Notes from the frontline(2)

In the midst of the global economic storm it is more important than ever for private equity firms to do what they do best – due diligence, writes Thomas Gibian.

The current economic crisis has impacted nearly every corner of the globe.  Some emerging markets – such as Africa – have been more sheltered from the fallout compared to those like India or China, because they were never subject to loose lending practices or “hot money”. 

However, fund managers can no longer assume that any country or company is perfectly uncorrelated to the US and other global markets.  Impacts of the crisis pose real threats to portfolio companies worldwide, including those in emerging markets least integrated with the global financial system. We have seen steep falls in certain emerging market stock exchanges, currencies and key commodities; but these declines have not been uniform.  Some markets have been left reeling, while others look nervously around and wonder if the worst has yet to come. 

Thomas Gibian

Unlike previous market shocks — such as the dramatic run up in the price of oil which left both winners (producers) and losers (consumers) – this global financial crisis has resulted in a diminution of value virtually across the board. Almost certainly one response to this will be a dramatically slower pace for private equity fundraising, including those directed toward the emerging markets.  This is in combination with severely restricted access to debt and equity financing for all companies, even those in high-growth markets. 

Developing the contingency plan

Navigating the new economic landscape calls for fund managers to evaluate differences in risk and reconsider any plans that were developed at the time of the initial investment – essentially re-conducting the due diligence process.  What has changed since the initial investment? How will the company perform if it loses its largest customer or supplier to bankruptcy? Under what circumstances would the company need additional financing? How secure are existing working capital and other credit lines?

Answering these kinds of questions enables fund managers to lay out appropriately conservative plans for their portfolio companies, in the event emerging market conditions worsen beyond where they are today.  Previous assumptions must be questioned about the quality of a portfolio company’s decision making or whether management fully understands the stress the company may experience. All of this information should be rolled into an actionable contingency plan that helps portfolio companies prepare for worst-case scenarios on both the micro and macro levels, and helps fund managers protect their investments. 

Evaluating new opportunities

In times of economic crisis, it is often prudent for fund managers to pull back on aggressively pursing new investments and focus on the stability of current portfolio companies. For managers with available resources to transact, investment opportunities will abound, but the timeline for conducting due diligence will likely stretch, no matter how attractively priced deals may appear.

Of course, opportunities to capture value occur in all kinds of markets – perhaps especially in this one.  Private equity firms are ultimately responsible for identifying and creating value for their limited partners. Doing so in this market will require a refreshed focus on due diligence and other private equity best practices. 

Thomas Gibian is chief executive officer of Emerging Capital Partners, an international private equity firm focused on investing across the African continent.