I OVERVIEW OF M&A ACTIVITY
Brazil’s political uncertainty and troubled economic scenario have brought challenging conditions to M&A activity in the country throughout 2015.
After a slow start to 2015, however, Brazil’s M&A market participants2 were positively surprised by the final results of deal flow in the second half of the year.3 According to PricewaterhouseCoopers,4 2015 saw a total of 742 transactions, which is a significant number, although 16 per cent lower than the 879 deals concluded in 2014. Non-Brazilian investors accounted for approximately 51 per cent in terms of transaction volume, and private equity activity was down to 221 transactions.5 Deals announced in 2015 with Brazilian involvement include BG Group’s US$70 billion merger with Royal Dutch Shell to create the largest foreign oil company in Brazil; the Brazilian investment group J&F Investimentos’ acquisition of an equity stake in the shoe manufacturer Alpargatas for 2.6 billion reais; and the acquisition of a cosmetic business of Hypermarcas for 3.8 billion reais by the US-based cosmetics company Coty.
Although foreign investment transaction volume decreased in the first quarter of 2016, with a total of 47 transactions (a 28 per cent decrease compared to the volume announced in the same period in 2015), M&A activity in general has gone up with a total of 198 transactions, which is 12 per cent more than the volume announced in the same period for the previous year.6 Deals announced so far in 2016 include the acquisition by the American private equity firm General Atlantic of a 10 per cent stake in Brazil-based XP Investimentos for 300 million reais, the BM&FBovespa merger with Cetip for 11 billion reais and the acquisition by HIG Capital, a US-based private equity firm, of a stake in Halex Istar Indústria Farmacêutica, a pharmaceutical company specialised in hospitals.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
In Brazil, M&A is regulated mainly by the Brazilian Corporation Law (Law No. 6,404 of 15 December 1976); rules, regulations, opinions and precedents of the Brazilian Securities Commission (CVM) (CVM Regulations), including CVM Rules No. 319 (mergers involving public companies), 358 (disclosure of material information by public companies), 361 (tender offers) and 481 (disclosure of information prior to shareholders’ meetings and proxy solicitation), and CVM Opinions No. 34 (conflicts of interest), 35 (fiduciary duties) and 36 (poison pills); and, in the case of companies listed on the Novo Mercado or Level 2 listing segments of BM&FBOVESPA (the Sao Paulo Stock Exchange), the corresponding listing rules (in addition to tax, antitrust and regulatory rules). M&A deals involving solely closely held companies are only subject to the provisions of the Brazilian Corporation Law (excluding those exclusively applicable to publicly held companies). Transactions that involve public companies are also regulated by the CVM Regulations and listing rules.
Foreign investment is restricted in certain industries as follows:
- a aviation: non-Brazilian capital is now limited to 20 per cent of the voting capital, and no nationality restriction is applied on the appointment of officers; during 2016, the limit on foreign capital was raised to 49 per cent by provisional Presidential Decree No. 714/2016; in June, the Brazilian Congress affirmed the change in regulation. The Presidency, however, vetoed the disposition containing the raise on foreign capital. As a result, Law No. 13,319/2016 does not provide for the 49 per cent cap, which in practice reinstates the 20 per cent limit. This limit became valid as of 25 July 2016, the date of publication of Law No. 13,319/2016 in the Brazilian Official Gazette;
- b public services: telecommunications, electric energy, gas distribution, rail transport, among many other public services, are provided by the government by means of concessions or authorisations; non-Brazilian investment is permitted, subject to certain restrictions (transfers of control of public service concessionaires may be subject to prior government approval);
- c real estate: ownership by foreign persons is subject to restrictions in rural areas and national border zones (transfers of rural real estate properties to non-Brazilian investors under certain circumstances are also subject to prior government approval);
- d mining: non-Brazilian investment must be made through a Brazilian entity, with mining in national border zones being restricted (transfers of mining rights are also subject to prior government approval);
- e oil and radioactive minerals are a Brazilian state monopoly; oil-related activities by private or state-owned companies are subject to authorisation;
- f media: companies must be controlled by Brazilian individuals, non-Brazilian capital being limited to 30 per cent of the company’s capital; and
- g banking: subject to the prior approval of the government (transfers of control of financial institutions or of significant stakes therein are also subject to prior government approval).
