Due Diligence 101: Private Equity Investing in Emerging Markets The - - PowerPoint PPT Presentation

Due Diligence 101: Private Equity Investing in Emerging Markets

The due diligence challenges

Jonathon Bond, Managing Partner & Adiba Ighodaro, Director Actis

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Executive Summary - Due Diligence in the Emerging Markets

1.

Due diligence in emerging markets is the same as developed markets with special emphasis on key areas

Don’t compromise on depth or quality because “the emerging

markets are different”

Be prepared for it to take longer 2.

Management strength & alignment are the central risks irrespective of geography

There may be cultural differences in relationship management

between regions, but structures that reinforce alignment remain the same

3.

In our experience, a special focus on environmental, social and governance issues tests management’s alignment, enhances value and obtains premiums on exit

Executive Summary Continued

Traditional approaches to responsible investment Traditional approaches to responsible investment

4.

The number of control deals in the emerging markets continues to grow, but the focus on control transactions should not cloud the importance of ensuring strong influence irrespective of level of shareholding

5.

Trade sales continue to dominate exit opportunities in the emerging markets (with the exception of China and Brazil), with a slowly increasing number of IPOs as stock markets mature

6.

In this presentation, we have drawn on lessons learned from having invested over US$4.2bn invested in over 150 Private Equity and energy transactions since 1998, with US$4.3bn returned to investors over the same period

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Agenda for the Session

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

1.

Due diligence overview

Commercial due diligence Financial and legal due diligence 2.

Key areas of emphasis in the emerging markets

3.

Environmental, social and governance (ESG)

4.

Minority vs. Control deals

5.

Exit opportunities

6.

Case study

7.

Lessons learned

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Due Diligence Overview

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Commercial Business model Revenue drivers Market research Customer analysis Competitive position Regulatory climate Management’s track record Local talent pool Financial Historical financials Forecasts EBITDA / profit margins Earnings quality GAAP / transparency MIS systems Legal Key risk areas Ownership / title Corporate structure Intellectual property Contingent liabilities Change of control Labor & pension Property Confirm investment thesis Identify & mitigate risks Reveal

• pportunities

for value creation Identify ESG risks Adjust price to maximize exit premium Ensure ethical integrity

Same standards and rigour as developed markets

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Issues Vary with Heightened Emphasis on Certain Elements

• Management
• Local management depth, ability and

experience

• Willingness to implement change
• Frequent need to professionalize family

businesses

• Governance arrangements
• Political and regulatory risk
• Verification of historic financials and tax position

Availability of reliable market research Adequacy of legal structures and remedies

• Myriad ESG obstacles

Management strength and alignment are the central risks, irrespective of geography Governance arrangements need improvement Market data is frequently limited ESG often identifies areas for improvement

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Commercial Due Diligence: Business Model

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

Business Model

What are the entry barriers? Are they high? What is the target’s economic model? What are the key success factors of the industry? How is the industry profit pool distributed among different parts of

the value chain?

How have similar businesses evolved in developed markets?

Implication to this market? Market Size and Growth

How big is the segment in which the target plays? How has it been growing historically? What are the major drivers for the market growth going forward? How big will the market be in five years?

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Commercial Due Diligence: Market Considerations

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

Customers

Who are the customers? Are sales concentrated among key customers / products? How loyal are the customers? How are customers acquired? At what cost?

Regulatory Environment

What are the most relevant regulations? How are the regulations expected to change? How will regulatory changes impact the target’s business?

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Commercial Due Diligence: Competitive Position

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Target’s Competitive Position

What is target’s market share in each of its key markets / segments? Who are the major competitors? Are they gaining or losing share compared to target? What are customers’ comments on target vs. major competitors?

Target’s Capability

What are the most important capabilities for this industry? How strong is target with regard to those capabilities? What investments has target made to buttress those capabilities? How aligned is the organization (e.g. structure, incentives, etc.) with target’s

strategy?

What is the management’s track record?

SWOT Analysis of Target What are the key strengths, weaknesses, opportunities, and threats to the target?

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Commercial Due Diligence: Target Financials

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

Historical Financials

What are the target’s historical and current (YTD) financials (P&L, balance sheet,

cash flow)?

How is current (YTD) trading compared with the budget? What are the major drivers for revenue, cost and cash flow? How have those

performed over time?

