By Bryan Turner
The aim of every fastidious private equity (PE) firm is to single out potentially worthy and lucrative investments, before building value creation development plans that, once executed, will ultimately generate superior returns for investors. However, this may be regarded as a tall order in the current global economic climate, unless we as an industry start targeting some of the lesser known opportunities that are making themselves known in emerging markets.
According to the McKinsey Private Markets Review 2020, $1.47 trillion of investor capital was deployed through the PE asset class globally in 2019. This represents impressive growth of private market assets under management by 10% for the year, on the back of total growth of 170% for the past decade.
The pre-COVID-19 PE outlook for 2020 had looked extremely favourable from a global perspective, with investment in emerging markets being no exception although jitters surrounding perceived risk remained consistent among many investors. Infrastructure development in emerging markets proved to be the guiding star for many PE investments in parts of Africa, Asia and the Americas, where the number of medium- to long-term infrastructure and development projects outnumbered the amount of available pounds and dollars to pay for them. The same could be said for tech and fintech industries, although the majority of entities in this sector in emerging markets were and continue to be in the venture capital phase.
Since the onset of the coronavirus crisis, which has seen “business unusual” collide rapidly with the subjective “new normal”, astute PE firms will need to reassess the opportunities offered by emerging markets, and may need to explore beyond traditional paydirt investment opportunities such as infrastructure for a while. Even in light of the 2007/8 global financial crisis, there are realistically no paradigms to measure the COVID crisis against, which is why PE firms will need to be bold and responsive in order to reap substantial returns from emerging markets on the back of the coronavirus pandemic – the effects of which the world is likely to be living with for years to come.
It’s vital to look at market trends. For example, in terms of fast-moving consumer goods South Africa’s burgeoning middle class is increasingly gravitating towards e-commerce, for the sake of convenience and affordability. In 2019, South Africa’s e-commerce market ranked 36th in the world with revenue of some $3 billion. Analysts had predicted that the compound annual growth rate for this market would increase by 10% between 2019 and 2023. However, the COVID-19 crisis and physical distancing has given rapid rise to South Africa’s e-commerce market over the past three months, as consumers across all demographics turn to the increasingly affordable online platforms for grocery, clothing and even luxury items, rather than braving the high street.
Although the coronavirus pandemic couldn’t have been foreseen by PE firms, the previously projected growth in this market provided the impetus for SPEAR Capital’s injection into the further development of South African online retailer RunwaySale.
That said, South Africa’s e-commerce market (among numerous FMCG sectors) is not alone in being attractive to PE firms. Boston Consulting Group in partnership with Facebook India this month released a report that evidences rapidly growing digital and online influence among lower-income consumers. Increasing alignment among trends in emerging markets points to the use of smartphones as a staple for consumer path-to-purchase in e-commerce markets. Prior to the pandemic, Boston Consulting Group had anticipated that around 3 billion emerging market consumers will be online by 2022. If South Africa and India are anything to go by, we could be looking at an even larger number of online consumers in the coming years – something to consider as part of a diversified FMCG investment mix.
However, convincing investors to take on board the risks associated with emerging markets in the current climate is easier said than done, particularly when there are safe haven assets through which to preserve capital, seemingly until markets settle. It cannot be denied that fundraising is currently severely stifled. Despite the aforementioned trend of consumers shifting to e-commerce, FMCGs will have taken a knock across all markets and varying recovery periods, which also ought to be borne in mind. So PE firms need to revise their approaches to investor engagement, strategy and transparency to convince, secure and guide investor capital into emerging markets presently.
It’s also worth bearing in mind that the typically limited capacity for government support in emerging markets should in theory result in a greater rate of business failure than in developed economies. Although this may have a profound economic impact, it allows the more agile and resilient surviving companies a chance to take advantage of a less crowded competitive environment. The situation also continually incentivises surviving companies to be geared towards value-driven operation and strategy efficiencies that the crisis has forced them to find.
The key is to be a value-oriented private equity investor while understanding the challenges and opportunities of investing in emerging markets. Aside from analysing industries, developing an investment thesis and valuing companies through intensified due diligence, liquidity management needs to be scrutinised on levels unlike ever before as current short- to medium-term forecasts vary wildly from sector to sector. This should be something of a golden rule for developed as well as emerging markets.
Therefore, liquidity management ought to take precedence over solvency, which can give an indication of top line growth, even in today’s unpredictable times. However, one must also take into account worst-case scenarios within the markets one is investing in and plan accordingly for crisis scenarios, such as debt, liquidity options and operational costs that can be scaled back.
PE firms that are perhaps considering taking a predatory stance, by offering capital akin to bailouts for embattled companies, are more likely to see investments disappear into black holes, with little if any return to speak of.
Many PE firms are also likely to see exit losses, although those that don’t require social proximity such as e-commerce and fintech, have a far stronger prospect of realising stellar returns than equivalent offline entities. Manufacturing, and focus on the internalisation of pipelines within emerging markets, is also worth serious consideration, as globalisation becomes less reliable as a result of closed ports and borders. There is debate as to whether fundraising in the medium term will be a PE stumbling block, given the hunt for yield , and as much as an additional year may need to be factored in for deploying capital. But for those who carefully identify unwavering trends in emerging markets over the next six to 12 months and articulate genuine opportunities to investors, there is scope for the PE asset class to exhibit substantial growth over the course of the coming decade.