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Emerging Markets Private Equity Association 14

Inside Perspectives: An Interview with Cartica


Capitals Teresa Barger
As an experienced investor in both the private equity
and public equity markets, where do the core invest-
ment principles of these two asset classes converge and
where do they differ?
There are signifcant differences between the private equity
and public equity worlds. Whereas my life is largely about
news, a private equity professionals life is primarily focused
on personnel and operational problems. While my time is
spent analyzing monetary policy, theirs is centered on
issues such as production bottlenecks. However, many of
the macro factors that are important to usinterest rate
policies, levels of infation, current account defcits, reserve
requirements for banks and the resulting looseness and
tightness of creditshould also be important to private
equity. While the private equity industry doesnt need to
follow these policy changes on a daily basis, to understand
the market as a whole, private equity funds should pay
special attention to who the decision makers are and what
political pressures these politicians face.
We look to go into countries where public policies are
changing for the better. The best deals are those that have
been made when people go into a market perceived as
high risk and exit at a point in time after positive policy
changes have been cemented. Despite differing time-
frames, this is a successful strategy for both private and
public equity investors.
Today, there are widely divergent pricing dynamics between
these two asset classes. We are currently seeing big splits in
places like Brazil, Turkey and Indiaand the reason is that
a lot of money tends to tumble into private equity at one
time as people follow the trend of the moment. As a result,
people are paying large sums for private companies in these
markets. In Brazil, we are seeing an average 8x price-to-
earnings ratio in the public markets, while valuations are
around 810x EBITDA in the private markets. And so, the
question for institutional investors is: what is the rationale
for putting new money into Brazilian private equity when
they can go into the stock market more cheaply than the
private markets? What is the right time frame and what are
the right comparisons?
In emerging markets, the line between public and pri-
vate equity can sometimes get blurry. What, if any, risk
is there for private equity frms that employ a strategy
of investing in listed companies?
In several emerging markets, there is a growing trend of pri-
vate equity frms buying shares in listed companies. Firms that
do this have to be aware of the plans of the other investors in
the company, as these investors are ultimately going to make
or break their price. For instance, a private equity frm can try
to exit a listed company by selling to a competitor, but they
can only do so if the majority owner is willing to sell.
We have found that sometimes private equity investors are
thrown off by the rules regarding non-public information.
For example, we looked at a listed company in China, in
which a large PE frm owns a 24% stake. When we spoke with
the investment offcer running the deal about basic strategy,
he refused to discuss his own thesis for the investment, in
part, I suspect, because he was uncertain what was public
and what was not. But there are certain ground rules every-
one knows about talking up ones book. If he doesnt care
enough about the stock price to be enthusiastic about his
own investment thesiswhich is not material non-public
informationwhy should anyone care about the stock?
In India, in particular, a lot of private equity ends up in public
companies. Surprisingly, sometimes when we come across
private equity funds going into public companies, we can
fnd that they are doing nothing in terms of creating value.
Theyll negotiate the purchase of a block with the control-
ling family, who will sell it to the private equity frm because
either it was the frst to ask or because it carries a good brand
name. But the private equity players in many cases dont
seem to be deeply involved. Im someone who believes if you
have a relationship with the people who are controlling the
company and you have something to say, it is not that hard
to get people to do things that are in their own self interest,
such as creating value in their own companies.
Some skeptics argue that value creationin both public
and private equitiesis a myth and that professional
investors merely buy low and sell high. What is Cartica
Teresa Barger, Managing Director of Cartica Capital, discusses the dichotomy between private
equity and public equity markets and argues that private equity investors could learn a great deal
from their listed market-focused counterparts and vice versa. Ms. Barger has spent more than 20
years investing in emerging market companies, previously serving as Director of Corporate Gov-
ernance for the World Bank and IFC as well as Director of Private Equity and Investment Funds at
IFC. Cartica is an alternative asset management frm focused exclusively on emerging markets and
is the sponsor of the frst global emerging markets corporate governance fund. Cartica invests
primarily in listed companies using private equity-style due diligence.
Emerging Markets Private Equity Review December 2011 15
doing to create value before exit and what lessons are
there in your approach for private equity investors?
We can often realize value by getting a portfolio company
