Private sector: The private side of Portugal

WHEN MAGNUM INDUSTRIAL Partners closed its fundraising efforts in November 2007, the private equity firm had secured an impressive €866 million in commitments. The roster of backers reads like a Who’s who of banks, institutional investors and family offices, including those of Portugal’s richest man, cork-to-petrol billionaire Américo Amorim. That war chest made the Portuguese private equity firm by far the largest of its kind in Iberia – long-established Mercapital is second – and was seemingly a vote of confidence not just in Magnum’s partners, lead by Ángel Corcóstegui, former chief executive of the then Banco Santander Central Hispano, but also in the prospects for profits in Portugal – and Spain.

“Of course it may seem strange that we decided to create this fund at a time when many people were expecting an economic slowdown in Spain and when growth in Portugal has been almost non-existent, and at a time when the availability of leverage, which many people see as vital to the success of private equity, has been dramatically reduced,” says João Coelho Borges, partner at Magnum. “But from the beginning we never had a strategy of using extreme leverage to generate returns and the crisis has actually created many opportunities.”

In Spain, the opportunities are obvious. The bursting of the real estate and construction bubble has forced the big companies in those sectors – which, in the words of one banker, “diversified until they owned everything worth owning” – to start a fire sale of their most attractive assets in order to reduce debts. So Ferrovial is selling Belfast airport, among others, and its subsidiary BAA is offloading property assets; Acciona has been forced to sell its 25% stake in utility Endesa; and Sacyr Vallehermoso has sold its Itinere highway business to Citigroup for €7.9 billion and might still need to find a buyer for its 20% stake in Repsol. As these and other firms continue to sell assets, there is clearly scope for such companies as Magnum to buy at attractive prices at what might be the bottom of the cycle.

Lost decade

In Portugal, the situation is more complicated. The economy may not be the train wreck that is Spain, but that is only because it never left the station. Even as much of the rest of the world was booming back in 2006, Portuguese GDP growth of 1.3% was the lowest in the whole of Europe, including the non-EU countries. In the previous six years, the Czech Republic, Greece, Malta and Slovenia all overtook Portugal in terms of GDP per head, and that was with a Maastricht-busting Portuguese budget deficit that at one stage hit 6.8% of GDP. Things haven’t got any better since then, with Portugal now seemingly at the beginning of another lost decade. Real GDP growth in 2008 was less than zero and the Economist Intelligence Unit forecasts a contraction of 4.2% in 2009 and another of 0.5% in 2010. It also forecasts budget deficits of around 5% for the next two years at least. Local companies agree. Rui Cartaxo, CFO of electricity grid company REN, says: “I am pessimistic on economic growth, but at least it is not anything like the Spanish situation. We had no bubble but our largest export markets are Spain, Germany and the UK.”

“We decided to make an offer to the private companies for the acquisition of Cosec. We want to have a direct intervention instrument” José Sócrates

This miserable performance explains bankers’ attempts to put a gloss on the Iberian comparison. “The Portuguese economy may have fallen out of the first-floor window,” says one. “But Spain has fallen from the 10th floor.” Bankers are salesmen and, even in these times, tend towards optimism. But this is a forced attempt to see the glass as half full, while the slump across the border is hardly a comfort. The Portuguese population knows it too. It’s always had a reputation for dour pessimism, and that annoys private-sector businessmen, who use their countrymen’s melancholy as a partial explanation for the country’s miserable economic performance. But at the moment, the population is right to be morose. This is not all Magnum – or indeed the private sector as a whole – has to contend with. In more than just economic torpor, Portugal is, to any free marketeer, a dystopian vision of where the rest of Europe is headed unless the global crisis resolves itself much more quickly than anyone is predicting. Government, in this case the socialist government of scandal-racked prime minister José Sócrates, is everywhere. The largest companies in key sectors retain significant government participation or influence, often exerted through cross-shareholdings. At the centre of this web sits a small group of rich families and the largest bank, Caixa Geral de Depósitos, also government-owned, which is a shareholder and often represented on the board in companies such as Portugal Telecom, EDP, Banco Comercial Português and Galp Energia (it sold its interests in REN and Águas de Portugal recently).

Caixa’s role infuriates private-sector institutions. They complain, ineffectually, that the bank’s leading position in the league tables for M&A, public-private partnership financing, debt and – when there is any – equity, is the result of captive business doled out by the state to its political cronies. This is not an easy charge to substantiate. Portugal is a small economy in which everyone in the elite knows everyone else; most senior people attended the same schools or colleges and a good proportion of them serve on the same boards. All the big banks end up in all the big deals in one way or another.

Big government

Regardless, the government has shown no great desire to reduce the weight of its hand upon the economy and indeed in mid-May made an offer to buy local credit insurer Cosec, equally owned by Banco BPI and France’s Euler Hermes. As Sócrates, taking a break from defending himself against bribery allegations, told parliament: “We decided to make an offer to the private companies for the acquisition of Cosec. We want to have a direct intervention instrument.”

Such a direct level of government involvement in business and finance is, by itself, not an obviously attractive environment for investment. But Magnum and others believe that another, even more pervasive, example of reliance upon the state does offer the chance of big rewards.

To maintain any semblance of growth, the government has funnelled billions of euros, a big proportion of which is grants from the European Union, into infrastructure spending and PPP projects. And it has ambitious plans for more of the same, including the privatization of airport operator ANA, together with construction of a new international airport for Lisbon (a develop-build-operate-transfer project financing), a high-speed rail network, new hospitals and a huge plan for the motoring sector involving many hundreds of kilometres of road construction.

