EMPEA Emerging Markets Mezzanine Report May 2014 WEB

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Private Credit Solutions

Mezzanine Financing in
Emerging Markets
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E M E R G I N G M A R K E T S P R I VAT E E Q U I T Y A S S O C I AT I O N • M AY 2 0 1 4
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About EMPEA EMPEA’s Board of Directors
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EMPEA is the global industry association for private capital in emerging H. Jeffrey Leonard, Chairman
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markets. We are an independent non-profit organization. As EMPEA celebrates President and CEO, Global Environment Fund
our 10th anniversary in 2014, we have over 300 member firms, comprising Teresa Barger, Vice Chair
institutional investors, fund managers and industry advisors, who together Managing Director, Cartica Capital LLC
manage more than US$1 trillion of assets and have offices in more than 100
countries across the globe. Our members share EMPEA’s belief that private Tom Barry
President and CEO, Zephyr Management, L.P.
capital is a highly suited investment strategy in emerging markets, delivering
attractive long-term investment returns and promoting the sustainable growth Michael Calvey
of companies and economies. We support our members through global Founder and Senior Partner, Baring Vostok Capital Partners
authoritative intelligence, conferences, networking, education and advocacy. Okechukwu Enelamah
Chief Executive Officer, African Capital Alliance
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Paul Fletcher
EMPEA Consulting Services
Senior Partner, Actis
Nadiya Satyamurthy Mike Casey Sam Verran Mark Kenderdine-Davies, Secretary

Senior Director Director Senior Analyst General Counsel and Company Secretary, CDC Group plc
Roger S. Leeds
Guest Contributors Professor, Johns Hopkins University, SAIS
Piero Minardi
Amjad Ahmad, Senior Managing Director, NBK Capital Partner, Gávea Investimentos
Luc Albinski, Managing Partner, Vantage Capital Sanjay Nayar

Chief Executive Officer, KKR India Advisors Pvt. Ltd.
Ben Edwards, Managing Partner, Syntaxis Capital
Ziad Oueslati
Rick Frank, Managing Director, Darby Private Equity, Latin America Founding Partner, AfricInvest Group
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Johnny Jones, Associate Partner, Vantage Capital Robert Petty, Treasurer

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Managing Partner and Co-Founder, Clearwater Capital Partners

Joachim Schumacher, Senior Director, DEG
Nicolas Rohatyn
Simon Sham, Managing Director, Darby Private Equity, Asia Chief Executive Officer and Chief Investment Officer, The Rohatyn
Group (TRG)
André Roux
Production Assistance Chief Executive Officer, Ethos Private Equity Ltd.
Ben Pierce, Pierce Designers Jean Eric Salata

Founder and CEO, Baring Private Equity Asia
Mani Saluja
Partner and Co-Head, Emerging Markets Private Equity, Quilvest
George W. Siguler
Managing Director and Founding Partner, Siguler Guff & Company
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Tom Speechley
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CEO, Abraaj North America/Partner, The Abraaj Group
Rebecca Xu
Co-Founder and Managing Director, Asia Alternatives
Management LLC
Yichen Zhang
Chairman, Chief Executive Officer, CITIC Capital
For more information or to begin a project

1077 30th Street NW • Suite 100 • Washington, DC 20007 USA with EMPEA Consulting Services, contact the
Phone: +1.202.333.8171 • Fax: +1.202.333.3162 • Web: empea.org team via email at consulting@empea.net.
Private Credit Solutions
Mezzanine Financing in Emerging Markets
Contents
Acknowledgements.................................................................................................................................. 2
Letter from EMPEA Consulting Services.................................................................................................... 3
What is Emerging Markets Mezzanine Financing?.................................................................................... 4
The Risk/Return Profile of Mezzanine in Emerging Markets..................................................................... 6
Investor Perspectives on Mezzanine: An LP Roundtable..........................................................................13
The Scale of the Emerging Markets Mezzanine Industry.........................................................................16
Sidebar: DEG’s Perspective on Emerging Markets Mezzanine.................................................................18
Regional Profiles
Emerging Asia...................................................................................................................................20
Sidebar: Darby Private Equity—The Mezzanine Landscape in Asia.................................................21
CEE and CIS.......................................................................................................................................22

Sidebar: Syntaxis Capital—A Focus on Mezzanine in Central Europe – A Historical Perspective.......23
Latin America....................................................................................................................................24
Sidebar: Darby Private Equity—The Evolution of Mezzanine Financing in Latin America...............25
Middle East and North Africa..........................................................................................................26

Sidebar: NBK Capital—Bespoke Financing – A Perfect Fit for an Imperfect Market.......................27
Sub-Saharan Africa...........................................................................................................................28
Sidebar: Vantage Capital—The Risk/Return Profile of Mezzanine in Sub-Saharan Africa...............29
A product of EMPEA Consulting Services
©EMPEA MAY 2014. ALL RIGHTS RESERVED. PRIVATE CREDIT SOLUTIONS: MEZZANINE FINANCING IN EMERGING MARKETS • 1
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Acknowledgements
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We are grateful for the generous support we received from EMPEA Members and industry
participants in producing this publication.
In particular, we would like to thank the numerous fund managers active in mezzanine investing across
the emerging markets that donated their time and provided valuable data sets to help inform our
analysis. We’d also like to thank the institutional investors and placement agents, both active and
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inactive in this segment, for sharing their insights with us.

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We would especially like to thank the following firms for providing key thought leadership as well as
the financial support necessary for this syndicated report:
C O R E UN DER WR I TER S
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S UPPOR TI N G UN D ER WRITE R DATA PARTNE R
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Disclaimer: This information is intended to provide an indication of industry activity based

on the best information available from public and proprietary sources. EMPEA has taken
measures to validate the information presented herein but cannot guarantee the ultimate
accuracy or completeness of the data and information provided. EMPEA is not responsible
for any decision made or action taken based on information drawn from this report.
Copyright © 2014 Emerging Markets Private Equity Association. All rights reserved. Any reproduction and/or
redistribution of any text, paragraph or illustration in whole or in part, without written permission from the publisher,
is strictly prohibited.
2 • EMERGING MARKETS PRIVATE EQUITY ASSOCIATION

A Letter from EMPEA Consulting Services
Dear Reader,
EMPEA is delighted to present this special edition of Private Credit Solutions:

Mezzanine Financing in Emerging Markets, our first in-depth look at the role that
private credit plays in supporting the development of small- and medium-size com-
panies across the emerging markets, and in offering institutional investors a means
of accessing this growth. This inaugural private credit report takes a deeper look
in particular at mezzanine, an instrument that occupies the space between debt
and equity in a firm’s capital structure, and offers entrepreneurs a financing option
with fewer restrictions than pure debt and less ownership dilution than pure equity.
Over the last few years, we have witnessed a surge in interest in emerging markets private credit. Growing numbers
of private equity and hedge fund managers have expanded into this space in the quest to become more diversified
asset managers, and new entrants have emerged seeking to offer a solution to countless businesses in desperate
need of financing. Amidst heightened competition, the sophistication and variations in financing structures have
increased, as has the diversity in the markets in which they are deployed. Institutional investors are increasingly
seeking to better understand how private credit can offer emerging market exposure with tailored risk mitigants,
including built-in exits and upside potential. Our latest Global Limited Partners Survey reveals that nearly half of all
surveyed participants have or want to have exposure to this asset class.
With this report, we tackle the broad and murky topic of mezzanine finance—and with few mezzanine transactions
structured the same, this segment is frequently and easily misunderstood. While mezzanine finance has evolved
into a US$100 billion industry in developed markets, it remains nascent in emerging markets. Our analysis shows
that mezzanine fund managers constitute 3% or less of each emerging market region’s private equity landscape,
most of which are also still very much in the process of developing. As such, the amount of research and thought
leadership devoted to this subject to date has been limited. We hope that this publication serves as a step toward
a broader conversation on many of the key questions top of mind for industry participants, such as: what is mez-
zanine and how is it distinguished from private equity? What is the risk/return profile of mezzanine investing in
emerging markets? Where does emerging markets mezzanine fit in institutional investors’ portfolios? And how
does the practice of mezzanine differ across markets?
We believe that private credit can play a critical role alongside private equity in filling the acute financing gap beset-
ting so many emerging market-based companies. And while this report focuses on just one slice of this universe,
EMPEA considers the development of other private credit strategies, such as direct lending and distressed/special
situations, equally important in fostering a vibrant private capital ecosystem. The release of this report coincides
with the launch of EMPEA’s Private Credit Council, which aims to provide a forum for our members to exchange
information and best practices on private credit investments in emerging markets and to also advise EMPEA on issues
impacting the community in order to help us identify and execute related priority content, programs and initiatives.
This report also marks the first syndicated report undertaken by EMPEA’s new Consulting Services team, which is
dedicated to providing bespoke research services to our members on the topics of greatest importance to them. We
look forward to working with many of our other members on similar initiatives in the future.
As always, we welcome any feedback you may have at consulting@empea.net.
Sincerely,
Nadiya Satyamurthy
Senior Director, Consulting Services
Emerging Markets Private Equity Association
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What is Emerging Markets Mezzanine Financing?
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Access to finance is one of the most prevalent challenges facing
countless entrepreneurs and business owners across the emerg- Constructing the Mezzanine Return
ing markets. Local banks have traditionally focused their lend- Although the structure of a mezzanine deal varies by transaction,
ing on only a handful of large companies—in part, because they there are a number of commonly used instruments that drive an
investor’s return. These instruments can generally be divided into
view smaller firms as having insufficient assets or collateral— those that are contractual and those that are performance-based.
while the global financial crisis and subsequent introduction This distinction is important as it helps delineate the key sources of
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of new capital adequacy requirements have resulted in many risk and return in a given deal and throughout a portfolio.
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of the international banks scaling back their emerging market Contractual

activities in recent years. Even when bank debt is available, it Cash Pay: The core of any mezzanine investment is a debt product
that pays a negotiated interest rate, or cash pay, on a regular basis
is often short term in nature and does not provide the type of (annual, semi-annual, quarterly, etc.). The cash pay depends on the
patient capital small- and medium-size companies need to grow. specifics of the investment but is typically set at a spread above a
base rate, such as Libor or Prime. In our data set on 109 mezza-
While private equity is one viable option to bridge this gap,
nine investments in emerging markets, this rate ranges between
entrepreneurs are sometimes hesitant to go this route due to a 5% and 21%.
reluctance to give up equity in their companies. In such cases,
Payable in Kind (PIK): Commonly used alongside subordinated
another alternative exists: mezzanine financing. debt, a PIK loan is a debt instrument on which the interest is not
paid out during the tenure of the investment but instead accrues
The Space In-Between to the principal, which is repaid at the end of the life of the loan.
One benefit of this structure is that it enables a portfolio company
Encompassing a wide range of debt and equity positions that
to postpone payment on a portion of its debt, reducing the near-
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can be structured in a variety of ways, mezzanine is a complex term financial burden on the business.
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sub-asset class. As one veteran of the industry explains, “The only

absolutes we know are that we’re not senior debt and we’re not Performance-based
pure equity.” Mezzanine refers to the level of financing that sits Equity Kicker: The term equity kicker can refer to a variety of
mechanisms through which an investor acquires an equity stake
above equity and below senior debt in the capital structure— in the portfolio company. Common equity kickers are warrants
in other words, in the event of a default, mezzanine investors (allowing for the purchase of equity in a company at a fixed price
stand in line behind all senior obligations but in front of equity until a set point in time) and conversions (allowing for the con-
holders—and is priced according to its position (see Exhibit 1). version of a bond to equity). Equity stakes held by mezzanine
investors can be monetized either through a put option agreed to
The various structures that mezzanine investors employ include between the investor and the portfolio company, or through the
sale of a holding during an IPO or strategic sale. Investors can also
secured subordinated debt, convertible subordinated debt and
achieve upside in returns through equity-like instruments, such as
preferred shares, and through combinations of various instru- profit sharing structures, which guarantee the investor a dividend
ments (see sidebar on Constructing the Mezzanine Return), based on a percentage of the company’s revenues, EBITDA or other
these providers are able to move up and down the capital struc- measurement of performance.
ture (from what some industry participants refer to as “debt
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plus” to “equity minus”) to achieve a desired risk/return profile. Exhibit 2: Illustrative Components to Mezzanine Returns
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Exhibit 2: Illustrative Components to Mezzanine Returns

This flexibility in structuring deals enables mezzanine investors
to create a blend of downside protection and upside participa- 6-8% 18-24%
tion tailor-made to each investment opportunity, for instance

by matching the structure to the cash flow profile of the firm. 4-6%
8-10%
Exhibit
Exhibit1:1:Mezzanine
Mezzaninein in
thethe
Capital Structure
Capital Structure
Senior Subordinated Senior Debt Cash Pay PIK Equity Kicker Total
Debt
Subordinated/
Together, each of these various instruments contributes to the
Unsecured Debt
Mezzanine overall returns of a mezzanine transaction. Exhibit 2 illustrates
how the returns on a mezzanine investment might be generated,
Convertible with contractual returns in blue and performance-based returns in
Subordinated Debt purple. Deals that are purely contractual are sometimes referred to
Equity as “warrantless,” while deals with an equity interest are referred
Preferred Shares to as “warranted.”

