Podcast transcript: Where PE should deploy capital in LATAM

24 min approx | 18 March 2021

Winna Brown

The number of LPs with exposure to Latin America continues to trend higher. According to the latest survey from the Latin American Venture Capital Association, about two-thirds of large LPs currently have exposure to Latin America, up from less than half five years ago. Moreover, their allocations are rising, with Latin American investments accounting for about one-quarter of LPs for emerging market investments, up from about 15% five years ago. Latin America is an exciting, growing market for PE, and I’m really pleased to welcome to the podcast my two EY-Parthenon colleagues, Angel Estrada, who’s based in Mexico City, and Juan David Taboada, who’s based in Bogotá. Angel and Juan have been instrumental in building our PE-focused EY-Parthenon strategy business in Latin America, and we’re really pleased to have them here with us to give an inside look into investing in the region. Gentlemen, welcome to the podcast.

Angel Estrada

Thanks Winna, thanks for having us.

Juan Taboada

Thank you Winna.

Brown

Pleasure, pleasure! So, gentlemen, let’s begin. And, to help set expectations for investors in the US and Europe, as it pertains to ways of doing business, what are the top five key considerations that investors really need to be aware of if they want to succeed in the region?

Estrada

One of the key aspects to be successful is having complete and reliable information, and we’ve found that across different industries, across different markets, across different countries, information is simply not there. So, we’ve found that building and creating information, updated information, is key. The other key aspect is that having local knowledge and expertise are also key success factors. Now, thinking about the other key considerations and taking into account that Latin America is still an American region, many of the potential investments, many of the potential opportunities are owned by families and by entrepreneurs. So, there we’ve found that corporate governance is not mature, so we’ve found that one of the key considerations, thinking about investors from the US and Europe, is having a more flexible approach when dealing with owners and other key stakeholders.

Taboada

Adding to just what Angel mentioned, one of the additional key considerations is that for these with experience in Europe and the US, it is important to understand that Latin America cannot be seen as a single body. LATAM is a heterogeneous region where each country is unique and should be analyzed with that mindset. Latin America, including the Caribbean, has more than 40 countries, and each one with unique cultural, political, economic and regulatory context. When exploring opportunities, PEs must understand these differences and find the right approaches to be successful in the selected geographies and businesses. One example that happens every day for us is that although the vast majority of the countries are Spanish-speaking countries, many times, we have challenges in communicating given the different expressions we normally use in each country. Lastly, as a region, we historically have not been able to integrate, to have an integrated vision when developing businesses. Many of those businesses have been built in a country-by-country basis, so we believe that one of the great opportunities in LATAM is the consolidation of businesses so they can become truly regional. For several years now, we have been talking about the consolidation of what we call here “multilatinas,” but the truth is that we have not seen many examples of companies that are really successful achieving that category name of multilatinas. So, within that, there’s a good opportunity to consolidate businesses across the industries in the region, and the PEs played a role there that is relevant for investors.

Brown

So, what I’m hearing is, clearly, LATAM is very heterogeneous and there’s great opportunity around consolidation of businesses across regions. In saying this, are there particular sectors that perhaps are unique to LATAM or to the region, or perhaps, the region is uniquely positioned to be a future leader in?

Estrada

Agribusiness is a sector where we expect to see continued growth, given the size of the population, given the expectations around growth in income and given the opportunity to catch up with the different consumer trends that we see in more developed countries; for example, having more healthy foods, having access to more protein, having access to more value-added products, definitely agribusiness in Latin America is positioned to continue growing and growing in a profitable manner. The other sector where I think we are uniquely positioned, and we are uniquely positioned in terms of the opportunity that it presents, is logistics. As we all know, we are having different trends derive from the impact of COVID-19-19, and, obviously, e-commerce and different digital channels are transforming the way in which we buy, we consume and we send products. So, logistics is a sector that is going to be here in the region as an opportunity; but, to be more specific, I think that the part of the logistics sector that offers multiple opportunities is the one related to the last-mile delivery. As we were discussing, Latin America is heterogeneous. We’ve found that, in general, there are opportunities to increase the efficiency of logistics from point A to point B. And definitely one of the key challenges, one of the key opportunities is in the last-mile portion of the process.

Taboada

And I would like to add two additional sectors. The first one is renewable energies, and Latin America is home to some of the world’s most plentiful wind and solar resources and is set to play a vital role in this energy transition. And we see a number of trends that point to now being the right time to invest in the sector here in LATAM. And, just reading about this recently, according to the International Renewable Energy Agency, many of the top markets for investing in renewable energy are in Latin America. The U.S. Department of Commerce, for example, previously ranked Brazil, Chile and Mexico among the top markets in the world for US firms and supporters of renewable energy and energy-efficiency technologies to invest. So, I think that is one of the sectors that is going to be hot in the next years.

