Cablegate: Prospects for Brazilian Investment Amid Crisis

Published: Tue 30 Sep 2008 05:39 PM
DE RUEHSO #0522/01 2741739
R 301739Z SEP 08
E.O. 12958: N/A
REF: A. Sao Paulo 0486; B. Rio de Janeiro 0159
1. (U) Summary: Prominent Investment magazine Latin Finance hosted
its 6th Annual Brazil Investment Forum in Sao Paulo on September 18.
While the original intent of the conference was to explore
financing growth and investment in Brazil, taking advantage of
Brazil's out-performance of its emerging market peers, the U.S.
subprime crisis and collapse of Lehman Brothers on September 15
redirected attention to the impacts of the current financial crisis
on the Brazilian economy (Ref A). With robust economic growth in
2007 and record foreign direct investment, attendees generally
agreed that Brazil had strong economic fundamentals with which to
anchor its economy. The Brazilian Development Bank (BNDES) said
investment grew in all sectors, with retained earnings and BNDES
loans as the two largest financing sources. Representatives from
large Brazilian companies told the audience that their balance
sheets were strong and had no plans to alter investment plans over
the next few years. Several commentators noted, however, that
smaller firms would face higher capital costs as a result of less
international credit. Many pointed to consolidation and
acquisitions as many companies would be unable to finance their
operations at higher costs as one of the biggest consequences of the
crisis. Although private equity would now face fewer competitors,
industry analysts suggested many Brazilian family-owned companies
were unprepared to work with private equity funds. Overall the mood
of conference participants was of cautious optimism, stating that
Brazil was well prepared to confront the external crisis, but with
careful attention to worldwide events and conditions. End Summary.
Investment in 2007
2. (U) The Brazilian Development Bank (BNDES) is the largest
Brazilian credit bank, disbursing 17 percent of total credit in
Brazil in 2007. About 40 percent of BNDES disbursements were for
infrastructure projects, 30 percent for private-sector manufacturing
and industrial projects, eight percent to agriculture, and 10
percent for exports. Between January and July of this year, BNDES
approved R$ 28 billion more than it disbursed (approximately 14.74
billion USD using 1.9 Reais/dollar). Ernani Torres Filho,
Superintendent of Economic Research for BNDES outlined Brazil's
investment performance in recent years. Investment has grown faster
than GDP in the last 13 quarters in a row. BNDES estimated that
investment would reach 19.7 percent of GDP in 2009 and 21 percent by
2010. (Note: This still lags significantly behind the other BRIC
economies where investment in infrastructure is considerably higher:
Russia (21 percent), India (34.6 percent), and China (40.4 percent).
End Note.) Through 2011, the manufacturing sector would receive
the most investment, about R$ 627.1 billion, followed by housing
with R$ 534.9 billion and infrastructure with R$ 304.6 billion.
Torres noted that although investments would be concentrated in the
oil and gas and mining sectors, all sectors are growing fast.
Shipyards would have the greatest growth increase, by about 68
percent between 2008 and 2011. Infrastructure growth in electricity
is expected to be 18.7 percent and 45 percent in ports development
and expansion. According to a BNDES' study, companies' retained
earnings and BNDES loans are the two largest financing sources;
however, Torres noted that the private sector was necessary because
public funds and retained earnings are not enough to fund Brazilian
companies' investment plans.
Big Business Feeling No Pain
3. (U) In a panel on the opportunities in Brazil, representatives
from the large multinational corporations in Brazil generally
thought that Brazil would fare well against the U.S. financial
system crisis and explained that the large Brazilian conglomerates
were well capitalized and would not initially feel the pinch of the
worldwide credit crunch. As a result, they expected some
consolidation among the smaller firms as credit access grew scarce.