Mezzanine in Emerging Markets infrastructure or real estate deals, and are often used to comple-
Since its genesis in the United States in the 1980s and expan- ment the funding provided by senior lenders and boost returns for
sion into Western Europe the following decade, mezzanine in equity providers. At the other end of the spectrum is “traditional
developed markets has matured into a US$100 billion dollar mezzanine,” which either represents a “sponsored” deal (where a
industry. Initially driven by interest from insurance companies mezzanine provider works with one or more investors—whether
but now supported by a range of institutional investors, mezza- financial or corporate—to offer a comprehensive financing pack-
nine financing in the West is used by companies for a multitude age to a company) or a “non-sponsored” or “sponsorless” deal
of reasons, including as growth capital, for restructurings or (where a mezzanine investor lends directly to a company).
recapitalizations, and as part of leveraged buyout packages.
Mezzanine financing in emerging markets—and the core focus of
In contrast, mezzanine finance in emerging markets is fairly this report—is about sponsored and non-sponsored transactions.
young and less commoditized. Parts of Central and Eastern Ben Edwards, Managing Partner of Syntaxis Capital, a mezzanine
Europe, Asia and Latin America were home to a few mezzanine provider focused on Central Europe and Turkey, notes, “In most
investments in the 1990s, yet the number of firms offering the emerging markets, mezzanine investing is traditional mezzanine.
product was tiny. While the universe has gradually and mar- We work one-on-one with companies, both in partnership with
ginally expanded in these regions and has begun to develop a private equity firm and directly with the entrepreneurs. We
in parts of the Middle East and Africa in recent years, there structure a mezzanine loan that fits their specific business plan
remain very few dedicated mezzanine specialists operating in and overall objectives, and typically we have active involvement
these markets. Further compounding the slow speed at which with the company’s Board. It’s hands-on at the operational level,
the industry is developing is the fact that in many of these in contrast to what one sees in the larger mezzanine segment
countries, the credit, private equity and capital markets are all such as the high-yield market in the United States.”
also themselves still in the process of developing.
There is a tradeoff between sponsored and non-sponsored deals
Mezzanine investing in emerging markets is markedly different for emerging market mezzanine fund managers. While partici-
than its developed market counterpart. As Rahul Bhargava, pating in sponsored deals brings many advantages, such as the
Managing Director and Partner of Southeast Asia-focused fund opportunity to leverage the resources of private equity investors
manager Leafgreen Capital explains, “Mezzanine in developed while conducting due-diligence on a target company and in sup-
markets is about filling a gap in the capital structure. In our part porting a firm should the business falter, there are also drawbacks.
of the world, mezzanine is about filling a funding gap. Perhaps In addition to negotiating the terms of the intercreditor agreement
a more appropriate label is structured growth funding. It’s with the senior lender, a mezzanine investor in a sponsored deal
about supporting good companies, typically in the mid-market, must negotiate with the equity sponsors its contractual returns
that are not able to access traditional bank funding; not able and equity participation, which may temper its overall return.
to access the bond or IPO markets because of their size and
depth; and, not wanting to take private equity just yet because Chris Chia, a Managing Partner at Asia-focused structured equity/
of the level of dilution and terms.” mezzanine provider Kendall Court Capital Partners, explains why
his firm only does non-sponsored deals. “[In sponsored deals]
This funding gap is widespread across all emerging market you’re sandwiched. The private equity guys want to cap your
regions and serves as the lead driver of mezzanine activity. upside and not share any equity because you’re both swimming
In Central and Eastern Europe, for example, Franz Hörhager, in the same lane and trying to maximize returns. And then the
Founding Partner of Mezzanine Management, states, “The main banks do not want to share the downside with you (especially
factor pushing companies in our markets to seek mezzanine in an undeveloped intercreditor regime), so you are left feeling
financing is the lack of SME bank debt available in the region. like an orphan in the structure. I’d much rather go directly to the
So many institutions in Central and Eastern Europe are owned companies that are looking for growth capital.”
by Western banks that have suffered under Basel III, which
forced them to cut the balance sheets of their subsidiaries. Regardless of whether a transaction is sponsored or non-spon-
And even the banks that are still present in this space are quite sored, much of the mezzanine financing in emerging markets
hesitant to get into the ‘riskier’ deals.” is committed to small- and medium-size companies that are
cash flow positive and looking for financing to fuel growth,
Institutional vs. Traditional Mezzanine fund acquisitions or recapitalize. The companies are attracted
In recent years, a stratification of the mezzanine industry in the to mezzanine because it offers long-term capital without heavy
United States and Western Europe has emerged. At the larger end equity dilution, and can be adapted to each business’s unique
of the spectrum sits “institutional mezzanine” or sizable financing situation. It is precisely this flexibility that is the sub-asset class’s
solutions often led by credit institutions that underwrite a signifi- key strength: the ability to weight debt and equity instruments
cant chunk of a deal and distribute the mezzanine component to with a bespoke approach to ensure an alignment of interests
other credit investors. Many of these transactions are focused on with the portfolio company.
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The Risk/Return Profile of Mezzanine in Emerging Markets
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Mezzanine fund managers often claim to provide 80% of the Security
returns of private equity with 50% of the risk. Though these Contractual security on a mezzanine loan is a key factor in reduc-
numbers are just estimates, they get at the heart of the challenge ing the risk of an investment. While mezzanine debt can be
either asset- or cash flow-based, the security on asset-backed
for mezzanine investors: a risk-adjusted pricing and payment
debt is traditionally second or third lien. Depending on the mez-
profile. Luc Albinski, Managing Partner at Vantage Capital, a zanine investor’s position relative to senior banks, security on the
South Africa-based investment and financial services group that assets of a portfolio company can, to varying degrees, protect its
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has raised two mezzanine funds to date, notes, “The risk that we invested capital in the event of a default or bankruptcy. Though
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are taking, and an assessment of that risk, is as important to us mezzanine debt is by definition subordinate to senior debt in the
capital structure, the dearth of senior lenders in many emerging
as the return. What we sell to our LPs is the fact that we are not
markets has resulted in mezzanine investors sometimes being
just chasing returns, but rather we are seeking the best possible the only debt providers in a deal, giving them the ability to
ratio of return to risk—and that is a much more challenging tar- secure senior rights to the assets of the target company or to
get than one of simply striving to achieve a return somewhere combine a second lien position on assets secured by banks with
between senior debt and private equity. You could get that return first lien rights that do not fall within the bank security pool.
but be taking completely insane risks in order to achieve it.” One institutional investor with experience investing in emerging
markets mezzanine observes, “Traditionally mezzanine funds
In general, the risks facing emerging market mezzanine inves-
haven’t had the experience of standing first in line for a security
tors are not that dissimilar from those facing their private equity
buffer as they were obviously behind senior debt. However, in
counterparts. They must contend with a variety of global, coun-
the last two years in a handful of the more developed emerging
try and company-specific risks (see Exhibit 3 for a sampling).
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markets, we have seen these firms manage to structure deals

However, this particular sub-asset class is designed to offer
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with a senior type of security while still achieving mezzanine debt

investors a less risky profile than equity, and as such, mezza-
returns. So the risk-adjusted return has been further enhanced in
nine investors can employ a number of tools to optimize their
the ‘new normal,’ as opposed to three to five years ago, depen-
targeted level of risk in any given transaction.
dent of course on the assessment of the underlying business risk.
This is definitely an attractive quality for the strategy.”
Mitigating Risk Through Mezzanine
Some of the factors that drive the level of risk in a mezzanine Regardless of whether a mezzanine investor holds first or sec-
transaction include the strength of security, the ability to influ- ond lien, an obvious question arises as to whether this security
ence a business through covenants, the terms driving self-liqui- can be enforced given the nascent state of legal systems in
dation, and the presence of a committed investor in sponsored many emerging markets and the wide-spread lack of well-devel-
transactions. Each of these factors can attenuate stresses at the oped bankruptcy codes. One fund manager advises, “You have
global, country and company level. A more detailed look at each to makes sure that the structures you put in place are adequate
of these features is summarized below. in terms of enforcement. In many markets, this means that
the enforcement needs to be as far outside the court process
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Exhibit
Exhibit 3:
3:Consideration
Considerationofof
Risks
Risksforfor
Emerging Market
Emerging Market as possible, for instance, by being able to avoid foreclosures
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Mezzanine
MezzanineInvestments
Investments and sell your assets through an auction.” Another mezzanine
investor notes, “When we have had to rely on built-in remedies,
they have worked—not painlessly, but they have worked. While
the equity might have been wiped out, we were preserved.”
Global Robert Graffam, Senior Managing Director at Darby Private

•Currency/FX movements
•Changes in key interest rates
Equity, recalls a transaction where relying on built-in remedies
•Health of export markets was the case. “We did a deal in Mexico ten years ago with a com-
pany focused on long-distance telephony. It sold calling cards to
the Mexican population in America so that they could call home.
This used to be a very attractive segment of the market but, in
Country Company the years after we invested, rates on calls between Mexico and
•Political stability •Scale and maturity the United States dropped from 19 cents to 3 cents per min-
•Legal and regulatory
environment
•Amount of leverage
ute. The industry disappeared. Nevertheless, we recovered our
•Market position
•Depth and sophistication
•Degree of security money, and the reason we could do this was we had a first mort-
of banking system
•Depth of capital markets
and covenants gage on the company’s fiberoptic cable. Though negotiations
•Presence of sponsor
•Inflation were acrimonious at times, we enforced our rights and sold the
•State of infrastructure
assets to Telmex. The important thing for mezzanine investors is
that they have a remedy should something bad happen, or if a
company is underperforming or violating covenants.”
Growth
is never by mere chance;
it is the result of forces
working together
Vantage Capital facilitates the growth of mid-market enterprises in South Africa

and the rest of Africa by providing expansion capital and strategic advice.
Growth capital for mid-market enterprises
+27 11 530 9100

www.vantagecapital.co.za
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The Risk/Return Profile, continued
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While the security on a debt is an important risk mitigant, many
fund managers stress that relying solely on such security is a
mistake, and instead argue for cultivating a strong relationship Does Risk Mitigation Actually Work?
with the company and all other interested parties before a deal
is inked. As part of this process, many mezzanine investors often
Case Study: Efekto Care
request to sit as observers on Boards and financial, audit and/or Country: South Africa
risk committees. Syntaxis’s Edwards explains, “Our investments
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offer downside protection through security—not because we ever Business Description: Efekto Care sources, packages and dis-
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plan at the outset to go down the enforcement route, but because tributes various plant protection, plant nutrition and home care
products. Efekto Care has a 70% to 80% market share in the plant
it gives us a seat at the table when things need fixing. In this way,
protection market through its Efekto brand, and a 50% to 60%
we can protect our position, often by providing new money, but on market share in the plant nutrition market through its Wonder
terms that work for all the other parties involved. Achieving con- fertilizer brand.
sensus is crucial, especially because we operate in markets where
Investment Details: In 2011, Vantage Capital invested ZAR87.5
the bankruptcy regimes and courts are often still developing.” million (~US$12 million) in the buyout of Efekto Care by Ascendis
Health and Management, a South African health and care brands
Covenants company. The proceeds of the investment were used to bolster
Covenants negotiated with a portfolio company are an import- Efekto Care’s working capital, and to finance capital expenditures
as well as Efekto’s bolt-on acquisition of Avima (a pesticide com-
ant tool mezzanine investors use to exercise control. Often
pany). Vantage secured an 18.4% equity stake in Efekto Holdings
mirrored after the documents put in place by senior lenders, and a further equity option to acquire a 5% or 10% sharehold-
certain covenants are triggered when a company undertakes a ing in Efekto Holdings, Ascendis Health or any shareholder of
prohibited action, such as raising new debt or selling existing Ascendis Health in the event of a listing or sale of shares.
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assets, while others stipulate certain performance requirements,

