July 24, 2013
Interviewed by: David Snow
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Profitable, Responsible Real-Asset Investing

Real-asset investing in Brazil can present a great risk-adjusted opportunity, provided you understand the municipal process of auctioning assets, say our experts in this third segment of a series on real assets in Brazil. Pros from Denham Capital, Vision Brazil and EY discuss getting the regulatory complexity right in exiting a real-asset investment, and the importance of community relations in mining deals and of housing when building a community around a real-asset investment.

Real-asset investing in Brazil can present a great risk-adjusted opportunity, provided you understand the municipal process of auctioning assets, say our experts in this third segment of a series on real assets in Brazil. Pros from Denham Capital, Vision Brazil and EY discuss getting the regulatory complexity right in exiting a real-asset investment, and the importance of community relations in mining deals and of housing when building a community around a real-asset investment.

Profitable, Responsible Real-Asset Investing

Real Assets in Brazil #3

David Snow, Privcap: Today we are joined by Amaury Junior of Vision Brazil Investments, Gustavo Gusmao of Ernst & Young, and Victor Munoz of Denim Capital. Gentlemen, welcome to Privcap Today!

We are talking all about real assets in Brazil and the investment opportunity. All of you have invested significantly in real assets across Brazil or you’ve advised clients. Sometimes the best way to learn about an opportunity is just to share some stories. And so I’m interested in hearing some very good examples from the three of you that illustrates the opportunity to invest in hard assets, real assets infrastructure in Brazil.

Gustavo, you are involved in many infrastructure and PPP projects in Brazil. Is there any project or investment that recently you’ve worked on that you think would be interesting to share with an international audience?

Gustavo Gusmao, Ernst & Young Terco: Yes, it’s interesting to mention the last round of airport concessions in Brazil, which was a process where the private sector actually dealt with some challenges.  And during the process, we had the public hearings for this project  during  a four to eight week period, just to help the government and just dialogue with the government in terms of the business plan that the government wanted to issue. And at the end of the day, this process was really… there were a few changes in terms of the requirements to bid for this project. And we have over 10 consortiums aligned for this bid. There was a lot of attention from the private market.  And about six to eight weeks before the final proposals, the government changed a major requirement which involved bringing international airport operators as a track record, as experience for this consortium. At the end of the day some of the consortium were not able to meet this requirement at such a short time.

So at the end of the day, and this is only to illustrate that when you have a process of a public RFP here in Brazil…for such a process, it’s important not to not to start assessing the project when the government decided to release it. Actually it’s homework that you have to do way before the government does that.  Of course you don’t know the requirements…the final requirements, but you had to have a jumpstart in terms of assessing these projects. Otherwise you’re going to be much less competitive than the other players.

Snow: Amaury, can you talk about an investment that Vision Brazil has been involved in recently that you think would really illustrate the opportunity to put capital into work in real assets?

Amaury Junior, Vision Brazil: Sure. Sure. So just to understand, I mean, the legal regulatory framework as well, when we deployed, a lot of our capital in agricultural land at peak time we had close to 900,000 acres of properties, so about 16 different farms. Large scale farms, chiefly in the range of 50,000 acres per farm. And with that we have, recently I would say, in the past one year and a half or so, exited about, 250,000 acres or properties where we initially thought there was a problem because the government came with sort of a new regulatory framework in 2010. In 2010 what happened is that with the fear of foreign enclaves being established in Brazil as they were in Africa seen in particular by sovereign states investing in Africa, the Brazilian government came with a new regulatory framework restricting the amount of foreign ownership of Brazilian lands.  Basically restricting, depending on the region of Brazil, between 1,000 hectors to 5,000 hectors which is about 2500 acres to about like say 12,000 or so acres.

When this new legal regulatory framework came into place, we got concerned about the exit opportunity because that would restrict the type of buyers of agricultural land, especially since we are developing agricultural land. But in reality, as we’ve seen, as Brazil is becoming more and more of a super power in agriculture, that really did not detract us from being able to exit. So the most recent exit we had was in July last year. That was a very interesting opportunity. We bought a very large farm in the range of about 80,000 acres in the state of Mato Grosso in Brazil. In 2007, the farm had all type of problems, you can imagine. We basically developed and fixed all the problems, sort of adequate the farm to be a fully productive farm and producing farm.  So we developed a farm from about a say producing 2,000 hectors to about 20,000 hectors of production. Andin the end we sold to probably the largest Brazilian soybean producer.  This was an amazing investment on am unleveraged basis and was about four times return on investment in five years. And on a leverage basis was close to seven times.

