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Implications of the Current Business Environment for the Nascent PE Industry in Colombia
Andrés Cadena, McKinsey & Company
Colombian Private Equity & Venture Capital Seminar
2
MAIN MESSAGES
• Leading up to mid-2007, the growth of the PE market was fueled by a flood of capital and easy lending standards. However, liquidity dried up following the credit crisis, causing the buyout markets to collapse
• General Partners will concentrate in the short term in turning around troubled portfolios and in taking advantage of distressed assets. In the mid term the industry will return to fundamental-based deals (smaller, less leveraged, longer holding periods)
• The nascent PE industry in Colombia could take advantage of the current market conditions to leapfrog other economies. However, it is critical to take immediate actions on regulation, infrastructure and, moreover, education of both GPs and LPs.
3
IN THE PAST YEARS THE PE INDUSTRY EXPERIENCED UNPRECEDENTED GROWTH
* Funds raised in the previous five-year period, by vintage year** Rest of the worldSources: Private Equity Intelligence; PreQin, press search; team analysis
238 266
400
584
14
135
387
2004
26
173
465
2005
39
228
667
2006
58
275
Europe
918
U.S.
+33%
2007
ROW**
CAGR %
61
27
35
164
146
107
195
117
Q1 Q2 Q3 Q4 Q1
“Global PE fund-raising in Q1 2008 reached $163.5bn, the second highest in the history of PE”– PreQin 2008
2007 2008
Global buyout assets under management (AUM)*$ bn
Global funds raised$ bn
4
FUELED BY A FALLING COST OF CREDIT
*Spread denotes industrial B-rated bond index over swap ratesSources: Bloomberg; team analysis
High-yield spread over swap rates*Basis points
150
200
250
300
350
400
450
500
550
600
650
700
2007’06’05’04’03’02’012000’99’98’97’961995
184 basis points
639 basis points
5
PRIVATE EQUITY BECAME EXTREMELY LEVERAGED
Private equity leverage multiples* Estimated hedge fund leverage**
4.0x
2002
4.6x
20042003 2007
4.8x5.4x5.3x
6.2x
2005 2006
*Source: Morgan Stanley, September 2008**Source: McKinsey, October 2007
3,51,1
0,9
1,5
Assets
undermanage-ment
Leverage
throughderivativepositions
Leverage
throughdebt
Total
leveragedassets
Hedge funds and private equity firms control ~$2.5 trillion of equity but borrowed several times this amount to fund their investments
6
0
10
20
30
40
50
60
HOWEVER, JULY 2007 BROUGHT A REVERSAL OF THE CREDIT AND LIQUIDITY GROWTH
Sources: Dealogic; team analysis
Main drivers of liquidity growth• Growth in financial assets
(e.g., equity, private and government debt, bank deposits)
• Increasing importance of private capital
• Entry of new investors in the market through innovative financial products (e.g., CDOs)
Triggers of liquidity crisis• Complexity and opacity of
subprime/CDO risk• Mispricing of risk• Aggressive pursuit of yield
Global CDO issuance$bn
Areas of contagion• Mortgage-backed
securities• Wholesale funding
market• Hedge funds• Private equity
Crisis onsetJuly 2007
Credit and liquidity growthCredit and liquidity crisis and contagion
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
7
*Total deal value includes both equity and debt**Average taken of disclosed deal values. May exaggerate actual average since deals with undisclosed value tend to be small
Source: Capital IQ
Avg. deal size**$ Millions
73
186213
38 55Mega Deals
(over $2bn)46
372401401
663611444
2005
Q Avg.2006
Q Avg.2007Q Avg.