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In July 2013, Vantage exited through a senior debt refinancing

such as meeting cash flow or EBITDA targets, or opening an (since Ascendis Health sought to list itself on the JSE) and received
agreed-upon number of new stores within a certain time period. a settlement of ZAR150 million, which together with interest gener-
ated a rand-denominated IRR of 51.7% (1.9x money) in 21 months.
If a company breaches the covenants of a deal, the mezza-
Sources of Risk:
nine investor often has the contractual right to force a partial • Competitive Landscape – International companies could
debt prepayment, intervene in the company’s operations (e.g., enter the South African plant protection or plant nutrition
changing capital expenditures or dividend policies), or adjust market, eroding market share;
pricing based on an increased risk profile. As Vantage’s Albinski • Company Risk – Inadequate financial and stock control
puts it, “Covenants are important because they ensure that if systems could lead to lost sales and poor working capital
things are not going to plan, you will be able to exercise sig- management; and,
nificant pressure to get the company to take remedial action • Macroeconomic Risk – Garden and home-care products are
to address the problems, to restructure the debt, or to prepay discretionary expenditures, which get cut during periods of
some of it through an equity issue.” soft economic conditions.
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Risk Mitigants: The Vantage facilities were secured by surety-

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However, having covenants that are too numerous or too strict ships from Ascendis Health (the equity sponsor), Coast2Coast
imposed on a company can have the opposite of their intended Investments (Ascendis Health’s parent company) and all whol-
effect. Syntaxis’s Edwards notes, “In the markets where we oper- ly-owned subsidiaries of Coast2Coast Investments. Vantage
ate, it’s often the banks that pose the biggest risk. Because they had a first-ranking claim over Efekto Care’s trademarks, which
were independently valued at ZAR80 million, in addition to
are still building their leveraged finance capabilities, they some-
second-ranking claims over all other assets. Vantage also had
times straightjacket a company by imposing a huge number financial covenants, observer seats on the Board and audit com-
of sometimes meaningless obligations and covenants. Imagine mittee, and super-voting rights in the event of default.
“
you’re working with a management team that has identified an
opportunity to buy a bunch of secondhand assets at a fantastic Our investment helped Efekto
price that will increase production and the value of their security,
but to do it the banks need to agree to a minor amendment. It Care fund growth, and at the
may make sense for the company and the value of the business, same time was a spectacular
but ultimately the bank might say no because it only sees the success for us: 52% IRR and
downside, and that’s probably after charging a fee to consider
the request. Having an unsupportive bank continually involved 1.9x in 21 months”
in a company’s operations to the point where management is — Luc Albinski, Managing
constantly looking over its shoulders can be soul-crushing for
teams and clearly not good for the value of businesses.” Partner, Vantage Capital

Self-Liquidation The Sponsor
Capital preservation is a core component of the mezzanine Sponsored mezzanine investments can further mitigate risks
investor’s value proposition. Unlike traditional private equity, in a transaction, as the resources that strategic or financial
where committed capital is locked into a deal until a liquid- sponsors bring to a deal can reduce the financial burden on
ity event occurs, mezzanine investments are self-liquidating, mezzanine investors while enhancing due diligence and moni-
removing a potential bottleneck should M&A or IPO markets toring. Furthermore, a strong sponsor can bring to bear finan-
become less favorable. cial and operational resources should the business falter and
require additional backing. “Typically, a private equity firm will
If risk is defined as the potential permanent loss of capital, the have significant additional capital that they can deploy into a
self-liquidating nature of mezzanine debt helps gradually to transaction if the company is not meeting its targeted profits
reduce risk throughout the life of the investment, as the cash and needs more support,” notes one industry participant, “This
pay on mezzanine debt reduces the capital exposure from makes the quality of the sponsor a key risk criterion for us when
the moment the investment is inked. According to Vantage’s evaluating investments.”
Albinski, “If you are earning a 20% cash return, after the first
year you have received 20 cents on your dollar back, and after Participation in sponsored deals can reduce the exit risk for
the second year, almost half of your capital has been returned. mezzanine investors as well. Whereas in direct deals the mez-
Typically, problems in a portfolio company won’t surface in day zanine investor must shoulder the burden of arranging an exit
one or year one; it may take several years for issues to arise, by for the equity position, the presence of a sponsor can amplify
which time you may have much of your loan already repaid leav- the likelihood of a liquidity event.
ing your net capital exposure at risk significantly reduced.” Even
when there is no financial distress, a company may show modest
The Track Record of Mezzanine in Emerging Markets
or no growth in earnings; a mezzanine investor will be protected
in this scenario, in part, by the cash pay and PIK components. The Data
EMPEA collected constituent investment and performance data
The equity component of mezzanine deals can also be self-liqui- from a number of mezzanine fund managers relating to 109
dating if a put option is obtained, providing an investor with a transactions. The data include a blend of fully exited, partially
guaranteed sale of their equity stake back to the company. Of the exited and unrealized transactions. Exhibit 4 provides a break-
56 deals with disclosed information regarding put options stud- down of the data set’s demographics by region, sector com-
ied for this report, 71% included a put option on the equity kicker. position and whether the deal was sponsor-backed or direct
This self-liquidating feature was one of the key drivers in the to company.
early growth of mezzanine in emerging markets, as many inves-
tors believed in the growth opportunity that emerging markets Of the 50 sponsored deals, 33 occurred in Central and Eastern
offered but were not convinced that proper exit avenues existed. Europe and the Commonwealth of Independent States;
Exhibit 4: Data Set Demographics
Exhibit 4: Data Set Demographics
Deal Count by Region Sponsored vs. Direct Deal Count by Sector
4 9
12
21
6
6
14
57 47%
8
53%
20
22 11
13
CEE and CIS Latin America Emerging Asia Non-Sponsored Sponsored Industrials/Manufacturing Consumer
Sub-Saharan Africa MENA Media/Telecom Infrastructure
Energy/Natural Resources Banking/Financial Services

Source:EMPEA.
Source: EMPEA.
Note:Sector
Note: Sector chart
chart based
based on with
on deals dealsdisclosed
with disclosed
sectors. sectors.
Healthcare/Life Sciences Other
14
’
10
’
10
’
10
’
innovative financing across

global emerging markets
In 2009, one of Turkey’s entrepreneurial families sought long-term financing in order to expand the family’s
bottled water business. Darby made a mezzanine and equity investment in the company to allow it to build
a modern factory and launch new products. The Darby investment combined with the expertise of the Darby
team facilitated the company’s rapid growth while allowing the family to remain in control during a major
10
expansion phase. By 2013, the company had grown to become one of Turkey’s leading branded bottled water
’
companies and Darby’s stake was acquired by a multinational.
Darby — partnering with growth businesses across the emerging markets.
For further information, contact Scott Gregory, Managing Director, at +1 (212) 632-4118 or sgregory@doil.com.
The Risk/Return Profile, continued
however, 81% of the region’s sponsored deals occurred between Deal-level Returns
June 2003 and September 2008, which speaks to the private Examining approximately 75 realized transactions—and
equity industry dynamics in the region in the years leading up excluding outliers—the median emerging market mezzanine
to the global financial crisis. This finding implies that mezzanine deal returned a 1.5x gross multiple, with the middle 50% of
in emerging markets is now more of a direct form of financing deals delivering between 1.1x and 1.9x money (see Exhibit
than the aggregate data might suggest. 5). Indicative of mezzanine’s risk/return profile, the minimum
return achieved a 0.1x return on capital, while deals incorporat-
ing substantial equity kickers achieved gross returns upwards of
Exhibit
Exhibit 5: Performance
5: Performance of EM of EM Mezzanine
Mezzanine Transactions
Transactions 6.4x. We acknowledge that there may be some bias in this data
Gross
Gross Multiples
Multiples on Realized
on Realized Deals Deals set and that not all mezzanine transactions are guaranteed to
7 achieve positive returns.
Max = 6.4x
Fund-level Returns
6
At the fund level, we received realized gross IRR data for approx-
imately 10 emerging market-dedicated mezzanine funds from
5 vintage years between 1999 and 2011. The median fund deliv-
ered a gross IRR of 17.2%, with the middle 50% of funds deliv-
Gross Multiple
4 ering between 13.4% and 29.3% (see Exhibit 6).
Debt Component Returns

3
Amongst the data set, 34 deals contained details on both the
duration and rates tied to the debt components utilized in
2 Q3 = 1.9x the transaction. The range of tenors was diverse on a regional
Med = 1.5x basis: average duration was longest in Latin America at seven
1
Q1 = 1.1x years, with tenors approximately half as long in Central and
Eastern Europe and the Commonwealth of Independent States
Min = 0.1x (see Exhibit 7). The average interest rate tied to debt financ-
0
ings was 540 basis points higher in Sub-Saharan Africa than in
Source: EMPEA.
Source:
Note: EMPEA. ~ 75 transactions; excludes outliers.
Incorporates Emerging Asia.
Note: Incorporates ~ 75 transactions; excludes outliers.
In general, investors are compensated for taking on greater

duration risk—not surprising given the shape of the standard
Exhibit
Exhibit 6: Performance
6: Performance of EMof EM Mezzanine
Mezzanine Funds Funds
Gross IRRs at Fund Level yield curve—but perhaps not as much as one might expect (see
Realized Gross IRRs at Fund Level Exhibit 8). The relationship between duration and yield exhibits
60%
an extremely weak correlation (R-squared of 0.07), suggesting
that mezzanine fund managers do, indeed, work with compa-
Max = 54.5%
nies to structure bespoke financing packages suited to corpo-
50% rate objectives and local financing conditions.
Exhibit 7: Debt Component Characteristics

40%
AVG. DURATION AVG. ANNUAL
(YEARS) INTEREST RATE (%)
Gross IRR
30% Q3 = 29.3%
Asia 4.6 10.4
CEE and CIS 3.7 11.3

20%
Med = 17.2%
Latin America 7.0 12.0
Q1 = 13.4%
10% MENA 4.3 11.1
Sub-Saharan Africa 6.5 15.8

0% Min = - 0.6%
Source: EMPEA.
Note: Arithmetic mean, not weighted by deal size; floating rate notes were pegged to base/reference rates
Source:
Source: EMPEA.
EMPEA. as of 4/14/14.
Note:
Note: Incorporates ~ 10
Incorporates ~ 10 EM-dedicated
EM-dedicated mezzanine
mezzanine funds
fundswith
withvintage
vintageyears
yearsbetween
between1999
1999and
and2011.
2011.
©EMPEA MAY 2014. ALL RIGHTS RESERVED. PRIVATE CREDIT SOLUTIONS: MEZZANINE FINANCING IN EMERGING MARKETS • 1 1
14
’
Risk/Return Profile, continued
10
’
What is clear in analyzing this data set is that each emerging Exhibit
Exhibit 8: Cash
8: Cash Pay
Pay on on Mezzanine
Mezzanine Financings
Financings
market transaction is unique as various combinations of instru- Returns
Returns on Debt
on Debt Components
Components (2006-2013)(2006-2013)
ments have been employed. In discussing this dynamic, Amjad
Ahmad, Senior Managing Director and Head of Alternative 25%
Investments at NBK Capital, a Middle East and North Africa-
focused alternative investments fund manager explains, 20%
Annual Interest Rate

