Private equity: Local drive to PE threatens offshore funds
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Private equity: Local drive to PE threatens offshore funds

Knowledge gives locals the edge; Deal is too small for internationals

Itaú’s asset management firm Kinea has raised more than R$1 billion for a new private equity fund, at a time when questions are being asked about the viability of large foreign PE firms operating in Brazil.

Kinea has announced its new fund will target minority investments in mid-sized firms that are active in consumer-related sectors, such as education, healthcare and food. It plans to buy stakes in up to eight companies and expects to announce its first transaction shortly. Thereafter, it aims to conclude two or three deals a year valued at between R$70 million and R$300 million.

The growth in the local domestic funds threatens the ability of international firms to deploy capital. One senior banker at an international firm says: "I see these firms come in with $1 billion-plus of capital to employ, they set up offices in Faria Lima and they are all brought the same deals.

"The competitive advantage is definitely with the locals, who have contacts throughout the country and who, generally, look to a smaller deal size. I fear for the internationals. It is inevitable that we will see some exits."

Marcelo Di Lorenzo, head of PE firm 3i’s operations in Brazil
Marcelo Di Lorenzo, head of PE firm 3i’s operations in Brazil

Marcelo Di Lorenzo, head of PE firm 3i’s operations in Brazil, agrees that the larger PE funds face a problem. "It is a difficult business model," he says. "You don’t have many deals that are $200 million or above. If your fund is $1.5 billion, then your average deal size has to be $150 million, which means you need to be doing some that are over $200 million. That makes the big deals very competitive and I am not sure how attractively they are being priced." 3i focuses on proprietorial deals valued between $30 million and $100 million, which Lorenzo says is a less competitive segment.

Cristiano Lauretti, head of PE at Kinea, says the company – which is 80% owned by Itaú, with the remaining 20% of equity shared between the firm’s management – believes its local relationships provide a strategic edge. "We have a competitive advantage over the foreign players," says Lauretti. "Possible targets all know Itaú well and that is really important. In a market that has seen a lot of competition in the last 10 years, it is vital to have local deal-sourcing capabilities."

Lauretti says fast-growing areas of the country, particularly in the north and the interior of the country, often offer the greatest opportunities for PE funds and these regions are hard to access without existing local relationships. However, he stops short of saying he agrees that some foreign funds will be forced out of the country.

"It’s difficult to say if people will have to leave," says Lauretti. "The traditional foreign model needs to be analyzed in more detail. It will not be easy for the traditional US buyout firm to [replicate their leveraged buyout business model] in Brazil. Even though interest rates are coming down in Brazil, they will need to adapt to the local market."

Lauretti also says local firms benefit from being denominated in local currency and so do not have the currency risk of the international firms when targeting returns of between 25% and 30% a year.

Flow of funds Trends on fundraising, investments and exits

Despite the growth in competition for deals from domestic, Real-denominated funds, money continues to flow into Brazil. In 2011, international PE funds raised $8.14 billion for Brazilian-based funds, which accounts for 79.2% of all the capital raised for the region, according to data from the Latin American Private Equity and Venture Capital Association. Latin America continues to attract increasing volumes of money, with $10.3 billion flowing to the region in 2011, up from $3.6 billion in 2009. Worryingly, for those concerned about the larger firms’ ability to deploy capital through large deals, the money is being concentrated on the larger firms. In 2011, 71% of all money raised went to the largest five PE firms, compared with 57% in 2010.

However, Di Lorenzo, who is a Brazilian with 16 years of experience working in the country’s PE sector, says while local knowledge is important for sourcing a deal, an international firm can use its international presence as an advantage when it comes to securing deals. He says entrepreneurs in Brazil are keen to access 3i’s global experience and international network of business leaders.

Di Lorenzo adds that Brazilian funds will have to find niches if they are to avoid competition. "Specialization will be key," he says. "Focusing on just a few sectors brings advantages, not just in finding the right deal at the right price but also into getting value when you are an investor, because the days when you had multiple arbitrage [opportunities] and could make easy gains in better productivity and improving the management of the business are over.

"Now you need to go beyond improving working capital, improve the debt profile and really grow the business. And for that you need a very clear view on the market."

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