Snow: Victor your firm invests globally. You invest in mining, power, energy… any particular deal recently that you think a good story and would help people to understand the opportunity here?

Victor Muñoz, Denham Capital: Yes, I’d like to talk about our investments in mining products in Brazil because I think it’ll help illustrate the importance of the local execution. Obviously you do your work, identify these themes and you see the opportunities in Brazil. To us it was very clear. The mining sector is highly dominated by iron ore. And everybody is focused on iron ore. It is the biggest product, the biggest production. Everybody wants to have an iron ore project. And what we see as a huge opportunity in a large prospective country of working in other sectors…gold, copper, phosphate, rare earths that are not as competitive as the world of the iron ore is.

So you do all these analyses, you identify the opportunities and then you invest. But none of the analytical work, none of the financial models, none of the PowerPoint presentations will help in what is probably the most key and crucial point for equity investment, which is the execution of the actual investment. And in that execution the local knowledge, the local understanding of how things work, the local capability of execution is key.  For example, in oneproject started pretty much pretty much from green field. And just to make things simple… you go and you drill to see if the commodity you’re looking for is in the ground. Then you move it towards a project. You want to develop a pilot plant. And then you want to build a mine. You start, doing the exploration, drilling the holes.

And what happens is you start to bring people to the certain region to do this work, and people start to see the cars, the trucks, with the logo of the company. And if you’re not local and you don’t address the community and tell them what’s going on, most probably than not what’s going to happen is the community is going start to wonder, what are all these trucks with this name of this company doing here. Are they taking away our stuff?

So it is very important that somebody local, who understands the culture, who speaks the same language, goes and engages the community and tell them, “Look, this is what we’re doing. We’re looking for a mineral. We might find it. We might not find it. If we find it there’s going be a project and it’s going to be good for everybody. For us as a company, for you because we’re going bring employment, we’re going develop, there’s going be taxes, etcetera.”

So, then as the project moves on you need to develop these private plants to test metallurgy and the process, etcetera. Now you need permits. You need a permit to build the facility. You need a permit to operate the facility.  It turns out that you cannot go to one agency and do it. There are the municipal authorities. There are the state authorities. And there are federal authorities. So you need to map it out and have it very clear. And quite frankly, when you map it out, and this is not a joke, this really looks like a huge spider web with a lot of dots and points of all the people that you need to address.

So you have to have an orderly plan, again, of local people understanding how are we going to present this in the right terms to the federal entities in Brazil? How are we going present these to state entities in the capital of that state? And how are we going present this to municipal people in the little town where we’re working? And the same it’s the project but it’s three different presentations. You have to address all of them. You have to, as I said, not only then engage with the community, not engage with the authorities, in some cases actually execute some formal understanding of what you’re going to do. And in doing all that, then you prevent, number one, having negative connotation of your project, but, number two, creating a good will so that the community will understand what you’re doing, that’s it’s good for them. And in the end also understand that your community is going to be your partner.

Junior: I would concur with Victor on that because, I mean, from our experience the success of the project tends to be a lot of social responsible investments because in reality what you are doing is really developing a sense of community and building up wealth in the community. And if you do not really share that in the sense of like bringing sort of like people to be engaged in the project, it tends to be a failure. So just to give you an idea for instance, for us to operate the farm, you’re going need at least 50 different type of licensing permits. Be that from federal, be that from state, or be that from municipal entities. And for you to be able to do that in a proper way, sometimes you have public hearings. So there’s a lot of work that needs to be done, from the perspective of operating under the legal regulatory framework, which is very strict. So if you think about just on the environmental side, Brazil probably, nowadays has probably the most, I would say, strict environmental code there is across many different nations. And for you to be able to operate under that umbrella, you have to be really careful about sort of engaging also the community that’s around you. I think the social aspect is quite important for any project that is a relative to scale in Brazil.

Snow: Very briefly, and maybe we can finish with this question…when investing in a project, whether it’s mining or whether it’s agriculture and there is a community being built, what are the most frequent forms of social infrastructure that you would always seek to build to give that assurance that you’re not just coming to extract but to build a community? Is it schools? Is it housing?

Junior: Absolutely.

Snow: Housing?

Junior: Housing first. And the housing, as a matter of fact, when we are building, tend to be above the standards in terms of like what’s required by the sort of the labor authorities.   Second is school access.  If the scale permits, we even build a school in the farm so we have in some cases we have a school being built in there. But aside that also employment and sort of good labor conditions for the individuals in the community, which creates also a sense of good will for the project.

And of course I mean, this is more of the social side, but in the environmental side there are a lot of things that needs to done to make sure that, not only you are compliant but also that you are basically developing and make good on the environment as well.

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