Chambers Latin America Guide 2020: Online Overview
Political and Economic Background
In 2018, Brazil broke a long succession of administrations led by a coalition of the left-wing PT and centrist PMDB political parties. The heated election of President Bolsonaro came in the wake of a period of political turmoil, following corruption scandals and the impeachment of a president. During his campaign, the new president promised a liberal economic agenda, in stark contrast to the interventionism that permeated previous administrations.
So far, the new government has pursued a positive economic agenda, aiming at approving major reforms to the country’s pension and tax systems, reducing government bureaucracy, curbing public spending, stabilizing public accounts, creating an investment/market-friendly environment and selling state-owned companies and disposing of assets.
In a snapshot, Brazilian economy is recovering steadily but slowly. Official forecasts set an expected GDP growth below 1% and reduced inflation projected to be lower than 4% in 2019. Unemployment rate, according to official statistics, is still high (around 12%) but falling. By the end of October 2019, the base annual interest rate (SELIC) was reduced to 5%, a record low, against this backdrop of low inflation, structural reforms and an expected economic rebound, the future looks promising for both capital markets and M&A transactions.
The government agenda of reforms includes proposals to pass new legislation which may impact business in general. The list below highlights a few matters addressed by recent legislation (adopted both by the current and the previous administration) which may affect the corporate and M&A landscape:• definition of bright-line rules regarding limitation of liability and disregard of legal entity, both for companies and investment funds;
• reduction in state intervention in private economic activity, including requirements for authorization and permits for certain activities, reduction of state bureaucracy for starting new businesses, enforcement of contracts among private parties;• end of the mandatory requirement to publish corporate and accounting documents in newspapers and official gazettes, with significant savings for Brazilian companies;
• comprehensive reform of labour laws (some of which dated back to the 1940s), to permit flexible working arrangements, reduce burdens imposed on business entities and reduce litigation;• approval of a data protection law in 2018, coming into effect in 2020, imposing the adoption of strict data compliance rules.
With respect to the tax reform, in particular, prospective legislation may significantly affect the corporate landscape, aiming at reducing overall tax burden and simplifying an intricate tax system which combines federal, state and municipal taxes. While the tax reform is still under discussion, it is expected to include a number of key tenets, including:
• taxation of dividends (which since 1996 are fully tax exempt in Brazil regardless of the location and nature of the recipient) and, on the other hand, reduction of corporate income tax;
• elimination of a number of different municipal, state and federal taxes that should be substituted by a single federal VAT;
• reduction or elimination of social security contributions over the payroll.
The government agenda for reforms also includes a number of components that are necessary to foster investment in several sectors, especially regulatory landmarks for specific sectors, such as sanitation, cable TV/streaming and airports. We also expect changes to regulation affecting oil & gas assets, following the results of the latest bidding process conducted by the government to sell concessions for exploration.
The Brazilian Securities Commission (CVM) has been active in its enforcement role and is proposing and passing new regulation affecting publicly-traded companies and investment funds, both key players in the corporate/M&A world. On the regulatory front, a few examples are rules for proxy and distance voting, which significantly impacted shareholders’ meetings, disclosure of a “comply or explain” form addressing significant aspects of the company’s corporate governance framework and reforms to the regulatory framework of investment funds. On the enforcement side, the CVM continues to pursue cases involving insider trading, market manipulation, inadequate disclosure and breaches of fiduciary rules. Recent regulation changed the framework for enforcement action, including with respect to leniency agreements, following the approval of new legislation that increased the enforcement capacity of both the CVM and the Central Bank.
Proposed regulation under discussion by the CVM includes requirements to approve shareholder litigation, which could impact shareholder activism strategies, review of certain tender offer and accounting rules as well as a revised framework for investment funds.
M&A: Current activity, trends and developments
M&A activity in Brazil remains strong and is likely to benefit from a continuing development of economic conditions, structural reforms and increase in investor confidence. The country benefits from a stable democracy (despite the recent political turmoil), a large internal market and several major conglomerates, both purely local or controlled by foreign players.
2018 and 2019 have seen a number of big-ticket transactions in Brazil, including both domestic and cross-border transactions, pursued by strategic and financial players. A few examples are the merger of pulp and paper giants Fibria and Suzano, the acquisition of Eletropaulo by Enel, the acquisition of education company Somos Educação by a subsidiary of Kroton, the acquisition of CPFL Renováveis by State Grid, and the acquisition by Advent International of Walmart’s local operations.
We expect this strong M&A activity to continue in 2020 and 2021, assuming continuing economic development, structural economic reforms and a stable – relatively speaking – political scenario. Major trends on the deal side should include:
• Sale of assets by public entities, in privatizations, divestments by public and mixed-capital companies (including Petrobras) and public offerings of shares, as part of the government policy to deleverage and reduce its influence and exposure in private enterprises;
• Transactions involving infrastructure assets (some of them distressed), both as a result of divestments by public and state and privately owned companies, concessions (airports, sanitation, roads, ports etc.);
• Cross-border acquisitions, as exchange rates continue to make the price of local assets attractive;
• Technology-driven investments and acquisitions, both as a result of private equity and venture capital investments and of established companies aiming to add tech-components to its core businesses;
• Continuing consolidation in specific sectors, including healthcare, education and agribusiness;
• Acquisitions pursued by public companies, following an anticipated increase in IPOs and follow-on offerings;
• Sale of distressed assets; and
• Reshuffling of real estate assets, with an increasing participation of real estate funds as a result of lower interest rates.
Prospects, Challenges and Opportunities
Despite the positive outlook and a relatively investment-friendly environment in comparison with other emerging markets, Brazil can be a challenging arena. However, we believe prospects for clients in 2020 are good, to the extent companies plan carefully.
Major challenges in Brazil relate to economic growth. As discussed, a number of structural reforms have been made and more are under discussion. The precise timing and content of these approvals, however, is uncertain, and effective results depend on a number of circumstances, including the political landscape and how courts will uphold new legislation. All of these factors pose obvious difficulties for corporate planning.
Nonetheless, this difficult scenario creates opportunities for businesses. For example, we are seeing a number of tech-based companies building businesses based on eliminating or bridging gaps created by inefficiencies in many sectors, such as fintechs and healthtechs that have emerged recently. Another example would be companies that are well capitalized, due to strong generation of cash, or through tapping capital markets or receiving private equity investments, could take advantage of this moment to grow by acquisition in order to consolidate and diversify. On the finance front, banks are increasingly trying to develop alternative and creative funding structures, which can permit new leveraged acquisitions, particularly given that BNDES is downsizing its operations and project finance is not particularly developed in Brazil.
Exploring business opportunities in an effective manner will require anticipating and preparing for changes on many levels. In this challenging new scenario, we expect the typical corporate/M&A work to be increasingly multidisciplinary and highly technical, and that clients will rely on legal counsel, more and more, not simply for transaction planning but as an integral part of business strategy.