PE Special Features
PE in emerging markets goes local   Emerging markets: Australia, its PE's Asia story   Emerging markets: South Africa's experience, diversity and access to debt   Emerging markets: Turkey, playing catch-up   Emerging markets: Brazil, domestic powerhouses

Last month, Chinese private equity firm Hony Capital (Beijing) Co. Ltd. trumpeted the simultaneous closing of two new funds that total $4 billion. That constituted the largest successful fundraising ever by a homegrown private equity firm not just in China but in the entire emerging-markets universe and rivaled TPG Capital and CVC Capital Partners for pulling off the biggest emerging-markets fundraising ever. "They raised the bar," says Jack Lange, a Hong Kong-based partner with Paul, Weiss, Rifkind, Wharton & Garrison LLP.

Hony's accomplishment sends several messages, and not just about China: Institutional capital to emerging-markets private equity is moving with renewed force after the global financial crisis. It is particularly flowing into indigenous private equity firms. And it is surging in a way that bolsters a select local private equity class in emerging markets, one that in those local markets begins to rival an international counterpart.

In emerging markets, "[t]here is a growing local elite that is competitive with the best private equity investors in the world, wherever they may be," says Sarah Alexander, president and CEO of the Washington-based Emerging Markets Private Equity Association. "They are competing for capital and for deals."

From Shanghai to São Paulo, Jakarta to Johannesburg, a top-tier cadre of indigenous private equity firms is establishing itself. These buyout shops are gaining strength and ground in the battle for both global money and home-field investments. They may not supplant the big international firms, but they are becoming more and more competitive. "What you're seeing in today's emerging markets is the emergence of some [private equity firms] ahead of the curve," says Peter Cornelius, a prominent economist with the huge, Amsterdam-based private equity investment manager AlpInvest Partners BV. "They have more experience, a good track record, stable managers. They have appeared on the radar screens of global investors, which has allowed them to raise more capital. Success breeds success."

Few can argue the importance of emerging-markets private equity, just as few can question how critical to global economics are emerging markets. Over the next several months, The Deal magazine will examine these emerging private equity markets, analyzing what propels them and which firms have emerged as leading lights.

This is a first step. An accompanying chart details prominent local private equity players in seven markets: China, India, Brazil, Southeast Asia, the Middle East, South Africa and Brazil, plus Australasia, a high-growth market with close ties to emerging economies. The chart isn't exhaustive. But it does show the firepower of local private equity.

Hony is often cited as Exhibit No. 1. With almost $7 billion now under management, the Beijing-based fund manager has attracted limited partners such as Goldman, Sachs & Co., Singapore sovereign wealth fund Temasek Holdings Pte. Ltd., the California State Teachers' Retirement Fund and the Stanford University and University of Notre Dame endowment funds. As a subsidiary of Legend Holdings Ltd., best known for its Lenovo computers, Hony has its own deep pockets. Founder and CEO John Zhao is an electrical engineer with an M.B.A. from Northwestern University. Working in the U.S., Zhao once headed research for Niles, Ill.-based audio company Shure Inc.

When Zhao, 48, founded Hony in 2003, he could raise only $38 million for the first fund. These days, Hony is able to compete for the biggest private equity investments in China and is beginning to invest as well in other Asian countries. In late 2010, for example, Hony acquired a 29.5% stake in Singapore medical-devices company Biosensors International Group Ltd., for about $220 million.

Hony is both an outsized private equity presence in the emerging world and "an indicator of an emerging trend," says Cornelius. "In the corporate world, you see the emergence of global players" from emerging markets. "You're going to see the same thing in asset management."

Indigenous private equity firms are becoming an increasingly more important component in an increasingly more important arena for capital formation and deployment. Regional Asian and China-specific private equity funds are in the process of "merely claiming the market share one would expect in any market as it matures," says John Fadely, a Hong Kong-based funds partner with Weil, Gotshal & Manges LLP. But that's substantial. "They are raising more of the capital and winning a proportionally bigger piece of the growing pie of capital allocations to private equity in Asia."

Emerging-markets private equity has skyrocketed over the past decade. Its advocates maintain that there is plenty of room to continue this rapid growth. According to data compiled by Empea, private equity ownership in the U.S. was 0.9% of gross domestic product in 2010. India had the highest private equity penetration of any major emerging market, with 0.44%. China had only 0.16%, while South Africa and Turkey had just 0.01% each. "Irrespective of the size of the pool of capital, [emerging markets] have taken a larger share," says Alexander. "Our surveys indicate they will take even more."

