May 13, 2013
Interviewed by: David Snow
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Infrastructure Investing in Brazil: Filling Gaps

Macroeconomic drivers and demographic shifts in consumer power consumption lead to fresh real-asset investment opportunities in Brazil, including in the agribusiness, power and social infrastructure sectors. In the first of a thought-leadership series on Real Assets in BrazilAmaury Junior of Vision Brazil Investments; Victor Muñoz of Denham Capital; and Gustavo Gusmao of EY Terco discuss how infrastructure gaps are creating private capital investment opportunities in Latin America’s largest emerging market.

Macroeconomic drivers and demographic shifts in consumer power consumption lead to fresh real-asset investment opportunities in Brazil, including in the agribusiness, power and social infrastructure sectors. In the first of a thought-leadership series on Real Assets in BrazilAmaury Junior of Vision Brazil Investments; Victor Muñoz of Denham Capital; and Gustavo Gusmao of EY Terco discuss how infrastructure gaps are creating private capital investment opportunities in Latin America’s largest emerging market.

Filling the Infrastructure Gaps in Brazil

Real Assets in Brazil 

David Snow, Privcap:

We are joined today 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.

We’re talking all about real assets in Brazil. It’s a very big topic. Many investors around the world are interested in understanding what the investment opportunity is and what the demand is that is driving that investment opportunity. All of you are involved in real assets defined in different ways in Brazil; and so you bring very valuable perspectives that we can talk about. So I’m interested in starting with maybe learning about what all of you are very busy with right now. And maybe you can give a sense of what’s happening right now in the Brazilian market or real assets. Maybe starting with Amaury, your firm, Vision Brazil invests in a number of different strategies. But can you talk about one that is particular active or that you think is particularly important right now?

Amaury Junior, Vision Brazil Investments:

Sure. We have been investing for a period of time in agricultural assets, in particular in farmland development. We have already gone through one cycle of, uh, exits, uh, these investments. And we continue to invest in the sector. We do feel that Brazil has a sort of unique sort of like position in-, in agricultural land development. In particular due to the amount of water that’s available for agricultural production.

Snow: So just a quick follow up. Would a lot of your investment theses be based on getting the water to the agricultural assets?

Junior: No. We tend to concentrate in regions that there is an abundance of water. Uh, be that sort of like from natural rainfall or for assets of like, uh, river flows where you can have like license to use the water. I think that the assets in the areas are really the fact that Brazil has sort of like an abundance of water. And in the end productivity tends to be relatively stable in the long run.

Junior: Gustavo, your group is very focused on infrastructure and real assets and social infrastructure. Can you talk about one really interesting area that you’ve been spending a lot of time on?

Gustavo Gusmao, EY Terco:
Actually I think one of the main drivers for infrastructure in the Brazilian market now is related to the logistics program released by the federal government. And we’re talking about 120 billion dollars worth of investments in the next 20 years. And this has been a major priority from the Brazilian infrastructure play. It’s like the construction companies, the concessionaries. And I think also the state level governments are really ahead of the major infrastructure investment in high stakes of some power. So I think it’s a great scenario for infrastructure right now in Brazil.

Snow: Thank you. And, Victor, your global firm is investing in a lot of energy assets and also mining. Can you talk about some of the key themes or a really interesting opportunity right now that you’ve been spending a lot of time with?

Victor Muñoz, Denham Capital:
We at Denham focus on three areas: oil and gas, mostly exploration and production, mining, and also power and renewable, mostly in the generation part. The three areas are very attractive in Brazil, quite frankly. With Northern Gas, right now, we’re just a few days from the return of the bid rounds for concessions. This is a very active sector. I think it’s going to be a good opportunity for investment. Mining is as well a very interesting area in Brazil. It’s a very prospective country for many commodities. But I would choose, for this conversation, the power sector, which also has a series of characteristics that make it very attractive for investments right now in Brazil.

Snow: Well, I’m interested in understanding the important macro and demographic drivers of demand that is leading to investment opportunity of all of you.

Gusmao: Actually, if you should take the per capital GDP for Brazil in the last decade, it has grown about an average of 18 percent each year. So it, is really, as Amaury mentioned, there’s really a new power in terms of chasing new goods. And the population it also means a major challenge for the infrastructure to bridge the gap to get this production done and distributed across Brazil.

Muñoz: Yeah, I’d just like to say that, I completely agree with what Amaury said. In the case of the power sector, I’d say that is one of the major drivers for the fact that, power demand, power consumption, grows faster than GDP. And it’s because these people located in the lower economic classes are getting now access to more means of consumption and they are driving at the same time larger demand for power. So that’s one of the interesting factors in the case of the power sector again, growth above and beyond GDP.

Junior: I would also add one that is not necessarily related to just purely the issue of wealth. But I think Brazil has two uniqueness factors that I think are quite important to point out among emerging markets. The first one is the legal regulatory framework. I think despite the fact that we had some changes on the sort of the regulatory side, sort of like, put away some investors. The legal regulatory framework in Brazil is relatively very stable. You have the capacity to challenge the government in courts and win. We have had several situations when we were looking at credit opportunities where we do that and we are successful doing that. Which I think sort of like brings the discussion that despite the fact that Brazil nowadays was perceived as moving a little bit away from, I would say, a steady legal regulatory framework, this is still in place. And we have a very strong independence of powers, being that legislative, executive and judiciary. And the second one I think is also very important. Brazil is a free flow country. What I mean by that is that, uh, once you register all your investments coming in anytime you want to take the investments out, meaning take the sort of the outcome of your investments, the realization of your investments, there’s no red tape. You can get out in one day. So I think that this true, I would say, I would say not regularly seen variables, I think they are very important because in many emerging market countries they are not present.

