Private Equity opportunities in Brazil
2008/06/05 in Tumblr blog imports
Local Challenges (high cost of Capital)
One of the major difficulties of private investing in Brazil is the relatively high cost of capital, and hence the high hurdle rate (see our discussion on WACC) when analyzing investment opportunities.
When looking at a private investment, it is important to also keep one eye on the returns that can be achieved in the stock market. Equity investors have a choice about where to put their money. On one hand, they can easily invest in the stock market, and achieve the expected average return (using an ETF, they would get the “market return”, and would assume the “market risk”). The benefit of investing in the stock market is that it is very liquid, transparent, and efficient. They can take their money out at any time. Also, because the companies publish all of their financial data online, it’s easy to check their balance sheets, and compare them vs other companies in the market. This is not true with private companies.
With private companies, investors should receive a premium over what the market is returning because they are assuming additional risk (less liquidity, less transparency, etc).
But, in Brazil there is a problem in that ordinary investors have come to expect 10-11% returns as normal (average) for assuming very little risk. With the stock market booming in recent years (it was the top performer in the past 12 months), there is an environment where local investors are facing a very large hurdle when analyzing local private investments. If more money can be made in the stock market, many local investors are hence wondering what incentives they might have to invest in riskier (and less liquid) assets.
Opportunity for Foreign PE Capital:
In my opinion, this creates an opportunity for foreign investors, who may be more patient, and more willing to finance deals that Brazilians are not. This reminds me of the situation back in the mid 1990′s when Japanese investors had a much lower cost of capital than US competitors, and were therefore more willing and able to consider investing in projects that paid back in a longer time period. If the WACC is too high, then local investors are discouraged from looking at long-term investments (because the discount rate compounds and makes it difficult to pay back). But, competitors (foreigners) with lower WACC are able to look at longer-term investments, and be more patient in their investment analysis.