Some rules of physics still apply. Emerging-markets private equity suffered some of the same pitfalls as their Western counterparts. Private equity investments in emerging markets peaked in 2008, several months later than developed countries' counterparts. As they did in the West, however, emerging private equity deals and fundraising fell off the cliff in 2009. According to Empea data, emerging-markets private equity (both local and global firms) raised $67 billion and invested $48 billion in 2008. The next year, just $23 billion was raised and $22 billion deployed.

For the first three quarters of last year, emerging-markets PE invested a total of $21.3 billion while raising $32.3 billion. Some suggest it will take two more years to reach the levels of 2008, and institutional investors are more cautious. Those trying to raise a first fund are especially vulnerable. "The very well-established players have no difficulty raising money," says Akil Hirani, managing partner of the Mumbai-based law firm Majmudar & Co. "The pace of newer funds is slower than before. They're struggling."

The bounce-back is notable, however. "Overall, there's been a considerable recovery in the appetite for emerging-markets exposure," says Cornelius. "Private equity firms, global and local, are quite busy deploying their capital."

Some now worry that too much cash is chasing too few worthwhile deals. "Our estimates suggest that there are at least four to five years on current dealflow levels of capital overhang in China and India," says Suvir Varma, the Singapore-based partner who heads consultancy Bain & Co.'s Asia-Pacific PE practice. "There's been so much money raised to be deployed in private equity in those markets, there's a massive overhang."

What's more, Varma continues, "exits in Asia have slightly lagged investing." He cites a 6% drop in capital returned to investors in 2011 and an increase in the average holding period. "There have been a number of IPO exits and some trade/secondary sales, but there have not been as many home runs as one would expect considering the deal activity, particularly in China and India."

Others, though, say that while the past year has been tough, the jury remains out on most major funds. "There have been decent exits," says Hirani.

The degree that local players now compete with their global brethren is tough to quantify. No one parses data in a way that compares global PE investments in emerging markets with local. Bain estimates that roughly 60% of 2011 deals in China were by domestic players.

An analysis by The Deal magazine of more than 700 emerging-markets private equity transactions in 2010 compiled by Empea shows indigenous private equity funds by number account for somewhere around nine out of 10 transactions. However, the vast bulk of these investments are small, often in the single millions, if there's any investment figure given at all. A majority of the biggest private equity investments remain the domain of the global players.

Then there are regional firms that are neither global nor indigenous. The most prominent example is Baring Private Equity Asia, an independent fund manager based in Hong Kong that invests across Asia. Its $2.46 billion Fund V close last year was by far the biggest Asia-related fundraise in 2011.

In general, indigenous firms "are much more middle market-oriented," says AlpInvest's Cornelius. "As you move lower [in investment profiles], it's much more local."

Not that long ago, any private equity investment in emerging markets was at best an afterthought. (The term of choice pre-2001 was "developing markets.") With the exception of South Africa, where private equity first took root in the '80s (see page 26), emerging-markets PE is a recent phenomenon. But that doesn't mean it's not going to be big. "There is no question that emerging-markets private equity is the story of this decade, and maybe of the whole 21st century for the private equity industry," says Alexander.

A quick history lesson: Beginning in the mid-'90s, a few of the biggest American and European firms -- 3i Group plc, Warburg Pincus, TPG Capital -- made occasional investments in developing Asia. The timing wasn't good. The Asian financial crisis of 1997 hit investors hard. For a few years after, private equity in emerging Asia "bumbled along," says Varma.

As Asia recovered and other emerging economies followed, some global firms established physical outposts in the markets they were investing in. They accelerated investments as emerging-markets economies flourished in the 2000s. Before the 2008 financial crisis, the biggest names in global private equity raised multibillion-dollar funds for investments in Asia. Billion-dollar Latin American funds gained ground as well.

Local private equity generally trailed the global firms. With a few notable exceptions such as South Africa, indigenous private equity firms are much younger than their international counterparts; five years is considered a veteran local fund management. But over the past decade, their growth has been much more dramatic than the global firms.

That stands to reason. For one thing, it's a numbers game. "If you look at the total number of funds in China and India today, clearly the fastest growth segment in terms of new funds are indigenous funds," says Varma. "For every one of those new [global funds] just entering Asia, there are probably 10 indigenous funds getting created, [although] the size in most cases is smaller."

