A Shrinking Universe

Mergers and acquisitions in Latin America are down by over a third so far this year compared to last. And while this is a significant decline, the level of corporate consolidations could have suffered much more given the amount of bad news hitting the region. Argentina’s debt crisis, the slowdown in the US economy and Brazil’s energy woes have been major shocks to Latin America.

Paul Salvodelli, partner at Buenos Aires-based BGS Group, an affiliate of US private equity firm Hicks, Muse, Tate&Furst, says the somber economic outlook this year for most Latin American countries means bargains are plentiful. “Everyone wanted to invest in Latin America in 1997 when Argentina was growing at 7% a year,” he says. “But [wise] investors are counter-cyclical and buy during the downturns to get the best returns. Right now there are huge opportunities in Latin America.”

Multinational companies, especially those in the banking and telecoms industries, are actively building enterprises that span the Latin market. “Whereas before multinationals primarily built presence in different Latin American countries, they now focus on creating pan-regional platforms,” says Guillermo Jasson, principal in Latin American M&A at Morgan Stanley.

Meanwhile, family-run Latin American conglomerates are focusing on their strongest sectors and divesting non-core assets to cope with rising competition and a debt hangover from a borrowing spree in the early 1990s.

Latin America generated $37.7 billion in M&A volumes in the first five months of 2001, according to M&A Global, a database that tracks global activity. Citigroup’s $12.5 billion bid in May to acquire Mexico’s Grupo Financiero Banamex-Accival accounts for a third of this year’s volume. During the same period last year, M&A volume totaled $40.8 billion. Telecommunications continues to be the single most important sector in Latin America these days, says Adolfo Ríos, head of Latin American M&A at Salomon Smith Barney. The burst of the dot-com bubble last year and the slump in global telecom stocks have slowed, but not halted investment in the telecom industry in Latin America. Joaquín Avila, co-head of Latin American investment banking at Lehman Brothers says, “The capital requirements in the cellular business are so immense that you have to be a monster to compete.”

Between January and May, foreign cell phone companies made 28 bids for Latin American operators worth $9.8 billion, compared with 40 bids worth $18.5 billion for the same period last year. Brazil, Latin America’s largest telecoms market, saw nearly all the action. Multinationals lined up for its second round of wireless license auctions between January and March. Telecom Italia Mobile paid $776 million for two licenses covering the Brasília and São Paulo regions.

The Brazilian government’s plan to fully liberalize the telecommunications industry early next year has also set off a wave of acquisitions of smaller wireless companies as multinational companies grab market share. Portugal Telecom, Spain’s Telefónica and pan-regional Telecom Américas, a joint venture between Mexico’s América Móvil, Bell Canada International (BCI) and SBC International, have all been acquiring smaller Brazilian cellular companies. BCI’s Chief Executive, Louis Tanguay, told shareholders in May: “We have strong competition from Spain’s Telefónica, Telecom Italia and others, especially in the populous Brazilian market, but our strategy to leave Asia and refocus on Latin America’s huge potential was timely and will pay off handsomely.”

In April, Telecom Américas bought a 62% stake in Brazilian wireless company Tess for $950 million in cash from Telia of Sweden. In March it bought a 65% stake in Brazilian wireless operators Americel and Telet for $583 million from Canadian wireless company Telesystem International Wireless (TIW) and other institutions.

PT’s Major Moves
Portugal Telecom has made investments in Latin America totaling $3.7 billion so far this year. In January, through its Brazilian unit Telesp Celular, it purchased Brazilian cellular operator Global Telecom from Japan’s DD Corp. for $1.2 billion in cash and assumed some $600 million in debt. The Portuguese company also launched a bid in May for the remaining 58.8% stake it does not already own in Brazilian telecommunication operator Telesp Participações in a stock deal worth $2.47 billion.

Multinationals are also moving into Mexico. Vodafone Group, the world’s largest cell phone company, entered the Latin market when it bought a 34.5% stake in Mexican mobile phone operator Grupo Iusacell for $971 million in cash from Grupo Peralta in January.

Fierce competition and the industry’s substantial capital requirements are forcing companies to forge alliances such as Telecom Américas. Bell Canada and SBC have a presence in North America and 12 Latin American countries but not in Mexico. América Móvil has 11.7 million subscribers, or 71% of the Mexican wireless market, and has bought companies in Guatemala, Ecuador, Argentina, Venezuela, Colombia and Puerto Rico.

In January, PT and Telefónica merged their Latin mobile phone assets into a joint venture with $10 billion in units and nearly 10 million customers. It will be Latin America’s largest cellular phone company if Brazil’s telecommunications regulatory authority Anatel approves the merger.

América Móvil is also trying to straddle the Latin American and US Hispanic markets. In addition to its Brazilian assets, it owns two wireless local loop licenses in Venezuela. In the US, it owns CompUSA, a Dallas-based computer hardware retailer and Tracfone, a Florida provider of pre-paid telephone cards and handsets.

