In this edition of the Financial Times’ Fund Management weekly supplement, Alvaro Goncalves – CEO of Stratus Group outlines the great opportunity for investors seeking returns in the Brazilian mid-market.
The article can be viewed online at: http://www.ft.com/intl/cms/s/0/9cedc63c-469e-11e1-89a8-00144feabdc0.html
The full text, in Alvaro’s words, is copied below:
Private equity chances in Brazil’s mid-market
By Alvaro Goncalves, CEO of Stratus Group
Overtaking the UK as the world’s sixth largest economy in 2011, Brazil has a surface area more than twice as big as Europe and a population over three times that of the UK. Since 1990, poverty levels have halved, with 40 million people joining the middle class since 2003. Despite GDP contracting in the third quarter of 2011, the IMF continues to make fluctuating predictions of a GDP growth between 3 and 5% for the coming years.
In a market that continues to be this dynamic, it is easy to see why Brazil has warranted such attention from investors looking for returns in a turbulent financial crisis. And the private equity world has not been exempt from scrutiny. Brazilian private equity has enjoyed a significant renaissance since the late 2000s when international investment managers re-entered the market, attracted by the prospect of strong returns and a proven resilience to the global financial crisis of late 2008. The period saw such landmark events as Carlyle’s first Brazil office opening, Blackstone’s acquisition of Patria Investimentos, JP Morgan’s acquisition of Gavea Investimentos, the establishment of BTG Pactual and Vinci Partners, and the launch of a Brazilian team for TPG Capital.
Despite drawing short of the totals of the other emerging markets comparable to its size, private capital raised by Brazilian private equity funds leapt 500% to over US$3 billion in 2010, driven predominantly by the greater participation from the mega funds. More than 90% of the capital raised in 2010/11 was poured in to only six funds in Brazil, with a few notable examples of billion-dollar plus funds closing in 2011.
Just take a closer look at the resulting evidence: more than 80% of the private capital available in Brazil is chasing deals from among a small pool of only 3000 large companies in the country (those with sales of more than US$200 million). And those few big companies have more alternatives for their capitalization – which means: deal flow tends to be scarce, competitive, and relatively expensive. Conversely, the mid-market private equity sector is underfunded – representing less than 15% of the total private equity money available in the country – with over 14,000 companies with sales of between US$30-200 million representing the sector. The picture is clear: the deal opportunity versus the investment equity ticket available is grossly mismatched.
As a direct result, valuations in the large cap market are rising and the space is becoming overcrowded. Anyone monitoring the Brazilian private equity market could therefore be forgiven for believing the resulting hype that it has reached a critical mass and the opportunities are rapidly disappearing. But institutional investors could benefit from a closer look.
Recalibrate your focus from the large cap onto the mid-market and the opportunity is most certainly still there, and will be there in the long term. Whereas the large companies have an enterprise multiple (EV/EBITDA) around 10x, the middle market firms are showing multiples below 8x, illustrating that they could well be undervalued and have the potential to produce better returns. What is more, the mid-market, as a broader sector of investment, is more resilient, more dynamic, and more mobile. In the Brazilian mid-market, there is an ocean of companies ready to emerge that are underserved and without access to alternative sources of capital. It is probably the sweetest spot – adjusted to underlying risks – for investments in the world today.
The opportunity is best illustrated with examples. Alog Data Centers, a data centre company based in São Paulo and Rio de Janeiro and firmly placed in the mid market, was sold in 2011 following three formal bids to the joint bid presented by Equinix Inc. (a NASDAQ listed data centre company) and Riverwood (a fund based in Menlo Park, California) for 18x capital in dollars (11x in Reais). Later in the year, Maestro, a well-run fleet manager of corporate cars with more than 2500 vehicles, received a control investment with a 50% valuation discount to the market leader. These markers are silently proving the trend, demonstrating that Brazil is an economy established over an ocean of mid-sized companies. That’s where Brazil can offer a long lasting wealth of opportunities.
Alvaro Gonçalves is Managing Partner and CEO of Stratus Group. He is also an Advisory Council of Empea – Emerging Markets Private Equity Association and Board Member of Lavca – Latin America Private Equity & Venture Capital Association