AThe global economy has still not recovered from the 2008 worldwide economic crisis. Global growth is in a low gear, and the drivers of activity are changing. These dynamics raise new policy challenges for developed and emerging markets, including Brazil. Advanced economies are growing again but must continue to repair the financial sector, pursue fiscal consolidation, and spur job growth. Some emerging market economies face the dual challenges of slowing growth and tighter global financial conditions – and the demands of the middle income classes. Some governments and countries that previously seemed immune from these global crisis, felt the tail of the recession and are now struggling to recover and find sustainable growth. Certain emerging market economies, like Brazil, were able to avoid the classical boom-bust cycle in the face of volatile capitalflows during the global financial crisis but now also face the challenges of increasing potential growth, including, investment in infrastructure, and other macroeconomic challenges (e.g. fiscal discipline, inflation and exchange rate
Brazil is in centrestage of this discussion and today faces the familiar challenges of growth – a new middle income class demanding better infrastructure, services and political transformation. 2013 saw a year of politicians yielding to the new-found power and demands of the ever empowered middle class.
Brazil has made impressive gains under Ms. Rousseff and her predecessors, Luiz Inácio Lula da Silva and Fernando Henrique Cardoso. Social programs, better infrastructure, macroeconomic development and better living conditions have all boosted daily life for the Brazilian people. However, the country’s inflation rate was 6.1 percent in August, according to the central bank who has raised interest rates several times during the last year. Given the focus of the monetary policy much more on growth than on inflation in the last years, the inflation neared the upper limit of the target driving the central bank to tighten the monetary policy since April to bring the inflation to lower levels. Last year, Brazil’s economy grew only 1.0 percent as private investment slowed.Analysts expect the growth rate to recover to circa 2.0 percent in 2013, but that is still far below the 7.5 percent growth the country realized in 2010. The stakes for Brazil are high and the need for decisive policy action is now. Give the time it takes to implement structural measures (something with which Brazil is intimately familiar), the Brazil rebound will not be fast nor easy.
The duration and ferocity of the slowdown will depend on the resolution of Brazil’s structural issues, and unfortunately, the country still has a way to go – bottlenecks in infrastructure, labor market, regulation and cost, power sector challenges and tax burn rate (the country’s tax burn rate is circa 38 percent-versus an average of 21 percent in similar countries). But Brazil’s growth in the near-term will continue to be a “hot button” issue. Policy makers will need to recognize that the country will grow at lower than expected rates during 2014 and 2015 and reseed the country’s future growth – again!
The Brazilian government must build enough roads, railways, ports and other infrastructure to keep pace with the economy’s growth – in Brazil only circa 1.5 percent of GDP is invested in infrastructure, compared with an average of 4 percent globally. Additionally, the country also needs to reform its education and healthcare systems. Productivity is a key word for Brazilians now and private industry needs to have the government do its part (or privatize in key areas, as recently seen with many of Brazil’s ports, highways, and airports.)Brazil achieved investment grade in 2008/2009, and today, a widely accepted measure of the risk of doing business is at near historic lows (circa 230 basis points).
In June 2013, millions of people joined street protests that were prompted by an increase in public-transit fares in São Paulo city but quickly became a way for Brazilians to air much wider demands about the rising cost of living, weak infrastructure, political corruption, lack of security, and government spending on big sporting events such as the 2014 FIFA World Cup. In response to the protests, politicians demonstrated they would push for political reforms and investments in infrastructure – but, to date, not much has been delivered.
From a long-term perspective, Brazil also needs to address its labor qualifications and a much wider and universally known issue: pension reforms. Today, public pensioners, which represent 20% of the total pensioners, draw some 50 percent of resources, while the remaining 80 percent of pensioners, share the remaining 50% of funds. Additionally, the government spends circa 11% of the GDP on pensions while the average in OECD countries is around 8.0%. This is challenging when one considers the proportion of pensioners in the Brazilian population compared to that of other countries.
Brazil continues to record low rates of unemployment – although the country still seeks qualified, skilled labor.
Emerging markets, Brazil included, can get their groove back. Adjustments in the fiscal and monetary policies along with the deepening of public services concessions are important to get the Brazilian economy on track in the short term. Brazil continues to have consumption growing at a relevant pace, not solely the movement of the population to higher social classes, which reinforces the purchasing power of the middle and high income classes.
