Political and Economic Background
As is happening throughout the world, 2020 is being a challenging year in Brazil. The outbreak of the COVID-19 pandemic has caught the country clearly unprepared for an unparalleled humanitarian crisis with deep implications for the economy.
The current administration, elected in 2018 amidst a wave of optimism towards much needed economic and structural reforms, was forced to switch to a crisis-management mode, including several economic relief measures which threatened the fiscal austerity policy required for reforms. This unfavourable scenario, coupled with highly criticised reactions to the pandemic, consumed political capital and weakened support in Congress.
Despite the clear difficulties and challenges, the economic branch of the government continues to pursue its liberal agenda, aiming at approving major reforms to the country’s tax system, curbing public spending (a particularly tough challenge given the circumstances), passing new legislation on key sectors, stabilising public accounts and selling state-owned companies and other assets.
In a snapshot, the Brazilian economy took a serious hit. Official figures set an expected GDP reduction of 5.5%, and unemployment rate is currently at 11.9%. However, inflation is measured at 2.4% in the 12-month period ending in June 2020, and by August 2020, the base annual interest rate (SELIC) was at 2.0%, a record low.
New legislation in 2020 leaned naturally to dealing with and mitigating the impacts of the COVID-19 pandemic. A few examples were standstills in tax payments and long-term financing, flexibilisation of labour rules, restriction of exports of medical supplies and rules for technology applied to life sciences, hospitals and medical procedures. On a state and local level, government authorities were forced to deal with the new circumstances, issuing laws and regulations limiting certain activities and restricting circulation in public areas, which deeply affected industries like aviation, hospitality, retail and real estate.
Besides this emergency reaction, other laws enacted may have major implications in the corporate/M&A landscape, such as laws and regulations fostering and simplifying the sale of public assets, including real estate property.
Much attention has been given to a recently approved new legal and regulatory framework for basic sanitation, establishing the grounds for the privatisation of the existing state-owned entities and the grant of new concessions for the exploitation of treated water, sewage and garbage disposal. These sectors require substantial investments over the next years, which is drawing the attention of strategic and financial players.
With respect to 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 involve certain substantial topics, 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 taxes);
• elimination of a number of different municipal, state and federal taxes that may be substituted by (i) a single federal VAT or (ii) a federal VAT and a state VAT; and
• reduction or elimination of social security contributions over the payroll.
The government agenda for reforms also includes a number of topics that are necessary to foster investments in a number of sectors, especially regulatory landmarks for specific sectors, such as natural gas and pay TV/streaming. Changes to regulation affecting oil & gas assets are also expected, following the results of the latest bidding process conducted by the government to sell concessions for exploration.
The Brazilian Securities Commission (CVM) has been quite responsive in its reactions to the pandemic. The agency has been quick to extend regulatory deadlines, issue guidance with respect to disclosure and regulate online shareholders’ meetings, following amendments to the Brazilian Corporations Law. On the enforcement side, the CVM continues to pursue cases involving insider trading, market manipulation, inadequate disclosure and breaches of fiduciary duties. Proposed regulation under discussion by the CVM includes topics like public offering of securities and investment funds, and regular review of accounting rules.
M&A: Current activity, trends and developments
Despite the COVID-19 pandemic, M&A activity is proving to be resilient, and prospects by mid-2020 are positive.
Certain sectors of the economy were obviously affected. For example, shopping malls, retail, airlines and airports have been drastically affected by measures requiring social isolation, and certain healthcare sectors which have seen a reduction in demand for services that command higher prices. In other sectors, however, business, new investments and M&A are thriving. To give an obvious example, there are currently unprecedented investment opportunities in telecoms infrastructure, related to the expansion of the optic fibre network throughout the national territory, with broadband demand in a peak.
The years of 2019 and 2020 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 sale by Petrobras of its stake in TAG – Transportadora Associada de Gás, the acquisition of power distribution company Eletropaulo by Enel, the acquisition of pharma company Takeda’s operations in Brazil, the sale of power transmission company Argo by Patria Investimentos, the formation of a joint venture between Bunge and BP to explore biofuels and the acquisition of Clinipam by Intermedica.
We expect this level of activity to continue in 2020 and 2021. Major trends on the deal side should include:
• Continued programs of sale of assets by public entities, in privatisations, divestments by public and mixed-capital companies (such as the sale of oil refineries and gas distribution assets by Petrobras);
• 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.);
• Transactions involving assets in the telecommunications sector, as major carriers spin-off fixed assets (fibre, towers and data centres) into new joint ventures with financial players, the market of internet service providers is under consolidation, Copel has initiated the privatisation of its subsidiary Copel Telecom and Oi, currently under judicial recovery, seeks the sale of strategic assets;
• Investments in the sanitation sector, following the approval of new legislation reshaping the regulatory framework, allowing both privatisations and new concessions and PPPs;
• 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 (a continuing trend fostered by the effects of the pandemic);
• 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 and stock-for-stock transactions;
• 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 current macroeconomic scenario, investments in general, and M&A in particular, are gaining momentum following the initial shock caused by COVID-19, and we believe prospects for clients in 2020/2021 are good, to the extent companies plan carefully. Brazil is a large country with a huge population, a stable democracy and an investment-friendly environment in comparison with other emerging markets, as, for example existing laws do not impose major restrictions on foreign investment, except in some very limited cases.
Major challenges in Brazil relate to economic growth. As discussed, a number of structural reforms have already been made, but other critical ones are still under discussion. Precise timing and content of such reforms, however, is uncertain, and effective results depend on a number of circumstances, including political landscape and how courts will uphold new legislation. All of these factors pose obvious difficulties for corporate planning.
This difficult scenario, however, creates opportunities for businesses, as the difficult times during the pandemic have shown. 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 emerged recently. On another example, companies that are well capitalised, due to strong generation of cash, tapping capital markets or receiving private equity investments can take advantage of the moment to grow by acquisition, to consolidate and to diversify. On the finance front, banks are increasingly trying to develop alternative and creative funding structures, which can permit new leveraged acquisitions, as the BNDES is downsizing its operations and project finance is not yet particularly developed in Brazil.
Exploring business opportunities in an effective manner will require anticipating and preparing for changes in 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, as an important component of business strategy, not only transaction planning.