Tuesday, March 29, 2011

In Brazil, No Room for Leverage at Buyout Firms

SÃO PAULO, Brazil — “We use zero leverage.”

Luiz Otávio Magalhães, the founding partner of one of the most successful private equity firms in Brazil, was trying to explain his business model to me. His leveraged buyout firm, Patria, easily garners more than 20 percent returns annually. 

That kind of performance attracted the attentionof Steven Schwarzman, whose Blackstone Group bought a 40 percent stake last year.
Yet this L.B.O. fund is, uniquely, missing the “L.”
“Zero,” he said again, as if to underscore the point.
Billions of dollars are rushing into Brazil’s economy. International private equity firms like Blackstone and the Carlyle Group are scrambling to capture of a piece of this emerging market before it has fully emerged. JPMorgan Chase recently bought 55 percent of Gávea, a seven-year-old investment fund with $6 billion under management co-founded by Arminio Fraga, the former president of the central bank of Brazil from 1999 to 2002.

But perhaps the most unusual aspect of the private equity industry here is that its success thus far has had nothing to do with burdening its acquisition targets with heaps of debt. Indeed, this version of the private equity business is exactly the opposite: improving a company’s operations instead of turning to financial engineering to squeeze out performance. It is a mantra that many private equity firms in the United States and Europe pay lip service to but do not follow in practice.
The reason that private equity firms in Brazil do not use debt is simple. In Brazil, money does not come cheap, Mr. Magalhães explained over coffee in the firm’s offices along one of the main sections of downtown São Paulo.

A private equity firm looking for a loan from a bank in Brazil might have to pay as much 20 percent interest annually. A loan in the United States, on the other hand, might pay only about 6 percent. The reason for the lack of leverage, at least for now, becomes obvious.

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