Presentation
Since 2018 Pebay gladly publishes its Price & Performance report,
revealing exclusive data that uncovers the true performance, in local
currency, of private equity funds as well as the price these funds are
paying to acquire companies in Brazil. Every year our report
concludes with a case study of a successful deal done in Brazil to
illustrate what happens at the micro level and inspire those looking
to venture into private markets in search of superior returns. While
investing in private markets carries greater risk, especially in
developing countries, the well informed investor will always be
better positioned to find the hidden gems and avoid the pitfalls along
the road.
Price & Performance of Private Equity in Brazil
Information on private equity entry price and fund performance is
tremendously important for those navigating through private capital
markets.
Market level performance metrics such as Internal Rate of Return
(IRR) and Total Value to Paid-In Capital (TVPI) are key for Limited
Partners (LPs) to decide their allocation plans, select the best funds
and managers and monitor their portfolio properly. It also helps
understand the impact of different economic cycles on funds, as well
as decide to sell or buy in the secondary market of funds.
Price metrics such as Enterprise Value (EV) to Earnings Before
Interests, Taxes, Depreciation and Amortization (EBITDA) and Equity
Value to EBITDA are also key for General Partners (GPs) to benchmark
against peers and know how close or far-off their multiples are
comparatively to the market. With that in mind, LPs can also assess
the discount of private versus public equity alternatives.
With access to price and performance data, buyers, sellers, advisors
and investors face less uncertainty and can better understand the
source of performance, being able to act in order to improve it. As a
result, more capital can flow into the market, with more liquidity and
better returns.
However, price and performance information is extremely hard to
come by. Let alone find unbiased information about it. This is due to
many factors:
- Opaque market: Private fund and deal information are usually kept private;
- Inaccurate news and gossip: Press releases and news articles tend to be biased towards bigger transactions that make it to the headlines, not always reflecting the true transaction values and participation acquired. Usually news do not bring complete and accurate financial information at company level, such as EBITDA or net debt (which are used to calculate EV);
- Biased fund performance: Fund performance information are usually made available by GPs in fundraising mode, creating a natural bias towards disclosing information about the most profitable funds and deals;
- Currency effect: The information usually available regards funds that catered to public pensions funds abroad, and is dependent on disclosure by foreign LPs that only provide the information in their own currency (generally US Dollars or Euros). Given the large fluctuations of emerging markets currencies, this can severely distort true results.
Pebay compiles data on funds, investment vehicles and companies
from several regulatory sources in Brazil. This data then undergoes
handcraft analysis from a group of specialized analysts. The result is
a complete performance set of more than 830 funds and club deals
in Brazil (1) launched from 1995 to 2019. In-depth analysis was
performed based on the financial reports of over 1,370 out of 2,355
companies that received investment from these funds.
The cash flow information needed was based on audited financial
reports and regulatory filings. Omissions, missing information or
uncertainties were identified and treated directly with fund
managers, administrators and LPs.
Note on IFRS 16
The International Accounting Standards Board (IASB) issued IFRS 16 which is in effect for financial periods beginning in 2019. IFRS 16 forces companies to recognize the net present value of leases as an asset – “rights of use”; and as a liability – “lease liability” which generates “interest” expenses (the lease installments) and amortization. This change is causing an increase in the following metrics without impacting cash flows: (i) Net debt, as the lessee will recognize the “interest-paying” liability for the lease; and (ii) EBITDA, as the lessee will recognize the interest cost and the depreciation of the leased asset instead of the operating lease expenses. Companies with high lease expenses are especially affected, such as retailers. As a consequence EV/EBITDA and Net Debt/EBITDA for 2019 tend to be higher than they would be under the former methodology.
Performance
The results below show the true performance of private equity funds
and club deals by vintage, in local currency (BRL).
It is important to highlight that some regulated funds charge
management fee and performance fee locally and others charge it
abroad. So to compare apples to apples, the performance was
analysed on grossed-up terms. It means that fees charged in Brazil
were added back to cash flows to allow full comparability. Also, for
pan-regional funds, or global funds, only the portion invested in
Brazil was included in the analysis.
Gross IRRs in Brazil runs around 10% p.y., a relatively low figure for
a country that only saw its sovereign interest rate (Selic) fall below
10% on three occasions in the last 18 years: 2009 (8.7%); 2012
(7.1%); and from 2018 on (2% in 2020).
Exception to the norm was the following especially good vintages:
2003, 2005, 2009 and years from 2015 on. In particular, 2003 and
2009 benefited from a crisis in the previous year, resulting in median
IRR around 20% p.y. In 2005, the market was starting to witness a
continuous expansion in liquidity and Initial Public Offerings (IPO) that
lasted for five years. That brought the median IRR up to nearly 14%.
