Brazil’s privatization process has stepped up a powerful gear. A mainly federal programme last year, it has now been joined with gusto by the state governments which are putting their own huge assets on the block. Behind them, the municipalities are planning sell-offs too in such sectors as water supply and sewage treatment.
The fact that privatization has been very much taken on board by the individual states and municipalities, despite opposition from such groups as the trade unions, is due in part to aggressive promotion by the federal development bank, Banco Nacional de Desenvolvimento Economico e Social (BNDES). Though not involved directly in state privatizations, the bank is exerting its influence, offering consultancy services on sales and in some cases pushing the states to speed up the sell-offs by offering loan programmes collateralized against future privatization proceeds.
At the same time BNDES remains very busy with its own schedule of upcoming federal privatizations. Telecoms is one important sector but the immediate focus is upon the mining conglomerate Companhia Vale do Rio Doce (CVRD). Everyone concerned with the Brazilian privatization programme, from investment bankers to foreign investors, is looking to BNDES to get this deal done in the near future.
The CVRD sale is viewed as a crucial test of credibility for the entire Brazilian privatization process and is also being watched closely by the state authorities, most of whom are under intense pressure to sort out their finances and curtail public spending. They are anxious for investors to remain focused upon Brazil and to retain international optimism about the prospects for the sweeping restructuring of the country’s economy.
The CVRD transaction ran into renewed controversy in December when vast mineral riches were discovered in the Amazonian state of Para. This led to fresh accusations from opponents of privatization that the country’s mineral wealth was being sold cheaply to foreign multinationals. Last month, however, new mechanisms were put in place to give the government a share of future revenues associated with these new discoveries and there is widespread belief among investment bankers that the first part of the CVRD sale a mergers-and-acquisitions deal bringing in a core group of strategic shareholders can be closed during third-quarter 1997.
Aside from CVRD, state and federal assets up for sale this year include the last pieces of the railway system, telecoms assets and electricity companies active in generation and distribution. Add all these together and analysts say that privatization proceeds could top $13 billion during the next 12 months.
Three electricity utilities owned by the state of Sao Paulo are causing great interest. Companhia Energetica de Sao Paulo (CESP), Electridade de Sao Paulo (Electropaulo) and Companhia Paulista de Forca o Luz (CPFL) are the main suppliers of electricity to the state, which has a population of 34 million centred upon the city of Sao Paulo, where some 20 million people live. Aside from this large base of residential households, potential bidders will be attracted by the industrial and manufacturing customer base. Sao Paulo is the industrial heartland of Brazil, accounting for approximately 40% of the country’s GDP.
Not surprisingly, the three companies up for sale are large. Affording their sales prices will probably require the formation of consortia of substantial international utilities. For example, the 10 gigawatt of installed generation capacity at CESP is twice that of the Tennessee Valley Authority in the United States, and taken together the three companies have a net worth estimated at $23 billion.
Consortia headed by investment banks submitted their bids for the three separate advisory mandates according to deadlines on January 8, 9 and 10. The state authorities are assessing the proposals, including ideas on how to break up the companies into more logical units prior to the sale. The proposals will be graded and given a weighting which will be combined with the price factor the two fees proposed by each bidder for a combined trade sale and public offering. The winners could be announced by the end of March and bankers in Sao Paulo are assuming that a different adviser will be appointed for each of the three deals. The more optimistic bankers think that the first of the three companies could be sold during third-quarter 1997, with the other two likely to follow in 1998.
Beginning again
All three are likely to begin with an M&A transaction, bringing in foreign utilities which will be expected to improve efficiency, introduce better technology and fund the heavy capital investment programmes needed to modernize the Brazilian power sector. Public share offerings are expected only as a second stage.
Octavio Castello Branco, managing director at JP Morgan in Sao Paulo, points out that many of the companies for sale in Brazil’s privatization process could benefit from the managerial experience and technical knowledge that strategic shareholders would bring. “That company will be in the hands of experienced shareholders and this will help attract investors for the subsequent global offering,” says Castello Branco.
