Brazil: Opportunities in Latin America's Largest Economy

When the term "BRICs" (Brazil, Russia, India and China) was first coined in 2001 by Goldman Sachs economist Jim O'Neill, many thought that Brazil did not deserve to be included in the group. Some Brazilians themselves have been skeptical of their country's inclusion among these fast-growing emerging markets given the economic and political volatility that has marked Brazil's history. Today, however, global businesses and the investment community have turned their attention to Brazil, recognizing the country as one of the leaders within this group of future economic powers.

Like most global economies, Brazil benefitted from the boom in the middle of the first decade of the 21st century, emerging from the dot-com bust and the Argentina default in 2002 to produce average real GDP growth of 4.8% per-year from 2004 through 2008. With the onset of the global financial crisis, Brazil's economy slowed down appreciably in 2009, and real GDP growth was flat. This slowdown, however, was largely caused by external factors as opposed to internal economic issues within Brazil. For example, the highly-regulated Brazilian banking system showed limited signs of weakness, and no banks in Brazil defaulted during the crisis. And since exports represent a relatively small percentage of Brazilian GDP (14.3% in 2008, compared to 24.0% in India and 35.8% in China), the Brazilian economy was less suseptible to the global crisis.

As a result, Brazil emerged from the recession quite quickly in the second half of 2009, and the economy grew 9% in the first quarter of 2010. Economists predict GDP growth of 6-7% (or higher) in 2010, with continued strong growth of 4-5% over the following years. A significant portion of this growth will be driven by the Brazilian consumer, a theme that has become an important area of focus for global investors. The buying power of Brazilians is rapidly increasing, as evidenced by a number of very positive data points:

• Per-capita GDP stands at R$16.4 thousand, representing a 10% CAGR since 2000 (in nominal terms); Brazilian per-capita GDP is approximately four times that of China.

• Unemployment rate has declined from 12% in 2003 to a record low of 7% currently.

• The percentage of Brazilians in the lowest income brackets (classes D and E) shrunk from 56% in 2000 to 35% in 2009.

• During the first quarter of 2010, retail sales grew 21% in annualized terms and 16% year-over-year.

Despite these positive trends and the strong economic outlook, there remain fundamental issues within Brazil that could hamper the country's ability to continue to grow at high rates. First, Brazil's education system needs to improve significantly to be able to produce the quality of workers required to support the country's ambitions. Today, half of all students drop-out before high school, and only 10% of students graduate from college. The government provides free education to students in K-12 schools, although the quality of this schooling is generally quite poor. Paradoxically, the best universities in Brazil are public institutions, where free tuition is offered to students - most of whom come from higher-income families and attend private high schools where they receive the necessary training to pass the public university entrance exams. Another major issue is the lack of infrastructure throughout the country, including power generation, roads, railroads, airports, and waterways / ports. It is expected that the 2014 World Cup and 2016 Olympics will provide strong incentives for infrastructure investment, but this will only be a start; the infrastructure build-out necessary to support Brazilian economic development will likely be a multi-decade-long effort. Finally, the public sector in Brazil can present significant roadblocks to a well functioning private sector. This includes inefficiencies such as: complicated tax codes, labor regulations, bureaucratic red tape to open a new business, and a growing base of public employees.

Nevertheless, international investors seem to be looking past these issues and are focused on Brazil as a market where they want to deploy additional capital. The capital markets bounced back from the global financial crisis in-line with the overall Brazilian economy: Brazil's stock market (the Ibovepsa index) was up 83% in 2009, and two of the largest IPOs in recent history took place in Brazil last year (VisaNet and Santander Brasil). This year, Banco do Brasil successfully executed a US$5 billion follow-on offering, and Petrobras is expected to launch an estimated US$50 billion follow-on later this year. However, the Brazilian capital markets continue to be volatile and demonstrate a strong correlation with the global financial markets. The Ibovespa has been down since the beginning of May, and the European sovereign crisis earlier this year effectively shut-down the Brazilian IPO market.

Private equity could play an important role in helping to stabilize Brazil's capital markets, while also bringing real value to the overall economy. The private equity market in Brazil is currently quite nascent, having become recognized by the local business community only very recently. Unlike in India or China, where international private equity firms have been established with local offices over the past 5-10 years, many PE firms are only now starting to look for investment opportunities in Brazil. The case for private equity can be quite compelling, given the large number of sizeable companies in Brazil that are still owned by families or the original entrepreneurs. Private equity can help these businesses to become even more successful and manage the transition to a publicly-traded company should they choose to pursue that path.

General Atlantic is very enthusiastic about the opportunity set in Brazil. GA has had a presence in Brazil for over a decade, though for most of that time, the firm's efforts were focused on helping our portfolio companies in other parts of the world open operations in Brazil. Since 2006, we have concentrated on finding investment opportunities in Brazil and throughout Latin America, having deployed over US$800 million in three investments to-date: MercadoLibre, BM&F Bovespa, and Grupo Qualicorp. We recently opened a new office in São Paulo where we have a staff of five investment professionals.

General Atlantic's interest in Brazil goes beyond the country's positive macroeconomic growth trends. We believe that GA's partnership approach, focused on minority investments and leveraging the firm's global base of experience and relationships, is well suited for the current stage of development of Brazilian companies. We are looking to partner with exceptional management teams and existing shareholders to work together in building outstanding growth companies - with the potential for success both domestically in Brazil and potentially abroad as well. Our current top investment themes include:

• Increased Penetration of Financial Services - The Financial Services industry should be one of the key beneficiaries of higher income levels and a growing middle class. Particular areas of focus include consumer finance and asset management.

• Shift from Public to Private Healthcare - The Brazilian Constitution provides for free healthcare to all citizens. However, the public system is under-resourced and over-stretched, which favors growth in the private system. As consumer wealth increases, one of the areas where the approximately 150 million Brazilians who currently rely upon the public sector will look to spend their disposable income is private healthcare. Growth in formal employment also favors an expansion of private healthcare through insurance benefits provided by employers.

• Need for Improved Quality of Education - As described above, failure to meaningfully improve the quality of education in Brazil could limit the economy's ability to continue to grow at high rates. Due to a lack of resources, the necessary improvements likely will not be delivered by either the government or the private, non-profit sector. This presents an opportunity for private, for-profit companies to fill this void and take advantage of the attractive growth characteristics of this market - while providing critical support to the future of the country.

• Increased Usage of Technology and Other Services - As Brazilian companies continue to grow their participation in the global economy, they will increasingly rely upon technology to compete effectively. In addition, we believe that Brazilian companies will develop more of a "culture" to outsource non-core functions, presenting a compelling opportunity to BPO companies.

• Growth in Internet Should Continue to Fuel E-Commerce and Digital Media - Online business models are leveraged to the consumer growth trends highlighted above, particularly as Brazil's Internet population of less than 40 million individuals continues to grow. Despite online penetration rates of less than 20%, Brazilians who are Internet users actually spend the most time online compared to Internet users in any other country in the world. E-commerce companies will experience above-average rates of growth compared to brick-and-mortar retailers as more sales shift online, and digital media websites should grow their share of the advertising market.

If you would like further information on GA's Brazilian investment activities, please contact the GA team in our São Paulo office.