The World Is Not Very Flat In Emerging Markets......

Evolution of the Chinese Private Equity Sector

Guo Guangchang, one of the most prominent investors in China, is betting big on the fast-growing domestic market.

via dealbook.nytimes.com

According the an article in the New York Times, some Chinese private equity firms are looking for deals to invest outside of the country. We can draw several conclusions from this event, of which the foremost should be the acknowledgement that that Chinese economy is rapidly transforming from an 'emerging market' to a 'developed market' (if you have to categorize).

This important act of diversification will prove well in an environment where many global investors are increasingly concerned with whether China will continue to keep its break-neck growth. It is a great way to mitigate any homegrown (domestic) risk. It is also a great investment strategy based on consolidation and international growth for local Chinese portfolio companies.

Obviously there are also several other conclusions we can draw from this: the high valuations in the Chinese market (which the article claims is one of the primary drivers for PE firms looking outward) is an indication that real incomes (and therefore real costs) are also on the rise in a country that relies on low cost manufacturing labor to keep its economy on the growth path. To this end, it is increasingly becoming clear that the Chinese economy must undergo significant transformation into an innovation/services based market.

 

How to Find the Best Deals in Turkey

Deal sourcing in Turkey can be a very daunting task for those who are not knowledgably of the local business culture. It is far different from the formal deal sourcing that investors are so used to in Western Europe or in North American environments.

The first thing many investors must take notice is that the market is relatively small as compared to other developed nations. To this end, practically every corporate advisory, private equity and venture capital firm is after the same group of companies. This can easily create an awkward environment where potentially everyone knows what everyone else is working on.

In an eco-system where deals are often known to be handled by multiple players, any confidentiality or exclusivity agreements lose some of their impact on the process. Clearly this is not the case with every deal – especially those that are traded publicly or those that are significant in size.

There are no ‘unique’ ways to identify new deals in Turkey. The process is really no different than it is in any other country. Investors should rely on local partners with local know-how and local networks.

There is one thing investors should keep mindful of here: everyone will claim to have access to the richest and most influential CEO’s in the country. The minute you hear this…. hold on to you wallets. It is interesting that many those that claim to have deep networks do actually have them – it is amazing how everyone knows everyone else in this country. What is critical is that not everyone will do business with everyone else so international investors must be careful to chose a partner who has business credibility and is known to deliver and produce actual results.

What can the Balkan Region Learn From the Western Markets?

It is often regarded that the Balkan Region must have to ‘learn’ from Western markets and not the other way around. I’ve now been living in Turkey since only last summer so it hasn’t even been one full year, however I can assure you that there is plenty of learning to do on both sides of the coin.

I do not believe in the fact that ‘best practices’ and ‘know-how’ are what the region can take from western markets. More often than not, many industry experts in this region have received their grooming in western companies in the first place. They automatically bring ‘most’ of the practical knowledge with them as they represent western funds/capital.

There are, however some general complaints I often hear from local private equity and venture capital players. These are:

1.     Lack of good deals

2.     Unreliable management

3.     Inadequate book-keeping and accounting practices

4.     Deal sizes often too small

5.     Lack of overall transparency and growth opportunities

Ironically, these have been the EXACT same complaints and arguments I hear from Californian investors. It seems private equity and venture capital must solve similar challenges in each region. After all, we are in the business of identifying the right deal and increasing its value before exit. This template is the same wherever you go.

So, what is it really that the Balkans region can learn from the West?

The answer is not what it can learn from the west, but what it can teach itself.

Most funds in the US are capitalized by actual US investors whereas a large majority of the funds in Turkey (and I’m assuming the Balkan region as well) is capitalized by foreigners – primarily US or European investors.

In my opinion, the critical lesson all Turkish investors must ‘teach themselves’ should be the ability to communicate the reasons why foreign investors should choose this region as opposed to any other. Turkish funds must realize that international investors do not have adequate knowledge about Turkey as they do on other places such as China, Brazil and Russia.

I have yet to see a compelling presentation as to why any investor should choose Turkey over other developing nations for their investments. I have not yet seen rates of return on private investments as compared with other nations across the globe (or even for that matter, with other European nations).

If Turkish funds want to capture more investors then they must be able to show them actual concrete evidence why choosing Turkey would be an advantage.

Putting the Angel back into Angel Investing...

The concept of angel investment groups has evolved much over the past seven years. It used to be that these organizations were semi-formal groups of high-net-worth individuals being able to discuss and invest into (primarily local) novel ideas and entrepreneurs. An added bonus offered to members of these groups was (and continues to be) the social aspect of being surrounded by like-minded and like-demographic ‘rich friends’. 

The method for investing into new ideas and entrepreneurs was relatively easy and un-intimidating. General group discussions took the place of more formal due diligence exercises and there was a very distinct difference (some refer to it as an invisible wall) between angel investments and venture capital.

The times have certainly changed.

Many angel investment groups (including the one I’m involved in: Icon Angels) have internationalized and formalized the angel investment process to a point where deals are fashioned together the same way as in any venture capital fund.

I’m a firsthand witness to a very real phenomenon within these groups: the impact of group think.

Due primarily to this new formal environment (investment process) of the angel groups, many ‘creative ideas’ are no longer being considered as investment grade and when they are actually presented to these organizations, they are often rejected by the very processes that were so essential to the development of new ideas only less than a decade ago.