Q2 Q3Q1
2008
Total value* of announced global buyout deals$ Billions
Announced global buyout dealsNumber of deals
321304164
RESULTING IN AN 80% DECREASE IN GLOBAL BUYOUT DEALS
118
8
48
76101
219
245
4653
81
188
278
244
284
2003 2004 2005 2006 2007 2008***
AN IN A DRAMATIC CAPITAL OVERHANG ($400 BILLION) THAT NEEDS TO BE INVESTED
Private Equity capital raised and invested$bn
*Assuming a 2:1 debt:equity ratio**EVCA (most accurate) figures for Europe not yet available. Alternative source used but this may understate the global total***Cumulative uninvested capital since 2003, capital committed pre-2003 is unlikely to be invested at this point; assumes that 1/3 of capital on the road will close in Q4NOTE:Overhang = Uninvested Capital
Sources: Private Equity Analyst, EVCA, AVCJ, Venture Expert. McKinsey analysis, PE Intelligence
Buyout Investments*
Buyout Fundraising
Capital overhang (cumulative since 2003)**
$393 billion overhang
5 10
97
156
9
RAISING NEW CAPITAL WILL BE THOUGH AS PENSION PENSION FUNDS WILL NEED TO REBALANCE PORTFOLIOSTypical LP allocation to PEPercent of total portfolio
*Footnote
Source:Press search, McKinsey analysis
ILLUSTRATIVE
1,0
2,0
1,5
1,00,5
2,02,0
Cash back
Startof2009
11.5
Cash called
9.0
12.0
10.0
8.0
Cash back
Start of 2010
Cash called
Pre-stockcrash
9.0
Cashcalled
Cashback
Start of2008
Denom-inator effect
Start of2007
PE
targ
et a
lloc
atio
n ra
ng
e
PE allocations rise due to fewer
distributions
PE share of portfolio rises
following collapse in stock values
Limited exit opportunities
reduce distributions
New allocations fall 50% to keep PE
within target range
10
MAIN MESSAGES
• Leading up to mid-2007, the growth of the PE market was fueled by a flood of capital and easy lending standards. However, liquidity dried up following the credit crisis, causing the buyout markets to collapse
• General Partners will concentrate in the short term in turning around troubled portfolios and in taking advantage of distressed assets. In the mid term the industry will return to fundamental-based deals (smaller, less leveraged, longer holding periods)
• The nascent PE industry in Colombia could take advantage of the current market conditions to leapfrog other economies. However, it is critical to take immediate actions on regulation, infrastructure and, moreover, education of both GPs and LPs.
11
DEALS WILL BE SMALLER
Private equity deals are smaller
134155
97143
171
519
294
422
251
2008 Q32008 Q22008 Q12006 Q3 2006 Q4 2007 Q1 2007 Q2 2007Q3 2007 Q4
*Source: Dealogic
Average deal size*$ millions
Credit crisis
12
THE CAPITAL STRUCTURE WILL REVERSE TO EQUITY LIKES
Private equity deals involve more equity - average equity contribution % of purchase price
40%
38%
36%
34%
32%
30%
28%
26%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1H08
2Q08
Credit crisis
13
AND COST OF CAPITAL WILL RETURN TO LONG TERM LEVELS
Private equity deals involve less favorable debt terms Average spread of leveraged buyout loans* Vs Libor
450
400
350
300
250
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1H08
2Q08
Credit crisis
Source:Standard & Poor’s
14
MAIN MESSAGES
• Leading up to mid-2007, the growth of the PE market was fueled by a flood of capital and easy lending standards. However, liquidity dried up following the credit crisis, causing the buyout markets to collapse
• General Partners will concentrate in the short term in turning around troubled portfolios and in taking advantage of distressed assets. In the mid term the industry will return to fundamental-based deals (smaller, less leveraged, longer holding periods)
• The nascent PE industry in Colombia could take advantage of the current market conditions to leapfrog other economies. However, it is critical to take immediate actions on regulation, infrastructure and, moreover, education of both GPs and LPs.
15
FOLLOWING THE CRISIS, BUYOUT ACQUISITIONS SHIFTED TOWARD EMERGING MARKETS
43
56 60 6456
30 30
371
Q2 ’07
10
35
97
Q3 ’07
49
57
75
Q4 ’07
18
51
39
Q12008
ROW
Europe
N.A.
