Private Equity in Brazil: ‘The Music Hasn’t Stopped’

Latin America: Private Equity in BrazilThis article was written by Camila Aguirre, Oscar Lauz del Rosario, Ryan Meehan and Rodrigo Patiño, members of the Lauder Class of 2014.

According to data provided by the Emerging Markets Private Equity Association (EMPEA), Brazil’s PE industry in 2011 raised a record US$7.1 billion, or 18% of the new capital committed to emerging markets. Of this total, it invested US$2.5 billion across 47 companies. More than half the deals were in the energy, infrastructure and consumer sectors. This comes as no surprise, as Brazil has the largest consumer market in Latin America, worth US$1.5 trillion in 2011. The country is more open to PE than ever before, with success stories covered in the local press, stronger capital markets and an increasingly institutionalized investor base.

Brazil’s Economic Takeoff

Over the past decade Brazil has exceeded expectations, becoming a success story among emerging market economies. Per capita GDP rose from US$2,812 in 2002 to US$12,594 in 2011, growing 18% a year on average. In September 2012, Brazil’s unemployment rate was at a near record low of 5.4%, compared to 7.8% in the U.S.

The Brazilian economy’s success has translated into increased consumer spending in a variety of areas, ranging from basic goods to furniture and automobile sales. In addition, the government continues to invest money in offshore oil exploration. The country is currently home to the second largest infrastructure project in the world — the development of its offshore oil deposits in the Pré-Sal, which will bring in US$270 billion in investments over the next 10 years and a huge demand for ancillary products and services. This project is expected to generate two million new jobs in an industry that currently has only 500,000 employees. Along the way, Brazil has attracted significant foreign capital, as investors seek to capitalize on the country’s growing consumer segment and infrastructure needs.

Despite Brazil’s relatively slow growth in the economy over the last two years, the consumer sector continues to see double-digit growth in the lower middle class. Given the country’s tumultuous history of government intervention, corruption and a bout of hyperinflation in the not-too-distant past, one must consider how the different administrations were involved with the marketplace and to what extent they have been responsible for Brazil’s current status.

Most people agree that the foundations for the consumer sector’s success were established during President Fernando Henrique Cardoso’s administration. The economic stability resulting from the Plano real of 1994, which consisted of a series of contractionary fiscal and monetary policies and the creation of a new currency, dramatically reduced the levels of inflation inherited from the post-military dictatorship, allowing consumers to save and purchase on credit. Inflation is corrosive to society and severely affects the purchasing power of the lower class, which is heavily affected by increases in staple goods and which possesses limited assets. Once inflation was controlled, it became possible to invest in the growth of the emerging Brazilian consumer.

The administration of President Luis Inácio Lula da Silva, from 2003 to 2010, although initially feared by the marketplace for its radical rhetoric, was able to gain the trust of the private sector by maintaining market-friendly policies. Over the same period, Brazil managed to increase its middle class from 26 million to more than 59 million, aided by social programs such as Bolsa Familia, which provided financial support to millions of underprivileged families throughout the country. New consumption patterns also developed, making Brazil one of the most coveted emerging markets.

Under the leadership of President Dilma Rousseff, investors are eager to see what new policies will be enacted. Although one should not expect major changes, due to the affinity between Lula and Rousseff, the current administration is under pressure to continue its predecessors’ consumer growth. During the last 12 months, the SELIC target rate has shown a substantial decrease from 11.0% to 7.25%. Analysts expect that Rousseff will offer cheaper lines of credit to the lower-middle class, often referred to as “class C,” a group that has long depended on credit provided by retailers. Euromonitor International research indicates that Brazil’s annual lending rate averages 43.9%, compared to 14.1% in Argentina, 12.4% in Indonesia, 10.4% in India and 6.6% in China.

Government support for consumer financing can be seen in the recent interest rate cuts at Banco do Brasil and Caixa, the two largest state-owned banks in Brazil, and the extension of credit to less affluent individuals. Despite substantial government pressure on banks to reduce their lending rates, there is anecdotal evidence that some private banks are pushing back. Recent media reports estimate loan growth of 10% in 2012, down from the previous estimate of 14% to 17%. This may be a signal from the banks that management is trying to reduce future exposure to bad loans by avoiding higher-risk loans, or that the demand for loans remains lackluster. As of February 2012, 44% of the total credit in the financial system came from the public financial system, compared to only 34% in February 2008. Such trends are being observed keenly by investors interested in the region, as they plan their next moves in the consumer retail sector.

Originally published by Knowledge@Wharton January 2, 2013 as part of The Lauder Global Business Insight Report 2013: Building Blocks for the Global Economy.

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