How globetrotters make money: top private equity firms, venture capitalists rely on strong on-site teams to close deals abroad.

Private equity investment in international markets comes with the same risks and rewards that it does in local ones--only more so, according to speakers on a panel at the Wharton Private Equity Conference earlier this year. To profit from economic growth abroad, private equity investors need strong people on the ground to source potential deals and nurture new companies.

Like investors in U.S. private equity, investors overseas have been coping with difficult markets. In Europe, private equity investment was up in the third quarter of 2002 to 6.3 billion euros, compared to 3.1 billion euros in the previous quarter, but the investments were concentrated in 17% fewer firms, according to the European Private Equity and Venture Capital Association. Fund raising was up 72% in the third quarter over the second quarter to 3.5 billion euros, but below the 5.4 billion euros raised in the first quarter. Meanwhile, the number of European initial public offerings fell from 285 in 2001 to 173 in 2002.

In Asia, venture capitalists invested US$1.9 billion in companies last year, down sharply from US$5 billion in 2001, according to Thomson Venture Economics. In all, 253 firms made investments in 362 companies. Australia was the top location for investment with US$450 million in financing, or 24% of the total. Computer software was the favorite sector with US$283 million invested, followed by communications and media with US$240 million.

Enrique Bascur, managing director of CVC Latin America, Citigroup's private equity business in Santiago, Chile, said his company finds many of its deals through a network of local business contacts in law and accounting, and from executives working for companies in CVC's current portfolio.

In a market like South America, there is a lack of information in the public domain about certain transactions, he said, noting that these business contacts "all provide a certain level of information that's not generally available to a private equity firm that does not have a local presence."

Other deals, however, come to Santiago by way of Citigroup's New York office, added Bascur, who oversees US$2 billion in investment in the region. "We are a very large, global and visible firm that attracts a lot of opportunities," he said. "Those looking for capital are going to knock on our door. They're looking to go to the head office, and it bounces back to the local offices."

DEMANDING GREATER RETURN

But there is risk even for those with a rich source of investment opportunities, warned Bascur. Many things that are taken for granted in the United States are not always available abroad, a situation that "forces you to acquire a much higher return."

Felipe Oriol, president and founding partner of Corpfin Capital in Madrid, said his firm, which focuses on traditional buyouts, is one of three main private equity firms in Spain with some competition from pan-European funds. The local firms do about two-thirds of the country's private equity business, while the other European funds take the rest. "It is important to have a presence in the country not only for sourcing but for execution," he said. "It's one thing to source a deal, it's another to close it."

According to Oriol, European unity is taking hold on the continent. It is therefore easier to bring managers to work in Spain who are not Spanish. "European unity is more than just a currency. The EU is developing into something different. It's not a single country, but it is different than what it has been for many years."

HARVESTING A PROFIT

Peter Yu, president and chief executive of AIG Capital Partners, is targeting Central Europe and Asia. "Our strategy has been to continue to look out five or 10 years and try to understand what multinational companies want to be buying, and then build those companies to sell to them," he said. For example, his firm is developing a football club in Turkey with the idea of building a television business around the club that could eventually be sold to a global media company.

Great opportunities in emerging markets spring from deep dislocation, he added, noting that AIG profited after the Asian financial crisis and the Russian devaluation in the late 1990s. "We are now very active in Latin America, and in telecom and commercial airlines where there has been dislocation in markets and in sectors," said Yu.

Thomas Arenz, general partner at Harvest Partners, a middle-market buyout firm in New York City that has a strong relationship with Germany's Deutsche Bank, focuses on buying U.S. firms with multinational operations.

To improve results in the overseas operations, Harvest looks to recruit strong executives. It uses search firms, which are paid on a fee basis since, according to Arenz, retainers do not work.

"Some of the search firms want not only a success fee, but also equity which we're happy to provide if it leads to a deal we close successfully," he said. Harvest searches for deals by networking with local professionals, but also looks for opportunities to partner with management teams that already have a relationship with Deutsche Bank.

