Latin America is being left to its own devices. Foreign direct investment is falling, privatizations have largely run their course, country-risk levels have risen to the point at which most investments make little sense, and no-one talks any more of Latin countries following Spain’s smooth transitional path from second world to first world. If anything, several countries in the region are moving in the direction of wealth destruction rather than wealth creation. Television pictures show malnourished Argentine children dying of starvation, and Venezuela and Colombia have been hugely damaged by, respectively, a general strike that has crippled the oil industry and a civil war.
And in the developed world, the boom years are over, closing the door on the wilder shores of foreign investment. Corporations that a few years ago were either swimming in cash or able to raise it at dirt-cheap rates are now pinched, with little appetite for exotic adventures.
Even at multinational level, the debates are no longer about whether to extend 11-figure bailout packages to beleaguered countries. Rather, they’re about deciding if existing debts should be rolled over, and whether or not the IMF should help some countries to default on their bondholders in an orderly and predictable fashion.
Cross-border risk reduction So countries that not too long ago were looking to Europe and the US to help them grow are now having to focus their attention on themselves just to keep their heads above water. But the condition of Latin America is not characterised by retrenchment back to the national level. Cross-border diversification remains a good strategy for companies in the region. Although companies operating exclusively in Venezuela and Colombia, say, might be at significant risk of being badly damaged by events that are completely outside their control, those with operations in both countries are in a significantly stronger position than those with operations in only one. Because event risks in the two countries are weakly correlated, the chances are that at least one of the operations is going to continue to generate solid cashflows.
As industries consolidate, merger and acquisition activity is increasingly taking place within Latin America, but across national borders.
The headline Latin American M&A deals of 2002 provide a good example. There was one big Latin acquisition by a non-Latin company: Pepsi Bottling Group bought Mexico’s Pepsi-Gemex for $1.7 billion. But that deal was dwarfed by an intra-Latin deal in the same industry when Coca-Cola Femsa bought Panamco for twice as much.
Elsewhere in the region, Brazilian companies showed a lot of interest in distressed Argentine assets, with oil giant Petrobrás snapping up Pérez Companc and brewer AmBev buying neighbouring Quilmes. In stark contrast, the one major announced acquisition of a Brazilian company from abroad – when Anglo-Dutch cement company Corus agreed to buy Brazil’s CSN – collapsed ignominiously a few months later.
Bankers don’t expect anything to change this year. According to the head of Latin M&A at one New York bank, “2003 cannot be worse than 2002, but I don’t expect huge deals in 2003 either”. Rather, the trend set in 2002 – of consolidation within the region, foreign investors exiting, and deals with very low headline valuations – is likely to continue.
Probably the best example of the last two trends is AT&T’s sale of AT&T Latin America – that’s 8 million Class A shares and 73 million Class B shares – to holding company Southern Cross Group for exactly $1,000. In its hurry to exit the region, AT&T took a $1.1 billion charge to write down the value of its Latin American subsidiary.
The way in which investors are continuing to exit Latin America could be considered a new, slower, form of contagion. When Argentina defaulted at the end of 2001, the conventional wisdom held that contagion was being kept to a minimum: Brazil’s spreads didn’t widen all that much, and the only country affected very badly was Uruguay. But just because contagion didn’t appear in the Asian guise of domino-effect devaluations is no reason to declare it nonexistent.
“Post Argentina,” says Carlos Guimarães, head of Latin America investment banking at Salomon Smith Barney, “losses to investors and banks have been high, and willingness to assume risk has diminished.”
As a consequence, banks were quick to pull credit lines during the turbulence in the run-up to the presidential elections in Brazil in 2002, and have yet to start building them up again. On the contrary, the Institute of International Finance (IIF) estimates that commercial banks will have net repayments of $4.7 billion from Latin America in 2003.
Brazilian companies have been particularly badly hit, because their government has large financing needs of its own. All available financing is being used to roll over existing government debt at very profitable rates, leaving nothing for investment in cash-starved companies.
And foreign banks in Brazil are uncomfortable about the way in which their assets are overwhelmingly risky Brazilian debt: Spain’s BBVA unloaded its Brazilian operations to local bank Bradesco in January for just over $800 million, taking a e250 million charge in the process.
Indeed, Bradesco has been on something of an acquisition roll of late, buying operations from foreign companies wishing to exit the market. In 2002, it bought a portfolio of retail loans from Ford Motor Credit in Brazil valued at about $430 million. Although financing operations can be extremely profitable for car companies in Latin America, Ford was no longer comfortable with the risks involved and wanted to be able to stick to what it knows best – making and selling cars.
“We are now in a different cycle from the 1990s,” says Richard Rainer, Merrill Lynch’s managing director for investment banking in Brazil. “We are not seeing a lot of multinationals calling us and saying that they are interested in acquiring in Brazil. Potentially, it’s going to be much more of a local market.”
