Felix Salmon

Brazil’s love of equity

Felix Salmon
Mar 29, 2011 13:44 UTC

About the same time that “junk bonds” became “high yield” and shortly after “third world” became “emerging markets,” the finance industry quietly engineered another rebranding: “leveraged buyouts” became “private equity.”

So as Andrew Ross Sorkin notes today, the idea of a private-equity shop without debt is fundamentally at odds with the genesis of the industry. This is private equity done the old-fashioned way, where “old-fashioned” means “unprecedented.” But in Brazil, it makes perfect sense: rates there are simply too high to be able to make LBOs profitable, and meanwhile there are lots of efficiencies to be found turning smallish family-owned companies into much larger professionally-run operations.

Brazil is particularly suited to this model, as it has a lot of family-owned companies, and it also has a large elite professional class which is more than capable of taking them on and running them efficiently.

Sorkin is a bit credulous when he wonders at how Brazilian private-equity shops can “make such huge profits,” citing returns of “more than 20 percent annually.” The fact is that many of these family-owned companies, if they’d simply waited two or three years and gone the IPO route instead, would have seen bigger returns than that on the amount of money that they actually sold for. The IPO market in Brazil has been white-hot for a while now, barely taking a breather for the global financial crisis to come and go. Brazilian private-equity shops fund themselves with 100% equity not just because debt is expensive, but also because equity is extremely cheap.

That said, it does make a certain amount of sense for a deep-pocketed investor to buy a good but small franchise and spend the money needed to get it big and efficient enough to IPO effectively: private-equity firms are probably a good way of shepherding companies to the promised land of an IPO, or some other big exit. Effectively, private equity in Brazil is behaving more like US venture capital than it is like US private equity. Except it’s more interested in old family-owned companies than in young technology start-ups.

All of this is a welcome development, in a world with enormous systemic risks associated with debt finance. Private equity might not be as good as public equity, from a public-policy point of view. But it’s still better than debt.


leveraged buyout investing is a class of private equity. so is venture capital (assuming the VCs buy equity and aren’t making some sort of loan). private equity is just what it sounds like – equity that is not publicly traded.

“the idea of a private-equity shop without debt is fundamentally at odds with the genesis of the industry.” this is not true. the idea that PE in Brazil is done with no/very little debt is only surprising/interesting/profound to people who do not understand finance very well (sorkin included).

private equity done the “old-fashioned way” was just people investing in businesses that couldn’t get bank loans…something more comparable to VC today and something akin to PE in Brazil right now. not something “unprecedented.”

Posted by Davie | Report as abusive

Emerging markets aren’t a bubble

Felix Salmon
Dec 4, 2009 15:31 UTC

Yesterday was the EMTA annual meeting, complete with its venerable and always interesting panel of buy-siders. My favorite is always Hari Hariharan of NWI managment: when asked what his favorite trade is, he never says something simple like “long Brazil”. Instead, it’s invariably a complex relative-value trade: this year he said that “a one year forward 2s-5s steepener in Korea could be an offsetting trade to receiving front-end Mexico”. You’re welcome.

Hari’s a smart and insightful guy, though, he’s not (just) a nerdy quant. When asked whether we were in an emerging-markets bubble, he pointed out that although property prices in Hong Kong are hitting insane levels in the region of $9,000 a square foot, those prices are being paid in cash, and banks aren’t lending against those values. And without leverage, of course, there’s a limit to how much harm a bubble can cause.

Similarly, I get the feeling that for all that Brazilian equities have been skyrocketing in dollar terms of late, that doesn’t mean that Brazilian companies have anything like the same access to the equity capital markets that they did before the crash: the primary markets haven’t recovered as well as the secondary markets, and people spending new money are still displaying signs of caution.

What’s more, in spread terms, emerging markets aren’t looking particularly bubbly, at least by 2007 standards when the EMBI+ index got as tight as 153bp over Treasuries. Right now, it’s 317bp over. In yield terms, however, things are much closer: 6.51% now (or yesterday, anyway, when the panel was going on and before the jobs report came out) compared to 6.37% at the low in in June 2007.

Mark Dow, of Pharo management, added that right now it’s easy to see bubbles everywhere, since we’re still so burned from the bursting of the last one. It’s a good point: while emerging-market assets may or may not be overpriced right now, it’s probably not particularly helpful to worry about bubbles. That said, everybody was a bit worried about the tens of billions of dollars flowing into Brazil from Japanese toushin funds: they’re not good for Brazil, and they’re unlikely to work out very well for Mrs Watanabe, either.

So although there’s bound to be some sort of correction in Brazil and other emerging markets sooner or later, that doesn’t mean they’re currently in a bubble. It just means that traders are making lots of money on the momentum trade right now, which isn’t the same thing at all.


Sorry I mean only after the fiat currency bubbles bust

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The emerging-market bubble

Felix Salmon
Nov 25, 2009 21:21 UTC


This chart (via Paul) I think is too meek: of course the current emerging-markets boom is debt-financed. And boy does it look bubblicious, what with the Bovespa having doubled in the past 12 months and rapidly approaching its all-time high. I’m a believer in the long-term future of Brazil, and even count a Brazilian ETF among my few investments. But at this point any investment in emerging markets looks very much like a speculative momentum play: don’t invest anything you can’t afford to lose.


The Dot-com bubble was debt-financed? That’s a new one.

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Brazil vs the global carry trade

Felix Salmon
Nov 25, 2009 17:06 UTC

Even capital controls, it seems, are powerless in the face of the global carry trade:

Brazil’s real is the “most overvalued” currency as a “wall of money” coming into Latin America’s biggest economy may overwhelm government efforts to curb its rally, said Goldman Sachs…

“After some initial success with capital controls, real appreciation appears to be on the rise again,” Stolper wrote in a note to clients.

The real has gained 34 percent this year, making it the second-best performer in the world after the Seychelles rupee…

A quickening economic recovery and the nation’s link to growing demand for commodities from emerging markets such as China have led to “unprecedented amounts” of overseas capital flowing into the country, Stolper wrote. Inflows reached $17.6 billion in October, compared with $6 billion to $8 billion in previous months, he wrote.

Yes, Brazil has a lot of commodities, but I can assure you that it’s not exporting $17.6 billion of commodities every month. This is hot money, plain and simple, the tool of speculators who fund themselves at near-zero rates in dollars and invest in an appreciating currency paying an interest rate of 8.75% and rising. The influx does no good for Brazil whatsoever (exporters hate overvalued currencies) while feeding huge dividends to hedge funds and others with little long-term stake in Brazil’s future.

The Brazilian central bank is saying that the current capital controls are “adequate”, and that it’s not targeting exchange rates. But it’s surely well aware that this is the kind of story which tends to end in tears. And that there’s not much it can do to stop the carry trade, without endangering the economy in other ways. Brazil’s technocrats have no desire to wall the country off from international trade and capital flows. Suffering this kind of problem is a natural, if unpleasant, consequence of their decision to open the country up.


I thought dsquared would bring up Paul Davidson’s international money clearing unit idea. I would do it, but I don’t think I’m qualified.

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