Marco Aurelio Garib,

The age of the Internet has arrived in Latin America, financed by many of the same US investment banks and venture capitalists that first backed the Internet revolution in the United States.

As well as dollars, the investors are bringing financial tools that were tried and tested in Silicon Valley and on Wall Street, but which are almost unknown in Latin America-principally the use of initial public offerings for start-up companies.

Only a handful of Latin start-ups launched initial public offerings last year, but those that did, have performed phenomenally well. Wall Street investment bankers are predicting that 10 to 15 Latin Internet companies could go public on the Nasdaq Stock Market this year. If investors stay hungry for new Internet issues with a Latin twist, more than 50 such companies could be trading on the US’s technology-oriented exchange by 2001.

The Nasdaq composite index rose 85.6% last year, but wobbled at the beginning of this year. Internet companies and their backers are scurrying to bring deals to the market while the going is good.

Ernest G. Bachrach, chief executive for Latin America at Advent International, a US private equity investment firm, says in the next six months, the pipeline of companies preparing to list could increase fivefold “because of the huge amount of activity in the dot-com area in Latin America.”

Local start-up companies are going through ever-shorter investment cycles as they attract more US private equity financing. However, investors also want reliable exit strategies to cash in their profits. The strategy of choice is a Nasdaq listing.

Gustavo Schwed, executive director of Morgan Stanley Dean Witter’s Latin American private equity group, says “to be a big Internet player long term you need public markets. That is where the funding is and if [you do not have access] you are at a competitive disadvantage to companies that do. You need large, developed and liquid markets and that generally means Nasdaq.”

The most successful Latin American start-ups to go public are known as portals, gateways to the Internet that also provide their own content and services. StarMedia Networks, the Latin portal based in New York, was the pioneer issuer with its May 1999 Nasdaq IPO that raised $105 million. By the end of the year, its share price had doubled. In November, Spain’s Telefonica spun off Terra Networks, its Internet company focused on Latin America, in a listing on Nasdaq and on the Madrid stock market. Terra’s market capitalization trebled to almost $13 billion within weeks of its debut. Then, at the tail end of 1999, came the Argentine portal El Sitio, which saw a 150% price increase on its first day of trading on Nasdaq.

They are likely to be joined soon by Yupi, a portal based in Miami, America Online’s Latin American joint venture with Venezuela’s Cisneros group and Universo Online, the dominant Brazilian portal.

These Internet IPOs are reopening the US market for new Latin equity issues after more than two years of virtual inactivity. However, it remains to be seen whether non-Internet companies will face an equally enthusiastic reception on Wall Street. Few traditional industries can match the returns promised by Internet stocks. Forecasters expect Latin America to see the fastest Internet growth in the world over the next five years.

That expected growth has made US venture capitalists sit up and take notice, especially after StarMedia’s successful IPO. While El Sitio required several years’ gestation before its founders and investors could even contemplate a listing, Mercadolibre, an auction site headquartered in Buenos Aires, took less than six months to raise more than $10 million in private equity funding.

A group of Latin American Stanford MBA graduates founded Mercadolibre last July, and plan an IPO as soon as possible after a second round of private financing.

Stelio Tolda, one of Mercadolibre’s founders, says “this is a very good time for investments in Latin America. Other firms are even getting local angel financing which I could not imagine happening six months ago.”

StarMedia’s IPO changed the way investors and even entrepreneurs in the US and Latin America viewed start-ups. Marco Aurelio Garib, founder and president of Brazil’s EverSystems, an online finance software house, says “my conversations with Fernando Espuelas [Starmedia’s founder] were what encouraged me to go ahead.” EverSystems plans to list on Nasdaq in mid-2000.

Investors and private equity fund managers say they are receiving about 200 business plans a month from Latin entrepreneurs, although they say only about 20 are worth following up. And of these, only a few are sound enough to actually receive funding.

Pedro-Pablo Kuczynski, president of Latin America Enterprise Fund Managers, a private equity fund in Miami, estimates that investors are channeling about $3 billion of organized private equity into Latin America each year. However, only a small portion of that money is going into technology or Internet ventures. Most of it remains targeted at buy-outs and acquisitions.

Still Small Potatoes
Last November, six Latin Internet companies raised $111 million in private equity funding. And of that, a single $67.4 million deal for Yupi, accounted for most of the financing.

Investment volumes may still be small, but they are increasing rapidly, given the substantial returns of several hundred percent over 12 to 18 months that investors are hoping for. American investors often say Latin America is at the same stage as the US Internet market was four years ago and they expect to see similar, if not faster growth patterns. Research firms like International Data Corp. and Forrester Research forecast Latin American Internet advertising revenues to grow to $645 million by 2003 from just $20 million in 1998. E-commerce transactions should rise to $8 billion in 2003 from $170 million in 1998.

