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SEPTEMBER 2010

QUARTERLY
NEWSLETTER

Q U AR T E R LY

VOLUME 3, ISSUE 3

NE WS LE T T E R

EMERGING MARKETS PRIVATE EQUIT Y:


A SPOTLIGHT ON THE IFC

n 2009, the emerging markets


accounted for a greater share
of worldwide private equity investment than ever before - attracting over 20% of the global total.
Fundraising by emerging market
private equity funds through the first
half of 2010 reached 14% of the
global total - the highest since at
least 2004, and up significantly

Fairview Capital Hosts:

The
Elements of Excellence
Symposium
Thursday, November 18, 2010
11:45AM-6:00PM
The Mandarin Oriental Hotel
New York City
Invited guests to the Elements of Excellence Symposium hosted by Fairview
Capital include limited partners, general partners, and industry advisors.
Utilizing unique formats, the Symposium will focus on pertinent topics
impacting the venture capital and private equity markets. Prominent venture
capitalists and private equity professionals who have demonstrated leadership in their respective domains will
share their unique perspectives and
keys to success.
Featured Sessions:

The Proliferation of Digital Media


The Evolution of Consumption Patterns
and Business Models
Successfully Achieving Liquidity
Perspectives from Growth Equity and
Lower Middle Market Veterans
Emerging Markets
Private Equity
From the Exotic to Mainstream
About the Elements of Excellence Series:

Fairviews Elements of Excellence


Series serves as a platform for sharing
successful private equity and venture
capital business practices. Participants
in the Elements of Excellence Series
have demonstrated expertise and
success in various facets of the private
equity and venture capital industry.
Fairview invites industry leaders to
share their stories, experiences and
approaches in engaging ways.

from 9% in 2009. This momentum,


a sign of rising investor confidence,
is driven by the compelling case for
private equity in the emerging markets. Across the emerging markets,
high GDP growth is accompanied by
increasing currency stability, fast
growing middle classes and consumer spending growth. The opening of trade and capital flows, along
with a move to market-based economies, has increased entrepreneurial
activity. In addition, structural elements, such as improving regulatory
environments, corporate governance and exit options are helping to
make the case of emerging markets
private equity even stronger. The
early track record for emerging market private equity funds is encouraging, with the Cambridge Associates
Emerging Markets Venture Capital &
Private Equity Index showing pooled
mean IRRs for mature vintage years
ranging from 12% to 25% over the
past decade.
Despite the compelling case for
emerging markets private equity
and record investment levels,
emerging market economies still
significantly lag behind developed
nations in terms of private equity
penetration, as measured by the
level of private equity investment
relative to GDP. Furthermore,
emerging markets private equity
investment remains highly concentrated. In the first half of 2010, over
60% of all deals and nearly 60% of
all capital invested in the emerging
markets went to India and China.
The lack of penetration, coupled
with the concentration of capital is

indicative of a vast opportunity still


relatively untapped in the broader
emerging markets. Why have investors been eschewing the broader
emerging market opportunity? Much
of it has to do with the perception of
risk and unfamiliarity. Macro/
political risk, liquidity risk, changing
regulatory and tax environments,
and unfamiliarity with GPs are often
cited as reasons why LPs are deterred from investing in new emerging market opportunities.
These perceived risks can, however,
be addressed and mitigated through
a nuanced, yet balanced approach
taken to investing in the broader
emerging markets. For example,
global macro risks can be addressed by implementing an investment strategy focused on domestic
growth - growth equity investments
that can capitalize on favorable
demographic and social trends
while avoiding competition with, and
reliance on, the developed world.
Country-specific risk can be mitigated through diversification, not
necessarily via pan-regional funds,
but through building a diversified
portfolio of country or region specific
funds managed by local GPs. The
identification and selection of these
GPs is what in turn can help mitigate and manage risk at the portfolio company level. Identifying GPs
with strong local networks, operating experience, stable investment
models and the proper mix of team
skills to match the opportunity is
crucial in mitigating regulatory, governance, and other market risks.
A prime example of achieving suc-

