Brazil Turns up the Deal-making Heat

Michael Klein, left, president of Casas Bahia, posed with Abilio Diniz, president of Grupo Pão de Açúcar.

SÃO PAULO – Abílio Diniz was flying in his private jet over the Brazilian city of Salvador on his way to Paris in December when he received an urgent call. Diniz, the 72-year-old chairman of the Pão de Açúcar retail chain, was in the midst of negotiating a major acquisition – news he intended to share with his French partners as soon as he arrived. But the call forced Diniz to order the Falcon jet to return him to São Paulo to quickly finalize the acquisition of Casas Bahia, the largest non-food retailer in Brazil.

The Casas Bahia purchase came just six months after Pão de Açúcar had agreed to acquire Ponto Frio, another leading retailer of durable consumer goods, such as home electronics and appliances. It was a busy year for Pão de Açúcar, also known as Companhia Brasileira de Distribuição (CBD), which counts the French firm Casino as a partner. But this string of acquisitions was just one of the most striking in a spectacular series of 2009 deals that underscored the return of merger and acquisition fever in Brazil.

Indeed, the Casas Bahia deal looked so hot that some investors may have been playing with fire – trading shares in anticipation of the deal. The telephone call that scuttled Diniz’s plans to meet with Casino board members in Paris alerted him to concern among officials at the Brazilian security exchange commission, the Commissão de Valores Mobiliarios, or CVM, over a 30 percent, one-day jump in the value of the usually thinly traded Globex Utilidades. The movement made no sense for Globex, the holding company for Ponto Frio, except for those who knew that it was to be the vehicle to complete the transaction with Casas Bahia.

Brazilian authorities later decided to open an investigation of possible insider dealings, but at the time, Diniz realized he had to move quickly, he said. An emergency meeting was arranged between Diniz and Michael Klein, the president of Casas Bahia. Advisers and lawyers worked all night to iron out the final details of the deal, even though they ran out of time to complete extensive due diligence. Both sides signed the contract at 6:30 a.m. and then company officials hurriedly alerted the media and market analysts to make the official announcement on December 4. Speaking before a packed auditorium, Pércio de Souza, the head of Estater Gestão e Finanças, alluded to the all-nighter. “That explains why we all look exhausted,” said de Souza, whose boutique financial firm played the role of matchmaker on behalf of Pão de Açúcar in the deal.

Diniz himself was ecstatic. “We are setting up a Brazilian company of an enormous scope,” said Diniz, whose Pão de Açúcar obtains a controlling stake in the business.  “It is going to be the largest retailer of durable consumer goods in the country.” Brazilian regulatory authorities must still approve the deal, but Diniz was optimistic they would also endorse what he called “a win-win-win deal.”

The transaction was complex, involving the transfer of equity from both companies, along with Casa Bahia debt of $559 million into a new company being called Nova Casas Bahia for now. After the deal is finalized, Nova Casas Bahia will have more than 1,000 stores and 28 distribution centers, separate from the 500 supermarkets and so-called “big box” stores still run by the Paõ de Açúcar Group. Executives estimate the combined sales of the merged retail operations will top $23.5 billion, while the new mega-retail chain will employ 130,000 people. After the Casas Bahia transaction and the earlier $420 million acquisition of Ponto Frio, Pão de Açúcar will dwarf both the U.S. Wal-Mart Stores and France’s Carrefour.

Emerging Consumer Classes

The eight years of President Luiz Inácio Lula da Silva have been marked by a surge of buying power among low-income and middle-class Brazilians, who have become major consumers of cellular phones, DVDs, computers and other electronics. “When I saw that Casas Bahia was opening a store in Paraisópolis, I felt a huge sense of jealousy – but also a great sense of pride to see a Brazilian company go as far as the population lives,” Diniz said about the store opening in one of São Paulo’s major slums. Diniz’s retail stores always had a rather up-scale image, especially in São Paulo where it owns a Dean & Deluca look-alike store in the posh Iguatemi shopping center. But Casas Bahia has long focused on low-income consumers who buy furniture and home appliances on installment.

Retail operations and companies dealing with end-consumer demand have been the main focus of Brazilian and foreign investors looking for M&A deals, accounting for more than half of recent transactions, according to PricewaterhouseCoopers.

