Latin American companies are snubbing local acquisitions in favour of far-flung deals but SMEs will find it hard to play.
Large Latin companies are in increasingly good shape to make international acquisitions but, rather than scouting in their backyard, blue chips are primarily pushing to become truly international with takeovers in developed markets, outside the region. Medium and smaller companies are typically more interested in shopping close to home, but the financing picture has worsened due to weak credit markets and nervy investors seeking liquid deals, damping activity in this segment. Although private equity companies are likely to step into the breach, big, mostly global acquisitions will trump mid-sized, regional ones, for now, say bankers.
Brazilian steelmaker Gerdau, which at the ripe old age of 106 is experiencing something of an adolescent growth spurt, made a splash with two significant acquisitions in 2007. The two big companies that it acquired, Chaparral ($4.22bn) and Quanex ($1.6bn), are both based in the US. Arch-rival Brazilian Votorantim also made two US acquisitions, snapping up the zinc operations of Aleris ($295m) and Prestige Group of Companies ($200m). In Mexico, Cemex took over Australian Rinker for more than $15bn, further expanding its international (and developed market) footprint.
New breed, new focus
The new breed of fast-growing Latin companies is more oriented towards developed markets, particularly the US, and bypassing Latin America to develop a foothold in developed markets. There are sound reasons why. The driver for large Latin companies to look at industrialised markets rests typically in diversification, gaining economies of scale and gaining access to stronger technology and cheaper production, or a combination of these, according to Hugo Verdegaal, co-head of investment banking at Citibank in New York.
Imagine you are a blue-chip commodity company in Brazil. One of the main factors for assessing an acquisition is the size of the market. That means a move into, say, Paraguay is less attractive than the US, which has an economy about 1000 times larger, he says.
Large Latin companies continue to look for opportunities in the teeth of the downturn, says Nicolas Aguzín, head of Latin America investment banking at JPMorgan. He admits that it is going to be more difficult to raise financing, certainly much tougher than it was six months ago, but believes that, with the right deal structure, Latin blue chips still have good market access.
That is not so true for the kind of company that is likely to expand closer to home. These are typically smaller companies that may be deterred for a number of reasons, both long term and short term. First, management time and resources for such significant deals are often limited. Moreover, family-based ownership structures typically spell higher financing costs because of insufficient financial transparency. That means large differential in the cost of funding between small and medium-sized enterprises (SMEs) and large companies. Add in jumpy current market conditions when investors are putting a significant premium on large liquid deals and you have the recipe for a slowdown.
Recent worries about bank financing and capital markets should not disguise the very real progress made in the past years, argues Raul Beer, partner and head of corporate finance at PricewaterhouseCoopers in São Paulo. In our firm, we have seen very significant growth in corporate finance activity from a very low base, he says. His area grew 40% in mergers and acquisitions (M&A) last year and by more than 20% in both 2004 and 2005.
Much of the activity is focused in Brazil, which represents more than half of all Latin activity, says Mr Aguzín. Despite Mexicos size, the regions second economy is producing a much lower level of M&A activity. That may be exacerbated if the US economy does deteriorate further because Mexico and Central America are more US-dependent economies than more distant Brazil, says Mr Beer.
There is more room for an expansion of regional consumer business and services, Mr Beer believes. Retailers food and cosmetics companies, for example tend to prefer acquisitions in Latin America before they take a bigger and more complicated step of managing a business in another continent. There has been a significant growth in acquisitions in the food sector with Brazilian Marfrig acquiring Argentinas Quickfood and its Uruguayan subsidiary for $267m. Food producers, brewers and specialty retail firms find it easier to grow in the region than in developed markets, says Mr Verdegaal.
Many brands are very local and to be successful in developed markets such as the US would require significant spending on marketing and brand recognition, the kind of investment that deters mid-sized companies.
The real estate and banking sectors offer more regional integration opportunities, says Mr Aguzín. There has been a large number of banking acquisitions in Central America in the past two years, including HSBCs purchase of Banistmo in Panama and Citigroups acquisition of smaller banks to build a footprint in that region. The banking sector is still fragmented in parts of the region, Mr Aguzín notes. On the other hand, areas such as telecoms and energy that have been active are maturing and slowing as opportunities become rarer, he says.
Despite the much-improved long-term outlook, recent market conditions are likely to make regional deals more sparse next year. SMEs are finding it more difficult to go to market, says Mr Aguzín. That is because jittery market conditions have made investors prize liquidity. Larger deals have become more common as companies that would have once raised $100m to $200m look to garner $300m to $500m, Mr Aguzín says.
Investors are now clamouring for even bigger deals or ones with a hot story, he says, pointing to the recent successes of the giant offering by stock exchange Bovespa Holding and the $600m initial public offering (IPO) of Mexican cable company Megacable, a well-liked consumer play. Specific, good stories are still wide open and the markets are as good as before. And you dont have as much competition because there are fewer deals in the pipeline, he says.
Smaller stories are struggling. For many deals to get done successfully, companies need to raise more than $500m, says Mr Aguzín. Smaller deals are being pulled or priced at the very low end. There is likely to be further downward pressure for smaller company deals. We have revised our forecasts for the number of deals downwards, he says.
Mr Verdegaal agrees that investors are focused on larger deals. They too want to achieve economies of scale and need to take relatively chunky stakes in deals to justify doing their homework on a company. We have clients who say: listen, we love the look of the deal but it needs to be $300m to $400m to make sense. For investors that do not know the region well, smaller companies clearly represent a higher risk.
Mr Verdegaal agrees that this is likely to have a negative effect on smaller capital raisings, although he also believes that smaller companies are much better positioned than they were five to 10 years ago. If youre growing in real terms, capital will come to you, he says.
Overall, the market will ration itself to the best available opportunities, says Mr Verdegaal. That may be positive six to nine months ago, some deals that were completed were of less sterling quality. Markets will be more discriminatory. Maybe that creates opportunities for truly value-added transactions, he says.
The murky outlook for SMEs if the US enters a recession means smaller companies will need to be nimble. In many cases, companies will seek to replace the public markets with private investments, Mr Aguzín believes. Companies that might have turned to an IPO will increasingly find funding from private equity, particularly with the entrance of new investors from the cash-rich Middle East and Far East.
We will not see the same number of deals next year that we saw in 2007, but there will be more involving private equity firms. They have been raising capital and can leverage this by working with co-investors, says Mr Aguzín.
The availability of aggressive risk capital looking for opportunities in the region means that deals will get placed through the private market, agrees Mr Verdegaal. It may cost a bit more but the good deals will keep on getting done, he says. He points to private equity success stories that include Brazilian real estate companies Gafisa and BR Malls.
To date, large US firms have been relatively small in the region, allowing domestic brands like Brazils GP Investimentos, the largest private equity investor in the region, to thrive. That has been changing recently with the growth of big hitters such as Advent International, Eaton Park, CVC, Southern Cross and Ashmore. Three years ago, private equity funds had no exit route through public markets, says Mr Beer. That has changed in the past four years, encouraging international firms to take a fresh look at Latin America.
While the rough trend is for larger companies to be more truly global and mid-sized companies to be more regionally focused, there is plenty of blur. Although less commented on, Brazilian steel giant Votorantim has also been on a spree in Colombia. This year, it bought a leading steelmaker there, Acerías del Paz, for $485m.