August 1, 2012
Interviewed by: David Snow
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Energy in a Fully Emerged Market

Brazil’s world-class energy market needs capital and ideas to transform itself to handle a “huge latent need” for power, according to Sergio Brandao, Partner and Co-Head of Energy of Rio Bravo Investimentos.

In a conversation with Privcap’s David Snow, Brandao gives an in-depth analysis of the investment landscape across Brazil’s massive energy sector. They discuss how wind has become “the most competitive form of energy,” the need to address losses in power transmission, why Brandao welcomes foreign capital and talent to Brazil’s energy sector, and what it was like to earn an engineering degree in 1985, in a very different Brazilian economic and political environment.

Brazil’s world-class energy market needs capital and ideas to transform itself to handle a “huge latent need” for power, according to Sergio Brandao, Partner and Co-Head of Energy of Rio Bravo Investimentos.

In a conversation with Privcap’s David Snow, Brandao gives an in-depth analysis of the investment landscape across Brazil’s massive energy sector. They discuss how wind has become “the most competitive form of energy,” the need to address losses in power transmission, why Brandao welcomes foreign capital and talent to Brazil’s energy sector, and what it was like to earn an engineering degree in 1985, in a very different Brazilian economic and political environment.

David Snow, Privcap: So we are joined today by Sergio Brandao from Rio Bravo Investimentos. We’re going to be talking all about energy in Brazil and the private equity opportunity to invest in the Brazilian energy sector.  So Sergio, welcome to Privcap today.

Many people around the world still refer to Brazil as an emerging market, and yet you have a slightly different view of that, right?

Sergio Brandao, Rio Bravo Investimentos: Not only I, but Jim O’Neill, in his recent book, has also mentioned that.

Snow: The Goldman Sachs economist.

Brandao: Exactly. Brazil has surpassed the definition of what makes an emerging market. Take the Brazilian energy sector, for instance. It’s a very developed sector. The regulation here is clear, it’s transparent. There’s a lot of room for improvement. Let’s not make any mistake. But like in everything that’s developing, there’s always room for improvement.

But the Brazilian energy business today, the sector is a long-term investment proposition. It’s financeable. You have all the basic legal framework in which to establish long-lasting contracts. You have arbitration, which is valid here, a developed legal system. So contracts are enforced.

Snow: You mentioned the term “room for improvement.” I’m going to guess that as a private equity investor, that’s really what you look for as far as an investment thesis is, how can the private equity firm take an asset or a company and get it from one level to the next? Where do you see the greatest need for capital, the greatest need for ideas in the energy sector in Brazil?

Brandao: Well, when you look at electricity, for instance, the energy sector is being transformed tremendously from a sector based primarily in large hydro schemes located in the center south of the country. These sources of energy have been exhausted. Now, for you to have large hydro schemes, you will have to go up to the Amazon. And when you go up to that area, you have all sorts of other problems, such as environmental and human problems.

So the transformation in Brazil, in the energy sector, for instance, is the appearance of new technology. And to name one, wind energy is a new form of generation in Brazil, was introduced several years ago, about a decade ago. But it’s taken a huge turn. And today, wind energy is probably the most competitive form of power generation in the country.

When we look at oil and gas, for instance, Brazil has, over the past decade, discovered huge reserves in the pre-salt. And we still have vast reserves to be developed and produced in the post-salt. So when a private equity firm looks at Brazil, it can be certain that there is a huge latent need, a huge demand, a demand that is sustained for the reasons I pointed out. You have clear legislation, friendly to private capital, foreign private capital. It’s not only welcome but needed. And there is the perspective of long-term contracts. Particularly in the energy and the power sector, one can have 20-year contracts indexed to inflation in the country in local currency, which provides equity investors with rates of return, which are attractive, indeed.

Snow: Let’s talk a bit about the energy infrastructure opportunity in Brazil. When discussing trends in Brazil and discussing, maybe, barriers to further growth, one often hears about the dearth of infrastructure across the country but including in energy. What kinds of opportunities do you, as a private equity investor, see in helping to build or improve the infrastructure to get energy from point A to point B?

