I OVERVIEW OF M&A ACTIVITY
Despite the continued economic downturn and political uncertainties due to the ongoing Operation Car Wash corruption investigation and, most importantly, the impeachment of a former president, M&A activity in Brazil remained at a significant level in 2016.
According to PricewaterhouseCoopers,2 2016 saw 597 transactions, which, although 20 per cent lower than the 742 deals concluded in 2015, is still a significant number. Non-Brazilian investors conducted 255 transactions, representing a 25 per cent decrease compared to the 342 deals in 2015, and private equity activity was down to 121 transactions among Brazilian and non-Brazilian investors.3 Deals announced in 2016 with Brazilian involvement include Brookfield’s US$5.1 billion acquisition of Nova Transportadora do Sudeste, a Petrobras’ pipelines unit, State Grid’s 17 billion reais acquisition of CPFL Energia and BM&FBOVESPA’s 11 billion reais merger with CETIP.
While the political uncertainty remains, the beginning of economic recovery gives the market a long-term positive scenario for M&A activities in 2017. The number of transactions increased in the first quarter of 2017. In the first three months of 2017, a total of 256 transactions were announced (a 6 per cent increase compared to the number of transactions announced in the same period in 2016).4 In terms of value, the first quarter of 2017 has significantly exceeded the same period in 2016, resulting in an increase of 180 per cent.5
Deals announced to date in 2017 include the acquisition of ThyssenKrupp CSA by Ternium for €1.2 billion and the acquisition of Salomão & Zoppi Medicina Diagnóstica by DASA, two of the biggest Brazilian players in the medical field; the acquisition of AES Tietê’s wind energy assets by Renova Energia for 600 million reais; and the deal that is likely to be one of the most important transactions of the year, the sale of 49.9 per cent of XP Investimentos, the nation’s third-biggest brokerage by equity-trading volume, to Itaú Unibanco SA, for 6.3 billion reais.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
In Brazil, M&A is regulated mainly by the Brazilian Corporation Law;6 rules, regulations, opinions and precedents of the Brazilian Securities Commission (CVM) (CVM Regulations), including:
- a CVM Rule No. 319 (mergers involving public companies);
- b CVM Rule No. 358 (disclosure of material information by public companies);
- c CVM Rule No. 361 (tender offers);
- d CVM Rule No. 481 (disclosure of information prior to shareholders’ meetings and proxy solicitation);
- e CVM Rule No. 561 (remote participation and vote of shareholders at shareholder’s meetings);
- f CVM Rule No. 565 (disclosure requirements to M&A transactions);
- g CVM Rule No. 567 (disclosure requirements regarding share buyback programmes and transactions with own shares);
- h CVM Rule No. 568 (use and disclosure of information of significant investments in listed companies);
- i CVM Rule No. 570 (application of remote voting rules);
- j CVM Opinion No. 34 (conflicts of interest);
- k CVM Opinion No. 35 (fiduciary duties);
- l CVM Opinion No. 36 (poison pills); and
- m 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, in addition to the CVM Regulations, are also regulated by the applicable 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 and 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 corporate and takeover law did not undergo major amendments during 2016. On 30 August 2016, however, CVM enacted Rule No. 578 to amend the rules that govern the formation and operation of FIPs in Brazil, and Rule No. 579 to establish accounting rules and standards for FIPs. The new rules move the Brazilian regulatory framework closer to offshore standards in line with recent discussions promoted by industry participants. The most significant changes for offshore players may be summarised as follows:
- a FIPs are now permitted to invest up to 20 per cent of their net equity in offshore private equity assets;
- b a special class of FIPs, offered exclusively to professional investors, has been created to invest up to 100 per cent of their net equity abroad. In addition, subject to certain restrictions and limits, FIPs are now permitted to invest in non-convertible debentures and Brazilian limited liability companies, expanding the investment strategies and types of assets suitable for FIPs;
- c FIPs are now permitted to have authorised capital, which means that the administrator may issue new quotas in FIPs without requiring investor approval;
- d the different classes of quotas may now have different rights, permitting differentiation as to, inter alia:
• hurdle rates;
• management fees and performance fees;
• the timing of capital calls, amortisation and redemption; and
• veto rights and the appointment of members of committees;
- e FIPs are now required to prepare and submit audited financial statements whenever there is a material change in the fair value of the investment company during the fiscal year; and
- f in an effort to harmonise Brazilian accounting principles with international standards, FIPs qualified as investment entities should mark portfolio assets according to their fair value, while FIPs that do not qualify as investment entities should register their investments in accordance with the rules applicable to affiliates of publicly traded companies.
