Download Credit crisis

Implications of the Current
Business Environment for the
Nascent PE Industry in Colombia
Colombian Private Equity & Venture Capital Seminar
Andrés Cadena, McKinsey & Company
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.
1
IN THE PAST YEARS THE PE INDUSTRY EXPERIENCED
UNPRECEDENTED GROWTH
Global buyout assets under management (AUM)*
$ bn
Global funds raised
$ bn
CAGR
%
918
58
195
61
164
+33%
667
39
275
146
27
117
ROW**
387
14
Europe
135
465
26
107
228
“Global PE
fund-raising in
Q1 2008
reached
$163.5bn, the
second
highest in the
history of PE”
– PreQin 2008
173
584
35
400
U.S.
238
266
2004
2005
2006
2007
* Funds raised in the previous five-year period, by vintage year
** Rest of the world
Sources: Private Equity Intelligence; PreQin, press search; team analysis
Q1
Q2
Q3
2007
Q4
Q1
2008
2
FUELED BY A FALLING COST OF CREDIT
High-yield spread over swap rates*
Basis points
700
639 basis
points
650
600
550
500
450
400
184 basis
points
350
300
250
200
150
1995
’96
’97
’98
’99 2000 ’01
* Spread denotes industrial B-rated bond index over swap rates
Sources: Bloomberg; team analysis
’02
’03
’04
’05
’06 2007
3
PRIVATE EQUITY BECAME EXTREMELY LEVERAGED
Hedge funds and private equity firms control ~$2.5 trillion of equity
but borrowed several times this amount to fund their investments
Private equity leverage multiples*
Estimated hedge fund leverage**
6.2x
5.3x
4.6x
1,1
3,5
Leverage
through
derivative
positions
Total
leveraged
assets
5.4x
4.8x
0,9
4.0x
1,5
2002
2003
2004
2005
2006
* Source: Morgan Stanley, September 2008
** Source: McKinsey, October 2007
2007
Assets
under
management
Leverage
through
debt
4
HOWEVER, JULY 2007 BROUGHT A REVERSAL OF THE CREDIT
AND LIQUIDITY GROWTH
Global CDO issuance
$bn
Crisis onset
July 2007
60
Credit and liquidity growth
50
Credit and liquidity
crisis and contagion
40
30
20
10
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
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)
Sources:Dealogic; team analysis
Triggers of liquidity crisis
• Complexity and opacity of
subprime/CDO risk
• Mispricing of risk
• Aggressive pursuit of yield
Areas of contagion
• Mortgage-backed
securities
• Wholesale funding
market
• Hedge funds
• Private equity
5
RESULTING IN AN 80% DECREASE IN GLOBAL BUYOUT DEALS
Total value* of
announced global
buyout deals
$ Billions
186
Mega Deals
(over $2bn)
73
611
Announced global
buyout deals
Number of deals
213
38
55
46
401
401
372
663
444
2005 2006 2007 Q1
Q Avg. Q Avg. Q Avg.
Avg. deal
size**
$ Millions
164
304
321
* 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
Q2
Q3
2008
118
6
AN IN A DRAMATIC CAPITAL OVERHANG ($400 BILLION) THAT
NEEDS TO BE INVESTED
Private Equity capital raised and invested
$bn
278
Buyout Investments*
284
245 244
Buyout Fundraising
219
Capital overhang
(cumulative since 2003)**
188
$393 billion
overhang
156
101
76
48
81
97
53
5
2003
46
10
2004
2005
2006
2007
2008***
* 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 Q4
NOTE: Overhang = Uninvested Capital
7
Sources: Private Equity Analyst, EVCA, AVCJ, Venture Expert. McKinsey analysis, PE Intelligence
RAISING NEW CAPITAL WILL BE THOUGH AS PENSION
PENSION FUNDS WILL NEED TO REBALANCE PORTFOLIOS
Typical LP allocation to PE
Percent of total portfolio
ILLUSTRATIVE
New allocations fall
50% to keep PE
within target range
11.5
1,0
PE target allocation range
PE share of
portfolio rises
following collapse
in stock values
12.0
0,5
1,5
PE allocations
rise due to fewer
distributions
9.0
9.0
Limited exit
opportunities
reduce
distributions
10.0
2,0
1,0
2,0
Start
of
2007
Cash
back
2,0
Cash
called
8.0
Start
of
2008
* Footnote
Source: Press search, McKinsey analysis
Cash
back
Cash
called
Prestock
crash
Denom- Start
inator
of
effect
2009
Cash
back
Cash
called
Start
of
2010
8
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.
