July 1, 2013
Interviewed by: David Snow
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Sourcing, Financing & Closing Deals

Many investors are interested in the Brazilian real-asset opportunity, but how can capital actually be put to work? Veterans from Denham, Vision Brasil and EY discuss how they source and close deals, and the sources of debt financing for Brazilian real asset deals. Part 2 of a series. 

Many investors are interested in the Brazilian real-asset opportunity, but how can capital actually be put to work? Veterans from Denham, Vision Brasil and EY discuss how they source and close deals, and the sources of debt financing for Brazilian real asset deals. Part 2 of a series. 

Sourcing, Financing and Closing Deals

Real Assets in Brazil 

David Snow, Privcap: Today we are joined by Amaury Junior of Vision Brazil, Gustavo Gusmao of Ernst & Young, and Victor Muñoz of Denham Capital. Gentlemen, welcome to Privcap Today! Thank you for being here.

Victor Muñoz, Denham Capital: Thank you.

Snow: We’re talking about real assets in Brazil. It’s a very important topic.  Many  investors are very interested in understanding more about how capital can actually be deployed into real assets in-, in Brazil. All of you are very active in the, uh, sector, so I’m fascinated to hear what you have to say. I think it’s well recognized that there are gaps in the Brazilian economy that need to be filled and that private capital can play a role. But actually identifying deals that can work and get completed can sometimes be a challenge. So I’d like to hear from all of you about your deal flow.

Maybe starting with Victor – how does Denham Capital identify some of the most important opportunities that you’re pursuing? And how do you figure out if it’s a real opportunity that can actually be closed?

Muñoz: David, let me start saying first that our approach to investment is developed in three steps. First one is theme. The second is team. And the last one is actual deal investment.

So a theme is, you know, recognizing/identifying these kind of macro opportunities that you see there. It could be the need of power. It could be oil and gas opportunities. You know, whatever it is. But you identify that macro theme. Once we say, okay, this looks interesting, learn about, we confirm that that’s the place where we’re going to focus, we go to the second step, which is team. For us team means to identify the best management team or local entrepreneurs who know the area, the region where they’re going to execute. They have the track record. They have local contacts and the expertise to actually execute. And that takes a lot of time. You walk around, you meet people, until you finally find that management team.  And then with them we actually go and do deals. If it is in power we create a company then we go develop power projects. Or invest in other power projects if it is in mining in a similar way. There are these three steps that we follow.

Now the actual execution of that takes a lot of being local…of understanding the culture, of understanding the way of negotiating, of understanding the regulations. And quite frankly I don’t think there’s a perfect way or doing it. I would say that the way of doing is just walking around. You meet people. You understand. You read. You have conversations with the government, with consultants, with executives in the industry.

Snow: Gustavo, what are some complexities that can pop up, you know, after a private capital firm, many of which are your clients, has identified an opportunity, maybe even a concrete opportunity? What are some complexities that might prevent that from actually getting close, from taking shape in a way that would be a real private capital deal?

Gustavo Gusmao, Ernst & Young Terco: Yes. The challenges are pretty much focused on the capacity of this project. To be really developed instead of just having an idea of a project, just to have the right team to develop this project and the right step-by-step to do that. Most of the times, some of these projects could be, conceived within the private sector interest. Then can present and solicit proposal for an infrastructure project. Or the government can do their own homework and develop this project in-house and then releasing to the market. The track record shows that when the private sector actually develops the business plan and tries to propose to be more proactive in terms developing this project, the process tends to go faster. And the projects, they accelerate…the level of projects that a government, a state government or a municipality can develop. On the other hand if you have a project developed in-house by the government, even though they have their own advisors and their consultant team. From our experience it usually takes longer than when the private sector do it. So I think one of the challenges is really keeping track of the project. Because we have, for instance in terms of PPPs and concessions in Brazil we have over 200 announced PPPs and concessions in Brazil. But we have only 28-30 contracts actually awarded for the private sector.

Snow: Can you talk about the competitive landscape for putting capital to work? Infrastructure, growth and improvement requires capital. Private capital firms are a source of that. But are there any other players in there that, you know, either both of you, or your clients, are, up against when they are proposing their ideas to whatever partners they’re thinking of working with?

Muñoz: I’d like to say that over the last few years Brazil has become one of those countries in fashion. So, yes, we do find several different sources of capital that compete with ours. And I could mention, well, certainly other funds that are coming to Brazil and have been formed…and also local forms, funds, using local money. But you have strategics in any of the sectors. At least in our experience in power and others you have, either local power companies who have liquidity and they can put the capital to work and compete with ours. Or you can have other types of companies who want to move into the power sector that also have liquidity. We have even seen a couple of opportunities when capital markets, IPO, have provided capital to come as well to the sector and, provide additional resources that could compete with ours.