Wouter Rosingh, vice-president at Booz Allen in Sao Paulo, also points to the importance of bringing in strategic partners via trade sales ahead of public offerings. “We are not throwing a lot of paper at the capital markets; we are bringing in strategic buyers with know-how,” he says. “This makes companies more attractive by getting experienced management in place, ahead of the second tranche.”
CPFL is tipped as the most likely contender to begin Sao Paulo’s electricity sector sell-offs; a trade sale is likely to be worth more than $1 billion. “CPFL will go first because it is a pure distributor play and you can sell it without dividing it up and the state of Sao Paulo wants that billion dollars in the bank,” says Walter Stoeppelwerth, head of research at Robert Fleming in Sao Paulo. In contrast, the other two companies will need to be broken up into smaller businesses before being sold and potential buyers will need a lot of time to study the various units before bidding.
Also expected to be sold this year is a 33% stake in the voting shares of CEMIG, an electricity utility owned by the state of Minas Gerais, which lies to the north of the state of Rio de Janeiro. CEMIG is a generator and a distributor and is looking for a strong international utility as an equity partner with a view to developing its generating activities in particular.
The company has a high-quality customer base of industrial users who buy more than half of its output, far ahead of consumers in the residential or commercial sectors. It needs private capital for ambitious expansion plans. In the first half of 1996 the company invested $237 million of which $124 million was allocated to distribution and $59 million to generation. The generation plans include a 380-megawatt (MW) hydroelectric plant scheduled to start up later this year.
Regulatory uncertainties have delayed the sale of CEMIG but BNDES is keen to press ahead quickly and has been looking at price-cap formulas for electricity tariffs, limiting price increases to the inflation rate minus a given percentage. As one analyst puts it: “Nobody is going to buy CEMIG without a tariff deal in place.”
Interest among foreign utilities is expected to be high for all these deals as was the case in the privatizations last year of Rio de Janiero’s electricity distributor, Light Servicos de Electricidade (Light), by the federal government and electricity distributor CERJ by the state of Rio de Janeiro. In November a consortium led by Enersis of Chile won the bidding for CERJ. Enersis, its Chilean affiliate Chilectra, Electricite de Portugal and Endesa of Spain together paid $587 million for 70% of the company.
The CERJ deal illustrates the dual nature of the privatization process in Brazil: bringing in much-needed revenue from the sale proceeds and new management to improve performance. Efficiency certainly needs to be improved. CERJ has 1.2 million customers and annual sales of over 5,000 gigawatt hours but like many electricity utilities in Brazil, its energy losses are high estimated anywhere up to 28%. This includes significant losses from illegal hookups to the wires, a widespread practice in the poorer neighbourhoods.
The electricity sector has long been a source of fiscal strain, requiring funding from state governments and BNDES. New capital investment is required to bring the power sector up to date and to enable it to expand to meet the needs of a growing economy. The states want to see the private sector assume this burden.
“The appeal, and the great upside potential of the electricity companies, is partly related to their inefficiency,” explains Sergio Werther Duque-Estrada, director at Banco de Boston in Sao Paulo. New owners of the electricity utilities will be looking to justify their purchase price in part by tightening up controls and by lowering energy losses in line with international standards, he says.
Then there is the growth potential to consider. In addition to growing investment from Brazilian companies, Sao Paulo is attracting plenty of interest from foreign multinationals. In 1995 and 1996, 115 foreign companies announced new investments in Sao Paulo state, expanding existing operations or starting new businesses. The names are a roll-call of large multinationals: Colgate Palmolive, Compaq, Ford, General Motors, GoldStar Electronics, Honda, Mercedes-Benz, Philips, Toyota and Volkswagen. As companies such as these pour billions of dollars into manufacturing plants, the demand for electricity is on the rise and analysts expect inward investment to speed up in coming years, due in part to the economic stimulation provided by the southern cone common market, which groups Brazil, Argentina, Uruguay and Paraguay and which is known as Mercosul in Portuguese-speaking Brazil and Mercosur in the Spanish-speaking nations.