Though telecommunication companies around the world no longer enjoy heady valuations and access to cheap capital, they continue acquiring attractive companies with capital raised on the stock market before the downturn or through stock deals. European companies, in particular are using stock swaps either to increase their existing stakes in companies or to buy new assets. Telefónica last year delisted four of its Latin American companies in a deal in which local shareholders were issued Telefónica stock.

The company carried out two more stock swaps this year. It swapped four Telefónica Móbiles shares for 57 shares in Celular CRT Participações for the remaining 54% it did not own in the Brazilian wireless company. That deal was worth $865 million. Telefónica also bought out Spanish power company Iberdrola’s Brazilian wireless assets for $313 million. Portugal Telecom paid for its 58.8% in Telesp Celular with new PT shares. Telefónica issued 122.6 million shares worth $1.8 billion in June to pay for four Mexican wireless companies acquired from Motorola.

Citigroup is also using a share swap to pay for half of its $12.5 billion Banamex acquisition (see cover story, page 15). It has offered $6.25 billion in cash and the rest in Citgroup stock, priced at $49.26 a share on May 11.

In Argentina, Banco Bilbao Vizcaya Argentaria (BBVA) launched a bid in January to acquire the remaining 32% stake it does not already own in its local bank, BBVA Banco Francés, for around $710 million. It offered investors two of its shares for three Banco Francés shares.

BBVA is among several multinational banks increasing their stakes in banks they bought in Argentina, Brazil and Mexico. M&A activity in financial institutions this year totaled $14.3 billion at the end of May, nearly all of it in commercial banking. The insurance sector accounted for $500 million. With Mexico’s three biggest banks and nearly all Argentine banks already owned by the multinationals, Avila says, “Brazil is the next stop in Latin America.”

Top Citigroup executives have confirmed that they expect to make a significant acquisition in Brazil next. The owners of Brazil’s largest private-sector banks, Bradesco, Itaú and Unibanco, insist that they are not for sale.

The Big Booty
The Brazilian government opened the doors to acquisitions by foreign banks in 1994 as part of a central bank-orchestrated restructuring of the banking system. European banks and Brazil’s big three private sector banks led the way. Locally owned Bradesco has made 28 acquisitions since 1995 for a total of $1.36 billion. HSBC of the UK, ABN AMRO of the Netherlands, and the two Spanish rivals, Banco Santander Central Hispano (BSCH) and BBVA spent $1.16 billion buying state owned banks or bankrupt private sector banks auctioned off by the central bank. Last year, BSCH paid a further $3.55 billion to acquire a controlling stake in Banespa, the São Paulo state bank, at a privatization auction. It followed this with a $1 billion tender offer for the majority, non-voting stock. Meanwhile, the big US banks watched from the sidelines.

It is easy to see why foreign banks are attracted to the huge, underdeveloped Brazilian market. Forty percent of Latin America’s consumers live in Brazil and low penetration rates of banking services promise potentially fabulous growth. But Paul Bydalek, president of Atlantic Rating, a Brazilian rating agency, warns that multinational banks “are coming into a country where the best banks are extremely competent and strong. They are not for sale. Any international bank is going to have to be extremely tough to compete with local players.”

The government plans to privatize seven small state banks in September, but Bydalek doubts multinationals will show much interest. They usually avoid buying state banks with their militant public sector workers and potentially strong political opposition to financial restructuring.

Still, overall competition from multinationals is forcing Latin American companies to restructure their holdings. “The increased level of interest by multinationals in the region is bringing more efficiency to companies in Latin America,” says Martín Sánchez, co-head of Latin American M&A at Goldman Sachs. “Latin companies are streamlining operations to translate into shareholder value.”

Mexican conglomerates in particular are under pressure. Their share prices have taken a beating for years as they struggled to pay down debt that financed their rapid expansion into a variety of industries in the early 1990s.Vitro, a glass and plastic manufacturer, Desc, a real estate, food and pharmaceutical business, and Savia, an agro-biotechnology, packaging and insurance company, all have towering debt burdens. “There has been a huge shift away from country bets in the last couple of years,” says Ben Uglow, cement and conglomerates equity analyst at Credit Suisse First Boston.

Monterrey-based Grupo Alfa is symptomatic of many of Mexico’s family-owned conglomerates that funded expansion with debt. “Grupo Alfa has, more than any conglomerate, made significant investments. Since 1994, fresh investment in all its operations has been $2.6 billion,” says Uglow. But Alfa’s share price has been severely dented by its loss-making steel division Hylsamex, which last year had revenues of $30 million and debt-service costs of $40 million.

Analysts would like to see Alfa buy back the minority shares in Hylsamex and dispose of its petrochemicals division. Alfa did sell its Total Home division to Home Depot of the US in May for an undisclosed sum. But Uglow says, “Although these are positive steps they are late in the day and they need to be bigger. Alfa’s disposals are only 8% of its total indebtedness.” Alfa baffled analysts in June when it bought polyester assets from US chemical group Du Pont.

Shedding Side Lines
Weak share prices and unsustainable levels of debt are forcing conglomerates to concentrate on their best-performing industries. “Investors reward pure plays and no one understands what [conglomerates] do,” says Uglow. “The catalyst for restructuring is that these companies may be able to sustain current level of indebtedness but they can’t pay it off. They need to make selective divestments to pay down debt.”

