Sustainable Investment in Emerging Market Small and Mid-Cap Enterprises

TBLI Conference, 24TH and 25TH MAY 2007. Bangkok, Thailand.

Liam Cully,Regional Managing Partner,Aureos South East Asia Fund.

Content

1. Aureos Capital - Who we are ?

2. Sustainability - What it means?

3. Aureos Business Principles.

4. An Investment Case.

5. Conclusion.

1. Aureos Capital

Aureos

• is a global private equity fund manager focused on investing in small and mid-cap enterprises in emerging markets.

• has 21 offices in 19 countries covering Central and Latin America, Sub-Saharan Africa, South Asia, South East Asia, China, Central Asia and the Pacific Islands.

• employs 100 professional staff worldwide.

• has currently US$570m funds under management in 24 active funds.

• investment size range in US$1m to US$8m.

2.Sustainability- What it means?

World Commission on Environment and

Development 1987

World Commission on Environment and

Development 1987

BruntlandBruntland

ReportReport

BruntlandBruntland

ReportReport

Sustainable Development“Meeting the needs of the

present withoutcompromising the ability

of future generationsto meet their own

needs...”

•In 1987 a definition of sustainability was developed.

•It is still widely used, although it is interpreted in different ways.

2.Sustainability – What it means?

• A sustainable investment in the medium to long term must:behave as a good corporate citizen.practice good governance in the areas of ethics, environment,

health and safety.practicing these principles can create real value and long term

viability of the company.

• A business to be sustainable must:have a record of profitability.demonstrate a clear path to future profitability.

• The investor must : leave a company stronger that when it enterednot extract returns at the expense of the company’s long term

viability.

3. Aureos Business Principles: what are they?

Aureos Business practices are governed by 6 principles:

1. Openness and honesty in all dealings, while respecting commercial and personal confidentiality;

2. Objectivity, consistency and fairness in treatment of all stakeholders;

3. Good corporate citizenship in dealings with investees and communities;

4. Respect for dignity and well-being of all stakeholders;

5. Respect for environmental and social capital of host countries and commitment to sustainability;

6. Professional operation in a performance-orientated culture and commitment to continuous improvement.

Six Fundamental Principles Aureos Business Policies

Business Integrity Environment

Health & Safety Social

3. Aureos Business Principles: what are they?

Business Integrity– Honesty, integrity, fairness, compliance, gifts, use of information...

• Health and Safety– Working conditions, compliance, risk reduction....

• Environmental– Protection, efficiency, improvement, sustainability.

• Social– Treatment, respect, compliance, conditions, consultation.

3. Aureos Business Principles: Why bother?

Good financial and legal sense!

£

FINANCIALFINANCIAL

Fork Lift Truckdamages

Oil drum store

Fork Lift Truckdamages

Oil drum store

Minor incidentMinor incident

Total: $220k

$20k

$200k

•Direct Costs•Repair to Fork Lift TruckRepair to storage area

Indirect CostsManagement TimeCompensation ClaimsIncreased Insurance CostsBusiness InterruptionLoss of Good WillAdverse Publicity

LEGALLEGAL

Safety Legislation (safe Workplace), Risk Asses-

ment, First Aid, FirePrecautions

Safety Legislation (safe Workplace), Risk Asses-

ment, First Aid, FirePrecautions

EnvironmentalLegislation eg air, noise,

Effluent, EIA, etc

EnvironmentalLegislation eg air, noise,

Effluent, EIA, etc

Occupational Health Legi-slation eg dust inhalationnoise, manual handling

Occupational Health Legi-slation eg dust inhalationnoise, manual handling

Business IntegrityLegislation eg anti-money

Laundering, bribery

Business IntegrityLegislation eg anti-money

Laundering, bribery

Social Legislation on workhours, employment of

child labour, etc

Social Legislation on workhours, employment of

child labour, etc

Fines?

Imprisonment

3. Aureos Business Principles: When are they relevant?

Deal Origination

Screening Investment Management Exit

Due Diligence

ThroughoutThe Investment Cycle

3.Business Principles and the Investment Process

Investees tend to move from a reactive to a more proactive approach to Business Principles

BP Ignorant

• Limited compliance• May only react to

incidents

BP Opportunistic

See market opportunities• Carbon trading• Greenness• Recycling

BP Engaged

• Listen to stakeholders and adjust strategies

• BPs managed on a risk basis

BP Compliant

• Meet legislation• View BPs as “a

necessary evil”

Value addition and sustainability are about moving a company along this trajectory!

Increase in Organisation Proactivity

3. Business Principles —from ‘do-no harm’ to value addition

• Sound application of Business Principles can add value to a business, facilitate the exit process, and increase the exit price.

Non-compliance•Does not meet local standards and nowhere near WB/IFC standards.•Management fails to recognise importance of Business Principles

Compliance•Meets local standards.•Management sees Business Prin-ciples as ‘necessary evil’ and as tangential to business.

Value Addition• Meets local standards, keen to reach international/WB/IFC standards.•Formulating practices of good governance, soc + env management.

Leadership•Company meets and exceeds highest international standards.•Company leverages improved governance and soc/env manage-ment throughout value chain.

Best PracticeHigh Risk

4. Investment Case – Plastic Packaging Company (PPC)

Background• PPC founded in 1971 manufacturing single layer plastics and plastic

bags.

• Main customers are multinationals companies.

• Traditional plastics business difficult with tight margins due to a combination of competition and rising raw material costs.

• Company is profitable but under pressure.

• Main shareholder worked for 3M in US for 12 years and possessed considerable experience in commercial application of new products.

• PPC developed a biodegradable plastic (using tapioca starch) with many traditional applications.

• Globally there is considerable demand for bio products, however, due to high cost of raw materials, the market failed to grow significantly.

4. Investment Case – Plastic Packaging Company (PPC)

Comparative Competitive Advantage• The plastic material is derived from Tapioca starch (abundant in South East

Asia) at significant discount to existing biodegradable materials and closely approximates traditional oil based plastics.

PPC Bio material Plastic

Raw material cost per ton US$1,200 US$3200-3600 US$1400-1500

• PPC developed the technology over 10 years and had proven its viability.

• PPC had produced various product applications on a commercial basis and sold them in the local market.

• PPC was marketing its products to international companies and had confirmed orders.

4. Investment Case – Plastic Packaging Company (PPC)

Company Need

• PPC needed funds to expand its traditional business to take advantage of the considerable resources it had invested in the new

biodegradable product applications.

• Banks would not lend and other sources of funding not available.

• Aureos invested US$4M risk capital in the form of a Redeemable Convertible Bond.

• The Bond has equity rights attached to it.

4. Investment Case – Plastic Packaging Company (PPC)

Why Invest?• Established company with history of profitability and significant growth

potential.

• Experienced and capable management team.

• Pent up demand for reasonably priced bio-degradable products.

• Technology proven by management and protected by patent.

• Commercial production of new products completed.

• Lack of bank and other traditional forms of funding.

• Investment structured to provide on going income to Fund and thereby reduce the pressure on achieving high capital gains at time of exiting.

• Management saw the benefits of adopting the Aureos Business Principles and signed up to their implementation prior to the investment.

5. Conclusion

It is possible for Private Equity to invest sustainably and successfully in small and medium enterprises, however, the traditional forms of finance such as banks and other institutions need to move from security based lending to more innovative approaches.

THANK YOU