Compare revenue, profitability and cash flow by major line of businesses How have those evolved over time? Have margins declined? What are the main reasons for historical margin decline?

Financial Forecasts

What are the consultant’s forecasts for the next five years? What are the key assumptions? Different scenarios? How do the consultant’s forecasts compare with management’s forecasts? What are the main differences in the key assumptions? What are the major risks for target over the next five years?

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Commercial Due Diligence: Value Creation Opportunities

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

Value Creation Opportunities

What are the major opportunities to drive target to full potential?

• Strategic
• Operational (revenue, cost, and cash)
• Organizational
• Financial

What can be done to help the target achieve full potential? Obtain input from sector & operating experts in articulating the full potential

100-Day Plan (In Control Investments)

What is the high-level five year strategy of the target? What are the immediate priorities for the target / management? Detailed 100-day plan including tasks, responsible person, timing, and

checking points

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Financial & Legal Due Diligence

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

Focus on Key Issues and the Commercial Implications Local Market Expertise

Industry knowledge and judgment to identify key issues Some markets prohibit use of international law firms

International Linkages

Crucial when multiple jurisdictions are involved

Experience in PE or Target Sector

Type of deal matters: minority vs. control, auction or share deal

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Due Diligence

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

• 2. Key Areas of Emphasis in the Emerging Markets

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Key Areas of Emphasis in the Emerging Markets

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

Management

Challenges Fewer established teams with long track record Finance function often weak Alignment – true partnership or banking relationship? Our Approach Disproportionate amount of face time with management teams Use of international HR consultants and psychometric testing Extensive referencing through personal networks on the ground Detailed discussion of terms of shareholder agreements, 100-day plans and keen observation of responses

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Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

Governance

Challenges In many cases family owned businesses have paid less attention to the separation of the board from the executive Important to diligence and understand relationships between “independent” board members and family owners Our Approach Spend time with Board prior to investment Make restructuring plans clear Seek at least 2 Board seats Good use of non-executive directors Note: increasing pull from sponsors for access to global industry experts

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Key Areas of Emphasis in the Emerging Markets

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Actis approach

Business sector Power Distribution Region of operation Uganda

Political & Regulatory Risks Umeme case study

Power distribution platform in East Africa 20 year concession from 2005 privatization US$65m capex program commitment to expand and upgrade system Regulated 20% return on equity capital World Bank and MIGA credit enhancement Platform to expand into mini-hydro in Uganda and other distribution in Sub-Saharan Africa

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Key Areas of Emphasis in the Emerging Markets

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

Political & Regulatory Risks Umeme case study

Challenges Key issue was nascent mid-privatization electricity sector - World Bank was creating a structure for private sector investment, but it was not perfect Regulator and government officials were inexperienced Uganda government’s commitment to following the rules was unproven Our Approach Worked alongside World Bank and Ministry of Energy to create a regulatory structure that worked for everyone, including Actis and multilateral lenders Insisted on multilateral partial risk guarantee to offset risk of Uganda government not following through on its commitments Created a well-understood 18 month off-ramp option that allowed Actis to exit the concession if the structure was not working

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Key Areas of Emphasis in the Emerging Markets

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach

Verification of Historic Financials and Tax Position Big 4 operational across all of the emerging markets Ask which auditors company works with; observe their response when change is suggested Note: Actis doesn’t expect perfection in target companies, but will work with company prior to investment Availability of Market Research Global relationship with leading consulting firm has been critical Actis uses insights gained from one market to the other

• e.g. Characteristics of C and D consumers in Brazil similar to where

Indian consumers were 5-10 years ago

• e.g. South Africa – a more sophisticated buyout PE market

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Key Areas of Emphasis in the Emerging Markets

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment

Adequacy of Legal Structures and Remedies Issue is not lack of familiar legal and regulatory frameworks

• Internationally recognized Common or Roman Law

Challenge is the Efficiency Our Approach

• Offshore SPVs
• Arbitration in international centers

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Key Areas of Emphasis in the Emerging Markets

Due Diligence

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

• 3. Environmental, Social and Governance (ESG)

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Financial Improvement From ESG Process

Marketing &

• rigination

Screening Due diligence Portfolio management Exit Sector/country in which we invest? Comfortable with investment partners? Effective controls in place? Meets ESG code standards? All areas of non-compliance can be addressed? ESG action plan Meeting the timetable for action plan? Adding value from ESG perspective? Comfortable with the potential buyer?