9
DEALS WILL BE SMALLER
Private equity deals are smaller
Average deal size*
$ millions
519
Credit crisis
422
294
251
171
155
143
134
97
2006 Q3 2006 Q4 2007 Q1 2007 Q2 2007Q3 2007 Q4 2008 Q1 2008 Q2 2008 Q3
* Source: Dealogic
10
THE CAPITAL STRUCTURE WILL REVERSE TO EQUITY LIKES
Private equity deals involve more equity - average equity contribution
% of purchase price
40%
38%
36%
Credit crisis
34%
32%
30%
28%
26%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1H08 2Q08
11
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
Credit crisis
350
300
250
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1H08 2Q08
Source: Standard & Poor’s
12
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.
13
FOLLOWING THE CRISIS, BUYOUT ACQUISITIONS SHIFTED
TOWARD EMERGING MARKETS
Announced global buyout deals, by region
%, $ bn
100% = 282
ROW
8
720
169
371
97
75
6
10
10
10
12
37
Europe
Buyout investments in emerging markets
$ bn
31
39
18
26
100% = 17
Middle East 5 1
Africa
12
Other
35
22
3
5
24
45
7
4
7
8
2
73
1
16
35
20
31
49
7
25
57
0
51
17
Asia
56
N.A.
60
83
82
64
69
56
61
57
43
48
30
2005
’06
Q1
’07
Q2
’07
Q3
’07
Sources: Capital IQ; Asian Venture Capital Journal (AVCJ)
Q4
’07
30
Q1
2008
2003
’04
’05
’06
2007 2008
14
WILLINGNESS TO INVEST IN EMERGING MARKETS GREW
DUE TO HIGHER RETURNS AND FALLING RISK PREMIUMS
Returns have increased in all emerging markets …
IRR
10-year returns
3-year returns
57
Avg. U.S. PE
returns range
Most LPs expect to invest in
emerging-market PE by 2013
% of LPs who expect to invest
in emerging regions
39
30
25
2006
2008
2013
68
Asia
83
19
89
0
Latin America
CEE* +
Russia
8
12
Emerging
Asia
All emerging
regions
43
… and PE risk premiums** over U.S. investments have
fallen
%
2006
2008
CEE+
Russia
57
75
5
Middle
East
11
35
9,0
5,8
5,9
6,5
6,4
8,9
8,0
6,7
6,7
5,0
20
Latin
America
40
65
4
Emerging
Asia
CEE+
Russia
Middle
East
* Central Eastern Europe
** LPs set the risk hurdle for U.S. PE investments at 16.3%
Source: Emerging Markets Private Equity Association (EMPEA)
Latin
America
Africa
Africa
30
52
15
RECENTLY, CAPITAL FOR EMERGING MARKETS HAS FROZEN
AS VOLATILITY IS HUGE AND CRISIS IMPACT IS UNKNOWN
CEE Current Account Deficits*
-4.9
Lat. Am. Fiscal Balances Pro-Forma
for Commodity Prices at 10 Yr Avg.**
8.7
-5.3
1.8
1.1
-13.7
-2.6
2007 Pro-Forma
-5.0
-22.0
Bulgaria Baltic
States
2007 actual
-2.0
-18.2
1.7
-8.1
Romania Hungary United
States
Argentina
Brazil
Chile
Peru
• 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
* Economist Intelligence Unit, 13 October 2008
** Morgan Stanley, 30 September 2008.
16
IF COLOMBIA MANAGES TO NAVIGATE THE CRISIS, IT COULD
BE IN A STRONG POSITION TO RECEIVE PE FLOWS
%, Change
2007
Δ Private
consumption
Δ Government
consumption
Δ Gross fixed
investment
2008 (Forecast)
4,4
1,7
1,1
0,6
5,1
Δ Stock
building
1,9
0
Δ Exports
0,6
1,9
Δ Imports
Δ GDP
• How exposed
are our exports
to a slowdown
in the US? In
Venezuela?
4,8
7,7
* Forecast
Source: DIAN-DANE; The Economist’s Inteligence Unit©, Oct 22th, 2008.
1,5
3,0
3,4
• Which
investments will
hold?
• energy?
• mining?
• Industrial?
• Infrastructure?
• What role could
PE play in
holding current
investment
rates? What has
to be done to
facilitate these
deals?
17
WHAT ACTIONS SHOULD BE TAKEN IMMEDIATELY?
NON EXHAUSTIVE
Can we create a more competitive
tax structure for GPs and LPs?
• Carryforwards
• Retefuente
• Ganancia ocasional
• Doble tributación
Should the government incentive the
industry?
• Cómo LP?
• Cómo GP?
• A través de políticas industriales?
• Articulando inversionistas?
• Generando economía de escala?
• Predefiniendo proyectos infraestructura?
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
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
18