“Mezzanine structures in our market can vary significantly from
10
on Debt (%)
one deal to the next. The asset class is not as structured as it 15%
’
R = 0.07348
is in developed markets; mezzanine is fairly new to both the
region and business owners, so structuring and pricing is inno- 10%
vative with no two identical instruments. Our typical structure
is a subordinated note with some kind of equity participation. 5%
Depending on the jurisdiction, we have structured preferred
shares, warrants, sharia-compliant notes and simple profit par- 0%
ticipation. Security is usually a pledge of shares with additional 0 1 2 3 4 5 6 7 8 9
security in the form of second lien on key assets; at times we can Duration of Debt Financing (Years)
secure first lien if available. Overall, the structuring and pricing
2006 - 2008 2009 - 2011 2012 - 2013
is more aggressive than developed markets given the lack of
Source:
Source:EMPEA.
EMPEA.
a transparent and structured market for these instruments.”
Another trend evident in the data set is that mezzanine strat- in the past, 80% to 90% of our returns would come from con-
10
egies in emerging markets have evolved over time. Kendall tractual obligations, and now maybe 40% of the returns will
’
Court’s Chia shares the drivers behind his firm’s evolution, come from the debt side and we’re willing to take more of an
“When we got started between 2004 and 2007, we approached equity view on the remaining 60% of the pie.”
mezzanine in a very structured debt-type manner, where we
wanted 20% plus fixed debt returns on everything. In 2008- The diversity of structures, approaches and markets may leave
2009, when the global financial crisis hit, our strategy had to institutional investors considering investing in emerging mar-
change because we started to see this structure as counterpro- kets mezzanine with a number of questions. The next section
ductive to growing businesses by compressing their net income of the report seeks to provide some answers, as a number of
and making it more difficult for them to get cheaper sources limited partners share their views on and experience with the
of funding. So we started to switch to more of an equity bias; sub-asset class.
A Closer Look at Mezzanine Performance in the United States and Europe

In the United States and Europe, where mezzanine finance has have been 21.5% and 17.4%, respectively. Median gross multiples
10
existed decades longer than in emerging markets, the track record during the same time period have averaged 1.4x in Europe and
’
suggests that returns for mezzanine have historically been fairly 1.5x in the United States, though they exhibit a downward trend
robust. According to data from CEPRES, on average, the median in recent years.
gross IRRs between 1999 and 2012 in the United States and Europe
Exhibit 9: Median Gross IRRs, Realized Transactions Exhibit 10: Median Gross Multiples, Realized Transactions
35% 35%
31% 31%
2.0
30% 28% 30% 1.87 28%
27% 27% 1.9 27% 27%
23% 23% 1.8 23% 23%

25% 22% 25% 22%
21% 21%
Multiple
20% 1.7 1.61 1.61 20%

Gross IRR
IRR
19% 19% 1.58

20% 18% 20% 18%
1.55 1.54 1.54
17% 1.6 17% 1.52
16% 16%
Gross
1.5 1.40
1.43
15% 15% 1.38
Gross
1.4 1.34 1.32

9% 9%
10% 10%
1.3
1.2
5% 5% 1.07
1.1
14% 17% 16% 20% 23% 23% 16% 14% 12% 12% 19% 7% 28% 24% 1.51
14% 1.53
17% 1.50
16% 1.48
20% 1.54
23% 1.51
23% 1.29
16% 1.26
14% 1.13
12% 1.39
12% 1.55
19% 1.15
7% 1.17
28% 1.17
24%
0% 1.0
0%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1999
1999 2000
2000 2001
2001 2002
2002 2003
2003 2004
2004 2005
2005 2006
2006 2007
2007 2008
2008 2009
2009 2010
2010 2011
2011 2012
2012
Europe United States Europe

Europe United States
United States
Source: CEPRES.

Investor Perspectives on Mezzanine: An LP Roundtable
EMPEA interviewed a blend of industry professionals to capture LP perspectives toward mezzanine funds in
emerging markets. In this LP roundtable, the participants share their candid commentary on mezzanine’s risk/
return profile, how it compares to traditional private equity, what deters them from committing to a mezzanine
manager and more.
The participants—who asked to remain anonymous—include senior professionals from a family office, a
foundation, an international finance institution, a fund of funds, an investment consultancy and a placement
agency. As a group, the participants have worked with fund managers active in each emerging market region.
What factors led you to begin committing capital From an asset allocation perspective, where does
to mezzanine funds in both developed and emerging mezzanine fit within your portfolios?
markets?
Family Office: We’re not very rigid in our approach. We sim-
Foundation: We have no mezzanine exposure in developed ply view it as a private markets opportunity, and we allocate
markets because the capital structures in private equity deals are roughly 20% of our portfolio to private company investments—
less favorable than they are in emerging markets. For example, be they through private equity (inclusive of venture capital,
in developed markets, mezzanine is sitting in the middle of growth equity and buyouts) or credit-related strategies. We
the capital structure between equity and senior debt; when an are completely flexible across strategies, so everything is bot-
investment goes into a restructuring, mezzanine is in a relatively toms-up and opportunistic.
weak negotiating position. We find that the return profile in
developed markets may be attractive from an IRR perspective, Foundation: For us, it’s within our private equity bucket. We
but not from a multiple perspective, largely because they tend define an asset class by the characteristics of the underlying invest-
to miss out on the equity upside. ment. The fact that there is a significant component of returns
that can come from equity leads us to put it in private equity.
In emerging markets, however, this is less the case, and the
risk/return profile is much more attractive. One of the funds in Fund of Funds: From a fund of funds perspective, we find that
which we are invested has a base contractual return between mezzanine can be quite complementary to our private equity
15% and 20% with equity kickers (or warrants) attached. A exposure. In particular, it gives us a greater degree of predict-
key difference from developed markets is that while invest- ability in terms of what the return outcome will be on a deal-by-
ments may legally be a mezzanine piece in the capital struc- deal basis—provided that each of the transactions is structured
ture, in practical terms it can be closer to being senior. This appropriately—and it also provides our portfolio with a cushion
fund manager often is the only lender so it has a much bet- through a flatter J-curve.
ter opportunity to negotiate terms, to the point of getting
What’s interesting is that our investors see the merits of looking
seniority on collateral in certain cases. It’s attractive to get
at mezzanine as an addition to their portfolio, but more recently
mezzanine returns with senior debt terms.
they are looking to us for pure private equity exposure. That
Family Office: I would agree with that perspective. We did said, our investors would allocate to a mezzanine fund through
not look at many mezzanine funds in Europe or North America their debt bucket. They look at it as an alpha generator overlaid
because the product is more of a commodity—it’s much more on a traditional bond portfolio.
standardized. Additionally, the banks are more dominant in
How does mezzanine stack up against pure play
those markets and the overall returns are not attractive.
private equity? How important of a factor is the
While we are invested in a private debt manager in Asia and a downside protection on offer?
venture-related debt fund in the United States, we only have
Foundation: Lending strategies in emerging markets are very
one pure mezzanine commitment—and that’s to a manager
competitive against private equity, since most of the private
in Africa. To be honest, we were not looking for mezzanine
equity returns we’ve seen have not been superior to those in the
investments in the region, but we liked the strategy, the mar-
Western world. We certainly try to understand the risks a fund
ket and the competitive landscape. We also thought it would
is taking, but we don’t invest based on a technical risk/return
be a good entry for us into the region—to invest in a product
metric. If we find a lending manager that does mezzanine or
that has a bit more downside protection and is less risky than
senior, an important aspect is to understand how thorough the
a pure equity play.
underwriting process is. If this is combined with an attractive
return profile, we will invest.
14
’
LP Roundtable, continued
10
’
“
Placement Agent: Large institutional LPs tend to look at a A key difference from developed
firm’s return profile, so instead of looking at the downside pro-
tection, they ask, “why should I go for a lower return if these markets is that while this fund may
companies are growing 4% to 6% per annum?” You might as legally be a mezzanine piece in the
well go for the action. The downside can tip the scale, but only capital structure, in practical terms
when there’s sufficiently attractive upside.
it is much closer to being senior.
10
IFI: To play devil’s advocate, I think mezzanine is attractive once It’s attractive to get mezzanine
’
it starts hitting 15% to 20% IRRs. But this can be difficult to

achieve even with straight equity funds. I’m also a bit skeptical
returns with senior debt terms.”
that mezzanine investors can sustainably get both upside and —Foundation representative
downside; after all, there’s no such thing as a free lunch. I’m
sure such deals have been done, but I’m inclined to think that
relying on the naiveté or lack of sophistication on the part of
sponsors is not a sustainable strategy. company and manage problems if and when they arise. I’m
not saying that private equity fund management is easier, but
Investment Consultant: I don’t entirely agree; I think the risk/ personally, from an IQ perspective, I think mezzanine is a bit
return profile is attractive. We are keen on mezzanine and think more difficult. A group of entrepreneurs can run a private equity
it fits nicely into an asset allocation strategy. A number of our fund successfully because they know how to run businesses;
clients that have gone into mezzanine understand it slightly but when it comes to engineering the capital structure of a
better than private equity, and the risk profile is more palatable firm—primarily at the debt level—I would prefer an experienced
10
to groups of trustees that do not want to embrace the per- mezzanine debt financier.
’
ceived risk of private equity funds. Our advice to clients is that

we can model a diversified portfolio that can meet their return Family Office: I agree. Whether it’s a private equity deal or a
objectives, and that mezzanine has a role to play because of its mezzanine deal, it’s always important to structure the transac-
risk/return structure. tion well; but it’s even more important to structure the terms
and the legal agreement the right way with mezzanine. What
Fund of Funds: Downside protection is important and mezza- we like about our private equity funds is that they’re active
nine debt can work extremely well, but there are times when it managers of the underlying portfolio companies throughout
can unravel. A cautionary example of this would be the global the holding period of their investments. Mezzanine, on the
financial crisis. We saw mezzanine managers with anywhere other hand, is more limited; the manager is kept informed but
between 1.5x to 2x collateral cover, but it was tied to property. is not as active as a private equity player, so it’s critical to do the
Well, along came the crisis and valuations got re-rated; all of right things up front when structuring the deal.
a sudden that 2x coverage dropped down to 1x. And then the
senior debt holders, who were ahead of the mezzanine man- What typically deters LPs from committing to
agers in the capital structure, began executing fire sales, which emerging market mezzanine funds? Are there any key
10
hit valuations even harder. So those who were left standing sec- pain points?
’
ond or third in line ended up recouping 70 cents on the dollar.

Granted, that’s a drastic example, but I think investors need to Foundation: In most cases it’s due to limited transparency;
be careful when choosing their managers to ensure that they’re in other cases, we see managers with strategies that are too
sophisticated enough to structure deals well. opportunistic. We look for a repeatable process in both private
equity and mezzanine. In some instances, we’ve looked into
What skillsets should LPs look for in a mezzanine mezzanine managers but they were taking on too much equity
fund manager? Are they qualitatively different than risk versus debt risk; and some have had very aggressive strat-
those they should seek in a traditional private equity egies putting too much leverage into a deal while lacking the
fund manager? appropriate underwriting for the transaction.
Fund of Funds: The skillsets are vastly different. In the mezza- Investment Consultant: This may be a function of the dynam-
nine space we prefer to see people with significant debt capi- ics of our market, but one of the key inhibitors is the size of the
tal markets, debt structuring and banking experience. We also local investor base. We don’t have a lot of institutional inves-
like to see lawyers who know how to structure agreements tors that have sufficiently large pools of assets to build private
appropriately to secure the liens. In private equity, on the other equity—let alone mezzanine—programs. So, for example, if an
hand, we like to see a blend of entrepreneurs, industry special- investor puts US$100 million into a fund, that could be upwards
ists, perhaps some engineers—people that can add value to a of 2% of their assets. This effectively serves as a barrier to entry.