And the last one is the think tank and the InsurTech sector. The insurance penetration on the financial inclusion in our countries is still very low if you compare that to the OECD countries, and we have seen here the emergence of new players in that Think Tank market and that has enabled an alternative way to reach populations that had never been served by traditional players before.

Brown

It sounds like the sectors that are growing in Latin America are closely tied to the macro trends that we’re seeing in the world, so, you know, agribusiness and food safety, renewable energy, the rise of technology and digital innovation, you know, helping you grow a FinTech business and, importantly, logistics, you know, just again, if the PE firm or the firm who can actually “crack the code,” if you will, to delivering opportunities in an efficient way through unique logistical means is likely going to be able to reap significant benefits. Is that what I’m hearing?

Estrada

Yes, that’s exactly right Winna. However, I would like to say that yes, we are experiencing some of the macro trends that we see around the world; however, here in the region, there are additional nuances. In some sectors, I would say that we are at the forefront of these trends; for example, in terms of thinking about InsurTech; but in others, for example, in logistics or in agribusiness, I think that we still have room for further development. So that’s what makes Latin America one of the most attractive regions because we have these macro trends, but we still have opportunities to get into them, not at the most mature stage.

Brown

If we take that and we think about the rapid growth in investment activity over the region in the last few years, what if some of those trends that you’re really trying, you’re seeing are emerging?

Taboada

One good surprise last year was that the appearance of IT work for us. While we think that the need for the adoption of digital capabilities by companies, especially as a means during the pandemic, has awake this sleeping giant of software houses in LATAM. For many years, we have known that LATAM is a region with high potential in the software development business with competitive labor costs, but now what we see is a growing appetite from the private equity funds to start investment opportunities in local software houses.

Estrada

The other key sector is related to education, including both K–12 and higher education. Education is a segment where, historically, we’ve seen a lot of investment activity; however, here I think that, related to COVID-19, we are seeing the emergence of new models, thinking about remote education, thinking about the different EdTech platforms that maybe in the past were not needed or were not a priority for the different educational institutions and going forward, we think that there is going to be an emergence of virtual or hybrid models to precisely deliver high-quality education to a broad sector of our population. The other key sector where we are seeing different trends is health care. As you would imagine, with the impact of COVID-19, this is a sector that is becoming more relevant. And talking about the health care sector, while we know is a broad sector, is a broad industry, but there we think that the role of pharma companies, of medical devices companies and the different services around health care is, again, going to offer investment opportunities in terms of winning new products, new services, but also for increasing the reach that they have across the region.

Brown

In what ways have you seen COVID-19 impact the way private equity looks at investment in Latin America? Are they approaching investments differently? How has it impacted their decision-making?

Taboada

I would say that the PEs now are having a broader vision. They want to explore new alternatives in new sectors, but what we have seen as well, is they are becoming more conservative I would say, or more shy when making decisions. So, what we have seen in the last months is that there’s a slower than usual decision-making dynamic, but the good thing is that they are expanding the reach of the investments in terms of sectors and countries I would say.

Estrada

In the past, I would say that investors would value physical assets, but now what we’re seeing is that PE funds are looking into service companies and companies that have innovative and disrupted business models, so that’s change that we’ve seen derive from the impact of or from COVID-19. The other aspect related to the impact of COVID-19 is the need to develop new capabilities, in particular to keep up with the changing consumer preferences. In the last couple of months, we launched another study to understand how consumers are changing the way they buy, the different selection criteria that they use across many categories, and we found that in Latin America, definitely there are changes that are here to stay. For example, the preference to buy products online, so definitely that has an impact on the business models of companies in different sectors and that conveys the need, if we think about companies, to strengthen their digital capabilities to be able to have a digital transformation, to launch a direct-to-consumer model. So that is another aspect where we see COVID-19 is having an impact in terms of the different capabilities that companies need to develop and obviously that has an impact on the talent that companies should attract, retain and develop.

Brown

That is the same theme that we’re seeing across the globe — the acceleration of digital technologies and the impact that has on talent. And, notwithstanding, COVID-19 has accelerated those trends. To your point, they were always going to come, they just come faster, and they’re here to stay.

Estrada

I agree. And the other key aspect of thinking about the impact of COVID-19 is that, right now, we’re facing more volatility. So, the impact, thinking about investment opportunities or how PE companies manage their portfolio of companies, is around the need to have more visibility or the need to have visibility around potential scenarios: what are the risks, and what are the initiatives to mitigate those risks? So again, having solid, complete and reliable information is becoming more relevant these days.