I’m finding that entrepreneurs with projects still in the ‘idea’ phase are no longer the projects angels are keen to explore. The novelty (and the adventure) of investing into a seed idea that could possibly bloom into the next Google or Apple is no longer a risk many angel groups are able to digest during their regular ‘round-table’ discussions and unfortunately the main culprit is the phenomenon of ‘group think’.  I often tell these daring entrepreneurs that their only real chance of finding the capital to launch their project is by identifying the lowest hanging fruit – their family and close friends.

There is a way to beat the group think phenomenon.

I believe it is now time for angel groups to focus on specific sectors where its members are well versed in the details, trends and strategies of identifying the right idea ready to blossom. Such an organization will remove that ‘one’ angel that may know just enough to be dangerous about a certain subject to derail a potentially brilliant idea within a group of angels who may not fully understand the subject matter.

If given the time, I hope to explore more focused angel groups with investors who are subject matter experts and are able to conduct detailed round-table discussions on novel ideas. This is all in the hopes that we can push through more deals and bring back adventure into angel investing once again!

In order to stay true to the angel investing principle: Is there anyone out there who is adventurous enough to help me put it together? ;)))

Is it a Good Time to Make an Acquisition?

It really depends on your investment criteria. In my books, there really is no ‘bad time’ to invest, but only a ‘more cautious’ time to invest. Specifically speaking about potential acquisition candidates in Turkey, we must be mindful of several factors that can affect the growth (or maybe I should refer to the stability) of your acquisition. These are:

- Currency exposure: what is the level of foreign currency risk? This is directly driven by the amount of imports (whether raw materials or final products/services) that is imported using Dollars or Euros or any other foreign currency that the Lira is sliding against.

- The level of debt and (once again) the currency exposure of that debt.

- The length of desired investment. This downturn of the economy will most probably be with us for the next two/three years, which mean valuations may not increase significantly before this time frame. The investor must be willing to lock its capital for at least this duration.

- Extra care should be given during times like these to the inflection point of your potential investment. What is that ‘magic bullet’ that will accelerate your company into continued growth? What product/service could you inject (from your network) into the company that is not subject to any of the exposures above and one that will serve as an ‘extra’ anchor product/service for the company?

- Will management – or at the very least the key personnel – stay with the company during these difficult times?

- Will any new injection of technology or services have the above mentioned exposures and what will be the costs associated with it?

One thing is for certain, investors have the upper hand. There was a time (beginning of 2008) when many companies were asking for astronomical prices from investors. And the odd thing was that many private equity firms were more than eager to get in on the action. It almost felt like the dot.com days in Silicon Valley here in Turkey. The situation has rapidly turned around.

Happy hunting!

Which Sector is the Unluckiest of All?

As the markets continue to slide, it may be worth thinking about which sectors will get hit the hardest in developing countries. More often than not, the problems that cause havoc in many developed countries will not necessarily have a direct affect on the economies of developing nations. So, we must first look at what exactly happens to these economies before we can effectively predict which sectors will get hit the hardest.

During a global economic downturn, one of the first things that we see is an increased pullout of liquid assets from the country. These primarily include two things: money from the sale of stocks and from the sale of local currency. We’ve seen billions of dollars being taken out of the IMKB (the Istanbul Stock Exchange) by cash-strapped US hedge funds and other international institutions. This results in a perceived increase in the risk that these countries pose, which in turn results in a sell-off of the local currency. So, with a lower stock market and a weaker currency, we eventually see cracks and instability in the political arena – which further drives the currency sell-off. Note that this is often an ‘indirect’ result of a particular problem in a developed nation (in this case, the real estate bubble burst in the US).

With this analysis, we can deduce those sectors that will get hit the hardest:

- Any company that imports its products in foreign currency. At this point, any company in Turkey that imports its products in USD but sells it in Turkish Lira is in trouble.

- If we dig a bit deeper, we see that sectors such as retail electronics or other goods that may be categorized as luxury will get hit even harder (as would be the case in any other recession in any other country in the world). What does this mean? Those companies who import and distribute retail electronics and other luxury goods will suffer more than others.

This, of course, is a double edged sword. Investors who do their homework and have capital on hand can swoop in and grab these firms at severe discounts. We all know that the economy will again pick up.

Deal Sourcing in a Developing Country

Sourcing the right deals can sometime feel harder than raising capital. I’m not joking.

Specifically speaking about the Turkish marketplace, it seems there are more investment funds in the ecosystem than there are good companies to acquire. We must therefore ask ourselves what factors are at play for what seems to be an off balanced perception of the dynamics of the market. After all, 95% of the Turkish economy is comprised of small to medium sized businesses and one would think that any investor would feel like a kid in a candy shop in this environment. I mean… just imagine the M&A potential this country holds!

Well, let me try to list some of the factors that I believe is at play here in this market:

1. The lack of information. Despite the abundance of small/medium businesses, many of them have never heard of angel investors, venture capital, or private equity. They have no idea as to what we do and how we do it and therefore I sometime have to write-off almost entire sectors off my radar.

2. Many companies are family owned (albeit some are very large) and they have survived and registered sometimes outstanding growth organically (even without external investment sources). Many of these companies are simply – believe it or not – afraid of partnering up with an 'outsider'.

3. The Turkish marketplace is based on relationships. In fact, the Turkish culture is based heavily on relationships. This is typical of many of the Mediterranean countries and Turkey is really no different. In order to source a good deal here, you need to either know the owner of that company very well or be introduced to it by someone very close. I would even say that a lack of relationships is the most important obstacle standing between an international investor and a local acquisition candidate.

My advice to foreign investors: find someone who is familiar with this market to hold you by the hand and lead you the way. It does not necessarily have to be some international conglomerate investment house as some of the smaller players may be able to identify some great opportunities.