June 1, 2012
Interviewed by: David Snow
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Sense of Urgency

The sense of urgency among Brazilian corporations to grow, innovate and compete on the world stage is growing, and private equity plays a pivotal role. The experts in this Privcap discussion provide insight into the impact of private equity on the Brazilian business landscape.

“Sense of Urgency: Innovation and Private Equity in Corporate Brazil” is the second video in this series, featuring Marcos Marinho Lutz of Cosan, Christopher Meyn of Gavea, and Carlos Asciutti of EY Terco in Brazil.

The sense of urgency among Brazilian corporations to grow, innovate and compete on the world stage is growing, and private equity plays a pivotal role. The experts in this Privcap discussion provide insight into the impact of private equity on the Brazilian business landscape.

“Sense of Urgency: Innovation and Private Equity in Corporate Brazil” is the second video in this series, featuring Marcos Marinho Lutz of Cosan, Christopher Meyn of Gavea, and Carlos Asciutti of EY Terco in Brazil.

David Snow, Privcap: I’m very happy to have you here today. We’re talking about the role that private equity is playing in transforming Brazilian business. All of you are on the front lines of that transformation, so I’m fascinated to hear your points of view.

First, I thought it’d be very interesting to talk about innovation and entrepreneurship in Brazil and the role that private equity is playing. Maybe starting with Chris, can you talk a bit about the sense of urgency among Brazilian companies and Brazilian corporations for finding innovation and for driving innovation, and maybe just kind of what the scene is like right now?

Christopher Meyn, Gavea Investimentos: Sure. It’s better to look a bit at the historical context. I think there has not historically been a great sense of urgency. You can start that with having a closed economy and then one that’s been heavily driven by commodity strength and low cost of labor. That’s changed rapidly as the country has entered a very strong growth cycle, I’d say, over the last eight years.

But that historical backdrop and a very low level of investment, particularly from the government. I mean we’re talking about mid teens investment as a percentage of GDP versus the rest of the emerging markets in the 20s and even into the 30s and 40s as sort of a sense of need to grow both the internal infrastructure and innovation of companies. Now I think there is a much greater sense of urgency as many of these things have started to unwind and productivity gains are on the forefront of the minds of most of the top companies here in Brazil.

Snow: Marcos, do you agree? As someone who’s been inside a large Brazilian corporation, do you see a sense of urgency to innovate and become more productive?

Marcos Marinho Lutz, Cosan: I think the sense of urgency is, let’s say, a very broad concept at the end. There’s a need for innovation in many sectors. I would say that one of the burdens of being a targeted country for investors and for companies as a market is the fact that our currency appreciates and when you have that you have an extra burden for companies in terms of competitiveness.

So people are clearly seeking more efficiency and when you basically are seeking that you have a larger sense of urgency on innovation. So at the end, innovating on the processes is something now quite part of the agenda and the companies are finding ways or sometimes struggling to find the source of new competitiveness. So in that term, I think it has accelerated quite a lot.

Snow: How about you, Carlos? What are you seeing among your clients as far as a need to innovate and to become more productive?

Carlos Asciutti, EY Terco: I think historically innovation has come from corporations, most of it. There’s very little money, public money or other private capital going into a venture capital or seed, that sort of investment. Probably most recently, in the last five years, you’ve seen some academia, some universities investing in companies for innovation.

But still, it’s pretty much any corporation world. Probably because of lack of capital, most of the capital has been through private equity or more late stage companies and probably also because it’s difficult from a regulatory perspective, startups and new companies, the regulatory burden to this is very difficult, it’s not very friendly for capital investing, venture capital. But it is changing. There’s a lot of room for change and I think it is changing as we see now and as we talk to more venture capital looking at Brazil and having Brazil on their radar screen.

Snow: I’m really interested in hearing how the Brazilian business community views private equity. Private equity does not have a very long history in Brazil and yet it’s clearly gained a lot of visibility. So maybe starting with Marcos, how do you think in general Brazilian business builders, Brazilian executives view private equity now and what the opportunities are to partner with private equity?

