LAVCA* spoke with Alvaro Goncalves, Managing Partner of Stratus Investimentos. Founded in Sao Paulo, Brazil in 1999, Stratus manages a $285 million mid-market private equity fund, which includes a mezzanine infrastructure fund in joint venture with Darby Overseas. Stratus is currently raising capital for the buyout platform and real estate.
* The Latin American Venture Capital Association (LAVCA) is a not-for-profit membership organization dedicated to supporting the growth of the private equity and venture capital industry in Latin America and the Caribbean.
LAVCA: How do you differentiate yourself strategically from other funds active in Brazil?
Goncalves: Our mid-market strategy is executed by dedicated investment teams in three platforms: 1) Growth Capital (minority, growth related investments), 2) Buyout (mid-market control situations for consolidations and successions in fragmented industries) and 3) Specialized Funds (sector specific funds in areas where Brazil offers major development opportunities, such as infrastructure and real estate). Over 80% of the local and international capital allocated to PE in Brazil is targeting larger transactions, despite the fact that the best track record of returns is in the middle market. In the Brazilian context, we define mid-market as companies with annual sales of US$30-200m, and between 250 and 1000 employees. So the first differentiation is the mid-market focus – not only based on size, but more importantly on the profile of our teams – with a more hands on, operations drive, in addition to financial management skills.
LAVCA: Why did you decide to partner with Darby on the infrastructure fund?
Goncalves: Darby and Stratus had a collaborative relationship well before we teamed up for our joint-venture fund. Then we recognized that there is a complementary fit for the two firms in Brazil. Darby has specific expertise in both the infrastructure and mezzanine fields, and Brazil offers an excellent opportunity in infrastructure. Stratus brings the middle market approach to the infrastructure segments (our fund does not compete with large scale financing providers for the giant projects in energy, national roads, etc), and also the relationship with local institutional investors who had indicated their interest in this approach.
LAVCA: What is your firm's strategy for financial engineering as a means of adding value to portfolio companies?
Goncalves: Given the macroeconomic conditions in Brazil and the middle-market essence of our strategy, we don't have financial engineering as a key source of capital gains. Growth, organic or through acquisitions is a much more important return driver. We tend to structure our transactions with equity or quasi-equity instruments and a very conservative consideration of leverage. Seller finance in add-on acquisitions is a frequent feature, and a more conservative type of leverage.
LAVCA: How do you attempt to mitigate currency risk for your LPs?
Goncalves: We don't pursue any single measure to hedge currencies in long term investments. We have Brazilian LPs investing local currency, and our new buyout fund is being set for LPs with US dollars, Euro and Asian currencies. A direct or indirect exposure to the Brazilian Real is positive for any diversified portfolio from a global, international allocation point of view. The dollar as an anchor is probably an assumption to be challenged for the term of a PE fund. With the goal of diversifying into currencies from strong economies, the Brazilian Real is very attractive.
LAVCA: Brazil has recovered remarkably from the global downturn in 2008-2009. How would you describe the PE/VC environment in Brazil today, in terms of deal and exit opportunities? What are the risks going forward?
Goncalves: Our market today is characterized by its diversity and a strong culture of entrepreneurship. It's an environment towards growth and consolidation, with a good stream of opportunities. There are less than 30 established PE teams in Brazil, including local and international GPs. More than eighty percent of the PE capital available is targeting large buyouts, primarily seeking opportunities to take companies to the regional / global level. Approximately 10% of established Brazilian PE is targeting the middle-market, where there are thousands of companies all over the country. We of course see the best opportunity in this segment going forward.
Exits will be dominated by sales to strategic buyers (international and local companies on the buy side) but local capital markets will continue to increase in importance as well.
LAVCA: How did the global financial crisis affect your investment strategy? Has your investment criteria changed at all?
Goncalves: Our investment strategy did not have a relevant component of leverage or an export focus. Therefore, we have not changed the strategy as such. We have in fact implemented a more rigorous screening on projections and stress tests of our analysis, to cope with the increased volatility which we think will remain present in most markets including Brazil.
LAVCA: Do current financial conditions present unique opportunities in any sectors?