In 2015-2016 Brazil suffered a serious economic and political crisis
with a sluggish recovery in the 2017-2019 period (around 1% GDP
growth p.y.). Interest rates came down from 13.75% in 2017 to 2% in 2020.
While Covid-19 harmed the economy even further, it also
helped foster technology-based companies and the number of
investors in the stock market (which grew from 1.9 to 3.1 million
investors). The search for higher yields helped the stock market
quickly recover and opened an IPO window that allowed 25
companies to go public, raising R$31 billion (second highest volume
ever, losing only to the 2007 IPO rush). Other 45 companies have
filed for IPO and are expected to go public in the next few months.
The combination of high liquidity, diminishing cost of capital and IPO
window coupled with the possibility to make investments after the
crisis has brought IRR up in the last few years: a median of 15% in
2015 and 2016; 30% in 2017.
While performance of 2017 vintage should still change over time
(five years is the advisable time-span to evaluate PE performance), a
great part of this early outperformance can be explained by the quick
reduction of interest rates in the last 3 years, which contributed to a
steep increase in the value of assets in general
(2).
Infrastructure investments with long and predictable cash flows are
particularly prone to this effect. These funds have become very popular
in the last four years in Brazil. According to Pebay.info data, in 2016
“Infrastructure” funds represented 17% of the industry’s aggregate
value. By September 30th 2020 this figure increased to 33%.
Good vintages also have another important feature. Not only returns
get better, but the risk is reduced. For example, in 2005, even the
bottom performers had 11% IRR on average. As for 2009 and 2017
vintages, bottom performers had IRR of -3% and 9%, respectively.
The results suggest that timing the market can be very helpful for
private equity investors. Investments made after the crisis and just
before a period of liquidity and IPO have shown significantly better
risk-adjusted returns.
Looking at the average of the top half performers and the bottom half
performers another relevant conclusion emerges. Until 2004 the top
performance was not too far apart from median performance. In
2003 for example the difference in IRR was barely noticeable. From
then on the gap widened, making top performers always hover above
15% (also above the prevailing interest rates), reaching heights of
63% in 2005, 45% in 2007 and 2009, and 78% in 2017.
The widening in performance among managers is consistent with the
idea that fund managers do get to differentiate over time based on
experience, reputation, access to capital, strategy, execution etc. This
is especially true for a young PE market such as Brazil. These are
major factors behind discrepancy of returns.
2014 is a good example of that. When bottom performers were
posting -49% IRR (losing almost two-thirds of capital invested), top
performers were, on average, posting 29% IRRs: a difference of
7,800 basis points!
In a market that looks like that, it is the manager/fund selection skills of
an LP that determine how successful or unsuccessful its private equity
program will be. With the only exception of 2005 (2017 is still too early
to tell), if one was unlucky enough to invest with the bottom performers
(and only them), money would have been lost on every vintage.
The performance was also analysed with multiples of capital invested
(see Graph 2). In line with IRR analysis, it shows median running
around 1.5x up to 2009, dropping to 1.15 ~ 1.20 afterwards, then
increasing to 1.5x in 2015 and 2017. It reached above 1.75x in four
moments: 2003, 2009 and at the beginning of the liquidity/IPO boom
in 2005/2006. For these vintages top funds had on average 3 to 4.5x
multiple on invested capital.
This analysis of multiples is especially useful to measure downside
as it shows for instance that low performers can, on average, lose
50% of capital. Or, lose virtually all capital as it was the case in 2002,
a vintage severely hit by the Internet bubble burst; and 2010, a point
of inflexion in the economy that ended up affecting many portfolio
companies and projects.
Price
Private Equity transaction entry price is another key piece of
information to understand the attractiveness of a private market. It is
something certainly known to the acquiring fund, the seller and its
advisors, but rarely publicised.
However, in Brazil corporations (Sociedades Anônimas – S.A.) are
generally obliged to publish financial information on an annual basis.
So by identifying the corporations in the portfolio of each fund (either Looking directly or indirectly under holding entities), Pebay was then able to handpick financial
reports of the portfolio companies to calculate accounting EBITDA
(without adjustments) and Net Debt of the same year the initial
investment took place. Whenever possible, consolidated
information was obtained on the higher available holding entity.
Results show that EV/EBITDA in Brazil range around 7.6x to 12.x, with
net debt representing 5% to 10% of EV, except for 2019 when this
figure reached 23%, perhaps as a result of the lower interest rates
and IFRS 16.
Despite the peak in 2019, a foreign investor looking at Graph 3 would
be intrigued to see how little debt is used by private equity invested
companies in Brazil when compared to US and European companies.
