Private Equity Case Study: Emerging Markets

Our Client:

A large private equity firm contemplating an emerging markets acquisition.

Situation:

A private equity fund was in a competitive bid situation to acquire a retail store chain in Eastern Europe. While the deal appeared attractive in local currency, it was uncertain when translated in USD. In addition, hedging seemed unattractive because forward exchange rates reflected the deep depreciation of the local currency.

Summary:

The investment team’s objective was to determine the most cost-effective hedging strategy, the likely key drivers of the local currency and the maximum exposure to their returns should their equity be unhedged. Chatham Financial was able to assist in exploring various hedging strategies including forwards, options and inflation-linked instruments. Also, we assisted in researching various macroeconomic data for the country to develop correlations against the investor’s base currency, modeling pro-forma financial statements using real (inflation adjusted) forward rates and quantifying the range of IRR and terminal value USD if the equity was unhedged.

Outcome:

Once the cost of hedging and risk of equity returns were considered, the firm was able to make an informed risk-adjusted bid for the business. While the firm ultimately lost the bid for the firm, the investment committee was able to establish firm norms and expectations around how to best evaluate bids in emerging markets.