Goncalves: Current conditions and some trends of the Brazilian economy do offer specific opportunities. Services and consumption related demand (to cope with the 25 million people added to the middle class over the last five years) share center stage with infrastructure related projects (general infrastructure and also with the World Cup and Olympics trends, in particular), Oil and Gas (massive oil discoveries were and continue to be announced every quarter in Brazil). We don't see specific opportunities coming from any financial trend, except for the consideration of a smaller demand for exports due to the lower growth rate of the global economy for the next few or several years.
LAVCA:What sectors should be avoided? Why?
Goncalves: Luxury, high ticket goods tend to be avoided in the short to mid-term. We also tend to avoid -or be very selective about- commodity related sectors, given a possible long cycle of corrections which may occur in the future - and other highly cyclical sectors as well.
LAVCA: Do you foresee any significant changes in the Brazilian regulatory environment?
Goncalves: No. We have a highly regulated financial sector and some improvements may occur, but most of the regulatory reform influencing capital markets directly was implemented in the past ten years. We hope, however, that a tax reform and a simplification of labor laws help the ease the functioning of Brazilian companies.
LAVCA: Can you mention one of your recent investments?
Goncalves: We have invested in Amyris Brasil, the operating subsidiary of Amyris Inc (USA) which produces fuels and chemicals from sugarcane, in partnership with TPG, Kleiner Perkins and Khosla (shareholders of Amyris Inc), among others.
LAVCA: Tell us about your most recent exit- how did that go?
Goncalves: We have sold our stake in Graúna Aerospace, an airline parts producer in 2008, with 27%pa return. We have also been able to recover capital in two exits in 2009 from two companies which did not perform so well. We have an aggregate return on our portfolio in excess of 22% pa and 2.5 times capital and in excess of 33% pa and 3.6 times capital in US$.
LAVCA: How has your strategy for exiting your investments changed in light of the economic downturn?
Goncalves: We are in the process of registering two companies for IPOs. As Brazil weathered the crisis quite well, we haven't changed our businesses strategy much, except for considering new trends, new volatility levels – which affect screening new investments more than any particular strategy or structure.
LAVCA: How have return targets for your fund changed since fall 2008?
Goncalves: Asset prices were corrected and we see a somewhat higher potential increase in new investments.
LAVCA: What are you hearing from LPs about their willingness to invest in emerging markets private equity?
Goncalves: We have heard a growing interest and we are sure the EM share of institutional LP's wallet will increase significantly in 2010/2011.
* The Latin American Venture Capital Association (LAVCA) is a not-for-profit membership organization dedicated to supporting the growth of the private equity and venture capital industry in Latin America and the Caribbean.
LAVCA: How do you differentiate yourself strategically from other funds active in Brazil?
Goncalves: Our mid-market strategy is executed by dedicated investment teams in three platforms: 1) Growth Capital (minority, growth related investments), 2) Buyout (mid-market control situations for consolidations and successions in fragmented industries) and 3) Specialized Funds (sector specific funds in areas where Brazil offers major development opportunities, such as infrastructure and real estate). Over 80% of the local and international capital allocated to PE in Brazil is targeting larger transactions, despite the fact that the best track record of returns is in the middle market. In the Brazilian context, we define mid-market as companies with annual sales of US$30-200m, and between 250 and 1000 employees. So the first differentiation is the mid-market focus – not only based on size, but more importantly on the profile of our teams – with a more hands on, operations drive, in addition to financial management skills.
LAVCA: Why did you decide to partner with Darby on the infrastructure fund?
Goncalves: Darby and Stratus had a collaborative relationship well before we teamed up for our joint-venture fund. Then we recognized that there is a complementary fit for the two firms in Brazil. Darby has specific expertise in both the infrastructure and mezzanine fields, and Brazil offers an excellent opportunity in infrastructure. Stratus brings the middle market approach to the infrastructure segments (our fund does not compete with large scale financing providers for the giant projects in energy, national roads, etc), and also the relationship with local institutional investors who had indicated their interest in this approach.
LAVCA: What is your firm's strategy for financial engineering as a means of adding value to portfolio companies?
Goncalves: Given the macroeconomic conditions in Brazil and the middle-market essence of our strategy, we don't have financial engineering as a key source of capital gains. Growth, organic or through acquisitions is a much more important return driver. We tend to structure our transactions with equity or quasi-equity instruments and a very conservative consideration of leverage. Seller finance in add-on acquisitions is a frequent feature, and a more conservative type of leverage.