Brandao: Talking about, for instance, the power sector, the infrastructure can actually be divided into three segments, the generation, the transmission, of the power, and the distribution of the power. In all three segments, there is a great need for investment– long-term investment, long-term investment which is based upon long-term contracting. And this is the norm in Brazil. There is very little in terms of speculation in energy. There is very few, if any, merchant power plants in Brazil. So the structure, the backbone of the power industry, so unpinned by long-term contracts, usually indexed to inflation and contracts with very creditworthy buyers. This is the way that regulation has been set up here in Brazil.

When it comes to specific investment opportunities, we, particularly in Rio Bravo, are focused right now in the generation component. We believe that generation is growing in Brazil at rates greater than the GDP, about 10%, 15% greater, which makes the requirement for generation in Brazil at about 3,000 megawatts per year of firm generating capacity. This is an amazing capacity of energy, which is equivalent to something like, you would say, several billion– 15, 20 billion REAIS of investment just in generation alone, just to keep up with demand.

Now, when you build generation, you also have to have associated transmission. The transmission network in Brazil is vast but still insufficient to cover the needs of the country. Losses in the transmission sector are high, and this is basically because of insufficient capacity in the transmission. So there is a huge opportunity there, too, although rates of return in transmission have been traditionally lower than rates of return of investment in generation.

Snow: What other forms of capital are competing with private equity capital to be the long-term partner in these projects, whether it’s the upstream at the generation or in any other part of the energy market?

Brandao: In Brazil, there are basically three forms of equity capital. You have the private capital, and you could, here, divide private capital into the corporate world and the private investor, private funds, private equity capital, who look at investing equity in the energy sector. You also have the public companies, or the state-controlled companies, such as Eletrobras and its subsidiaries. They also are having investors in the energy, in the power sector in Brazil.

When it comes to the oil and gas sector, you have private companies, Brazilian and foreign companies. And the foreign companies can also subdivide into state-controlled companies and purely private companies, and you have Petrobras. So here, the equity capital for the development of infrastructure is really multifaceted.

Snow: But where do you think capital from private equity funds, from private capital funds, is most competitive? Where is it the most natural long-term partner, considering that there are other places that some of these projects could be getting capital?

Brandao: I can talk about our experience. We have, in Rio Bravo, a power fund, a sustainable renewable energy fund. And in this fund, we have created partnerships with Brazilian groups. We have created partnerships with, for instance, Eletrosul, which is a subsidiary of Eletrobras, which is a company that’s controlled by the federal government but has its stock also traded in the stock exchange.

We have a partnership to build 500 megawatts of wind farms in the south of Brazil with Eletrosul. And it’s an equal partnership where each partner has half of the joint venture. And in the other parts of Brazil, we have partnerships with private companies, with industrial groups and developers. So we, as private equity investors, have chosen to go both ways. And there is absolutely no limitation for private capital to associate with state-controlled companies or with private companies here in Brazil.

Snow: You mentioned foreign sources of capital. How welcome or how needed is capital from overseas, let’s say private capital firms, in Brazil? Are they changing the opportunity, or are they competitive?

Brandao: I think you said it really well. It’s not only welcome but needed. Domestic sources alone will not be able to take care of the huge demand. And it’s not only equity but also debt. Today, the largest provider of long-term finance in Brazil is BNDS. The government has been taking serious measures in order to provide other options for private investors to obtain long-term financing in local currency, like, for instance, special incentives, tax incentives for the ventures to be acquired by specialized investors. So I think that when you look at private capital investing in energy, sorry–

Snow: Well, I was asking, to what extent do foreign sources of capital change the game, or to what extend are they needed.