BTG Pactual, the financial institution managed by star banker André Esteves – formerly of UBS – invested in the gas station chain Via Brasil, the drugstore chain Farmais, the parking lot chain Estapar and also flirted with acquiring Ponto Frio.

Hypermarcas, Brazil’s largest manufacturer of cosmetic and cleaning products, completed four of its 15 transactions last year, including the acquisition of Jontex condoms from Johnson & Johnson and the generic drug manufacturer Neo Quimica. Founded by Brazilian businessman João Alves de Queiroz Filho in 2000, the company is trying to expand into over-the-counter medicines.

In April, Sanofi-aventis, the French pharmaceutical giant, also acquired Brazil’s third-largest pharmaceutical company, Medley, as part of a strategy to expand into generic drugs in emerging markets.

No End In Sight for M&As

While 2009 ended with a bang, more transactions are in the pipeline for 2010.

Anbima, the Brazilian capital market association, expects the volume of M&A transactions will rise more than 30 percent in 2010 compared to 2009. With the Brazilian economy accelerating to an expected growth rate of 5 percent in 2010, the appetite of investors has increased dramatically, especially in the financial, retail and consumer goods sectors. Gains in jobs and real income, rising consumer confidence and strong credit activity have all contributed to improvements in these sectors. More deals are expected in higher education and real estate, according to M&A experts. As host of the 2014 World Cup and Summer Olympics in 2016 in Rio de Janeiro, Brazil’s medium-term prospects look bright, while long-term trends are also favorable. According to a survey from Ernst & Young, Brazilians are expected to be better educated, with the average Brazilian completing 10 years of school by 2030, compared to 7.5 years at present. Ernst & Young said the greater education would translate to 2.5 percent annual gains in income and almost a 4 percent annual increase in consumption.

The share of foreign multinationals in Brazilian transactions has been falling recently, mainly due to the global recession. “Over the past two years, 70 percent of the deals have been closed between Brazilian companies,” said Carolina Lacerda, head of the merger and acquisition department at Anbima. But Lacerda said this trend could change. “Foreign companies are looking closely at Brazil again,” she said.

The hyperactivity on the M&A front is also a consequence of the global financial crisis and the subsequent credit crunch, which hit Brazil in the last quarter of 2008. For some companies the crisis presented opportunities. As the crisis hit, Pão de Açúcar CEO Claudio Galeazzi named a dedicated M&A team to be on the look out for bargains, like Casas Bahia, which appeared vulnerable and closed several stores in southern Brazil at the time.

For some major Brazilian names, the financial crisis has sparked a reversal of fortune.

The credit crunch badly hurt several sugar cane producers, paving the way for consolidation among ethanol producers. Louis Dreyfus Commodities signed the biggest deal when it acquired Santelisa Vale – formed by the merger of two traditional large mills, Santa Elisa and Vale do Rosario – for $470 million in debt in October after lengthy talks.

Large exporters, such as the food processor Sadia and the pulp and paper manufacturer Votorantim Papel e Celulose, were stunned by the sudden drop of the Brazilian currency against the dollar. Having bet on the Brazilian real strengthening, they lost several billion dollars on their derivatives. Sadia, which had sought to launch a hostile takeover against rival Perdigão several years ago, soon became the target of Perdigão, which managed to acquire Sadia to form a new joint venture called BRF Brasil Foods.

Similarly, Votorantim Papel e Celulose’s position has considerably weakened the position of the Votorantim conglomerate in its merger talks with Aracruz Celulose. Both groups eventually set up the largest paper pulp company in the Southern hemisphere, Fibria, last year. In both cases, the Brazilian development bank, BNDES, provided financing for the deals. The bank was also involved in the mega merger between Brasil Telecom and Oi in order to strengthen a Brazilian competitor against Teléfonos de México and Telefónica.

“The BNDES has acted as a catalyst. It has clearly been helping to create large Brazilian conglomerates,” said Lacerda, citing the global meatpacking company JBS as another example of BNDES involvement. “The bank says ‘if there is a Brazilian company in a position to become a global leader, we will support it,’ ” Lacerda said.