Susan Segal, general partner at Chase Capital Partners, says she aims to net returns of at least 10 times her firm’s money in very early-stage private equity deals. Chase whetted its appetite in May with the StarMedia public offering, which earned the bank a return of over 10 times its original investment. Chase has invested more than $55 million in five pan-regional Internet ventures, including Starmedia. Chase’s picks are, a leading financial website now based in Miami, Viajo, an online travel agency, Sportsya a sports site, and Mercadolibre.

Segal says Chase generally backs “the biggest and most scaleable [business models].” Furthermore, investors prefer companies that emulate successful US ventures. “We are not going to finance unrecognizable models,” she says. The key factor Segal and other investors look at is the quality of management teams. “We are looking at people, people and people.” Signing up well-recognized US investors like Chase gives a company a seal of approval that makes it easier to ensure a successful IPO.

Naturally, there is a limit to the number of businesses meeting these basic criteria, especially at a time when investors who arrived late on the scene are scrabbling for deals to back. Indeed, several veteran investors are complaining that valuations for Latin ventures are rising too high. “There is so much money chasing deals that it is getting dangerous,” says one investment banker. “They are pushing up the value of companies that are not ready to receive money.”

Maria Eugenia Estenssoro, who heads the Buenos Aires office of Endeavor, a US non-profit organization created to support Internet businesses in Latin America, recently gave a speech at a business conference. She says “I talked about how we identify entrepreneurs and after I was finished [investors] came at me like flies.”

The arrival of the Internet revolution and US-style venture capitalism is forcing local financiers in Latin America to reexamine their old prejudices against backing risky new start-ups. Latin private equity fund managers are seeing that backing fast-growing companies can be more lucrative and possibly require less management effort than handling a $150 million investment in a turnaround.

Although local investors often lack the analytical skills and experience of established US Internet backers, the leading Latin private equity funds like Exxel in Buenos Aires and GP Investimentos in São Paulo are quickly getting in on the act.

Exxel funded LatinStocks, an online Internet financial services company, which plans to trade regional stocks, bonds, and mutual funds through alliances with brokerages. America Online has decided to invest in LatinStocks and will use it as a content provider for its Latin American websites. GP Investimentos is backing Submarino, a Brazilian e-commerce company.

Susan Segal,
Chase Capital

However, Latin America’s equity markets are unlikely to share in much of the Internet bonanza. Although share price indices in Brazil, Mexico and Chile rose strongly in 1999, these markets are probably still far too small and illiquid to accommodate high-value Internet IPOs. Daily turnover on the Buenos Aires stock market, for example, rarely rises about $30 million.

Some companies like Patagon or Mexico’s Todito e-commerce venture say they are mulling dual listings on Nasdaq and their local stock markets. However, most of the trading is likely to be concentrated on Nasdaq.

Latin American investors won’t have much difficulty investing in Latin Internet stocks on Nasdaq, though, thanks to on-line brokerage services offered by financial websites like Patagon or LatinStocks.

But venture capitalists in Latin America cannot match the sophistication of US investors used to backing loss-making Internet companies. It is still anathema to most Latin investors to put money into a six-month-old company that may only start generating positive cashflow five years down the road.

An official at the São Paulo stock market says “there is little demand [for start-ups] from investors. They are not accustomed to [Internet companies]. We at the Exchange are always trying to get new companies and products to list, but the underwriting banks are very demanding because the risks are high. This makes local listings unrewarding for the companies.”

El Sitio’s Chief Executive Roberto Cibrian-Campoy and his partners decided to list on Nasdaq rather than on local exchanges. “Latin America is still very immature,” he says. “It still needs to see that the Internet business has a long-term future. In Latin America, business people and investors are used to speculative investments and do not understand the concept of a start-up.”

But the huge returns on US Internet IPOs have made them appear less and less risky to American institutional investors who are increasingly willing to put money into deals that they would have considered beyond the pale a few years ago. Similarly, these supposedly conservative investors have become the main sources of financing for many of the US and Latin private equity funds backing the region’s new Internet entrepreneurs. US private equity funds get about half their money from pension funds. Most of the rest comes from university endowments, foundations, banks and insurance companies, plus wealthy individuals.

By contrast, Argentina’s pension funds, created a decade ago to provide capital for private industry among other objectives, simply do not invest in start-ups. One reason for this is a legal requirement that their investments-including equities-must be rated by a rating agency. And it would be almost impossible for a new company to satisfy some of the agencies’ basic criteria such as liquidity and profitability ratios.

Endeavor’s Estenssoro says that it is important that pension funds be allowed to invest in start-ups or early-stage companies. She has tried to push for changes in regulations, but says it is hard to interest politicians in the plight of would-be Internet entrepreneurs. “There is no awareness of this problem in the government,” says Estenssoro. “We have gone to Congress, but it is not on the public agenda. It is very new and the people are involved with other things like the recession.”

