May 1, 2012
Interviewed by: David Snow
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Adding Value to Brazilian Businesses

How are middle-market GPs adding value to Brazilian businesses? Tim Formuziewich, Managing Partner of Brookfield Brazil Capital Partners; Nicolas Wollack, Founder and Managing Partner of Axxon Group Private Equity; and Cristiano Boccia, Managing Director of Graycliff Partners Latin America compare notes and share real value-add stories.

Topics include helping companies get their finances and operations in order, sourcing management talent, solving succession issues and helping niche players grow into national champions.

How are middle-market GPs adding value to Brazilian businesses? Tim Formuziewich, Managing Partner of Brookfield Brazil Capital Partners; Nicolas Wollack, Founder and Managing Partner of Axxon Group Private Equity; and Cristiano Boccia, Managing Director of Graycliff Partners Latin America compare notes and share real value-add stories.

Topics include helping companies get their finances and operations in order, sourcing management talent, solving succession issues and helping niche players grow into national champions.

David Snow, Privcap: We’re joined today by Tim Formuziewich of Brookfield Brazil Capital Partners, Nicolas Wollak of Axxon Group Private Equity and Cristiano Boccia of Graycliff Partners Latin America. Gentlemen, welcome to Privcap today.

We are talking all about the Brazilian middle market for private equity. All of you invest in the middle market. Not only do you have to provide capital to help them grow, but there are other levers of value creation that all of you have in your tool kit to help these middle market companies grow. I’d like to hear all about it.

So possibly starting with Cristiano, in addition to providing capital to the portfolio companies that you invest in, what else do you bring to the table that can help them get to the next level?

Cristiano Boccia, Graycliff Partners: We like opportunities that we can put capital into the business and then work with the family or the founder in helping growing that business. So we’re value-added investors and we want to back people that welcome and want to have a more active party to the table. I think we do that in many different ways.

It’s important that the middle market in Brazil actually needs a lot of help. Some of those companies, as we were discussing before, they don’t have their house in order as they should have. So there is a lot of low-hanging fruit. That’s the good news about it.

The value creation aspect, once you invest in the middle market, is very tangible. You can identify several opportunities from the get-go. It comes very simply.

We usually assume the finance department. We make sure that the company becomes audited. We improve governance. We go like Private Equity 101 in that part of the market and we create a lot of value. Of course, we also try to improve operationally, bring in some operating partners.

The last bit of our value-added in that particular part of the market, which is a recent phenomenon in Brazil, it’s very hard to find talent with Brazil becoming really hot and different companies opening up offices, it’s actually hard to attract people. There is a shortage of talent to bring particularly to a middle market play. So the fact that we are a private-equity-backed company and we can put stock options or better alignment, it creates a better story in attracting people to those players, those middle market companies.

Snow: So Nick, when you invest in a company, they probably ask, well, what are you going to do? What are you going to do to my company after you invest? So what are some of the changes or what are some of the improvements that you typically make?

Nicolas Wollack, Axxon Group Private Equity: Typically, first of all, in our case certainly whenever we invest, a company that only isn’t looking for capital from us is not going to be something that we’re going to be interested in. So by definition for us, we’re looking for companies that are looking for capital and for management or this value-added component that a private equity investor can bring to the table.

Fundamentally the issues in the types of companies that we target and that are attractive to us are the companies that we would characterize as being quote, unquote, “underperformers.” So for some reason, very often linked to their ownership structure, they’re not performing to the level that they could be performing. And very often the way you resolve these issues or you start resolving these issues has to do with management changes.

So we tend to be very proactive on the management chain front. I think there’s no company in which we have invested– I think it only happened once in 12 years where we did not change at least a CFO. We’ve had more than one situation, maybe three or four, where we will actually change over the whole senior management team. So we’re prepared to do that and be extremely proactive with these companies in terms of defining the right management structure, in terms of complementing the management where needed, or just completely changing it over if that’s required.

As a complement to that, our model of investing is one where the involvement of the Axxon Partners in every company in which we invest is very active. So we spend a lot of time when our companies, particularly during the first 12 to 18 months. That’s a time of high intensity in terms of involvement on our part. We stay very close to these management teams that very often we’ll have brought into the companies to support them and help them take what we think are going to be the decisions that are going to create value for us as investors over the medium to long term.

Tim Formuziewich, Brookfield Brazil Capital Partners: I think from our perspective, Cristiano highlighted the issue the best. That’s when you’re trying to grow a business from, say a regional champion into a national champion, or from a small business into a medium-sized business, that your biggest challenge is people and human capital generally. What we try and do is we try and utilize the human capital that we have within the existing platform and redeploy them into opportunities where, into positions where they can continue to grow their career.