The government continues to be characterized by more expansionary fiscal policy, industry specific incentives, and a devalued exchange rate (although a devaluation of some 30% percent was observed during the year, with the exchange rate in January at 1 USD$ to R$ 1.80 and is expected to end 2013 around USD$ 1 to R$ 2.4), From a
monetary point of view, very low interest rates were observed in 2012 – the benchmark interest rate in real terms (net of inflation) was at circa 1.5 percent at the end that year – but given the hike in interest rates since April by the Central Bank, the real interest rate should reach 4.0% by the end of the year.
In response to recent economic developments the Brazilian central bank raised interbank basic interest rates to 10.0% as the country continues to address the fiscal deficit.
It is important to note that the Brazilian Central Bank is actively intervening in the foreign exchange market by selling dollars on a daily basis which began in July 2013 and is expected to continue through 2014.
Market players seem to understand that the Brazilian Central Bank effectively balanced growth and inflation in 2013 (as perceived during 2012 that government was much more focused on growth than inflation). Target inflation in 2013 should not exceed the government’s ceiling of 6.5 percent.Finally, during 2013, we observed a continuation of many components of the government’s agenda since 2012; the intense use of fiscal policy, as the government pushed to reduce certain taxes in order to boost economic activity – especially for consumption items – while controlling inflation. In the same vein, the government continued to reduce taxes on the purchase of vehicles and household appliances and replaced certain payroll taxes with a sales tax to reduce production costs (all of these are subject to review in early 2014).
Public banks such as the BNDES (Brazilian Development Bank), Caixa Econômica Federal and Banco do Brasil continued to be active in lending money to industry, thus boosting consumption and investments. While BNDES is expected to reduce this trend during 2014, Caixa Econômica Federal and Banco do Brasil shall continue as the largest lenders to the Brazilian housing segment.
In 2014, the government is likely to deepen a strategy to address long term growth as well as winning the elections. The challenge is to introduce the ambitious investment agenda designed for the infrastructure sector, which totals more than US$ 110 billion (US $45 billion for railroads, US$ 27 billion for ports, US$ 21 billion for highways and US$ 17 billion for airports).
In 2013 Brazil observed important changes in regulations and auctions for the concession of operations in the oil/gas and infrastructure sector (airports, ports and roads). Some highlights include:
• Libra Field (pre-salt) sharing concession (October) will be operated by Petrobras (40% of the consortium), Shell (20%), Total (20%), CNPC (10%) and CNOOC (10%), who agreed to pay a down payment of US$ 7 billion, plus share in all future profits, with Brazil compromising these resources with public education and healthcare systems;
• Aeroporto Internacional do Galeão (RJ) concession was granted to Aeroportos do Futuro consortium (Odebrecht,Singapore Group and airport operator Changi) with
a bid of c.US$ 9 billion. Government estimates that an additional US$ 3 billion will be invested in the airport infrastructure;
• Aeroporto Internacional de Confins (MG), in Minas Gerais, concession was granted to an AeroBrasil consortium (CCR, Flughafen Zurich and Flughafen Munchen) for US$ 1 billion;
• Aeroporto Internacional de Brasília has been operated since the beginning of 2013 by the Inframerica consortium (Infravix and Corporación America). The group bid US$ 2.1 billion and is expected to invest an additional US$1.5 billion in the airport. The concession of Viracopos (Campinas/SP) airport was awarded to Aeroportos Brasil (TPI, UTC and french company EGIS Airport) at a bid of c.US$ 2 billion. The consortium started operating the airport in early 2013 and will make new investments of c.US$ 4 billion;
• BR-163, one of the most important roads for soy output in Mato Grosso had a bidding process in November won by CCR;
• Triunfo Participações won the bid to operate 1,177 km of roads (BR-060/153/262) in Goiás, Distrito Federal and Minas Gerais in December. Expected investment totals US$ 4 billion.
• Concession of BR 040 (Distrito Federal/Goiás/Minas Gerais) with a total of 1 thousand km was won by Invepar in December 2013.
This continues a trend of privatizations that started in recent years. In 2012, the Brazilian government awarded the concession of São Paulo International Airport in Guarulhos, for c.US$ 8 billion to Invepar e Airports Company, South Africa. In 2011, the concession of São Gonzalo do Amarante (RN) was granted to Inframerica (Infravix and the Argentinean group Corporación America).
2014 should be paramount for President Dilma in her effort to attain greater economic growth and, hence, reelection. The current political and economic challenges are quite complex. Dilma’s ratings, however, are highly positive, given the low unemployment rate. Nevertheless, Brazil is still struggling to find the path to higher economic growth levels.