Jose Olympio Pereira, Managing Director and Head of Investment
Banking for Credit Suisse said that this was the first external
crisis that Brazil had faced in recent years, but that Brazil was
resilient due to the virtuous investment cycle and less dependence
on foreign debt. He thought that credit would be tight and the
question would be how Brazil would finance its growth. He explained
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Bovespa's decline as a pull-out by foreign investors (nearly 70
percent of the total), many of whom are selling off their
investments due to cashflow problems. He underscored that Brazilian
companies are healthy and that long-term horizon investors would
continue to invest in Brazil. He also pointed to infrastructure,
electricity generation, and real estate as positive sectors for
4. (U) Despite the external scenario, Luis Felipe Schiriak, CFO of
Votorantim (family owned, multinational corporation with 50,000
employees conducting business in the industrial, financial, and
information technology areas among others) said the company had not
altered any of its planned investments. He noted that Votorantim's
business calculations were in flux, but that the Brazilian internal
market was growing so fast that it continued to experience supply
shortages. Schiriak said that Votorantim had prepared an
international bond issue but lacked the market. Aymar Giglio Jr.,
Treasury and Finance Director of Supermarket Chain Pao de Acucar,
said that the company expects strong medium and long-term growth,
but will be more cautious over the short-term. He explained that
Pao de Acucar had all of its funding needs met until 2011.
5. (U) Luis Largman, CFO of Cyrela Brazil Realty was optimistic
about the Brazilian real estate sector. Cyrela is fairly well
insulated and has enough money to fund five years of construction at
competitive rates, but would need to be more conservative. He said
that demand for housing would continue despite the external crisis.
Largman underscored that housing is relatively more affordable in
Brazil; he said the average home in Brazil costs two to three annual
salaries, while in London it is approximately 50 salaries. Pereira
added that Credit Suisse had already identified some consolidation
in the real estate sector because the cost of capital for larger
firms is half that of small and medium size Brazilian companies.
6. (U) Francisco Gros from OGX Petroleo and Gas was somewhat less
optimistic despite OGX's IPO that captured USD 4.16 billion in June
(Ref B). He noted that while for many Brazilian firms it was
business as usual, companies have no map from which to make
predictions about the future business climate. He reminded the
audience that Brazil had paid the price of complacency in the 1970s,
only later paying the price. Despite his uncertainty, he believes
the floor for oil prices is about USD 90 given the escalation of
production costs and relative demand. He noted that the pre-salt
reserves have an estimated USD 30 to 40 per barrel cost in the best
case scenario. (Note: The Federation of Industries of Sao Paulo
Director Thomas Zanotto noted in a recent meeting that the cost was
closer to USD 70 to 80 a barrel. End Note.) He similarly believed
other commodity prices would stabilize given Chinese and Indian
demand and the logistics bottlenecks of expanding the supply of
various commodities.
7. (U) Wilson Ferreira Jr. the CEO of CPFL Energy believed that the
Brazilian energy sector would muddle through the crisis. Despite
the critical shortage of electricity infrastructure, a slower
economy would help alleviate demand. He noted that the
infrastructure gap was partly due to a lack of regulation and
institutions to encourage investment. CPFL estimated that the
Brazilian economy needed R$ 87 billion in infrastructure, but only
received R$ 52 billion. Of that, last year Brazil made only 60
percent of the needed transportation investments, 75 percent in
electricity, 92 percent for oil and gas, and 96 percent for
telecommunications infrastructure. He pointed to proper regulation
and positive investment climate within telecomm as an explanation
for why that sector nearly met its infrastructure investment needs
last year.
8. (U) Carlos Camargo, Aerospace Giant Embraer's Head of Capital
Markets and Investor Relations said that Embraer has a very robust
cash position which should not require them to change any
investments. Similarly, he did not foresee credit tightening as a
problem for Embraer's clients in the near-term because they lock in
financing 24 months prior to the delivery date. He added that 70
percent of 2009 deliveries have already been financed, but that
clients could find it more difficult for 2010 financing. Despite
the recent events, Camargo boasted that Embraer continued to sign
new contracts and suggested that Embraer's high net worth client
base was removed from the crisis.
