Today, political and economic turbulence permeate certain geographies and industry sectors in Latin America. Nevertheless, international and domestic investors continue to seek attractive assets in the region. In this article Alvarez & Marsal discuss the importance of integrated due diligence to strengthen investor’s position at the negotiation table and maximize return on investment.
By: Fabio Pires Managing Director, Alvarez & Marsal and Alvaro Araujo, Managing Director, Alvarez & Marsal
Latin America is a dynamic environment for investors; economic cycles are often fueled by trade imbalances, consumption and income volatility, and the timing of capital inflows. As we have seen recently in Brazil, economic cycles are also heavily influenced by political change and corruption.
Despite the ever-changing conditions in these economies and the related challenges, countries have consistently demonstrated their ability to emerge successfully (and stronger) from a crisis. Latin America has experienced significant shifts in political power over time – from the mid-1980s when the left held the majority of the executive power throughout the region, followed by a shift in power to the right in the 1990s, only for the left to take over again starting in 1998 with the election of Hugo Chaves in Venezuela. In Brazil, Dilma Rousseff, a left wing president, is facing an impeachment trial that could permanently end her presidency and the Workers Party’s 14-year grip on power. Such volatility represents opportunity for entrepreneurs, but also requires commercial insight and thorough due diligence.
Despite the ever-changing conditions in these economies and the related challenges, countries have consistently demonstrated their ability to emerge successfully (and stronger) from a crisis. Today, political and economic turbulence permeate certain geographies and industry sectors in Latin America. Nevertheless, international and domestic investors continue to seek attractive assets in the region.
There is a view in the Latin American market that companies in the region are going through a certain level of distress; some are experiencing first-hand the effects of a vulnerable and perhaps flawed business model, while others are feeling the impact of servicing US-dollar denominated debt or simply being over-leveraged. Some are going through painful debt renegotiations, while still others are facing a complicated judicial recovery processes. One thing is clear — many businesses are waiting for a savvy investor to kick-start growth by bringing experience, operational knowledge, and expansion capital.
According to LAVCA Industry Data, private equity and venture capital funds dedicated to Latin America raised US$10.4 billion and US$7.2 billion in 2014 and 2015, respectively. Investment dollars in the same period amounted to US$7.9 billion and US$6.5 billion, respectively, and there is a significant amount of dry power remaining to be deployed over the next few years.
As advisors to a number of sophisticated private equity funds and strategic investors operating in the region, we know first-hand that volatility and uncertainty are not scaring away prospective investors, rather, many are seizing the opportunity. Combined increases in investment activity, competition, and market turbulence have caused the diligence processes to evolve, especially to accommodate auction processes.
The ability to integrate various diligence work streams (i.e., financial and accounting, tax and labor, commercial, operating, and anti-bribery and corruption) and incorporate the results into a well-structured financial model and investment thesis is more art than science. An integrated approach allows prospective investors to strengthen their position at the negotiation table and maximize return on investment.
Integrated Due Diligence Cases
During a recent evaluation of a capital intensive services business in Latin America, seeking for ways to improve cash flow generation in a down market, A&M diligence teams worked together to challenge management’s assertions related to return on capital and their ability to maximize utilization levels. With a hands-on and multi-disciplined approach, the integrated diligence team quantified, within a reasonable level of precision, return on capital investment and levels of utilization, which were different than those represented by management. Our calculations were better aligned to market conditions experienced in similar businesses elsewhere in the world. This experience allowed a sophisticated investor to obtain an unfiltered view of the target business, both historically and prospectively.
While evaluating a manufacturing operation in the Andean region, concerns were raised about the target company’s ability to sustain over time. Financial diligence procedures were designed not only to scrub historical results and cash flows, but also to perform robust reviews of the projections, from both commercial and financial perspectives. Restructuring professionals were integrated into the engagement team to carry out detailed diagnostics of the target company’s liquidity position and suggest alternatives for restructuring and performance improvement.
We also evaluated a target company experiencing significant financial distress on behalf of a private equity investor looking for a platform acquisition in the manufacturing segment in the Andean region. Bringing financial, tax, and restructuring professionals together, the diligence team identified the root causes of the financial distress which not only facilitated valuation, but also allowed us to devise a practical restructuring plan focused on lifting the business from financial distress, improving performance, and ultimately achieving growth through organic and inorganic initiatives.
When signs of stress are apparent, as is the case in some Latin American markets right now, opportunities may be difficult to see. An integrated diligence approach forms financial and operating links in order to pinpoint where investors need to focus to find a clearer path to growth.
For one particular investor, performing financial, tax, and operational due diligence on a Brazilian agribusiness company was not sufficient. The investor required a detailed commercial understanding of the distribution network covering thousands of kilometers of roads, rails, and waterways available to the target company. With a combined and integrated team of financial, tax, and commercial diligence professionals, key variables of the investment thesis were scrutinized enabling a comprehensive view of the business model and fundamentals.
Private equity funds considering investing in Latin America are progressively moving away from “check the box” type due diligence exercises. Too often, these processes fail to properly identify and/or quantify relevant transaction risks and opportunities. It is critical to obtain a comprehensive and in depth view of the target company’s business through a combination of classic financial and tax due diligence, as well as industry knowledge and functional expertise. Investors with the foresight to integrate multi-discipline due diligence expertise will not only build a stronger business case for potential investments, but will be smarter at the negotiating table.
ABOUT THE AUTHORS
Fabio Pires and Alvaro Araujo co-lead A&M’s Transaction Advisory Group in Latin America.
Mr. Pires brings over 15 years of transaction experience throughout Latin America and the U.S. He developed a Brazil-based high-growth sell-side practice and led complex cross-border buy-side due diligence engagements on behalf of multinational strategic clients as well as Brazil-based and international private equity firms. Prior to joining A&M, Mr. Pires was a partner with EY where he focused on Latin America cross-border transactions while based in EY’s Miami, Los Angeles and São Paulo, Brazil offices.
Mr. Araujo has extensive experience advising prominent private equity firms, strategic buyers and multinational corporations on their investments in Latin America. Prior to joining A&M, he served over 10 years as an auditor and member of EY’s Transaction Advisory Services group in New York and Miami where he led financial and accounting due diligence initiatives, including cross-border and cross-functional teams. Mr. Araujo also served as lead transactions partner for EY Peru and was responsible for developing a transactions team in-country. Additionally, he has held the role of Chief Restructuring Officer for a manufacturing company in Central America and successfully founded and operated a business process outsourcing entity.
ABOUT ALVAREZ & MARSAL
A&M is a leading global professional services firm that delivers business performance improvement, turnaround management and advisory services to organizations seeking to transform operations, catapult growth and accelerate results through decisive action. Our senior professionals are experienced operators, world-class consultants and industry veterans who leverage the firm’s restructuring heritage to help leaders turn change into a strategic business asset, manage risk and unlock value at every stage.