Since the mid-2000s, local principals have formed hundreds of funds. The pace and relative number of these funds varies from region to region. Turkey has only three firms of any size (see page 28). Sub-Saharan Africa, dominated by South Africa, counts about 80 funds "that raised or are raising investment capital," estimates Graham Stokoe, Ernst & Young's private equity leader for Africa, in a recent seminar. "Private equity is definitely starting to see increasing interest, but it's early stages."

China, by contrast, has anywhere from 2,500 to 10,000 funds, depending on who is counting. However, about six or so stand at the top of the heap: Hony, CDH China Holdings Management Co. Ltd., SAIF Partners, New Horizon Capital, Citic Capital Holdings Ltd. and China Bright Stone Investment Management Group Co. Ltd. Of the remaining thousands, "many of these are very small, very local," says Paul Weiss' Lange.

These small shops, in fact, stretch the definition of private equity sometimes beyond recognition. In China, for example, there's a booming business in what is often referred to as IPO approval arbitrage. Entrepreneurs who want their companies to go public turn to local shops with connections to officials in the approval process. In return for giving up an equity stake in the companies, the promoters gain what they hope is an inside track to an IPO.

"There's an almost endless number of firms in emerging markets," concludes economist Cornelius.

Private equity investing -- global and local managers alike -- in emerging markets over the past decade (2002-Sept. 30, 2011) totaled about $236 billion, according to Empea. Of this, emerging Asia accounted for more than 60%. Fundraising for the same period totaled $278 billion.

Most local private equity firms lack the lengthy investment track record of their global counterparts. Their association with institutional investors doesn't stretch back for decades. What they do have, says Cornelius, is "local expertise, local knowledge," and that's very attractive to institutional investors.

Many if not most managers of major local funds trained and gained both experience and contacts with Western PE firms, investment banks or consultancies before setting off on their own. Goldman's China operations alone count as alumni Richard Ong, a former co-head of Asian investment banking, who founded RRJ Capital; Frank Tang, who started FountainVest Partners; and Fred Hu, who quit as chairman of Goldman Sachs in Greater China to found Chunhua Capital.

Local Chinese private equity managers are "either extremely well-connected locals from prominent families who had access to proprietary dealflow [or] people who had cut their teeth in the Goldmans of the world and branched out and raised their funds," says Varma.

New Horizon Capital is an oft-cited exemplar of political connections, although some question how far these linkages carry. New Horizon's co-founder is Wen Yunsong, the son of China's premier, Wen Jiabao. Since 2005, the firm has raised three funds totaling $2.5 billion. (Wen Yunsong reduced his role at New Horizon and is now listed as an adviser.)

Indigenous private equity is relatively young. But it has developed enough -- or is in flux enough -- for a second generation of new funds. Ong, for example, joined fellow Goldman alumnus Fang Fenglei to form Hopu Investment Management Co. Ltd. in 2008. Hopu's first fund raised $2.5 billion. But Hopu couldn't muster enough interest for a second fund and is now winding down. Ong quit, set up RRJ last year and raised an astounding $2.3 billion.

Weil Gotshal's Fadely expects a list of the most prominent local private equity shops in China five or 10 years from now to have several new names and lack some of those now prominent. "It is an intensely dynamic and competitive market, and one that hasn't gone through a major shakeout yet."

A changing of the guard is already apparent in India. Its two most famous private equity figures are Ashish Dhawan and Renuka Ramnath. After a decade of leading and building up ICICI Venture -- promoted by one of India's largest banks -- into the country's biggest indigenous private equity firm, Ramnath left to found her own shop, Multiples Alternate Asset Management. She closed her first $400 million fund late last year.

Dhawan is another Goldman alumnus. He founded ChrysCapital in 1999 and built it into the country's largest independent private equity firm. Only 41, he announced he would move out of private equity this year to focus on philanthropy.

Indian private equity's unique development helps explain this kind of transformation. The global players have been in India in force for the past decade. But early on, local players such as ICICI Venture and ChrysCapital began to compete for private equity transactions. They served as a training ground for ambitious individuals who have split off to form their own shops.

Private equity "was initially established by [the country's] larger financial institutions and then morphed into their own beings" with their own corporate cultures, says Majmudar's Hirani, who has worked with some 15 PE funds over the past four years. "At the same time, international firms became more prominent." Managers there spun off as well.

In addition, some of India's oldest and most prominent corporate families -- notably Tata and Birla -- have plunged into private equity. They bring to the field deep pockets, name recognition and an inside track to dealflow.

