Private equity as an asset class in the

Private equity as an asset class in the region: a multi-focal approach Prof. Luc Nijs Founder & Chairman Horizon Ltd Istanbul April 27 -28, 2009 Buy-outs & growth capital in the Balkans and emerging markets 2009

Where to start? § § Why not fundraising! Despite the market conditions EM PE raised $ 66, 5 bio in 2008, a 12% rise Proportional share in total global PE fundraising for 5 years in a row now Relative decoupling & economic power shifting is reinforced by current recession Cyclical recession became a structural one and the risk of L-shape depression is looming (cf. Ponzi economy) Source: EMPEA April 2009

Fundraising per region

Market outlook for fundraising

Market Outlook § A few conflicting data: § Preqin (April 2009): § US leads the way with 23 bio $ § Europe 20, 2 bio $ § EM 2, 7 bio$ § Lot of funds postpone final closing § Development finance will focus more on direct investing (FOM, …) § Force of consolidation coming in

Market outlook for EM fundraising

Market Outlook § Argumentation for EM proposition: § Resilient growth § Less use of leverage § Wider CEE massively impacted § 20% of investors refer to increase EM risk

Investors stay committed…but…

Some of the underlying fundamentals

What about the converts…

Market Outlook § Argumentation for refusal of EM proposition: § (Short-term) EM risk § Lack of experience in EMs § Only few quality GPs available in EMs § Quantitative easing and systemic risk?

Some of the underlying fundamentals

A (new) inconvenient truth about risk Emerging Markets Risks Political instability Market fundamentals Counterparty Emerging Markets Curreny (F/X) Pre-crisis Thinking High Risk High Growth Low Risk Low Growth High Risk Low Growth Post-crisis Thinking Market fundamentals Developed Markets Legal / Regulatory Developed Markets Risks Structural issues Environmental Legal / Regulatory

Av. risk premiums in EMs (%, 2008 -2009)

Another inconvenience § Capital inflows to developing world (Source: IFF, 27 January 2009)

Historic & projected EV/EBITDA Source: Prop. Research, averages for the clusters

Market Outlook § Cheaper valuations (although some parties are still in denial) § Attractive deal flow to arrive (Q 1 2010 onwards) § Capital constrained entrepreneurs & management § BRIC as a catalyst gone? § But major differentiators among emerging markets § Semi-globalization = procession of Echternach

Market Outlook But major differentiators among emerging markets § CEE & CIS: § Sovereign risk & currency management § Debt-financed growth model is broke § Euro and Nordic currency infrastructure has eroded fundamentals § Mid/Long term catch-up dynamics still in place § South-East Europe & Turkey still attractive § Russia has a significant implied X-factor at present time § MENA: § Undeniable impact on economy § SWFs are diverting capital flows back home § Mid/Long term outlook still positive § Valuations in region still need recalibration to new reality

Market Outlook But major differentiators among emerging markets § Mena: § Still growth but impact of the credit situation trickling down § Commodity play § Sector focus § Sub-Saharan Africa: § Limited effect of credit situation § Tremendous improvement in investment environment § Good risk-adjusted returns § GDP growth & overall economic development decoupled from commodity play

Market Outlook But major differentiators among emerging markets § Asia: § China as a manufacturing hub § Semi-globalization shows § Global gross capital formation (cross-border at risk) § Unrealistic valuations in India at present § Volume of investments dropped 38, 5 % in 2008 to $ 10, 7 bio and are expected to drop to $ 5 bio this year § 3/4 th of PE investments were done in listed entities § Can they become our customers of last resort? § Social unrest might destabilize the vulnerable progress made § South Korea, Singapore, Malaysia etc weak on their feet for the time to come

Something else that is inconvenient Past performance & GP selection

Institutional investor views: EM versus developed (December 2008)

Institutional investor views: EM versus developed (April 2009)

Portfolio allocation

PE penetration as an asset class Source: Goldman Sachs, EMPEA

Portfolio exposure

Reasons for expansion or continuation Source: EMPEA 2008

EM Private Equity performance Source: Cambridge Associates LLC & prop. research, : pooled end-to-end returns, net of fees, expenses and carried interest

Comparative end-to-end results 6/30/2008 (*) Statistical noise likely due to low sample distribution Source: Cambridge Associates LLC & prop. research, : pooled end-to-end returns, net of fees, expenses and carried interest

Impact on portfolio construction § § In 2008 about 1/3 of the total pool of LPs had some kind of exposure to EMs Portfolio weighting somewhere between 10 -30% Do or die for LPs the next couple of years Systemic risk in Western markets are not reflected in risk premiums Source: Proprietary data

Smoke & mirrors… § BVCA and E&Y 2008 performance study

A disaster waiting to happen

So now what… § If PE is an activist shareholders’ position than why have these funds been managed as investment vehicles § Demonstrate inept to manage companies § Focus on financial engineering § Models have to change § Fund structure § Terms & conditions § Exit modeling § Valuation and transparency

So now what…life after leverage § Value creation/operational side § Impact of average /holding periods § Massive room for improvement of private capital formation § Put capital to work § But do they have the right ‘human capital in place’?

The 7 deadly sins of banking (Mike Mayo) § 5 April 2009 -more bad weather to come § § § § Greedy loan growth Gluttony of real estate Lust for high yields Sloth-like risk management Pride of low capital Envy of exotic fees Anger of regulators § Each reflects a way that banks tried to compensate for lower natural rates of growth by taking more risk

The 7 deadly sins of banking (Mike Mayo) § Zombie banks versus complete recapitalization of system § Relaxation of mark-to-market rules will impact balance sheets but the upswing will be largely out powered by the later downswing § A potential artificial accounting-induced capital injection that does not change the economics

Is this time going to be different for EMs? § During previous booms and busts the developed and developing world evolved in a parallel fashion § This time there is a (partly) contra-cyclical pattern § Political & regulatory impact § Global versus local teams: the best of both § Business model rethinking & paradigm shift § EM debt usage less or more prudent

Let gravity have its way

Darwinian tsunami & paradigm shifting Where are you?

Contact Riga Graduate School of Law & Finance Chair Strelnieku iela 4 k-2 Riga LV-1010 LATVIA luc. nijs@rgsl. edu. lv Tel. +37167039230