There are other things that we can do, that we do to create value. We think we have expertise in specific sectors as well that we like to redeploy either into that sector in another part of the value chain or into cross-sectors. For example, we consider ourselves to be energy experts. So we like to look at very energy-intensive industries, because we think that we have an ability to reduce energy costs working with our partner.

We think that there’s a lot of opportunity in a lot of the sectors and opportunities in the companies that we look at to create a lot of value on the greenfield side, for a number of reasons. One of them is that historically they may not have had experience with greenfield. They may not have experienced with M&A. They may have not had access to or tried to have access to the BNDN financing that supports the greenfield development. All sorts of things, all sorts of opportunities that are available to assist a portfolio company over and above the sort of standard building out operational metrics and that sort of thing.

Wollack: I think just to complement, what we’re finding in the types of companies that we look at in sectors, very often they are companies that are in what tend to be niche industries very often, very fragmented. So consolidation plays have tended to be an important part of the value creation process for us. We don’t necessarily go in there with the roll-up or consolidation as the main thesis, but they end up being often attractive opportunities to grow the business.

Certainly in all of our investments but one we’ve done at least one add-on acquisition. So certainly what we look to bring to the table is the ability to assess the opportunities to generate value through these consolidation plays, and very importantly, assistance and direction when it comes time to integrate these companies together, which is not an easy process. It’s obviously a lot more complicated than many people often anticipate.

Boccia: The other thing that I would add is working on succession. There is an important aspect of making sure that the company becomes less dependent on the founder and less dependent on the history of the family and can start walking on its own legs and that you transition that to a more strategic or board involvement. It’s harder done than said. It takes an enormous amount of time and energy to working with that party in making sure that that transition happens.

Wollack: Here again, to compliment, for us the exit in our segment of the market tends to be almost always strategic players. That’s how we think about the business. IPOs can happen, but they’re very opportunistic and a lot of things have to come right at the right time to make them work. When you’re thinking about a strategic exit, we believe that we need to have companies that have a fully professional management team in place for that strategic to– particularly if there’s a foreign strategic player– to be in a position where you can consider seriously making the acquisition. So this process of transitioning from the family type of management to a fully professional management structure is a fundamental part of the process.

Snow: These are all great examples of how your firms think about adding value to the middle market companies in which you invest. I’d love to hear some stories or examples from your histories as private equity investors about how this has actually taken place. I won’t assign a story to anyone specifically, but if something pops to mind as being a really good example of your firm sort of coming in and really partnering with the management or the new management to grow something special, I’d love to hear about it.

Formuziewich: One that I’ll speak to is one that we actually effectively started from scratch by going out and building a business from effectively a single asset. In 2003, we acquired a renewable power asset, a hydropower asset. Then through that process started building a team to build out a national renewable power champion.

So in 2003 we had five megawatts of power. Today we have over 600 megawatts of operating power. That’s 21 transactions, 14 Greenfield and seven acquisitions over the course of about seven years, into a business that is now a four billion reais business. We deployed about 1.6 billion reais of capital on those 21 transactions. So those are 30 million reais transactions as well as 250 million reais transactions throughout that process.

Some of those transactions were shared within the group. So we have a farmer who’s looking to sell his farm but also has an ability to build a run at the river renewable power asset, a hydro asset on that river. Those are great acquisitions, because there’s not very many groups out there that can do acquisitions across sectors. Today that business is 250 people.

On the exit what we did is we actually rolled that business up into a renewable  power business that we had in North America listed on the Toronto Stock Exchange. Now it’s one the world’s biggest renewable power businesses on a global basis.

Snow: You’re saying that the experience that Brookfield and your group specifically had in the Greenfield projects and also in basically executing so many acquisitions was something that was sort of the value brought to the project that you backed.

Formuziewich: Well, it was human capital. It was Greenfield expertise. It was M&A acquisition. It was building a business into a national champion. It’s really what we’ve been– for 110 years, Brookfield’s been building businesses into the national champions, starting and focusing primarily on mid market. That’s one example of something that we’ve done very recently in that sense.

Snow: Great. Nick, any interesting stories that come to mind as far as your firm really pulling some interesting levers of value to help a company get from one level to a higher level?

Wollack: The levers are the levers that we’ve talked about and that Tim just mentioned. To give you an example, we invested in a company, which was in Brazil a leader in specialized engineering services to large construction companies. They also rented equipment to these companies. This is a business that when we went into it had a little less than 20 million reais in EBITDA and we felt there was an enormous amount of value to be unlocked in that company.

