Venture Capital in Latin America over the next decade

Latin American Venture Capital will remain attractive for investment in the middle of a deceleration of the Emerging Markets in general and of the BRICs in particular. The appeal of its Copycat Ventures continues in place due to its still high growth and large market size; while the appeal of its Innovative Ventures grows because of a maturing ecosystem, backbreaking growth on R&D and Education Investment and active Public Policy to promote Innovation, Entrepreneurship and Venture Capital.

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As we discussed in a previous posts, Venture Capital in Latin America has mostly focused on Copycats that replicate and adapt US business models in their local markets (i.e. Mercado Libre/ Ebay, Despegar/ Expedia). Over the past ten years there has been a surge in the interest for these investments with key GPs (i.e. Redpoint, Burril, Sequoia) and LPs (i.e. Horlsey Bridge, Silicon Valley Bank, Cisco) entering the Region with a focus in Brazil.

VC Investmet Distribution in Latam

Source: Axia Ventures Proprietary Analysis

This growing interest was the consequence of Latin America´s high growth, Brazil´s new role in the world as a key market and a member of the BRICs and the successful Copycat Ventures of the 90s.

Today, the main driver of the growth of the last 10 years in the region is not there anymore: the rise in in commodity prices is slowing down as China rebalances and reduces its growth. Furthermore, the increase in asset prices via reduced risk spreads caused by institutional improvements has evaporated since spreads have compressed to almost zero.

Therefore, the growth of Latin America over the next few years will not come from the rise in commodities; it will come from productivity gains. Productivity gains in Latin America could be achieved by raising the capital and technological intensity of production, specializing through more trade or innovating.

In this context, the decision by the Pacific Alliance (Chile, Colombia, Peru, Mexico) to create a regional free-trade market for their already open economies has been appreciated by the markets that believe such strategy is a cornerstone of future growth and a sign of a willingness to eliminate red-tape that will allow for higher capital efficiency and intensity. Although we agree with this view, we believe that the region as a whole will continue to grow at a higher pace than developing nations because it is still far from the capital and technological frontier and it has stable institutions in a converging world. This is the fundamental secular reason to invest in the region since the rest of the issues will prove cyclical (i.e. politics). Most International Economic Organizations are forecasting Latin America to grow at a 6% CAGR over the next five years, 50% higher growth than the Advanced Ecomies.

Source: IMF World Economics Outlook

Furthermore, the valuations in the region have already adjusted to the slow-down of the past 2 years, paving the way for further gains by riding the growth in multiples and diminishing the downside risk. Low entry multiples have been one of the most important conditions for high PE and VC returns over the decades. Jim O'Neil, the former Goldman Sachs guru that coined the BRIC term in 2001 and predicted the emerging markets rally, says the selloff has made the Emerging Markets "very attractive".

Consequently, we believe that investing in Copycat Ventures in Latin America continues to be a sound investment due to Latam´s big and growing market and its discounted valuations and costs.

Source: Yahoo FInance

But above all, we believe there is a great story to invest in Innovative Ventures in Latin America. The Region has doubled its R&D and Education Investment over the past 6 years, on the back of growing GDP and the increasing relevance of Innovation Policies. However, there is very little capital pursuing these opportunities since there are no key innovation hubs in Latin America when looking at it on a single city or country basis. 

Source: OECD

Innovation Policies in South America

Sources 1) 14/03/2013 – FINEP- Launch of Plan Inova 2) http://www.finep.gov.br/inovaempresa/ 3) Financial Statements 1H 2013 4) Colciencias 5) MINCyT 6) “Fronteras en Biociencia" 7) Cumbre Latinoamericana de Innovación 8) Josh Lerner and Ann Leamon – Harvard Business Review

This is starting to change because R&D and Education are cumulative long-term investments that are starting to show the results of a decade of hard work and Rio de Janeiro, Medellin, Santiago de Chile and Buenos Aires are aggressively trying to position themselves as Innovation Hubs with a global competitive mindset. The Region is already producing some top-notch innovative companies like IndexTank, CVDentus, Amyris, Ciencias para la Vida, Keclon or Bioceres.

These opportunities are coming at very competitive valuations today because of the lack of capital for such investments, the recent steep decline in foreign exchange rates and the competitive pricing of technology experts and scientists. Those investors prescient enough to invest in this embryonic part of the Latin American VC ecosystem will get rewarded in kind. 

To exploit these opportunities consistently as a Venture Capitalist, a Latin American geographic and a generalist industry approach are necessary since only then will the Deal Flow have enough depth to make an Innovative Fund viable. Also, Innovative Ventures need to have Validation from Key Innovation Hubs and Business Development in the Advanced Economies. In the past, this would have been a great difficulty; but in an integrated digital world it is actually an opportunity since it creates a global company from day one.

To sum up, Latin American Copycat Ventures are still a sound investment since the Region has a big market that will continue to grow. But we also believe that there will be a growing success story in the Innovative Ventures of the Region.

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Thank you to Lisandro Bril -Managing Partner of Axia Ventures- for his collaboration on this piece

Latin American Private Equity and Venture Capital: A Decade in Review

Latin America has had a decade (2002-2012) of solid growth and social improvements.  We believe there were two main factors behind this success: the steep rise in commodity prices and the significant improvements and stability in the politic and economic institutions after 20 years of democracy.

