October 29, 2012
Interviewed by: David Snow
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LatAm Energy Investing

Demand for energy across Latin America is set to surge over the next decade; conservative estimates of required investment to meet this demand are around $130 billion. Clearly, there is an opportunity for private equity firms to make money, but what expertise is required?  Scott Swensen, Managing Partner of Conduit Capital Partners, and Russell Deakin, Managing Director of Rio Bravo Investimentos, describe their energy-investment strategies in a fascinating Privcap conversation.

Demand for energy across Latin America is set to surge over the next decade; conservative estimates of required investment to meet this demand are around $130 billion. Clearly, there is an opportunity for private equity firms to make money, but what expertise is required?  Scott Swensen, Managing Partner of Conduit Capital Partners, and Russell Deakin, Managing Director of Rio Bravo Investimentos, describe their energy-investment strategies in a fascinating Privcap conversation.

David Snow, Privcap: Today we are joined by Scott Swensen of Conduit Capital Partners and Russell Deakin of Rio Bravo Investimentos. Welcome, gentlemen, to Privcap today. Nice having you here.

Scott, you”re mostly pan-Latin America, and Russell, you”re mostly Brazil. So we have a nice combination of experiences here to talk about. So what”s driving the ability to make money as a private equity investor in Brazil”s energy scene?

Russell Deakin, Rio Bravo Investimentos: Certainly. First of all, the macroeconomics, the demographics of Brazil. Brazil has 200 million people. It has an economy of $2.2 trillion. So we have scale. One of the things that Brazil has had is a tremendous increase in the last decade– actually, of the 200 million people in Brazil, 75 million have moved up significantly in terms of economics. That”s either from lower class to middle class, or  even middle class to upper class.

So that”s obviously generating more energy consumption and more demand. And as Scott had mentioned, there”s a multiplying effect. There”s a multiplier in terms of the GDP. And you have increased consumption in the houses.

So to give you an idea, Brazil has about 113 gigawatts of installed capacity. So it”s the third largest market in North America, behind the US and Canada. But even looking at conservative estimates over the next eight or nine years, there”s basically a need of about $130 billion of investment just to meet the minimum energy capacity for the country to grow at a sustainable growth rate, whether it”s a GDP of 4% or whatever the case may be. There”s a great foreseen, forecasted shortage and that needs to be financed. So that creates a lot of opportunity.

And again, just as Scott had mentioned previously, in Brazil as well, whereas a dealer in the United States would have a yield much lower– single digits– we as well have very high yields in Brazil. We can do purchasing contracts that basically give nominal yield of 18%, and then total returns much better than that. We”re looking at nominal rates of high 20% to low 30%, which is very attractive.

Snow: Well, it”s one thing to paint the picture of what”s driving demand for energy across Latin America and in Brazil. It”s another thing to actually deploy capital into strategies that seek to capture that. So what are some really important things that institutional investors need to understand about the private equity opportunity in Latin American energy? What are some questions that you get? Or rather, what are some questions that they should be asking you, Scott?

Scott Swensen, Conduit Capital: Well, I think the great misperception among investors is that this is a highly regulated business. Power generation in most countries is a totally unregulated business. And I have a very good friend who runs one of the large US power funds. And we argue– I think my business is less risky than his is.

Once you sign a power contract, whether it”s with a municipality, a distribution company, an industrial– whenever rate of return you”re able to make, you keep. In the 19 years we”ve been doing this, we never once have had to show financials to a government agency. It”s an unregulated business. People don”t understand that.

Snow: Russell, what are some things that institutional investors either should, or perhaps would be surprised, to learn about the ability to make money doing what you do?

Deakin: Certainly. Because the focus is on renewables, for example, in Brazil 70% of Brazil”s energy– it”s actually even higher, 75%– is hydro, which is by default renewable. Then if you add the other renewables, another 8%. So 85% of the country”s energy is in fact clean energy. That”s a very high percentage that most people don”t realize.

But what”s very important is that, as we say, clean energy is actually mainstream energy. One of the biggest differences is Brazil”s energy is unsubsidized. So it”s viable. And that has a very different outlook going forward than some of– for example, most recently, as we know, in Spain. They”re taking away the subsidies in the wind. That has caused tremendous financial distress for the companies, for the supplies, et cetera. Those type of problems Brazil does not have.