LAVCA: How do you attempt to mitigate currency risk for your LPs?
Goncalves: We don't pursue any single measure to hedge currencies in long term investments. We have Brazilian LPs investing local currency, and our new buyout fund is being set for LPs with US dollars, Euro and Asian currencies. A direct or indirect exposure to the Brazilian Real is positive for any diversified portfolio from a global, international allocation point of view. The dollar as an anchor is probably an assumption to be challenged for the term of a PE fund. With the goal of diversifying into currencies from strong economies, the Brazilian Real is very attractive.
LAVCA: Brazil has recovered remarkably from the global downturn in 2008-2009. How would you describe the PE/VC environment in Brazil today, in terms of deal and exit opportunities? What are the risks going forward?
Goncalves: Our market today is characterized by its diversity and a strong culture of entrepreneurship. It's an environment towards growth and consolidation, with a good stream of opportunities. There are less than 30 established PE teams in Brazil, including local and international GPs. More than eighty percent of the PE capital available is targeting large buyouts, primarily seeking opportunities to take companies to the regional / global level. Approximately 10% of established Brazilian PE is targeting the middle-market, where there are thousands of companies all over the country. We of course see the best opportunity in this segment going forward.
Exits will be dominated by sales to strategic buyers (international and local companies on the buy side) but local capital markets will continue to increase in importance as well.
LAVCA: How did the global financial crisis affect your investment strategy? Has your investment criteria changed at all?
Goncalves: Our investment strategy did not have a relevant component of leverage or an export focus. Therefore, we have not changed the strategy as such. We have in fact implemented a more rigorous screening on projections and stress tests of our analysis, to cope with the increased volatility which we think will remain present in most markets including Brazil.
LAVCA: Do current financial conditions present unique opportunities in any sectors?
Goncalves: Current conditions and some trends of the Brazilian economy do offer specific opportunities. Services and consumption related demand (to cope with the 25 million people added to the middle class over the last five years) share center stage with infrastructure related projects (general infrastructure and also with the World Cup and Olympics trends, in particular), Oil and Gas (massive oil discoveries were and continue to be announced every quarter in Brazil). We don't see specific opportunities coming from any financial trend, except for the consideration of a smaller demand for exports due to the lower growth rate of the global economy for the next few or several years.
LAVCA:What sectors should be avoided? Why?
Goncalves: Luxury, high ticket goods tend to be avoided in the short to mid-term. We also tend to avoid -or be very selective about- commodity related sectors, given a possible long cycle of corrections which may occur in the future - and other highly cyclical sectors as well.
LAVCA: Do you foresee any significant changes in the Brazilian regulatory environment?
Goncalves: No. We have a highly regulated financial sector and some improvements may occur, but most of the regulatory reform influencing capital markets directly was implemented in the past ten years. We hope, however, that a tax reform and a simplification of labor laws help the ease the functioning of Brazilian companies.
LAVCA: Can you mention one of your recent investments?
Goncalves: We have invested in Amyris Brasil, the operating subsidiary of Amyris Inc (USA) which produces fuels and chemicals from sugarcane, in partnership with TPG, Kleiner Perkins and Khosla (shareholders of Amyris Inc), among others.
LAVCA: Tell us about your most recent exit- how did that go?
Goncalves: We have sold our stake in Graúna Aerospace, an airline parts producer in 2008, with 27%pa return. We have also been able to recover capital in two exits in 2009 from two companies which did not perform so well. We have an aggregate return on our portfolio in excess of 22% pa and 2.5 times capital and in excess of 33% pa and 3.6 times capital in US$.
LAVCA: How has your strategy for exiting your investments changed in light of the economic downturn?
Goncalves: We are in the process of registering two companies for IPOs. As Brazil weathered the crisis quite well, we haven't changed our businesses strategy much, except for considering new trends, new volatility levels – which affect screening new investments more than any particular strategy or structure.
LAVCA: How have return targets for your fund changed since fall 2008?
Goncalves: Asset prices were corrected and we see a somewhat higher potential increase in new investments.
LAVCA: What are you hearing from LPs about their willingness to invest in emerging markets private equity?
Goncalves: We have heard a growing interest and we are sure the EM share of institutional LP's wallet will increase significantly in 2010/2011.
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