Private Equity in Emerging Markets: Opportunities and Risks in 2024

What is Private Equity (PE)?

Private equity refers to investments made directly into private companies or the buyout of public companies, resulting in their delisting from stock exchanges. 

Private equity firms raise capital from institutional investors and high-net-worth individuals to invest in these companies to improve their value over time. 

This is often done by implementing new management strategies, restructuring operations, or providing financial backing for growth.

The ultimate goal is to sell the company at a higher value through a sale, merger, or public offering, generating a profit for the investors. Private equity investments are long-term and considered a higher risk, but they also offer the potential for high returns.

Private equity investments are increasingly focusing on emerging markets. As these regions continue to grow in global significance, private equity firms are uncovering exciting new opportunities. 

However, a unique set of risks comes with the prospect of high returns. In 2024, steering the constantly evolving environment of emerging markets requires a sharp focus on both the opportunities and the potential pitfalls.

Understanding Private Equity in Emerging Markets

Private equity involves investment funds that buy into companies, usually to restructure and sell them at a higher value. 

Emerging markets, typically including regions such as Latin America, Africa, Southeast Asia, and parts of Eastern Europe, offer fertile ground for such investments due to their growth potential. 

These economies are developing rapidly, often outpacing more mature economies in terms of GDP growth, urbanization, and technological adoption. Private equity funds have become a pivotal tool for channeling capital into these economies, providing investors with opportunities to tap into sectors experiencing significant expansion.
 
In 2024, the allure of emerging markets for private equity is fueled by a mix of economic growth, favorable demographics, and investment-friendly reforms. However, investing in these regions also requires a keen understanding of their unique challenges.

Opportunities in Emerging Markets for Private Equity in 2024

 

Emerging markets present a fertile ground for private equity (PE) firms seeking high-growth opportunities in 2024.

As the global economy shifts, PE firms strategically tapping into these regions can access significant returns by leveraging local trends and overcoming market inefficiencies.

Market Growth Potential

Emerging economies are often characterized by rapid GDP expansion, urbanization, and an expanding middle class. This environment creates a goldmine for PE firms investing in sectors like healthcare, infrastructure, technology, and consumer goods.

For example,  PE firms investing in local tech startups stand to benefit significantly from the wave of innovation in Africa, which is witnessing a boom in its technology sector, with digital adoption accelerating across the continent.

Technology

Technology has long been the crown jewel of private equity investments. From startups in Silicon Valley to established firms in Europe, tech companies are seen as a goldmine. 

For investors, focusing on essential sectors in the digital transformation age is crucial. Companies offering cloud solutions, AI-based services, or cybersecurity can be highly attractive for long-term growth.

For example, the recent rise in fintech companies in regions like Southeast Asia is tapping into the unbanked population, providing financial services that traditional banks have struggled to penetrate.

Healthcare

Private equity firms are focusing on everything from pharmaceutical companies to health tech startups. When evaluating opportunities, private equity investors prioritize businesses developing innovative treatments or cutting-edge medical devices. 

Healthtech startups that offer solutions like remote monitoring or telemedicine are particularly valuable, especially in underdeveloped regions.

As part of recent developments in India, private equity investment in healthcare is skyrocketing, especially in rural areas where access to healthcare has been historically limited. Companies offering affordable diagnostics and telemedicine services flourish, driving profits and improving health outcomes.

Infrastructure

Infrastructure investments are the foundation for long-term, stable returns. As governments across the globe ramp up infrastructure spending, private equity firms are taking note, especially in emerging markets.

Investors seek opportunities in regions where infrastructure is still developing, such as Africa and Southeast Asia. Focusing on green infrastructure—like renewable energy projects—can also align with growing ESG (Environmental, Social, and Governance) criteria.

For example, private equity firms are increasingly investing in renewable energy projects, such as solar farms in Kenya and Nigeria. With a growing demand for sustainable energy and governmental backing, these projects offer societal impact and strong financial returns.

Undervalued Assets

Emerging markets often offer undervalued assets compared to those in more developed economies. This allows private equity investors to acquire businesses at lower multiples, restructure them, and sell them for a significant return on investment (ROI).

