August 1, 2012
Interviewed by: David Snow
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The Maturation of PE in Brazil

The next 10 years of private equity in Brazil will be “much better than the past 10 years,” argues Fernando Borges, a current Vice President of ABVCAP as well as Managing Director and Head of South America for the Buyout Group of The Carlyle Group.

In an exclusive Privcap interview, Borges describes the industry’s evolution from an initial bad spell in the 1990s to a new era after 2007. Other topics: the importance of local stock markets to private equity exits, how GPs have more ways to make money now, how Brazil’s huge under-40 population drives growth and how a tax-law change is one of ABVCAP’s biggest accomplishments.

The next 10 years of private equity in Brazil will be “much better than the past 10 years,” argues Fernando Borges, a current Vice President of ABVCAP as well as Managing Director and Head of South America for the Buyout Group of The Carlyle Group.

In an exclusive Privcap interview, Borges describes the industry’s evolution from an initial bad spell in the 1990s to a new era after 2007. Other topics: the importance of local stock markets to private equity exits, how GPs have more ways to make money now, how Brazil’s huge under-40 population drives growth and how a tax-law change is one of ABVCAP’s biggest accomplishments.

Privcap: Why is not an attractive time for private equity in Brazil?

Fernando Borges, ABVCAP; The Carlyle Group: First, we need to understand that the private equity in Brazil is still very young and we went through cycles. So we had the first cycle until late ’90s, where we had a lot of money invested, but the macroeconomic fundamentals were not there. The way people did private equity was very different. No local presence, most of them.

So what happened was it was very bad for the industry. Nobody made money. Everybody left.

Then we went to the second cycle, which is from 2002 to 2006. Very few players remain. Market fundamentals improved a bit, but we didn’t see a lot of views or a lot of players investing.

And then we came to this new era of private equity that started in 2007 where we see a lot of money, raise it, a lot of new players, local and international players, and managers start to get track record and then they continue to raise more money. And more important, the macroeconomic fundamentals are there. So people started looking to the country because the country was growing, because of the politicoeconomic climate, this large, growing middle class. People buying more stuff. So that’s the private equity area that we’re seeing now.

And for investors in this industry, I think what makes this cycle now more attractive is that in the past, the only way to make money was buying cheap because there were no growth, very hard to improve the companies operationally, no leverage. So the only way to make money in private equity was true arbitration– buying cheap, selling expensive. This cycle we have today, you have the possibility of making money, of growth, because we see companies are taking advantage of this growth of middle class and people buying more stuff. Leverage is expensive, but it’s possible.

More importantly, operation improvement. We see companies that, despite the size they have, you see that you can go there, add value, and they can become much better companies in terms of operational efficiency. And the mood for arbitration is still possible. Even though the multiples went up, it’s still possible to have some arbitration there. So today, it’s much easier to make money in private equity. And so that’s why I think the next 10 years of private equity will be much better than the last 10 years.

Privcap: How does the Brazilian consumer figure in to the private equity investment thesis in the country?

Borges: I think first, we need to understand the good demographics that Brazil has. So it’s a large, young, urbanizable population. 192 million people, 70% below the age of 40, 85% live in cities. That’s very good demographics.

Then we have this growing middle class that five years ago accounted for 35% of the population, today is 54%, and in the next five years will probably account for more than 60% of the population. And this middle class is getting more access to credit. They’re having increasing wages. They have more disposable income, more purchasing power, and they always want to have access to certain items that only now they can afford to buy.

So that’s why you see industries like consumer retail, education, travel, health care, financial service just growing at double digits. Brazil is one of the five largest market for cars, women’s spending, cosmetics, beverage, and still there are a lot of industries where the penetration is very small, like education. So that’s what is driving the Brazilian consumer.

Privcap: How important are the local stock exchanges as exit avenues?

Borges: It’s very important. When you make an investment, basically you have two alternatives– sell to a strategic or going public. So the stock market in Brazil has become much more mature, has developed a lot. It’s definitely mature enough for private equity companies that want to get liquidity in the market. It’s not easy as 2007, but definitely is much more feasible than 10 years ago.

Stock markets there are mature for that, but they become more selective. So for a company to go public today, you need a middle size, you need corporate governance, you need good internal controls and process, you need a minimal liquidity. So if you have all that, definitely the stock market today is an alternative for you.

Privcap: How can the Brazilian private equity market mature further?

Borges: Still we see a big gap in what the Brazilian GPs want and the local LPs want. The local LPs, in my view, still dictates the rules. So they want more control. They want governance. They want to pay lower fees.

So some Brazilian LPs, they accommodate and they bring those investors. Some international GPs prefer, sometimes, not to have those local LPs. So still, there’s a big gap. This dynamic is changing, but slowly.

What happened is the local LPs have become more selective. They just don’t want only GPs that accept their terms. They want quality GPs. The GPs, on their hands, they have become less sensitive or less worried about everything that the Brazilian LPs want. So we’re seeing some conversion

That conversion must happen because at the end, LPs must invest, especially with the declining interest rates. They have to locate their money where they can get higher returns. But it’s a process that takes a longer time.

Privcap: What are some of the most important accomplishments of ABVCAP to date?

Borges: First, it’s good to talk about that because since I was not in ABVCAP the last three years, I feel more comfortable in talking about good things that the other people did. I think ABVCAP accomplished a lot of things, but I think the most relevant is more cooperation with other associations, with British Venture Capital Association, the Canadian one, LAVCA, EMPEA. More attraction of international investors, and especially International LPs through those round tables. and other events.

Most importantly, ABVCAP played a very important and proactive role in the process of convincing the government to reduce the IOF tax on long-term foreign investors in private equity from 6% to 2% and then to 0%. Despite, for instance, all the agreements that they did with Inter-American Bank and with Apex, I think those are the big accomplishments of ABVCAP.

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