Investment Process Key ESG Questions

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Integrated Focus on ESG is Critical

HIV/AIDS Working Conditions Environmental Issues Health & Safety Climate Change Corporate Governance Human Rights Business Integrity

E S G

Attention to ESG issues:

Reduces investment and portfolio risk Reveals opportunities for value creation May improve commercial returns while

enhancing quality of life and the environment

Enhances transparency and governance Builds reputational capital

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ESG in Practice

DRAFT

7 Days (China)

Installed intelligent power and water control systems Safety a priority 7 Days Management Academy

IPO NYSE 2009 G-Tex (Brazil)

• Full audit of 4 main

production facilities (98% of production)

• Improved labor safety

conditions

• Introduced environmentally

friendly new product lines

Nilgiri (India)

Addressed food safety issues Improved labor conditions Dairy business obtained ISO22000 certification

Vlisco (Sub-Saharan Africa)

Addressed ground pollution at the Helmond factory Installed wastewater treatment plant in Ghana Explored best practices regarding Trichloroethylene, a global watch list pollutant

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Due Diligence

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

• 4. Minority vs. Control Deals

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Differences in Minority vs. Control

In developed markets, control is synonymous with Private Equity and facilitates: Use of leverage – critical to returns in markets with limited growth ‘Control’ of management and strategic decision-making within the business Ability to change management easily, when necessary Maintaining control of eventual exit In emerging markets, the picture is different: High growth markets don’t require leverage to generate returns Typically influence has been established through strength of personal relationships In our experience, relationships and influence have enabled structuring of strong minority protection rights

• Only 14% (by cost) of the 59 investments in our 1998 vintage funds were “control”
• We had board seats in the majority of the companies

Personal relationships

• Remain very important in Africa and Latin America
• Are decreasing slightly in India (as industry is becoming more competitive)
• Differ slightly in China

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Actis Fund 3 (2007) Actis Fund 2 (2004) Actis Fund 1 (1998)

Increasing Number of Control Deals Across the Emerging Markets

Over the last 12 years we have seen an increasing number of control and joint control deals Compared with 14% in our first fund, over 50% of Fund 3 is control – why the growing trend?

• More efficient way of obtaining rights
• Being a majority institutional owner

facilitates the ability to bring on board professional world-class management that would otherwise be wary of committing to a family-owned company

• Platform transactions – increased use of

a buy & build approach to help manage high valuations in “hot” markets

• Control deals are generally becoming

more familiar in our markets

Minority 86% Minority 56% Minority 42% Majority 14% Majority 44% Majority 58% 26

Due Diligence

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

• 5. Exit Opportunities

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Effective Due Diligence Drives Higher Exit Premiums

Effective due diligence Management assessment Identify value add Valuation adjustment Exit premium

Availability

• f exits

Put back to seller Local or international IPO Strategic sale Secondary sale

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Exits

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach

Significant growth in M&A activity from one EM to the other

(e.g. China to Africa, India to Brazil & SE Asia)

Premiums paid for comfort that ESG standards are world-class Trade sales continue to dominate

exit opportunities in the emerging markets (with the exception of China)

Slowly increasing number of IPOs

as stock markets mature Our Experience:

No lack of trade buyers for

companies that have had an institutional investor involved driving best practices

Exit method* Africa India China SE Asia Total Trade sale 10 10 1 1 22 Public

• ffering

3 7 4 14 Secondary 3 5 1 9 Share buy- back 3 6 9 Loan repayment 4 3 7 Write-off 3 3 1 7 Total 26 31 10 1 68

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* Actis Private Equity exits from January 1998 – December 2010

Due Diligence

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

• 6. Case Study – Paras Pharmaceuticals

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Case Study: Paras Pharmaceutical

Description

Leading FMCG company in India Diversified portfolio of personal care and healthcare brands Strong management track record Presence in fastest growing personal care segments (e.g. male grooming) History with Actis since 2001, when company was first reviewed for Private Equity investment

Investment Thesis

Rapidly growing disposable income Expanding per capita consumption Strong growth prospects Extremely detailed due diligence confirmed the investment thesis & identified key areas to focus on for post-acquisition value addition, on which we agreed with management from the outset