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Financing Alternatives
9. (U) While Brazil's capital markets have grown more
sophisticated, several commentators said that Brazilian small and
medium firms would face a liquidity crunch, which would eventually
lead to a more "lean and mean" Brazilian economy. Henrique Teixeira
Alvares, founding partner at NEO Investimentos, said that Brazilian
companies that had done their homework would have access to the
limited international credit. He said creditors would be looking
for efficiently-run companies to put their money. Frederico
Flossbach, the Deputy Director of the Andean Development Corporation
(CAF) told the audience that the CAF also finances itself from
international capital markets, but should be in a good position to
capture the limited financing. Indeed, the head of Investor
Relations for Localiza Silvio Guerra posited that the crisis created
opportunities for companies that are able to finance themselves to
buy out competitors struggling to get access to financing. Alvares
suggested that companies willing to absorb the higher borrowing
costs would have ample available financing.
10. (U) Francisco Gros pointed out that Brazil would be competing
with hundreds of solid companies available at liquidation prices,
which could undermine FDI flows as investors opt to acquire existing
companies rather than new investments. Flossbach argued that the
Brazilian Central Bank would keep interest rates high to avoid
capital flight, which could slow Brazilian economic growth in 2009.
Guerra suggested that the Middle East and Asia could replace the
U.S. and E.U. as important liquidity sources. Claudio Ramos from
KPMG's Financial Advisory Services commented that the crisis has all
but eliminated possible funding for IPOs, given that nearly 70
percent of investors were from the U.S. and the E.U. He noted,
however, that companies that completed successful IPOs last year
would be in a better position to acquire others. Ramos posited that
we would see buy-outs of companies listed on Bovespa, noting that it
would a difficult environment to defend against takeovers.
The Losers - Small and Medium Size Firms
11. (U) In a frank side discussion about the recent events, several
participants expressed concern to Econoff about small and medium
size banks in particular. Fernando Meibak from Sunrise Investments
and Claudio Goncalves from Plurimax Asset Management, both based in
Sao Paulo, said that many smaller banks had financed auto loans at
fixed rates without the deposits to back them up, and instead
expected falling interest rates and had relied on short-term
financing. They also suggested that the agriculture sector was in
bad financial shape. Fernanda Dezotti, Planning Manager for Clean
Energy Brazil told Econoff that many ethanol mills had maxed out on
debt to expand and were now hoping that foreign investors would bail
them out.
Private Finance to the Rescue?
12. (U) The credit tightening and stock market decline worldwide
has opened the door for private equity in Brazil, according to
several conference participants. Joao Marcelo Eboli from CPR
Companhia de Participacoes explained that private equity funds would
be looking for companies with high-quality leadership and that
industrial firms would be a natural first choice. Ramos agreed that
private equity would most likely seek out sectors more closely tied
to internal demand and infrastructure. Despite this opening,
Nicolas Wollack, CEO of Axxon Group affirmed that many Brazilian
companies were ill-prepared for private equity, lacking a level of
professionalism and understanding about the different role that a
private equity partnership implied for a company's decision making.
Marcelo Xando Baptista from Verax Financial Services commented that
while family companies had used IPOs as a financing tool, private
equity would impose technology and culture that many family
companies were not ready to accept. He further commented that
private equity was easier to incorporate into a business model in
good times and would be more difficult now.
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13. Brazil's economy is strong, perhaps in the best position in
years to defend itself against the U.S. crisis. In fact, while many
emerging markets suffered after the first signs of the U.S. subprime
crisis emerged last August, Brazil continued to out-perform.
Despite the U.S. economic downturn, Brazil forged ahead by becoming
a net external creditor in February, and then achieving recognition
as an investment grade sovereign in April. The decline of foreign
capital in Brazil is more about investors pulling money out of
Brazil to have liquidity in the U.S. Even with a strong economy,
however, Brazilian authorities will need to remain vigilant and take
steps to counter the slowing of investment inflows. Some mergers
and acquisitions could strengthen the Brazilian economy and make it
more efficient, but eventually reforms would be needed to make
Brazil more competitive. End Comment.
14. (U) This cable has been cleared/coordinated with Embassy
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