News Column

2005 HB 500: A Rich New Niche

June 2005, HISPANIC BUSINESS Magazine

Judi Erickson


For more than two decades, the Hispanic Business 500 has provided a national benchmark of the surging development of U.S. Hispanic-owned companies. Using sustained revenue growth as a standard and a globally accepted foundational measure of corporate performance, the ranking's valuation has swiftly risen this year to more than $30 billion.

But in recent years, a type of firm whose business model defies standard measure has begun to exert an increasingly significant force in the market's development, and this year Hispanic Business debuts a special listing of U.S. Hispanic-owned private equity funds.

While just a handful of major players exist in this niche, over the past decade they have drawn hundreds of millions of dollars from investors eager to diversify their assets and tap the booming U.S. Hispanic economy. Today they wield more than a half-billion dollars in capital under management and are fostering the growth of nearly two dozen companies across the country whose combined sales total more than $3 billion.

"There are tremendous opportunities in the market right now," says Victor Maruri, co-founder and principal in the Chicago-based private equity firm Hispania Capital Partners, which manages $125 million dollars and targets Hispanic-owned middle-market companies with potential annual revenue growth of 15 percent to 25 percent. "There is significant investment in the market. It's wide open."

Operating with investment horizons that average three to five years although some may be as long as 10 years private equity funds target aggressive annual internal rates of return (IRR) of 20 percent or more. But with investors typically looking for capital gains only upon realization of a sale, private equity funds rarely offer running yields, making inaccurate comparisons with more traditional revenue rankings.
Fund investments and divestures can create frequent revenue peaks and valleys from year to year. They also may hold varying stakes anywhere from 20 percent to 100 percent in each of the six to 10 companies that make up an average fund's active portfolio, so tallying those revenues also does not provide a clear portrait.

Capital under management a fund's available capital to invest provides a more accurate picture of the market and a fund's investment health, according to the National Venture Capital Association (NVCA). And so far this year, the overall asset class is on a strong track: According to both Thomson Venture Economics and the NVCA, 48 venture funds nationwide raised $5.3 billion in the first quarter, while 38 buyout and mezzanine funds attracted $15.8 billion. The NVCA also estimates that more than 50 percent of investments in today's venture capital/private equity market are from institutional public and private pension funds.

"This year will likely out-raise 2004 in total dollars because of where we are in the business cycle," says Mark Heesen, NVCA president. "Clearly, venture capital firms with a strong track record are going to be the most successful in this environment, as will new firms founded by successful veterans of those established firms. Money will also go to firms with demonstrated competencies in niche sectors."

The increasingly healthy venture and private equity market provides growing opportunities for middle-market Hispanic companies looking for funding. Experts have said that while minority-owned businesses remain largely underfunded by venture capitalists only 1.5 percent of private equity capital goes to minority companies, according to the National Association of Investors Corp. Hispanic-owned companies now have a greater opportunity to attract investors, though competition is increasing.
The funds in this year's Hispanic Business 500 directory illustrate both of the currently strong inflow and outflow trends.

Luis Nogales, managing partner of the $99-million Nogales Investors Fund I, is drawing investors for a second fund estimated to close early next year at $200 million. While his current fund focuses on companies with revenues of $5 million to $20 million, the new fund could target slightly larger firms with as much as $30 million in revenue.

Palladium Equity Partners, currently managing its second fund with $231 million in equity capital through Palladium Equity Partners II LP, is in the process of closing a third fund with a target of $500 million. For this fund, Palladium Equity Partners III LP, Palladium has capital commitments from Spanish bank Banco Bilbao Vizcaya Argentaria, the California Public Employees' Retirement System, New York Common Retirement Fund, the Los Angeles Fire and Police Pension Fund, and others estimated, according to industry sources, to $420 million. Palladium declined comment on the status of fund raising.

Substantial transactional and fund-raising action is also taking place at Bastion Capital. Once completed, the sale of all Bastion I's investments in late 2004 will yield a final gross IRR of 25.2 percent. Acon-Bastion is raising Bastion II with a $300 million target to focus primarily on Hispanic middle-market investments in the United States. The State of New York will be an anchor investor in Bastion II with a commitment of $65 million.

According to founding partner Guillermo Bron, although Bastion I is closed and Bastion II is still raising funds, Acon-Bastion is already making investments in the U.S. Hispanic market, having invested $150 million recently in three companies through a Special Purpose Investment Vehicle.

The firms have moved swiftly this year on investments. Mr. Maruri, who manages Hispania Capital with principal Carlos Signoret, says the fund recently purchased a controlling interest in survey firm Eastern Research Services Inc., and expects to add two more firms to its active portfolio by June. Nogales Investors also expects to add two more firms to its portfolio, and Palladium Equity in early March sold Phibro Animal Health Corp., one of six active portfolio companies.

Palladium Equity managing member Marcos Rodriguez says the firm which focuses on companies in the U.S. Hispanic market reviews as many as 200 potential investment opportunities a year, and is seeing a growing number of opportunities.

"The capital flow has not matched the growth in the demographics and disposable income that has come from that economic growth and the hard work of Hispanic entrepreneurs," Mr. Rodriguez says. "There are companies that are focused on the U.S. Hispanic market that are extremely attractive and we are continuing to see very exceptional opportunities."

Some fund experts note that with the influx of private equity funds looking for investments, a "barbell theory" is emerging: With lots of funds in the $500 million to $1 billion range all going after the same size investment, an auction environment may be driving prices to overvaluation.

"What is happening in the private equity market is that it is so competitive at the larger level, they're bidding up prices," says Mr. Maruri. "Hedge funds are increasingly looking at private equity. We're not feeling the increased competition but it could lower the costs of capital and I think in the long term it will create distortions. The risk-reward will drop precipitously."

Still, Mr. Nogales and others say more funds are needed for mid-market investments. "The companies on the Hispanic Business 500, for example, have grown significantly over the past 10 years and the amount of capital has not been available at the same rate," Mr. Rodriguez notes, adding that he also sees growing opportunities for $100 million companies, and larger, as well.

Fund experts note that continuing success will require disciplined and expert management of their portfolio companies. With a reliance on debt financing and a responsibility to add value to each company, cash is viewed as a scarce resource. Using equity to maximum advantage is essential.

"Every time you draw down, the clock is running," says Mr. Nogales. "There is pressure and it is intense. You better have a plan and do it real fast. There is a fiduciary responsibility with investors' money."

Most of the funds take a majority owner or significant minority (40 percent) stake in the companies, while fund executives serve on the board and actively work with company owners to provide consulting, senior-management experience, and networking in addition to capital.

The firms maintain an independent view, taking an active role as shareholder with the overarching understanding that within a specified time frame they must be positioned to sell the company for more than they paid for it.

"One of the great features about this business is that while we track [internal rates of return], the ultimate goal is what happens at the end," says Mr. Nogales. "The big bang comes when you sell the company. There's a beginning and end and you can't fudge the numbers. Either that was your performance or it wasn't."


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