Private Equity Funds Should Take a Good Look at Emerging Markets

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The party for the large Western multinationals may be coming to a close. The reason: technology is rapidly leveling the playing field for all nations.

Even though there is a temporary backlash against globalization, I believe there are real, long-term opportunities in Emerging Markets (EM) for Private Equity Investors.

As pointed out in a recent Harvard Business Review Article, the past three decades have provided an unprecedented period of prosperity and record earnings for the large multinational companies. But, alas, the article goes on to point out that the party for the large Western multinationals may be coming to a close. The reason: technology is rapidly leveling the playing field for all nations. Adam Smith’s Comparative Advantage may be just another theory to hit the trash bin of economic history. However, the NATURE of global investment may also be changing. And this change may present a growing opportunity for Private Equity Investors. Indeed, in many areas of the world, the structure of business lends itself better to private partnerships and joint ventures than the traditional investment in public EM stock offerings. This is due to the fact that in most EM, the rich and powerful companies are not usually publicly owned. Of course, this is mainly due to the fact that there is limited liquidity in poorer economies. However, with the ease of technology transfer, demographics and demand will become the fertile land of opportunity.

The article states: “Half of world GDP growth over the next decade, and many of the new competitors will come from smaller cities in the emerging world—places such as Kochi and Kumasi—that most Western executives would be hard-pressed to locate on a map. Indeed, the world’s megacities in the EM are becoming intolerable (for example, Mexico City has 27 million inhabitants!) and many citizens and companies in those crowded national capitals are moving to other major in-country cities where growth is exploding as citizens flee the higher cost of living and lower quality of life of the big national capitals.

As the graphic demonstrates, the majority of companies and economic power resides in private companies that form the “real” drivers of the local economy. And this scares most of the institutional investors who are used to playing by a different set of rules. However, that should not scare off private equity funds who can function in a more flexible investment environment. Over the past few years, there has been a greater acceptance and adoption of “alternative investments,” however, public companies operate under closer regulatory scrutiny, and do not have the same flexibility that Private Equity funds have.

Of course, there are certain risks when investing in a foreign private company, but that can be moderated by learning and understanding what the local EM rules are. Most institutional investors have their hands full just trying to understand how the home rules apply. Indeed, this lack of understanding of local rules can help shield direct foreign investment from the distortions of large capital inflows as well as provide foreign investment and management know-how to help improve local EM businesses. Bottom-line is that local businesses understand their customers and have established local brands. However, it’s a well-known fact that most family-owned businesses can have a lot of baggage and intractable political dynamics that make it hard for just a cursory “industry” style due diligence. But those hurdles can be easily overcome with qualified and experienced professionals who speak the local language, understand the customs and local business ground rules.

As technology levels the playing field, future growth becomes all about the marketplace, and the demographics that drive future revenue. Despite the current globalization backlash, Private Equity investors should take a good look at the potential of investing in private companies in emerging markets.

Uncle Sam Can Help

In almost all nations, the US has an economic attaché or export business development department. In addition, the US. Department of Commerce has an entire section devoted to researching overseas market opportunities ( US Commercial Service – International Trade Administration is dedicated in helping US exporters but also provides valuable information about the markets as well as provide vetted local business contacts and professional associations (foreign branches of The U.S. Chamber of Commerce-usually made up of expat business owners) who can help guide the due diligence process. In addition, most of the major U.S. Universities have MBA graduates from EM markets who are usually well connected in their home countries and can act as an entre into local markets as well as provide current real-world local business information and guidance.

Naturally, there are many special considerations when considering direct foreign investment: currency exchange rates, foreign corporate ownership laws and political risks (although the current global state of affairs very much resembles a grand EM), those concerns can also act as hurdles for competing investors.

In conclusion, even though there is a current backlash to globalization, globalization proved to be a very viable model as it has lifted millions-if not billions- of people out of poverty and to better quality lives to say nothing of the vast profits to those now seen as villains and opportunists. As private equity investors, there can be a real benefit to taking the global view-particularly over the long term.

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