COLOMBIA’S PRIVATE EQUITY industry has taken off in the past five years – local managers have already committed $1 billion to deals and are in the process of raising up to a further $2 billion.
A decade ago, the country had a limited private equity industry with only some well-known international players, such as the Carlyle Group, AIG Private Equity, Darby Private Equity and Newbridge Capital, investing in businesses in Colombia. However, in 2007, the government introduced an important new regulation, Decree 2175, which allowed domestic pension funds to allocate up to 5% of their assets to local private equity managers, giving a huge boost to the fledgling industry.
Some five or six local private equity managers have now secured capital and closed their funds – averaging around $200 million – and a further 20 groups are fundraising, according to the Latin American Venture Capital Association (Lavca). The average size of investment in local companies is $20 million but deals of up to $60 million have taken place.
“The international interest in Colombia among private equity players has been growing significantly during the past couple of years,” says Cate Ambrose, executive director of Lavca. “The government’s commitment to the local funds industry has been very strong, too. Its encouragement has been among the strongest of any Latin American country.”
Eduardo Elejalde, chairman of Lavca and head of the Latin America Enterprise Fund (LAEF), a Bogotá-based private equity manager, says: “The 2007 law change was extremely important to the domestic industry. Before the reform, local pension funds could invest in local managers but it was not straightforward and they could not do so on a long-term basis.
“Now, pensions funds do not have to commit all the money upfront. Private equity managers have much more autonomy in their decision-making and they have fiduciary committees which play a significant advisory role.”
In 2005, LAEF set up the first private equity fund domiciled in Colombia, the Colombian Hydrocarbons Fund, which raised $62.3 million (it closed that year) and invested in companies related to the oil industry. Its main investor was Ecopetrol, Colombia’s biggest oil and gas company, although some domestic pension funds and insurance firms also backed it. It has had an internal rate of return of 30%. Elejalde says it was difficult to set up this fund at the time, before decree 2175 was issued; however, it set an important precedent for the establishment of other domestic funds.
Stability and growth
Colombia has become a much more politically and economically stable country during the past decade. Its government – led by President Alvaro Uribe since 2002 – has followed an orthodox economic policy and this has started to pay dividends. Uribe’s administration has also managed to tame the Farc guerrilla movement and dramatically improve the country’s image. Although Colombia still has a great deal of poverty, especially in the remote countryside or forested regions, cities such as Bogotá, Medellín and Barranquilla have almost become boom towns.
Colombia is rich in natural resources and has benefited greatly from the rise of China, India and other emerging markets. Until now, the most popular sectors for private equity investment have been oil and gas, mining and forestry. However, Colombia is also witnessing the rise of a sizeable middle class, yet while domestic services and other industrial sectors have taken off the country still has poor infrastructure, made worse by a mountainous terrain, creating a big investment opportunity.
Recently Ashmore Investment, an emerging markets specialist, and Inverlink, a local investment bank, beat four other bidders for a tender by the Colombian government, the Inter-American Development Bank and the Corporación Andina de Fomento, the regional multi-lateral development agency, to set up a private equity infrastructure fund in the country. It plans to raise up to $500 million from local pension funds and foreign investors, although the total might rise depending on investor appetite.
Infrastructure opportunities
“Colombia needs infrastructure investment to the tune of $21 billion to $22 billion,” says Jerome Booth, head of research at Ashmore. “It is fairly easy to deal with the Colombian government. As is the case in many emerging markets, political risk in the country is low. Many emerging markets have learned the hard way the importance of sticking to long-term contracts with the private sector. In the developed world a blame culture has emerged and I am not sure if the same can now be said about the UK or the American Midwest, for example.”
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“Colombia needs infrastructure investment to the tune of $21 billion to $22 billion”
Jerome Booth, Ashmore Investment |
He adds that there are fantastic opportunities in Colombia in electricity generation and distribution, in roads, in the gas and water sectors, and in waste management. Ashmore’s fund will invest in and manage projects, rather than fund local companies. The time horizon is for up to 15 years. Last year, Lavca placed Colombia fifth – up one place on the previous year – among the 12 countries it ranks on its scorecard (Chile is ranked first, followed by Brazil, Trinidad and Tobago, and Mexico). It says the main strengths of Colombia’s private equity industry are: low barriers to participation by institutional investors; improved laws on fund formation and operation; liberal policies toward foreign portfolio investment; and improved minority rights and corporate governance.