In many cases, the children of the founders of Mexico’s ailing conglomerates now run the companies. Few of them show great management talent and seem more concerned with collecting dividends than restructuring their companies. Many are not interested in selling more stock in the company that would dilute the family stake and subject them to control from outside shareholders.

Alonso Romo managed to sink Savia, a holding company with silver, insurance, tobacco and biotechnology interests. A member of Monterrey’s business elite, Romo borrowed heavily to develop a US seed business, Seminis. In 1999 he raised $650 million in a three-year syndicated loan arranged by JP Morgan, ING, Citibank and Bank of Montreal, and a syndicate of 12 other banks. But Seminis has yet to make a profit and Savia suffered $445 million in losses last year on revenues of $3.2 billion and debts of $1.3 billion. Romo had to restructure $310 million in debt and sold his majority stake in Mexico’s largest insurance company, Seguros Comercial América, to ING Group for $791 million in May.

Mexico’s successful companies have prospered by remaining focused on a single sector and hiring professional managers. A new generation of value-conscious managers is transforming these companies into global leaders that have started acquiring foreign assets.

Cemex’s Model
Cemex, owned by Monterrey’s Zambrano family, has transformed itself from an inward-looking Mexican concern into the third-largest cement company in the world. Since the North American Free Trade Agreement in 1994, Cemex has steadily pursued its global expansion, acquiring 22 companies – 13 in Latin America and the rest in the US, Western Europe, Asia and Egypt – for around $4.4 billion. Its acquisition of Houston-based Southdown last November for $2.8 billion was the largest acquisition of a US company by a Latin American company to date.

Telmex, Mexico’s largest telecommunication company, through its América Móvil wireless subsidiary, set up the Telecom Américas joint venture with BCI and SBC International to acquire cell phone companies elsewhere in Latin America.

The fact that these multinationals are based in Mexico hampers their growth. “They don’t have the access to cheap capital that [most] multinationals do,” says Avila. Nevertheless, that hasn’t stopped them from expanding abroad. Since 1996, Mexican companies have bought 22 US companies totaling $5.6 billion according to M&A Global.

Although Brazil lags behind Mexico, sector-focused companies are consolidating their position in their markets. Companhia Vale do Rio Doce (CVRD), acquired Rio de Janeiro-based Ferteco Mineração from Germany’s Thyssen Krupp for $566 million in April. CVRD also bought a 50% stake in Caemi Mineração e Metalúrgica from Japan’s Mitsui for $280 million.

Votorantim, the Brazilian family-owned conglomerate, made a bid to acquire the North American cement assets of UK cement company Blue Circle Industries from Lafarge of France for $727 million at the end of May. Bruno Boetger, head of Brazilian M&A at Salomon, which advised on the deal, says: “What we have seen with Votorantim in the cement industry is evidence that consolidation is the name of the game and if they want to continue gaining global presence they need to acquire in the region and in the US or Asia where they don’t have a significant presence yet.”

Few other Brazilian companies have invested overseas. Gerdau, a steel maker, has quietly accumulated foreign assets over the years and now generates a large proportion of its revenues outside Brazil. It has subsidiaries in Canada, Chile, Uruguay and the US. Banco Itaú bought troubled Argentine commercial bank Banco del Buen Ayre in 1998. CVRD owns minority stakes in steel mills in the US and France.

However, these tend to be exceptions to the rule that Brazilian companies are concentrating on coming out on top as consolidation advances in the large domestic market.

Retail’s Next
Bankers expect consolidation in the Brazilian retail sector to continue and attract interest from multinationals looking for growth. Although considerable retail consolidation in Brazil and Argentina took place in 1998 and 1999 when there were 108 acquisitions, Eduardo Centola, co-head of Latin American M&A at Goldman Sachs says, “Interest in consumer products and retail is increasing and companies will look for growth on a domestic and global basis.” Portuguese retail group Sonae SGPS acquired two Brazilian supermarkets from French supermarket operator Carrefour in May for an undisclosed price. Dutch supermarket operator Royal Ahold acquired a 14% stake it didn’t already own in the Bompreço supermarket chain the same month.

Nicolás Aguzín, head of Latin American M&A at JP Morgan, says Brazil’s retail industry still remains fragmented and offers good opportunities for consolidation. He expects Mexico to produce the most retail-based M&A activity in the coming months. The success of Walmex, the Mexican division of US supermarket chain Walmart, which has a 40% share in the retail sector, could spark acquisitions by other chains. “All the multinationals are looking at retail in Mexico and several local players could present attractive opportunities,” says Auguzín.

Salomon’s Ríos says he expects more interest in food and beverage companies. “Multinational companies are looking to continue acquiring strong brand names in Argentina, Chile, Brazil and Mexico, although few deals have materialized to date we are aware of a huge interest in Latin America,” says Ríos. Amid the changing landscape of risk and reward, Latin America is still dominated by traditional family run companies at different stages of growth offering plenty more opportunities for consolidation and rich pickings. LF