Transformational times in Brazilian infrastructure M&A
June 2016 | SPECIAL REPORT: MERGERS & ACQUISITIONS
Financier Worldwide Magazine
It is time to do business in Brazil. Indeed, it seems to be the right time to buy in Brazil, given that it is unlikely that an opportunity of the same magnitude will arise in the next decade. The entire country is struggling due to unsuccessful economic policies implemented over the last eight years. Local and global facts, such as the shifting of China’s growth inductor to the consuming market, the downturn of commodities prices, the skyrocketing dollar exchange rate vis-à-vis the Brazilian currency (which affected balance sheets), and the unceasing consequences of corruption scandals, have affected the country from south to north and most of its industries.
As a result of this multi-faceted crisis, some of the most important Brazilian corporations are taking a considerable hit. This is the case across the entire Brazilian economic spectrum and in all industries, but is particularly true in the infrastructure segment, where rates of return have been hit by the economic downturn and access to credit and capital markets was made very difficult – if not impossible – as a result of investigations regarding cartel and corruption scandals. The scandals tainted such corporations on an unprecedented level and have also affected, to a certain extent, the speed at which traditional lenders in Brazil grant credit – chiefly the national development bank, Banco Nacional de Desenvolvimento Econômico e Social (BNDES). As a result, some of the key corporations acting in the infrastructure market in Brazil are no longer able to finance their backlog – which is by no means acceptable and needs to be corrected soon.
Accordingly, we are in the midst of a transformational moment in the country’s infrastructure. Corporations acting in this industry have to sell assets to stay afloat, with some of them already in judicial recovery procedures – the Brazilian equivalent of the US Chapter 11. It is the perfect storm for them and the perfect opportunity for foreigners that wish to expand their portfolio and create – or increase – their exposure to emerging markets. In a nutshell, large corporations that have been dominating the Brazilian market for decades were hit hard, have no access to credit and are thus in a selling mode.
New players have already identified these opportunities and are now buying. It is easy to identify targets. The deals are in the headlines and the mandates on the street. The window of opportunity is clear, but may be a small one.
The distrust of the population toward the current government (which may be already impeached by the time this article is published) was made clear when the Brazilian House of Representatives approved the opening of impeachment procedures in mid-April. It is expected that the Senate will also approve the impeachment procedure in early May. At that time, a new government led by the current vice-president will take office. There is nothing new about the probable new government. The vice-president has been around for the past three decades and has presided over Congress several times. On top of that, he was the running mate of the current president and is no stranger to the political environment and practices. There is good and evil in that. On the dark side, there is a risk of getting more of the same. On the bright side, the likely cabinet members are increasingly showing signs of a more orthodox approach to economic policies. Talks of no increase in taxes (which is always hard to believe), less governmental intervention and less public expenditure are hitting the newswires. The fact that the new government knows the Brazilian political system inside-out is also important and encouraging to a certain extent. The largest institutional changes in recent history started with a president belonging to the same party, who was lifted from vice-presidency after an impeachment and who was able to implement changes from within. Brazilians do not like revolutions or disruptions. It is easier to work from within the system to implement changes. This is very important and should not be taken lightly.
The markets always like stability, and price the movement ahead of time. In other words, assumptions of pricing will be made as if the changes were already implemented and as if the government was already successful. It is not relevant if this pricing ahead of time is correct; it is only relevant that it happens. This is why the window of opportunity may be short.
The question as to the right design of a deal is as important as its timing. Of course, foreign buyers are very sensitive to cartel and corruption scandals, as they should be, and such a driver is also important in M&A deals. The answer is as old as M&A – thoroughness of legal, financial, accounting and routine due diligence. Transactional cost may increase, but the benefit of not having to deal with unforeseen and immeasurable risks will pay off. You will be more likely to be able to focus on your business and make more money in the future.
Also, it is important to have knowledge of the local market and practices, so despite the current turmoil we tend to see clearly when a foreign company joins a local player in a joint venture. The negotiation of documents is frequently difficult but, again, pays off. Brazilian joint venture agreements are sophisticated and similar to UK and US style documents.
You have to set your priorities right, provide the local partner with the right level of protective vetoes and establish way-out clauses (put, calls, rights of first offer, rights of first refusal, tag-alongs, etc.). If you get that right, life will be easier.
More than anything, though, partnering with a local player will provide you with local insight and more efficient ways of communicating with the government. Communication with the government is not only legal, but necessary. It controls a very large stake of the national economy and influences local markets. This will not end and is not likely to be significantly reduced in the short term – especially in the infrastructure segment. A new player needs to know its way around, and the best way to learn this is to have a local experienced tutor.
Finally, it would be foolish to ignore the fact that most of the sophisticated international players are worried about being tainted by legal scandals and therefore tend to resist partnering with locals. This is a mistake. It is possible to identify and quantify risks both at the target level and at the partner level during a thorough due diligence process. If necessary, one is always able to get out of the deal. Moreover, there are ways that allow companies – to a certain extent – to ringfence such risks. One needs to clearly identify the risks to do that – hence the importance of due diligence.
The Brazilian economy, like every capitalist economy, works in cycles. Right now we are experiencing a downturn but there is light at the end of the tunnel, in the form of likely changes to economic policy. In a country with 200 million inhabitants, a democratic regime and strong institutions (as proved by the recent events), this creates rapid change. As we say again and again, the time to buy is when the market is down.
Thiago Sandim is a partner and Fábio Tayar is a lawyer at Demarest Advogados. Mr Sandim can be contacted on +55 11 3356 2085 or by email: firstname.lastname@example.org. Mr Tayar can be contacted on +55 11 3356 2094 or by email: email@example.com.
© Financier Worldwide
Thiago Sandim and Fábio Tayar