Building a Critical Mass of Sustainable Emerging-Market SMEs The Role of Private Equity Noah Beckwith, Partner, Aureos Advisers Limited, London TBLI Europe 2007, Paris

1)The Myths of Investing in Emerging-Market SMEs… SMEs are inordinately risky Management and governance are poor, financial discipline is lacking / non-existent Contractual arrangements cannot be enforced SMEs are not scaleable SMEs cannot compete owing to: Dis-economies of scale Oligopolistic market structures Un-level playing fields Capital growth is insufficient to generate returns Risk-return reward is unattractive Exits are difficult or impossible due to: Lack of investor demand Market illiquidity The private equity model is inappropriate for SME investment in emerging markets

SMEs are inordinately risky

Management and governance are poor, financial discipline is lacking / non-existent

Contractual arrangements cannot be enforced

SMEs are not scaleable

SMEs cannot compete owing to:

Dis-economies of scale

Oligopolistic market structures

Un-level playing fields

Capital growth is insufficient to generate returns

Risk-return reward is unattractive

Exits are difficult or impossible due to:

Lack of investor demand

Market illiquidity

The private equity model is inappropriate for SME investment in emerging markets

2)…The Myths Debunked Illiquidity is not the problem – IPOs, buy-backs, trade sales, other exits all possible Exit strategies require careful planning from ex ante Exits Track record in SME private equity is misleading Risks of investing in private equity can be mitigated Risk-reward unattractive The traditional private equity model must be modified A portfolio approach to investing is vital to the sustainability of the model Private equity model Inappropriate for SMEs Absolutely – reliance on capital growth, alone, is dangerous A portfolio approach is critical – capital growth, income, income/growth transactions Capital growth prospects are limited Market structures often disadvantage SMEs Competitiveness must derive from tailored growth and strategic development plans SMEs are uncompetitive Scalability is achievable but requires context-specific strategies Regional growth strategies are vital Scalability Often poor, although not always – a critical part of the investors’ value proposition Alignment, deal structures and rights are key Management, governance, financial controls Local professionals, local presence, established networks Early stage / venture capital versus late stage – a crucial distinction SME Risk Profile

Illiquidity is not the problem – IPOs, buy-backs, trade sales, other exits all possible

Exit strategies require careful planning from ex ante

Track record in SME private equity is misleading

Risks of investing in private equity can be mitigated

The traditional private equity model must be modified

A portfolio approach to investing is vital to the sustainability of the model

Absolutely – reliance on capital growth, alone, is dangerous

A portfolio approach is critical – capital growth, income, income/growth transactions

Market structures often disadvantage SMEs

Competitiveness must derive from tailored growth and strategic development plans

Scalability is achievable but requires context-specific strategies

Regional growth strategies are vital

Often poor, although not always – a critical part of the investors’ value proposition

Alignment, deal structures and rights are key

Local professionals, local presence, established networks

Early stage / venture capital versus late stage – a crucial distinction

Towards a reformulated SME investment strategy Revenue / Profit Regional investment strategies: De-risk SME funds Generate deals and exits Domestic demand assumptions are vital Investment ranges are critical Geared equity structures enhance viability Good transactions attract liquidity Maintain strategic focus Relationships are key – capital is ubiquitous Time Embryonic Growing Expansion Seed Start-Up Maturing MBO/MBI Roll outs/consolidations Replacement Capital Aureos Regional Funds – Product Types

Regional investment strategies:

De-risk SME funds

Generate deals and exits

Domestic demand assumptions are vital

Investment ranges are critical

Geared equity structures enhance viability

Good transactions attract liquidity

Maintain strategic focus

Relationships are key – capital is ubiquitous

Transaction Structuring: A Cash Flow Focus is Key Deal structures that generate a high proportion of returns through ‘cash flow’, reducing the reliance on the equity multiple Fund Managers targeting at least 40% cash flow based deals. Cash Flow Structure Enhances Returns – income and capital Less reliance on ‘equity’ multiples (where volatile markets cannot guarantee exit through IPO's / trade sales) Enhances our controls Protects in downside scenarios Benefits Preferred Common Stock - higher ranking ordinary shares, with investor rights (e.g. preferential dividends; exit and control rights) Self-Liquidating instruments - returning a combination of capital and yield throughout the holding period Core Instruments Provide a head start to achieve target returns and reduce the overall risk of the Fund

Deal structures that generate a high proportion of returns through ‘cash flow’, reducing the reliance on the equity multiple

Fund Managers targeting at least 40% cash flow based deals.

