Private Equity in Global Growth Markets: A New Perspective Josh Lerner, Andrew Speen, Chris Allen, and Ann Leamon Harvard Business School and Bella Research Group

The Project Definition • A series of working papers on differing aspects of investing in global growth markets: – In 2014, represented 13% of total PE fundraising (~$350 billion). – Evidence-based approach.

• Prepare short, readable white papers. • The process: – Review of secondary literature. – Building of proprietary databases on exits and small and midcap enterprises (SMCs). – Analysis of available information.

• Sponsorship by Abraaj Group. 1

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Cross-Cutting Themes • Comparison of GGMs to Developed Markets – Faster Growth • Real GDP growth trends similar to U.S. from 1933-1958 and Japan from 1955-1980. • Rising middle class may add up to $22 trillion to GGM economies. • Non-BRIC GGMs have higher aggregate profits than U.S. since 2007.

– Public Markets Are Not Representative • Consumer, Industrial and Healthcare sectors covered best by private equity.

– Manager Selection is Critical • Expertise is essential to reduce GGM investment risks.

– Exit Markets Are Similar • More IPOs for GGMs.

– Minority Positions Are More Prevalent in GGMs • Preliminary research indicates equivalent returns compared to majority positions. 2

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Faster Growth: GGM Development Trajectories Many GGM Economies Have Developed as Rapidly as the U.S. and Japan.

• Others Appear Poised to Replicate those Trends after “Lost Decade”.

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Source: Bella Research Group Analysis Based on data from International Monetary Fund, World Economic Outlook. Base Year Follows Country Name.

Faster Growth: GGM Development Trajectories (2) Growth in Other Selected GGMs Has Been Below Historical U.S. Trend, But Started to Accelerate Recently.

Source: Bella Research Group Analysis Based on Data from International Monetary Fund, World Economic Outlook.

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Faster Growth: Demographic Momentum: Rise of the Middle Class in Global Growth Markets. Developed Markets Stagnant.

Source: Data compiled from Brookings Institution, Development, Aid and Governance Indicators, 2012 (database accessed 8/27/2015): Proprietary & Confidential 5 http://www.brookings.edu/research/interactives/development-aid-governance-indicators. GGM countries defined using the Bella Research list of GGMs and Developed markets. Middle class defined as “people living in households earning or spending between 10 USD and 100 USD per person per day (2005 PPP USD).”

Faster Growth: Share of Profit Growth Since 2007 for Small and Medium Sized Non-BRIC GGM Public Companies Exceeds Similar Sized Public Firms in the United States. Share of Global SMC EBITDA Gain by Region, 2007-2013

United States 20%

Other Developed 19%

Non-BRIC GGMs 28%

Global Growth Markets 46% BRICs 18%

Japan 16%

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Public Markets Not Representative: Public Markets Dominated by a Few Companies Share of Market Cap Held by Top 10 Firms in Selected Countries, As of 12/31/2014 Argentina Colombia Russia Peru Mexico Australia Brazil Poland

Chile South Africa Germany Hong Kong Developed nations are shown in black.

Canada United Kingdom India Japan United States China 0%

10%

20%

30%

40%

50%

60%

Source: Bella analysis of data compiled from S&P Capital IQ (accessed July 11, 2015).

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70%

80%

90%

Public Markets Not Representative (2): Important Sectors Underrepresented by MSCI EM Index Sector Weights of MSCI EM Index and Cambridge Associates EM PE/VC Index 100% 80% 60% 40%

Financials

10% 6%

28%

Energy

21%

8% 18% 2% 19%

Consumer

10% 14%

Healthcare Info Tech

20%

Other

39%

25% 0% Public Equity

35% 30% 25% 20% 15% 10% 5% 0%

Private Equity

Sector Weights of MSCI Emerging Market Index vs. Share of Global Growth Exits by Sector Since 2005 MSCI EM Index

Underexposed by 6-11%

PE Exits Share 2005+ 11% 9% 6%

Source: Top: Public equity data (weights as of March 31, 2015) adapted from MSCI Emerging Markets Index Overview, March 31, 2015. Bottom: Data compiled from MSCI (as of March 31, 2015) and Bella Research Group Exits database (n=455; 2005-March 31, 2015) via S&P Capital IQ.

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But Private Equity Plays a Smaller Role in GGM Economies. Private Equity Investment as % GDP 1.6%

1.4%

PE / GDP (Avg 2013-14)

1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0%

Source: Adapted from EMPEA, Emerging Markets Private Equity: 2014 Annual Fundraising and Investment Review, March 2015, p. 32. PE includes buyout, growth, PIPE, mezzanine, special situations and venture capital.

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But Manager Selection is Critical for Top Returns. Cambridge Associates Global Emerging Markets Private Equity & Venture Capital Index Returns, by Quartile 25%

20%

IRR (Net to Limited Partners)

Upper Quartile 15%

Median Lower Quartile

10%

5%

0%

2001 (12)

2002 (11)

2003 (11)

2004 (28)

2005 (44)

2006 (50)

2007 (63)

-5%

Source: Adapted from Cambridge Associates, Global ex U.S. Private Equity & Venture Capital Index and Selected Benchmark Statistics: December 31, 2014, May 2015, p. 20. Data as of December 31, 2014. Returns are net of fees, expenses, and carried interest. Number of funds Proprietary & Confidential per vintage year is shown in parentheses.

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Exit Markets Are Similar: Holding Periods For Private Equity Investors are Generally the Same or Shorter.

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Exit Markets Are Similar (2): Private Equity Capital Distributed at the Same Rate or Better, and Healthier Mix of Exit Types.

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Minority Investments Seem to Perform Comparably/Better. Average IRR of IFC Exits

60% 50%

IRR

40%

Majority

30%

Minority

20% 10% 0% IPO

Trade Sale

MBO

Structured Exit

Source: IFC, “Emerging Market Equity: Private Equity, Public Equity, Risks & Opportunities” (Feb. 2012). Based on exits of 61 majority positions; 251 minority positions.

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Summary • Evolution of Global Growth Markets – Growth trajectory of most GGMs shows similarities to Japan and U.S. in earlier years.

• Public and Private Equity – PE essential to cover fast growing industry sectors. – But manager selection is critical for top returns.

• Exit Markets – Few substantive differences from developed markets.

• Minority Positions – Returns from minority positions comparable to majority positions. 14

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Thank you! Josh Lerner Harvard Business School Rock Center, Room 314 Boston MA 02163 USA [email protected]

`

www.people.hbs.edu/jlerner m: +1.978.390.1973 @joshlerner

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Bella Research Group 221 Essex St. Suite 21 Salem MA 01970 USA [email protected]