Downplaying the Risks
US investors seem surprisingly sanguine about the risks of investing in Latin America’s Internet industry, even though the economies of many countries in the region are in recession or struggling to return to growth.

Some private equity fund managers argue that investing in Latin American Internet stocks can be less chancy than putting money into existing businesses where suspect accounting or contempt for minority investors are frequent problems. One Californian private equity fund manager says “these are young kids who are just starting out. There is not much to steal, at least not yet.” Start-ups are also less likely to have unpaid tax or social security bills. They also tend to be headed by enthusiastic US-educated entrepreneurs comfortable with American business methods.

The relatively small sums committed to the region and big returns seem to make these investments manageable-and irresistible-for fund managers. They claim their charges are all meeting their performance benchmarks, for now.

However, companies may face trouble raising more capital as competition intensifies or if they fail to meet their targets. Disappointing results could suddenly make Latin American Internet stocks unpopular on Wall Street, especially if US stock prices start slipping.

Advent’s Bachrach warns that “there is a huge volume of companies coming to the US market, but if it gets the sniffles or a cold, the first to fall off the line are emerging market [issues].”

However, Garib of EverSystems says he is not too worried about the state of the US market later this year when he plans to take his company public. “We have always been self-financing. We do not need money [from investors] to keep going but to expand the company aggressively.” He says Eversystems, which provides Internet-based financial software for banks and brokerages, has profit margins of 60% and is increasing revenues at a rate of about 70% a year. The company had revenues of about $20 million in 1999 and expects this to rise to $390 million by 2004.

But there is not a bottomless pit of capital for Latin Internet entrepreneurs. Struggling second- and third-tier Latin Internet ventures that never made it onto Nasdaq may be forced into trade sales. This may mean that mergers, not IPOs, turn out to be the main exit for most venture capitalists.

Analysts say the first to fall by the wayside could be the so-called vertical websites that specialize in niches like health, sports or auctions. There are already at least four competing auction sites from Argentina, Brazil and Mexico aiming to serve a pan-regional clientele.

But strong companies with a Nasdaq listing should be able to use their stock to buy weaker competitors once the expected consolidation phase sets in. Morgan Stanley’s Schwed says “I think we will see a fair amount of consolidation by companies using stock as currency. Terra bought companies with its IPO stock, and we will see more and more of that.”

Buying may be a faster and cheaper way into Latin America than building new businesses from scratch. American giants like America Online and Yahoo and Microsoft have turned their sights on Latin America. Microsoft has teamed up with Telmex in Mexico and Globocabo in Brazil. And AOL has a 50-50 joint venture with the Cisneros group of Venezuela.

Universo Online, the big Brazilian portal, is also expanding around the rest of Latin America. It already claims to be the world’s most-visited non-English language portal with 1.5 billion page views in the third quarter of 1999. UOL is a joint venture between Brazil’s biggest newspaper publisher, Empresa Folha da Manha, and its biggest magazine group, Editora Abril. Its parents’ deep pockets and access to a treasure trove of news and magazine content make UOL a particularly strong company.

UOL’s owners raised $100 million in first-round financing last September by selling 12.5% of the company in a private equity deal led by Morgan Stanley, which is also preparing the company’s impending IPO.

Some of Latin America’s biggest banks are now beginning to enter cyberspace too. Bradesco, Brazil’s biggest bank, owns 20% of non-voting shares in Multicanal, a company that will offer customers high-speed Internet access.

The bank also provides sophisticated Internet banking services and will soon have a proprietary internet service provider offering free access plus additional financial and shopping sites.

Unibanco, Brazil’s third-largest private bank, is offering a similar scheme, to the horror of commercial Internet companies like UOL, which has already had to cut access charges following the arrival of AOL. Banco Opportunity, a Brazilian investment bank, and GP Investimentos, a São Paulo private equity fund, plan to spend $120 million on a new Internet company that will offer free Web access in Brazil’s 80 largest cities by March.

BBV of Spain, which owns a string of banks throughout Latin America, will set up an Internet banking service that would cover the region.

In December, Banamex, Mexico’s biggest bank, announced a joint venture with the US’s Commerce One to set up a business-to-business, web-based marketplace for Latin America that they plan to take public. Market reaction was immediate: Banamex’s market capitalization rose by almost $900 million the day it made the announcement.

Although the banks are taking a keen interest in the possibilities – and threats – the Internet presents, none seem particularly keen on supporting entrepreneurs.

But some of the US investors backing Latin Internet ventures say they want to nurture the new generation of professional investors in Latin America and the new generation of entrepreneurs. Chase’s Segal says that as well looking for strong management and promising business plans, she also looks for people who can help lead the market and create a sustainable venture capital industry. “Look how it works in the US,” Segal says. “They create companies, make a lot of money and provide seed capital to help others.”

She may yet be proved right. However, that does not necessarily mean that the venture capital revolution in Latin America will benefit traditional capital-starved industries fighting for survival-or even revive help the region’s equity markets.