The industry’s challenges are listed as the restricted size and liquidity of capital markets, limited options for exits, delays in the transition to international accounting standards, perceived corruption and the weakness of the local judicial system. The country also needs to display more entrepreneurship, although that has improved.
“One of the biggest issues for us is exit strategies,” says Ambrose. “This is something we have been discussing with our Colombian members. We have not really seen yet any exits for any companies that private equity funds have invested in. I think we will witness it within the next two to three years. The stock market is limited in the country, so IPOs are really ruled out as an exit strategy.”
Elejalde says: “The stock market has been rising dramatically recently. However, companies that have received private equity investment are not really big enough to consider a flotation. It is not like Brazil, or to a lesser extent Chile. However, I think that within five years we will see a much stronger IPO market in Colombia.”
Ambrose adds that most private equity managers see strategic sale as the main exit route. Selling the business to an international private equity player is also a possibility. Elejalde says that the internal rate of return on infrastructure investments is around 15% to 18% in real US dollar terms annually, while funds that invest in services and industry see IRRs of up to 20%. His company has set up a second fund for the forestry sector and it expects an IRR of 18%.
Recently, the government changed the rules to allow domestic pension funds to allocate up to 5% of their assets to well-established international private equity groups that manage more than $1 billion (they are able to invest this money in companies anywhere in the world). Some local managers are concerned that this could soak up the capital that has been available to them.
Mauricio Camargo, director of Altra Investments, a Bogotá-based private equity investor that manages $185 million, says: “At the start of the decade, there was a convergence of factors that led to the growth of the private equity industry: the rise of local pension funds, government commitment to the sector, and strong economic growth.
“In some ways the latest rule change to enable investment in foreign groups is a threat and in other ways it is not. Overall, the amounts that the local private equity managers are trying to raise add up to a small proportion of pension funds’ total assets and I think they have a commitment to the local private equity industry. However, it is very difficult to get foreign investors for local funds, so they are dependent on the pension funds.”
Changing regulations
Elejalde believes the regulations need to be changed again to allow pension funds to allocate up to 10% to private equity funds, creating a big enough pool of capital to invest in local groups and foreign players.
Most private equity managers in Colombia are based in Bogotá, the capital, but Promotora de Proyectos is headquartered in Medellín, one of the country’s most dynamic cities. Its Escala fund has raised $45 million and will back emerging industries in the energy, consumer goods, services and agribusiness sectors. “This fund will back companies with high growth potential,” says Francisco Mira, president of Promotora de Proyectos. “It will invest in businesses with the best prospects anywhere in the country.”
His group is also one of the first to set up a venture capital fund, called Progresa. It aims to raise $15 million and will commit up to $500,000 to new businesses in health care, biotech, IT and applied engineering, with a holding period of four to six years. The fund has been backed by the Inter-American Development Bank and the Spanish government, and is seeking an IRR of 20% to 25%.
“The private equity industry is very new to Colombia,” adds Mira. “Local entrepreneurs have never had access to this form of alternative financing before. It is very good for businesses where traditional financing is not available. We are focusing on companies with great potential and that have international expansion plans.”
Colombia’s economic and political turnaround during the past decade has been remarkable. The country has presidential elections in May and Uribe would like to stand for a third term. This would involve a change in the constitution and one of the country’s top courts is ruling on whether to allow a referendum to decide whether he can stand again – yet, whoever becomes the next president, a political consensus exists and there is not likely to be any divergence from Uribe’s orthodox economic policy, say analysts.
Colombia is expected to expand economically by between 2% and 4% this year. However, relations with Venezuela have become dire and this could hit trade between the two countries, lowering growth by between 1% and 1.5%.
It is still early days for the private equity industry in the country. However, it is becoming an increasingly important source of alternative financing for local entrepreneurs. The sector should expand dramatically within the next five years, as resource-rich Colombia attracts ever-increasing foreign interest and the country’s capital markets become more sophisticated.