Finally, how do you see mezzanine in emerging Fund of Funds: I see mezzanine continuing to grow. With the
markets evolving over the next three to five years? new Basel capital adequacy rules rolling out over the next few
years, banks will continue to be under pressure; so there will be
Family Office: In general, I think private debt and private credit an opportunity for niche, specialized lenders to emerge. Africa, in
are attractive. As we all know, the banks are pulling back; there particular, will be a lot more exciting over the foreseeable future
simply is space in emerging markets for other forms of credit from a mezzanine perspective because the banks are not skilled
aside from the big banks. We would certainly like to add more enough to provide structured finance or mezzanine facilities just
private credit products to our portfolio in the future. yet—they are still mostly involved in vanilla senior lending.
Placement Agent: I believe private credit will have a much more
“
important position in investors’ portfolios going forward. Two of
The skillsets are vastly different. the emerging market credit funds we’re working with manage
3x to 4x portfolios; a firm that can provide a 3x gross return
In the mezzanine space we prefer with full downside protection and potential upside participation
to see people with significant debt will garner attention. Investors are looking for yield and they
capital markets, debt structuring are no longer as content with minority stakes in their pure pri-
vate equity allocations. Investors today are open to choice and
and banking experience.” mobility in the capital structure, so they will want to retain a
—Fund of Funds representative degree of flexibility and not be locked into one rigid structure.
∆DEG – financing opportunities

in future markets.
Perspectives for businesses and people.
Enterprises seek to seize opportunities, develop markets and

succeed in their environment. At the same time they foster
economic growth, create jobs and give people a future.
For more than 50 years DEG partners with enterprises invest-

ing in emerging economies. At DEG we promote successful
entrepreneurial initiative as key catalyst for sustainable growth.
Creating opportunities for businesses and people.
More information:
www.deginvest.de
info@deginvest.de
14
The Scale of the Emerging Markets Mezzanine Industry
10
’
As highlighted on previous pages, the mezzanine industry in However, a greater awareness of what mezzanine offers—the
emerging markets remains fairly small. The competitive land- asset side of its equation and not just the liabilities—may unlock
scape to date has been comprised of (1) dedicated mezzanine the door to more partnerships as this financing vehicle may
sometimes be better suited to a firm’s strategy and/or situation
specialists; (2) private equity firms that have raised focused
than other sources of capital. As NBK Capital’s Ahmad explains,
mezzanine funds; (3) private equity firms that have made ad hoc
“We try to be pragmatic and base our approach on achieving
mezzanine investments through their private equity funds; and the business owner’s goals while providing the right return for
10
(4) banks and (less frequently) hedge funds that have provided the level of risk we are taking. In many cases, business owners
’
mezzanine financing to select companies. For the purpose of are seeking equity capital while they are reluctant to offer a
analyzing how much money has been raised for mezzanine in significant stake, appropriate minority rights and/or Board seats.
emerging markets over the last several years, we have included They are in essence seeking mezzanine but are not aware of the
product. Mezzanine has its advantages in such cases as it reduces
only the first two categories in Exhibit 11.
dilution for current shareholders and eliminates the need for
Coming off of a peak of nearly US$1.9 billion raised in 2008 extensive structuring around minority rights and in particular
just prior to the onslaught of the global financial crisis, emerg- exits. The product is well suited for growth capital opportunities.”
ing market-dedicated funds have witnessed a slowdown over
In addition to the entrepre-
the last several years. Many
neurs, a lack of familiarity,
of the mezzanine funds that Exhibit 11: Emerging Markets Mezzanine Fundraising,
as well as general disinterest,
have recently closed are tar- 2008–2013
Exhibit 11: Emerging Markets Mezzanine Fundraising, 2008-2013 within pockets of the limited
geting Emerging Asia, which
partner community has also
10
may not be surprising given $2,000 1,866 12

restrained a more rapid devel-
’
the explosive growth in pri-

10 opment of emerging markets
vate equity across the region $1,600
mezzanine. Several of the fund
No. of Funds
over the previous decade, and 8
US$ millions
indeed may be a harbinger for

$1,200 managers that we interviewed
6 for this publication com-
the sub-asset class’s coming 783
$800 658
of age. In 2013, Hony Capital 492 4 mented that they have found
457
closed its China-focused Hony $400 numerous institutional inves-
218 2
Capital Mezzanine Fund with tors to be generally uninter-
RMB1 billion (US$163 mil-
$0 0 ested in risk-adjusted returns.
2008 2009 2010 2011 2012 2013
lion) in capital commitments, One notes, “They just want
Total Capital Raised No. of Funds
while the prior year saw you to colonize Mars and get
CITIC Private Equity Funds,
Source:Source:
EMPEA.EMPEA. the highest returns possible
Everbright Private Equity and when investing in an emerg-
10
Darby Private Equity all close ing market.” Another fund

’
on their most recent Asia-focused mezzanine vehicles. In fact, manager remarks, “I have had investors say to me that if I go
in the last two years, 75% of the capital raised for emerging to China, which is already a high-risk play, I want the maximum
market mezzanine funds has been earmarked for Emerging Asia. upside. After all, this is my mad money.”
Several key factors currently hinder greater development of mez- Nonetheless, several institutional investors have embraced
zanine in emerging markets, including a lack of understanding of emerging markets mezzanine, including insurance companies
the product amongst emerging market entrepreneurs. Nicholas and development finance institutions, which like its ability to
Kabcenell, head of Darby’s mezzanine investment platform in offer access to a growing segment of an economy while mini-
Central Europe notes, “One of the challenges we’ve faced as a mizing volatility in returns, particularly in the post-financial crisis
firm doing mezzanine for 15 years is that the product is often world. Mezzanine Management’s Hörhager, comments, “There
misunderstood by investee companies. The growth stage firms we was a time when people thought mezzanine returns were not
look at start out seeking either additional cheap bank-like debt or good enough and they would only go for equity, but people
minority equity. Many of these companies learn eventually that have become more realistic and changed their views. When
they can’t get any more debt and they can’t get minority equity as markets are hot, people are often just focused on returns and
many private equity investors insist on a controlling stake. As such, want to make a killing. In difficult times, especially after the
a core part of our business and marketing efforts is focused on crisis in the years between 2009 and 2011, investors are more
educating prospective borrowers. In time, many of these compa- focused on protection of capital. This has given mezzanine a
nies come to understand the benefits of patient, long-term capital revival and we now get many unsolicited calls. We offer a rela-
and the value-add that an experienced partner can provide.“ tively safe product with an attractive return.”
“
When markets are hot, people are often just focused on returns and want
to make a killing. In difficult times, especially after the crisis in the years
between 2009 and 2011, investors are more focused on protection of capital.
This has given mezzanine a revival and we now get many unsolicited calls.”
—Franz Hörhager, Founding Partner of Mezzanine Management
While development of the asset class has been slow, several emerging markets (see Exhibit 12). One institutional inves-
signs point to the potential for a brighter outlook going for- tor cautions, “I think several of these guys are going to get
ward. Institutional investor interest is growing—in EMPEA’s lat- hurt along the way because they have still got to experience
est Global Limited Partner Survey, nearly half of the surveyed something called time.” But regardless of how they fare, this
respondents want to have exposure to private credit, inclusive rise in the number of new fund launches is a critical step in
of mezzanine—but as noted in many of our conversations building the skill sets and track records that these markets
with LPs on the subject, a key barrier for them is the limited need to attract funding.
number of funds in this space. However, several mezzanine
funds are now being launched across a number of emerging The following pages take a deeper look at each emerging mar-
markets that have historically offered little to no financing ket region to give our readers a better sense of some the partic-
products beyond plain vanilla debt, public and private equity, ular dynamics affecting mezzanine investment in each of these
including in parts of Africa beyond South Africa, the Middle markets. In addition, some of our members who have pioneered
East and some of Latin America’s more frontier markets. These mezzanine in their respective regions share in their own words
new funds are joining a small but active base of established more on the history, challenges and opportunities of mezzanine
mezzanine investors in actively deploying capital across the investing in emerging markets.
Exhibit 12: Sampling of Recent Mezzanine Investments in Emerging Markets

INVESTMENT INVESTMENT
FUND MANAGER C O M PA N Y N A M E COUNTRY SEC TOR
A M O U N T ( U S$ M ) DAT E
Adobe Capital FINAE Mexico Banking/Financial Services N/A January 2013
Alta Ventures Mexico Clip Mexico Banking/Financial Services 2 November 2013
Chevalier International
Asia Mezzanine Capital Group China Industrials/Manufacturing 30 May 2013
Holdings
Darby Private Equity China F&B Group China Consumer N/A December 2013
Darby Private Equity Bioerix Uruguay Technology N/A September 2013
Darby Private Equity Alta Rail Technology Brazil Technology 15 April 2013
ICICI Venture Funds

Jyoti Structures India Energy/Natural Resources 31.6 September 2013
Management
Kendall Court Cambridge

Merdeka Serasi Jaya Indonesia Mining 80 February 2014
Investment Manager
Mezzanine Management
Bella Bulgaria Bulgaria Industrials/Manufacturing 18.5 August 2013
Central Europe
NBK Capital Al Rowad Saudi Arabia Consumer 27 October 2013
Reliance Private Equity Khadim India India Industrials/Manufacturing 14 September 2013
Forbes and
Resource Capital Funds South Africa Energy/Natural Resources 6 September 2013
Manhattan Coal
Small Enterprise Assistance

Alzani II Georgia Energy/Natural Resources 3 May 2013
Funds (SEAF)
Syntaxis Capital BIK Brokers Poland Financial Services N/A September 2013
Vantage Capital Kgoro Central South Africa Real Estate 16.1 June 2013
Vantage Capital Genser Energy Ghana Energy/Natural Resources 15 March 2013

Democratic Republic
XSML Cotrama Services N/A November 2013
of the Congo
DEG’s Perspective on Emerging Markets Mezzanine
14
’
10
A Conversation with Joachim Schumacher, Senior Director
’
Why should private pools How has DEG’s experience with mezzanine funds led
of capital, such as pension the organization toward its long-term belief in the
funds, endowments and sub-asset class?
family offices commit to
emerging market mezza- We are an investor in 12 mezzanine funds with a total exposure
nine funds? of more than US$200 million. We also have a direct investment
mezzanine portfolio of more than US$1 billion. We invested in
10
On why they should commit to the first mezzanine funds in Eastern Europe, China and India;
’
emerging markets, these econ- and our portfolio is performing well. If you look at our transac-
omies demonstrate strong tions that are closer to equity mezzanine than debt mezzanine,
long-term growth based on a the overall return is just slightly below that of our equity port-
number of competitive advan- folio. And my perception is that the risk is significantly lower.
tages, including resources, For example, following the financial crisis, we saw private equity
demographics, increasing funds in some of our South African investments taking large
trade, and a growing middle class with consuming power. At haircuts whereas, in the mezzanine position, we felt comfort-
the same time, the lack of risk capital is much more pronounced able and had a relatively strong negotiating position.
than in developed markets. Emerging markets are less efficient,
For commercial LPs that are considering commitments to
so there is an ability to arbitrage between perceived and actual
emerging market mezzanine funds, what distinguishing
risks. I personally believe that over the past five decades this
characteristics or skillsets should they look for in a manager?
arbitrage opportunity has been a significant contributor to
DEG’s bottom line. The teams that we have backed have equity experience, but
10
they also have to have a credit track record. I believe it is more