The other aspect, as actually Scott mentioned, is in terms of the perception of the risk/reward– if I can go into a contract, have a 20-year purchasing power agreement, locked into a yield, we”re talking, again, 17% or 18% percent nominal, which is very interesting in Brazil. In the contracts, actually you lock in a real yield above inflation.

So even in the United States, over a 20-year contract, inflation is going to eat away at your real return. In Brazil, you have that protection. And so on a risk/reward basis, it”s very intriguing to have that protection on the downside, but yet because it”s a new, developing market, you still have very attractive private equity-like returns.

And it”s that communication, getting past a little bit more into the details and explaining that the environment and the market is very different than it is in the United States or Europe, that people sometimes don”t understand. And when they do, they realize that there”s quite good opportunities.

Snow: Well, let me ask you, then– it sounds like a very attractive opportunity, both from your perspective and also for Conduit Capital. Why aren”t there more firms out there doing your type of investing in Brazil and also looking at power plants across Latin America if, as you say, it”s unregulated, the long-term contracts are very meaningful, the yields are higher than one might find for similar deals in the United States? Why don”t you have more competition, Scott?

Swensen: We do, but it”s on the larger size. The global strategic power companies are all over Latin America. And Brazil”s probably the only market where the majority of power is domestically owned. Most of the other countries have sold their utilities out. Where we don”t see competition is at the smaller size. If you”re an AES or a Duke Energy, the thought of spending three years to build a $50 million hydroelectric plant just doesn”t work with their cost structure.

So for us, while there”s a lot of activity at our lower level, it”s us and some local players. The global funds that have tried to go into our business have not succeeded. And so we think we”re in a really unique position.

Snow: How about you, Russell? What does the competitive landscape look like for your firm?

Deakin: Well, similar to as Scott had already mentioned, there is competition on the large scale. There”s no question. Even more so in Brazil, because Brazil”s more attractive in terms of international investors coming and looking at it and having scale. For the large companies, scale is important.

However, Rio Bravo was founded in the year 2000, and we”ve learned over time that local presence is essential. And that can be in terms of creating the pipeline, for example. We”ve had a company advisory business over the years that has given us a proprietary pipeline, very strong. If you are an international investor, it”s hard to get that if you”re not on the ground so much. And frankly, when it”s accumulated, the size of the deals can be quite attractive.

For example, on a hydro, we”re going to invest in a 161 megawatts. That”s attractive for a larger player. But one of the projects we”re doing is only three. That”s not of any interest to the larger player. And on the wind projects, we”re doing 524 megawatts. 524 megawatts is one of the biggest wind projects in all of Brazil. But again, individually, they”re quite small.

The other aspect I would say is, especially on the financial companies, there”s a lot of people who like the idea of doing– it is, certainly in Brazil”s case, quite regulated, quite integrated in terms of the regulation, and quite complex. And it has a local aspect to that. For example, on the project financing, a lot of that”s done with BNDS, which is the Brazilian Development Bank. Well, if you have outstanding relationships with them over the last 20 years, it certainly helps speed up the process.

And when you have the auction base in Brazil, the auctions are basically twice a year and they are live. It”s a very sophisticated process, a reverse Dutch auction. And you have to have all your financing, all your technical analysis, all the finance beforehand, because what can happen is there can be competing offers that are very close, and then you have to adjust quite quickly in real time.

And unless you have that expertise of the local markets, of the studies, as well as perhaps some of the engineering expertise that not all of the financial houses have, then it”s quite difficult to do.

Snow: You mentioned a flow of deals, a pipeline. Can both of you talk about how you source opportunities, maybe starting with Scott? Latin America is a big place, but you have a very specific type of deal that you do. So as you go across Latin America, how are you sourcing the assets and opportunities that you invest in?

Swensen: The most important source of deals for us are local partners on the ground. And typically, they have done the up-front development. So they”ve spent $1 million to $3 million. They have a site, they have an environmental impact statement that”s approved. They have a potential off-taker.

So for us, the most critical is aligning ourselves with those technically qualified, competent developers. And we have a number of them in many countries.

A secondary source are ex-CFOs, because we insist on appointing the CFO in every country. A third are the multilateral lenders, the IFC, the IDB, CAF, FMO, and DEG out of Europe. All five of them have been investors in our funds and constantly are sending us deal flow.

And then we”ve been doing it for 19 years. We”re just well-known in the market. So there are times we just get a phone call. I heard about you and we have a project. Are you interested?

