FT REPORT – CORPORATE FINANCE: In defiance of the downdraft – so far

The smooth conclusion of the takeover of a big US steel company by a Latin American-owned pretender still raises eyebrows, although perhaps these days only a Roger Moore-style half inch. But when such deals are financed with a jumbo bridging loan and carried out in the teeth of a global credit squeeze, bankers do take note. Brazilian-owned Gerdau Ameristeel’s deal to buy Chaparral of Texas for more than $4bn in a move with bridge financing from JPMorgan was concluded in mid-September and speaks volumes about the maturing of Latin financial markets and their slow decoupling from the US.

M&A bankers covering Latin America say the region is set to continue to buck the weakness seen in developed markets.

So far, Latin America has witnessed little sponsor-driven M&A activity and very few deals are funded with heavy debt components, says Nicolas Aguzin, head of Latin America investment banking at JPMorgan in New York. That means that the fall-out on M&A activity is limited. Even so, if things get much worse, markets in Latin America will start to seize up. Already the big global banks are imposing blanket restrictions on lending. That makes planning acquisitions funded through jumbo bridging loans, such as Gerdau Ameristeel’s purchase, much harder to contemplate now.

On a longer perspective, the M&A picture in Latin markets has been strong and accelerating: “The size of deals has increased a lot. We’ve seen transactions in excess of $1bn which we wouldn’t have seen in the past. And we’ve never seen so many deals in the history of Latin America,” says Roderick Greenlees, head of M&A for UBS Pactual in Brazil. While that may be the case, performance has been uneven between the two largest markets: red-hot Brazil has been making up for a tepid showing from Mexico.

Brazil is reaping the benefits of economic stability and the consequent fall in interest rates as well as improved confidence in the management of the stock exchange. Brazilian companies tapped equity markets for $21bn in the first half of this year. All of this extra cash in companies’ coffers generated from IPOs has oiled M&A transactions. The total number of deals rose 28 per cent in the first half year-on-year, with domestic transactions increasing by more than 50 per cent, says Cláudio Ramos, a partner at KPMG in São Paulo.

Mr Ramos sees the merger trend being particularly strong in industries that are highly fragmented, such as real estate and ethanol.Furthermore, there is a domino effect because as soon as one company raises money, its competitors are forced to follow suit. They either carry out defensive IPOs to avoid becoming prey or go on the acquisition trail themselves, he says. Over the past two years, nearly 20 property companies have listed, for example.

The other giant market, Mexico, has been a relative disappointment, however, in terms of equity issuance and M&A, says Mr Aguzin. He attributes the inaction mostly to companies’ strong balance sheets coupled with last July’s general election and its hotly-contested results. Still, Mexican cement giant Cemex’s $17bn takeover of Australia’s Rinker shows that those global blue chips with long-term expansion strategies can continue to execute deals smoothly. Furthermore, Mr Aguzin sees Mexico reviving in 2008, both with more issuance and M&A activity. He is aware of a large number of deals in the pipeline, he says.

Aside from Brazil, Colombia and Argentina are also witnessing more corporate finance activity, says Mr Aguzin. Banks and energy companies in Argentina have been particularly strong in raising money and some are even tapping multiple markets, including Brazil’s Bovespa and New York’s Nasdaq.

Colombia is reaping the benefits of its improved stability and the lessening of violence, leaving Mr Aguzin bullish on the country’s prospects. That has shifted the onus for banks from tracking down deals to ensuring that the companies planning on coming to market are fully ready to do so. “There’s so much issuance coming out of Colombia that the important thing is to carry out proper due diligence,” he says.

For most of the deals in the region, cash remains king. Even though a handful of Latin blue chips have enjoyed easier access to debt markets, for most companies it is hard to come by. That may be good news right now, and may be protecting the region from the subprime fall-out, but over the long term it is a serious disadvantage for Latin companies when going head-to-head with companies based in developed markets in the global market for assets.

Mr Greenlees predicts the next stage of growth will see debt play a far more significant role in M&A by Latin companies, particularly in Brazil as ratings continue to improve, thereby closing the funding gap with developed countries.

Brazilian companies are underleveraged and may be inclined to borrow as interest rates come down and the market opens, Mr Greenlees notes. First and foremost, Brazilian companies will add debt to their balance sheet to ensure a healthy balance between equity and debt. But access to fixed-income financing will also allow companies to use debt for acquisitions, he says.

The other much-awaited change in financing techniques, particularly inBrazil, is the arrival of large financial sponsors. Those private equity firms already active in the country, such as local GP Investimentos or US-based Advent International, have exploited improved equity market conditions to list a number of holdings on public equity markets and start rounds of fresh fund raising.

US private equity giants have been slow to open offices. Many say the delay is caused because of difficulties in finding experienced staff at anything less than stratospheric rates. That is perhaps the biggest difficulty confronting banks, and the biggest boon for bankers in Brazil.

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