Brandao: They are not only welcome, but they are also needed. And when you look at the huge challenge ahead in the power sector, when you look at not only generation and transmission over the next 5 to 10 years, you’re looking at 1 trillion reais in demand for capital. A portion of that comes from debt, primarily long-term debt from Brazilian sources. But one-third to 40% percent of that will have to come from private capital. Private capital being, again, equity capital coming from federal sources and also from private equity sources.

Snow: Well you had the opportunity to tell international GPs to stay away from the Brazilian energy market. But it sounds like you don’t fear any increased competition or the influx of foreign capital.

Brandao: Not at all. Not at all. I think the cake is huge, and there is a piece for everyone. The country needs the investment. I think the investment brings along with it new management practices, new technologies, new ways of looking at businesses, governance. So it provides a new level of sophistication, which the country needs as it evolves into a full development stage.

Snow: Let me ask one final question, and it’s about a very important piece of the private equity puzzle, and that’s human capital. What is the pool of talent like for managing some of these very big and complex energy projects that you back?

Brandao: Yeah, that is perhaps the most important component when looking at investments, in particular in the energy sector. You have to find professionals who are not only competent– technically competent– in the nature of the business but also managerially competent, financially competent, that these are complex structured projects, all of them, and they have to be put in place, and they have to survive over the long term profitably. And to find the right people to build these projects and then operate them and with the highest standards of ethics and governance, looking at the community in which they are inserted, looking at the environmental impact, which they have, all the sustainability issues, this is the real challenge.

Brazil has a huge pool of talent, but this industry has been growing tremendously. And despite the fact that the country has great universities and technical colleges, but what we look at, what we need to develop more and more, is the experience. We need to have the experienced manager and infrastructure in energy. And this is not something, which you develop very quickly. So it will be over time. So this is a challenge, indeed.

Snow: Are you finding success in convincing, maybe, managers from a public company background to join a privately financed project? Do they see that as an attractive move? Or do they say, hm, sounds kind of risky. I think I’ll just stick here in my large corporation?

Brandao: No, I think there is a lot of rotation in Brazil right now. Opportunities abound. There is no shortage of opportunity if you’re competent, if you have a solid track record. So what we see today is movement from private to public, public to private. And the compensation schemes in several public institutions, such as Petrobras and others, has been totally restructured so as to attract high-caliber professionals.

So we see today a competition for talent coming from all sides. And we see, also, what’s interesting, demand for talent from abroad. More and more, we see professionals coming from all countries, from North America, from Asia, from Europe, coming to Brazil, bringing their experience, which is much needed here.

Snow: So there’s an influx of Canadians coming down to Brazil?

Brandao: There is a few Canadians, yes, coming down, very welcome. And also Americans and lots of Europeans from all nationalities. And very welcome. Brazil is a very diversified country where all nationalities of all creeds are very welcome. This is a melting pot. And what they see, now, is through economic growth and stability, it seems that there is a new wave of immigration coming to Brazil of highly skilled professionals. And they are very welcome, indeed.

Snow: Well, it must be exciting to be part of an investment opportunity and to be part of an economy that, not too long ago was not the most popular place in the world for investment, and now has become, as you say, a magnet for talent and capital.

Brandao: Yeah, like everything, if you have good management for a prolonged period of time, patience, if you nurture, you will see results. And that’s what has happened here in Brazil. We’ve had a transformation in the way government looks at the country. There’s a lot more respect, there’s a lot more attention to development of the population, of creating the trickle down effect, of giving a wider range of opportunities, educational opportunities, daycare opportunities, more jobs. So there’s a lot of importance given to the social aspect of government, the sustainability aspect of business.

And this is transforming Brazil tremendously. And I’m very fortunate. I’ve lived through the military regimes. I’m 50, and I’ve seen– when I graduated in 1985 as an engineer, I basically had difficulty finding a job. Had I graduated today, I would have probably several opportunities to find a very good meaningful employment. So the country has changed tremendously over the past two decades.

Snow: Well, Sergio Brandao, thank you so much for speaking with Privcap today.

Brandao: It’s my pleasure. Thank you for having me.

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