Snow: Well, it is possible to see the investment opportunity for almost anything, but certainly for real assets as looking for opportunities to to bridge a gap in, you know, helping supply meet demand. All of you again are sort of focused on different areas in the market. But can you talk about some interesting gaps that you see exist and you think there’s an opportunity for private capital to come in and and build assets or to own improved assets that would make for an interesting investment opportunity.

Muñoz: The size of the system itself is really, really big. Brazil has, today, around 130 Gigawatts or installed capacity in power generation. And independent of whether the growth is going to be around 3 and a ½ – 4 percent, all the forecast indicate that Brazil will have to, at around, 4 to 5 Gigawatts of power per year over the next five years. Just to put this in context, at least regionally, uh, we’re talking about 20-25 Gigawatts of additional capacity that needs to be built and therefore there’s going to be needs for equity investments due to that. But to put it in context, Chile, for example, is a country that, in total, has about 14 Gigabytes, in total today. It’s not what they need to add. It’s the installed capacity today. Brazil needs to add around 25. So Peru’s got like 9 Gigawatts. So if you add Peru and Chile you’re still smaller than what Brazil will have to build. So the size of the opportunity is real interesting.

There’s been another series of developments over the last year that make it even more attractive. For example, from the side of the demand, distribution companies are now regulated to make their forecast with higher demand than before. Before they needed to go, I guess between 100 and 102 percent of what they estimated the demand. Now it’s going to be 102 to 103. So it’s going be more demand. And in the side of the offer projects that go to the ministry auctions will now have to be responsible for their own interconnections. So a lot of projects that are far away from interconnections places will not be able to go to the auctions. And therefore these auctions are going to be more attractive for those participants. So there’s a series of reasons why the power sector is an interesting place to invest for private equity. And that’s certainly one of the areas where we’re focusing right now.

Snow: Gustavo, you and your team spend a lot of time with sort of different infrastructure types of assets. Can you talk about can you frame it, as gaps that can be filled with private capital?

Gusmao: Sure. Clearly, if we could pick up two segments in which Brazil has gaps it would be in railway infrastructure and port infrastructure. These two are really important to really reduce the cost of transportation in Brazil. I mean, Brazil the mode of transportation is still pretty much based on road infrastructure. And there is common sense that the new investments need to be more focused on rail and imports. And for that I think that the private sector is really starting  to take a closer look at these programs that the Brazilian government is releasing. But there is still, especially in the port infrastructure, there is still a challenge from the Brazilian government to really have, a solid regulatory institutional framework. And as we speak, the Brazilian congress is really, trying to reach common ground in terms of the new legislations for port infrastructure. And, I think in the upcoming weeks we probably will have some new legislation, which will allow a better flow of private capital in terms of the infrastructure for ports.

Snow:            Amaury, you have many different strategies that you focus on obviously. But can you think about the opportunity for private capital to come in and connect sort of two different areas that are far apart as far as being able to help the Brazilian economy be even more efficient?

Junior: Yeah. I would say, similar to what we are discussing here, in the case of agriculture, the big gap is logistics. And I think the logistic gap-, I would say logistics in infrastructure, as a matter of fact, is relatively very large. I mean, just to give you a few examples even at this crop year, for instance we developed farmlands in different parts of Brazil. One of the parts we developed is in the northeastern part of Brazil. And typically these farmlands are in the areas that are more remote in the northeastern part, which is the western part of the northeastern part. In contrast, the sort of the coastal areas, which are eastern of the northeast, they end up due to the logistic gap, buying, let’s say, grains, from outside Brazil because it’s cheaper to bring them by ship than to bring them by motorways to the same region of the country. So I think that there’s sort of a big contrast what you would expect, because you are producing, a sort very large scope of production in the same sort of geographical region. But at the same time the cost of transportation is extremely high.

Another one that I would say is also the shipping investments. They don’t have to be relatively large. They can be in tandem with say infrastructure being developed by the government. The government is in the process of developing several new railways. In particular for the case of the northeast, there is one that we look very closely, which is called the Trans Northeastern Railway. We expect the Trans Northeastern to be ready by 2014-2015. At least the first tracks will be there in place. With that of course, there’s still a gap. And the gap relates to, port infrastructure, processing units, shipment units, etc. So I think that there are tremendous opportunities for the private sector to piggyback on the government investments especially in the layout of the infrastructure.

Gusmao:     I would say that one of the concerns of the private sector, regarding these upcoming opportunities of investments in ports is regarding the rates of return announced by the government. We’ve seen a lot of criticism, a lot of resistance from the private sector in the roadway round of the concessions. And this will probably be the case for ports as well. We have rates of return ranging between 6 and 7 percent a year. The market is really concerned about this range of returns. And if you’re looking for more return, even though you will assume more risk, but at the end of the day, the government is trying to regulate too much on the rate of return. And this is a concern of the market. And but I think at the end of the day, the government will probably realize that they need to be more flexible in terms of this, just to foster better competition for these projects.


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