Source: World Bank and IMF

The result was a boom focused in the industries connected to commodities (energy, agriculture, metals) and the industries with high leverage and low risk that benefit from falling bond rates (infrastructure, real estate, transportation, utilities); with spillovers to domestic-demand industries via income growth.

Source:  IMF (2005 base=100)

Source: Multiple sources via http://www.quandl.com/economics/spread-over-us-treasuries-all-countries

The Private Equity Industry had a very good decade as it rode the growth in revenues and multiples of their companies:

• It went from USD 0.5B raised in 2003 to USD 10B in 2011 according to private sources
• It had Return Multiples of 2.4x Market Returns (Bovespa)

Ernst & Young assumes these extra returns come from PE Strategic and Operational Improvements, but that is a rushed conclusion since PE Investments are usually highly leveraged and have a higher beta. However, 2.4 times market returns are great returns and probably well in excess of its risk premiums. PE in Latam was a great investment. 

It is interesting to understand the main drivers of EBITDA growth. PE is usually associated with cost reductions and hard social outcomes as it lays off workers. However, as we can appreciate from the data, PE benefited mainly from Organic Revenue Growth, specially when investing in companies under USD 100MM. Geographic expansion and demand growth, both deeply connected to macroeconomic growth, were the key growth sources. Upon exit, high multiples via lower risk-premia and high growth rounded up the great returns.

This decade also saw the rise of Brazil as a new economic power and a part of the BRICS. Brazil is half of the South American Economy, but it received way more attention from the investment world than the other half. According to private data, Brazil represented 80% of the total Fund Raising of 2011 and 60% of the Investments.

The Venture Capital Industry took part in this wave by investing mainly in Copy Cat Ventures that expanded and replicated companies across the Latin American Market. The focus was mainly in Internet where replication is more often not protected by patents, the technical threshold is low and the market is regional. The main strategic focus when investing in a Region for such ventures is the Size of the Market and its growth. Therefore, its incentives and timing are closely aligned to those in standard PE.

VC Investmet Distribution in Latam

Source: Axia Ventures´ Proprtietary Analysis

Since most investments in VC were made over the past 2-3 years, the jury is still out on its performance. However, early signs suggest good returns for the bigger funds in the Region.


This decade things are starting to change. Growth has slowed down a bit, the investors are paying more attention to the Pacific Alliance countries, R&D Investment is growing quickly, Exchange Rates are changing directions, Bonds have almost no default-risk upside, the Political Map is mutating...

How will the next 5-10 years look like? Should one invest in Latin America? How? Where?

 A new article soon to come.

Financial Risk in Latin America: Beyond Country-Risk Analysis

The financial risk of investing in Latin America is usually misrepresented because of a tendency to synthesize all the risks in a "country risk" analysis.

The most simple way this is implemented is by selecting target countries deemed for investment because of their general risk configuration.Another common analysis of an investment includes building an earnings projection and producing a discount rate. The discount rate is where the risk is accounted for and it is built by adding to the comparable rate from a US company, a "country risk" factor based on the sovereign spread over treasuries.

However, this represents an oversimplification of the risks associated to investments, mainly: Firm Risk, Macroeconomic Risk and Political Risk. 

I have little objections to the analysis of firm risk per se since it is not where the country risk usually comes in. However, the interaction between certain sectors/ firms and other risks should be accounted for.

When investors usually talk about investing in a country, its Macroeconomics are the first thing they look at: GDP growth, Inflation, Real Interest Rate, Probability of Default, etc. However, not every company is equally exposed to these macro trends.

For example, exporters have little exposure to the local GDP, but are exposed to the volatility of the Real Exchange Rate. Even within exporters, Capital or Land intensive companies -i.e. Farms, Metals- are less exposed to Exchange Rates than Human Capital intensive companies -i.e. Business Process Outsourcing-.

Also, the cash flow stress associated to this risk can be stabilized by hedging in the financial markets; but markets are not deep enough to hedge currency or GDP risk for long periods.

To sum up, Macroeconomic risk is based on the company´s exposure to a local economy which is not necessarily only the country where it produces and the risk can be reduced (or exacerbated) by correctly managing it in the financial markets.

Political risk is even more subtle since a company is evidently exposed to the local politics that can expropriate, tax, regulate, declare war, etc. Some extreme events, like war, affect every company alike but are very unusual and have barely ever occurred in Latin America in the past 3 decades.

The main political risk in Latin America is a market disruption (expropriation, regulation, tax), that is why the most "market friendly" governments in the region are the ones foreign investors usually target. This targeting  has three main shortcomings.

Firstly, this analysis overestimates the duration of the political processes in Latin America, extrapolating current government behavior into future decisions.

Also, even if market friendliness is a good proxy for political risk, it overlooks some other associated risks. For instance, Peru and Colombia are the new vedettes of the Latin Financial Markets for their market-oriented governments and their high growth rates. However, in Perú police brutality is a big problem and in some regions in Colombia security risk is still an issue.

Finally, the political risk in every sector and industry is very different in each country. For example, Brazil has more political risk than Chile; but investing in Apparel Retailing in Brazil has much less political risk than investing in Copper Mining in Chile; not only for Copper´s general political risk, but for its cornerstone role in the Chilean Economy. There are differences even within mining: being a supplier to mining companies is a much safer bet than being directly involved in the industry.

In conclusion, yes there are some countries that are more risky than other, but the risk of a company or project should be fully analyzed without simplifications and investors should focus on the level of each risk they are willing to take.


PS: Thks to James Knight of Pionero Partners for his input

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