There is still a final block of the Light stock to be sold, currently owned by the federal government via its electricity holding company Electrobras. The successful bidding consortium when the company was privatized last May included Electricité de France, Houston Industries and AES Corporation, each with 11.4% of the shares, and also featured local partner Companhia Siderurgica Nacional.
Individual projects are also up for sale. Chase Manhattan and Banco de Boston have been conducting a roadshow for the sale of Cachoeira Dourada, a 65-MW power plant being sold by the state government of Goias.
However, the electricity utility programme has begun by concentrating upon companies that are strong in distribution, even though they may own generating assets. As the generators come up for sale, uncertainties about the regulatory framework will become more critical to the sell-off process. BNDES views it as advantageous to have strong private-sector distributors in place before selling the generating companies, while it is generally assumed that transmission will remain in public-sector hands, providing open access and so being neutral for all players.
But complex issues such as a future role for independent power projects (IPPs), despatch rules, spot-market pricing and other regulatory matters still cloud the picture for electricity generators. In mid-1996 the federal government hired Coopers and Lybrand to conduct a study of the electricity sector, looking at these and other issues. The report should be out by May.
How these issues are resolved will be important in attracting investors into building generating capacity in Brazil. “There is a great need for new investment in generation,” says Paulo Dal Fabbro at Price Waterhouse in Sao Paulo. There is likely to be a role both for co-generation and IPPs and it needs to be decided how these will fit into the overall system, he says.
Envelopes and mobile phones
Telecommunications is another important sector moving rapidly toward privatization in Brazil. The sale of new band-B cellular licences is planned this year. This is one of the first steps in the planned privatization of Telebras, the telephone monopoly. The sale of Telebras requires legislation; this is being worked on. “The plan of the government is to privatize the whole Telebras system in stages but they need to change the constitution to do that,” says Dal Fabbro. He expects to see a high level of interest in the telecoms sector, especially from European operators which have moved into other Latin American countries.
A clue to the level of interest was provided in December by the highly successful sale of CRT, the telephone utility controlled by the state of Rio Grande do Sul. This was the first privatization in the telecommunications sector and was unusual in that only a minority 35% of the company was put up for sale. CRT currently operates a monopoly, providing local telephone, cellular, data transmission and other services within the state. It has a concession to operate conventional line services until 2003 and a concession for cellular band-A which will expire in 2009.
The highest offer for CRT came from a consortium led by Telefonica of Spain and including RBS, Citicorp, Telefonica de Argentina and CTC of Chile, the last two being affiliates of Telefonica. The sealed-envelope bidding process proved to be highly successful in realizing a good premium for the government. At R681 million ($654.8 million), it was 55% higher than the floor price set by the state. The sellers were represented by Salomon Brothers together with Salomon’s 50%-owned Brazilian affiliate, Banco Patrimonio de Investimentos.
A key issue in this sale was that, despite the minority shareholding, buyers were being given an active management role in the company. Such assurances were important to potential buyers and helped contribute to the high level of interest. Indeed, the second-placed bidder, a consortium led by STET of Italy and advised by Dresdner Kleinwort Benson, came within a whisker of the Telefonica offer, bidding R677.7 million.
Luigi de Vecchi, managing director at Dresdner Kleinwort Benson in Rio de Janeiro, who worked on the deal, says that CRT bodes well for future privatizations in the telecoms sector: “The bidders had a strategic interest in Latin America.” De Vecchi says he expects more European interest in the various units of Telebras as they come to market. CRT also attracted interest from Asia. Korea Telecom participated in one of the consortia.
