November 3, 2012
Interviewed by: David Snow
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Latin American Energy: Two Case Studies

Required viewing for investors serious about understanding the energy and emerging market opportunities in private equity. Two Latin American energy investors offer insights into two recent deals: Scott Swensen of Conduit Capital Partners details investing in a Peruvian solar project and why his firm already is getting exit offers; Russell Deakin of Rio Bravo Investimentos describes how his firm won a government energy auction and why wind-energy assets are price- and energy-efficient.

Required viewing for investors serious about understanding the energy and emerging market opportunities in private equity. Two Latin American energy investors offer insights into two recent deals: Scott Swensen of Conduit Capital Partners details investing in a Peruvian solar project and why his firm already is getting exit offers; Russell Deakin of Rio Bravo Investimentos describes how his firm won a government energy auction and why wind-energy assets are price- and energy-efficient.

David Snow, Privcap: Today we are joined by Scott Swensen of Conduit Capital Partners and Russell Deakin of Rio Bravo Investimentos. So welcome to Privcap. Thanks for joining us.

We are talking about energy investing in Latin America. A lot of investors really want to understand Latin America. And they certainly want to understand the energy opportunity. So the fact that both of you are experts and seasoned veterans of Latin American energy investing is great. So I’m interested to hear your stories.
I think the best way to really understand your strategies and the way you see the world and the opportunity is to hear about some deals that you’ve done. So maybe starting with Russell, what’s an investment that Rio Bravo has done recently that really exemplifies your strategy and also the way that you see the opportunity to make money from investing in energy.

Russell Deakin, Rio Bravo Investimentos: Certainly. So in August of last year, Rio Bravo won basically the semi-annual auction that the government has in which you compete in Brazil on an even basis to provide energy– and it can be any source of energy– at a cost which the government accepts you. And then you have, in this case it’s called an A3. You have three years to build that energy. So obviously we had been studying.

Snow: So it could be wind?

Deakin: It can be wind. It can be hydro. It can be thermal, bio, or gas. It’s very interesting in Brazil, which is one of the few countries where there’s not real subsidies, so it’s an even playing field. So all forms of energy are on the table, as it were. So obviously, before you do that, in order to be in a position to win that, you have to line up not only you supplies, et cetera, but obviously a joint venture partner. You have to have done your studies. You have to identify the location.
So to give you an example, we were fortunate enough. We had a large project in which we formed a joint venture with Electrobras and its subsidiary Electrosul. And Electrosul is one of the largest electricity companies in the Americas. So that’s helpful because it takes up a lot of those perceived sovereign risks, risks, et cetera.
And we had already identified, had been working with our local advisers and people that we’ve known in the network to develop a very large project. It was actually 22 wind projects in Southern Brazil in the state of Rio Grande do Sul. And that was a total of 524 megawatts. So it’s extremely large project. Probably about a Capex of about $1.6 billion, all in. So that was a situation in which it was a long-term process.

It took us well over a year to identify it, work through the negotiation, have it lined up for the auction to be in a position to win the auction. And so we had identified the process beforehand, decided with whom we’d like to do a joint venture, had already pre-negotiated that, obviously had pre-negotiated with a lot of the suppliers, the cost. And then we had made sure, and it was one of the attractive parts, also as a joint venture partner.

So we were fortunate to have a successful auction. And now we’re fortunate that here we are at the end of 2012, and the first wind power project will come online and start producing revenue as early as 2013, the early part of 2013.

Snow: How do you win an auction? Is it price alone?

Deakin: It’s not just price alone. We were not the cheapest price. So price, for the government, is important. I believe there were two people who had provided lower cost energy. And also the government may choose in who won is not just we were wind power. But there were other also types of power. So I think they like to have a mix of different types of energy.

And then also it’s the reputation of the firm. It’s the perceived risk, if they’ve work before together, I think. And again, how neat is the package. Because remember for the government in Brazil, there is a perceived– and there is now but it will get worse– there’s a very large forecasted shortfall. And this is essential for Brazil and the government not to create the shortfall.

I remember being in the summertime having brown outs. Well, as Brazil is growing, it cannot afford that. So it’s a very strategic process for the government to get it right. So they have to be careful with whom they are. What’s the credit risk? What’s the institutional risk? What’s the operation risk? Someone who put together the bid, have they built it before? Those type of questions are equally as important as the price.

Snow: Scott, before we get to your story, since you’re an energy investor, any expert questions for Russell about this investment?

Scott Swensen, Conduit Capital Partners: About this investment, yeah. Whose turbines are they? And what’s their role in the project.

Deakin: Well, we were fortunate. Again, I think one of the–

Snow: Is that a good question?

Deakin: That’s a good question. One of the factors that we, in Brazil, are fortunate to have are there are many supplies of different turbines. And that has been because, obviously, the problems. Especially in Spain and in Europe, we’ve seen that recently the Spanish, the Germans, and we’ve always had now the Chinese, and the Indian, there’s a lot of new suppliers who are building factories in Brazil. So that led us to a very fortunate situation, especially in the wind.

To give you an idea, the price over the last three or four years of the turbines has dropped 40% to 50%. And yet at the same time, the technical capacity has improved. So now the wind turbines are, as you probably well know, 80-meters tall, 100-meter blades. Instead of capturing 22% percent of the energy, they’re now at 42%.
So now, at least in Brazil– and I’d be interested to hear, Scott, from the rest of Latin America– wind is the cheapest form of energy in Brazil. It’s less than three million Brazilian REIS. So let’s say a million and a half per megawatt. And that has dropped dramatically. Because if you looked at the scenario a few years ago, it was not the case. So it’s to take advantage of– it’s a dynamic environment. And prices are moving.

