“May you live in interesting times”
Ancient Chinese Proverb
After the fall of Lehman Brothers and the crash of the stock market in 2008, Latin American countries have managed to live through and survive the world crisis very much unscathed. Although the majority of the Latin American countries have endured the crisis, in the rest of the world, its effects have continued through 2009 and affected eventually not only the financial markets, but also the real economy .
In 2010, the crisis in Europe has spread out around the globe and yet again, Latin American countries are alive and kicking. In the first quarter of 2010 Brazil grew at a staggering 9% rate as compared to 2009; whilst Argentina did it at more modest 8.1% rate in the same period . Argentina had in April 2010 an historic record of income tax collection for 2009. In this same venue, Merry Lynch has recently increased its growth rates both for Argentina and Brazil, (Brazil from 5.3% to 6.0% and Argentina from 2.2% to 4.8%) . In line with this, the majority of the analysts argue that in the next decade Latin America will have a decisive role in the world’s growth.
Argentina, however, has not yet fully convinced investors. There are still things to resolve; in general the business environment needs more predictability and clearer rules for the businesses; other issues that need to be taken care of in the short term are the termination of the procedure with the hold-outs, the control imposed by the government over the statistics bureau and the control of the inflation. In spite of this, we are seeing that investors are preparing the field for 2011 or 2012 when the prospects are clearer.
This article will analyze the evolution of investments in Latin America, with special emphasis in Argentina, then describe the current investment mood and structures chosen by some investment entities and finally define some sectors that have particularly interested foreign investors for the future.
A new Period?
The current crisis in Europe and the United States has made investors look deeper into countries that were considered riskier in the past, such as Brazil, Chile, Mexico and to some extent, Argentina. This is of course a new period.
How to define this new mood or trend and what characteristics make it unique as compared to other investment periods?. Let us begin by defining and analyzing the past investment periods to asses the current trend.
In the first period, foreign investment came exclusively in the form of foreign direct investment lead by large multinational companies with operations all around the globe. These were companies that were just transplanting their business philosophy and know-how into the Latin American countries. These companies were investing with the same brand and structure as in their relevant home jurisdiction and were controlling 100% of the corporate capital in the local companies.
In the period from 1991 to 1994 private equity funds came about. These funds were originally foreign. With State deregulation, privatization and familiar companies in need of cash many private equity funds looked into Argentina as target for their investments. In this period, private equity firms concentrated in companies with good cashflows and were basically focused in sectors such as telecommunications, transport, cable tv, financial services and retail. In this period, Argentina was the second largest receptor of private equity capitals in Latin America.
Between 1995 and 1998 the free market model was widely accepted in Argentina and private equity deals came about as customary run-of-the-mill transactions. In this era, many regional (and local) private equity funds were created.
Between 1999 and 2001 is the period of Venture Capital funds. In this period private equity funds are less interested in Latin American because of the Asian crisis and the devaluation of the Brazilian real. However, Venture Capital funds emerge as a new way to finance projects. New companies were created and Argentina became a part of the internet bubble. Venture Capital firms invested in innovative companies developing new technologies. In this phase, 20% of the investments were directed to internet projects in their first steps of developments.
Between 2001 and 2005 there was almost no foreign investment in Argentina. However, some local funds were created and were actively involved in the energy sector, basically acquiring the assets left behind by funds or companies from Europe and North America.
We are now slowly experiencing the commencement of a new era. This period has some traits of the past and some particular new features. It is not yet defined as companies and funds are aiming at 2012 after the presidential elections in Argentina. This new period is probably a mix between all of the past experiences.
It is worth mentioning that this new form of investment is somewhat opportunistic, because it is looking for large profits, but also very patient and looking into the long run at the same time. Let us define some of the sectors specially considered by this dormant and embryonic new investment wave.
Some interesting sectors
Whilst some investors, be it individuals, private equity funds, familiar funds, or just investment companies have already set foot in Argentina seizing some opportunities, such as in the case of agriculture, lithium mines, gold, or real estate; some investors are just approaching the sectors, analyzing and studying the target. Below, we will review some of these opportunities.
The first sector that comes to mind and that grew at Chinese rates (and probably actually because of the Chinese growth) is agriculture. In spite of an incredible tax on exports (withholding) of 35%, the agricultural sector has steadily grown since 2005, both in land prices and yields per hectare. The price of the queen of crops (soybean) more than doubled since 2002 reaching its peak just before the fall of Lehman Brothers.