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
Brazilian takeover law did not undergo any major amendments during 2015. However, there have been certain developments on the CVM Rules and Regulations, such as Rules No. 561 and No. 565, enacted by CVM in April 2015 and June 2015, respectively; Rules No. 567 and 568, both enacted by CVM in September 2015; and Rule No. 570, enacted in November 2015.
Rule No. No. 561 concerns the remote participation and vote of shareholders at shareholders’ meetings, which may be an important development for M&A transactions that depend on a shareholder vote. To allow companies appropriate time to comply with the requirements of such rule, Rule No. 570 clarifies that such remote voting rule will be optional in 2016 (for all companies): for companies included in the IBrX-100 index and IBOVESPA on the date of publication of CVM Rule No. 561, it will become effective as of 1 January 2017. As of 1 January 2018, it will become mandatory for all companies listed in category A and with shares traded in the stock exchanges.
With Rule No. 565, CVM’s regulations on mergers were amended, imposing new and more detailed disclosure requirements.
In September 2015, Rule No. 567 was enacted, providing for specific disclosure requirements to be followed by companies regarding its share buyback programmes and transactions with own shares. In turn, Rule No. 568 regulates the use and disclosure of information of relevant investments in listed companies.
In addition, of particular importance in areas that are related to M&A was the regulation of the Brazilian Anti-Corruption Law7 by Decree 8,420 in March 2015, in the federal sphere. Since liability arising out of compliance violations will survive not only an acquisition of a company, but also a merger of a company with, or into, another entity, as well as similar corporate transactions, compliance matters continue to be an important part of the due diligence process.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
In the first half of 2015, Brazil experienced a slow start as a result of the impact of the political crisis and the economic downturn. However, after a positive outcome in the second half of the year, M&A activity with foreign involvement has remained steady and comparable to that of 2014.
As examples of the important revitalisation of the flow of foreign investment from Japanese companies into the country, in June 2015, Japanese company Fuji Oil concluded its acquisition of 83.33 per cent of Harald, the largest producer operating in the Brazilian chocolate professional supply market; and in July 2015, Japan-based Mitsui & Co signed an agreement to acquire from BG Brazil, a subsidiary of the BG Group, a 10 per cent stake in four oil blocks in the Barreirinhas basin.8
In October 2015, British American Tobacco acquired 22.44 per cent of Souza Cruz through a public offer, holding 97.7 per cent of Souza Cruz equity stake after the deal was closed.9
In December 2015, Compass Minerals announced its acquisition of 35 per cent of Produquímica capital stock for 452 million reais; Portugal-based Principal Gestão de Activos acquired 34.75 per cent of Unidas, a car rental company, for €100 million; the American educational company DeVry announced its acquisition of a 96.4 per cent stake in IBMEC, an educational institution offering graduate and postgraduate courses, for 717 million reais. In January 2016, DeVry announced its acquisition of the remaining 3.6 per cent of the capital stock, and now controls 100 per cent of the company’s equity stake.10
With respect to outbound M&A activity, Brazilian companies and investors have concluded most of the deals that were announced in 2014 in addition to new transactions. Some of the important outbound transactions concluded are as follows.
In September 2015, Brazilian company Marfrig sold its Ireland subsidiary Moy Park to Brazil-based JBS for US$1.2 billion. In December 2015, Brazilian foods producer BRF, through BRF Austria, announced the acquisition of GFS, a Thai company engaged in poultry production and commercialisation, for US$360 million. The transaction was concluded in January 2016.
Finally, the Operation Car Wash corruption investigation is expected to continue to increase M&A activity involving distressed assets, strengthening foreign investors’ long-term interest in such investments.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
Some of the most active target sectors involved in announced M&A deals in 2015 in Brazil were technology, retail, telecommunications, financial, industrial (transportation and infrastructure), energy and power (including oil and gas).
In the technology sector, Totvs signed an agreement to acquire 100 per cent of Bematech for 550 million reais. The transaction was concluded in February 2016.11 In addition, the purchase by Redknee, a Canadian software company, of all the equity stake of the Brazilian subsidiary of Orga Systems, a German software company, for €38 million, represented another important deal in the technology sector.
