By John Barquin, Partner and Ned Crady, Partner, King & Spalding LLP
M&A activity in Latin America reached record-breaking heights in 2007, with more than $100 billion of transactions reported. Competition for quality targets remains high, and as a consequence buyers continue to accept more contingent liability than has historically been the case (or as might be seen in U.S. or European M&A transactions). Although significant questions remain about the impact of the current instability in credit markets, Latin America stands to fare better in 2008 than other regions. Nevertheless, the level of M&A activity throughout the region will continue to vary largely, with Brazil, Mexico and Chile exhibiting the greatest levels of activity as measured in dollar terms. Given that political and legal stability are often cited as the top concerns of foreign firms transacting in Latin America, it is no surprise that the countries topping the list of M&A activity are those exhibiting significant political stability.
Brazil shows no sign of removing or otherwise addressing numerous legal constraints — e.g., the Plano Real, the lack of any ratified investment treaties, a Byzantine tax system – that arguably hinder investment activity. Indeed, if anything, the tax system appears to be growing in complexity. However, strong global demand for commodities, new offshore oil and gas discoveries, and booming domestic demand make for strong fundamentals (note that this year Brazil gilts were accorded investment grade status). All of this has triggered significant increases in M&A activity over the last few years, and in 2008 Brazil is poised to account for approximately two-thirds of all M&A activity in Latin America.
Domestic M&A activity is a trend that continues to strengthen: so far this year eight domestic M&A transactions account for over $27 billion in value.
Legal reforms continue to be fostered by, and help foster, strong economic growth. In this respect, a general pattern of targeting legal reform to better align Brazilian and international markets can been discerned. A case in point is Law 9514/97 (recently creating a new framework for mortgage financing), which coincides with strong interest in the Brazilian real estate sector. Similarly, Law 11638/97 is part of the Comissão de Valores Mobiliáres’ efforts to align Brazil with International Financial Reporting Standards. Although the tax authorities have yet to promulgate valuation rules in connection with Law 11638, and Bill 3937/04 (relating to pre-merger control rules) slowly progresses through the Congress, the potential impact of these unresolved issues continues to be eclipsed by the broader fundamentals. And while the eventual promulgation of valuation rules under Law 11638 may (or may not) encourage more transactions effected on a stock basis, to date cash consideration continues to be the norm.
Porfirio Díaz famously bemoaned Mexico’s proximity to the U.S., and the interdependence of the two economies would appear to bode ill for Mexican M&A activity in 2008. However, inflows of capital from Brazil and Chile are serving to mitigate some of the impact of the U.S. credit crisis. Moreover, government plans to spend approximately $450 billion in infrastructure and housing projects through 2012, together with the emerging market for mortgage-backed securities, have supported the current high level of interest in construction and housing markets. The passage in 2003 of a package of amendments (DOF 13.6.2003) to several laws relating to the creation of liens has enhanced the attractiveness of this sector to investors. Similarly, the Ley del Mercados de Valores, enacted in 2006, has served to increase transparency and bring Mexican securities laws further in line with international practice, and addresses (in some cases quite indirectly) some reforms aimed at facilitating private equity activity. However, strong arguments remain for a fundamental reform of the corporations law.
Outbound investment by Mexican firms reached historic highs in 2007 and, as in Brazil, local fundraising is beginning to become more common. However, unlike Brazil, stock consideration in M&A transactions is beginning to be more common.
Chile represents the third most active Latin American M&A market as measured by transactional value. While Chile’s market-oriented policies and strong global demand for copper continue to attract foreign investment (as evidenced by Marubeni’s recent $1.3 billion acquisition of interests in two mining firms), the sizable offshore funds held by Chilean firms are now translating into outbound investment. The impact of potential energy shortages in Chile – triggered in part by rising oil and gas prices and the interruption of Argentinean gas supplies – coupled with the prospect of falling copper prices, may well impact the pace of inbound investment, but nevertheless may actually accelerate the rate of outbound investment. n