Brazil’s state-run oil company has spent a year trying to sell its Argentine assets. Now, in a sign of investor interest returning to the country that was previously a global financial pariah, Petrobras is on the verge of finalizing a more than $1 billion deal.

Petrobras wants to exit Argentina to help shore up its finances, which are strained by low global oil prices, heavy debts and a corruption scandal at home.

While it failed to find a buyer last year, a new candidate has stepped forward: Pampa Energía, Argentina’s biggest electric utility. The deal seems like a natural fit. Through the acquisition, Pampa would gain oil and natural gas fields, a refinery and service stations in a country with huge energy resources and rising demand.

More broadly for Argentina, the dealmaking is a sign of how improving business confidence could unleash a flurry of mergers and acquisitions after years of little movement. Optimists forecast brisk activity that could redraw the business landscape in important sectors. Skeptics, too, predict a rise in dealmaking, but warn of bumps along the way.

M&A slumped in Argentina after 2010, when big acquisitions in the oil sector by Chinese firms pushed activity above $6 billion. But in the subsequent years, potential buyers were turned off by limits on moving capital in and out of the country. Galloping inflation, heavy taxation, price caps, regulatory uncertainty and trade restrictions also turned buyers away. Last year, Argentina ranked sixth in Latin America in M&A activity, with 77 deals totaling nearly $2 billion, or 2% of activity in the region, according to data compiled by Dealogic. By comparison, Brazil had 707 deals totaling $44.6 billion, or a 51% share, followed by Mexico with 29%. Chile, Peru and Colombia trailed, but still saw more deals than Argentina, the data shows.

“For buyers, Argentina was basically off the radar screen,” says Matias Eliaschev, a managing partner of MBA Lazard, an investment banking and asset management firm.

Now it’s back.

The new government of President Mauricio Macri, a conservative businessman, has taken steps to improve the business climate in Argentina. Since taking power in December, he has cut export taxes, lifted capital flow restrictions – companies can once again take profits out of the country – and allowed an overvalued peso to devalue by more than 40% and float freely. He also has settled the country’s remaining debts from a 2001 default on $100 billion of borrowing, expanding access to financing for the country and companies. Resolving the debt issue is expected to gradually bring down lofty borrowing costs and inflation, improve government finances and revive the economy.

“The new government is sending a message to the world that there is more predictability for doing business,” says Carlos Germano, a political analyst in Buenos Aires.

As a result, more firms are on the hunt for assets, with a number of deals already on the books. New York-based hedge fund Fintech Advisory closed the purchase of a controlling stake in the holding company for Telecom Argentina, one of the country’s two telecommunications giants, for $960 million. Cablevision, a pay television operator, completed the takeover of the now defunct US cell phone operator Nextel’s operations in Argentina for $178 million. Arcor, a local food producer, bought 30% of Mastellone Hermanos, a leading milk producer, for $60 million.

The takeover tide could swell over the next few years.

One reason is that asset prices are far cheaper than in most of Latin America.

The enterprise value of Argentine companies was around six times their earnings before interest, tax, depreciation, and amortization at the end of September 2015, according to data compiled by First. This EV/Ebitda ratio was 6.9 in Peru, 9 in Colombia, 10.3 in Chile, 12 in Brazil, and 12.2 in Mexico. The lower the ratio, the more attractive the acquisition prospects.

“Those who enter first are going to get the lowest prices,” says Luis Dubiski, a partner at First. “When the economy improves, Argentine companies are going to have higher values.”

With Macri’s reforms, most economists expect the country to return to growth in 2017, boosting profits and asset prices. The IMF expects 2.8% growth in 2017 after a 1% contraction this year.

That means some potential sellers may hold out for better deals once the economy improves. But others will choose to sell sooner, including companies that want to refocus on core tasks to help curb costs and boost profitability. Years of weak or no growth will also motivate sellers. Petrobras, for one, wants to divest $15.1 billion in Argentina and elsewhere this year. US-based Citigroup is another. It plans to sell its retail banking and credit card business in Argentina, Brazil and Colombia to cut costs. HSBC, a UK-based bank, could do the same in Argentina, having already exited Brazil. Duke Energy, a big US electric utility, may hive off assets in Argentina and elsewhere in Latin America on low profits.

