2015 was a record-breaking year for Latin American M&A. Western investors were encouraged by the advantageous emerging market climate which exhibits low-interest rates, cheap debt financing and dilutive cash hoards. The first quarter of 2016, has comparatively been characterised by uncertainty.
“Perhaps, inevitably, global M&A has found it’s cooling after 2015’s record deal making – in effect a sort of rebalancing”
The slowdown in the Chinese economy causing stock markets to fall by a third has depressed commodity prices. As a cornerstone to the Latin American economies, commodity devaluation has exerted a significant degree of volatility in the region, diverting the attention of Mergers and Acquisitions investors.
The primary concern is in Brazil, where the doubts surrounding the Petrobras scandal has resulted in the on-going impeachment of President Dilma Rousseff. She faces charges including the manipulation of government finances and the obstruction of Petrobras investigations As the chairwoman of nationalised oil company during the height of the scandal, 2010-2013, Rousseff has subsequently been accused of funding her election campaign with Petrobras profits. If she is to be removed, Vice President Temer will take over as acting President of Brazil. However, he too could face impeachment charges. Not only has this created a cause for concern for investors, but with 352 out of the 594 sitting politicians facing accusations of criminality, there are serious doubts about the future of the nation’s democracy. Many politicians are calling for early elections, which will potentially involve the drafting of a new legislation and the revision of the constitution.
As a result, two out of three of the investors taking part in Mergermarket intelligence reported that the Petrobras scandal made it more difficult for other domestic businesses to secure financing. Indeed, the Brazilian stock market has lost US$197 billion in value. Brazil, the region’s primary M&A dealmaker, previously accounting for half of the quarterly activity in both deal value and volume has not maintained this position. Its total market share halved, reaching 25.9% by value down by 27.9%, while the volume of deals decreased from 48% to just 11%.
Furthermore, Mexico, the second largest contributor to M&A deals in Latin America, displayed a weak performance with only 14 deals representing US$547million in Q1. This is the lowest value the country has seen since Q3 of 2010. Mergermarket intelligence predicts a weak average deal value around US$20m or less. Mexico has been subjugated to a parallel corruption scandal in the takeover of Oceangrafia by the government. The IMF cut the economic forecast for Mexico in November. Both have strained the reputation of the region and discouraged some investors. The graph demonstrates the sharp decline in M&A deals in 2016
Where do the prospects lie for M&A in the region?
Expectations should remain high amongst potential investors in the region. On the whole, the region still demonstrates advantages definitive of the emerging markets. They have succeeded in shaking off the recession more quickly than the developed countries have, and Nirmalya Kumar, of the London Business School, points out that emerging markets are less interested in cutting costs through greater efficiency and lower headcount because they know that they can plug their acquisitions into their low-cost production machine at home. Ownership is concentrated, and hence, the emerging market companies find it easier to take risks.
According to the Market Merger Intelligence, oil, gas and mining, and consumer industries are the major ones to watch in the coming year, following AT&T’s US$1.5billion move to acquire Mexico’s Nextel in the TMT space. This is a result of attractive pricing in oil and gas sectors were valuations have fallen. The local currencies have also slipped against the dollar.
Latin America is making progress towards a more balanced regulatory environment. Regulation improvements in the region were highlighted by the World Bank report ‘Doing Business’ which listed resolving insolvency alongside start-ups, receiving credits and trading across borders. In particular, Chilean insolvency laws have created specialised insolvency courts and enhanced debtor protection. The Chilean economy grew by 2.2% from 2015. Moreover, Peru has introduced a new online registry of employee information, which makes it easier for companies to pay taxes at a reduced rate for corporate income.
Free elections in Argentina have placed Republican Mauricio Mari in power, who promises to open up growth prospects for new businesses and make financial reforms following the conclusion of 12 years of Kircherism. Most likely the liberalisation of trade will boost energy and consumer sectors and support new M&A activities. Political stability is also emerging in Colombia, whereby the Revolutionary Armed Forces reaching a common ground may open the country to further business and investment opportunities.
Moreover, Latin American economies are less dependent on commodity wealth than they were previously, having diversified into consumer deals. These now count for 32% of M&A across the region.
Chile, Peru and Argentina may conduct smaller deals, but they are more frequent and are on the rise. With less risk, they still carry the potential growth rates characteristic of the emerging markets. Rich resources and strong institutions in these Latin American countries are favourable environments for foreign investors. As bank lending as been strong in these regions, 90% of investors believe that capital will increase, meaning that there is more finance available to fund the deals.
“It will be a difficult year ahead for the region’s primary players, Brazil and Mexico, as Petrobras and other related scandals have understandably deterred M&A investments. However, the impact on Latin American M&A can be geographically isolated. With emerging countries making a larger contribution to M&A deals than before, the region may experience a rebound. Investors should look towards consumer sectors in order to extract potential and avoid risk. It is a challenging territory to navigate, but whilst the rewards remain characteristic of the region, they are to be found in different areas than before.