Latin Finance - March 2008 - 38

Brazil m&a much greater due diligence, with clients insisting financing packages are water-tight. “Let’s not fool ourselves, current market conditions are extremely challenging,” agrees Lacerda. Equity funding for all SMEs, regardless of reputation and track record, has been choked, though it remains conditionally open for blue chips. “The equity market is not accepting small deals right now. The deal size has to be large and from a large company,” says Denise Moura, head of investment banking at Bradesco, which deals with a large spread of companies, including SMEs. A $300 million offering from a company with total equity of $600 million runs into a brick wall. The same sized issue from a $1.5 billion company can be pushed through, she adds. As SMEs are no longer able to tap equity, they will look to grow organically and through small acquisitions to accumulate the muscle to come to markets when they re-open, Moura predicts. That is, as long as they do not fall to larger predators. Even bullish Beer sees a reduction in equity activity, with some knock-on effect on M&A. Still, he believes the stock market pause is not all bad. The market was looking frothy and starting to encourage companies to rush to market, inflating valuations to unrealistic levels and encouraging unlisted rivals to harbour illusions about the multiples they could generate. The effect of the downturn will be an adjustment in valuations and willingness to sell to strategic investors. particularly on credit ratings. Heightened sensitivities from banks and agencies’ need to show that they are not patsies after the subprime crisis mean blue chips need to work extra hard to keep their grade during transactions. That is particularly the case for Vale (Baa3/BBB) and other Brazilian blue chips, which are held back by sovereign weakness and hover perilously close to junk. Bond investors also prefer solid stories in these markets. That is in evidence at the smaller end of the market where companies are already suffering the credit drought. Bicbanco postponed a deal in the region of $100 million run by UBS because of market conditions at the end of January. That suggests it will be difficult for SMEs to use debt markets to fund acquisitions, particularly in the banking sector. Even Petrobras had to pull a mid-February attempt at a bond reopening that was launched too tight for the buyside. Foreign Bidders Jump In It is not only Brazilian companies that are acquiring, but foreigners, says Roderick Greenlees, head of M&A for Brazil at UBS Pactual. Anglo American’s $5.5 billion offer to purchase majority ownership in miner MMX shows that foreign interest is alive and kicking. Anglo wanted to grow in iron ore and was happy with earlier investments. Greenlees believes that despite weaker market conditions, foreign companies will continue to enter. He adds that hostile transactions are unlikely because most Brazilian companies are still privately owned or have a control group. “We will continue to see negotiated “friendly” transactions,” adds Greenlees. Finally, private equity firms, hedge funds and commercial banks are all combining in new ways to facilitate deals. Financial sponsors are able to compete in Brazil as the cost of funds has trended lower. They are starting to use leverage plus expertise in reorganizing companies. “We will see more creative types of financing,” says Goldberg. These include hybrid debt-equity deals and convertibles, for example. Moura confirms that banks like hers are lending to private equity firms. It is an area that has become attractive quickly. “You find a niche but then everyone does it and very competitively,” she says. Here again, though, there are stringent conditions on providing financing which favor cash generative, established businesses. “We are flexible for strong cash generators but strict for capital intensive businesses,” she says. Leverage for the former can reach a 40:60 debt-to-equity ratio. M&A bankers predict continued activity across many sectors. Moura says she has never seen such an eclectic range of companies eyeing transactions. Bradesco is working on M&A in services, logistics, ethanol, retail, petrochemicals, food, textiles, financial, industrials and mining. Brazil used to be focused on just four or five industries. Broadly, the sectors most favored are related to consumer growth stories and include services, manufacturing and financial institutions, says Greenlees. Insurance and healthcare will also be strong, driven by new regulations to strengthen minimum capital requirements in what is a highly-fragmented industry, adds Goldberg. Many firms will not be strong enough to survive. LF War Chests Build There are plenty of Brazilian companies able to buy, particularly those listed over the last couple of years that are flush with cash. “Even those IPOs from companies that have disappointed investors raised significant amounts of private capital,” says Lacerda. These firms will lead consolidation through M&A to boost results, he predicts. The other development is interest in domestic, semi-private deals, says Nicolas Aguzin, head of LatAm investment banking at JPMorgan. He adds that for public markets, volume in the first half is likely to be down some 30% year-on-year. Debt markets too are also doing the splits. Giant mining company Vale’s ability to obtain $50 billion in debt funding promises for the possible purchase of Xstrata after its jumbo purchase of Inco shows market appetite remains solid for the crème de la crème. Vale managed to line up a strong syndicate dominated by international banks including Santander, HSBC, BNP Paribas, Credit Suisse, RBS (via ABN AMRO), Citi, Calyon and Lehman. That may seem surprising as banks like Citi have been severely battered by the US credit crisis. Lacerda insists that the Brazilian operation remains unaffected, and its promises proves that there is still a lot of money out there for the right Brazilian names. Still, with US banks becoming incredibly selective in how they spend capital, prospects for big acquisitions with bank financing must be damaged, reasons Aguzin. Financial institutions are starting to re-price risk, insist on stricter covenants, and retain the right to change terms, says Goldberg. He adds that corporate ability to leverage will fall as banks grapple with more restricted lending policies and putting together syndicates becomes more uncertain. Bridge financing, in particular, will become harder. Banks are indeed already insisting on stricter covenants, UPDATE For more on Brazilian M&A see www.latinfinance.com > 38 LATINFINANCE March 2008
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Latin Finance - March 2008

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