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Latin America’s Pending Fire Sale

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Private equity groups are licking their lips at the prospect of acquiring Latin American assets at fire-sale prices.

BY JOHN PRICE

Experienced Latin American investors understand that today’s financial crisis will present discounted buying opportunities to those with the authority and boldness to quickly negotiate an acquisition and the cash to pay for it.

Six years of rapid growth in the region invited a lot of new players into the market, overcrowding supply in several sectors. Tight credit, faltering demand and falling prices put to the test the viability of many players, particularly recent entrants who may have overpaid to compete in the region. As a result, several sectors are overdue for some consolidation.

Different from the M&A dynamic of an expanding Latin America, acquisition opportunities present themselves very quickly in a down market, triggered this time around by exiting multinationals or over-indebted multi-latinas. After building a significant presence in Argentina, Brazil and Chile, Ryder Logistics, for example, was poised to enter the Colombian market in 2008 when global trade flows slowed and then collapsed, sparking a retreat by the company to its core NAFTA market position. Ryder’s exit from South America was swift and muted.

STRONG MOTIVE

The financial need to focus on core and profitable markets is a strong motive for global firms to exit from Latin America, especially if they are recent arrivals still nursing a developing investment. Another motive may be the need to raise cash to repair a damaged balance sheet. RBS has been ordered by its new majority shareholder, the British Treasury, to shed assets, so it plans to sell operations of its subsidiary, ABN AMRO, in Argentina, Venezuela, Chile and Colombia. Retreating multinationals are the first and possibly the most attractively priced acquisition opportunities presented in the region.

The financial crisis hit Latin American markets anywhere from three to nine months after first striking in the U.S. It is only now that the need to consolidate in over-supplied sectors in Latin America is becoming evident. The first industries to feel the pain of falling demand are the region’s burgeoning commodity exporters. Junior mining companies in Peru and metal manufacturers in Argentina and Chile all share in common a rapid fall from grace as prices collapsed and their debt servicing costs skyrocketed thanks to scarce corporate credit. Cut off from capital markets, junior mining companies are busy flogging their new exploration properties in South America to the handful of cash-rich mining majors. But there are too many junior mining companies looking for too few majors, leaving many stranded and ready to sell to financial investors at discounted prices.

In Mexico, auto parts exporters have watched their U.S. customer demand collapse as two of three U.S. major car companies faced bankruptcy. The top 10 Mexican auto parts product category exports are anticipated to drop 50 percent from $53 billion in 2008 to $26 billion in 2009. The capital intensive industry cannot survive intact under the scenario of losing half of its revenue. During the last few years, many of Mexico’s auto parts exporters were able to borrow in dollars at historically competitive rates, assured of demand in the U.S. Now, with a devalued currency and rising corporate debt pricing, the Mexican auto parts sector is under attack from the revenue and cost sides of the ledger.

PRESSURE ON CARGO PLAYERS

Across Latin America, trade with the United States will decline close to 40 percent in value and an estimated 10-15 percent in volume. That will place enormous pressure on international cargo players, particularly air cargo in and out of South America, as well as cross-border trucking between the United States and Mexico. Latin American players in the space grew market share over the last six years, their expansion fuelled by access to cheap debt. They face the same margin squeeze as auto parts exporters with falling demand, weakened prices and growing finance costs.

After retreating multinationals and exporters under siege, the third source of distressed assets evolving from this crisis will be capital intensive service sector providers that took on too much debt too quickly in their effort to grow over the last six years. Retailing, consumer credit, construction, and tourism are all sectors that enjoyed spectacular growth and intra-regional investment in recent years.

Consumer credit grew by an average of over 20 percent per year between 2000 and 2007 (see Birth of a New Banking Model, Kroll Tendencias, April 2007). Construction grew on the heels of government spending while fiscal budgets in most countries expanded at 10 percent+ per year over the last five years. Latin American retailers like Pao de Açucar, Falabella and Soriana all fought back against the wave of foreign retailer investment and staked their claims, particularly in middle markets. Latin American hoteliers grew in multiple segments and now face falling demand from both international and domestic tourists. All of these industries were over built and face consolidation. The trigger point will be expiring debt contracts that force these over-leveraged players to shed non-core assets.

DUE DILIGENCE IS KEY

All three areas of acquisition opportunity reward speed and boldness, the operational advantages of private equity and venture capital, as well as wealthy individuals in the region. The private equity sector raised record cash from 2006 to 2008 and is waiting patiently on the sidelines for the fire sale to commence. Strategic investors can join the party of buyers as well, but must take pre-emptive steps if they are to compete. They will need to line up funding from head office ahead of negotiations, much like a first time house buyer. Most importantly, strategic buyers need to identify targets with sufficient time to conduct reputational due diligence before engaging in negotiations, when financial and legal due diligence activities usually begin. In a time-compressed buying process, due diligence must be swift and pre-emptive.

Due diligence must also be thorough. Fire sales are fraught with risk because the seller is operating from a position of weakness and has every incentive to hide potential liabilities in the hope of pushing through a quick sale that preserves maximum value of its assets. Certainly, the ability to purchase discounted assets allures buyers, but the degree of liability can often overshadow the rewards. The most common liability of cash-strapped companies is the non-payment of taxes, particularly value added sales taxes, a form of tax evasion that is a criminal offense for business owners and board members in some Latin American jurisdictions. Other liabilities include unpaid worker wages, AML non-compliance, FCPA non-compliance, as well as internal fraud. Understanding these issues ahead of negotiation may be the key to purchasing at fair market value. Knowing the full extent of any liabilities may be vital to avoiding a regretful acquisition.

John Price is Managing Director of Business Intelligence at Kroll Latin America and based in Miami. This article originally appeared in the Latin American PE VC Report, the official newsletter of the Latin American Venture Capital Association (LAVCA). Republished with permission from Kroll.

 

 

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