Experienced Latin American investors understand that today’s financial crisis will present discounted buying opportunities to those with the authority and boldness to quickly negotiate an acquisition and the cash to pay for it. John Price, from Kroll, analyzes how and where to profit from the downturn.

Six years of rapid growth in the region invited a lot of new players into the market, overcrowding supply in several sectors. Tight credit, faltering demand and falling prices put to the test the viability of many players, particularly recent entrants who may have overpaid to compete in the region. Several sectors are overdue for some consolidation.

Retreating Multinationals

Different from the M&A dynamic of an expanding Latin America, acquisition opportunities present themselves very quickly, triggered this time round by exiting multinationals or over indebted multi-latinas. After building a significant presence in Argentina, Brazil and Chile, Ryder Logistics was poised to enter the Colombian market in 2008 when global trade flows slowed and then collapsed, sparking a retreat by the company to its core NAFTA market position (Canada, US and Mexico). Ryder’s exit from South America was swift and muted, without even the bother of an asset sale. The financial need to focus on core and profitable markets is a strong motive for global firms to exit from Latin America, especially if they are recent arrivals still nursing a developing investment. Another motive may be the need to raise cash to repair a damaged balance sheet. RBS has been ordered by its new majority shareholder, the British Treasury, to shed assets, so it plans to sell operations of its subsidiary, ABN AMRO, in Argentina, Venezuela, Chile, and Colombia. Retreating multinationals are the first and possibly the most attractively priced acquisition opportunities presented in the region at this early juncture of the crisis.

Exporters under Siege

The financial crisis hit Latin American markets anywhere from three to nine months after first striking in the US. It is only now, in the 2nd quarter of 2009, that the need to consolidate in over-supplied sectors in Latin America is becoming evident. The first industries to feel the pain of falling demand are the region’s burgeoning commodity exporters. Junior mining companies in Peru and metal manufacturers in Argentina and Chile all share in common a rapid fall from grace as prices collapsed and their debt servicing costs skyrocketed thanks to scarce corporate credit. Cut off from capital markets, junior mining companies are busy flogging their new exploration properties in South America to the handful of cash rich mining majors. But, there are too many junior mining companies looking for too few majors, leaving many stranded and ready to sell to financial investors at discounted prices.

In Mexico, auto parts exporters have watched their US customer demand collapse as two of three US major car companies face bankruptcy. The top ten Mexican auto parts product category exports are anticipated to drop 51% from $53.7bn in 2008 to $26.3bn in 2009. The capital intensive industry cannot survive intact under the scenario of losing half of its revenue. During the last few years, many of Mexico’s auto parts exporters were able to borrow in dollars at historically competitive rates, assured of demand in the US. Now, with a devalued currency and rising corporate debt pricing, the Mexican auto parts sector is under attack from the revenue and cost sides of the profit ledger.

Across Latin America, trade with the US will decline close to 40% in value and an estimated 10-15% in volume. That will place enormous pressure on international cargo players, particularly air cargo in and out of South America and cross-border trucking between the US and Mexico. Latin American players in the space grew market share over the last six years, their expansion fuelled by access to cheap debt. They face the same margin squeeze as auto parts exporters with falling demand, weakened prices and growing finance costs.

Overleveraged Service Sectors

After retreating multinationals and exporters under siege, the third source of distressed assets evolving from this crisis will be capital intensive service sector providers that took on too much debt, too quickly in their effort to grow over the last six years. Retailing, consumer credit, construction, and tourism are all sectors that enjoyed spectacular growth and intra-regional investment in recent years. Consumer credit grew by an average of over 20% per year between 2000 and 2007 (Birth of a New Banking Model, Kroll Tendencias, April 2007). Construction grew on the heels of government spending while fiscal budgets in most countries expanded at 10+% per year over the last five years (Country reports, EIU). Latin American retailers like Pao de Azucar, Falabella and Soriana all fought back against the wave of foreign retailer investment and staked their claim, particularly in middle markets. Latin American hoteliers grew in multiple segments and now face falling demand from both international and domestic tourists. All of these industries were over built and face consolidation. The trigger point will be expiring debt contracts that force these over-leveraged players to shed non-core assets.

Due Diligence is the Key

All three areas of acquisition opportunity reward speed and boldness, the operational advantages of private equity and venture capital as well as wealthy individuals in the region. The private equity sector raised record cash from 2006 to 2008 and is waiting patiently on the sidelines for the fire sale to commence. Strategic investors can join the party of buyers as well but must take pretty extraordinary pre-emptive steps if they are to compete. They will need to line up funding from head office ahead of negotiations, much like a first time house buyer. Most importantly, strategic buyers need to identify targets with sufficient time to conduct reputational due diligence before engaging in negotiations, when financial and legal due diligence activities usually begin. In a time-compressed buying process, due diligence must be swift and pre-emptive.

Due diligence must also be thorough. Fire sales are fraught with risk because the seller is operating from a position of weakness and has every incentive to hide potential liabilities in the hopes of pushing through a quick sale that preserves maximum value of its assets. Certainly, the ability to purchase discounted assets allures buyers but the degree of liability can often overshadow the rewards. The most common liability of cash strapped companies is the non-payment of taxes, particularly value added sale taxes, a form of tax evasion that is a criminal offense for business owners and board members in some Latin American jurisdictions. Other liabilities include unpaid worker wages, AML non-compliance, FCPA non-compliance, as well as internal fraud. Understanding these issues ahead of negotiation may be the key to purchasing at fair market value. Knowing the full extent of any liabilities may be vital to avoiding a regretful acquisition.

About the Author

John Price is Managing Director of Business Intelligence at Kroll in Latin America. Kroll is the world’s leading risk consultancy and the leading transaction due diligence consultancy in Latin America with offices in Miami, Mexico City, Sao Pablo, Bogota and Buenos Aires. Kroll Tendencias is a monthly newsletter focusing on market trends and business risks in Latin America and the Caribbean.

To learn more about Kroll’s services visit www.kroll.com.