Private Equity Opportunity


2000: Start of a Rapidly Growing Opportunity

Developed Markets
Emerging Markets With Private Equity Opportunity

cess with emerging markets private


equity while mitigating risk is the
International Finance Corporation
(IFC), the private sector arm of the
World Bank Group. Maintaining a
longstanding commitment to developing the asset class in the emerging markets, the IFCs Investment
and Private Equity Funds Department has been investing in emerging market private equity funds
since the early 1990s. The IFC has
been successful in acting as a catalyst for mobilizing institutional capital in the emerging markets by working with fund managers on corporate governance and sustainability
and enhancing the transparency
and accessibility of emerging market funds. The IFC has also been
able to achieve outsized returns
(consistently outpacing the Cambridge Associates Emerging Markets
Private Equity Indexs top quartile)
on their investments in emerging
market private equity funds, many
of which at the time of commitment
may have been considered by traditional investors as being too risky.
The following is a look at the approach the IFC has taken:
Growth Equity

The IFC learned early on that IRR in


the emerging markets is driven by
growth and efficiency, as opposed
to leverage or multiple expansion.
Higher growth and lower leverage
shifts the source of risk from macro
and cyclical to operational. The IFCs
growth focus is evident in the higher
rate of job creation by companies in
IFC-invested funds: a mean annual
rate of job growth of
over 22% compared to
In The Emerging Markets
a regional averages of
Now: The Opportunity Continues To Expand
2% to 3%. Compound
annual revenue growth
of IFC-invested funds
portfolio companies is
almost 38%. The IFCs
growth strategy has
also meant companies
are less levered, evident in the average
Continued on Page 2

Source: International Finance Corporation

Fairview Capital 75 Isham Road, Suite 200, West Hartford, CT 06107 860.674.8066 www.fairviewcapital.com

QUARTERLY NEWSLETTER

Page 2

EMERGING MARKETS PRIVATE EQUIT Y:


A SPOTLIGHT ON THE IFC
Continued from Page 1
debt-to-equity ratio of 0.74 which
contributes to considerable resilience in downturns. The IFCs
growth equity focus (72% of the
portfolio) has been a major driving
force behind the outsized returns
the group has achieved.

Africa is 14%, compared to 2% for


the Cambridge Benchmark; and the
IFCs exposure to Asia is around
33%, compared to a 70% weighting
in the Cambridge Benchmark. The
construction of the IFCs portfolio
demonstrates that attractive, and
often outsized, returns can be attained by investing more broadly in
the emerging markets.

Investing Broadly
Manager Selection
From the IFCs experience, the
emerging markets private equity One of the major keys to the deopportunity is much broader than risking of emerging markets private
current capital flows would indi- equity has been the emergence of
cate. Asia (predominately China local private equity capacity across
and India) has attracted the vast a wide range of countries. Since
majority of non-IFC capital raised private equity in the emerging marfor emerging markets private equity kets, and growth equity even more
over the last three years even so, is a local business, competent
though the investable geography, in local capacity is very important in
terms of private equity capacity and managing risk. The IFC has found
meaningful deal flow volume, has that for emerging market GPs,
significantly broadened (see chart access to transactions requires
on page 1). The IFCs case for in- the right local connections to build
vesting broadly can be made on a trust and credibility with company
performance basis as well. The owners; adequate due diligence
Cambridge Associates Emerging depends on an intimate knowledge
Markets Private Equity top quartile of local accounting, governance
returns have outperformed the and regulatory quirks; attracting
Cambridge Associates Asia (ex Ja- quality executives to investee compan) top quartile consistently, indi- panies requires sufficient trust and
cating there is clearly a
Multiple Avenues For Exit
benefit in diversifying
IRR By Exit
60%
beyond Asia. Furthermore, the IFC, while fol50%
lowing its development
40%
mandate, which necessitates investing broadly,
30%
Median
has produced returns
Mean
20%
that have outpaced the
10%
Cambridge
Emerging
Markets top quartile. For
0%
a weighting comparison,
IPO
Trade Sale
Structured
MBO
the IFCs exposure to