How did we go about it? First of all, these management changes that we’ve talked about. So we made it a condition to our investment that a new CEO would have to be appointed.

We refocused the business in some of the areas where we thought were more promising. So we shut down one division we thought was unpromising to reallocate the capital where the growth opportunity was more compelling. We made a small add-on acquisition, which complemented the existing business. We also changed the capital structure of the business. This was a company that had been very conservatively managed, because as a family-owned business, one of the issues that the owner had was an aversion to risk, concern about assuming debt, et cetera, et cetera.

So with our support and our orientation advice, we were able to put in place a more effective capital structure so that the combination of all these actions took the company from a little bit less than 20 million reais in EBITDA to approximately 170 million reais in EBITDA over a four-year period, which actually allowed us to take the company public here in the Sao Paolo Stock Exchange. So these are the combination of actions that I think we look to bring to bear on our companies.

Snow: Cristiano, any interesting anecdotes you can share?

Boccia: I’ll try to just bring a different angle to how we can add value to some of our portfolio companies, which is also helping the company become a little bit more international. We made an investment about three years ago in an IT Service provider. Most of their clients are international players. So the company has operations throughout Latin America.

It was helpful actually to help the company expand besides just the reach of where it was regionally in and help develop new clients, help doing some acquisitions and become a better and larger platform, which definitely created value when you become a strategic interest that is in step into Latin America. So the connections that we have by being an international fund and helping the company reach some international clients or strategic buyers is always very helpful in addition to all the usual things that have been described.

Wollack: I would also say these are kind of the good stories, the happy stories. But the times where we found where we’ve encountered difficulties is when for some reason or another we’ve underestimated the operational challenges that we were facing. We always know that we’re going to have operational challenges, because these are the natures of the businesses in which we invest. But when you’re looking in from the outside, it’s not necessarily that transparent, basically.

That’s why it takes a long time to do due diligence. But even all this time may not be sufficient. When underestimating the operating challenges, then resulting often in making bad decisions in terms of the management changes that needed to be made. We’ve had situations where it has taken more than one try at it.

So luckily up to date we’ve never had a loss situation. We’ve certainly had situations where it’s taken us more time and more effort than we expected to get to where we wanted. I think that’s one of the key challenges, at least for us in our investment approach.

Snow: So I’d like to talk about one more quick topic. And that’s you’ve added value, and now it’s time to realize value. Very briefly, where do you expect exit opportunities to come from over the next 5 to 10 years for you? I know Nick, you mentioned that you think it’s almost going to be entirely strategic sales. Do you think 10 years from now that’ll still be the case?

Wollack: I really don’t know. We don’t know because that’s a function of how do you think the capital markets, the equity markets, are going to evolve. I don’t know, frankly. Since we don’t know, we don’t want to make that bet.

So our investment, or our mind is just what we know is there. That does fluctuate, but what we do know is there is the strategic buyer for the right types of assets, the right types of companies that have been properly positioned with the right management teams in the market. I think that’s a pretty proven model over 20 years of doing that in the region.

So we really look to build our investment thesis around what’s our strategic exit going to be. If there’s an opportunity to do an IPO, fine. We certainly won’t ignore it. But today, the reality I think the IPOs that are trying to take place in the market now, anything under 500 million reais apparently are difficult transactions, lack of liquidity, et cetera.

So for us to be in a position to bring a company to that level to the market is unusual. We don’t want to make a better on a 100 million reais offering being possible 10 years from now. If they are, great. That will give us more liquidity. If not, we’ll keep doing what we’re doing.

Snow: And for both Cristiano and Tim?

Boccia: I agree 100%. We look at companies that the exit will likely be strategic. There is one new trend in Brazil that’s happening and it’s driven by the larger funds who raised capital, which is secondary transactions. It’s starting to happen. It’s a large component internationally.

Brazil hasn’t really become an exit alternative that is too concrete. But I think over the next couple of years, we’ll probably by taking a company at the low end of the middle market, preparing it a bit and then passing it to another private equity to take it to the next level will become a new strategy that will probably generate value to us.

Snow: Brazil is a popular place now to invest, whether you’re a private equity firm or a multi-national corporation. Do you see more exit opportunities coming from the international buyers, including dipping down into the middle market? Is that already happening or is that further down the road?

Wollack: I think very much so. I would say it cuts both ways. We’re seeing more opportunities on the exit side. But we’re also seeing more competition, at least for us, for this control approach, and we’ll buy 100% of businesses. We’re finding strategic players making acquisitions in this low end of the market much more aggressively than they used to in the past. So it goes both ways.

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