“We are seeing more companies than we thought that want to exit as soon as the sales window is open, and they don’t care if they leave some money on the table,” Eliaschev says. “There could be better offers in a year or two, but that doesn’t matter. Price maximization is not the only concern or objective, but rather the certainty of a closing is as important as price.”

Potential sellers could also include family businesses, which make up 70% of the corporate register and of which only 25% survive to the second generation – and fewer for longer, according to the Argentine Family Business Club, an industry group.

To survive, they need to go public to raise capital for growth, a stiff challenge in Argentina. The market capitalization of listed domestic companies was $56 billion in 2015, a fifth of the $293 billion average between Brazil, Chile, Colombia and Mexico, according to the World Bank. Only 13 companies have done initial public offerings in Argentina over the past decade, of which two have already delisted.

“With the such a small capital market in Argentina, there is not much option but to sell part or all of the company,” Dubiski says.

The buy side

On the buy side, the first to make offers likely will be Argentine groups like Pampa looking for growth opportunities, says Marcelo Iraola, manager of corporate banking at Banco Galicia, an Argentine bank.

Another pool of early buyers could be private equity firms, which made a splash in the 1990s in Argentina. The new blood would bring capital and professionalism to companies struggling to find the expertise and finances to grow, in particular those run by the second- or third-generation of the founding family.

Private equity firms likely will focus on “taking positions in medium-sized companies with certain potential for growth,” says Dubiski, whose firm has received a steady flow of inquiries from funds this year. “This will give them the leverage to grow so they can go on to sell them strategically.” 

Fewer deals elswhere

Another driver of M&A in Argentina will stem from a lack of dealmaking opportunities elsewhere, with slower economic growth in Brazil, China, Europe and the US and low commodities prices hurting profits and shrinking cash supplies. 

“There are few countries today with a good outlook, a good economic storyline,” says Zafer Mustafaoglu, lead economist for the World Bank in Argentina, Paraguay and Uruguay. “Compared with other countries, Argentina has a lot of opportunities.”

Foreign business leaders are taking note. When US President Barack Obama visited Argentina in March, he came with an entourage of 750 executives and officials. The visit followed meetings between Macri and the presidents of France and Italy, other signs of renewed interest in the country. 

After years of cuddling up to China, Ecuador, Russia and Venezuela, Argentina is now looking to Europe and the US as strategic allies, says Iraola. 

The size of the Argentine market is another reason to expect more dealmaking.The third-biggest economy in Latin America after Brazil and Mexico, Argentina is still home to a large middle class. The number of families with disposable annual incomes of between $45,000 to $65,000 is expected to grow by between 4.2% and 4.5% between 2015 and 2030, according to Euromonitor International, a research firm. That would be faster than 2.1% to 3.9% growth of those with disposable incomes of less than $35,000.

“For those regional and international companies that grew in Latin America but are not present in Argentina, it’s a significant market to be in, and the barriers to entry are mostly gone,” says Eliaschev. 

The rebuild

There’s also a lot of opportunity for new capital deployment. 

“Argentina needs to receive an enormous amount of investment,” says Iraola. “In terms of infrastructure, it is like it was at the beginning of the 1990s,” when a massive rebuild was needed after the return to democracy and bouts of hyperinflation. 

The country needs investment in ports, power plants and lines, railways and roads, plus better mobile and internet connections. 

Investment, too, is needed to unlock the country’s wealth of natural resources. Argentina holds shale resources so large that it could replicate the US oil and natural gas boom. Chevron, ExxonMobil and Shell are already drilling, and there are a handful of juniors with acreage in the shale formations, and some are already marketing assets to sell. The country also has large mineral resources and one of the world’s greatest wind power promises in gusty Patagonia.

To attract investors, the Macri administration has begun to improve business conditions. It raised energy prices – the price of gas has more than doubled this year – and rolled out incentives, including a requirement for factories to buy a share of renewable power or get fined. 

Banking is another potential hotspot for dealmaking, as big financial institutions seek to build market share. 

