For investing, Brazil still rules the school

Sometimes I get the chance in my job to respond to journalists requesting the data we produce every year. I don’t often get credited for my responses in the press- that honor goes to my boss – but sometimes I think it’s worth sharing some of the more interesting nuggets that pop up.

There’s been a lot of consternation of late in Brazil about a slowdown in growth, a slump in Chinese/Asian demand, and a fear that Brazil became a commodity behemoth without looking after its more labor-intensive sectors. But the work I’ve been doing with Brazilian private equity has defied these expectations, with a good flow of investments targeting a very sophisticated and dynamic group of target companies.

Here are a few of my responses to the latest spate of questions from Dow Jones.

Q. With Brazil’s tepid economic activity, are Brazilian asset prices more attractive from private equity investors perspective?

A. I’m inclined to say that the more moderate economic growth over the past several years is more reflective of external factors, particularly regarding shrinking demand from China and other major commodity-importing economies than a lack of local opportunity for business to grow or generate efficiency. A combination of the slow natural depreciation of the real and a slight shift towards return expectations more in line with a maturing market have made prices more attractive than in the past few boom years.

Still, deal activity has been robust. There was a significant year-on-year increase in both the number of deals and new capital committed in Brazil in 2012. In dollar terms, $5.7bn of new capital was committed to investments through 147 deals, an increase over 2011 of 36% and 63% respectively. Also, the number of investments over $100m in Brazil grew from 14 in 2011 to 18 in 2012. Brazil was also home to eight of the 10 largest deals closed in Latin America in 2012, including two investments in the oil & gas sector, as well as deals in infrastructure, manufacturing, real estate and consumer-focused deals in retailing and a restaurant chain.

Q. Are currency risks and inflation pressures is a point of concerns for private equity players in Brazil.

A. Currency was more of a concern when the ‘real’ was valued at 30% above what it is now, making deals expensive and not competitive with other similar opportunities in the region. Now the risk is less of rapid devaluation or high inflation, because of macro-prudent management on the part of the Brazilian government and a shift in focus of PE investors towards mid-market deals that are smaller and more focused on long-term organic growth trends that we don’t see changing. In addition, most of the private equity funds raised in Brazil are denominated in ‘reais’, which ultimately mitigates risk and creates a much more stable environment to avoid currency mismatches.

Q. Even with tepid Brazil economy performance in 2011 and 2012, what are the main reasons that Brazil attracted the major portion of investment in PE industry in Latin America? 

A. Brazil’s sheer size is probably the most reliable reason why the country attracts so much PE investment. With twice the population and more than double the GDP of Mexico, the next largest market in Latin America, Brazil is a natural market leader. Still, there are other factors that contribute to Brazil’s continued dominance, including the maturity of the Brazilian PE market, with a long track record of successful investments, and a developed funds structures (FIPs), which provides a ready-made vehicle for PE firms to raise funds and invest efficiently.

Beyond these factors is a growing sense that deal opportunities are cropping up outside of traditional investment centers like Rio and Sao Paulo, including in the country’s richer southern and poorer northern regions. Two examples include CRP Companhia de Participacoes’ acquisition of a 25% stake in Tecnoblu, a leading producer of decorative and retailing materials, in Santa Catarina.  Another is Darby, who injected BR$ 35m (USD 17.7 m) in Dall, a company in the northern state of Sergipe that supplies food, logistic services, and hotel management for the Brazilian oil& gas and infrastructure sector.

While Colombia, Mexico, and Peru have shown impressive growth in their activities over the past several years, these factors give Brazil an edge to dominate the market for the foreseeable future. 

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