Private equity firm 3i is the latest global player to open a fund based in Brazil – the most popular country for new private equity funds. Research by the Emerging Markets Private Equity Association (EMPEA) and Coller Capital found that Brazil had replaced China as the most attractive emerging market jurisdiction for private equity funds’ limited partners.
3i announced its first acquisition at the end of last year, taking a “significant minority stake” in TV cable and bandwidth services provider Blue Interactive for R$100 million ($55 million). It is 3i’s first transaction following a search process that has covered more than 240 companies since April 2010.
Marcelo Di Lorenzo, partner and head of Brazil for 3i, declines to reveal the size of capital the global firm has ready to deploy in Brazil but he envisages completing an average of three deals a year with the aim of building a portfolio of about 10 Brazilian companies.
Some private equity funds have found recent valuations of Brazilian companies prohibitive. For example, BR Partners told Euromoney in December that it was yet to invest any of the $200 million private equity fund it had raised because of higher valuations of targets. However, Di Lorenzo says he does not believe either valuations or a limited supply of opportunities will prevent 3i following up its Blue Interactive announcement.
Middle-market focus
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| Marcelo Di Lorenzo, 3i |
“We are focusing on the middle market, with deals of between $30 million and $100 million,” says Di Lorenzo. “It’s a space that has a lot of demand for capital and there are a lot of interesting companies that are growing significantly, and not only want capital but also a partner who can help them go further and reach a different level.” Private equity flows into Brazil have surged since the trough of 2009 when, according to EMPEA data, the global crisis slowed fundraising to $401 million from $3.589 billion in 2008. The industry has bounced back since, with $1.078 billion raised in 2010 and by the end of last September – the latest data available – $4.465 billion was raised by Brazilian equity funds in 2011. In 2010, Brazil accounts for 69% of the Latin American private equity industry.
The money flowing into the industry is inevitably leading to high valuations, but high multiples aren’t themselves a problem for 3i. Di Lorenzo says the days of private equity funds making money from buying companies at lower multiples that they can sell have gone.
“It was easy to buy at a lower multiple and find a strategic buyer who would find a premium or, if you were lucky, go through an IPO,” he says. “That’s going to be more difficult to achieve.”
Instead, his firm identifies management teams it can partner with, who are open to implement global best practices in areas such as governance, operations and finance to increase the profitability and performance of the company.
“Once these companies realize you bring something beyond capital – although of course you need to be competitive – valuation becomes a secondary issue,” says Di Lorenzo. “Having the right partner matters more than anything, but we are seeing companies that have 30% to 40% annual growth consistently over the last four years. That should command a different valuation.
“There is no way they are going to use a historical multiple – people just won’t sell the business. The companies demand higher multiples because of the growth and that’s the art of private equity – the question is how sustainable the growth is and are we pricing it correctly.”
Carrots
The growth of Brazil’s stock exchange is providing a powerful carrot for mid-tier companies’ managements to seek partners to enable them to grow in size, and also to implement the level of governance required to go through a listing. However, Di Lorenzo says there is also a stick that is having an important motivating effect on his target middle tier to seek private equity partners.
“In Brazil, a lot of wealth was created just by evading taxes,” he says. “The government has introduced a lot of mechanisms that are making not paying taxes a lot harder. It used to be very hard to compete with the small companies who were evading taxes but now they can’t evade as much and they’re losing their competitiveness.
“And the smart companies realize this trend is creating opportunities for consolidation. We are seeing several examples of this over many sectors and that’s very interesting for private equity.”