There’s room to grow. The large privately-owned banks in Argentina have market shares of less than 10%, compared with over 15% in Brazil, Chile, Colombia and Peru, says Eliaschev. They’ll need additional scale to afford the large investments in beefing up technology, and this should spark consolidation, he says. But new players could opt not to enter Argentina. Many big banks already have a presence the country, and the top Chilean, Colombian and Peruvian banks have scaled back their regional expansion drives of the past few years to focus on existing markets due to slow growth. 

M&A activity, however, may lag in other sectors after a consolidation push in the 1990s left them in the hands of a few players, which are now focusing on efficiency to gain scale and improve returns, says Eliaschev.

Fiat Chrysler Automobiles, for example, has said it plans to invest $500 million to build a new model at a pace of 100,000 units per year starting in 2017, a project that will involve installing more than 150 robots in its factory for more automation and improved efficiency. 

The carmaker already competes with the world’s other car giants in Argentina, including Ford, General Motors, Toyota and Volkswagen. Other industries are more concentrated, like beer, dairy, oil, sugar and telephony. Mexico’s Grupo Bimbo, for example, dominates the packaged bread market, Argentina’s Arcor that of canned foods and US-based Dow Chemical of plastics. 

This means that to get into the market, it’s either buy one of the leaders or piece together a slew of small firms to gain size, Dubiski says.

Fertile fields

That is not the case with agriculture. 

Expansive, fertile fields have helped make Argentina a leading world supplier of beef, corn and soybeans. However, production of some products sagged over the past decade, as high export taxes and domestic price caps curbed returns. Farmers, for example, turned over grazing land to more profitable soybeans. As a result, cattle supplies shrank to 52 million in 2015 from 58 million in 2007, cutting production and exports.

Now with the elimination or reduction of the export taxes, the agribusiness sector is poised to take off. 

Crop output, for one, is on track to increase by 50% over the next three to four years, says Gustavo Grobocopatel, president of Grupo Los Grobo, the country’s biggest wheat producer and second for soybeans. This will mean more business for the suppliers of everything from fertilizers and seeds to technology, tractors and trucking, as well as in the underdeveloped food processing industry, he says. 

His company is looking for growth opportunities, both organically and through acquisitions in an industry with lots of small companies.

“We want to grow in our volume of activity, in production and processing,” he says. “It’s a time to buy in Argentina, not to sell.” 

A rough start

Not all is bright for the near future of dealmaking in Argentina.

Macri’s reforms, including large hikes in bus fares and electricity and gas rates, have accelerated the inflation rate to nearly 40% this year from 26% in 2015. This is cutting consumer spending and increasing unemployment. The poverty rate surpassed 34% in March, up from 29% at the end of 2015, according to the Pontifical Catholic University of Argentina.

“It’s crucial for the government to reactivate the economy and reduce inflation in the second half of this year,” says Germano, the political analyst. “If it doesn’t cut inflation, the situation is going to get harder for the government.”

While many Argentines expected a rough first half of 2016 because of the economic problems inherited from the previous government, frustration over rising consumer prices is growing, Germano says. Macri’s approval rating shrank to 54% in March from 64% when he took office, according to a poll by Grupo de Opinión Pública, a consultancy. Of those polled, 53% said Macri must do more to halt the rise in consumer prices immediately.

The discontent could intensify social protest, says Claudio Lozano, coordinator of the Instituto de Pensamiento y Políticas Públicas, a think-tank.

Beyond this year, however, the economic outlook should get better, helping to ease public frustration over inflation. 

“We are living through a recession, but we are not heading toward a crisis,” says Luciano Cohan, chief economist at Elypsis, an economic consulting firm in Buenos Aires.

While inflation should end at between 36% and 38% this year, it will start declining in 2017, or before, Cohan says. He also expects a rise in dollar inflows from crop exports as well as sovereign bond sales to beef up dollar supplies and keep the exchange rate stable, while gradually bringing down interest rates now at 38% annual to help cut the fiscal deficit and refuel growth. 

“As the flow of news turns from negative to positive, investments are going to start to get unlocked,” he says.

For Grobocopatel, this means that now is the time to dive in.

“In my lifetime, I’ve lived through three or four of these economic shocks in Argentina, and I’ve learned that the worst time to exit is during the shock,” he says. “We get through these shocks and come out fine. Now is the opportunity to take advantage of the growth to come. If you wait to get in, you will have more certainty about an acquisition, but probably fewer opportunities.” LF