Now IPOs, they’re a very volatile source of funds, as we know. But yes, there are several other sources of capital that clearly compete with ours. And especially over the last five years, I would say, in Brazil. There’s been a lot of attention from international players coming in, both financial and strategic…and also the development of a local private equity sector that is growing fast in the country.

Gusmao: Yeah, and just to add to that, I agree that there is, a lot of infrastructure funds internationally and locally looking for these opportunities. And also more recently we also have the role of the pension funds who are also –

Snow: The local Brazilian pension funds.

Gusmao: Local Brazilian pension funds. They are also looking for opportunities of investments. And we even have some international pension funds as well. Especially they are looking for these federal programs of infrastructure. They are becoming interested in coming to Brazil as well.

Snow: But with the international pension funds, do they imagine that they’re gonna come and invest directly? Or are they looking for local partners?

Gusmao: Local partners. Yeah, yeah. They have to partner with the local construction companies and local players.

Snow: Is that an opportunity for both of your firms to create maybe a separate account for a big international fun?

Muñoz: We have had so far for a philosophy of having one global fund invested at a time and have, uh, opportunities to compete globally for the best opportunities for the capital. As to whether that will change in the future, I can’t speak right now about it. But so far we have a very clear philosophy to have one global fund.

Snow: Amaury, what have you seen by way of competition in your markets?

Amaury Junior, Vision Brazil: Yeah, I would say I would classify basically agriculture in three layers. Upstream you have highly consolidated sectors. Sort of like seed providers like, say, defensives, so all types of sort of inputs you need for agriculture, huh? Then you have agriculture per se, which is the area where we specialize. I would say that this sector is definitely not consolidated. Still I would say very dispersed in terms of like concentration of players. And then you have downstream highly consolidated, which are the trading the companies,  which are the off takers of the agricultural products.

Snow: So follow up question for Amaury. So you’re in touch with many owners of small and medium sized agricultural, um, companies essentially. Do they understand the benefits of being part of a consolidation? Are they eager to sell? What are some hurdles in convincing them that your platform would be beneficial to them in the long run?

Junior: Well, the way we approach that, as a matter fact there’s a new legal regulatory framework in Brazil that was established in 2010 regarding investments in agricultural land. By luck we are already in compliance with that because our investments have been always in partnership with local producers. However the type of producers we work with are relatively large-scale producers because of the size of investment that needs to be affected. And I think that this is the approach that I think we all have a stake in because I think it’s very healthy in the sense that the expertise of the production it really tends to be more of the locals. And it varies a lot by region. So the expertise in a certain region does not necessarily apply to another region. And that’s what we also learned from the perspective of doing the investments. I would say that the approach really for agriculture has to be really focused on local expertise. It’s very difficult to translate, of course, even if we only had scale the expertise you have in one area to another area. And in particular we lack really scalable projects. What I mean by that, is you have a concession. If you had like, say, a way to sort of explore land, in 1,000 hectors, let’s assume, the fixed cost is relatively very high vis-à-vis the production that you’re going to extract out of that. On the other hand, if you’re producing let’s say in 10,000 hectors, then the scale for that, and consequently the fixed cost investments tends to be diluted. So our approach tends to be really for larger areas where you really dilute the needs that you have in any sort of infrastructure and logistics.

Snow: So any consolidation play would be within a very specific region where the characteristics of the assets were similar?

Junior: Yes. Absolutely. Absolutely. It tends to be like in clusters, huh? It intends to be also leveraging the fact you have to create a proper infrastructure on your own operations, meaning like say processing, uh, storage, etcetera. Which helps you bridge the logistics in infrastructure gap that’s prevailing in the country.

Snow: A follow up question for all of you. The debt financing markets and the capital markets in general are very important to completing and to underwriting deals. Maybe all of you can tell me what you think some of the most important characteristics are of the local or possibly even the international financing and capital market considerations that you take into account. Maybe starting with Gustavo, what are some, you know, important drivers in deals from those markets in the areas that you work in?

Gusmao: Yes, BNDES, the Brazilian Development Bank, plays a major role in terms of financing infrastructure. In Brazil this has been the case for many years. They have subsidized fees for infrastructure. And I believe for the near future they will keep being the main lender for infrastructure. On the other hand, the BNDES is really trying to, the Brazilian government actually is trying, to rely less on BNDES loans. So recently the Brazilian treasury, they are lending money to private banks that they will be able to lend to for infrastructure projects at the same conditions that BNDES does.

