Exits in emerging markets
How, when and where?
The question of how, when and where we will exit investments is one that we get asked by almost every potential or existing LP that we speak to. There is a perception, rightly or wrongly, that it is not possible to exit startups in an emerging market. This common refrain supposedly negates the potential upside, because, quite rightly, no one gets rich from paper returns. As with anything, the best way to challenge this hypothesis is with real world data. This is something we did in a recent investor letter and wanted to share more broadly.
To summarise, our conclusion is that there are certain traits, consistent across markets and business models, that have been common to successful exits, and that by optimising around these we can increase the probability of cash returns for our founders and investors.
This analysis is based on seven companies from across our region. They represent a range of business models, some being single-country leaders while others have a multimarket presence. The acquirers include global players looking to enter new markets, as well as local players building out their ecosystem of products and services. While Covid and the accompanying glut in venture funding led to a distortion in valuations of the companies in our sample, only Paystack is likely to have been impacted by this, so we do not think that it distorts our conclusions. In this piece, we have chosen to focus on acquisitions rather than public listings as the sample size is larger and the likelihood of an acquisition is greater than a public offering, therefore of greater relevance.
We see four common traits from across these transactions that we believe will endure:
Being number one matters. Perhaps the best example of this is Careem, the Middle East-based ride-hailing app that went toe-to-toe with Uber and came out on top. Founded by Pakistani Mudassir Sheikha and Swede Magnus Olsson, Careem scaled to 33m users across 14 countries, including Pakistan as one of its core markets. With greater localisations in each market, Careem overcame its better-funded rival until Uber decided acquisition was a better strategy than competition. Another prescient example of this is Alibaba's acquisition of ecommerce player Daraz. As the largest player in Pakistan and with operations in Bangladesh, Nepal, and Sri Lanka, Daraz had set itself up as the natural acquisition target for an international player looking to expand into these countries. The case of both Daraz and Uber would suggest a connected point that being multimarket is important for an exit to global players.
Better margins = higher multiples. Comparing the revenue multiples of Cloudways, Payme and My Group to those of Daraz, Careem, and Namshi, it is clear that higher margins lead to higher multiples. The first group are all pure software companies with inherently higher margins, for which we would expect a revenue multiple of 6.50-7.50x as a base case in an acquisition scenario. The second group are all operationally more complex companies with lower margins and multiples that should trend to 1.0x GMV/revenue. The cases of Daraz and Careem indicate that if companies have become number one in multiple markets, then strategic acquirers are willing to pay higher multiples. Paystack shows that if the domestic market is big enough, like in Nigeria, a strategic acquirer will also pay a higher multiple relative to margins.
Captive distribution attracts ecosystem builders. TBC's acquisitions of My Group in Georgia and Payme in Uzbekistan are good examples. TBC is a Georgian bank listed in London that has been trying to evolve from a traditional bank into an ecosystem of complimentary products and services. At the time of acquisition, My Group had 1.7m unique monthly visitors, or 45% of Georgia's population, across its automotive, spare parts, C2C and housing marketplaces. TBC has also expanded outside of Georgia into Uzbekistan and acquired Payme in 2019 for its distribution of 1.3m active users. By 2023, when TBC acquired the remaining 49% of Payme, its unique users had grown to 3.1m, and the platform will be incorporated within the wider TBC ecosystem.
Business complexity is attractive in the long term. When Kaspi acquired Santufei, an online travel agency in Kazakhstan, in 2020, it did so to accelerate the launch of its travel service within its super app. The online travel agency business is complex, requiring multiple integrations, licenses, and B2B relationships. For Kaspi, it was cheaper and quicker to acquire Santufei than to build this themselves. However, this also serves as a cautionary tale for a startup operating in a country with an existing dominant ecosystem player. With 6m daily and 11m monthly active users on its consumer super app (out of a population of 18m), Kaspi has such powerful captive distribution that it can dictate terms to any potential acquisition target – "either you sell to me, or I build it myself and take you out". This mantra was proven after the acquisition when Kaspi launched Kaspi Travel in December 2020 and grew to 26% market share in six months.
So, what does this mean for Sturgeon’s investment strategy across Central & South Asia (ex. India)?
Being the market leader with established captive distribution is a clear path to exit. We believe now is an opportune moment to identify and invest in these potential market leaders. On the one hand, the digital ecosystems are nascent, meaning there is limited competition. On the other hand, any startup that is well-capitalised through this downturn in global funding can capture greater market share at low acquisition costs while competitors are underfunded or busy elsewhere.
We are biased towards high operating margin businesses. These margins give operating leverage and increase the multiples that acquirers are willing to pay, hence our returns as early-stage investors. Lower operating margin businesses must target significantly large enough markets (and be able to build a market-leading position) to attract strategic acquirers willing to pay a multiple premium.
Caution where there is an established player with a captive distribution base. The clearest example is Kazakhstan, where we rarely consider B2C businesses because the threat of "what if Kaspi launched this?" is too great. Any hope of an exit in this situation is a function of having a degree of operational or business model complexity that the incumbent cannot match from its resources.
While the exit horizon for most of our portfolio companies is distant, it is important that we incorporate the exit opportunities into any investment decision today. The key impact of this is the valuation we are willing to pay for a company, as time and again we have seen this is the only form of effective risk management across market cycles. This valuation must be proportionate to the true revenue opportunity for a business, which requires a degree of intellectual honesty from both us as an investor and the founders.
What is clear though is that when a company has established itself as the market leader with captive distribution and profitable operating margins that it can deliver a significant outcome for founders and investors. Getting to this point takes time and an efficient allocation of capital across market cycles, and most companies in these regions are still at the early stage of that progression. Over the next 5-10 years we expect to see many more exits via acquisition, and we will update this piece over time as these happen.