by Jef Cozza
Technology may not be the first sector that leaps to investors’ minds when they think of LatAm. The region is more often dominated by deals from the oil & gas or mining sectors, which between them represented $94.5 billion in M&A deal volume in 2010, 38% of all deals that year, according to Dealogic.
But investment in the technology sector, though still at low levels, is beginning to catch the eye of some major strategic and financial investors.
“Colombia has the same level of penetration that the US did in 2000,” says Daniel Gertsacov, new markets director for Google Latin America. “It has the same percentage of e-commerce as a percentage of total retail that the US had. This isn’t going to take 10 years this time. It’s going to take three or four. What we didn’t have ten years ago was mobile phones and tablets.”
“The region is a little bit lagging what’s happening in other parts of the world: Asia, Europe and the US,” says Hernan Kazah, CFO of MercadoLibre, the Argentina-based online retailer. “Investors have seen what has happened there. Their models are successful in those regions and they are now trying to find winners for those models in Latin America.”
In March, Google announced plans to increase its headcount in the region by 50%. It is also expanding, opening new offices in Peru, Chile and Colombia last year to supplement its existing locations in Brazil, Mexico and Argentina. Gertsacov says he also has plans to open two additional offices this year in Central America and the Caribbean.
“This is the region that grew quickest [for Google in 2010]. And it’s not just because we’re starting from a base of small numbers. It’s because it’s really starting to become an important place for our business,” Gertsacov says.
It is also becoming an important place for Google’s competition. In February, Facebook announced that it had poached Alexandre Hohagen, Google’s vice president in charge of LatAm. He will serve as vice president of sales for LatAm at Facebook, according to the company.
Middle Class Growth
Much of the interest in LatAm, and specifically Brazil, is a play on that country’s expanding middle class. Depending on who you talk to, the country is listed as either the third or fourth largest market for PC sales in the world, potentially beating Japan and Germany and putting it behind China and the US. PC consumption grew by 17.7% from 2008 to 2010, according to BANIF Securities.
“There’s a huge opportunity in the technology sector just to support the macroeconomic consumer opportunity,” says Fabio de Paula, investment director of Intel Capital in LatAm. Intel has been investing in technology companies in the region for the last 10 years, de Paula says. “We have a portfolio of 11 companies in the region. Eight of them are in Brazil, but we also have invested in Chile, Colombia, Mexico and Argentina.”
De Paula says Intel does not have numbers for how much it has invested in the region so far, but worldwide the VC firm invested $327m in 2010. It is expanding its presence in LatAm. The firm hired Alexandre Villela away from Stratus Group to join its São Paulo operations at the beginning of 2011, and is looking to add another investment professional, de Paula says.
“We definitely have been seeing an increase in interest in Latin America overall, especially Brazil,” de Paula says. “The other regions now are also picking up along with overall interest from more mature market investors looking at the region.”
De Paula credits the strong macroeconomic trends experienced by Brazil and several other countries in the region as the main drivers of the increased interest. De Paula says technology is following the same path as other sectors in the country and in the region: infrastructure, services and plays on the expanding consumer power of the so-called “C class” of middle-income consumers.
Google is likely to make several acquisitions in the region this year, according to Gertsacov, although he says he has no knowledge of any specific plans at Mountain View. The company plans to make around 50 acquisitions worldwide this year, he says. “I wouldn’t be surprised if more than one of those came from Latin America,” though any deal will have to fit within Google’s core businesses of mobile internet, YouTube, and display advertising.
Maria Cristina Machado Cortez, an M&A lawyer with Trench, Rossi e Watanabe specializing in the tech sector, says she is seeing in uptick in M&A and investment throughout the sector. “We know there are more transactions going on,” Machado says. IT outsourcing, software and services and cloud computing are areas where Machado says she sees the greatest potential for growth.
French technology company Capgemini announced it had agreed to acquire a 55% stake in Brazilian IT outsource provider CPM Braxis for 517 million reais. In 2008, Brazilian software developer TOTVS acquired fellow Brazilian software company Datasul for around 710 million reais. And PE firm Apax Partners acquired Tivit, another Brazilian IT services and outsourcing firm, for 873 million reais in 2010.
