Due Diligence 101: Private Equity Investing in Emerging Markets The due diligence challenges Jonathon Bond, Managing Partner & Adiba Ighodaro, Director Actis
Executive Summary - Due Diligence in the Emerging Markets 1. Due diligence in emerging markets is the same as developed markets with special emphasis on key areas � Don’t compromise on depth or quality because “the emerging markets are different” � Be prepared for it to take longer 2. Management strength & alignment are the central risks irrespective of geography � There may be cultural differences in relationship management between regions, but structures that reinforce alignment remain the same 3. In our experience, a special focus on environmental, social and governance issues tests management’s alignment, enhances value and obtains premiums on exit 2
Executive Summary Continued 4. The number of control deals in the emerging markets continues to grow, but the focus on control transactions should not cloud the importance of ensuring strong influence irrespective of level of shareholding 5. Trade sales continue to dominate exit opportunities in the emerging markets (with the exception of China and Brazil), with a slowly increasing number of IPOs as stock markets mature 6. In this presentation, we have drawn on lessons learned from having invested over US$4.2bn invested in over 150 Private Equity and energy transactions since 1998, with US$4.3bn returned to investors over the same period Traditional approaches to Traditional approaches to responsible investment responsible investment 3
Agenda for the Session 1. Due diligence overview � Commercial due diligence � Financial and legal due diligence Actis Actis 2. Key areas of emphasis in the emerging markets approach approach 3. Environmental, social and governance (ESG) 4. Minority vs. Control deals 5. Exit opportunities 6. Case study 7. Lessons learned Traditional approaches to Traditional approaches to responsible investment responsible investment Traditional approaches to Traditional approaches to responsible investment responsible investment 4
Due Diligence Overview Same standards and rigour as developed markets Reveal Identify & Legal Confirm Commercial opportunities mitigate investment for value Business model Key risk areas risks Actis Actis thesis creation approach approach Revenue drivers Ownership / title Market research Corporate structure Customer analysis Intellectual property Adjust price Ensure Identify Competitive position Contingent to maximize ethical ESG risks liabilities exit premium integrity Regulatory climate Change of control Management’s track record Labor & pension Local talent pool Property Financial Historical financials Forecasts Traditional approaches to Traditional approaches to responsible investment responsible investment EBITDA / profit margins Earnings quality Traditional approaches to Traditional approaches to GAAP / transparency MIS systems responsible investment responsible investment 5
Issues Vary with Heightened Emphasis on Certain Elements � Management Management strength and alignment are the - Local management depth, ability and central risks, experience irrespective of - Willingness to implement change geography - Frequent need to professionalize family businesses Governance arrangements need � Governance arrangements improvement � Political and regulatory risk � Verification of historic financials and tax position Market data is frequently limited � Availability of reliable market research � Adequacy of legal structures and remedies ESG often identifies � Myriad ESG obstacles areas for improvement 6
Commercial Due Diligence: Business Model Business Model � What are the entry barriers? Are they high? � What is the target’s economic model? � What are the key success factors of the industry? Actis Actis � How is the industry profit pool distributed among different parts of approach approach the value chain? � How have similar businesses evolved in developed markets? Implication to this market? Market Size and Growth � How big is the segment in which the target plays? � How has it been growing historically? � What are the major drivers for the market growth going forward? Traditional approaches to Traditional approaches to � How big will the market be in five years? responsible investment responsible investment Traditional approaches to Traditional approaches to responsible investment responsible investment 7
Commercial Due Diligence: Market Considerations Customers � Who are the customers? � Are sales concentrated among key customers / products? � How loyal are the customers? Actis Actis � How are customers acquired? At what cost? approach approach Regulatory Environment � What are the most relevant regulations? � How are the regulations expected to change? � How will regulatory changes impact the target’s business? Traditional approaches to Traditional approaches to responsible investment responsible investment Traditional approaches to Traditional approaches to responsible investment responsible investment 8
Commercial Due Diligence: Competitive Position Target’s Competitive Position � What is target’s market share in each of its key markets / segments? � Who are the major competitors? � Are they gaining or losing share compared to target? Actis Actis � What are customers’ comments on target vs. major competitors? approach approach Target’s Capability � What are the most important capabilities for this industry? � How strong is target with regard to those capabilities? � What investments has target made to buttress those capabilities? � How aligned is the organization (e.g. structure, incentives, etc.) with target’s strategy? � What is the management’s track record? Traditional approaches to Traditional approaches to SWOT Analysis of Target responsible investment responsible investment Traditional approaches to Traditional approaches to � What are the key strengths, weaknesses, opportunities, and threats to the responsible investment responsible investment target? 9
Commercial Due Diligence: Target Financials Historical Financials � What are the target’s historical and current (YTD) financials (P&L, balance sheet, cash flow)? � How is current (YTD) trading compared with the budget? � What are the major drivers for revenue, cost and cash flow? How have those Actis Actis approach approach performed over time? � Compare revenue, profitability and cash flow by major line of businesses � How have those evolved over time? � Have margins declined? � What are the main reasons for historical margin decline? Financial Forecasts � What are the consultant’s forecasts for the next five years? � What are the key assumptions? Different scenarios? Traditional approaches to Traditional approaches to � How do the consultant’s forecasts compare with management’s forecasts? responsible investment responsible investment Traditional approaches to Traditional approaches to � What are the main differences in the key assumptions? responsible investment responsible investment � What are the major risks for target over the next five years? 10
Commercial Due Diligence: Value Creation Opportunities Value Creation Opportunities � What are the major opportunities to drive target to full potential? - Strategic - Operational (revenue, cost, and cash) Actis Actis - Organizational approach approach - Financial � What can be done to help the target achieve full potential? � Obtain input from sector & operating experts in articulating the full potential 100-Day Plan (In Control Investments) � What is the high-level five year strategy of the target? � What are the immediate priorities for the target / management? � Detailed 100-day plan including tasks, responsible person, timing, and Traditional approaches to Traditional approaches to checking points responsible investment responsible investment Traditional approaches to Traditional approaches to responsible investment responsible investment 11
Financial & Legal Due Diligence Focus on Key Issues and the Commercial Implications Local Market Expertise � Industry knowledge and judgment to identify key issues Actis Actis � Some markets prohibit use of international law firms approach approach International Linkages � Crucial when multiple jurisdictions are involved Experience in PE or Target Sector � Type of deal matters: minority vs. control, auction or share deal Traditional approaches to responsible investment Traditional approaches to Traditional approaches to responsible investment responsible investment 12
Due Diligence Actis Actis 2. Key Areas of Emphasis in the Emerging Markets approach approach Traditional approaches to Traditional approaches to responsible investment responsible investment Traditional approaches to Traditional approaches to responsible investment responsible investment 13
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