Growth path optimism is over Certainly, the optimism that once surrounded the region is long gone. The IIF expects Latin American GDP growth to recover to 2.4% this year after contracting by 1.5% last year. Even that forecast is optimistic, as it assumes that Brazil will continue relatively smoothly on its path to lower interest rates and lower inflation and not have difficulties on the debt front. Meanwhile, emerging markets in aggregate are forecast to see GDP growth this year of 4.5%, up from 3.3% in 2002.
Latin America remains the slowest-growing region in the emerging-market world, just as it was in 2002 and 2001. In terms of stock markets, Latin America’s bolsas constitute the only emerging-market region that has failed to outperform the S&P500 over the past couple of years.
With slow growth comes lower levels of investment. The IIF forecasts that net direct investment in Latin America will shrink for the fourth year in a row this year, to $33.7 billion. That’s down from $75.3 billion in 1999.
Suddenly, official financing, which is meant to play a catalytic role in jump-starting emerging-market economies, is now a vital lifeline. The IIF forecasts that net official flows to Latin America will be $17.7 billion in 2003 – half the level of foreign direct investment flows. What’s more, that $17.7 billion is a stunning 170% of total net official flows to emerging markets this year. Every other region in the world is now repaying the official sector, while Latin America continues to have to borrow money.
Of course, not all non-Latin companies are exiting the region. Consider the telecommunications sector. The companies leaving, such as AT&T, are often those that came late to the game and started buying Latin assets more out of fear that they would otherwise be left behind than because they felt they had any particular advantage over the foreign players already there.
So while Telecom Italia and France Telecom retrench and refocus their energies on their home markets, Spain’s Telefónica and Portugal Telecom are still investing in the region, taking advantage of valuations that would have been unthinkably low a couple of years ago.
The 800-pound gorillas of the Latin American telecoms sector, however, remain Mexican billionaire Carlos Slim’s Telmex and America Móvil. Taking full advantage of their dominant position in the Mexican market – and the huge amounts of cashflow that come with it – Slim has been expanding into the rest of the region without having to worry about what scared Spanish shareholders might think.
Indeed, as the Coca-Cola Femsa takeover of Panamco indicates, the most attractive deals for Mexican companies at the moment could well be to the south, rather than to the north.
Mexico has spent the past few years carefully differentiating itself from the rest of the region, integrating itself into the North American Free Trade Agreement bloc and becoming a fully fledged north American investment-grade country. Indeed, from the point of view of many US corporations, especially the ones that make use of Mexican manufacturing operations, Mexico is very much a part of their north American, as opposed to Latin American, business.
But the view from south of the border is a little different. “I don’t think it’s set and done that Mexico is really north American,” says a New York bank’s head of Latin M&A. The slowdown in the US manufacturing sector has hit Mexico very hard, and there’s a desire to diversify from the one big trading partner. Also, Mexico’s very strength with regard to the rest of Latin America gives it opportunities in the region that no-one else seems willing to take. In a sense, Mexico’s strongest businesses – monopolies and duopolies like Telmex and Coca-Cola Femsa – are taking on the mantle that once was worn by Spain’s Telefónica and Santander.
When Spain first started investing in Latin America in a big way, the argument always went that Spain had only recently made the transition to a stable free market itself, and that Spanish companies were therefore well versed in managing that transition. They understood the region in a way that northern European companies did not.
Attuned to volatility The big companies in Mexico and Brazil are now approaching Latin America in much the same way; they are used to operating in a volatile, high-risk environment. And they’re perfectly happy to take on the companies that the Europeans built up and have now decided to leave behind.
Even foreign equity portfolio managers see some opportunities. “As equity investors, our overriding view is if capital doesn’t flow freely, it tends to be allocated better, and you see rising returns,” says Luke Richdale, who runs Latin American equity funds for JPMorgan Fleming.
But neither Latin corporates nor foreign portfolio investors are going to be investing anything near the amount of cash in Latin America that the region has become accustomed to. Although individual investments might pay off, in aggregate the region is likely to continue to underperform. Its highly indebted countries will continue to crowd out the market for corporate debt, and investment capital is going to be rare and insufficient for Latin America to achieve its growth-rate potential.
One person who understands this situation is Henrique Meirelles, the new governor of the Brazilian central bank. “To achieve higher productivity growth, it is essential to increase the public sector’s savings rate, thereby allowing society to invest in production as opposed to primarily financing the public sector,” he said in his inaugural address last month.
This is not a new refrain: economists and government officials in Latin America and beyond have been saying for years that the reason Latin America has lagged so far behind Asia in terms of development is to be found in the two regions’ respective domestic savings rates.
Asia can finance itself – and indeed, when it did accept large amounts of financing from abroad in the 1990s, the consequences were disastrous. Latin Americans, on the other hand, with much lower savings rates, have been much more reliant on foreign investment.
But the days of massive foreign investment have gone, and Latin America’s companies – and countries – are going to have to steer their own courses to sustainable growth.