Until recently Brazil has had relatively high interest rates and a
concentrated banking industry. So medium and small size companies
in Brazil used to face interest rates of 25% to 30% p.y. Gladly the
financing gap has been fulfilled by the private equity industry. Now
medium companies have access to debt at much lower rates.
Box 1: Investing successfully in the Brazilian e-commerce logistics sector 2020 was marked by the outspread of Covid-19 which has sadly taken many lives and changed the way we live. Thanks to technology society was better prepared to face such a tremendous challenge. Broadband, apps with online chat/video services and streaming helped us stay connected, entertained and educated. E-commerce platforms allowed big and small shops to start selling online quickly while helping the population cope with stay-at-home policies by having services and goods delivered at home. Brazil has a large territory and online customers accustomed with seamless digital experiences demand increasingly shorter delivery times. This creates a huge opportunity for logistics companies specialized in online retail that can reach Brazil’s farthest corners such as private-equity-backed Sequoia Logistica (SEQL). Present in more than 3,359 cities that represent 92% of the Brazilian GDP, the company rose to the challenge and was able to grow considerably (80% in the nine first months of 2020), allowing it to make its successful debut in the Brazilian stock exchange (B3) in October 2020, with outstanding returns for its existing and new investors. Founded in 2010, SEQL is one of the leading tech-enabled logistic companies in the Brazilian e-commerce, with 16% market share3. Between 2014 and 2019, its net revenue and EBITDA increased at an annual growth (CAGR) of 24% and 29%, respectively. In 2019 it made 30 million door-to-door deliveries and over 1.4 millions same-day deliveries, totalling R$527 mn in net revenues and R$65 mn in EBITDA. The company has an asset-light business model: 98% of its fleet is either outsourced or leased, allowing it to post a 34% return on invested capital (ROIC). In 2014, the company attracted private equity investment from global growth capital manager Warburg Pincus (WP), a group with a strong tech-enabled logistics expertise that has invested over U$86 bn in more than 930 companies around the world. As a result Sequoia has achieved a long-term strategic plan which included revision of its brand concept, implementation of a meritocratic culture and improvement in corporate governance and internal controls. SEQL fostered its M&A capability. Six acquisitions were made in the last eight years, which allowed the company to access new States and verticals such as fashion and financial services. WP invested a total of R$171 mn in the company, valuing SEQL’s equity initially at R$194 mn. Company had around R$18 mn in EBITDA and R$54 mn in net debt, resulting in an EV/EBITDA of 14x and EV/Revenues of 1.4x. WP amassed a total stake of 70.5% before the IPO, which allowed the fund to reduce its stake to 21.7% and recoup R$522 mn, or over 3 times the amount invested. The remaining stake was valued at almost R$342 mn at the IPO price, thus resulting in an interim multiple of invested capital (MOIC) of 5.0x and a gross IRR of 39%. SEQL’s IPO came in a rare moment when the market was receptive to new listings, even though global economic uncertainty was still high (i.e. US Elections and the possibility of a second wave of Covid-19 lockdowns). Price was set at R$12.4/share, below the range of R$14.25 to R$17.15, giving the company a market cap of almost R$1.6 bn, which translates to a multiple of 18.5x EV/EBITDA (twelve months up to September 2020). Investors that bought shares in the stock market saw their investments rise nearly 60% in 2 months, making it a top performing IPO of 2020. There is great expectation about the sector’s future. According to Ebit and Forrester, e-commerce in Brazil is expected to increase by approximately 250% (CAGR of 23%) until 2025, reaching R$377 bn in sales volumes. At 7.2%, the penetration rate of e-commerce in Brazil to total retail is much lower than in more developed countries. In China and in the US penetration is 27% and 15%, respectively. It is reasonable to expect a good performance for the sector in the next few years. However competition should be fiercer. Big marketplaces such as Mercado Livre have developed proprietary logistic networks to insure quality and increase same-day-delivery. Brazilian government is also preparing to privatize Brazil’s post service (Correios) which is SEQL’s main competitor with 33% e-commerce market share. While present all over Brazil, Correios suffers with management issues, recurring employee strikes, poorer client service, making its delivery time slower and less reliable. This could well change once the service falls in private hands. |
About Private Equity Bay (Pebay)
Private Equity Bay (Pebay) maintains an online private equity
intelligence service (Pebay.info) specialized in PE, Real Estate,
Infrastructure and similar investments in Brazil. Pebay tracks and
analyses performance of more than 1.040 funds, of 415
managers, as well as more than 2.900 invested companies and
projects with data on investments, financials and valuations. All
based on the highest standards of quality and reliability. With Pebay
investors can better monitor their investments, compare
performance, originate opportunities, access the secondary market
and reduce time spent with search and treatment of information.