Examples of significant transactions in retail include the following: Brazilian investment group J&F Investimentos acquired 44.12 per cent in the capital stock of shoe manufacturer Alpargatas for 2.6 billion reais in November 2015; again in November 2015, Mobius Health, which is controlled by private equity firm Verti Capital, made the 44 million reais acquisition of a 60 per cent stake in the Brazilian drugstore chain Drogaria Mais Econômica; and in December 2015, the sale of 17 per cent of Pague Menos, another Brazilian drugstore chain, to US-based private equity firm General Atlantic, took place for a total amount of 600 million reais.12 Another remarkable transaction announced in 2015 was the acquisition by the American leading global beauty company Coty of 100 per cent of Hypermarcas beauty and personal care business, corresponding to an investment of 3.8 billion reais, which was concluded in February 2016.13
In the telecommunications services sector, an important transaction that was announced in March 2015 was the joint venture formed by Telefônica Brasil, Claro, Tim Celular and Algar Telecom for approximately 3.7 billion reais, representing a strategic partnership to operate and explore 700MHz radiofrequency projects14 that will expand internet 4G in Brazil.
The acquisition of HSBC bank operations in Brazil by Banco Bradesco announced in August 2015 was a highlight in the financial sector, corresponding to an investment of 17.6 billion reais. The transaction is still awaiting the approval of the Administrative Council for Economic Defence (CADE), Brazil’s antitrust authority.15
With respect to the industrial area (transportation and infrastructure), of note was the sale of 36.4 per cent of Minerações Brasileiras Reunidas held by Companhia Vale do Rio Doce to FIP Multisetorial Plus II, held by Banco Bradesco BBI, an investment of 4 billion reais.
A significant energy transaction was the sale of power assets by Renova Energia to US-based TerraForm Global, a subsidiary of US-based SunEdison that invests in wind, solar and hydro projects in emerging markets, including Brazil. The deal was closed in November 2015, and included the power assets of Centrais Elétricas, Parques Eólicos Salvador and Parque Eólicos Bahia, representing an investment of approximately 1.2 billion reais, of which 451 million reais was paid in cash and 1.026 billion reais was paid with shares issued by TerraForm Global.16
In the oil and gas sector, BG Group announced its US$70 billion merger with Royal Dutch Shell, which is thought to be the 14th-largest M&A deal in history, and which is the largest transaction to take place in the oil and gas sector in more than a decade. The merger has created the largest foreign oil company in Brazil. The transaction was approved by CADE in July 2015.17
During the past year, examples of investment opportunities and transactions that have arisen due to changes in the applicable regulations to allow foreign investment in healthcare providers in Brazil include the acquisition in May 2015 of an 8.3 per cent minority stake by the Carlyle Group of Rede D’Or Sao Luiz, the largest private hospital operator in Brazil;18 and the acquisition by Goldman Sachs of 32 per cent of Oncoclínicas capital stock, a group of medical clinics specialised in the treatment of cancer in Brazil, for 200 million reais.
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
It is common knowledge that the cost of credit in Brazil remains prohibitively expensive.
In Brazil, acquisitions are usually funded via securities offerings (debt and equity) and bank loans. Private equity investment funds (FIPs) may also serve as vehicles for funding in specific cases.
Furthermore, financing is generally not available in all industries. Inbound cross-border investments are typically financed outside of Brazil. Leveraged buyouts are not usual, although in certain cases (especially where the buyer is a local private equity fund) pre-acquisition debt is pushed down to the target following the closing (subject to certain conditions or requirements in cases in which the target is a listed company).
Security for acquisition financing normally consists of shares of the target company and guarantees of the acquiring group.