That leaves TOTVS and Stefanini IT Solutions as the largest independent IT services companies remaining in Brazil, according to Machado. Both are likely to see interest from potential investors, she says. Machado says she expects Microsoft, Accenture, Salesforce.com, Hewlett-Packard and IBM to be major investors in the Brazilian IT outsourcing and cloud computing markets.
“Most of the acquisition interest comes from the US,” Machado says. “But we also see France and China participating in this market.”
MercadoLibre’s Kazah says interest from both financial and strategic investors is increasing. “Both markets are more active than what they used to be a few years ago,” though he believes corporate investors have been somewhat more active.
Brazilian companies, sometimes backed by financial investors, are also expected to be major players in consolidation. “We are ourselves very interested in companies in Brazil,” André Frederico, director of M&A and strategic planning at Tivit says. “Of course we’re seeing international private equity firms [buying companies]. . . but also we ourselves are looking for opportunities.”
Regulation Driving Spending
New legislation being drafted by the Brazilian legislature which would ensure data privacy for end-users and facilitate the transfer of data from Brazil to other countries will allow the country to develop into hub for IT outsourcing, Machado says.
Improvements to Brazilian copyright law, which governs software in the country, are also being discussed and making the country more attractive to foreign software developers. “I have heard of five projects from five leaders in the IT sector setting up operations in the country,” she adds, though declines to disclose the names of the companies.
Taiwanese electronics giant Foxconn, which produces components for Apple, is looking at a potential $12 billion investment in Brazil, President Dilma Rousseff said in mid-April.
That is a marked change from the behavior of those companies in the past, Machado says. Previously, major IT and technology companies were hesitant to launch local operations in Brazil due to high taxes, she says. The fact that the same companies no longer see taxes as a barrier to entry, despite the fact that they have not gone down, indicates how positive they are on the market.
New regulations are starting to draw the eye of PE firms in the US. “Regulations and compliance is always a key driver of adoption of technology,” says Brett Rochkind, managing director at General Atlantic, a global growth equity firm. Rochkind is part of the firm’s Internet & Media sector.
General Atlantic entered Brazil’s IT space in 2007 with a $70 million investment in MercadoLibre. “At that time, people started to get comfortable with the financial stability of the Latin American market,” Rochkind says.
General Atlantic, which typically makes investments of $50 million-$500 million in companies, has about a half dozen investment professionals in São Paulo, its only LatAm office. Rochkind tells LatinFinance the firm has looked at investments in internet, software and outsourcing services in Mexico and Argentina, and gaming companies in Brazil.
“You haven’t seen as much early stage funding going into these markets,” Rochkind says. “You haven’t had a lot of copycats come up. If you look at a lot of the venture markets in the US, you’ll see 10 or 20 companies doing the same thing. When you do see a financed company in Brazil, they tend to have established a market leadership position earlier than a relative company in the US.”
Where’s the Exit?
But significant barriers to increased IT investment still remain, according to Mauricio Bejarano, chief of staff to former Colombian vice president Francisco Santos. Bejarano is now an angel investor in Colombian IT companies. “In Colombia at least there’s huge missing gaps in venture capital. There are very few angels. If you talk to them about exit strategy they don’t know what you’re saying,” Bejarano says.
In Europe and US, many tech companies are traditionally founded as start-ups backed by venture capital funds. “The primary thing Latin America could do to facilitate venture capital and private equity activity around the sector is work on the capital markets,” says Gertsacov. “There’s no exit. IPOs are few and far between. The mergers and acquisitions stuff usually happens between the big family groups and the big [corporations].”
It’s a problem that’s being seen in several countries. “We think that’s a problem in the region, especially in Colombia,” says Francisco Mira of Promotora, a VC firm focusing on Colombian tech companies.
Mira says Promotora solves the issue by investing in companies that make good potential targets for global strategic investors. “For example, Spanish strategic investors are looking for new technologies to be included in their portfolio, or are looking for companies that could develop their own technologies here in Colombia at a lesser cost.”
Mira says the best solution may be the development of new bolsas. “We have to develop secondary stock exchanges that allows this kind of company to go public. Like a Nasdaq.”