We have not seen that sort of change. Small hydros are very attractive and probably the second cheapest form of energy in Brazil at the moment. But there’s been dramatic shifts in the wind. And we’ve been able to take advantage of it.

Snow: I’d like to hear a recent deal story from Scott. And Russell, think of a good question for Scott along the way.

Swensen: We, a year ago, did a wind project as well. And just to support, when we became involved they had an EPC. And the first thing we did was went out and rebid the turbines. And General Electric won it at a price 40% below the prior quote. And we will start operations on that project by the end of the year.

But what I wanted to talk about is a deal we actually closed two weeks ago, which was our first solar deal level. It’s in Peru. And there, unlike the Brazilian model, the Peruvians had made a decision that they want a certain amount of solar. The south of Peru is the Atacama Desert, which extends into Chile. And so they put out a solar-only auction.
A Spanish development group, which has moved to Latin America because of the difficulties in Europe, won the bid, was in construction. It’s a smaller project. It’s about $200 million in size. The equity check is about $30 million. They couldn’t find people that had the capability and the interest to do it. And we became aware of the project in either May or June. And, as I said, we closed it two weeks ago.

The off-taker is the Peruvian grid. The power gets spread among the entire system. The financing is the US government. It’s OPEC, 20 year debt, 85%. That will go with the project when it’s sold. And without an exit, this project will produce 16% IRRs in dollars with inflation adjustment on top of it. An exit in three to five years will bring us somewhere high 20s to low 30s depending on how soon we do it.

Snow: For a project like that, Scott, who would you see exiting the solar asset to?

Swensen: The most likely would be a European utility. The European Union has put in place a 20% global renewable mandate by 2020. And it’s very difficult to do those projects in Europe. So we sold three hydros in Mexico three years ago. I think we had 12 European bidders. And the winner was a European utility. So that’s the most likely.
But I think there are local groups that could be interested. We’ve seen family groups, because of the dollar nature of the cash flows, also interested. So we think we’ve got a number of options when it comes time to exit.

Snow: Any questions for Scott?

Deakin: Yeah, it was interesting. Because we have done– we’ve seen Brazil very dynamic exit market.. So we have, for example, even though we are coming online just the beginning of 2013, we already have unsolicited bids. So I want to see if you have the same sort of potential exit channels as what we’re seeing already. Two of them, for example, our own LPs, energy LPs, the pension funds, they want the–
Swensen: They want the asset long-term.

Deakin: They want the asset.

Swensen: It makes a lot of sense.

Deakin: Another was an Asian manufacturer who wants the energy directly for the new manufacturing facility in Brazil. And then the last one was one of our competitors who had an infrastructure fund who were not able to buy the assets in time for the investment period. And so they are needing assets. So that’s the dynamics in Brazil. It’s been very dynamic given the shortage, et cetera. Are you seeing those type of exit?

Swensen: All of that, absolutely. And in fact, these hydros, and they were in Mexico, that we sold, the buyer is still there. We’re building two more hydros and, as I mentioned, this wind project right now. They have already told us once they’re up and running, don’t hire a bank. We’ll pay more than anybody else. Come back to us. You know, as a private equity owner, that’s very comforting to hear.

Snow: It sounds like you did the deal and the exit in the same meeting.

Swensen: We could have.

Snow: That’s great.

Is it the case that a lot of these acquirers, who might be a nice exit route, see Latin America as a– they’re under-allocated to it as far as energy assets in their overall mix? Is that how it works?

Deakin: I personally don’t think that’s the main reason. It could be. But to give you an idea, if you look at the world right now, we are at an incredibly low interest rate environment. And obviously, depending, it could be even negative.

Very few places in the world provide one, even on a fixed income basis, the yields that we were able to obtain in Latin America. We have a tremendous amount of interest from Asia, from the Japanese, from the Korean pension funds to buy our assets. Also the US. And I’m not even talking about the local Brazilian market. So that’s one aspect is with this low-yield environment that we’re seeing, people, even on a fixed income basis, see this as very attractive.
Now what’s interesting, what we do, so you have a very attractive, let’s say, fixed income yield, which is four or five times the US Treasury. Sometimes it could be in dollars as well. So you could take out that risk. Other times it could be in the local currency, but even at higher yield. That’s attractive. But you’re also getting the private equity-like returns. And what I mean that, high 20s, mid 20s, low 30s percent.

So as the world has become deleveraged as well, the buyouts who traditionally had produced very high returns, obviously using debt, using leverage, that is difficult to replace. And so there’s very few investment opportunities that find that. So we actually are finding people who are looking for absolute returns interested in that. And we are finding people in the sector, because of the energy, looking at that, looking at real assets. And then there’s the fixed income investors. So it’s really a quite interesting mixture between that, and who are looking for that.

And yes, I didn’t mention whether the Latin America exposure is important. I think most people these days are increasing their exposure to emerging markets, but not necessarily Latin America. They’re agnostic. So they’re looking for the best investment opportunity. And at the moment, one of the best investment opportunities happen to be in Latin America.

Snow: Do you agree, Scott?

Swensen: I totally agree. When we started raising the third fund in 2004, Latin America was still a dirty word because of the terrible experience on a number of large Latin American funds in the late ’90s. Today we are seeing people that have Latin American allocations. And when they looked at the emerging markets– the Brick Concept was invented by Goldman Sachs.

Well, look at the non-Brazil component, corruption in Russia, a stock market in India that’s absolutely collapsed, the issues in China. I think people are now saying yes, Brazil is important. But Colombia, Peru, Chile, Mexico all offer viable, growing markets where you can make good return. And they don’t have the issues that these other countries have.

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