Nicholas Callinan had to bring maps with him to presentations in 1994 to show U.S. investors the location of central and eastern European countries in which his firm, Advent International Corp., planned to make private equity investments through its Central and Eastern Europe L.P. fund.
Making private equity investments in the developed markets of Europe was relatively new; it was largely unheard of in the emerging markets.
And Advent's timing couldn't have been worse.
The Mexican financial crisis was unfolding and jittery investors lumped all emerging markets into one pot. The partnership, nevertheless, managed to close raising $125 million.
Fast-forward to 1998. Asian flu still sends a shudder through markets worldwide. But Advent International had an easy first close on Advent Central & Eastern European II L.P., its second fund which also targets the emerging markets of eastern and central Europe.
And, Mr. Callinan no longer has to carry maps around.
"The investors are far more sophisticated," said Mr. Callinan, senior vice president with Advent. "They (investors) know the difference between Asian risk, central Europe risk and Latin America risk."
WESTERN EUROPE STILL TOPS
Overall, the developed markets of western Europe still receive the largest amount of U.S. tax-exempt money headed for other shores. That is due to the financial and cultural similarities.
"Europe and the United Kingdom are the models that are understandable to U.S. investors," said Gary Solomon, chief executive officer of the New York office of London-based Granville Private Equity Funds.
"In Germany and France we are beginning to see corporate restructurings," said Mr. Solomon. "That provides a source of raw materials for buyouts in particular.
"Merger and acquisition activity is increasing, which is another source of activity for buyout investing as well as exits," Mr. Solomon said.
Despite the cultural similarities that make European private equity a layup for U.S. investors, there is a growing level of financial commitment by these investors to emerging market private equity partnerships.
It hasn't been accurately quantified or documented, but it is there.
"I have been to four or five conferences this year devoted just to emerging markets private equity," said Mr. Callinan.
Emerging markets private equity "is increasing in interest and people are spending time in it," said Kevin Albert, managing director of private equity with Merrill Lynch & Co. Inc., New York.
"The gross numbers are not that huge because (partnership) sponsors are early in their evolution and can't justify raising large sums."
"Absolutely," said Lawrence Unrein, managing director with J.P. Morgan Investment Management Inc., which oversees the private equity investments for the AT&T Co. and Lucent Technologies Inc. pension funds.
"There is more money going into these areas, just based on the number of funds and opportunities we have seen."
PIONEERS IN FIELD
Tax-exempt investors that are at the vanguard of making private equity investments in the emerging markets are the Colorado Public Employees' Retirement Association; the State of Wisconsin Investment Board; the pension funds for General Motors Corp., IBM Corp., BellSouth Corp., General Electric Co., AT&T and Lucent Technologies; the pension and endowment of the University of California; and the Ford Foundation.
Emerging markets private equity owes its popularity to an overheated domestic private equity market; the inability of U.S. investors to fund private equity allocations; attractive valuations of foreign companies: U.S.-type corporate restructurings in Europe; and the privatization of state-owned businesses in central and eastern Europe and Latin America.
"You can't keep stuffing money into the United Kingdom and United States markets," said Mr. Callinan. "The emerging markets are the last real frontier to try and keep returns up."
"It's an idea whose time has come, at a time when the money is there," said Mr. Callinan. "This is as good as it gets."
EYES TURN SOUTH
Latin America has sprinted to the front of the pack as U.S. tax-exempt institutional investors turn their attention to private equity investing in the emerging markets.
"We see Latin America as a real big opportunity since they are privatizing," said Norman Benedict, deputy executive director of the $24 billion Colorado Public Employees' Retirement Association, Denver.
According to Price Waterhouse, U.S. private equity funds have committed more than $2.6 billion in Latin American private equity, although the amount may be three times higher.
"The increase has been exponential," said Ricardo Silvagni, managing partner of Price Waterhouse's Latin American Business Center, New York, who estimates the actual amount committed by U.S. investors to be between $7 billion and $8 billion.