’
On why they should commit to mezzanine, I’d make two

difficult to find a good mezzanine manager than it is to find
points. First, a large portion of the growth dynamics in emerg-
a good credit or private equity manager because you have to
ing markets is driven by owner-managed companies, which
think upside while protecting the downside; and it is very tricky
you cannot buy on a stock exchange; and oftentimes there are
in mezzanine not to get caught in a trap where you sacrifice
difficulties accessing these companies with traditional private
more return than you mitigate risk. It’s also helpful if they have
equity because owners are reluctant to cede control. Unlike
a private equity network, since sponsored deals can be an easy
developed markets where buyouts are used to align interests
way to generate deal flow.
between the investor and owner, emerging markets primarily
consist of growth capital deals, which can create challenges In my experience with mezzanine, it’s also very useful to be able
when attempting this alignment. Many of our family-owned to play the entire risk/return curve. Fund managers have to earn
and -run portfolio companies tell us that they were very happy their carry, which can often lead to equity-style mezzanine, but
to receive risk capital that did not interfere as much with their we like to see structures that balance the interests of owners
decision-making, strategy and vision as private equity would and investors.
10
have, which leads us to believe that mezzanine in emerging

’
markets can provide a good menu of options for structuring Looking forward, what are the prospects for mezzanine
deals that balance the interests of owners and investors. in emerging markets?
Second, you can de-risk your investment faster with mezza- If you look at the evolution of financial markets in emerging
nine structures. For example, you can have a cash coupon, markets, my sense is that credit markets come first, then the
regular interest or principal payments resulting in a sched- equity markets, and mezzanine is the last segment to develop.
uled amortization of your principal. With small- and mid-size My thesis is that as these markets mature, you will have more
companies where you have higher exit risk, sometimes having active players, more people gaining experience in different types
regular payments can also increase the firm’s financial disci- of financings, and increased competition in the debt and equity
pline. You have a preference over the equity investors in the markets—these are catalysts for the mezzanine sub-asset class.
capital structure, and from a portfolio perspective, the J-curve The largest bottleneck to its development is to convince owners
of a mezzanine fund is much less pronounced, enabling you to to accept the value proposition of mezzanine, which can take a
smooth your cash flows. This makes mezzanine an attractive long time. However, the potential for mezzanine is significantly
option for entering a new market or balancing volatility. Finally, higher than anything you see in the markets today.
with mezzanine you can make a more conscious decision on
DEG, member of KfW Bankengruppe (KfW banking group),
how exchange rate risk is allocated among the company and finances investments of private companies in developing and
investors by choosing your currency, and because you have a transition countries. As one of Europe’s largest development
repayment schedule, it is easier to hedge some of this risk than finance institutions, it promotes private businesses to contribute
with an equity stake. to sustainable economic growth and improved living conditions.
INNOVATE  EXCEL  LEAD
NBK Capital’s Alternative Investments Group is a leading private equity and mezzanine fund manager in the MENA
region. Since 2005, we have raised over USD 700 million for growth capital investments in middle market companies.
With a focused strategy and strong investment team, we consistently develop businesses to deliver value for investors.
NBK Capital Equity Partners Fund I (closed): USD 250 million private equity fund focused on acquiring both minority
and majority stakes in growing middle market companies across the MENA region.
NBK Capital Equity Partners Fund II (raising): USD 300 million private equity fund focused on acquiring both minority
and majority stakes in growing middle market companies across the MENA region.
NBK Capital Mezzanine Fund I (closed): USD 158 million credit fund focused on providing tailored credit financing
to growing middle market companies across the MENA region.
KUWAIT  DUBAI  ISTANBUL  CAIRO nbkcapital.com

14
Emerging Asia
10
’
10
’
COMPETITIVE L ANDSC APE
# of Known Mezzanine Fund Managers as a % of Private Equity/

2.6%
Private Credit Managers in Region
Depth of Local Banking Systems Legal Protections

10
160
80 Indonesia
’
140
70
Commercial Bank Branches
Enforcement of Contracts
60 120
(Costs as % of Claim)
(Per 100,000 Adults)
50 100
40 80
OECD
30 Members 60
India
40 OECD
20
Indonesia High Inc.
10 India 20
China China
0 0
0 20 40 60 80 100 120 140 160 0 10 20 30 40 50 60 70 80 90 100
Domestic Credit to Private Sector by Banks Resolving Insolvency

(% of GDP) (Recovery Rate – ¢ on $)
10
Sampling of Mezzanine Funds in Emerging Asia

’
F U N D M A N A G E R / S P O N S O R (S ) FUND NAME FOCUS WEBSITE

Asia Mezzanine Capital Group Asia Strategic Capital Fund (2007, US$95 million) Asia www.asiamezzanine.com
CITIC Private Equity Funds Management CITIC Mezzanine Fund I (Fundraising) China www.citicpe.com
The Enterprise Fund I (2006, SGD124 million/US$74.7 million);

Crest Capital Asia Singapore www.crestcapitalasia.com
The Enterprise Fund III (Fundraising)
CX Partners CX Partners Intermediate Capital Fund (2014, US$70 million) India www.cxpartners.in
Darby Asia Mezzanine Fund II (2006, US$254 million);

Darby Private Equity Asia www.darbyoverseas.com
Darby Asia Opportunities Fund III (2011, US$83 million)
Everbright Mezzanine Capital Fund (2012, RMB1 billion/

Everbright Private Equity China www.everbright165.com
US$158 million)
Hony Capital Hony Capital Mezzanine Fund (2013, RMB1 billion/US$163 million) China www.honycapital.com
ICICI Venture Funds Management India Advantage Fund VII (Mezzanine Fund I) (2007) India www.iciciventure.com
Intermediate Capital Group Intermediate Capital Asia Pacific Fund 2008 (2008, US$1 billion) Asia www.icgplc.com
Kendall Court Mezzanine Bristol Merit Fund (2008, US$150 million); Southeast
Kendall Court Capital Partners www.kendallcourt.com
Kendall Court Cambridge Fund (Fundraising) Asia
Phillip Ventures Enterprise Fund 3 (2010, SGD170 million/

Phillip Private Equity Asia www.phillipprivateequity.com
US$129.7 million)

The Mezzanine Landscape in Asia
Simon Sham, Managing Director, Darby Private Equity, Asia
As large buyout funds became growth capital in Southeast Asia. We believe tighter local lend-
active in Asia in the mid-2000s, ing conditions will increase the flow of mezzanine investment
U.S. and regional commercial opportunities in the coming years as many small to mid-sized
banks—and a few dedicated local companies seek expansion capital. We also see growing
mezzanine funds—partici- demand for mezzanine financing for mid-sized buyout invest-
pated in several high-profile, ment opportunities, particularly in Singapore and Malaysia,
non-infrastructure buyout driven by first- or second-generation entrepreneurs who are
transactions through mezza- nearing retirement and looking to sell their businesses.
nine loans, attracted by the
large deal size and relatively With respect to Asia’s two largest economies, there are unique
higher return. At the same regulatory hurdles in China and India impacting mezzanine
time, mezzanine emerged as investors. Direct mezzanine investment by a foreign fund in
an alternative form of growth China is extremely difficult as a government license is required
capital for small and medium-sized companies in the region for the extension of loans, and U.S. dollar debt would require
that had difficulty securing long-term bank financing for additional approval from the State Administration of Foreign
growth, but were generally hesitant to accept private equity Exchange. Therefore, U.S. dollar mezzanine investment in China
partners due to concerns over equity dilution. As a result, ded- may only be done via lending to offshore holding companies
icated growth capital mezzanine funds, hedge funds and sev- that have operating subsidiaries in China. The offshore holding
eral large regional commercial banks became active suppliers companies in turn inject the loan proceeds into their Chinese
of expansion capital to these medium-sized companies using operating subsidiaries in the form of equity or shareholder loans.
mezzanine structures.
In India, a foreign fund, unless categorized as a “Recognized
Since the global financial crisis of 2008-2009, however, growth Lender” by the Reserve Bank of India (RBI), is only legally per-
capital mezzanine investing by hedge funds and commercial mitted to invest in an Indian company in the form of equity
banks has been significantly curtailed. Today, only a handful of investments or unsecured rupee-denominated debentures
dedicated growth capital mezzanine funds continue to operate that are mandatorily convertible to equity at maturity. Some
actively in the Asian market. We have noticed select private foreign mezzanine investors have attempted to replicate the
equity funds beginning to offer an investment structure similar downside protection of a mezzanine instrument by structuring
to mezzanine, but accepting higher equity risks than traditional a put option back to the controlling shareholder of the portfolio
mezzanine loans in exchange for a higher expected return. company, but a recent RBI notification has cast doubt on con-
tractual arrangements that create an obligation on an Indian
Looking forward, we believe China continues to offer promising
party to buy securities at a price that results in assured returns
prospects for mezzanine growth capital investment given its
for the investor.
large economy and expanding number of mid-sized companies.
With credit tightening, many of these Chinese companies that While these regulatory issues present challenges to mezzanine
wish to expand their operations have difficulties in securing investors in China and India, the overall future for the prod-
long-term financing from domestic banks, which are primar- uct in Asia is bright. Given the region’s anticipated economic
ily asset-based lenders or focused on state owned enterprises. growth, the continued reluctance of the banking sector to pro-
The uncertain prospect of listing an IPO on the domestic stock vide long-term unsecured capital, and the desire of entrepre-
exchanges has forced many mid-sized Chinese companies to neurs and family groups to obtain needed long-term growth
look for alternative sources of funding, including both private capital without losing operating control or experiencing heavy
equity and mezzanine capital. equity dilution, we believe mezzanine will play a critical role
Outside of China, Southeast Asian countries have been gaining in the financing of Asia’s small- and mid-sized businesses.
favor as growth capital destinations over the past few years, as
Darby has been a mezzanine investor in Asia since 2002, having
evidenced by the growth of dedicated Southeast Asian private managed three regional mezzanine funds totaling US$533 mil-
equity funds—EMPEA data show that US$2.9 billion was raised lion, which have invested in 23 companies across China, South
for Southeast Asia-dedicated funds in 2013, following US$4.4 Korea, India, the Philippines and Indonesia. Our initial focus was
billion in aggregate capital raised between 2010 and 2012. the infrastructure sector and our first vehicle was active in pro-
Although investors have become cautious about Indonesia viding mezzanine loans to infrastructure companies as expansion
recently, Darby views the country as a leading market for capital for development of new projects.
14
CEE and CIS
10
’
10
’

1.6%

10
50
’
70
60 40
50
Russia 30
Turkey
40 OECD
High Inc.
Poland OECD Poland
30 Members 20
Russia
20 Turkey
10
10
0 0
0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80

10
’
Sampling of Mezzanine Funds in CEE and CIS

FUND MANAGER /
FUND NAME FOCUS WEBSITE
S P O N S O R (S)
BPM Capital BPM Mezzanine Fund (Fundraising) CEE N/A
Bulgaria Mezzanine Partners Bulgaria Mezzanine Capital I (Fundraising) Hungary www.mezzanine.bg
Darby Converging Europe Mezzanine Fund (2006, ¤208 million);

Darby Private Equity CEE www.darbyoverseas.com
Darby Converging Europe Fund III (2011, ¤140 million)
Central Europe,
Mezzanine Management Accession Mezzanine Capital II (2007, US$340 million);
the Balkans, www.mezzmanagement.com
Central Europe Accession Mezzanine Capital III (2011, US$275 million)
Ukraine and Russia
New Russia Growth Private Volga River Growth Fund (2010, US$135 million); Kazakhstan, Russia
www.nrgc.com
Equity Advisors (NRG) Volga River Growth II (Fundraising) and Ukraine
Small Enterprise Assistance Armenia, Azerbaijan

SEAF Caucasus Growth Fund (2012, US$47 million) www.seaf.com
Funds (SEAF) and Georgia
Syntaxis Mezzanine Fund I (2007, ¤118.6 million);

Syntaxis Capital Central Europe www.syntaxis-capital.com
Syntaxis Mezzanine Fund II (2009, ¤124.5 million)