Taboada

And I would like to add something to that. Now that we have this historic information that is no longer irrelevant, we have the challenge of building new ways of evaluating the businesses, and that’s an additional impact that COVID-19 has brought to us when having these conversations with the PEs.

Brown

Do you both have a view around what the future of private equity is going to look like across Latin America, and does it look different to different countries?

Estrada

That’s a great question Winna. I can give you a short answer in two words: promising, brilliant.

Brown

I love it!

Estrada

Let me elaborate on that. First, I think that we still have room to grow faster than more developed economies. That’s one key aspect, as we were discussing, there are multiple sectors, there are multiple opportunities in some trends; in some areas, we are at the forefront, but in many others, we are still a little bit behind. So, I think that there are opportunities to grow at a very fast rate. The other key aspect and let me give you the macro answer and then we can discuss some of the nuances in our countries, is that we are a region with a relatively young and growing population.

Taboada

I would like to add to that. One good thing about the future of PEs here in Latin America is that since we are so diverse, we have a flavor for everyone, you know. We have some of the most growing economies in the world. We have a growing population, which is also young, and we have seen the consumption habits in Latin America increasingly resemble the habits of more metro countries. So, what we have here is a good mix that brings all the options, as I was saying, all the flavors for a lot of opportunities here. So, there’s no silver bullet for Latin America, but we have a lot of options to invest in the future.

Brown

Well, it sounds like a very, very exciting time, as you say, lots of opportunity for growth: the future is unlimited. You both have been instrumental in building the EY-Parthenon practice in Latin America. What have been some of the most exciting and challenging aspects of doing that, and what are you most looking forward to in the future?

Estrada

It’s been quite a ride. We launched EY-Parthenon practice in Latin America five years ago. Our first offices were in Mexico and in São Paulo. Today, we are six offices in the region, so it has been very exciting to see the practice grow. It has been very interesting to learn about the different sectors, but more than learning, it has been the opportunity to work hand in hand with private equity funds, with investors, with entrepreneurs and, in general, with companies to create value, to identify what are the most attractive opportunities, and to make a difference and make an impact in our region.

Brown

So gentlemen, maybe you can touch a little bit on the risk profile for PE investors looking to invest in the region. Given as you’ve outlined, it’s a very fragmented and developing market, is there anything that, you know, we can address that will help alleviate concerns that private equity might have about deploying capital in Latin America?

Estrada

I would say that one of the key aspects that is important for funds is to define, in a clear way, which are the segments or the industries where they want to invest, make sure that they engage consultants who know the market and the nuances of the different segments very well, and get that sense that they can do an informed decision. Obviously, there are some trends, some risks, in the region, in the different countries; but, in general, what we’re seeing is that that is not preventing investments in Latin America. I would say in general, the region offers a good risk-reward equation, but it’s key to make the proper due diligence and making sure that they do not rely too much on what happened, but on what is right now happening in our markets and, in particular, what is going to likely happen in terms of regulation, in terms of trends, in terms of decisions that the different governments are likely to make. I would say that’s one of the key challenges to be very close with the market so they can take an informed decision.

Brown

And then following on from that and conscious that things are evolving very rapidly, are there currently some countries that are more attractive than others for PE to make investments in? You know, that might be from a regulatory perspective or from a natural growth perspective, what are you seeing?

Estrada

Well, I think that if we think about the different sectors, the different industries that we were discussing, for example, agribusiness, IT, education, health care, I would say that Mexico, Colombia, Peru and Brazil are some of the markets where the opportunities in Latin America are located. But Mexico offers a unique location because we are next to the US, so that offers opportunities for international trade; however, in South America, thinking about Colombia, Peru, there are multiple opportunities there.

Brown

And Juan, any thoughts to add?

Taboada

As Angel was mentioning that what we have seen here in LATAM is that the appetite is more related not to regulatory concerns, but to the size of the economy and the population, and that’s why we see presence of the main piece in Colombia, Mexico, Brazil and Peru. One additional economy to consider is Chile. Chile is kind of our more mature country in terms of behavior, in terms of risk, in terms of regulation; so it might be a lower population country, but we are always looking what it works in Chile because it tends to be a good example of the things that are going to work in the other countries in LATAM.

Brown

Well gentlemen, thank you for your time today and for sharing your insights on the Latin American private equity landscape. While the region has a lot of challenges, you’ve clearly shown us there’s also significant opportunities for growth and investment. So, we’re really looking forward to seeing your strong growth story continue over the years to come. Thank you so much.

Estrada

Thank you.

Taboada

Thank you Winna and happy to share our thoughts and experience with you.