Enhances Returns – income and capital

Less reliance on ‘equity’ multiples (where volatile markets cannot guarantee exit through IPO's / trade sales)

Enhances our controls

Protects in downside scenarios

Preferred Common Stock - higher ranking ordinary shares, with investor rights (e.g. preferential dividends; exit and control rights)

Self-Liquidating instruments - returning a combination of capital and yield throughout the holding period

Sample Transactions – Avance Ingenieros Avance Ingenieros Opportunity to invest with leading player in a homebuilding sector with strong demand driven by long term financing, remittances from abroad and recent conversion to dollar Poor bottom line visibility led to an investment structure where fee was tied to top line performance Investment Thesis: 29.9% Expected Return (Mar 07): US$ 5 million Current Valuation (Mar 07): US$ 4 million initially, with an additional $4m after prepayment of initial $3m loan Amount Invested: Receive in excess of 40% yield on equity investment. Have lent company an additional $4m in 2006 which was mostly repaid. Outcome: Leading homebuilder in ES targeting mid/high income buyers Brief description: TBLI Thesis Risk mitigation strategies reflect social capital Price premium through reputational advantage TBLI Thesis Extensive consultation with local communities Environmental best practice  competitive advantage Social best practice  competitive advantage

Opportunity to invest with leading player in a homebuilding sector with strong demand driven by long term financing, remittances from abroad and recent conversion to dollar

Poor bottom line visibility led to an investment structure where fee was tied to top line performance

Receive in excess of 40% yield on equity investment. Have lent company an additional $4m in 2006 which was mostly repaid.

TBLI Thesis

Risk mitigation strategies reflect social capital

Price premium through reputational advantage

TBLI Thesis

Extensive consultation with local communities

Environmental best practice  competitive advantage

Social best practice  competitive advantage

Sample Transactions – Aluminios de Panam á Aluminios de Panamá Production bottlenecks and limited working capital restricting production to 32% of capacity despite strong demand for its products Boom in construction sector in Panama driving local demand Construction and hurricanes in Southern US driving international growth Investment Thesis: US$ 3.05 million ($5m committed) Amount Invested: Local demand stronger and more than offsetting weaker int’l (less hurricanes in ’06) Company on schedule for CAPEX expansion Have already been approached by two interested buyers Outcome: ALPAN: Leading Aluminum Extruder in Panama, SD&W: Window frames manufacturer Brief description: TBLI Thesis Environmental best practice enhances brand TBLI Thesis Reducing macro-risk by investing in domestic producer Environmental leadership helps to capture market share

Production bottlenecks and limited working capital restricting production to 32% of capacity despite strong demand for its products

Boom in construction sector in Panama driving local demand

Construction and hurricanes in Southern US driving international growth

Local demand stronger and more than offsetting weaker int’l (less hurricanes in ’06)

Company on schedule for CAPEX expansion

Have already been approached by two interested buyers

TBLI Thesis

Environmental best practice enhances brand

TBLI Thesis

Reducing macro-risk by investing in domestic producer

Environmental leadership helps to capture market share

The Aureos Latin America Fund: Building Critical Mass in Emerging Market SMEs Andean companies looking northwards Central America companies positioning themselves as intra-regional conduits Mexican companies moving southwards Winners will be companies best able to adapt to new competitive factors Outsourcing of products and services with a “near shore” advantage Aging populations in US & Canada  demand for products and services Remittances / returning migrants drivers of local consumption FTAs to drive consolidation and cross border expansion as companies adjust to new competitive environment Not just about opportunities in USA Demographic Trends Beyond geographical competitive advantage Free Trade Agreements Domestic and regional markets as growth drivers Andean companies looking northwards Central America companies positioning themselves as intra-regional conduits Mexican companies moving southwards Winners will be companies best able to adapt to new competitive factors Outsourcing of products and services with a “near shore” advantage Aging populations in US & Canada  demand for products and services Remittances / returning migrants drivers of local consumption FTAs to drive consolidation and cross border expansion as companies adjust to new competitive environment Not just about opportunities in USA Domestic and regional markets as growth drivers

Andean companies looking northwards

Central America companies positioning themselves as intra-regional conduits

Mexican companies moving southwards

Winners will be companies best able to adapt to new competitive factors

Outsourcing of products and services with a “near shore” advantage

Aging populations in US & Canada  demand for products and services

Remittances / returning migrants drivers of local consumption

FTAs to drive consolidation and cross border expansion as companies adjust to new competitive environment

Not just about opportunities in USA

Andean companies looking northwards

Central America companies positioning themselves as intra-regional conduits

Mexican companies moving southwards

Winners will be companies best able to adapt to new competitive factors

Outsourcing of products and services with a “near shore” advantage

Aging populations in US & Canada  demand for products and services

Remittances / returning migrants drivers of local consumption

FTAs to drive consolidation and cross border expansion as companies adjust to new competitive environment

Not just about opportunities in USA

Conclusion Why private equity? SMEs require ‘patient capital’ Financing is available – SMEs require ‘financing plus’ The whole capitalisation structure must be taken into account Why SMEs? An ‘under-served’ market segment The lifeblood of the emerging markets Today’s S’s are tomorrow’s Ms and the future’s Ls Why a TBLI thesis? Ignore social and environmental criteria at your peril! The triple bottom line nexus is even tighter at the SME level

Why private equity?

SMEs require ‘patient capital’

Financing is available – SMEs require ‘financing plus’

The whole capitalisation structure must be taken into account

Why SMEs?

An ‘under-served’ market segment

The lifeblood of the emerging markets

Today’s S’s are tomorrow’s Ms and the future’s Ls

Why a TBLI thesis?

Ignore social and environmental criteria at your peril!

The triple bottom line nexus is even tighter at the SME level