International Finance
Economy

M&A deals flow in Brazil

It could have been better if political situation in the country were stable Suparna Goswami Bhattacharya April 8, 2016: The unending corruption scandal that has mired the political parties in Brazil has hurt its global image. At least that is what it seems from various rating agencies’ outlook towards Brazil. From Moody’s, Standard & Poor to Fitch, all have downgraded the recession-hit nation to junk...

It could have been better if political situation in the country were stable

Suparna Goswami Bhattacharya

April 8, 2016: The unending corruption scandal that has mired the political parties in Brazil has hurt its global image. At least that is what it seems from various rating agencies’ outlook towards Brazil. From Moody’s, Standard & Poor to Fitch, all have downgraded the recession-hit nation to junk status.

One would not be completely at fault to think there is little business activity happening in the country. After all, recent numbers for GDP growth available from Brazil’s statistical institute IBGE show that during the fourth quarter of 2015 Brazil’s GDP contracted by 5.7%.

Jens M Arnold, head of Brazil and Portugal desk, economics department at OECD says the outlook for the current year is -4% and 0% for 2016 and  2017 respectively.

The political scene in Brazil is a dampener for sure. The crisis has two main roots: the popular backlash against the government due to the state of the economy, and a large corruption scandal that is engulfing all major parties in Brazil. However, the situation has not surprised economists worldwide. Says Romesh Jayawickrama, CEO, BankerBay, “For all BRICs or emerging market specialists, such issues are woven into the fabric of emerging market risk. It’s just unfortunate that it is all peaking together, and at a time when the world is that much more cautious about liquidity and global economic strength,” says Jayawickrama.

Notwithstanding all these bad economic and political news, investors globally are looking at Brazil as potential market for M&A deals. Data from BankerBay shows that Brazil still accounts for a substantial majority of the potential opportunities in South America across the board. “M&A activity in Brazil is rising thanks to the dwindling economy which has  prompted a number of companies in the country to look for acquirers. And, due to the weak currency, companies look attractive, in terms of valuations, to buyers from abroad,” says Jayawickrama.

A few big ticket M&A deals that closed towards the end of last year suggest a healthy investor appetite, which again could in part be due to lower acquisition costs stemming from a weaker currency. Coty Inc., for example, agreed to buy the personal care and beauty division of Hypermarcas SA for about $1 billion in cash late last year, followed by shoe manufacturer Alpargatas SA selling two brands to a group of investors led by Carlos Wizard,a Brazilian entrepreneur, in a deal worth 48.7 million reais ($12.8 million).

The sectors that look promising are energy and materials, wherein there is lot of consolidation happening. In addition, activity in capital goods, retailing and services sector are drawing interest from investors abroad.

In fact, this is the first time since 2000 that foreigners have outpaced locals. According to data from PwC, through October, international investors like Coty closed on 285 mergers and acquisitions in Brazil, up 5% from the first 10 months of 2014, according to data from PricewaterhouseCoopers.

“There is a lot more that could have happened in terms of M&A deals but for the political situation in the country,” says Rafael Armani, mergers and acquisition advisor in Brazil. Armani adds that it is not just a matter of one scandal. “It is a conjunction of some of the biggest companies in Brazil —  Petrobrás and Odebrecht — the President, leaders of two houses all getting mired in huge and unprecedented corruption scandal.”

Natalia Pasquelini, who deals with global investor market, equates Brazil’s situation with that of Greece. “We see a lot of M&A activity happening in Greece the way it is happening in Brazil right now. However, unlike Brazil, Greece has not been mired in corruption scandals,” she says adding that strong fiscal and monetary policy changes need to be done urgently to improve the situation.

Investors see Brazil’s promising long-term prospects and business opportunities, but they also see a complex political situation in the near term. To strengthen investor confidence, Brazil would need to overcome its current political divisions and implement the reforms needed to start growing again.

“The changes include macroeconomic policies like fiscal adjustment and reining in inflation, but also structural reforms like tax reform, opening up to international trade, reducing administrative burdens and improving infrastructure. Right now, reaching a political consensus on some of these crucial issues seems difficult, but the smoke over the political divisions should eventually settle and this should create the conditions for Brazil to implement reforms,” says Arnold.

Arnold has the below suggestions for the government in Brazil:

  • Fiscal policy: Achieving a substantial fiscal adjustment will be seen as a litmus test for improved macroeconomic policies. In the longer term, there is a need for a better targeting of social expenditures. Reforming Brazil’s pension and social assistance system, which costs over 10% of GDP and whose expenditures are increasing rapidly, would be an essential ingredient of a sustainable consolidation. Several policy measures could contribute to containing pension and social assistance expenditures, but changing the indexation mechanism of minimum benefits will be an inevitable feature of any pension reform that would effectively contain expenditure growth. Currently, the minimum benefit is equal to the minimum wage, and two-thirds of pensioners receive this benefit level. By contrast, preserving the purchasing power of pension and social assistance by indexing current levels in line with the relevant consumer price index for low-income households (INPC) would roughly stabilise pension expenditures at 10.3% of GDP as of 2030.
  • Monetary policy: Although the economy has been growing below potential since mid-2013, inflation and core inflation have been close to the 6.5% upper bound of the tolerance band and has recently risen above 10%. The effectiveness of monetary policy could be improved further by strengthening its perceived independence. One way to do this would be to set a fixed term for appointments of the central bank governor and the other members of the monetary policy committee, during which they cannot be dismissed. Most inflation-targeting countries have such a fixed term.
  • Structural policies: Reforms of structural policies are equally important to raise productivity growth in Brazil. Raising productivity is key for Brazil because the scope for growth through factor accumulation has recently become more limited, due to low investment and demographic changes. Structural reforms that could boost productivity include a reform of the indirect tax system, which generates extremely high compliance costs. Brazil should consolidate indirect taxes at the state and federal levels and work towards one value added tax with a broad base, full refunds for input VAT paid and zero-rating for exports.

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