Sometimes bad times make for good buys. Market volatility and corruption scandals are two adverse characteristics that, for the worse, have come to define the economic outlook in Latin America in recent years. Political instability and slow economic comeback in some of the biggest markets have not helped matters. Combined, these factors paint a picture of a region where fewer funds are interested in staking their claim.
Lower returns might have edged some private equity players out of the market for now, but for those with staying power, the region remains attractive. At Latin Lawyer Live 9th Annual Private Equity, which took place in New York last year, conference co-chair Todd Crider, partner at Simpson Thacher & Bartlett LLP, sat down with The Carlye Group’s global head of operations, Christopher Finn.
Under the helm of its next generation of leaders – Kewsong Lee and Glenn Youngkin – since 2018, Carlyle continues to find opportunities in Latin America. It runs a South America buyout fund from São Paulo and has a smaller fund in Lima that invests in the Andean region. In early 2019 (shortly after this interview took place) Carlyle ended a two-year investment hiatus from Brazil when it acquired a minority stake in well-known restaurant chain Madero.
The transcript below has been edited for ease of reading. The conference was co-chaired by Crider and Jean Michel Enríquez of Mexican firm Creel, García-Cuéllar, Aiza y Enriquez SC.
Todd Crider: Over the last few years, Latin America’s – and particularly Brazil’s – economic performance has meant the private equity industry there has faced a lot of challenges. As a result, there’s been a thinning of the ranks. How does Carlyle view the region?
Christopher Finn: Timing is everything in life. The same is true for investing in the emerging markets. If you break down the last several years in Brazil, you have a trough to peak. Looking at the investments that we made in Brazil, the timing was really important. We did a bunch in 2015: we invested in a public company and a distance learning business. Both looked really great out of the blocks, because we quickly distributed a lot back to our investors. It wasn’t just about getting the timing right in terms of the cycle, it was about getting it right in terms of the psychology of our competition. If our competition thinks somewhere is a tough place to invest right now, that may be a good time for us to invest there, because we have access to assets that might otherwise have been too competitive.
If you look at economic cycles, emerging markets generally – and, of course, no two countries or regions are the same – tend to have longer cycle times. In our private equity model of a 10-year closed-end fund that has a five-year investment period and then a five-year harvest phase, we generally know that in developed markets you can work through the economic cycle and still make money. If you have a four-year holding period, you have a chance to work through difficult situations and get in and out of really great situations. That’s true in Europe, the US, and to a lesser extent in Asia (depending on where you are).
In emerging markets – and I’m talking about Africa more than Latin America – if you have a 10-year investment period and a 15 or 20-year fund, you have a lot more time to make decent investments at various points in the cycle, rather than just backing up the truck at the top of the cycle and then waiting to get through it. The results from a funds standpoint, and from an investor standpoint, as well as for us as a business, are a lot more gratifying. The length of a cycle is a concern I have in emerging markets, but I actually think, given the right fund structure, it’s an opportunity.
In recent years several private equity firms have adopted long dated fund structures, enabling them to buy assets to hold for 10 years or longer. The economics of it are slightly different from a typical two and twenty fund and there are some minuses. But there are also some pluses: it’s a very attractive product for companies with long-dated liabilities, like insurance companies, but also for development finance institutions (DFIs) and bilateral investors like OPIC.
Although I’m talking particularly about Africa, it’s also relevant to some parts of Latin America. For example, Argentina might be a 20-year cycle. I know you don’t want to hear that, but we’ve tried to look at opportunities in Argentina over the years and it’s just so difficult to read the future.
Crider: Looking at Latin America, you hear that certain funds are really hard-pressed to retain their talent as the returns are not there. Does that mean there are opportunities to purchase assets at interesting prices?
Finn: Absolutely. There are a lot of players in various markets that don’t have the staying power that a firm of our size has, and yet they manage money for great limited partners, and, in many cases, they have great assets. They just don’t have a bridge to their next fund and therefore talent leaves. That presents opportunities to step into a secondary position or a general partner interest position and take that over.
