there will be around three billion new middle class people and more than 65% of them will be from global growth markets. This shift will reshape the consumer demand – more than 80% of middle class demand will come from global growth markets. Global growth economies will be driven by consumption, which will become 70% of GDP, an increase on today’s 55%. Latin America is different since consumption is already high. Median age in global growth markets is 26 and in Nigeria it is even lower. As there are fewer old people in global growth markets there are fewer to take care of and the pension system is easier to fund. Spending usually peeks at around 40; the median age in developed markets is around 40, and so the peek has already been reached.  

However, to achieve this growth potential reforms are necessary. Infrastructure needs in global growth economies is enormous, for example just a third of Mexico roads are paved. Today global infrastructure market is around 2 trillion USD and South-South infrastructure trade is bigger than North-South. Abraaj Capital had a very successful investment in a hospital business in the Far East that ended with the third biggest 2012 IPO in Singapore.

Today there is a big problem in some developed markets such as Spain where the unemployment rate among young educated people is higher than 50% with no economic opportunities. These problems also exist in some global growth markets such as Pakistan where entrenched political parties can impede growth.

Arif’s speech was followed by a panel discussion that posed the following questions: how does Private Equity assess opportunities? Can you make money? Is the process of selection the same regardless of the Government and its accountability? Are returns the only goal or is doing well also important?

Diana Noble’s view on the future is that in the next 10 years there will be a hiatus in Europe and the US due to the financial crisis and global growth markets will provide good returns. This is one reason why CDC fund focuses only on South Africa and Asia. The fund cares about job creation and capital going to harder places (places where 2/3 of population don’t have a permanent job). CDC determines a hard place for capital by dividing geography of their investments into four categories according to ease of access to capital; the returns in those regions where capital is hard to flow are the highest. Diana acknowledged that from time to time in order to optimize operations and make the business viable tough business decisions have to be made.

Tsega Gebreyses started the panel discussion by explaining how Satya Capital does business on the ground. Satya Capital puts the capital and knowledge to work together with the entrepreneur and then works with other shareholders and management. Usually, Satya is not the only shareholder and very often it doesn’t have a majority in the company, therefore working together with other shareholders and management teams is of crucial importance.  As an example, Tsega described their successful investment in a healthcare business in Nigeria that had 2 hospitals and struggled to generate 1.2m USD cashflow.  Satya Capital helped recruit talent and implement best business practices. She noted that often family run businesses are very reluctant to change their business practices and when there is no majority in shareholdings it is absolutely necessary to communicate with the family as to how the company can benefit from new business practices.

Arif Naqvi explained how Abraaj Capital investment in a Karachi power plant turned an unprofitable power generating business into a business that is admired by the whole society. He noted that it is very important to selectively invest, e.g. healthcare in Turkey is a good business sector because the government doesn’t invest in healthcare therefore private healthcare services will grow.

The event concluded with questions from the audience and closing remarks from Felda Hardymon.

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