The return of M&A activity in Brazil
April 2018 | PROFESSIONAL INSIGHT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
April 2018 Issue
The outlook for global M&A activity this year is broadly positive, with an uptick in both deal volume and transaction amounts expected. The Intralinks Deal Flow Predictor projects that the number of worldwide announced M&A deals in Q1 2018 will increase by around 2 percent year-on-year, with Latin American growth predicted to be around 3 percent. This will be supported by a backdrop of strengthening global growth, low inflation and interest rates and upside pressure in equity and investment markets. According to Deloitte, “corporations have spending firepower; more companies say their cash levels have increased, and M&A remains the number one intended use of those funds. There also is a marked downtick in interest in global deals”. Nonetheless, “the risks to the scenario of steadily increasing M&A activity are twofold: political and financial,” adds Philip Whitchelo, vice president of strategy and product marketing at Intralinks. “Increases in protectionism and restrictions on global trade all have the potential to negatively affect deal making sentiment. With almost nine years since the last major [market] trough, a correction that turns into a more serious sell-off could also prove negative for deal-making confidence”.
This investment thesis is backed by Merril Lynch: “Global stock markets are at or near all-time highs, supporting confidence among corporate executives and providing additional currency in the form of robust equity valuations for those hunting for deals to fuel future growth. Furthermore, the private equity market this year has raised the most capital since the financial crisis. Firms are under pressure to deploy a record level of ‘dry powder’, or else face returning it to investors. This is increasingly pitting PE firms against strategic acquirers in a competition for attractive assets, underpinning buyout activity”. Technological disruption is another key driver of M&A, as companies turn to dealmaking to achieve the innovation necessary to gain an edge on competitors in rapidly changing business landscapes.
Looking at M&A activity in Latin America, dealmaking has seen acute downside pressure, driven by a retreat in commodity prices, economic stagflation in key markets and Brazil’s political crisis. With an improved macro environment, Baker McKenzie expects activity to have stabilised in 2017 and forecast the region’s M&A deals to peak at US$142bn in 2019, dropping to US$113bn by 2020. Analysis by Intralinks suggests that early-stage M&A activity in the region increased year-on-year for the fourth consecutive quarter, confirming the region’s return to growth. “The region’s economic activity rebounded in 2017 and is forecast to increase steadily over the next two years, driven by increasing consumption in Brazil and Colombia, economic and monetary reforms in Argentina and energy-sector liberalisation in Mexico. The healthcare, technology, media and telecoms (TMT) and financials sectors are predicted to lead the growth in LATAM M&A announcements over the next six months”.
In Brazil, positive economic news is likely to drive the M&A market away from predominantly scandal-driven asset sales, for example the conglomerate J&F Investimentos’ sales of Vigor Alimentos SA to Mexico’s Grupo Lala SAB de CV and pulpmaker Eldorado Celulose Brasil SA to Paper Excellence in 2017, to investor plays on a broad-based recovery. Reuters reports that “conglomerates under pressure from corruption probes and excessive debt were forced to sell major assets last year, lifting the value of Brazilian M&A to $61.77bn, up 33 percent from 2016. Bigger transactions drove the increase, as the number of deals fell to 544 from 615 a year before”.
According to Angela Bouzanis, senior economist at FocusEconomics, recently released data “indicates that GDP grew for the first time in over three years in Q2, confirming that the [Brazilian] economy has turned a corner”, led by falling inflation and export growth. These factors, together with historic lows in the benchmark SELIC interest rate, which is currently at 7 percent, emerging discourse over political and fiscal reform and economic growth, have fuelled investor optimism and capital flows into Brazilian assets. Uncertainty, led by concerns of a return of ex-president Lula as a candidate for the left-wing workers party, had kept markets on eggshells during 2017. This uncertainty, which was potentially holding back further upside pressure in financial and M&A markets, was cleared up early in 2018 and greeted warmly by investors. Lula was condemned to 12 years in prison on corruption and money laundering related charges, therefore ruling him out as a presidential candidate.
Appetite for the Brazilian risk and return profile is increasing. Indeed, according to Euromonitor, 2018 could see two years of pent up activity as companies and investors who have delayed investment allocation and strategic plans for the last few years return to a new normal. Capital markets activity should increase from last year’s high volumes, potentially reaching record volumes.
2017’s improvement in Latin American fundamentals and the continuation of an incredibly benign environment for emerging market inflows saw a big pick-up in all capital markets activity in 2017. Investment banking fees picked up, reaching $1.7bn, up from $1.1bn in 2016 and $970m in 2015, according to Dealogic. Experts, including Leandro Miranda, head of investment banking at Bradesco, argue that there is broad sectoral demand and focus outside the established São Paulo-Rio de Janeiro axis. The southern region, including Paraná and Santa Catarina, is expected to be a key market in the first half of the year. Investors are adding Brazilian assets and exposure to their portfolios. However, Mr Miranda notes that such levels are below the 2010 peak. He expects “PE funds to be selling their stakes on the stock exchange” as well as being busy throughout the PE cycle – returning funds, raising more funds and leveraging up new targets through an expected spike in acquisition finance. “Many companies are pursuing a dual-track process: they are preparing for an IPO but are prepared to sell controlling stakes through M&A”. An increase in volatility, perhaps due to an uncertain outcome in October’s presidential election, would lead to less IPO activity and more short-term follow-ons. Brazilian FinTech companies, including PagSeguro, an online payment company, are leading the IPO charge. Leading American and Asian firms are increasingly looking at Brazilian acquisitions, such as Boeing’s deal with Embraer and Didi Chuxing’s control acquisition of Uber rival 99 taxis.
Roderick Greenlees, head of investment banking at Itaú BBA SA, says, “We will still see a lot of deals in infrastructure and energy, but the recovery may stimulate acquisitions in retail and consumer industries too”. The state national development bank, BNDES, is also betting on national and international private sector participation in infrastructure investment as it deleverages and shifts disbursement policy to SMEs and socioeconomic linked projects. The rally of the benchmark Bovespa share index to record highs this year has also boosted valuations to levels that could stimulate more M&A activity. All in all, investment bankers expect a refreshingly positive year in corporate and investment activity in the Brazilian market.
Adam Paul Patterson is a director at Legacy Partners.
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Adam Paul Patterson