In February STET increased its shareholding in the Cuban telephone company Etecsa. It already has equity stakes in telecoms companies in Argentina and Bolivia. The company expects to participate in the bidding for band-B cellular licences in Brazil. And Telefonica of Spain has made Latin America a key element in its strategy to become one of the most important global players in telecoms.
One possibility, voiced late last year by Brazilian planning minister Antonio Kandir, is that before being sold, Telebras should be broken into four regional companies covering all 26 Brazilian states. Further, analysts speculate that the international and inter-regional long-distance carrier Embratel could be sold separately first.
However, Telecomunicacoes de Sao Paulo (Telesp), generally is regarded as the most attractive company in the Telebras system. Telesp serves both the state of Sao Paulo with its large residential customer base of wealthy families and in the city of Sao Paulo it has the best roster of big corporate clients anywhere in the country. Operating margins are high. According to forecasts from Banco Bozano Simonsen, Telesp will have net sales of $4.1 billion in 1997 and net income of $1.12 billion.
Online for privatization
Telesp has taken great strides to increase its efficiency, which is vital since the band-B cellular licence for Sao Paulo is likely to attract competition from the cream of global telecoms companies. It already offers its own cellular services, which are highly profitable, and how well it competes in this market is likely to have a significant effect upon its own value when the time comes to privatize.
All the operating companies in the Telebras system have been preparing themselves for privatization by implementing efficiency measures and sliming down their workforces in an industry which traditionally has been overstaffed. The two largest local subsidiaries in the system, Telerj and Telesp, have laid off staff recently.
Telebras shares trade on the Sao Paulo Stock Exchange (BOVESPA) and its American Depositary Receipts are listed on the New York Stock Exchange. The company’s earnings in the last few quarters have been affected by provisions for a voluntary retirement programme at Telerj and asset write-offs at Embratel designed to bring the balance sheet into better shape.
The number of lines in service per employee has been increasing though it still lags well behind other regional players such as Telecom Argentina, CTC of Chile and Telefonica del Peru. And although efficiency has been increased in cellular services, the companies in the Telebras system are still finding it hard to keep up with demand (up by more than 100% in 1996). The pressure is now on them to improve the quality of these services and to sign up as many new customers as possible in the time that remains until the foreign operators appear on the domestic scene via the band-B concessions programme. The speed with which the band-B concessions are awarded is therefore of great concern to the Telebras operating companies.
In the plans for band-B the first bids will be invited for concessions in April. Concessions will run for 15 years and operators will be allowed to apply for a further 15-year concession 30 months before expiry of the first term. Initially foreign capital will be limited to 49% of the voting capital of the concession companies, so bidders will need local partners. These new cellular operators will still be dependent upon the Telebras network for interconnection so the Telebras operating companies do themselves stand to benefit from the new services. At present all the operating companies within the Telebras system offer band-A cellular services but over the next two years they will be required to spin off these cellular operations into separate subsidiaries. However the permissions granted at the start of the decade for the Telebras companies to provide band-A cellular services will be converted into 15-year concessions without any payment to the government for these licences.
The government has split the country into two regions and 10 distinct concession areas for the purposes of band-B. Region A comprises areas one through six, which includes the more densely populated parts of the country and plum concessions such as the city of Sao Paulo, the interior of Sao Paulo state and a single district comprising Rio de Janeiro and Espirito Santo. These will be the main areas of interest from foreign bidders, rather than the four concession areas in Region B in the less economically developed north, northeast and midwest of Brazil.
The government is anxious that the areas in Region B are not neglected and has decreed that for the first five years of operations any single bidding consortia is limited to one licence in each of the two regions. In addition the government has stated that once the band-A companies are privatized, companies will not be allowed to hold both band-A and band-B licences in the same concession area. The authorities hope that the restrictions will promote competition and attract foreign capital into some of the less developed parts of Brazil.