A Focus on Mezzanine in Central Europe: A Historical
Perspective | Ben Edwards, Managing Partner, Syntaxis Capital
In 1981 Bill Gates purportedly and lows, with the biggest boom and bust occurring pre-, then
said, “640k RAM ought to be post-Lehman. A key difference, however, is that due to its later
enough for anybody,” which, arrival on the scene, the amplitude of the swings in Central
if true, shows that even the Europe was possibly greater. The promise of high equity returns
best and the brightest can get in Central Europe led private equity fund sizes to double and
their predictions wrong. While sometimes treble from 1995-2005, while deals done at greater
few would have foreseen the than 5x leverage levels equalled those in Western Europe (and
extent to which microchips were sometimes higher due to the “trophy” status ascribed to
changed the way we do things certain participants’ first big buyouts in the region). The evo-
today, the development of lution from mid-market mezzanine deals to very large, widely
private equity and leveraged syndicated transactions occurred in an instant.
finance—and the mezzanine
sub-segment in particular—in the United States in the 1980’s Post-2008, macro uncertainty, and the fact that most of the lenders
and Western Europe in the 1990’s, was certainly more predictable active in Central Europe saw the market as attractive but ultimately
(albeit less life-altering). This trajectory carried over to Central peripheral, meant that liquidity in the private equity markets dis-
Europe at the beginning of the last decade, increasing the ways appeared just as swiftly. When pre-crisis structures needed fixing
in which our regional private equity industry was able to create post-crisis, few lenders were prepared to be flexible (being too busy
(and sometimes destroy) value over the last 15 years. putting out their own fires), with a devastating impact on returns.
The arrival of mezzanine in Central Europe followed much the One thing the credit-crunch and euro crisis did was to differ-
same path as it did in developed markets, starting with a promising entiate those stronger companies from their weaker rivals. As
cycle of growth-driven private equity investment, which led to GPs such, for many remaining industry participants, the competi-
subsequently raising larger funds due to robust investor appetite. tive marketplace is now much more attractive; their positions
To achieve returns in line with those generated in the preceding are solidified, and consolidation opportunities remain relatively
cycle, managers of these now larger funds looked to lever their abundant. This is a feature we are seeing in our portfolios and
investments. Leveraged buyouts emerged, not only because the in new deals across industries, most notably in Poland—which
credit conditions were better for lenders, but crucially, managers is dominating current activity due in part to its size, stability and
were able to achieve these returns in a much shorter timeframe. relatively advanced stage of development, as well as to entrepre-
High profitability encouraged banks to invest in leveraged finance neurs’ mentality toward buying and selling businesses—but also
teams, and credit became abundant, leading to greater leverage, in the Czech Republic and parts of the Balkans.
increased valuations, higher returns, robust investor appetite, big-
Additionally, the relative lack of liquidity has meant that the
ger funds, etc. In this environment, mezzanine emerged as a means
investments we see are particularly compelling. With less buy-
of increasing leverage (but not necessarily financial risk). The first
out equity capital available in the lower- to mid-market segment,
mezzanine funds dedicated to Central Europe (primarily focus-
entrepreneurs looking to expand are not necessarily selling out,
ing on markets such as Poland, Hungary, Bulgaria and the Czech
while the relative lack of bank finance means that we can often
Republic) were established in the early 2000s. By the middle of the
originate opportunities to provide senior-secured financing at
decade, some of the international fund managers had expanded to
low leverage levels, and with equity upside.
the region and local banks were beginning to structure mezzanine
financing, increasing the overall level of competition. Samuel Goldwyn advised, “Never make forecasts, especially
about the future.” But in this instance I am prepared to take the
Interestingly, the evolution of the mezzanine sub-asset class
risk. We think the Central European private equity market will
led to a bifurcation in the market in developed markets. The
generate highly attractive returns going forward, especially in
development of the U.S. high yield and junk bond market in
the mezzanine segment in which we are active. Our economies
the 1980s and the arrival of independent mezzanine funds in
(Poland in particular) are recovering quickly—for the right rea-
Western Europe ten years later defined the large-cap segment. At
sons—underpinned by favorable demographics, while the relative
the other end lies the lower- to mid-market. The hallmark of the
scarcity of alternative capital means that leverage levels and valu-
traditional mezzanine players focusing on this latter segment is
ations remain relatively low. These all point to an appealing risk/
their equity bias and direct involvement with entrepreneurs and
return opportunity, a forecast that even the great movie mogul
equity funds to finance corporate expansion (not as syndicatees
might have been comfortable making.
on bank-led deals). In the early years, the bulk of mezzanine
investing in Central Europe was in this traditional mid-market Syntaxis Capital is a leading provider of mezzanine finance for
segment, which has always been the focus of Syntaxis. mid-market buyouts and similar transactions in Central and
Eastern Europe. To date, the firm has raised two mezzanine funds
Private equity and leveraged finance markets in the United States, for the region with aggregate commitments of approximately
Western Europe and Central Europe experienced similar highs EUR245 million.
14
Latin America
10
’
10
’

1.4%

10
90
’
60
80
Peru
70
50
60 Colombia
40
Brazil
50
Peru Mexico
40 30
OECD
30 Members
20
OECD
20 Mexico Colombia High Inc.
Brazil
10
10
0 0
0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80
Domestic Credit to Private Sector by Banks
10
Resolving Insolvency
’
Sampling of Mezzanine Funds in Latin America

FUND MANAGER /
S P O N S O R (S)
Adobe Capital Adobe Social Mezzanine Fund I (Fundraising) Mexico www.adobecapital.org
Capital Indigo Fund Indigo 1 (Fundraising) Mexico www.capitalindigo.com
Darby Private Equity Darby Latin America Mezzanine Fund II (2009, US$87 million) Latin America www.darbyoverseas.com
Brazil Mezzanine Infrastructure Fund (BMIF) (2008, BRL388 million/ Brazil,

Darby Private Equity www.darbyoverseas.com
US$236 million) Infrastructure
LAP Latin American Partners Central American Mezzanine Infrastructure Fund Central America,
www.latinamericanpartners.com
(formerly EMP Latin America) (2008, US$150 million) Colombia
Neo Investimentos Capital Mezanino Fund (2009, BRL50 million/US$28.7 million) Brazil www.neoinvestimentos.com.br

The Evolution of Mezzanine Financing in Latin America
Rick Frank, Managing Director, Darby Private Equity, Latin America
Mezzanine investing across control—an important consideration for family-owned busi-

Latin America has had a rela- nesses. That said, many mid-market companies appreciate the
tively short history with a lim- benefits that an experienced global investment partner can pro-
ited number of participants. vide, including corporate governance enhancements, access to
Darby traces its involvement in global networks, management inputs and assistance in craft-
this market back to 1999, with ing a business strategy. Active mezzanine investors can play a
the organization of one of the role as a business partner via board membership or observer
first U.S. dollar-denominated rights, and provide other value-added services that a typical
pan-Latin American mezza- bank lender does not.
nine funds. Darby has set
Within the evolving commercial landscape of Latin America, we
up one of the only two local
continue to see excellent opportunities for investing in mid-cap
currency mezzanine funds in
companies. The larger markets of Brazil, Mexico, Colombia and
Latin America to capture coun-
Peru have a rapidly growing middle market, which lacks access
try-specific opportunities—in a Brazilian fund focused on infra-
to the capital markets and is significantly underserved by the
structure—but the pan-regional mezzanine opportunity across
local lending community when compared to developed markets
Latin America remains relatively untapped.
that can provide 3x to 5x more domestic credit to the private
While active in the region, hedge funds and commercial banks sector as a percentage of GDP. In addition, smaller markets
generally have not been consistent providers of subordinated such as Ecuador and Uruguay are showing great promise and
financing in the region, although deals have been completed have produced high-quality investment opportunities that offer
from time to time. As a result, mezzanine remains a relatively higher average expected returns compared with better known
unknown product for prospective investee companies in Latin countries in the region. The private equity community is also
America, and therefore an educational process is often required growing in the region, but in our view the greatest amount of
to explain the characteristics and benefits of mezzanine to capital has tended to flow to firms that focus on larger buyout
entrepreneurs, particularly in comparison to private equity. transactions, so the flow of growth capital to mid-market com-
At first glance, potential investee companies in Latin America panies continues to be constrained. Compared to other parts
often view U.S. dollar mezzanine structures as “expensive debt” of the world where there are regulatory and legal obstacles to
compared to local bank financing packages. In addition, some investing mezzanine capital, the regulatory framework in the
region has not hindered our ability to deploy capital. Therefore,
investee companies may be concerned with the currency risks
we expect the need—and the demand—for growth capital mez-
associated with U.S. dollar-denominated debt. Despite the rela-
zanine to be robust for the foreseeable future.
tive stability of the region’s currencies in recent years—indeed,
real appreciation against the dollar in some cases—the mem- Darby has been a mezzanine investor in Latin America since 1999,
ories of sharp devaluations still linger. From a fund manager having managed three mezzanine funds totaling US$519 mil-
perspective, long-term hedges are typically cost prohibitive, so lion, which have invested in 23 companies across Brazil, Mexico,
mezzanine investors often seek to find companies with a natural Colombia, Peru, Bolivia, Uruguay, Ecuador and Argentina.
hedge such as exports or contracts denominated in U.S. dollars.
“
Nevertheless, through dialogue and education, potential
investee companies come to understand key benefits of a From a fund manager
mezzanine structure compared to typical bank financing: the perspective, long-term hedges
flexibility to provide long-term capital—up to seven years or
more—and a much less demanding principal amortization
are typically cost prohibitive,
schedule. These characteristics fit well with the long-term so mezzanine investors often
capital needs of fast growing mid-market companies in Latin seek to find companies with a
America. Since portfolio company owners may be exploring
natural hedge such as exports
relationships with private equity funds or other equity providers,
they also come to appreciate the fact that mezzanine capital or contracts denominated in
provides a lower level of equity dilution and loss of business U.S. dollars.
14
Middle East and North Africa
10
’
10
’

1.2%

10
35
’
35
30
30 Saudi Arabia
25
Egypt
25
OECD UAE
Members 20
20 OECD
High Inc.
15
15
UAE
10
10
Saudi Arabia
5 Egypt 5
0 0
0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80
10

’
Sampling of Mezzanine Funds in the Middle East and North Africa

FUND MANAGER /
S P O N S O R (S)
CDG Capital Fonds CapMezzanine (2008, MAD350 million/US$47.5 million) Morocco www.cdgcapital.ma
CORECAP Corecap Islamic Private Equity Fund (CIPEF) I (2007, US$150 million) MENA N/A
MENA,
EMP Global Arab Infrastructure Investment Vehicle (AIIV) (Fundraising) www.empglobal.com
Infrastructure
Gulf Capital GC Credit Opportunities Fund I (Fundraising) MENA, Turkey www.gulfcapital.com
NBK Capital NBK Capital Mezzanine Fund I (2008, US$157.4 million) MENA www.nbkcapital.com

