With record fundraising for LatAm PE last year, the question now is, how will managers put money to work in 2015? Plummeting oil prices and slowing growth have created new challenges, and currencies have devalued around 20% across the region – does this mean that it is the worst of times, or maybe the best of times for LatAm deal making?
Brazil dominates Latin American private equity, consistently capturing about two-thirds or more of fundraising and investments, so it’s important to understand how the current challenges in that market are affecting the environment for deals. Managers I spoke with over the last week all reported falling valuations and increasing opportunities; according to one mid-market manager based in São Paulo, “In the past we looked at about 10 deals a month, and in the first half of March we saw 24 – it is a buyer’s market. Companies are in dire need of cash, of course this includes both good companies and bad companies.”
The same investor went on to say that today the cost benefit of Brazil is tough to beat compared to other LatAm and emerging markets, and this is consistent with comments I have been hearing in recent months regarding valuations in Brazil in particular.
But a veteran manager with offices in multiple LatAm markets highlighted that falling valuations are associated with increased risk: “It is not only devaluation but the increased volatility in FX affecting the PE industry in emerging markets. Let’s not lose sight that most of the LPs are dollar denominated. They want their dollars back with the adequate return. Volatility makes investment decisions more complex. The natural consequence should be a reduction in asset prices to compensate for the increased risk.”
He also pointed out the effects of currency devaluation at the macro (country) and micro (company) level in LatAm: “There is also the FX impact related to the region’s economies – on GDP growth, inflation and consumer spending. For example, if a business was an importer of cars into one country and was selling a certain volume, today their product has become intrinsically more expensive in local currency because of the devaluation and therefore it is likely to suffer a decline in demand. Each market will be exposed to a different set of circumstances depending on the nature of the economy and business. And then there is the impact at the company level – each business will be affected differently depending on its sourcing mix (imported versus local), client mix (domestic market versus exports), and debt structure (borrowing in US dollars or in local currency).”
Another common theme among managers I spoke with is the challenge posed by rising interest rates in Brazil and tightening credit markets across the region, which is complicating financing for new deals and existing portfolio companies.
In Brazil, investors have a new opportunity to invest in distressed companies, with Eike Batista’s assets, energy companies, and the bankruptcy of valve maker Lupatech in the mix. But one global PE investor with an office in Brazil pointed out that Brazil is not easy for turnarounds, given legal risks (sometimes inefficient judges and prosecutors), high severance costs and union risk for layoffs, and high taxes.
Long-term demographic and market trends mean that companies in sectors including technology, healthcare, and education continue to be attractive plays. And well managed businesses in these and other industries that are challenged from a restructuring, or are running out of cash, can efficiently be taken over by PE portfolio companies, allowing for sector consolidation. One manager also speculated that we may see the de-listing of some public companies in Brazil with a wave of public-to-private deals.
Major markets outside of Brazil, such as Mexico, Colombia, and Peru, have not seen the same shift in valuations, and competition for deals continues to be intense among local, regional, and international players, especially in Colombia and Peru. The excitement over Mexico has tempered with the drop in oil prices, as the opening up of the country’s energy sector has been a major driver, drawing the interest of global energy investors such as Riverstone. But Mexico’s close correlation with the growing US economy and other ambitious reforms targeting telecoms and other sectors mean that flights to Mexico City continue to be over-booked in business class. Regional and global PE players that I spoke with consistently referred to Mexico as a priority.
A range of new and different opportunities are emerging in Latin America tethered to a complex set of macro and micro challenges. For seasoned local GPs knowledgeable about the market and global firms looking to do their first deal in the market, the timing is favorable.