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Restructured family management team to:

• Implement changes
• Reduce execution risks

Aligned management’s interests with performance goals Sought operational expertise Utilized Actis network for recruitment of CFO and various positions

Key Finding: Need to Augment Management

• Head of international business
• Sourcing and supply
• Brand managers
• Regional sales
• Product development managers
• OTC category management chain

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Introduced new products to:

• Displace MNCs in established categories
• Develop new categories

Evaluated management’s focus on fastest growing segments (e.g. premium skin care and deodorants) Leveraged Malaysian and Indian precedents Found MNCs likely to concentrate on larger categories and global brands Limited downside with continued focus on 10 cash generating brands

Key Finding: Gaps in Product Offerings

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Analyzed historical performance to validate figures Gained confidence in forecasts through FY08:

• Revenue growth at 24%
• EBITDA growth at 40%

Forecasted EBITDA at 25% through FY10 Grew margins by reducing ad spend and promo costs:

• Umbrella branding strategy
• Less individual brand focus

Key Finding: Potential to Cut Costs

500 1,000 1,500 2,000 FY06 FY07 FY08 FY09 FY10 FY11 0% 5% 10% 15% 20% 25% 30% 35% FY06 FY07 FY08 FY09 FY10 FY11

Operating EBITDA EBITDA Margins

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Tax / Legal ESG

• Received significant tax reduction from plant move to Baddi
• Negotiated specific legal protections and deal rights
• Improved business principles and ESG standards
• Formulated health, safety, environment, and social policies
• Created 100-day action plan

Tax, Legal & ESG Findings Improved Commercial Results

De-risked company Created potential for exit premium

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Due Diligence

Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment Traditional approaches to responsible investment Actis approach Traditional approaches to responsible investment

• 7. Lessons Learned

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Lessons learnt

Previous industry experience leads to high quality debate and helps win deals Previous experience means consultants understand needs and focus Involvement of sector and operating experts throughout Sharing of findings with target companies is appreciated by management and brings value to the business going forward Regular meetings with consultants prevents surprises and ensures good coordination Articulating investment thesis too late Insufficient scrutiny of forecasts and scenarios Unclear expectations and scope of the work

What works well? What has not worked well?

Nebulous 100-day plans Lack of relevant statistics makes findings less credible and reliable Insufficient benchmarking of management performance against industry

Lessons Learned

Assuming management is qualified owing to involvement of a well-known sponsor Failing to revisit management’s alignment, not being prepared to change management early

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Contact Details

Actis 2 More London Riverside London SE1 2JT, UK Jonathon Bond Partner Tel: +44 (0)20 7234 5098 jbond@act.is Adiba Ighodaro Director Tel: +44 (0)20 7234 5125 aighodaro@act.is

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This document is issued by Actis LLP (‘‘Actis’’) which is authorised and regulated by the Financial Services Authority in the UK (“FSA”). Funds promoted by Actis (the “Funds”) fall within the FSA’s definition of “Unregulated Collective Investment Schemes” (“UCIS”) and the promotion of a UCIS either within the UK or from the UK is severely restricted by statute. Consequently, this document and interests in the Funds are only made available to Professional Clients as defined by the FSA’s rules and any other person who receives this document should not rely upon it. This document has been approved by Actis solely for the purposes of Section 21 of the Financial Services and Markets Act 2000 for communication to Professional Clients as defined by the FSA’s rules. Actis is a limited liability partnership registered in England and Wales (registered no. OC305927). A list of the members of Actis is open to inspection at its registered office, 2 More London Riverside, London SE1 2JT, England. The information contained herein may not be relied on for any purpose and no responsibility is accepted by any person for the accuracy or completeness of such information. Readers should not treat these materials as advice in relation to legal, taxation

• r investment matters and are recommended to consult their own advisers in relation to any such issues.

Any prior investment results and returns of the Funds in this document are provided for illustrative purposes only and are not necessarily indicative of the Funds’ potential investment results. There can be no assurance that these or comparable investment results or returns will be achieved by the Funds, that the Funds will be able to avoid losses or that Actis will be able to make investments similar to the existing and historical investments of the existing Funds managed by Actis due to, amongst

• ther things, economic conditions and the availability of investment opportunities.

Important Notice

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