Bespoke Financing: A Perfect Fit for an Imperfect Market
Amjad Ahmad, Senior Managing Director, Alternative Investments, NBK Capital
“
While scouring the MENA As the region’s markets develop
region for private equity invest-
ments in 2006, we quickly further and continue to grow,
realized that companies were we anticipate more favorable
starved of credit. In some conditions for mezzanine
instances, businesses had no
bank facilities, while in others investments.
the facilities the companies had
were inadequate (e.g., short
of the investments have been growth capital rather than buyouts.
term in nature, carrying exces-
sively high interest rates and/ All of these factors result in an investment model that differs
or highly restrictive covenants). from developed markets, yet provides an attractive risk/return
In addition, the local private profile given the market inefficiencies. During the last several
equity industry was developing and increased the need for sophis- years, we have spent considerable time educating the market
ticated capital structures to finance the growth of portfolio com- regarding the application of mezzanine and talking to countless
panies. This prompted us to launch the first private credit fund in corporates regarding the use of the product effectively. While
the MENA region, NBK Capital Mezzanine Fund I, which focuses time consuming, the proprietary nature of these discussions has
on providing flexible financing to middle market companies. allowed for innovative and lucrative structuring options leading
to positive outcomes both for NBK Capital and the recipients of
The evolution of the mezzanine product and our mezzanine
mezzanine financing.
fund in the MENA region is a familiar story of credit financ-
ing in many emerging markets. Financing for small- to medi- Since the launch of our credit fund in 2008, we have tailored
um-sized companies is inaccessible and inefficient due to a lack several bespoke financing structures in support of growing
of appropriate coverage for such businesses, local banks’ rigid SMEs, including convertible preferred shares for a wastewa-
lending practices—including a focus on asset-based lending— ter treatment company in the UAE, a sharia-compliant subor-
and an inadequate banking infrastructure to handle non-tradi- dinated debt instrument for an education company in Saudi
tional financing. In our region, the primary customers for banks Arabia and a profit-sharing subordinated loan for a fish farming
tend to be large local conglomerates (synonymous with family company in Turkey. The combination of long tenors, tailored
groups and high net-worth individuals) and government-related amortization, sensible covenants and creative equity participa-
entities. This ecosystem has led to a situation where only one tion structures has benefited companies tremendously while
in five small- to-medium-sized companies has access to credit. providing attractive returns for our investors.
While these companies are deserving of financing and have
ample capacity to service debt, their capital structures are sub- As the region’s markets develop further and continue to grow,
optimal and generally overcapitalized. Couple this financing we anticipate more favorable conditions for mezzanine invest-
inefficiency with a healthy dose of growth in the region and an ments. Across the region, governments are embracing regula-
attractive opportunity to fill the gap emerges. tory and market reforms to stimulate private sector growth to
drive higher employment, which has led to increasing demand
While the opportunity is clear, capturing it has posed a challenge for growth financing. We have begun witnessing a gradual
for a variety of reasons. First, intermediaries in the region are improvement in the use of sophisticated financing structures
fairly weak, with few reputable players possessing the requisite evident not only through our experiences, but also in the debt
skills to study capital structures and propose optimal financing capital markets of the UAE and Turkey specifically. While we do
solutions; as a result, most investments are unstructured and not believe that there will be a convergence of emerging and
require an introduction to cash flow-based lending for both developed markets in the near future, the present inefficiencies
the intermediary and borrower. Second, many companies, after will continue to drive opportunities for innovative credit pro-
exhausting their possibilities for bank debt, seek passive equity viders in the MENA region. This will be positive for investors
where shareholders are reluctant to provide basic minority pro- seeking strong returns, companies looking to finance growth
tection rights and are averse to substantial dilution. In such cases, and countries working to diversify their economies.
it looks like credit, talks like credit, and walks like credit but is
packaged as equity. Patient, long-term and flexible financing NBK Capital is a leading alternative investments firm specializing
presents a viable alternative in such transactions. Finally, the in growth capital in middle market companies throughout the
private equity industry has not driven significant sponsored deal Middle East and North Africa region. The firm launched its first
flow in mezzanine, as the number of fund managers has declined mezzanine fund in the region in 2008 with US$157.4 million in
substantially post-crisis due to negative performance and many capital commitments.
14
Sub-Saharan Africa
10
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1.9%

10
30
160
’
OECD
Members
25 140
120
20
100 Nigeria
15
80
South Africa 60
10 Kenya
40 OECD
Nigeria Kenya South Africa High Inc.
5
20
Tanzania Tanzania
0 0
0 10 20 30 40 50 60 70 80 90 100 0 10 20 30 40 50 60 70 80
10

’
Sampling of Mezzanine Funds in Sub-Saharan Africa

FUND MANAGER /
S P O N S O R (S)
46 Parallels 46 Parallels Fund I (Name Unknown) (Fundraising) Sub-Saharan Africa www.46parallels.com
Greylock Capital Management Greylock Africa Opportunity Fund (Fundraising) Sub-Saharan Africa www.greylockcapital.com
Helios Investment Partners Helios Credit Opportunities Fund (Fundraising) Sub-Saharan Africa www.heliosinvestment.com
Jacana Partners Jacana Mezzanine Fund Sub-Saharan Africa www.jacanapartners.com
Makalani Makalani Fund II (Fundraising) South Africa www.makalani.co.za
Sahel Capital Fund for Agricultural Financing in Nigeria (FAFIN) (Fundraising) Nigeria, Agribusiness www.sahelcp.com
Vantage Mezzanine Fund I (2007, US$100 million);

Vantage Capital Sub-Saharan Africa www.vantagecapital.co.za
Vantage Mezzanine Fund II (2010, US$185 million)
Central African Republic,

Central Africa SME Fund (CASF) (2010, US$19 million); Democratic Republic
XSML www.xsml.nl
African Rivers Fund (ARF) (Fundraising) of the Congo, Burundi,
Rwanda, Uganda

The Risk/Return Profile of Mezzanine in Sub-Saharan Africa
An Interview with Vantage Capital’s Luc Albinski, Managing Partner, and Johnny Jones, Associate Partner
How should potential Johnny: We only invest local currency in South Africa; when we
investors evaluate mezzanine look at any other African market, we invest hard currency—either
investments in Sub-Saharan U.S. dollars or euros. With our hard currency-denominated loans,
Africa? we are in a better position to protect our returns against adverse
currency fluctuations. As we invest in markets outside South Africa,
Johnny: Returns are only half we seek an additional return premium for the risks we are taking.
the equation. The returns in our But we also seek to adapt our deal structures to the local regula-
first fund, which was deployed tory and legal environments. Each of these markets has its own
between 2007 and 2008 (a dif- legal and tax regime that can impact the ability to enforce our
ficult vintage), are on par with fund’s debt and equity rights, including guarantees and put rights.
private equity, but our investors
took on significantly lower risks Luc: We look at all of the various components (e.g., leverage, cov-
Luc Albinski to achieve them. An investor enants, cash pay, etc.) of any transaction in order to develop a
cannot just look at returns on composite view of its relative riskiness. Then we look at all of those
an absolute basis; he or she has factors within the context of the country in which the company
to look at the risk profile of a operates. For instance, it wouldn’t make sense for us to invest in the
transaction too. What is the Democratic Republic of the Congo as a mezzanine investor because
value of the collateral? What is we would consider that country to be so far up the risk curve that
the leverage level? What is the the risk you are taking by just going there pushes you into equity
periodic cash servicing? What territory. The country ranks 167th out of 189 in terms of resolving
is the strength of the covenant insolvency and there would be significant challenges for our fund
regime? Since our investments to enforce its lender rights in a default scenario.
are designed to deliver annual
What is the key thing investors should know about com-
cash yields of 10 to 16%, cap-
mitting to a Sub-Saharan Africa mezzanine fund?
ital is returned throughout the
Johnny Jones investment period, thereby Johnny: In Sub-Saharan Africa, investors can find attractive
reducing risk. risk-adjusted mezzanine returns that are competitive globally.
Mezzanine allows investors to side-step the high valuations that
Luc: When we engage with private equity sponsors on the poten-
private equity firms can be exposed to in a crowded marketplace,
tial sell-down of some of their mezzanine positions, we typically
while gaining exposure to fast-growing African countries in a
find that the pricing may be more or less in line with the returns
risk-mitigated format. We deploy capital into select countries in
we are looking for, but they usually have less-than-adequate pro-
the region that are experiencing high economic growth rates,
tections—be it the security, the debt covenants, or the cash flow
significant government reforms, and a rapidly expanding middle
waterfall—to make us comfortable with the level of risk that we
class. In contrast to the U.S. and European mezzanine investors,
would be taking if we went ahead and purchased their mezza-
however, we enjoy lower senior and mezzanine debt leverage
nine assets without first significantly rewriting their agreements.
ratios, and oftentimes an opportunity to acquire a senior position
Unlike private equity, we spend 80% of our time assessing risks
in the capital structure through first lien security rights.
and structuring for downside scenarios.
What is the outlook for mezzanine in Sub-Saharan Africa
Vantage has expanded beyond South Africa. How do you
over the next five years?
assess risk and execute deals in other markets?
Luc: Mezzanine is in its early childhood, and will continue to
Luc: It’s not an exact science. There are some countries that have grow in Sub-Saharan Africa. In five years’ time, we should see
a risk profile that is arguably slightly better than South Africa, the emergence of a more competitive environment, with several
such as Botswana, and there are others that are significantly players seeking to fulfill the demand for expansion capital from
riskier, such as Mozambique or Nigeria, and there are some in-be- small- and mid-sized businesses. We currently see more than one
tween, such as Ghana. Then there are the more exotic countries hundred requests totaling over US$1 billion in mezzanine funding
found in the bottom quartile of IFC’s “ease of doing business annually, and we expect this amount to increase substantially
index” that we leave to our competitors: we consider mezzanine over the medium term, particularly amongst borrowers in infra-
investing in such markets to be an oxymoron! But of course we structure-related and consumer-facing industries.
would consider limited exposure to high-risk African countries
if we were backing a regional player with businesses across a Vantage Capital is a black investment and financial services group,
diversified basket of markets. which manages a number of Sub-Saharan Africa-focused funds.
14
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14

Private Credit Solutions

Nadiya Satyamurthy Mike Casey Sam Verran Mark Kenderdine-Davies, Secretary

Luc Albinski, Managing Partner, Vantage Capital Sanjay Nayar

Johnny Jones, Associate Partner, Vantage Capital Robert Petty, Treasurer

Managing Partner and Co-Founder, Clearwater Capital Partners

Ben Pierce, Pierce Designers Jean Eric Salata

CEO, Abraaj North America/Partner, The Abraaj Group

For more information or to begin a project

Letter from EMPEA Consulting Services.................................................................................................... 3

What is Emerging Markets Mezzanine Financing?.................................................................................... 4

The Risk/Return Profile of Mezzanine in Emerging Markets..................................................................... 6

Investor Perspectives on Mezzanine: An LP Roundtable..........................................................................13

The Scale of the Emerging Markets Mezzanine Industry.........................................................................16

Sidebar: DEG’s Perspective on Emerging Markets Mezzanine.................................................................18

CEE and CIS.......................................................................................................................................22

Middle East and North Africa..........................................................................................................26

A product of EMPEA Consulting Services

inactive in this segment, for sharing their insights with us.

S UPPOR TI N G UN D ER WRITE R DATA PARTNE R

Disclaimer: This information is intended to provide an indication of industry activity based

2 • EMERGING MARKETS PRIVATE EQUITY ASSOCIATION

EMPEA is delighted to present this special edition of Private Credit Solutions:

As always, we welcome any feedback you may have at consulting@empea.net.

of the international banks scaling back their emerging market Contractual

sub-asset class. As one veteran of the industry explains, “The only

Exhibit 2: Illustrative Components to Mezzanine Returns

tion tailor-made to each investment opportunity, for instance

4 • EMERGING MARKETS PRIVATE EQUITY ASSOCIATION

markets, we have seen these firms manage to structure deals

with a senior type of security while still achieving mezzanine debt

Global Robert Graffam, Senior Managing Director at Darby Private

Vantage Capital facilitates the growth of mid-market enterprises in South Africa

Growth capital for mid-market enterprises

+27 11 530 9100

assets, while others stipulate certain performance requirements,

In July 2013, Vantage exited through a senior debt refinancing

Risk Mitigants: The Vantage facilities were secured by surety-

8 • EMERGING MARKETS PRIVATE EQUITY ASSOCIATION

Deal Count by Region Sponsored vs. Direct Deal Count by Sector

Sub-Saharan Africa MENA Media/Telecom Infrastructure

Energy/Natural Resources Banking/Financial Services

innovative financing across

companies and Darby’s stake was acquired by a multinational.

Darby — partnering with growth businesses across the emerging markets.

4 ering between 13.4% and 29.3% (see Exhibit 6).

Debt Component Returns

In general, investors are compensated for taking on greater

Exhibit 7: Debt Component Characteristics

CEE and CIS 3.7 11.3

10% MENA 4.3 11.1

Sub-Saharan Africa 6.5 15.8

Annual Interest Rate

A Closer Look at Mezzanine Performance in the United States and Europe

23% 23% 1.8 23% 23%

20% 1.7 1.61 1.61 20%

19% 19% 1.58

1.4 1.34 1.32

Europe United States Europe

12 • EMERGING MARKETS PRIVATE EQUITY ASSOCIATION