The 2014 football World Cup and the 2016 Olympics are only part of the story behind increasing investment in infrastructure.
By Joe Leahy
DEMAND FOR ROCK AND sand may not sound like the most sophisticated investment theme but in Brazil it is one that is gaining momentum. With a wave of infrastructure investment expected in Latin America’s largest economy, wily private equity firms are looking to put money into companies at all points of the supply chain in a sector predicted to boom in the next few years.
“You have large projects going on around the country, from roads to dams, power plants and the World Cup,” says Antonio Bonchristiano, co-chief executive of GP Investimentos in São Paulo. “All of that means demand for concrete, which means at the end demand for rock and sand.”
It is no accident that infrastructure has become one of the main areas of activity for dealmakers in Brazil. After 20 years of relative neglect, the government is trying to attract R$955bn ($471bn) in investment for the country’s roads, ports and airports, as well as housing, construction, sanitation and energy industries between 2011 and 2014.
The most visible reasons for the surge in infrastructure spending are the demands of hosting the 2014 football World Cup and the 2016 Rio Olympics. But underlying this is the government’s desire to rebalance Brazil’s economic growth model from one overly reliant on consumer spending and debt, which tends to lead to inflation, to one in which investment plays a more important role.
“The dream is that Brazil is still to be built,” says Marcelo Kayath, Credit Suisse’s head of Latin American securities, about the growing interest in infrastructure.
Of the top 10 announced mergers and acquisitions in Brazil this year, at least six were directly related to infrastructure. Another, the purchase of a 5.63 per cent stake in billionaire Eike Batista’s EBX Group by Middle Eastern sovereign fund Mubadala Development, is linked to the sector, according to Dealogic, the data provider.
The biggest deal was the $2.9bn acquisition of a 59 per cent stake in São Paulo’s Comgás, the gas distributor, by Brazilian group Cosan but other notable transactions included the takeover of Viracopos airport in Campinas near São Paulo by Brazilian group Triunfo and the purchase of an 11.7 per cent stake in MPX Energia, Mr Batista’s energy group, by Germany’s Eon.
These deals helped revise an otherwise lacklustre M&A market in Brazil, with total year-to-date volume at $47.2bn by August 28 compared with $58.8bn a year earlier, according to Dealogic.
“What the government is doing now is the right thing – to try to address the problem of competitiveness in terms of productivity and infrastructure, that’s the next wave of growth that Brazil has to capture,” says Patrice Etlin, chairman of the Latin American Private Equity and Venture Capital Association.
But infrastructure construction is easier than it looks in Brazil. Throughout the country’s recent history, one of the biggest challenges was how to structure deals. The lack of a vibrant long-term corporate bond market has meant the onus has fallen on BNDES, Brazil’s development bank, to bankroll just about every significant project in the country.
This financing bottleneck has stemmed partially from the country’s historically high interest rates, a legacy of previous years of high inflation.
This year, however, hope is building that the central bank may finally have broken the back of Brazil’s high interest rate regime. After hitting a peak of 12.5 per cent last year, the benchmark Selic rate has fallen to a low of 7.5 per cent in August.
This outlook of lower rates is, for the first time, forcing Brazilian savers, accustomed to leaving their money in high-interest liquid deposits, to think more creatively about investing. Infrastructure is an obvious choice for those seeking higher returns.
“We are only beginning to understand the consequences of living in a low interest rate society,” says Credit Suisse’s Mr Kayath.
The government is also introducing micro-reforms to encourage more private sector interest in infrastructure. The most significant is the introduction of more public-private partnerships, with the auctioning of concessions for big airports in São Paulo, nearby Campinas, and Brasília earlier this year. In August, the government also announced the auction of R$133bn ($65.6bn) of road and railway concessions.
The success of these ventures, however, will depend on how well they are structured. A report by the Institute for Applied Economic Research, the Brazilian government think-tank, shows that many of the concessions for the most lucrative highways in the country have already been sold to private sector operators, for instance.
The remainder will need to offer a mixture of toll revenue and government contributions if they are to deliver sufficient returns to attract private sector interest. In spite of having world-class construction and infrastructure companies in Brazil, complicated project finance is still a relatively new area for the country.
“The demand exists in Brazil, but you have to have well-structured projects. I think this is one of the main challenges,” says Glaucia Calp, head of the Latin America infrastructure team for Fitch Ratings.
AMONG THE BIGGEST RECENT micro-reforms is a waiver of income tax on infrastructure debentures that would reduce the tax rate from between 15 per cent and 22.5 per cent to zero for individual investors, and 15 per cent for companies.
While the new debentures are not expected to replace BNDES loans in the short to medium term, they could prove handy for items that the development bank cannot finance. Companies could use the proceeds of the bonds to pay annual concession fees to the government – an area off limits for BNDES.
Although none have yet been issued, Autoban, a unit of large toll road operator CCR, was recently reported as considering about R$1bn of issuance, of which part would be sold to individual investors subject to the new income tax exemption.
“You could have very positive demand for these types of instruments from local pension funds,” says Alexandre Leite, vice-president and senior analyst at Moody’s, the rating agency. “They have to meet actuarial targets of 6 per cent in real terms and these infrastructure debentures could be a natural choice.”
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