Europe is a fertile environment for private equity, most firm managers agree. "The European market has developed to the point where executives understand private equity far better than they did a decade ago," said Arenz. "The caliber of those executives is very high."

Timothy Purcell, a general partner with JP Morgan Partners responsible for private equity investment in Latin America, described his firm's strategy of investing in mid-market buyouts in five industries.

SOME CATS ALREADY FAT ENOUGH

Latin America, Purcell said, lacks the entrepreneurial culture found in the United States and Europe. It is very difficult, for example, to convince managers ensconced in large companies overseas to take on the entrepreneurial task of starting up a new company.

"When we look at putting management teams together to go after a company, we find a lot of the talented managers are employed by leading companies in large industrial groups," he said. "These are prestigious jobs, and it's very difficult to convince the managers to take the risk of going into a smaller company."

Insiders attribute much of that reluctance to outmoded thinking about compensation. "Management is not accustomed to the type of scheme private equity firms will offer with significant upside," said Purcell. "It's a learning process. We are seeing some management teams interested in taking the risk in exchange for the upside, but it's still significantly behind markets in the U.S. and Europe."

FORGET THE AFFILIATES

The company had earlier tried to run its international business through a network of affiliates, the JP Morgan partner indicated, but those people in the field lacked the sector expertise to build companies. "With very few exceptions, those affiliate relationships did not work out. The few that did, worked only because there was some real chemistry there."

Even a large institution like JP Morgan has limits. "We'd love to have offices in every country," said Purcell. "But there's a question of scale. Some of the markets we're in, we don't think there is enough opportunity to put a partner on the ground and all the resources surrounding that."

Purcell's firm has US$1 billion invested in Asia, and offices in Hong Kong, Korea and Tokyo. The company has been active in the Korean auto market and is beginning to look more closely--though with caution--at China.

"We are analyzing some opportunities in financial services, and we think that there will be some significant opportunities," he said. "When you look at the Chinese markets and the corporations that have invested in China, for the first time you see companies like Procter & Gamble showing profits. That's a good leading indicator."

On the other hand, he added, "there are partners who don't think China's ready and won't be for a longtime. Others, particularly those close to the market, think we should be more aggressive. We're beginning to reach some conclusions internally ... Time will tell."

PULLING BACK IN ASIA

At Advent International in Boston, the firm is organized by teams doing traditional private equity finance and others funding venture capital, according to Jason Fisherman, managing director. The company focuses on health care, energy information technology, and telecom. It staffs its own offices in most of its key markets, but uses affiliates in Israel, India and parts of Asia.

Advent's strategy is to take ideas that work in one market and transplant them into another. For example, Fisherman said, the company used its experience with the Dollar Tree discounter in the United States to create Poundland in Britain. In addition, the firm's limited partners are constantly assessing geopolitical risk and country-specific risk: "But you need to balance that against deal-specific risk. Most deals with greater country risk may be balanced by the ability to buy deals with lower [business] risk. You have to adjust."

Fisherman recognized that his firm has been pulling back on Asia, saying, "We clearly slowed down our investment in the Pacific Rim and in Asia. We expect to come back and continue to look at deal opportunities, but there's no question it has proven to be difficult."

At Apax Partners in New York, general partner Greg Case said the company used its network in Italy and throughout Europe for due diligence before signing its exclusive deal to finance Phillips-Van Heusen's purchase of Calvin Klein. "To know how much value there is in the brand, we needed to take the temperature in Europe," he said, particularly among the company's Italian franchisees.

The partnership's biggest obstacle in doing business abroad is finding the right people, Case added. In Japan, for example, there is a sharp generational line. According to Case, those over age 40 have no sense of what it takes to become an entrepreneur, although those younger than 40 are beginning to understand.

Hong Kong, China and Taiwan have long been a magnet for freewheeling, ambitious entrepreneurs, but those markets often lack adequate legal structure and, in turn, discourage daring ventures. "That's one of the main drags on private equity investment in the region," said Case. "If the legal structures are not in place to do the things we need to do, we have no protections."

This article is reprinted with permission from knowledge@wharton, on online resource affiliated with the University of Pennsylvania's Wharton School of Business.