The state has also enthusiastically embraced the grant-and-subsidy machine that is renewable energy generation. Portugal has only developed about half its potential for hydroelectric power, and wants to double output from windfarms by 2012 as well as to double liquid natural gas (LNG) reception capacity. Again, substantial funding comes via the European Investment Bank, and a key driver is European government or regulatory policy. For example, the LNG plan is a product of Europe’s regulations on security of supply since Iberia represents 60% of Europe’s LNG reception capability.

One effect of all this state- and European Investment Bank-funded spending is to make even the best-run private-sector companies reliant on government in one form or another. Take MSF, whose core business is construction. Its future success depends in no small part on contracts to build and upgrade dams for state electricity utility EDP and the plans to build new motorways and the associated bridges. Its second-biggest business is concessions and PPP in the motorway sector. Chief executive Carlos Fortunato says: “The government’s drive for PPP, its investment in infrastructure and the push for more hydro power to reduce the budget deficit is good for us.” However, the state’s ability to dictate pricing is sometimes painful. “Unfortunately – you might say – the state is now much more sophisticated in pricing and structuring, and so projects in this sector are beginning to see a squeeze in margins,” explains Nuno Capucho, finance director.

Or take Brisa, the Grupo Mello-connected company whose main business area is the construction and operation of tolled motorways. The firm is aggressively expanding outside Portugal and has long been in Latin America. It is changing its corporate structure in order to create a more transparent portfolio of separate assets, which will make divestments easier. But still, in the words of João Azevedo Coutinho, Brisa’s CFO and executive director and an ex-Deutsche banker: “Portugal is our biggest source of cashflow right now and you could argue that this lack of diversification is our biggest weakness.” A key lender to the company is the EIB.

The good news

However, the other effect of the state crowding out the private sector with spending on airports, roads, hospitals and power is to create a huge potential market in highly regulated assets within a PPP framework. And this is where Magnum and other investors see profit.

“The common theme in all these transactions is some form of guaranteed cashflow,” says one investor. “And as long as you can be sure that the regulator – the government – is committed to making the projects work, and so will not push pricing down too far, then there are very attractive opportunities for yield in the current environment.”

This explains one of Magnum’s largest deals to date. Last November, a consortium led by the firm acquired the majority of the assets of the leading Portuguese wind business, Enersis. The new company, branded Iberwind, became the leading wind energy development and operating firm in Portugal, managing windfarms that provide 25% of the country’s installed capacity. The business forecasts 2008 revenues of €120 million, with an ebitda in excess of €100 million, and expects strong cashflow growth in the coming years. Present regulations require that energy produced by windfarms be purchased by the local operator in a fixed-tariff regime that is guaranteed for 15 years. In other words, the government agrees to buy expensive electricity at a fixed price for a long time. And as João Arantes de Oliveira, chief executive of Espírito Santo Capital, a backer of the deal, points out: “That means you can take on a lot of debt, because of the certainty of revenues. You can have 85% debt and 15% equity, which means the returns are very attractive while the risks remain low.”

Highlighting the attraction of regulated assets, this transaction was concluded during the global financial crisis at a time when leverage was in very short supply. Magnum’s Borges says: “Falling interest rates, lower yield expectations and generally higher risks in most sectors make the returns from regulated assets very attractive and these assets are among the very few that can be leveraged. They’re also ones that tend to be available at times of economic stress, again because those desirable cashflow characteristics make them saleable at a reasonable price.” Companies that need to raise money can sell them quickly.

The state benefits too. Utility EDP has also taken advantage of the premium investors attach to these kinds of assets. In June last year the company raised €1.57 billion through the IPO of its renewables unit, EDP Renováveis, valuing the company at €6.9 billion. “Given the environment at the time, some banks were scared and said: ‘Don’t do it’. But we went ahead anyway and we’re very pleased we did,” says CFO Nuno Alves. “We had a premonition that things would get bad and so we decided to go. We had a great roadshow – there was no competition – and the deal was a great success.”

And even in the debt markets investors queue up for Portuguese credits linked to regulated markets. Power grid operator REN, while nominally constrained by anaemic GDP growth, can in fact look forward to a 50% increase in capex over the next five years versus the previous five-year plan. This will be partly funded from a euro medium-term note programme through which in December 2008 – when, according to CFO Rui Cartaxo, the markets were effectively closed – the company was able to issue €500 million of five-year paper. It then tapped that for a further €300 million in February this year.

Small fish, big pond

The addiction of Portugal’s public and private sectors to government-sponsored PPP and project finance has had one other counter-intuitive effect. Portuguese banks are small by global standards and have wisely avoided precipitous international expansion. It is odd therefore to find that in the first quarter of this year, the investment banking arm of Caixa Geral de Depósitos was not only top of the Dealogic league table of lead arrangers for global PFI/PPP loans but also fifth in the table of providers of global project finance loans.

According to Gonçalo Vaz Botelho, executive director at CaixaBI: “One reason for this is that Portugal is a small market. This has dissuaded the larger foreign banks from investing in teams inside the country and allowed the domestic banks to develop this expertise.” Clearly the demise of previously dominant institutions such as RBS will also help – the UK bank was the biggest contributor to Brisa’s 2007 refinancings, for example.

Whatever the case, Portugal makes it clear that, while dependence on state spending can keep an economy just above water and generate attractive investments for banks and private equity firms, it is not a long-term strategy for success. As the communist party wins the race to be first to put up its election banners in the streets of Lisbon, the rest of Europe might want to remember that a government big enough to give you everything is also big enough to take it all away.