Brazilian private equity market still attractive, says BCG

Brazil remains an ideal target for private equity (PE) firm investment, according to a new study from The Boston Consulting Group (BCG). The emerging economy, which is projected to rebound from a two-year recession with steady growth over the coming years, has a relatively mature PE market with low penetration compared to its Latin American peers.

The global private equity industry has grown rapidly over the past decades. Wealth under its management has swollen to $3 trillion worldwide, while the number of active firms in the private equity industry has rocketed to more than 4,700.

A new report from The Boston Consulting Group (BCG) – based on the firm’s recent in-depth analysis of the Brazilian economy – considers future prospects for private equity in the South American country.

Recession market winners and losers

Brazil enjoyed explosive growth between 2001 and 2011, with its economy rising from the world’s 11th to 6th largest, fueled by consumer debt and workforce expansion. Since 2013, however, the country has suffered a period of economic decline, punctuated by a series of political scandals and crises. Currently, the economic fuel that spurred the country’s wild growth seems to be exhausted: high commodity prices have crashed, demographic shifts which vastly expanded the workforce have tapered off, and household debt has decreased. Economists, however, expect the economy to begin growing again at a modest rate of 1.8% till 2021.

The Brazilian recession has depressed growth in all but two industries: utilities and financial service. Mining, which experienced a stratospheric 44% compound annual growth rate between 2009-2012, has been crushed by low commodity prices, seeing a -34% CAGR from 2013-2016. Construction also was hit by a significant decrease in growth, falling from a rate of 19.7% to 1.6%, while growth in the transportation industry fell from 18.7% to 5.5%. Meanwhile, utilities’ growth rate increased by about 10%, and financial services experienced a growth rate increase of 7%.

The report also examines which consumer goods segments enjoyed the highest level of growth during the years of recession (2013-2015) compared to the years immediately before (2010 to 2013). While spending in most segments declined (e.g. consumer electronics, apparel, jewelry), spending at gas stations, super markets, pet supply stores and pharmacies all enjoyed relatively high, resilient levels of growth. These rather recession-proof segments maintained good growth, as hard-hit consumers did not cut back on food and drugs for themselves and their animal companions, instead preferring to limit spending on less essential products.

Brazilian consumers spent particularly less money on durable goods such as consumer electronics, apparel, and furniture and home décor. Within the furniture and décor category, spending growth fell precipitously, from more than 12% CAGR to a lowly 3%. While the Brazilian economy obviously contracted between 2013-2015, BCG notes that growth in consumer goods spending still managed to remain relatively robust during recession years.

Brazilian private equity market

According to BCG, the Brazilian PE market has major potential for growth. PE activity represents around 0.31% of GDP in Brazil, substantially lower than the US proportion of 1.41%, and the UK mark of 1.91%. Competition between PE firms in Brazil remains relatively fierce, however, as a substantial amount of global players are entering the country, enticed by relative maturity and lower levels of penetration.

Average PE deal sizes in the country also tend to be smaller than those of developed markets, with firms investing relatively small amounts per deal in the country. From 2006-2015, 63% of Brazilian PE deals were in the $50 million to $200 million range, as opposed to 47% for the US during the same period. Correspondingly, 2.3% of deals in Brazil exceeded $2 billion, compared to 9.7% in the US. According to BCG, the large number of deals in the low range signals tighter competition on a smaller playing field – where even huge firms like Blackstone and The Carlyle Group compete for smaller deals.

The research also looked at PE and VC activity in Brazil over the past six years, in terms of investments, dry powder (highly liquid uninvested assets), and other categories (reinvestments in companies, operating expenses, and returns to shareholders).

Total investment increased even during the recession period, reaching $53.9 billion in 2014, before dipping to $45.9 billion in 2015 and then $41 billion in 2016. The largest segment by a long shot was investment, followed by dry powder.

Value creation in portfolios in Brazil has increasingly been derived from revenue growth and margin improvements, with 50% and 33% of returns, respectively, in 2014; in 2011 returns attributed to revenue growth and margin improvements were a lower 45% and 25%, respectively. Additionally, Brazil’s high interest rates have served to keep leverage in an insignificant position with regard to value creation. 

Lastly, exit activity has remained relatively stable, even while investments have declined considerably – falling by 39% between 2015 and 2016. Exits were primarily effected by strategic buyers (45%), followed by IPOs (19%).

“[A] combination of factors puts Brazil in the sweet spot for companies willing to invest in emerging economies,” concluded report co-author Heitor Carrera, BCG Partner. “Over the next decade, the country will offer a rare opportunity to both global firms that want to add emerging markets to their portfolios and local firms in Brazil that want to step up their investments there.”