Prices of farm land have increased at similar or higher rates, while crop yields have not grown as much, basically because of the above mentioned export withholding currently set at a 35% rate.
In the case of agriculture, we see two types of investors, (i) farming funds and farming companies looking for a long term business and (ii) speculators looking for another increase in these commodities prices and the reduction (or annulment) of the export tax after the elections in 2011. The votes of the farmers will be necessary for anyone with an aspiration on wining the presidential election in 2011, therefore any of such candidates will have to include a reduction or annulment on the withholding on faming commodities exports.
Another interesting sector, for the large institutional investor, is the public utilities sector. Utilities fees have been frozen approximately since the end of the termination of the convertibility between the peso and the dollar in the end of 2001. After major complains from the operating companies, including some companies that had to fire-sell their assets in Argentina, just in 2009 the State has agreed to subsidize part of these fees to the operating companies.
It is also expected that increases on utility fees be authorized in the not so distant future. Just to give an idea on how depreciated the current structure is, 100 dollars in electricity in the City of Buenos Aires cost 985.63 dollars in the city of Montevideo, Uruguay and 744.49 dollars in Sao Paulo, Brazil, and 790.89 dollars in Santiago, Chile. This is being studied and analyzed by a few large funds and companies.
Some minerals have also drawn up a lot of attention in Argentina. Notably, the case of lithium. With an increasing long-term demand for oil, the search for energy conservation has increasingly aimed at lithium, the key resource needed for the manufacture of energy-efficient ion batteries powering hybrid cars.
Demand for lithium carbonate doubled from 2003 to 2007, and a report by Credit Suisse states that the market for lithium-ion batteries may expand to 14 times its 2009 size by 2030. Lithium is typically recovered from high-altitude desert areas, chiefly in the Andes Mountains, with roughly 80 percent of the world’s known lithium reserves found in Argentina, Bolivia, or Chile.
Being Argentina one of the largest producers of lithium, and holding one of the largest reserves in the world, the interest in this mineral has grown exponentially. One hectare of lithium potential property could be bought at 100 dollars in 2008; currently that same hectare of lithium potential property can be bought at 5,000 dollars.
In this sector, there all kinds of investors, some were speculators that obtained good profits in a relatively short period of time, while other investors were looking at the very long run, like Toyota that has recently invested 100 million dollars in a lithium project in Salta, Argentina .
Another market that has grown exponentially since 2002, whose growth could also be explained in part because of the commodities’ prices (agricultural profits) and indirectly the Chinese demand. What is striking about the Argentine real estate market is that it has grown with no credit, no leverage. In 2009, only 5.2% of the transactions involved some form of credit for the purchase.
In the graph below, the green arrow depicts the growth of build square meters and the blue arrow depicts the average price per square meter.
In this sector, there are investors of all sorts. Individuals willing to diversify their assets without running large risks, speculators, large funds, familiar funds, in short investors from all walks of life.
We would not call this boom a bubble as it is not fuelled with credit, but by genuine and real investment. Also, the current lease prices provide for a return of investment between 4% and 15% depending on the asset and the lease, and even without taking into account the appreciation of the assets as such.
Finally, a few words on China and its influence in Latin America. Although China’s interest in Latin America is a rather new experience, it is nevertheless increasing its importance remarkably. In the first quarter of 2010, 83% of the M&A transactions in Argentina involved Chinese capitals .
With China’s every increasing economic muscle its interest in the region keeps growing. China being eager for access to such commodities as iron and other ores, soybeans and soybean oil, copper, iron and steel, integrated circuits and other electrical machinery, and oil in order to meet the demands of China’s booming economy .
This new scenario has brought about speculators willing to seize the opportunities lead by Chinese interest. This has also triggered interest from investors looking to provide services and goods to the Chinese investors.
If crisis means danger and opportunity, then Latin America is abundant of both. There are indeed plenty opportunities in diverse sectors, but also there are other risks involved in the doing business in Argentina, basically all stemming from the little respect to the rule of law.
The picture will be much clearer in 2012 and for this reason many funds, individuals and companies are preparing for this second wave of investment. Let us hope it is not another lost opportunity.