Digital Deals in Brazil

M&A activity in Latin America’s largest economy is recovering quickly from coronavirus, writes Adam Patterson in Curitiba. The lessons learned from the first lockdowns means investors are better-placed to handle any further restrictions...

The pandemic hit Brazilian M&A hard. Over the first quarter of 2020, transaction numbers fell 26%, halting the quarterly trend of rising M&A deals since 2018. By the end of April 2020, accumulated deal value was down 52% year over year as Brazil hit its lowest M&A volume since 1999. Several potential M&A transactions and securities offerings, including privatisations and federal government concessions were pulled as Covid-19 clouded deal certainty in the country. Investors took a step back to assess the situation and the stockmarket fell almost 40% in the month to March 18th.

Digital deals

Yet market was quick to adjust to the new reality. Many Brazilian M&A and investment banking firms already used platforms like Zoom and Teams to help surmount logistic challenges in a continent-sized country, making it easier to switch to digital deal making as such tools became increasingly used in the broader economy.  As in other sectors, the crisis helped amplify existing trends.

According to Gabriel Loest, partner in leading middle-market M&A boutique Redirection International, “we closed out several sell side deals during the pandemic with leading national players, with most of the process, including Q&A, due diligence and ‘visits’ being conducted virtually. Buyer and seller alignment and commitment were key.” Attractive deals were still getting done, even if closings were put back for reporting reasons. Greater focus was given to more flexible deal structures, especially to bridge any coronavirus-enhanced value gaps, whilst buyers doubled down on due diligence to better understand short and longer-term pandemic impacts on performance.

Overall, operational dynamics remained practically the same, the biggest difficulty was not being able to get stakeholders together in person to aid in decision making and negotiations. A challenge in Brazil where face-to-face meetings are highly valued. And yet the common, and time-consuming, aerial bate-voltas (day trips) to São Paulo and other business centres were quickly swapped for videoconferences and digital contract signings helped overcome the traditional, often Byzantine, processes at local registry offices. WhatsApp groups were also formed to connect stakeholders, and negotiations were even conducted via video on the beach to help get deals over the line. Welcome to digital deals, Brazil style. According to Gustavo Pires, Head of M&A at law firm Marins Bertoldi, “advisors are envisioning ‘hybrid’ digital and physical M&A processes even when things normalise, especially in the initial deal stages to enhance resource management”.

Few deals were seemingly cancelled due to financing concerns. Local and international private equity firms are sitting on record dry power levels. Even Boeing’s cancelled $4.3billion purchase of Embraer did not explicitly cite Covid-19.  Brazilian strategics and large cap companies were also, in part due to the 2016 recession, better positioned to withstand financial stress and continue to make acquisitions. For Rafael Pilotto, from private equity fund Concept Investimentos: “the restriction is often not finding capital but finding the right asset”. After all, M&A is a long-term game and private equity houses often make their best investments in downturns.

Quick recovery

The first wave of transactions consisted of follow-on offerings providing “rescue capital”, before pivoting to incremental capital in order to expand investments and “go shopping”, especially in the e-commerce, tech, finance, health, agribusiness and logistics sectors, which had outperformed broader segments. Surprisingly, there has yet not been a significant uptick in distressed asset transactions.

Historic low benchmark interest rates of 2%, combined with the liquidity generated by extensive fiscal support and monetary injections boosted fundraising through initial and follow-on share offerings. Indeed, Brazilian capital markets stormed back in the second quarter, powered by domestic investors seeking alternatives to historically low fixed income yields and betting on an accelerated economic recovery.

Reuters reported that up to 50 companies are in talks for IPOs and new issues, potentially overtaking the R$90 billion raised in 2019. And yet, foreign investors seemed unconvinced: international capital outflow was $87.5billion from Brazilian equity markets between January and September. Leery global investors also accounted for a below average take up of Brazilian IPOs and M&A in 2020. This could revert as confidence returns and the devaluation of the Real, by around 30% so far in 2020, makes Brazilian assets relatively cheap.

PwC estimated that by July, M&A volume was up almost 5% year-on-year as a basket of economic indicators started to increasingly point north. By August deal numbers had hit a monthly record – 65% up on 2019 – and volume was up 39% month-on-month, led by middle market deals as companies sought to defensively restructure, recapitalise and maintain competitive advantages via strategic acquisitions. Indeed, total M&A deal value from January to September was up 9% on 2019. Incredibly, even though 700,000 companies closed their doors by the end of August, this was less than in the same period in 2019. Meanwhile, net job creation was positive.

Agro, Tech & Retail

Brazilian agribusiness drove the economy during the pandemic, with 3% growth in 2020. Brazil's agribusiness exports reached a new record in the first nine months of 2020, with volume 16% higher than same period in 2019. Low exchange rates and export capacity make Brazilian agribusiness companies attractive for foreign investors, especially in the ingredients and input distribution sub-sectors. Large cap domestic corporates and industries are looking for further opportunities to consolidate. Sector deals grew by about 20% in 2020.

Tech deals continue to dominate the M&A deal landscape. Technology, media and telecom M&A value grew 55% in September compared to 2019. Investment in Brazilian startups hit a record amount with R$12.8billion invested by venture capital funds to Q320. Fintech, in particular, is in expansion mode: JP Morgan announced acquiring a stake in FitBank, whilst Bank of Brazil (BBAS3) announced R$200million to invest in fintech startups. 2020 was the year of tech convergence and digital transformation in Brazil and M&A has certainly played a part in these trends.

Magazine Luiza (MGLU3), a major retail marketplace, led the way in digital consolidation in 2020 with more than eight acquisitions of smaller tech and retail companies. In traditional retail, Unilever bought 123 laundry stores of the Acerte Group, to boost its exposure to health and hygiene related areas. Leading retail firms are increasingly looking to boost market footprint, create platform capacity and acquire technological capabilities.

The medium-term M&A outlook is broadly positive and supported by improving macroeconomic fundamentals. Historically the crises of 2008-9 and 2015-16 were followed by an uptick in deal-making in following years. The government should also return to its privatisation agenda and infrastructure investment as focus shifts to the 2022 presidential election which could enhance deal making. Even sectors more impacted by the pandemic, such as entertainment, tourism and restaurants may give rise to M&A opportunities, as seen in the R$50billion mega merger between car rental companies Localiza and Unidas in September.

Bank of America is forecasting a V-shaped recovery for Brazil. It’s now expected the economic contraction will ‘only’ be 4%, better than the -10% predicted in April. While above trend growth of 3.5% is expected in 2021. Improvements in inflation and exchange rate dynamics are expected making it easier for investors to price assets and maximise dollar denominated future earnings. Analysts suggest the stock market is still relatively under-valued.

The biggest current challenge is not the pandemic but the slow pace of tax and administrative reforms. Nonetheless, we saw a record number of M&A transactions in 2020. With growth set to rebound in 2021, is looks like all will be tudo bem for dealmakers.