Lutz: I think the private equity role in the economy in Brazil has being changing very fast. To start, companies seek to discuss deals with private equity when they need cash. So I think that the primary source will be always that. But the thing is the role is mainly on step changes.

So when a company is facing a step change or something that is, in their view, a large move and they feel that they should share risk or they should find a partner to share discussions and bring in outsiders’ information in the process, this is the time when private equity deals, on at least the ones that are more successful, reoccur. The stressed ones, the ones that people seek when they are under stress. It’s really the ones that they normally don’t see a bright future.

In our case, we have always discussed deals with private equity companies when we find that first, a need for, let’s say, different discipline on the governance side. The second is when we feel that we should share part of the new risk. So we have a new business idea, so sometimes you would like to have somebody sharing the risk because sometimes you’re conflicted on the process of your thinking. So having somebody from outside will question you, make your review more the plans, and will make you do more profound homework on your plans.

And obviously, the third one is capital. Especially in countries like Brazil when you have some turmoil, you have really a liquidity issue, and normally on those times are when great opportunities occur. So it’s kind of a good com bination.

Snow: Chris, as someone who’s been involved in private equity really from the early days of private equity in Brazil, how do you compare the impression that Brazilian business has of private equity now versus maybe 10 years ago?

Meyn: I think it’s improved greatly. I think that’s not only a product of private equity having more exposure, it’s become a more acceptable, tool for companies to utilize in their capital structure. That’s a product of both focus on the market and acceptance of governance.

You have today a situation where most companies, executives, owners, shareholders really do share a common belief with the financial market of where Brazil’s going. It’s no longer a debate as to, is this a short cycle? Is there going to be another crisis in a year? Is there going to be a period where I need to hold my capital? In many ways, that leads to a cycle of less transparency and less desire to really share gains and risks.

When you share the common goal of Brazil’s going to be in a long term, positive, upward cycle, you start to have a more comfortable view of actually opening your company, having a partner, and looking to share growth. I think Marcos said very well what the reasons are, we’re still in the early stages of private equity here. I think when you look at developed markets and you look at a lot of private equity focused on operational improvement at the margin, where you have very efficient companies and you’re looking to improve very small gains in operational efficiency combined with, say, leverage, you’re in different phase of maturity relative to where we are today, where capital access is still one of the primary drivers, if not the absolute driver here.

We have high interest rates, we have periods during stress with absolute shutdowns in liquidity. Private equity is a very valuable tool for companies that want to take advantage of opportunity during these periods. That still shows you where we are in the cycle of private equity, when capital availability is still the absolute primary driver for companies today.

Snow: Carlos, do you agree? Is it the capital and the fact that private equity offers something that the rest of the capital markets cannot offer that makes it very valuable?

Asciutti: I think so. If you look at 10 years ago, in the mid ’90s, there were only three private equities doing transactions in Brazil. In the last six, seven years, you see there’s probably about 30, 40 managers now doing some serious transactions. I would link the answer into when you have the large companies or large target companies over $500 million companies, those are really aware of private equity, how they can help. They are connected to PE, sometimes compete with the IPO because entrepreneurs are looking also for the IPO as a source of capital.

In the more mid-market, between $50, $100, $200 million, I would think that there’s still a lot of opportunity for PEs to be known. They’re not known and most of these entrepreneurs have never heard of PE. And like Chris said, the market has a liquidity problem and we don’t have pretty much a debt market in Brazil. So the game that PE is playing in Brazil is less of a financial and more of an operational game. And you have to find the right companies, so we have to be connected with the local people, local entrepreneurs. So I think there’s a lot of room for PEs to work on that marketing of making themselves known by the mid-market entrepreneurs in Brazil.

Snow: Well once a private equity firm is involved with a corporation, with a company, they bring capital to the table, but they also hope to bring a new set of alignments, they hope to align management with the private equity firm and, as we discussed earlier, create more of a sense of urgency for change. So I’m wondering if you see evidence that private equity firms are sort of creating a bit of a cultural shift within the companies that they partner with in sort of giving management a new set of alignments, a new set of incentives that perhaps they had not enjoyed under the previous structure. I don’t know if you’re seeing anything like that.