Infrastructure’s the key
Analysts are divided as to how fast the band-B concessions are likely to be awarded and at what date cellular competition will begin. Officially a number of band-B licences could be awarded mid year, allowing band-A companies to be separated and privatized in mid 1998. But some analysts believe that only a few band-B concessions will be awarded this year, the process spilling over into 1998. This could give the current Telebras cellular operators some valuable extra time to strengthen their hold on the fast-growing cellular market.
The development of a better telecommunications infrastructure is seen by the government as a key element in the restructuring of the Brazilian economy, and the same applies to the transportation sector, also viewed as a bottleneck hindering economic activity. In the more immediate future, interest centres upon the last piece of the railway system, the Northeastern Network with 4,629 kilometres of track. And there are concessions up for sale in specific rail sectors such as freight transport.
The railway network of Sao Paulo state, Ferrovia Paulista SA (FEPASA) is asking for bids to run its freight transport network, which includes such crucial lines as the link between Sao Paulo and the port of Santos. These and other lines play a key role in linking together the Sao Paulo area with the south of Brazil, and as in many other privatizations bidders will be looking at the growth prospects connected with trade in Mercosul.
Sao Paulo state is looking for large close to $1 billion capital investment on the part of the eventual winning bidder to expand and modernize the network, which the state forecasts could carry 66 million tonnes of freight annually by the year 2015. The state is also seeking to make its transport infrastructure more efficient by awarding concessions to operate ports, including Dersa-Sao Sebastiao. This port is ideally situated to become the centre for intermodal freight operations, involving sea and road transport. Dersa offers roll-on roll-off services for heavy trucks moving between Brazil and Argentina and Mercosul trade is adding to the level of demand for this type of transport alternative.
Sao Paulo state also is putting on sale a number of toll roads, including some 5,000 kilometres of roads currently run by the state road department, DER, and road development company Dersa to be put in private hands via concessions. The new owners, who will typically be looking at a 20-year concession period, will maintain and operate existing highways while also expanding the network. This could involve a $5 billion programme of new investment, according to state government forecasts.
Also in Sao Paulo, Companhia de Gas de Sao Paulo, is expected to be sold during 1997. It is the largest distributor of piped gas in the state and has annual sales of around 1 billion cubic metres of gas.
Foreign companies are also waiting for details on the planned opening up of the oil industry, where exploration and refining are monopolized by Petrobras, despite entering into some risk-sharing exploration contracts with private companies. A long list of Petrobras petrochemicals subsidiaries has been sold and private-sector competition is thriving in this sector.
Petroleum-sector deregulation is getting underway and last May the government ended controls on petrol prices charged by distribution companies to service stations and on the prices these service stations charge to the consumer. However, it left in place controls on the prices charged by Petrobras to distributors. Distribution already has foreign participation. Shell, Esso and Texaco have significant market shares.
Petrobras has traditionally sought to equalize the price paid for petroleum throughout the country. Calculating into its prices to distributors a factor known as freight price unification, fuel transportation costs have effectively been reimbursed by the National Fuel Department. The modification and partial abolishment of the system is being closely watched by foreign oil companies hoping at some point to enter the oil refining industry in Brazil.
At present there are two domestic refining companies outside the Petrobras monopoly which owe their refining rights to exemptions granted during 1953 when constitutional restrictions were put in place. Petroleo Ipiranga trades on BOVESPA and its activities provide foreign oil companies with some sort of private-sector yardstick with which to measure the efficiency of Petrobras.
Over the past year, Ipiranga has spent heavily to strengthen its brand name, modernize its service stations and acquire new ones. These measures should make the company well-placed to compete in a deregulated environment. However, there remain great uncertainties as to how such deregulation might proceed. The first step is likely to be a series of stock offerings by the government, reducing its holdings in Petrobras. The first tranche could come to market as soon as the fourth quarter of 1997.
Such a Petrobras stock offering, together with the CVRD trade sale, will confirm that the Brazilian privatization programme is proceeding full speed ahead, despite opposition from some quarters. The Brazilian programme looks set to be the biggest of any country in the coming two to three years.