"Three to four years ago, there were almost no funds for this part of the globe."
Latin America popular
Latin America is popular with U.S. investors because it is the back yard of the United States and there have been success stories, said Mr. Callinan.
"Eastern Europe has ideological baggage, and there is the (specter) of organized crime in Russia," he said.
"There are a number of people of Latin American descent here," said Mr. Callinan. "It is the same hemisphere.
"Chile has indicated it (privatization) can work well. Argentina and Brazil are getting their acts together," he said.
Colorado made its first commitments to emerging markets private equity in 1995-1996, and has so far committed a total of $500 million, or about 2% of total assets, according to Mr. Benedict.
The Colorado trustees committed $200 million to Latin American private equity in 1997, and Mr. Benedict expects an additional $200 million commitment this year. Partnerships targeting Brazil, Argentina, Colombia, Ecuador, Venezuela and Mexico will be the likely recipients, he said.
"The key is investing with the right people that have proven experience and the right culture," he said. "The returns are attractive: 25% to 30% net (to the limited partners), and it's a good way to diversify."
NOT WITHOUT GLITCHES
Latin America's sanguine environment is not without glitches.
Lazard Freres & Co. LLC in March told limited partners in its Mexico Partners Trust that it would dissolve the partnership because of a failure to execute its buyout strategy, a spokeswoman for the firm confirmed.
The fund was started in 1995 to make controlling investments in companies in need of capital. The currency crisis was shorter than anticipated, making it difficult to execute the partnership's stated strategy, the spokeswoman acknowledged.
There were no tax-exempt investors in the partnership, said the Lazard spokeswoman.
Colorado also likes China, and has committed $100 million to the HSBC Equity Fund Two Ltd. and $30 million to the Hambrecht & Quist Asia Pacific Growth Fund L.P. partnerships.
China, historically, has been capitalistic in nature, and the two groups with which Colorado is investing have been able to exit investments, said Mr. Benedict.
"We see (China) as an opportunity in consumer-related products: soap, bicycles, tires and ball bearings," he said.
The State of Wisconsin Investment Board, Madison, ranks Latin America behind eastern and central Europe and Asia in attractiveness, said Michael Wagner, assistant portfolio manager for the $55 billion pension fund.
The pension fund's Opportunity E portfolio, which was established to make opportunistic investments, has invested between $150 million and $200 million in emerging market private equity partnerships and $10 million directly, he said.
Latin America looked attractive, but family owned businesses predominate, and the owners typically want to sell a stake in the business but continue to operate it, said Mr. Wagner.
Asia is attractive, but it will take time for the currency devaluations to result in a fair valuation of businesses, he noted.
"Historically, most of Asia was built on debt," he said. "There was no need for equity.
"At some point, Asian banks will have to write down those loans, and that is when a need for new equity will surface.
"We are very high on Asia, but it will take time. They are trying to digest the fact that their business isn't worth $1 billion but $300 million."
BENEFITS OF COMMUNISM
Eastern and central Europe are attractive, but not by default, according to Mr. Wagner's explanation.
"One legacy of the communist system is a high level of education," said Mr. Wagner.
"You are talking about people with master's (degrees) and Ph.D.s.
"These countries have had a central economy, but someone remembered how to run a business. And, they are next door to developed countries.
"Eastern Europe can tap people from Western Europe to come and get things up and running," said Mr. Wagner.
The appeal of developing Europe is that an investor can buy today at restructuring prices, but in a number of years they countries will be part of developed Europe and the investments will be priced accordingly, said Mr. Callinan.
The common thread in the different approaches to making private equity investments in the emerging markets is it's time-consuming, and the investments are relatively small.
But the purpose of spending time now is to gain a toe hold in parts of the world with higher growth rates and more attractive demographics than the United States.
"Everybody is taking a leap of faith," said Mr. Wagner. "The obvious one is China.
"This is a warmup for the big money later. If we wait five years, we will have to start then."