Meyn: It’s case by case and I think you definitely break it down into companies that have a more mature profile and experience with either international and capital markets or private equity, and that tends to be a situation where you’re really focusing on either a step changes, as Marcos said, or really a transactional goal. More mature businesses, I think, more mature companies here that have experience with international capital markets tend to be looking at partnering with private equity for exactly a strategic initiative. That could be new project development, it could be accessing capital markets jointly, it could be looking to make an acquisition and having shared knowledge at the table. But generally, governance tends to be something well-accepted.

I think at the earlier phase companies, middle market, and ones with less experience with private equity, your role actually is in helping that first phase governance. And you are seeing the need for private equity and the acceptance of companies to enact change more focused on alignment of shareholders, management, and the board of directors where you are putting in new ways of running a business from sort of a governance standpoint.

Snow: Since Gavea is a much larger private equity firm in Brazil, focusing on kind of the larger opportunities, what types of industries do you think are most in need of capital or transformation of urgency?

Meyn: I think there’s so many sectors that are in need of capital. You’re talking about an overall growing economy in a fairly long term cycle, both looking backwards and forwards, so you’re seeing this across economies. It becomes more of a desire, a taste of where an individual private equity feels most comfortable investing.

So I can speak from Gavea, where we see opportunity match with a long term vision of where Brazil is going tends to be looking domestically. And that’s in both, let’s say, the road block issues for the growth, which can be infrastructure, education, power, transport, et cetera, or purely the growth side of what’s happening in Brazil, which I would say is consumption driven, and that can be both through consumer products or retailing and the like. We tend to stay in those areas.

Asciutti: Most of this business in Brazil, mid-market, they are family owned, they never had an accountability, they’ve never reported, because we don’t have the debt market, they never had loans, so they never had to report to banks or anyone, they’re just a family business. So the cultural change is traumatic when you receive somebody that is either through buying a control or a minority stake, the changes that the family has to go through is unbelievable.

That’s probably the most important issue for any PE. So having an understanding and sometimes being flexible, having to understand what the company is doing, understanding what the family does is very important to be successful in the middle market, different from the larger entrepreneurs in Brazil.

Meyn: I think the acceptance of change, which is sort of issue at hand, has moved radically over the last 10 to 15 years, where in the ’90s it didn’t matter the size of the company. The issues were would you be accepted as a true transparent partner to even start the process of changing governance and, let’s say, transformational moves within a company.

Today, I think there’s enough success cases and enough examples throughout middle market, large cap, that most entrepreneurs that we meet today are fairly advanced in their thinking and looking for a partner, looking for this advice. It’s no longer trying to explain why this might be necessary, it’s starting with what are we going to do first in our first 100 days and our next 200 and then the like, which I think is a very, very important step that’s been made in the corporate environment here in Brazil.

Asciutti: Something I might comment on, some of those cases have been very helpful to the market, saying I was an entrepreneur, I got money from private equity, and I learned, and I got better because of that money, because of that relationship, because of changes they made in the corporate governance. So these cases now, in the last 10 years, have become very important for other entrepreneurs to look and say, this is a way forward before I even think of going to the market and being public, I’ve got to have a partner that understands what I need to do before going public.

Lutz: And the size of the exit market has changed at lot. So I think the old cases, the unsuccessful ones, I would say were mainly when the time to exit arrived and there was no option. So at the end, the relationship at that point is quite complicated. So once the Brazilian market, the public market is a lot more developed day. And also even another PE transaction or something in the lines of giving exit options for both sides are happening quite often now in a successful way. This helps a lot in the stocks.

Meyn: Yeah, definitely. You’re aligning the believability of a shared goal. You have the ability to align cycle, to align exit alternative, exit objectives, and it’s sort of a classic win-win. But it’s happening now and I think that’s the most important part that you’re seeing this happen across Brazil over the last 10 years.

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