China and India garner the lion's share of emerging-markets PE. In the first three quarters of 2011, according to Empea data, China alone accounted for 40% of the $21.5 billion invested in emerging markets. India accounted for another 26%. By average deal size, however, India and China trailed Brazil and Russia. That reflects a difference within markets between buyouts and growth capital.

Bain estimates, for example, that Southeast Asian PE is traditionally buyouts, 50% to 60% of the total deal value. In the gold rush days of 2007, about two-thirds of PE deals in the region sometimes known as Asean were buyouts.

Southeast Asian private equity is proving particularly resilient after the global financial crisis. Navis Capital Partners Asia Ltd., based in Kuala Lumpur, is a veteran firm now gaining recognition. Richard Foyston and Nicholas Bloy, who had been with the Boston Consulting Group in Asia, co-founded Navis in 1998, gaining a foothold at a time when most capital was running away from the region.

Indian PE, says Hirani, is split about 50-50 between growth and buyout. In China, by contrast, analysts estimate an overwhelming proportion of private equity is being deployed as minority-stakes growth capital.

That stands to reason. The kind of Chinese companies that attract private equity are young and expansive. Owners have no desire to cede control. What they need is additional capital, but are tapped out of commercial borrowing, don't want additional debt and aren't developed enough for the public markets.

That favors indigenous private equity players: Monetary stakes are smaller, often too small for a global firm. Sourcing deals is paramount. Trust with entrepreneurs is critical.

The number of indigenous firms in emerging economies may stretch into the thousands. However, in each market, a handful of homegrown private equity shops is far outpacing the pack. They have created a local elite.

These local funds are "growing much faster in terms of fundraising and money invested," says Lange. He is speaking of China, but he could be describing many emerging markets. "They have enormous momentum, good exposure with Western institutions, and they are building up indigenous, sophisticated organizations that just haven't existed before."

They compete against global funds not only for deals, but for capital -- and they compete effectively. They have been able to attract limited partners from the same global pool as Western counterparts: pension funds, insurance companies, funds-of-funds and other institutional investors.

Emerging markets "are obviously a growing part of everyone's portfolio," says T. Bondurant French, the CEO of Adams Street Partners LLC, a Chicago-based largely fund-of-funds with $22 billion under management. "And, they've expanded well beyond the BRICs" -- Brazil, Russia, India and China.

The pool of capital invested in emerging-markets private equity is expanding rapidly. Varma lists three general reasons why: increased allocations by Western institutional investors to emerging markets, growing petrodollars and a new breed of homegrown institutional investor.

In 2010 and 2011, for example, Adams Street placed 30% of its funds with emerging markets-related private equity, says French. But part of that was catch-up, he continues, after more than a year when almost no funds were placed with emerging-markets private equity.

Petrodollar sovereign wealth funds are adding billions of dollars to their reserves every week. Private equity gets a portion of that investment. These Middle Eastern funds "are most comfortable with markets closest to their home," says Varma. "These guys are investing far more than what the neutral allocation would suggest because they're far more comfortable with Asia."

The Middle East itself is producing indigenous private equity that is gaining clout, experience and capital. By far the most prominent is Dubai-based Abraaj Capital. Founder and guiding light Arif Naqvi, 51, has emerged as a significant figure in PE investments that stretch from Turkey to India.

Then there are new LPs in emerging-markets private equity, including Japanese asset managers and Chinese pension funds. That corpus could increase substantially as regulations restricting investments in alternative assets such as private equity by, say, local insurance companies, ease. "What hasn't been discussed so much is the emerging markets as a source of global capital, with the exception of sovereign wealth funds," says Cornelius. "Pension funds, insurance companies in these markets, at the rates their assets are growing, these are going to be really spectacular."

In an effort to tap local institutional capital, China in 2008 instituted local-currency renminbi funds. Hony crafted the first one. Perhaps 50% of the deal activity last year in China was in renminbi, estimates indicate.

French, who has been in private equity for more than 30 years, says he's struck by how much emerging-markets private equity managers in one market are aware of the dynamics of others and how much they speak a common language of dealflow and asset allocation, managing their own firms, recruiting and training people, compensation and the like.

"When you invest in emerging markets, you're 100% dependent on the people being there on the ground, their relationship to local founders, local companies, their understanding of the rules and regulations," he says. "Their connections, networks, the ability to recruit people. When it comes to emerging markets, we're not investing based on GDP growth. It's very much down to micro factors, specific managers and their skill sets and the specific businesses they invest in." Some things don't change.