January 10th, 2018
Private Equity in Emerging Markets
Comparison with Developed Nations
Although the private equity market are picking up in the developing economies, various studies have indicated that such markets still remain underdeveloped in comparison to the developed economies. For instance, in a study by Groh, the US and UK are indicated to a predominant share of the global private equity market (3). However, when adjusted for economic size of the countries, countries such as the United Arab Emirates, Singapore, Israel and Hong Kong show significant Private equity activity (3). Among the emerging markets, countries such as India, South Africa, Malaysia and China have been noted to have rapidly growing, private equity markets (Groh 3). To evaluate the disparity between private equity (PE) activity in the US and the UK and that in the emerging markets, Groh’s article evaluates the factors that determine such activity in the emerging markets.
One of the determinants noted to influence the level of activity in the emerging market, is the corresponding activity of the stock markets in the respective countries. Quoting previous studies, Goh for instance argues out the critical role played by the stock exchange in providing an exit strategy for PE investment via IPOs (3-4). Accordingly, the study identifies one challenge of the emerging markets in attracting PE capital to be the lack of “deep and liquid stock markets” (4). Such a contention is supported by a review by Leeds and Sunderland, who argue that dysfunctional capital markets in the developing economies, limit the exit strategies to strategic buyouts and secondary leveraged buyouts, who do not offer substantial returns as those achieved via IPOs (115).
A second determinant for vibrant PE markets, as noted by Goh is availability of debt financing and supporting institutions that facilitate PE transactions. With respect to debt financing, the importance arise since buyout deals mostly involve negotiated debts from financial institutions to supplement the funds invested from the capital committed by LPs. Availability of other supporting institutions such as auditors, consultants and law firms facilitate deal flow and exit transactions (Goh 4). In a study that evaluated the effect on legal differences on the success of venture capital undertakings, Kaplan, Martel and Stromberg noted that venture capitalist who implemented US-style legal contracts, were significantly less likely to fail compared to those who used host-country styles (20). Although, in the same study, the authors note that application of US-styled contracts is possible even in other jurisdictions (14-15), in countries where restrictions preclude such adoption, PE activity may remain low as investors shy away from contracts styled differently from the US-defined style.
An addition aspect affecting the progress of PE markets in emerging economies is the economy size. According to Goh, such size determines the activity of PE markets since investors would demand their funds to be committed in investees that offer the potential to cover management fees and the required rate of return (4). Accordingly, where the economy size precludes the development of such investment targets, the PE markets in these economies have low activities.
Apart from these factors other studies argue the regulations in a particular market to affect the attractiveness of such a market to PE firms. For instance, in a review that discusses the determinants of foreign direct investment, a form that PE firms could pursue on firm buyouts, Moran notes that regulations that for instance prescribe mandatory joint ventures or require foreign investors to enter into technology-sharing agreements with local partners dissuade investors from entering such a market (6-7). Other country-specific aspects include labor laws that for instance impede reorganization attempts by PE firms. For instance, Goh notes that “institutional investors could hesitate investing in countries with exaggerated labor market protection and immobility,” quoting a study by black and Gilson that demonstrated that disparities in labour market restrictions were correlated with PE activity (6).
Current State of the Market
PE markets in the emerging economies have experienced mixed results since their establishments two decades ago. In the early 1990s, PE markets in the emerging markets were showing signs of achieving rapid growth in subsequent years. For instance, Leeds and Sunderland note that from virtually no private fund in the 1980s, there were more than 100 PE funds that had been established in Latin America by the end of 1999 (113). However, the initial optimism for a vibrant PE market that was witnessed in the mid-90s was quashed by the underperformance of PE firms compared to their peers in the late 90s (Leeds and Sunderland 113). For instance, in a 2004 survey of PE investors, quoted by Makhene, investors voiced their dissatisfaction with the rates of returns that prevailed in PE markets in emerging markets (27). Such dissatisfaction was for instance attributed to currency volatility and illiquidity in stock markets, differences in cultural perceptions on the cooperation demanded of entrepreneurs and insufficient risk-mitigation opportunities. However, a follow-up survey three years later indicated an increasing confidence and higher optimism among PE investors for growth of PE markets in emerging markets (28). Such optimism is evident in noted increased PE activity in the Middle East and North African Economies (Ismail 54).
In Turkey, the potential for a vibrant PE equity is indicated by increased investor attention due to its high economic growth and the development of a strong stock exchange market (Hisa 2). Additionally, the trend towards privatization (Yavilioğlu and Özsoy 10-15), presents opportunities for PE firms to play a significant role in the economy. However, limited research exist as to the activity of PE market in the country and the predominant business models of the PE firms in the country. The dissertation fills this gap by evaluating such aspects.
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