This is the third article in our continuing Leadership in Latin America series.
Richard Frank is the former World Bank Director (from 1994 to 1997) and current Managing Partner of Darby Overseas Investments, Ltd. His address is especially interesting due to the credentials of Darby’s top managers; this is a team of very high profile leaders. The firm’s founder is none other than Nicholas Brady, the father of the famous Brady plan, and the Managing Director, Hollis McLoughlin, is former Assistant Secretary of the Treasury (under Mr. Brady).
The Marketplace Mr. Frank began by highlighting the $1.7 trillion regional GDP, and 4-5% long-term growth forecast. While the short-term GDP growth will probably decline in 1998 by one percent due to the Asian crisis, the region’s long-term growth forecast is still double or triple that of the industrialized world. Of course, sustaining policy reforms are critical to these forecasts. Mr. Frank noted that the Latin American economies are no longer determined by the industrialized world as they were when the region was still natural resource driven.
Flows to Emerging Markets Private financial flows to emerging markets are helping make the Latin American economy more independent. A fundamental shift has occurred in the external flow picture: official flows such as world bank funds and foreign aid are no longer as important as they were ten years ago. Private flows made up of Foreign Direct Investment, portfolio equity (stocks), private non-bank, and commercial bank funds now make up roughly 3 to 4 times the official flows to Latin America. This year alone, $20 billion is expected to flow into brazil as a result of privitizations.
Key Characteristics of the Latin American Financial System The credit markets in Latin America are dominated by short term bank credit with trends towards lengthening maturities, lower inflation, and interest rate convergence with currency and inflation stability. The new issuance volume has been affected by the Asia crisis, but a 10 year comparison of the major indices shows the Morgan Stanley Latin America index far outperforming the S&P 500. It’s outperforming the S&P by 3-4%. Mr. Frank asks where the risk is, if the returns don’t diminish over the long term. His answer? Latin America might just be a better investment. The securities markets are dominated by government bonds. The equity markets only offer a small number of highly liquid shares. There is a second tier with limited liquidity, and finally many listings with no liquidity at all. The stock market capitalizations as a percentage of GDP are very low when compared to OECD countries or Asia; Essentially, issuing stock is not a common way of financing growth in Latin America where 3-4 stocks make up the bulk of each market. These capital markets are beginning to deepen, however, with the growth of private pension funds throughout the region.
Capital for Growth: Darby Overseas’ Role How does one sustain the growth of companies? The normal path begins with personal savings and the use of internally generated cash, and continues chronologically with venture capital or private equity, private placements, the over the counter market, and finally ends with the major stock exchanges. Where does Darby Overseas fit into this growth process? In 1994, Darby raised $150 million for a Private Equity fund for Latin America which is currently about 80% invested and will reach 100% later this year. Essentially, Darby Overseas has been playing the role of a late stage venture capitalist, providing not only capital but also strategic direction to companies pursuing acquisitions, sector roll-ups, or regional plays. It frequently is involved in assisting firms with the transition from family to corporate management and with the change from private to public financial disclosure. Darby’s involvement is designed to prepare companies for IPO or for a strategic sale. As Mr. McLoughlin put it, "The companies we invest in usually want more than capital, they’re looking for the value added component and it’s important to us that they want this." Mr. Frank called the Darby formula, "profitability through partnership". A recent report shows a 28% discounted return, which reaches into the 30s if you look at peak values.
Private Equity Comparisons In the US, Private Equity totals $60 billion or .75% of GDP whereas in Latin America it reaches only $8 billion or .5% of GDP. In the US, entrepreneurs are usually the recipients of these funds, commonly through complex deals which investors can price easily in part due to easy access to good quality information. In Latin America, on the other hand, family-owned firms are usually the recipients and the deals should be simple because they are hard to price; information is hard to obtain and usually of poor quality. Whereas Private Equity in the US is normally an early stage investment, in Latin America it’s a late stage investment and subject to higher macro-economic risk and a shortage of experienced management. Exit strategy in Latin America is also more likely to involve a strategic sale that in the US as a result of less mature securities markets. What’s similar about US and Latin American Private Equity? Darby uses the same financing instruments, hands-on approach, deal sources, fund structures, and sources of funds that are commonly used in US Private Equity deals.
What’s Next for Darby Overseas? According to Mr. Frank, Darby will start a second Latin American Private Equity fund this year and is working on a $500 million Latin American mezzanine finance product. When asked whether good deals are becoming scarce he replied "There’s more competition in Mexico than in Brazil, but with the shallow capital markets and the small number of family firms that have been opened, there is not a great shortage of deals. Large pools of capital in the US such as State pension funds still haven’t gotten involved." Will the Darby management team have as great an impact in the business world as in government? While these leaders may be modest (Mr. McLoughlin commented that Nick Brady has always felt that his role in launching the Brady plan was that of a facilitator and that the real leadership and work was done by the presidents of the Latin American countries in maintaining the discipline necessary for success) I think you'll hear a great deal more about Darby Overseas in the future. Reported by Eric Shannon, President, Latin America's Professional Network Subscribe to our online newsletter, LatConf to receive future related articles, you can also subscribe by sending a blank email to join-LatConf@mailer.latpro.com ).
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