The deepening of public services concessions to the private sector provides a unique opportunity to promote and attract investment, leveraging the potential of the country and
helping reduce the infrastructure deficit. The realization of mega events like the FIFA World Cup this year and the Olympic Games in 2016 reinforce this opportunity.
Attracting these investments requires a major organizational effort, particularly strong synergy and integration between the various public and private entities, directly or indirectly linked to the sports industry. Currently, a total of US$ 50 billion is estimated to be invested in the infrastructure of all cities involved in both events.
Brazil has, over the last four years, maintained robust levels of M&A activity. With an all-time record of 811 transactions announced in 2013, 2010 to 2013 had, on average, 783 announced deals.
The level of activity experienced in the Brazilian M&A market is a testament not only to Brazil’s rebound from the global downturn started in 2008, but also to its underlying strength. While international market sentiment around M&A activity in 2012 and 2013 swung between optimism and skepticism, Brazil continues to show good momentum in what looks to be sustained activity. Strategic and financial investors (private equity) have reached historical record levels of deals, supported by a solid macroeconomic scenario and tremendous consolidation opportunities. Middle market M&A activity remains strong and is expected to continue to drive M&A in 2014 – transactions involving up to US$ 100 million lead M&A activity in 2013 with a 69 percent share of the announced deals.
One supporting factor for the high M&A volumes, despite the sluggish economic growth in Brazil, is an observed return to deal multiples more in-line with global markets. While certain industries and growth businesses continue to command premium EBITDA multiples, the greater market understands that the “price to do business in Brazil” has been reset. This presents opportunities for interested buyers to pick up valuable assets at a “discount” as multiples continue to normalize.
Majority stake transactions represent around 55 percent of all announced transactions, while non-controlling positions account for 32 percent, indicating a long-term investment
strategy. Strategic and financial investors are both participating aggressively in the fast developing Brazilian economy.
A multi-sector and multi-region deal profile that was observed in 2012 remained during 2013, with the leading sectors, by deal volume, being IT, Retail, Consumer Products
(including Food/ Agribusiness & Beverages, Healthcare and Cleaning products), Mining, Services (Healthcare, Education and general services) and Chemicals/Oil & Gas. Next in
relevance are Financial Services, Logistics and Infrastructure/ Construction. It should be observed that the largest sector holds some 10% of total deal volume with other sectors following close behind.
Private equity activity maintains a high level of activity, being present in almost 45 percent of the deals announced in 2013. This share, which was 15 percent in 2007, reflects ag-
gressive private equity investment strategies and consolidation of various sectors.
Capitalized with some US$ 15bn available for investments, a significant part of private equity activity in Brazil has involved consolidation opportunities in “capital for growth” deals. The largest investments this year are in the segments of food and beverage, retail, consumer goods, IT, education and financial and energy sectors. Additionally, deal size has started to increase from the small-to mid-market transactions that have historically dominated the market. The Brazilian private equity market has been stimulated by a combination of several factors that have strengthened Brazil’s position as not solely an emerging market alternative to China and India – although other Latin America
countries gained momentum during 2013. A combination of factors, such as increasingly sophisticated and liquid capital markets, new financing instruments and existing exit alternatives (such as sale to a strategic player, capital markets/ IPO or sale to another PE or funds), along with the continuing demonstration of political and economic stability have opened the eyes of foreign private equity investors to Brazil, which is now regarded as a serious player in the global market. We expect much more active equity and debt markets in 2014(after a modest 2013 performance).
The main sectors for investment will continue to be IT, retail, food and consumer goods, healthcare, education, general business services, energy and finance, with consolidation in all these sectors continuing to be a key driver.
Infrastructure, given Brazil’s structural deficiencies, and oil & gas are also sectors likely to see improved activity. Companies in Brazil continue to face a transformation period. With better corporate governance and accounting practices in place, most companies are experiencing the challenges of having a local company that is being transformed into a regional, then national and finally international operation.
In addition to record-high M&A levels, foreign multinationals continue to invest in the region via organic expansion as well. In 2013, international large retailers, high end fashion lines, and family-friendly dining chains have all announced plans to open locations in Brazil in 2013/2014. Additionally, automotive production continues to be a large source of foreign direct investment, with four of the world’s largest automotive manufacturers recently announcing plans to each open a local manufacturing presence in 2014/2015.
Main economic indicators
(1) 2013 figures are based on the most recent published data.
(2) At the average annual exchange rate. IBGE.
(3) Year-end to year-end.
(4) Including intercompany loans.