This post is the first in an FT Alphaville series in which we speak to specialist private equity investors in emerging markets [Part 2: Aureos] [Part 3: Actis]
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CDC is unapologetic about making money, Richard Laing, its chief executive told the FT earlier this year. The government-owned private equity fund of funds does business in the poorest countries around the globe, but CDC, which started life in 1948 as the Colonial Development Corporation, has a determinedly commercial outlook.
“Being commercial and developmental go hand in hand,” says Laing. “It’s the only way to ensure it is sustainable. Historically there’s been too much investment in non-sustainable enterprises and you do damage, not good, by investing in businesses that are not going to last a long time.”
That is not to say that CDC, which currently has about $3bn in net assets, is unwilling to put its money in regions that other emerging market investors shy away from. The group spreads its investments between two broad categories of emerging markets funds: ‘best of breed’, which account for the majority of its investments, and what it calls “pioneering” funds – which address a particular area of market failure, a sector, size bracket or region where it believes risk is being mis-measured with an ensuing lack of investment. Examples have included investment in smaller companies, in early stage mining in Africa, and a buyout fund in India.
“We love to attract other investors in,” says Laing. “We want to demonstrate that you can make money in these markets. That’s one reason to be adamant that we must make good returns.”
CDC does, explains Laing, advise what he calls “our shareholder,” the UK government, if they are going into a new market – as it did in both Afghanistan and Rwanda last year. The limits are broad – no porn, arms, illegal drugs or tobacco, and a set of business principles that surround environmental and social issues, health and safety and business ethics. “Most responsible investors would look at [our principles] and say ‘that’s fine’”, he adds.
What about a Zimbabwe? “We have a historical investment in Zimbabwe,” says Laing. “We take a commercial view. At the moment, it’s unlikely that a fund manager would invest in Zimbabwe, but if they [wanted to] we’d listen. I believe that at a certain time Zimbabwe will be a very interesting place to invest.”
CDC’s return on net assets in 2005 was 35 per cent and the group recycles profits into new investments. Figures for last year are not yet out but the group’s five-year average return in “in the high-teens” says Laing. “It is not a venture model,” where a handful of so-so investments and the odd flop can be born thanks to that one extraordinary success. “That is a dangerous model in emerging markets – you’re unlikely to get a significant number making 20 times your money.”
CDC places its capital with about 26 fund managers, including those at Actis and Aureos, the two emerging market investment groups spun out of CDC as the company moved away from direct investment. The approach is robust: “There is sometimes a view that businesses in developing markets should be let off being commercial. They have to be as strong or even stronger than in developed markets to cope with the disadvantages.”
Information required for due diligence should be available, he says. “Businesses have got to pass a certain minimum or the fund manager won’t invest. There’s no reason for companies in the developing world to have second rate standards.”
There are some differences. Diligence work is arguably heavier – both for CDC when vetting funds that are often in their infancy, and for the funds themselves. Exits, in parts of the world with nascent equity markets and scarce deal flow, may take longer to come by. “Structuring is also really important in these deals,” says Laing. The funds use self-liquidating instruments, such as convertible debt, to extract a return at an early stage. “In a scenario where you can’t get an exit, you are getting an on-going return and your money back, having got a yield on it. Companies learn that capital doesn’t come for free and it offers downside protection in the event that you can’t sell the equity.”
CDC has almost half of its portfolio in Africa - it last month agreed to plough $100m into a new Africa fund launched by Citigroup. But is also active, and sees opportunities, in Asia and Latin America. “There’s a lot still to be done in China,” says Laing. “It’s a massive and very sophisticated economy but there are pockets of extreme poverty and where there are shortages of capital. Latin America has had a difficult time since 2001. It takes a long time to recover – many years to get the courage to go back in.”
But he points out, that is where CDC differs from some other investors: “We’re not fickle. We can’t back out and go and put all our money in the New York Stock Exchange. We’ll always be there.”
