The Crisis and its Investment Opportunities
By Evy Marques, Paulo Campana and Thiago Medaglia
The slowdown in the Brazilian economy, together with the repeated scandals involving the infrastructure and oil and gas sectors, have brought about successive drops on São Paulo’s stock exchange and a sharp devaluation in the securities and commercial papers of the companies involved. On top of this, one can also add the acceleration and greater liquidity of the US economy, the devaluation of the Brazilian Real and the desperate need for infrastructure.
This scenario favors the development of transactions aimed at acquiring companies or the assets of companies in financial difficulties. These distressed M&A transactions became more viable with the reform of the Brazilian Bankruptcy Law in 2005 and, with the crisis that followed it, the market witnessed their increased appearance.
Operations involving distressed assets attract investors who are willing to accept a higher degree of risk in exchange for greater and faster return. If the slowdown of the Brazilian economy is enough, in itself, to attract the attention of this type of investor, the abundance of offers and the existence of legal mechanisms and contractual structures capable of reducing the risks seem to eventually make Brazil a more fertile ground for this sort of business than it was a decade ago.
Distressed M&As usually move ahead faster in order to stem the inevitable devaluation of a company’s assets
Distressed M&As are very different from traditional mergers and acquisitions. The risks involved are higher, including those related to the execution of the project, due to the existence of different interests, that are very often conflicting, and which emerge and govern an insolvent company. Shareholders and administrators may, for example, find themselves compelled to sell assets against their will due to pressure from creditors. Or there may be hold-out creditors committed to either blocking a sale of assets or to fighting for the proceeds from the sale to be used to be distributed among them rather than any pressing cash needs.
Due to the risks, the majority of these operations are structured in the form of acquisition of assets, rather than equity interest, so that the investor does not inherit the debts – and the problems – of the company that has gone under. Brazil’s Bankruptcy Law provides legal mechanisms that make it possible to separate the assets from the liabilities meaning that a potential investor can acquire goods at the price they are effectively worth on the market, without having to pay the bill that others bring with them. The possibility of transferring a corporate activity free and clear of the liabilities of the debtor company, including those of a tax or labor nature – not too dissimilar from a U.S. §363 sale, but which was unheard of in the country 10 years ago –, has become one of the great attractions for acquisitions within bankruptcy or judicial reorganization proceedings in Brazil.
Distressed M&As are usually processes that move ahead very quickly, basically in order to stem the inevitable devaluation of the assets of an insolvent company. Due to the serious time limitations, as well as the previously recognized situation that the liabilities of the selling company may well far outweigh its assets, the due diligences performed tend to be much more limited in terms of its scope and, depending upon the investor’s desire to go ahead, even non-existent. The most common guarantees an investor has may be simply a pipe dream, since the creditors of the debtor company are usually eager to snatch up the amounts paid for the acquisition.
The “white knights” (i.e., investors supported by the debtor company’s administrators) may be real-life saviors in winning over the creditors. But Brazilian law also provides mechanisms, even though they are little used, for “black knights” (i.e., investors who pit themselves against the debtor company’s administrators) who may encourage a hostile takeover, notably in bankruptcy processes, in which shareholders and administrators are removed from the management of the company. In certain situations, the acquisition may be performed by means of a competitive process (such as a judicial auction), as a means of bringing transparency to the operation, accelerate the sale, maximize the amounts and allow greater security for potential investors. In this type of scenario, a “stalking horse” (i.e., the investor who makes the first bid) may well benefit due to having entered the “race” for the assets of an insolvent company early on.
Whatever the case, distressed M&As are risky operations. The buyer’s guarantees are much more tied to the solidity of the legal mechanisms employed for the acquisition than to the remote possibility of having any possible damages reimbursed by a company tied up in debt. These operations clearly require great care and specific guarantees for the sellers and the buyers, as well as analysis of the risks and contingencies, the different tax structuring involved, and coordination of the multitude of interests involved. The creativity required of the professionals involved in these types of transactions challenge the application of old and well-tried formulas. Even faced with all these challenges, the increasing frequency of distressed M&As in Brazil, pushed on by the opportunities they offer, appears to be a collateral effect of the slowdown in the Brazilian economy and the recent scandals which have been appearing in the news with more and more frequency.
Evy Marques, Paulo Campana and Thiago Medaglia are the Coordinators of the Distressed M&A area of Felsberg Advogados and, respectively, partners in the Corporate, Insolvency and Tax departments.
This article reflects the opinions of the authors and not those of Valor Econômico. The newspaper assumes no responsibility and cannot be held responsible for the above information or for damages of any nature that may arise as a result of the information presented.