VII EMPLOYMENT LAW
Recent employment law and legislation developments relevant to M&A in Brazil include the e-social government project, court precedents on economic group liability, company succession issues, issues concerning social security taxation of stock option plans and a new bill of law on labour outsourcing, as described in more detail below.
i The e-social project
The e-social (single digital reporting system) project is a government initiative designed to unify the submission of social and employment information that employers are obliged to provide to the labour and tax authorities. It is expected to become effective as of September 2016 for all companies whose annual turnover exceeds 78 million reais. The system is still being tested. However, this will certainly be an important feature of M&A transactions in the near future.
ii Conglomerate or corporate group
In accordance with Brazilian labour and employment laws, corporate entities that are under the same direction, control or management constitute a ‘conglomerate’ or a ‘corporate group’; in terms of liability, which is important in the context of M&A, companies from the same corporate group are jointly responsible for obligations to employees of the group or of any company of the group; furthermore, certain precedents of the Brazilian labour courts have ruled that any company of an economic group, even if that company is considered to be only an investor or even if it does not have control over the economic group, may in any event be held liable for labour obligations to employees of the group.
iii Companies’ succession and compliance agreements
In cases of succession among two or more companies (as a result, for instance, of an M&A transaction), the labour rights of the relevant employees must be maintained at least at the same level. Compliance agreements are entered into with the Labour Prosecution Office when a company (or companies of the same corporate group) is not in compliance with the Brazilian labour laws. If a compliance agreement was signed by a company that is later subject to succession, that compliance agreement will be binding upon the successor company. Ongoing collective lawsuits filed in the past may also be directed against successors in certain circumstances.
iv Officer (or executive) compensation
Especially in the case of stock options plans, there is considerable controversy involving the tax and labour authorities in Brazil as to whether stock options should be considered to be part of the officer’s (or executive’s) compensation, and what taxes would apply in respect of such stock options. Until the matter is settled definitively, M&A due diligence exercises will need to carefully consider the potential risk exposure.
v New law on outsourcing
Companies in Brazil are currently prohibited from outsourcing their core business due to labour court precedents, and may only outsource non-core activities (i.e., activities that are not considered ‘essential’ to the company’s corporate purposes). However, a new bill of law is being voted on by the Brazilian Congress. In addition, a case to be ruled on by the Brazilian Supreme Court will be binding on all Brazilian courts, which may allow companies to outsource both non-core and core businesses. These developments may also impact companies’ businesses, and therefore become relevant in M&A due diligence processes.
VIII TAX LAW
On 17 March 2016, Law No. 13,259 introduced a new system for the calculation of capital gains realised by (Brazilian resident individuals upon the disposal of assets and rights, and entities that are not subject to the real or presumed profit tax regimes (and that are not subject to the method that tax authorities use to assess corporate income tax upon the disposal of non-current assets and rights).
Although the wording of Law No. 13,259/16 does not directly reference capital gains realised by foreign investors, they may, in certain circumstances, be impacted because the Brazilian tax legislation generally requires that capital gains realised by an individual or entity resident or domiciled abroad be calculated in accordance with the rules applicable to individuals residing in Brazil.
Law No. 13,259/16 establishes a progressive taxation method that will replace the current 15 per cent rate levied upon capital gains. These progressive rates are as follows:
- a 15 per cent on any capital gain that does not exceed 5 million reais;
- b 17.5 per cent on the portion of the capital gain ranging between 5 million which exceeds reais and 10 million reais;
- c 20 per cent on the portion of the capital gain ranging between 10 million which exceeds reais and 30 million reais; and
- d 22.5 per cent on the portion of the capital gain which exceeds 30 million reais.
Law No. 13,259/16 only covers general rules regarding capital gains, or certain scenarios that were specified, as in the case of a sale or disposition of assets that are carried out in more than one stage. However, other situations regulated by specific rules that were not specifically modified by Law No. 13,259/16 are not covered therein, and will remain subject to the current 15 per cent rate, which is the case for the following:
- a the net gains method applicable to transactions carried out by individuals on stock exchanges and similar markets, for which a specific tax rate of 15 per cent is established;
- b the specific tax treatment granted to non-resident investors who are not located in favourable tax jurisdictions (JTFs) that invest in the Brazilian financial and capital markets pursuant to Resolution No. 4,373/2014 of the National Monetary Council, which also contemplates tax exemptions and specific rates; or
- c the higher 25 per cent rate applicable to certain investors located in JTFs.
With respect to foreign investors, a wide range of aspects must be analysed to determine whether any specific case is impacted by Law No. 13,259/16 – for example, the location of the investor, how the investment is carried out and the environment in which the sale is concluded.
