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Brazil: FDI Opportunities and Pitfalls

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Despite the general optimism in Brazil, pitfalls are real and can be extremely detrimental to the foreign investor.

BY SHANTI SALAS


Brazil’s GDP grew 5.4 percent in 2007 to $1.1 trillion. Foreign direct investment in Brazil practically doubled from 2006 to 2007, from $18.7 billion to over $34 billion. While growth is projected to slow to 4.8 percent in 2008, investment opportunities abound in Latin America’s largest economy. Brazil is slated to have more IPO’s than any other Latin American country in 2008. Despite the general optimism, pitfalls are real and can be extremely detrimental to the foreign investor. Undisclosed liabilities, hidden ownership, and questionable practices and reputations of local management are some of the issues that a company could face when doing business in Brazil. In almost 30 percent of all partnerships, acquisitions or joint-ventures, a potential problem lies just under the surface.

Brazil, the world’s tenth-largest economy and the largest in Latin America, attracted record foreign direct investment in 2007. According to a November 2007 InfoAmericas survey of 50 U.S. multinational companies operating in Latin America, strategic planning managers cite Brazil as the top market of interest for new investment in 2008.

WHAT ARE THE ATTRACTIONS?

This country of 190 million inhabitants currently enjoys a stable monetary policy, controlled inflation, record employment and falling country risk ratings. Brazil is also more diversified as far as Latin American economies go—even as the world’s second largest agricultural exporter, agriculture as a sector accounts for only 5 percent of Brazil’s GDP.

Its diversification is noteworthy, as Brazil exports less to the U.S. relative to other economies in the region, reducing its vulnerability to a U.S. economic slowdown.

However, the main attraction is the Brazilian consumer. Consumers have an increasing capacity to purchase imported goods coupled with an unprecedented access to credit. For one, buying power is buoyed by an appreciating currency, which already has reached R$1.63 to the U.S. dollar in 2008. Additionally, interest rates remain at a historic low — the benchmark SELIC lending rate currently sits at 12.25 percent — while auto financing, home mortgages, credit and debit cards are penetrating previously "unbanked" sectors of society.

The strengthening muscle of the Brazilian consumer is also reflected in industrial growth. Overall industrial output stood at 6 percent in 2007, compared with 2.8 percent and 3.1 percent in 2006 and 2005, respectively. Domestic demand and expanded access to credit are largely responsible for this growth, according to the Instituto Brasileiro de Geografia e Estatística.

In January 2008, Brazil’s international reserves exceeded its foreign debt for the first time in its history, according to the Banco Central do Brasil. This year could also herald some good news on the foreign investment side. The major credit rating agencies of Standard & Poor’s and Fitch Ratings recently raised Brazil’s debt to investment grade.

REALITIES OF DOING BUSINESS

Brazil’s economy continues to be robust and holds many investment opportunities for foreign firms. However, substantial risks remain for the investor considering an acquisition, partnership or joint-venture.

According to Kroll’s analysis, almost 30 percent of all due diligence investigations conducted on Brazilian companies for a foreign investor uncover some kind of problem. In 60 percent of those cases, the problem is a deal-breaker — serious enough to make the outside company back away from the investment altogether. In the remaining 40 percent of cases, a deal was struck but only after the proper adjustments were made.

Problems can lie right under the surface, yet are often not easily detected by a typical legal or financial due diligence that relies solely on public record information and whatever data the prospective business partner has disclosed. Public records in Brazil are often scarce, out-of-date or incomplete, reducing their usefulness for making investment decisions.

However, proper due diligence both facilitates a deal and avoids potential pitfalls. The following are actual cases where on-the-ground investigators with an intimate knowledge of local conditions helped a company detect and navigate serious financial, legal and reputational hazards before they adversely affected an investor:

Kroll helped an American investment bank underwriting the IPO of a Brazilian real estate firm discover undisclosed ownership. Investigation found that a Brazilian executive had hidden his interest in the real estate firm through a complex set of straw entities. Moreover, this individual had a track record of managing companies that eventually went bankrupt. The investment successfully went forward after the executive in question left.

Kroll assisted a foreign private equity firm preparing to invest in a Brazilian logistics provider avoid a potentially massive legal problem. Investigation determined that the company’s vehicles were being used for local drug trafficking operations. The private equity firm ultimately backed away from the investment, as the risk was considered too high.

Questions to be asked before an acquisition, partnership or joint-venture:

PartnerLegal/RegulatoryCompetition

Has disclosure been complete and honest?

What’s the ethical track record and regulatory history of the prospective business partner and its management?

Are competitors fair? Could there be kickbacks or bribes that give them an ill-gotten advantage. 

Is there hidden ownership or off-the-books liability?
Are there connections with local public officials that could become legal liabilities? (This question is particularly relevant for U.S.-based companies that must comply with the Foreign Corrupt Practices Act.).

These are a few of the questions that ought to be asked, and hopefully answered, before jumping in.

This article is republished with permission from Tendencias, the magazine of Kroll InfoAmericas. 

 

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