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The Deal, USA, February 27, 2008

Emerging markets watch: The challenges of selling to booming Brazil

The M&A landscape in Brazil overall is "extremely strong," says Don Baker, a White & Case LLP partner in Sao Paulo. The strong economy coupled with all-time high commodity prices and low interest rates make the country an attractive place to do business.

The IPO market was the third in the world in 2007, Baker says, after the U.S. and China. From an industry standpoint, a report from RBI International Trade Services citing data from Brazil's Trade and Investment Promotion Agency, APEX, points to Brazil's leading position in varied sectors, including: the production and export of iron ore, coffee, orange juice, sugar and ethanol; export of beef and chicken; and high rankings in commercial aircraft and steel production. By the end of 2007, Brazil was No. 11 on the U.S. Census Bureau's list of U.S. total import/export trade (up from 12 in July, as RBI noted).

But for midmarket U.S. companies trying to sell into the market either by acquiring Brazilian companies or forging JVs, there are challenges.

  • Informality -- There is a "level of informality in the market," Baker says. Couple that with a "labor system that's extremely inflexible," marked by social charges and significant contingencies could make a deal much more expensive. There's a high cost to following all of the rules, he says. Of course, the larger the Brazilian company is and especially if it's publicly traded, the situation becomes more formal and some of the contingencies are mitigated.
  • The Tax System -- Brazil's tax system is complex, and there's not really any getting around it. "Ongoing tax compliance and the ongoing cost of doing business" in Brazil are high, Baker notes. But for many investors, tax woes are offset by the size of the market, the opportunity and lower labor costs. A January 2005 report from PricewaterhouseCoopers outlines some of the basics around asset purchases versus stock purchases:

    An asset purchase significantly reduces the buyer's tax exposure in the U.S., while offering only limited protection from tax contingencies in Brazil. U.S. buyers might thus be tempted to structure their Brazil acquisitions as stock purchases. However, this requires careful assessment to ensure that the transaction structure allows the buyer to deduct any premium paid.

  • IP Laws -- In terms of IP protection, laws enforcing IP rights are increasing. "Do they have a ways to go? Probably, yes," Baker says. But there are strides, as the Latin Business Chronicle reported in May, "the Office of the U.S. Trade Representative recognized Brazil's successful crackdown on counterfeiting and piracy, moving the country from the Priority Watch List to the Watch List in its annual Special 301 report."
  • Exports Bottleneck -- "There's definitely issues here of infrastructure and logistics," Baker says, which create "bottlenecks on every level in terms of the export market." And companies need to make sure the problems at ports and airports won't tie their goods up, causing them costly delays. Foreign sellers are best-served not ignoring the issue and "making sure that there is an avenue to get the goods out at a reasonable price."
  • Protectionist Sentiment -- Some sectors have government protection, like airlines and publishing, while banks, for instance, are huge and would be expensive for foreign buyers, Baker notes. But generally, companies are welcome to compete in Brazil as long as they follow the rules, he says, like talking to the government and playing the game.
  • Cultural Divide -- Finally, there are cultural issues related to finding workers and the lack of a deep pool of English speakers, so companies need to be able to and commit to paying for qualified people, especially outside of the three main cities: Sao Paolo, Rio de Janiero and Salvador. This again becomes less of an issue when companies get to a certain size and scale.

Brazil is becoming investment-grade, Baker says, and as commodity prices remain high, investors are confident about the market in the short and medium term, despite a worldwide slowdown. As a result, companies, like Nestle SA, will continue to find ways to tap the local consumer market. As the FT points out, the food and product maker is going door-to-door in Brazil peddling goods to the poor who have benefited from years of low inflation. - Carolyn Murphy 


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