Another initiative by the federal government in 2011 was to put in place a legislation to issue the tax exempt infrastructure bonds, which suppose the Brazilian government is targeting to have perhaps 20 percent of infrastructure funding based on these infrastructure bonds. So one of the struggle from the Brazil market, is really relying more on capital markets. And indeed private financing. Because one of the criticisms that you may find is that, okay, at the end of the day it’s public funding…if you used BNDES you are talking about public funding and not private funding.

Snow: Is that a similar situation to the power and energy and mining deals that you pursue, Victor?

Muñoz: Certainly power. You know, actually the power sector in Brazil compared to power sector in most of other Latin American countries has a key characteristic which is the long term contracts which you sell you power are denominated in local real currency (R$). That creates a whole different set of dynamics in terms of financing. Because in the rest of the countries, you get PPAs. You know, in Chile and Peru and other places you get PPAs and dollars. And therefore you can finance these projectss with US dollars. And there are many alternatives out there to do that. However, when you get a long term in real, you have to make a decision, am I going to finance this in real which is quite frankly the only alternative that makes sense because of the volatility of the currencies in the long term of project. Or, am I going to take the risk and finance this with dollars. So the obvious decision so far as being I’m going to finance with real. When you go to finance in real in long term in the amounts that power projects require, there’s only one lender which is BNDES.

Now, that takes us to another set of issues, which is getting money from BNDES is not easy. There are a series of requirements, etcetera. And quite frankly project financing from BNDES for the power sector is not the project finance that we know outside Brazil. Let’s put it that way. Where the lender looks at the merits of the project only, and if it gets satisfied with the merits of the project, it lends the money. Versus the project and no other collateral guarantees. And BNDES doesn’t do that. They require guarantees that have to be provided from a balance sheet, from a powering company, from others. So it’s not true project finance in the sense or the word.

And there are points that are important to mention which is you can only access BNDES if you comply with certain things. Perhaps one of the most important is you have to have a minimal level of local content in your project. So if you’re going to do, let’s say, you’re going to build a wind farm, you need the turbines to be produced and the towers to be produced in Brazil. Otherwise there’s no way that you get to the level of local content required to access BNDES financing. And your project could be the most sound financial project. If you don’t meet those local requirement thresholds you just don’t get access to the financing. So it is in the case of the power sector, BNDES is paramount in understanding how to get there. It’s extremely important to have a successful investment. And sometimes it’s not easy because it could be a little bit of a complex road to get there.

Snow: Does that sound familiar, Amaury, or is it slightly different for you?

Junior: Yeah, in agriculture very different because really you don’t get much access to finance. So initially the first decision has to be, from a risk management perspective, what culture are you going to be growing. For instance if you are, for instance, growing sort of the sugar cane for the purpose of like producing it and all, it’s purely a local markets play. And consequently you better get like finance in local currency. On the other hand, if you are producing, let’s say grains, let’s say soybeans, this is a market that’s really correlated to sort of the international markets. And consequently you don’t have a problem to really finance that in dollar terms, huh? But said that, I would say the access to finance relatively, I would say restricted. Why? Because there is also a relatively good access for small producers. I would say what we call more on the social programs of the federal government through the state banks. However when you go to medium and large size producers they tend to be either self-financed or they tend to finance short term.

Gusmao: Just to add, other players in the financing market in Brazil as well, we also have a public bank, Caixa Econômica Federal, which is…they will play a major role in financing housing and sanitation. Sosometimes they act as a BNDES for these sectors. They also have very good rates, subsidized rates. And we also have some of the funding, which have been done by ITP and the World Bank. But still BNDES prevails over all these other options.

Expert Q & A with Gustavo Gusmao, 

Executive Senior Manager, Lead Advisor Public Sector,

Ernst & Young Terco

In addition to your financial advisory work, how else do you help real-asset investors find success in Brazil?

Gusmao: Not only do we do the financial advisory for our clients but we also to be more of a strategic advisor in terms of the investment strategy. In Brazil especially we deal with most of the construction companies involved with infrastructure. The concessioners, the patient funds, the infra funds locally and internationally. But we also try to make a link between the actual opportunities in the market with our clients profile. So this is something that we’ve been doing for a while with the Brazilian market.

Do you help investors navigate the various government agencies that regulate infrastructure?

Gusmao: Yes, actually we have our GPS team, our Government and Public Sector team. They also view the relationship with all the level of governments and we are really counting on them to approach with our investment clients.

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