Brazil: Latin America M&A—the Year Ahead: Activity And Trends

In Short

The Situation: M&A activity in Latin America is poised for a comeback following a difficult 2020, during which the COVID-19 pandemic heavily impacted a region already burdened with political and social unrest and deep structural weaknesses. 

The Upshots: We expect a substantial increase in M&A activity in the region with opportunities stemming from an increased digitalization of the region's economies, rising interest in the new infrastructures and energy packets adopted during the pandemic, and greater opportunity in the supply chain and manufacturing spaces. We also anticipate the region to benefit from President Biden's "Root Causes Strategy" framework, which includes proposals to advance the rule of law and create labor opportunities in Mexico and Central America.

Looking Ahead: Opportunities for growth in Latin America will present in many sectors, with mobile banking, e-commerce, tech, consumer retail, and real estate paving the way. In particular, we expect Brazil to carry the lion's share, with jurisdictions such as Mexico, Colombia, Peru, and Chile also contributing to regional growth. Investors can expect 2021 to be a buyer's markets, with earnouts, comprehensive material adverse effect ("MAE") clauses, and holdbacks or indemnity escrows that are larger and longer in duration continuing to dominate the market.

On February 2, 2021, President Biden signed an executive order to address "the root causes of irregular migration," asking relevant federal agencies to develop a "Root Causes Strategy" that identifies and prioritizes "actions to address the underlying factors leading to migration in the region," and include proposals to advance the rule of law, promote respect for human rights and labor rights, and address economic insecurity and inequality. Addressing the root causes of migration through the creation of labor opportunities in the region, and advancing the rule of law, will mobilize hundreds of millions of dollars in U.S. capital available to companies seeking to do business in Latin America.

This new Root Causes Strategy comes at a time when companies are broadly reassessing their supply chains for many reasons—trade wars, COVID-19, national security concerns, pressure from courts and legislatures all over the world to eradicate forced labor—and companies should anticipate heightened scrutiny, enhanced due diligence, stronger reporting and compliance procedures, and increased litigation risk relating to supply chain challenges.

We expect a substantial increase in M&A activity in Latin America to benefit from this new Root Causes Strategy and help successfully establish or strengthen supply chains throughout the region. In addition, as described below, we anticipate a boost in environmental, social, and governance ("ESG") investing in the region, a push by investors to capitalize on the increased digitalization of the region's economies as a result of the pandemic, and strong interest by investment funds in the new infrastructure and energy packages adopted during the pandemic. Successfully navigating these transactions in a region with deep structural weaknesses will be a challenge for many clients in 2021. In this Commentary, a number of our M&A partners throughout Latin America provide their perspective and identify trends that might help anticipate recurring risks.

What Defined the Latin American M&A Market in 2020?

María Luisa Cánovas: Foreign direct investment in Latin America fell 44% during the first nine months of 2020. The pandemic hit a region already saddled with political and social unrest and with deep structural weaknesses, pushing the region's economies into deep recession. Overall, uncertainty was prevalent in the market, which was dominated by strategic buyers. Prolonged lockdowns made it more difficult to determine the value of businesses, slowed down due diligence processes, and heightened compliance concerns, which resulted in deals often taking longer to put together and bring to closing. 

Enrique Martin: The overall deal market in 2020 fell to record lows, but showed signs of recovery during the second half of the year. The pandemic has presented savvy investors with opportunities to deploy accumulated capital into sectors that have benefited or grown despite the pandemic. For example, technology M&A increased by 29% by value compared to 2019, highlighting the growing tech sector in Latin America. The uptick in early stage and venture capital activity involving alternative investments is also noteworthy.

Which Sectors Will Lead the Way for M&A in 2021?

María Luisa Cánovas: Infrastructure, energy and projects will lead the way across the region, with a renewed interest in ESG investing mostly from established players in the United States, France, and Germany. In addition, we expect that the boost experienced by Mexico in its manufacturing sector during the third quarter of 2020 will continue and extend to other jurisdictions well suited to the relocation of global supply chains currently underway. Consolidation in the life sciences, tech, and fintech industries is also expected to continue, with companies tapping into the increased digitalization of the region's economies as a result of the extensive migration of customers to digital services during the pandemic. 

Enrique Martin: Private equity firms with excess liquidity will likely become increasingly aggressive in their efforts to capitalize on Latin America's "technological gap" in 2021. We have already seen this year a surge in deal activity involving the outright or partial acquisitions of earlier stage tech companies in the region that are well positioned to grow through the remainder of the pandemic. Savvy investors will likely continue pursuing these opportunities throughout the region using earnout mechanisms and minority investments tied to negotiated exit rights in an effort to achieve high returns from modest investments in high growth businesses. In addition, investments within the infrastructure development, energy, and mining sectors may become more attractive to U.S. and foreign corporate buyers who are looking to capitalize on the combination of record low interest rates and weak local currencies to achieve outsized returns on distressed assets. Long-term strategic investors from China will also likely continue to seek targeted acquisitions in critical infrastructure as part of a comprehensive plan to expand their geographic footprint throughout Latin America.