But there are signs things may be improving for investors looking for exit opportunities. “We have been doing exits the last four years,” says Intel’s de Paula. “We have lots of large corporations around the globe that are interested in Brazil and are doing acquisitions. And you have the local markets doing IPOs.”
De Paula says he sees this trend spreading outward from Brazil to some of the countries in the region with smaller capital markets. “I think Brazil is a little ahead of the pack,” he says. “But I can see this [sales to global strategic companies] happening in other countries as well. I think we’re going to see more and more this type of exit opportunity in the region. It’s improving a lot as time passes.”
Outside of Brazil, the lack of capital markets has been problematic, Bejarano says. But some countries are looking to step into the breech. Chile, for example, launched Start-Up Chile last year, a government program looking to spend $40 million funding entrepreneurs, according to Nicolás Shea, CEO of the program. Half of the funds awarded so far have gone to tech companies, he says.
Strategics to the Rescue
“Potential buyers are back at the table and looking for countries in Latin America,” says Ariel Muslera, director of strategy and product development at LAVCA. “Brazil, Chile, Colombia, Peru . . . those countries are back on the top of the minds of large companies as a place where they can find growth and opportunity. So that brings potentially more exit opportunities.”
Bejarano sees some of the newer, North American technology companies stepping up to provide exits for investors in early-stage LatAm tech companies. Playdom acquired Argentinean gaming company Three Melons for an undisclosed sum last year, before itself being bought by Walt Disney.
Bejarano says he knows of other Argentinean gaming acquisitions in the works, though he declines to disclose the players, and says he expects Zynga, a social network video game developer, to make a large acquisition in the region soon.
While not necessarily every acquisition will be of significant size, Bejarano says the cumulative effect of tech start-ups being acquired and demonstrating the viability of exit opportunities to tech investors will increase funding to the sector.
“The only thing that’s missing is local success stories. When young guys have a successful company, that’s what inspires the next generation,” he says.
“The capital markets will open up, particularly in the US,” General Atlantic’s Rochkind says. “For leading companies in areas such as the internet or technology, there will be US market opportunity available for them in the next two years, particularly as US investors are starved for growth.”
He says he expects the local exchanges to become more active as well. “People are starting to recognize the attractiveness of the business models in the internet and software services space. It will be a very hot IPO sector over the next few years.”
Meanwhile, Rochkind says the M&A sector is also heating up, pointing to the CapGemini and Apax deals. “You have a set of strategic acquirers that want to gain access to a very fast growing market,” he says. “You’re going to see a lot of M&A activity in the next few years.”
Some early stage investors appear to be getting involved already. According to LAVCA, a VC association focused on LatAm, VC investment in the information technology sector nearly doubled from 2009 to 2010, reaching $767 million in 2010 from a base of $395 million the year before. Other technology-based sectors saw a spike in new VC capital last year as well, according to LAVCA. The clean tech and alternative energy sector leapt to $731 million in venture funding from $224 million the year before, while life sciences and healthcare combined for a whopping $1.3 billion, up from $160 million the year before, a 717% increase.
“Most likely the exit side of the business will come from a strategic investor from the US,” Muslera says.
“The tech sector within Latin America is going to face very strong growth in the coming years,” says José Rogério Luiz, CFO at TOTVS. TOTVS, a Brazilian software services developer, acquired SRC Serviços em Informatica for $24 million in cash in August 2010. Luiz says he expects to see the LatAm sector continue to grow by double digits in the coming years, partly driven by increased regulatory requirements from Brazil, Argentina and Mexico. In Brazil, for example, companies must now file their taxes electronically, further increasing demand for software solutions.
Luiz also cites the falling price of hardware as another factor leading to increased demand for software service in Brazil and throughout LatAm. “A few years ago, in order to get a very good server, a company had to pay $16,000. Nowadays, with $2,000 you can have a very good server. So companies are buying more hardware. And when they buy more hardware they also demand more software.”
If Brazil and the rest of the region follows the same technology trends seen in North America, Europe and Asia, LatAm may be poised to launch its own Facebooks, Groupons, and Netflixes.
“Latin America presents today a golden opportunity for folks to rewind the clock and invest before the herd stampedes,” Gertsacov says. LF