Private equity value creation in
Our second annual study extends our research into PE's transformational role in Latin America's continued economic development.
In less than a decade, Brazil has surpassed the UK, Italy and Canada to become the world's sixth-largest economy. This year, we see more PE interest in the region beyond Brazil—namely Colombia, Peru and Mexico.
This year's study solidifies our main theme from last year: PE firms are focused on growth and hands-on partnerships with entrepreneurs to transform companies into market leaders. PE investors work with the entrepreneurs they back to identify and develop new products, expand geographically and exit profitably.
We also see a new trend—the emergence of a two-tier model as the ecosystem continues to develop and mature. Finally, we see geographic expansion playing a larger role for many companies in Latin America.
Exits in brief
Here are some highlights of our findings. For more details, download the full report.
One of the most striking features of Latin American PE compared to developed or other emerging markets is the near-universal focus on portfolio company growth. This stands in sharp contrast to developed markets, where cost reduction plays a bigger role.
Across our sample, organic revenue growth accounted for about 69% of EBITDA growth, with acquisitions accounting for 28% and cost reductions less than 3%. Of the organic revenue growth, 48% came from geographic expansion. New product lines and sales processes accounted for 28% and 22% resulted from overall market growth.
Two models in Latin America
Our findings confirm the development of a two-tier model in which small- and mid-market firms focus on prudent sector selection, operational expertise and close ties with entrepreneurs. Large-market firms, on the other hand, are evolving through an increased focus on geographic expansion in Latin America and beyond.
Illustrating this point, companies in our sample with EVs less than US$100m showed a larger reliance on organic growth compared to large firms. Approximately 82% of EBITDA improvement came from organic growth, 13% from acquisitions and just 5% from cost savings.
In contrast, deals with an EV over US$100m saw 68% of EBITDA improvement come from organic growth, 29% from acquisitions and 3% from cost savings.
EBITDA attribution by entry enterprise value
Our 2012 study of PE exits identified geographic expansion—especially domestic expansion—as an established trend for companies pursuing growth. Increasingly though, international growth is becoming a focus.
From our sample of businesses with EVs over US$100m, nearly half are pursuing international expansion alongside domestic expansion.
Growing a Latin American business has evolved beyond a regional focus, and many firms have set their sights squarely on expansion in other emerging and developed markets.
Mean internal rate of returns in the region continue to compare favorably with returns from the US and Europe. Although there is likely statistical bias around the reporting of successful deals versus negative outcomes, we are comfortable that our sample accurately reflects the approaches PE firms take to creating value.
Moreover, PE returns in Latin America compare favorably to what investors have achieved in the public markets. Our analysis shows that PE deals returned 2.4x the market return (as defined by the Ibovespa Index) over an identical period.
Outlook for the region
As the pace of GDP growth slows and the modest scale of most companies becomes an impediment to returns, the current PE operating model in Latin America will need to broaden its focus beyond growth. This could include an emphasis on cost reduction as a lever to drive value creation.
We also expect to see new strategies reflective of a maturing market. In small- and mid-cap markets, deep local knowledge will drive deal flow and value creation, as PE firms work with entrepreneurs and family owners to instill discipline.
PE buyers will need a full complement of value creation strategies as organic growth becomes harder to achieve. This includes execution and integration skills, bolt-on acquisitions and broader business transformation.