belief in the GP for local executives


to leave safe and prestigious positions; and local knowledge helps to
obtain the best access to limited
local debt finance. Backing GPs
that understand these nuances is
crucial for success. The IFC probes
into the workings of proposed
strategies and their fit with the
evolution and dynamic of local environments. Ensuring GP skills match
deal flow and that their value-add
skills are evident is extremely important given the prevalence of
minority positions.
Working Around Misperceptions
In successfully building its private
equity program, the IFC has had to
work around the many misperceived risks associated with private
equity in the emerging markets.
Namely, risk associated with minority positions, risk associated with
smaller companies, first time fund
risk, and exit/liquidity risk. From its
experience, the IFC has been able
to address these misperceptions.
The IFC has seen minority positions
perform well in all forms of exit,
with median IRRs for minority and
majority deals nearly identical;

deals as small as $2 million have


resulted in positive IRRs in line with
larger deals, indicating that smaller
companies are less risky than perceived; the top 10% and bottom
10% of the IFCs portfolio contain
the same percentage of first time
fund managers and the return distributions for first and non-first time
funds are similar, indicating that
experience is the differentiating
factor in fund quality, not first time
fund risk; and attractive exits have
been attainable, in fact, the IFC has
seen exits despite less developed
capital markets (although access to
an IPO improves return), and these
exits occur after an average holding
period of 4.9 years, less than in
many developed markets today.

The IFC has proven that perceived


risks associated with emerging
markets private equity can be addressed and mitigated through a
diligent investment approach. A
broad, but attentive and locally
driven growth equity strategy can
tap the attractive growth and demographic profiles of emerging market
economies while mitigating many of
the risks commonly associated with
emerging markets priAttractive Returns Across All Investment Sizes vate equity. With private
equity in emerging marIRR Per Investment Size
80%
kets still in its nascent
70%
stages, significant oppor60%
tunity still remains for
50%
investors to build expo40%
Me dian
sure and access the
30%
Me an
enormous
untapped
20%
potential
in
emerging
10%
economies.
0%

Source: 325 IFC fund investments by vintage year as of December 2009. March 2010, IFC The Case for Emerging Markets Private Equity

Data: The Emerging Markets Private Equity


Association (EMPEA) and the International
Finance Corporation (IFC).

US PRIVATE EQUIT Y AND VENTURE CAPITAL MARKET UPDATE

rivate equity was not immune to the uncertainty


prevalent in the US macroeconomic climate during the first
half of 2010. On one hand, the
industry benefited from the general
stabilization of the equity markets
and loosening of the credit markets. On the other hand, there is a
lack of consensus on future growth
and the prospect of a double dip
recession. This dichotomy has
manifested itself across the private
equity value chain. Despite a strong
rebound in liquidity and continued
strength in investment activity,

fundraising volume has slowed. We


are optimistic, however, that the
uncertainty may subside in the next
twelve months, bringing increased
confidence in the private equity
asset class.
Fundraising activity for private equity funds in the US continued its
decline in the first six months of
2010. A total of 198 funds managed to raise $45.1 billion during
the period, a 26% decline from the
$61.2 billion raised in the first half
of 2009. Venture capital funds, in
contrast, saw a positive first half of
2010 with $7.5 billion raised

across 72 funds. This was up 14%


from the $6.6 billion raised by 68
funds over the first six months of
2009.
Venture capital investing also registered an increase in the first half of
2010. Venture firms invested
$11.4 billion in 1,646 deals in first
half of 2010. This was up 9% in
dollars and 6% in deals from the
second half of 2009.
Exit activity across the private equity spectrum showed strong improvement in the first half of 2010,
driven primarily by the apparent
return of the IPO as a viable exit.

The period saw 26 venture-backed


IPOs, with 17 in the second quarter
alone. M&A exits of VC-backed companies continued to be a highly
resilient source of liquidity, increasing to 211 deals in the first half of
2010. This compared favorably to
the 142 deals in the second half of
2009, and represented the highest
number of M&A transactions ever
recorded by the NVCA.
Data: NVCA, the PwC/NVCA MoneyTree Report based on data
from Thomson Reuters and Private Equity Analyst .
Copyright 2010 by Fairview Capital Partners, Inc. All rights
reserved. Reproducing this publication without the written
consent of Fairview Capital Partners, Inc. is illegal.

Fairview Capital 75 Isham Road, Suite 200, West Hartford, CT 06107 860.674.8066 www.fairviewcapital.com