Eisner PEQ: Global Ambitions

After a half-decade of betting their capital on domestic deals, U.S. private-equity funds have turned their attention overseas. Emerging markets like China and India present tantalizing opportunities to achieve better pricing, returns, and growth rates compared to deals in mature U.S. market sectors. The protracted credit crunch has squeezed financing, at a time when markets in emerging economies are growing. Given intense competition for the best deals in America, U.S. private equity firms have their crosshairs sighted beyond the U.S. and Western Europe, where they can still hit bull’s-eyes.

“Until credit disappeared, private equity could borrow cheaply and leverage off of that to maximize returns,” explains Richard Addelstone, a partner in the private equity group at Caymans Islands-based law firm, The Walkers Group. “Now that this has gone away, funds are looking to fast-growing markets in China, India, Russia, the Middle East and even Africa. Growth rates are 7 percent to 10 percent in these regions, compared with less than 2 percent in the mature markets of the U.S. and Western Europe. Emerging markets also are less affected by the credit crunch; you can still find relatively cheap financing in these countries, such as from local regional banks.”

Private equity funds’ strict objectives concerning pricing, returns and structure (the ability to influence the business contracted), added to much less competition overseas, make this year’s flurry of deals the tip of the iceberg. According to Thomson Reuters, through August more than half the takeovers announced by U.S. private equity firms were foreign targets, up from 35 percent in 2007. “This is a function of competition and opportunity,” says Dory Wiley, president and CEO of Commerce Street Capital, a Dallas-based merchant bank. “Private equity is branching out where the pricing is better, the growth rates are higher and the economic dynamics fare well, and that is no longer the United States.”

Far and Away

John Forry, a principal in the international finance and taxation practice of Eisner LLP, a new York-based accounting and financial advisory firm, says many joint ventures are undertaken with foreign sovereign wealth funds, "which give private equity funds access to larger pools of capital for equity purposes, given the squeeze on credit."

Others agree. “The U.S. market is very competitive, with deal auctions raising the prices up in the U.S. and Western Europe,” says Mark Thompson, partner and co-head of the private equity practice at King & Spalding LLP, an Atlanta-based international law firm. “There are no more bargains to be had. Meanwhile, there are opportunities around the world where the returns are more attractive, particularly in emerging markets. Many funds also seek to diversify their risks by investing in more than one economy. If the economy in one country falters—the situation in the U.S. at present—there’s always the possibility of better returns elsewhere.”

As in any mature market, there comes a time when good deals winnow and few linger on the horizon. Such is the case in the U.S. and Western Europe. “It’s pretty tough to find a good deal in the U.S., even for mid-sized private equity funds,” says Thomas Bonney, managing director of CMF Associates, a Philadelphia-based financial due diligence and consulting organization that provides turnaround expertise to mid-market private equity firms. “We’ve seen great success the last ten years assisting family owned businesses to private equity ownership and management, but these are few and far between now. The number of funds also has risen significantly, translating into more firms chasing fewer deals and dollars. Add to that the credit situation changing the pricing of deals across the board, and you can see why firms are going offshore to get the returns they’ve committed to.”

A final reason for the migration is the burgeoning consumer classes in China, India, and other emerging markets. Virtually overnight, millions of people now have the financial wherewithal to live in houses adorned with various electronic devices. “It took the U.S. a hundred years (to develop a middle class), whereas these countries are developing it on an accelerated basis,” Peterson says. “The velocity is incredible. Private equity seeks something that is growing and that can be bought, held, improved and sold. Emerging markets are where the action is now.”

This “action” is primarily in the Asia Pacific region, although Eastern Europe, the Middle East, Africa and parts of South America like Brazil also are deal targets. Recent deals funded by U.S. private equity include Providence Equity Partners $640 million investment in India’s Aditya Birla wireless communications company; Red Fort Capital’s $600 million investment in several infrastructure projects in India; J.C. Flowers & Co. decision to increase its stake in Shinsei Bank in Japan; and Carlyle Group’s investment in Coates Hire Ltd. in Australia, and its ongoing quest to purchase Xugong Group Construction Machinery, the largest firm of its type in China. Carlyle also has made several smaller deals in the Middle East. “Everyone knows that Carlyle has lots of investors in the Middle East, but the fact that they’re now also investing in the region says a lot about the growth opportunities,” says Thompson.