Snow: Are there any countries in Latin America that you have not done a deal in?

Swensen: Yes. We”ve been in 11 countries, and if you include the Caribbean, there are something like 36. If you exclude a number of the islands– which we do because they”re so small, it just doesn”t make sense for us– there”s probably an investable universe of 17 or 18, from our point of view.

Snow: Which countries have you avoided, either because a deal never came up or you just absolutely will not go there?

Swensen: Well, today, we”re avoiding what we would call the Chavez axis. Venezuela, Ecuador, Bolivia, Argentina, Nicaragua, and Belize. If you”ve got a risk of expropriation or of adverse price caps, it can absolutely destroy your investment.

And then our job is a regional capital allocator. If you”ve got countries like Brazil, like Peru, Colombia, Chile, Mexico, Panama, that open their arms and want the foreign investment, why would you go to a country where you worry about them taking your asset, either through adverse regulation or through outright expropriation?

Snow: Russell, can you talk about the deal flow that Rio Bravo has throughout Brazil?

Deakin: Certainly. We are fortunate. We have a very large institutional base. We have 64 pension funds that are investors with us.

Snow: Are these local?

Deakin: These are just the local ones I”ve mentioned. I”m not talking about the–

Snow: 64 Brazilian pension funds.

Deakin: 64 Brazilian pension funds. So that obviously creates a very strong network. A lot of these pension funds, for example– in our recent energy, we had 30 investors in the energy fund. Of those, 24 were local pension funds, and of those, 18 were pension funds from energy companies. So not only are they providers of capital, they also can be providers of deals and providers of liquidity. So we”re very appreciative of it, and we think it”s very much a win-win situation.

The other aspect is the team itself. We have vast experience. We have engineers who have 25 years experience in the industry. They obviously create their own network. We also have one of the few firms– we have project finance experts and engineering experts. So those two sides can also develop deals. So as Scott said, maybe a call from the project finance. It can be from other advisers. And since we are very well-known in the industry, very well-known in Brazil for that, it helps feed on itself.

Snow: Final topic, and I”m very interested to hear from both of you. But Scott alluded to risk, and maybe one would be risk of a Chavez taking over your power plant. But what are the more common risks that you analyze for your deals? And how do you understand them? And how do you evaluate whether or not they”ll be a factor in the success of your deal?

Swensen: The first thing for us is we want to invest in a plant that is very economically competitive in its host market. And so one of the first things we do is we hire an engineering firm to model this plant, assuming it”s a green field we”re going to build. Or if it”s an existing one, we”ll still do it.

15-year outlook– where is this plant going to rank in the cost of power in that country? If we don”t receive the answer that this is, for the foreseeable future, going to be a very competitive plant, we go home. We will not rely on a pile of paper if the economics don”t support it.

After that, inflation. Russell mentioned inflation adjustments. We always insist on getting inflation adjustments. You sometimes don”t get 100%. We”ve seen recently some of the wind deals, because your capital cost is fixed, they”re saying, well, you”re operating costs are only 20%. So we”ll give you 20% adjustment. There are things like that that are going on.

Snow: Russell, what are some of the risks that you spend the most time with before you do a deal?

Deakin: Well, our fund, as you know, is focused on Brazil. But Brazil itself is a very large country. It”s larger than the continental United States. And so what that means is land cost varies tremendously. So we have projects, for example, in the South, near Ilha Granda, Azul for the southern states. Up in the Northeast. Wehave hydro projects in Mato Grosso, Rio de Janeiro, which is basically the southeast center of the country.

And as you may have noticed, I didn”t mention Sao Paulo, because for the moment a lot of the projects in Sao Paulo, because of the increase in land costs, et cetera, are not viable per se. So that”s one issue, that we graphically diversify our investment to make sure that has its component. Obviously the construction component, the technical component, is an important part.

The other thing that we”ve been able to do, I think, is take advantage– at this moment, for example, with the economic crisis in Europe, there are many manufacturers, especially on the wind side, the wind turbines, the wind blades that come to Brazil, whether they are Spanish, whether they”re Indian, whether they”re Chinese, American, et cetera. There”s probably 11 countries that are building plants in Brazil.

We”ve been taken advantage of that, because usually, for example, on a project, the supply gives you an 18-month guarantee of performance. We on our deals were able to negotiate a five-year performance. So that”s very unusual and very attractive. So that is taking out some of the risk as well.


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