to behave like a listed companyand not like the private
company it used to be. On the fip side, the private equity
folks could realize greater value on exit by making some of
these changes happen before the company gets listed.
For example, we like going into companies that are not
covered by analysts. Generally, they dont have coverage
because they are small; but even small companies can get
coverage if they make it reasonably easy for the analysts to
cover them. This means having discipline around granular
reporting that includes line of business disclosure (seg-
ment reporting), a quarterly earnings calendar, quarterly
earnings calls with the analysts, and published information
that is easy to understand and available to everybody at the
same minute. We see signifcant opportunities in fnding
these frms that have great products and solid positioning,
but lack the disclosure needed to get analyst coverage.
We can also work with companies to help them understand
the pitfalls of being cash heavy, which investors discrimi-
nate against. Most companies in emerging markets have too
much cash, which ultimately creates a cash drag, or a rate of
return that is lower than what it could have been. Getting
an emerging market company to part with its cash is like
taking a newborn away from its mom. While it is certainly
understandable how many have developed an attachment
to cash, having been through previous cycles when no bank
credit was available, there needs to be a happy medium,
such as having a dividend policy that shows investors the
company is thinking about how to ensure management is
effcient with cash.
Today, headline and macro risk seem to be driving pub-
lic markets more than core fundamentals. With all this
volatility in the market, how do you ensure that the
beta doesnt overwhelm any alpha that you can try to
drive in an underlying company through initiatives such
as greater fnancial disclosure?
Public markets in the last few years have been completely
different from public markets in the preceding 100 years.
Today, its ordinary for a companys stock price to go up or
down by 78% in one day, which was unusual before 2007
2008. Synchronicity (meaning the correlation of stocks to
the index) in the United States is typically the lowest in the
world. In other words, the prices of good companies go up
and bad companies go down of their own volition, regard-
less of how the index performs. However, this August,
correlations in the United States reached a high of 90% for
one day. As an investor, you cant fght that.
Synchronicity in the emerging markets tends to be higher
than in the United StatesSaudi Arabia, where there is lit-
tle analyst coverage of companies, has one of the highest
synchronicity quotients in the world. What we like about
the emerging markets is that all of these countries are on a
curve moving from more to less synchronistic, and so one
can take advantage of this deepening of the markets. In
times of high volatility like today, there is not much to be
doneprices are going to move up and down together.
But, over time, companies can distinguish themselves as
winners in the marketplace.
Many of EMPEAs members believe that often the best
investment opportunities in the emerging markets are
those that are unlisted and not yet able to access fnance
for further growth. By ring-fencing your investment strat-
egy around countries that have deeper and more robust
capital markets, are you giving up more attractive invest-
ment opportunities in less developed or frontier markets?
There are certain country opportunities better accessed by
private markets and others that are either better or equally
accessed through the public markets, and therefore, an insti-
tutional investor needs to think long and hard about asset
allocation for any given country. Some markets, including
many in Africa where market capitalization and liquidity are
limited, cant be tapped through public markets at all. In
China, where there are more options, a lot of investors still
prefer to go in through private equity. There is a huge cor-
porate governance crisis going on in China right now and
people are very suspicious of investing in local companies
in the wake of Sino-Forest, [a commercial forest plantation
operator in China that has recently been accused of infat-
ing its revenue and assets]. That is not to say that there
arent very good listed opportunities, but there is comfort
in a private equity frm being the majority owner of a Chi-
nese company, and thus owning the corporate governance.
The reason I chose to work in public equity is because I can
fnd good companies that produce good products, and which
are essentially mispriced. Because of the lower liquidity in
emerging markets versus developed markets, there is less
price discovery. We can fnd undervalued stocks, work with
the owner to take actions that unlock the companys true
value, and then realize a higher returnand we can do it in
a short period of time. Private equity frms are often waiting
anywhere from 3 to 7 years to realize the fruits of their labor,
whereas, in our experience, if the company is ripe, it can hap-
pen in 1 to 2 years. With an auction on your company every
day, one can get the returns much more quickly.
Inside Perspectives, continued
We can often realize value by getting a
portfolio company to behave like a listed
companyand not like the private company
it used to be. On the fip side, the private
equity folks could realize greater value on exit
by making some of these changes happen
before the company gets listed.

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