Never waste a good crisis
Monday, 20th April 2015
Much ink has already been spilt analysing the impact of Brazil’s economic slowdown, but amid the doom and gloom, there are also opportunities to be had for investors willing to take a risk. Evy Marques, Paulo Campana and Thiago Medaglia, who coordinate Felsberg Advogados’ distressed M&A department, highlight the issues they should be aware of when seeking to bag a bargain.
Successive drops on BM&F Bovespa, Brazil’s most important stock exchange, brought about by the slowdown in the Brazilian economy and ongoing scandals in the infrastructure and oil and gas sectors, have led to a sharp devaluation in the securities and commercial papers of the companies involved. On top of this, the acceleration and greater liquidity of the US economy, the devaluation of the Brazilian currency and the continued need for infrastructure in the country are creating opportunities for those who know where to look.
This scenario favours the development of transactions aimed at acquiring companies or the assets of companies in financial difficulties. These distressed M&A operations, as they are known internationally, became more viable with the reform of the Brazilian bankruptcy law in 2005 and, with the crisis that followed it, the market has seen 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 make Brazil a more fertile ground for this sort of business than it was a decade ago.
Evy Marques, Thiago Medaglia and Paulo Campana
Time is of the essence
Distressed M&A operations are very different from traditional mergers and acquisitions. The risks involved are bigger, including those related to the execution of the project, due to the existence of different interests that often conflict, and which emerge and govern an insolvent company. The shareholders and administrators may, for example, find themselves compelled to sell against their will due to pressure from creditors. Or there may be creditors committed to either blocking the sale of assets, or fighting for the return from the sale to be used to pay them rather than other pressing cash needs.
Due to the risks, the majority of these operations are structured in the form of an acquisition of assets, rather than equity interest, so that the investor does not inherit the debts and the related 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 without inheriting the liabilities attached to the debtor company, including those of a tax or labour nature, has become one of the great attractions for acquisitions within the areas of bankruptcy or judicial restructuring.
Distressed M&As are usually processes that move ahead very quickly, 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 recognised 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 debtor company’s creditors are usually extremely eager to snatch up the amounts paid for the acquisition.
The white knights, namely investors supported by the debtor company’s administrators, may be real-life saviours in winning over the creditors. But Brazilian law also provides mechanisms, even though they are little used, for black knights, defined as investors who pit themselves against the debtor company’s administrators, who may encourage a hostile takeover, notably in bankruptcy processes. 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 process, maximise the amounts paid and allow greater security for potential investors. In this type of scenario, a stalking horse, that is 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 diverse interests involved. The creativity required of the professionals involved in these types of operations challenge the application of old and well-tried formulas. Even faced with all these challenges, the increasing frequency of distressed M&As, 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.
This article is based on an article originally published in Brazilian business news daily Valor Econômico.