Which Geographies Are Better Positioned for M&A in 2021, and Why?

María Luisa Cánovas and Enrique Martin: The mobile banking, e-commerce, tech, consumer retail, and real estate sectors are expected to pave the way for Latin America's rebound in 2021, with Brazil carrying a lion's share, and jurisdictions such as Mexico, Colombia, Peru, and Chile also contributing to regional growth. The Latin American renewable energy, prepackaged food, education, and healthcare sectors should also see solid growth in 2021. In addition, President Biden's $4 billion investment plan to decrease violence, corruption, and poverty in El Salvador, Guatemala, and Honduras in an effort to address the root causes of migration into the United States is expected to have a positive impact in companies looking to reallocate their supply chains to Mexico and Central America. 

Which Trends and Opportunities Will Characterize the Deal Market in 2021?

Wade Angus: U.S. and European companies and their shareholders, as well as global private equity and sovereign wealth funds, have focused on ESG criteria in investments and acquisitions, which has had a significant impact on M&A and private equity investing in the United States and Europe. ESG (especially environmental and social development) will become a greater focus in Latin American M&A and private equity investments in 2021 and beyond. Private equity and sovereign wealth investors have already had an impact on how many Brazilian targets focus on ESG initiatives to attract international investors. ESG will be a focus in Brazilian cross-border transactions in particular, given the federal government's policies on the Amazon that have raised concerns in Europe and the United States on the environmental and social policies of many Brazilian companies. In addition, the robust capital markets in Brazil during the second half of 2020, which included a number of IPOs, have brought a renewed focus on corporate governance to attract foreign investors and potential international acquirors. 

Marcello Hallake: Brazil is on the verge of enacting new legislation to regulate its natural gas market, which should increase competitiveness by breaking the natural gas monopoly of state-owned Petrobras and generate investment opportunities in this sector. Privatizations of state-owned companies are expected to continue in 2021, but it remains to be seen whether and to what extent the most attractive assets will make it to market before the Brazilian 2022 presidential election. In addition, as pointed out above, foreign investors will favor ESG-friendly companies. Finally, we expect an increase in M&A activity from some of the Brazilian companies that went public through IPOs in the second half of 2020, and which by doing so reduced M&A activity by favoring exits through the capital markets rather than by private sales. In general, we anticipate that in 2021, historically low interest rates will continue to motivate investors toward equity investments favoring higher returns, and that some of the larger Brazilian companies will continue to look for acquisition opportunities abroad in an effort to diversify risk. 

María Luisa Cánovas and Manuel Romano: In Spanish-speaking Latin America, we expect that 2021 will be a buyer's market. This means that earnouts, comprehensive MAE clauses, and holdbacks or indemnity escrows that are larger and longer in duration (given limited availability of representation and warranty insurance) will continue to dominate the market except for top assets. In addition, the integration of ESG considerations in M&A activity will increasingly affect Latin America's deal flow and impact the acquisition process, from selection of targets and business partners to due diligence. Among investment opportunities, in light of the impact of the COVID-19 pandemic on supply chains and the new policies of the Biden administration, we expect that Latin America will attract significant investment, particularly in manufacturing, with Mexico as a top beneficiary of this opportunity given its proximity to the United States and its "new" NAFTA treaty (the USMCA), and in energy and infrastructure projects. During the second half of 2020, several countries, including Mexico, Chile, Colombia, and Peru, announced energy and/or infrastructure investment plans totaling tens of billions of dollars. In Mexico, for example, the government and the CCE, a body that brings together the main Mexican business associations, announced a first package of infrastructure projects to address the pandemic crisis in early October. This first package includes 39 projects worth about US$14 billion, of which half will be financed with private contributions, according to the CCE. Enabling many of these plans is the public-private partnership model, which looks to become even more instrumental as governments face budgets depleted by the pandemic. The success of these opportunities could be critical to a sustainable recovery of the region.

Three Key Takeaways

1. While the COVID-19 pandemic severely impacted deal trends in Latin America in 2020, it has also presented savvy investors with opportunities to deploy accumulated capital into sectors that have benefited or grown despite the pandemic. 
2. Infrastructure, energy and projects will lead the way across the region, with a renewed interest in ESG investing, following trends in the United States and Europe where ESG investing has had a significant impact in the M&A and private equity markets.
3. In Brazil, historically low interest rates will continue to motivate investors toward equity investments favoring higher returns. In addition, increased activity in capital markets in Brazil during the second half of 2020 has brought renewed focus to corporate governance practices in order to attract foreign investors and potential international acquirors. We also expect Mexico to be a top beneficiary of new investment opportunities in the region, particularly with respect to the reallocation of supply chains, and the manufacturing and infrastructure sectors.