I should mention another really important thing: we are 100% committed to Latin America. Someone a lot younger than I am will be up here in 10 years’ time telling you and demonstrating the same thing, in part because the investment opportunities are not limited to a local investment strategy. For example, three investments that our flagship fund, US Buyout, has made are Brazilian investments: one was a travel agent business called CVC, another a medical insurance company called Qualicorp, and the third is an investment in a hospital group. That last one was a small minority investment, but it’s a huge group that you all know, Rede D’Or. In the first two, we did very well for our investors, and we would not have been able to do those deals if we didn’t have a very strong team on the ground in São Paulo. The investment in Rede D’Or is three years old at most, so it has yet to completely prove out but what I will say is that, so far, it’s proved the investment thesis in a serious way. It’s also rewetted the appetite of our US buyout colleagues for other opportunities in the region that they would not be able to capitalise on if we did not have that commitment to the region embodied in our office in São Paulo.
Crider: One way that Carlyle distinguishes itself from other firms is by having regional or targeted funds. Looking at Latin America, one of the concerning data points is that the fundraising totals have been down for the last two or three years. Do you find that your model affords you flexibility to bring in funds from elsewhere? Or do you see yourself coming back into the market and raising funds in the near future?
Finn: It’s driven in large part by fundraising. Fund formation is one thing, but actually getting the money is another and this is not a good time to raise money for the region. As a consequence, I think you’ll see a lot of players dropping out and providing opportunities for others – including perhaps ourselves. We will likely go back to the market at the right time, but we are being patient.
We have a relatively expensive model as opposed to, say, KKR, which has a handful of offices, a fraction of the people we have and a massive war chest to invest. Their approach has a potentially higher margin than ours. Having said that, certain global players, not necessarily KKR, have gone into certain markets and come out with their hands burned. We have a very strong team on the ground in Brazil, and while that does not mean we would definitely have caught what was missed by somebody else in due diligence, I sleep better at night knowing that we have local people who look at the entire environment in which an investment is made, rather than just the nuts and bolts of, say, a healthcare deal with certain metrics.
Crider: As chief operating officer, you deal a lot with your co-general counsels, as well as with outside law firms. What are some of the things that you look for in your external counsel?
Finn: Our deal teams have embedded in them somebody from our co-general counsel for investments team. The deal teams also have somebody who brings specialised expertise that people who do one or two deals a year won’t have. The ability of outside counsel to work well with that person and, in effect, at critical junctures report not just to the deal team but to Carlyle, is extremely important to us. Because deal teams everywhere in the world, when they get into a deal, what looked like a beautiful bride in due diligence looks just as beautiful even when counsel – be it legal or accounting or other – tells them, “hang on a second, there’s an issue here that you need to pay attention to”. It is about giving objective advice and not worrying that Carlyle is not going to use you on the next deal because you raised your hand and put a brake on the deal team. You don’t have that concern because you don’t work for the deal team exclusively, you work for Carlyle, and we work for our investors. You go hand in glove with the deal team and the in-house lawyers but, ultimately, you’re working for Carlyle.
As a US private equity firm, we run the risk of assuming that the business culture in any given country is similar to US business culture and that the tolerance for pain is the same. That isn’t true. On things like the Foreign Corrupt Practices Act (FCPA), we really have zero tolerance, and yet you could poll people in different parts of the world – in Italy, China, Africa and São Paulo – and have a discussion about what zero tolerance means and you might get different answers from everybody. For us, the franchise risk of finding ourselves in an FCPA investigation or enforcement action from the Department of Justice is unimaginable. It would be terrible for the firm, for the franchise, for the public company, as well as for the specific fund. So to minimise that risk, when we use local counsel on a deal we overlay FCPA or anti-bribery and corruption counsel who ensure that we apply the highest standards on every transaction in every jurisdiction. What might not look like a bad situation to a deal person on the ground but might actually represent a huge risk, is then captured by local counsel and Ropes & Gray, which handle all our FCPA deal reviews around the world. It doesn’t necessarily stand in the way of doing the deal, but it means if we manage around the risks, we’ll have done a much better deal.