Sri Lankan Sunshine

Private equity firms looking to invest in emerging markets know that it's getting to be an awfully crowded field. In the first six months of 2008, emerging markets-focused private equity groups raised $35.3 billion (€24 billion), according to the Emerging Markets Private Equity Association.

But EMPEA notes China and India together account for 80 percent of country-dedicated private equity funds in Asia. This makes next-door neighbors like Sri Lanka – where private equity activity is near non-existent – satellites rather than gravitational centres for capital.

But things may be about to change. Last week marked the disclosure of the first sizeable private equity transaction in the country: Aureos Capital's acquisition of a 25 percent stake in Sri Lankan conglomerate Sunshine Group via a private placement. The emerging markets-focused firm has a $122 million South Asia Fund dedicated to India, Sri Lanka and Bangladesh, which should be fully invested by the middle of next year.

With a value of about $5 million, the Sunshine deal would hardly make headlines in the Western financial press. But in the context of a deal space long dominated by strategic buyers like apparel manufacturer MAS Holdings, the transaction may be an important first step in attracting more private equity capital to the island nation, whose stock market capitalisation tops $7.7 billion.

Sri Lanka's leaders – albeit slowly – have taken steps to make the country more amenable to investors. Last year's revision of Sri Lanka's 1982 Companies Act lifted prohibitions on leveraged buyouts and share buybacks, eliminated (some) red tape, strengthened shareholder rights and codified directors' responsibilities and disclosure requirements.

This made private equity in Sri Lanka – dominated by venture capital firms since the early 1990s – more amenable to traditional leverage-based private equity funds. But for Aureos, the investment was anything but a bet on regulatory changes.

Aureos Sev Vettivetpillai told PEO that upon discovering Sunshine, “we were surprised that it actually existed” since the opportunity was so impressive.

As Vettivetpillai explained, there are two value plays to the transaction: growth and a gain in the stock price from better marketing of the company's shares, which trade on the Colombo Stock Exchange. He cited Sri Lanka as an excellent launching pad for a expanding a business regionally – a key lever of success for emerging markets deals.

This is not to suggest, though, that successfully executing transactions in a developing market like Sri Lanka is a cakewalk. Business in Sri Lanka is dominated by family-owned enterprises, which makes developing relationships and trust crucial and can take considerable time and effort, noted Indika Hettiarachchi, an Aureos investment principal involved in the deal. Aureos struck a relationship with Sunshine via a local intermediary and kept a dialogue going for about a year before the transaction went through.

All of which highlights that, as with any market, there are good opportunities for those willing to take the risk and do the hard work. And for Sri Lankan private equity, the opportunities are just beginning.