100% =
8
282
2005
6
37
720
’06
1210
31
169
Q1 ’07
10
26
82
61
83
6957
48
12
3120
25
17
87 16
7
35
5 5
’06
173
2007
0
7
2008
Middle East
Africa
Other
Asia
100% =
4
’05
24
2
’04
4522
3
2003
171
Sources: Capital IQ; Asian Venture Capital Journal (AVCJ)
Buyout investments in emerging markets$ bn
Announced global buyout deals, by region%, $ bn
16* Central Eastern Europe** LPs set the risk hurdle for U.S. PE investments at 16.3%Source: Emerging Markets Private Equity Association (EMPEA)
8,98,0
9,0
6,45,86,76,76,5
5,05,9
Emerging Asia
CEE+Russia
MiddleEast
LatinAmerica
Africa
2006
2008
4
20
5
43
68
30
40
11
57
83
52
65
35
75
89
Asia
CEE+Russia
Middle East
LatinAmerica
Africa
2006
2008
2013
WILLINGNESS TO INVEST IN EMERGING MARKETS GREW DUE TO HIGHER RETURNS AND FALLING RISK PREMIUMS
… and PE risk premiums** over U.S. investments have fallen%
Most LPs expect to invest in emerging-market PE by 2013% of LPs who expect to invest in emerging regions
Returns have increased in all emerging markets …IRR
8 12
19
0
39
25
57
30
EmergingAsia
All emergingregions
10-year returns
3-year returns
Latin America CEE* +Russia
Avg. U.S. PE returns range
17
RECENTLY, CAPITAL FOR EMERGING MARKETS HAS FROZEN AS VOLATILITY IS HUGE AND CRISIS IMPACT IS UNKNOWN
CEE Current Account Deficits* Lat. Am. Fiscal Balances Pro-Formafor Commodity Prices at 10 Yr Avg.**
-5.3
-18.2
United States
-22.0
-4.9
HungaryRomaniaBaltic States
Bulgaria
-13.7-2.0
Chile
-5.0
Argentina
-8.1
8.7
Brazil
1.1 1.8 1.7
Peru
-2.6
*Economist Intelligence Unit, 13 October 2008**Morgan Stanley, 30 September 2008.
2007 actual
2007 Pro-Forma
• Eastern European account deficits and Latin American commodity dependency are key vulnerabilities – Certain CEE countries will experience credit contractions, reduced investment, and slower growth– Latin American governments may have to raise taxes or cut spending as commodity related
revenues fall
18
IF COLOMBIA MANAGES TO NAVIGATE THE CRISIS, IT COULD BE IN A STRONG POSITION TO RECEIVE PE FLOWS
7,7Δ GDP
4,4Δ Private
consumption
1,1Δ Government
consumption
5,1Δ Gross fixed
investment
0Δ Stock
building
1,9Δ Exports
4,8Δ Imports
1,7
0,6
1,9
0,6
1,5
3,0
3,4
2007 2008 (Forecast)%, Change
* ForecastSource:DIAN-DANE; The Economist’s Inteligence Unit©, Oct 22th, 2008.
• How exposed are our exports to a slowdown in the US? In Venezuela?
• Which investments will hold?
• energy?• mining?• Industrial?• Infrastruc-
ture?
• What role could PE play in holding current investment rates? What has to be done to facilitate these deals?
19
WHAT ACTIONS SHOULD BE TAKEN IMMEDIATELY?
Can we create a more competitive tax structure for GPs and LPs? • Carryforwards• Retefuente• Ganancia ocasional• Doble tributación
Can we strengthen the regulation (articulo 2175) to facilitate/stimulate investments from pension funds and insurance companies?• Flexibilidad en clases de activos• Desregulación vs. Lavado de activos• Condiciones de contratación pública
Should the government incentive the industry? • Cómo LP?• Cómo GP?• A través de políticas industriales?• Articulando inversionistas?• Generando economía de escala?• Predefiniendo proyectos infraestructura?
Is it feasible to accelerate the creation of top quality GPs?• Co-inversiones• Definición de conflictos de interés• Gobierno Corporativo• Procesos operativos claros• Certificados para GPs
NON EXHAUSTIVE
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