For example, while private equity investments in the U.S. or Europe may come with hefty price tags in Southeast Asia or Latin America, businesses can be acquired at more attractive valuations.

PE investors should identify sectors or companies undervalued due to market inefficiencies to maximize returns. This could involve looking beyond the surface and identifying hidden gems in manufacturing or renewable energy industries.

Risks in Private Equity in Emerging Markets

Understanding and mitigating the risks impacting investments' success are important for PE firms aiming to capitalize on emerging market growth without jeopardizing returns.

Political and Economic Instability

The political siuations in emerging markets can be volatile, with changes in government or policy leading to abrupt shifts in the economic environment. This creates uncertainty for investors, as sudden changes in tax laws, trade policies, or foreign investment regulations can undermine the profitability of an investment.

The political climate in certain parts of Eastern Europe remains fragile, with ongoing geopolitical tensions. This instability may deter private equity firms from fully committing capital to the region without proper risk mitigation strategies.

Currency Volatility

Emerging markets often have fluctuating exchange rates, making investments more vulnerable to currency risk. If the local currency depreciates significantly against the investor’s home currency, the value of the investment can plummet, eating into profits.

Investors can hedge against currency risk by entering into forward contracts or other financial instruments that protect against adverse exchange rate movements.

Regulatory Challenges

Regulatory frameworks can be inconsistent or underdeveloped in emerging markets, creating a challenging investment environment. Corruption, bureaucracy, and lack of transparency in legal systems can hinder a firm’s ability to operate smoothly and profitably.

For instance, in some regions, foreign investors may face restrictions on ownership or repatriation of profits. Figuring out these regulatory hurdles requires a deep understanding of local laws and a solid relationship with local legal experts.

 

Best Practices for Private Equity Investors in Emerging Markets

Private equity investors must adopt tailored strategies to navigate these dynamic environments successfully. Key practices such as thorough due diligence, strong local partnerships, and a solid risk mitigation strategy are essential to maximizing returns while minimizing risks.

Conduct Thorough Due Diligence

Due diligence is critical for private equity investments in any market but is especially important in emerging markets. This process should go beyond the financials, considering political risks, market conditions, and regulatory challenges.

Engage local experts to assist in the due diligence process. Their on-the-ground knowledge can help identify risks that may not be apparent from a distance.

Build Local Partnerships

Local partnerships are important for success in emerging markets. Collaborating with local experts, businesses, and governments allows investors to navigate cultural, regulatory, and market-specific challenges.

1. Regulatory Navigation: Local partners understand the regulatory landscape, helping private equity firms comply with complex local laws and avoid costly errors, especially in heavily regulated sectors like healthcare and infrastructure.
2. Cultural Insight: Partners provide valuable consumer behavior and cultural norms knowledge, ensuring businesses adapt effectively to local markets. This is essential for sectors like technology and healthcare, where local preferences and needs can shape success.

For example, several private equity firms in Africa havy partnered with local entrepreneurs to invest in healthcare and energy projects, leveraging local knowledge and networks to drive growth.

Implement a Risk Mitigation Strategy: Diversification

Given the inherent risks of investing in emerging markets, private equity firms must implement a robust risk mitigation strategy. 

This may involve diversifying investments across sectors or geographies, hedging currency risks, or engaging in active portfolio management to respond quickly to changing market conditions.

Diversification is one of the golden rules of investing. This principle holds true for private equity, especially when they’re investing in sectors like technology, healthcare, and infrastructure across various regions.

1. Sector Diversification: By spreading investments across multiple industries, private equity firms reduce the impact of sector-specific risks.
2. Geographic Diversification: Investing in different regions protects against localized risks, such as political instability or economic downturns. A balanced portfolio across developed and emerging markets minimizes the negative impact of regional issues.

For example, a firm might invest in fintech in Southeast Asia, healthcare in Latin America, and infrastructure in Africa. This reduces the chance that a setback in one region will heavily affect overall performance.

Regularly review and adjust your risk mitigation strategy as market conditions evolve. Proactively monitoring political, economic, and currency trends can help mitigate potential downsides.