Some controversy may arise in connection with the application of Law No. 13,259/16. One issue we note applies to future payments for transactions carried out in 2016; for example, how to apply the new tax rates contemplated in the Law for transactions that have been already concluded in 2016, but for which the purchase price will be paid after the Law becomes effective – which will occur on 1 January 2017; and future payments deposited in escrow accounts or that are contingent upon certain events, such as earn out payments that depend on the calculation of disposed-of profits of the entity.
The applicability of the new capital gain rates introduced by Law No. 13,259/16 should be analysed together with the provisions established by double tax treaties entered into by Brazil and certain countries to avoid double taxation. These agreements generally provide maximum rates that are lower than those stipulated in Law No. 13,259/16.
IX COMPETITION LAW
Throughout 2015, we saw the following changes in terms of policy related to merger control in Brazil:
CADE published Resolution No. 13/2015 on 30 June 2015. This resolution provides guidelines governing the administrative proceeding to investigate mergers. According to these rules, CADE may launch a proceeding to investigate:
- a mergers submitted to CADE but implemented prior to obtaining the antitrust clearance;
- b mergers not submitted to CADE because the transaction was not subject to mandatory notification in Brazil; and
- c mergers not submitted to CADE but subject to mandatory notification in Brazil.
The proceeding may be opened ex officio by CADE’s General Superintendency, or as a consequence of a request made by CADE’s Tribunal or by a third party. CADE understands that the hypotheses described in (a) and (c) above should be considered as violations of the standstill obligation (also known as ‘gun jumping’). In those cases, CADE may impose the following penalties on the parties: fines ranging from 60,000 reais to 60 million reais; the opening of an investigation into the parties’ behaviour prior to obtaining CADE’s clearance for potential antitrust infringements; and administrative remedies, which may result in any act implemented in violation of the standstill obligation being declared null and void. On the other hand, as hypothesis (b) does not entail any violation of Brazilian antitrust law, CADE may not impose such penalties, although the authorities can request the parties to submit the transaction to CADE’s review and, if necessary, impose remedies in order to approve the transaction. The resolution also provides the procedure for all requests to submit transactions and for all merger reviews.
Moreover, CADE has recently issued a preliminary version of its Horizontal Merger Guidelines, a new proposal for a resolution regarding notification rules for ‘associative agreements’ and a proposal to limit CADE’s review period for transactions submitted under the fast-track procedure to 30 days. All documents are subject to comments from legal counsel, economists, associations and any other parties that may be interested. The final versions of such documents are expected to be issued in 2016.
In spite of the challenges facing the Brazilian economy and the current political scenario, M&A activity is expected to increase in the second half of the year.
As a result of the variation of the Brazilian real in relation to the US dollar, Brazilian assets became cheaper, thus creating an additional incentive for seasoned foreign investors (especially private equity) to take advantage of investment opportunities in the country, which are expected to resume soon.
Another important driver for M&A activity in Brazil should continue to be the increasing number of companies facing severe financial difficulties as a result of the prevailing macroeconomic conditions. Distressed assets available for sale are likely to include companies in various sectors. Also contributing to this trend is ‘Operation Car Wash’, involving Brazil’s oil company Petrobras, which should continue to boost divestitures as companies affected by the scandal struggle to raise funds and shift their focus to core or new activities.
Finally, changes in the regulatory environment, such as the recent lifting of certain regulatory restrictions on foreign investments in the healthcare and airlines industries, will most likely continue to increase transactional activity in regulated industries.
1 Moacir Zilbovicius and Rodrigo Ferreira Figueiredo are partners at Mattos Filho, Veiga Filho, Marrey Jr e Quiroga Advogados.
4 ‘Fusões e Aquisições no Brasil – Dezembro de 2015’, PwC, available at www.pwc.com.br/pt/publicacoes/servicos/assets/fusoes-aquisicoes/2015/pwc-fusoes-aquisicoes-dezembro-15.pdf.
7 Law No. 12,846, of 1 August 2013.
16 www.ttrecord.com/en/exclusive-area/transactions/mergers-and-acquisitions/Salvador-Holding-Nova- Renova-Energia/224975.