Private Equity vs. Hedge Fund in Emerging Markets

Comparing the strategies and approaches of Private Equity and Hedge Funds in emerging markets:

 

Outlook for Private Equity Funds in 2024

Private equity funds are set to navigate both challenges and opportunities in 2024, influenced by macroeconomic trends such as inflation, interest rates, and global supply chain dynamics. 

Here’s what to expect:

1. Inflation Stabilization: As inflation stabilizes in many major economies, private equity funds will likely focus on consumer-driven sectors in emerging markets. With purchasing power regaining strength, sectors like e-commerce, retail, and consumer goods are expected to thrive, providing growth opportunities for PE investments.
2. Interest Rate Environment: Higher interest rates in many regions will continue to push PE firms to carefully evaluate their leverage strategies. This could result in a shift towards lower-risk sectors like healthcare and infrastructure, which offer stable returns despite rising borrowing costs. Additionally, PE firms might focus more on operational improvements within portfolio companies to drive value organically.
3. Global Supply Chain Recovery: With global supply chains recovering, private equity funds will see renewed opportunities in sectors like manufacturing, logistics, and technology. Emerging markets that serve as key production hubs, particularly in regions like Asia and Africa, will be attractive for PE investors looking to capitalize on reshoring and supply chain diversification trends.
4. Shift Towards ESG: The rising importance of Environmental, Social, and Governance (ESG) criteria will shape private equity strategies in 2024. There will be increased investment in renewable energy and sustainable infrastructure, especially in emerging markets where governments are prioritizing green growth.
5. Geopolitical Factors: Ongoing geopolitical tensions and trade realignments will push private equity firms to diversify across multiple emerging markets, minimizing exposure to any single region. This will likely spur more partnerships with local players to better navigate regulatory and market-specific challenges.

 

Private Equity Transaction Timeline in Emerging Markets

Private equity transactions in emerging markets often follow a unique and extended timeline compared to deals in developed markets. This is primarily due to factors like regulatory complexities, political instability, and the need for thorough due diligence. 

Here’s a breakdown of the typical stages involved:

1. Initial Market Research and Target Identification (3-6 months)

Before making a transaction, private equity firms need to conduct in-depth market research to identify potential investment opportunities. This phase can be longer in emerging markets. Lack of transparency and inconsistent market information can delay the identification of suitable targets.

2. Due Diligence (6-12 months)

The due diligence phase is more extensive and time-consuming. PE firms must assess the target company's financials, regulatory compliance, operational risks, and market conditions.

This process involves legal, financial, and operational reviews and ESG evaluations. Political instability, opaque regulatory frameworks, and inconsistent accounting practices can lengthen the due diligence process.

3. Regulatory Approvals (6-18 months)

Countries have unique legal and regulatory environments, often involving multiple layers of government approval. Regulatory bottlenecks, changing government policies, and bureaucratic delays can slow the process.

4. Negotiation and Deal Structuring (3-9 months)

After initial due diligence, PE firms begin negotiating terms and structuring the deal. Hedging against currency risk, mitigating political risk, and aligning interests with local stakeholders can lengthen negotiations.

5. Post-Investment Strategy and Value Creation (5-10 years)

The post-investment period in emerging markets requires more active involvement from private equity firms. They work closely with portfolio companies to improve operations and governance and scale the business.

Political instability or changes in local policies can derail post-investment plans. Additionally, firms must proactively address operational inefficiencies or cultural barriers that affect growth.

Conclusion

Private equity in emerging markets presents both substantial opportunities and significant risks. In 2024, as global growth becomes more uneven, these markets will remain attractive to private equity firms looking to tap into sectors with high growth potential, such as technology, infrastructure, and consumer goods.

However, success in these regions requires a careful balancing act. Investors must stay agile, conduct thorough due diligence, build strong local partnerships, and implement effective risk mitigation strategies. As the saying goes, “Fortune favors the bold,”—but in private equity, fortune favors the prepared.

By understanding both the opportunities and the risks, private equity firms can make informed investment decisions that maximize returns while minimizing exposure to potential pitfalls.