Finally, Rule No. 578 has also segregated the roles performed by the portfolio manager and the administrator in such way that they will not be jointly liable for their acts. Therefore, the administrator and the portfolio manager will only be liable according to their respective duties and actions.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
In 2016, following the political tensions of 2015, Brazil experienced a downturn in foreign involvement in transactions. With 255 transactions until December 2016, non-Brazilian investors faced a decrease of 25 per cent compared to the 342 in the same period of 2015.7
Foreign investors took a leading role in major transactions announced in 2016. Examples of significant foreign investment in Brazil included the acquisition of 54.64 per cent of CPFL Energia and the controlling block of CPFL Energias Renováveis by the State Grid Corporation of China from Camargo Corrêa, Bonaire and Previ for a total of 17 billion reais, which was announced in July 2016 and closed in January 2017.
In June 2016, the Chinese HNA Group, which provides ground services in the aviation sector, acquired 100 per cent of Swissport from French private equity firm PAI Partners for €2.8 billion, and in December 2016 concluded the acquisition of a minority stake of 25 per cent of hotel business Hilton Worldwide Group.
In September 2016, Athens-based Titan Cement Group expanded its operations to Brazil by acquiring 50 per cent of Apodi, a Brazilian cement and building materials producer and distributor.
In October 2016, two transactions carried out by Canadian private equity firm Brookfield Asset Management were considered among the most significant transactions announced during the year: the 70 per cent stake acquisition in Odebrecht Ambiental for US$2.5 billion, and the US$4.2 billion acquisition of Nova Transportadora do Sudeste, one of Petrobras’ divestments, which was concluded in April 2017. In December 2016, the American mining company Mosaic announced the acquisition of Vale Fertilizantes for US$2.5 billion.
The ongoing Operation Car Wash investigation is expected to continue to drive 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 2016 in Brazil were education, financial, industrial (transportation and infrastructure), energy and power (including oil and gas).
In the education sector, Estácio Participações announced its merger with Kroton Educacional. The transaction value is 5.5 billion reais, and is still awaiting the approval of the Administrative Council for Economic Defence (CADE), Brazil’s antitrust authority.
In the financial sector, the 11 billion reais merger of BM&FBovespa with Cetip was announced in April 2016 and concluded in March 2017. In May 2017, the sale of 49.9 per cent of XP Investimentos, the nation’s third-biggest brokerage by equity-trading volume, to Itaú Unibanco SA for 6.3 billion reais was announced (still subject to regulatory approvals). XP was valued at approximately 12 billion reais. In addition, within the context of this transaction, Itaú also agreed to make a 600 million reais capital increase in XP, and committed to buying an additional 12.5 per cent of XP in 2020 and a further 12.5 per cent in 2022.
With respect to the industrial sector (transportation and infrastructure), of note was the acquisition of Odebrecht Ambiental for US$768 million by Brookfield Asset Management. In December 2016, Norsk Hydro, an aluminium producer, made a US$113 million acquisition in the mining company Paragominas.
Another significant transaction, this time in the energy sector, was the US$2.5 billion acquisition by Statoil Brasil of BM-S-8 Oil Block, operated by Petrobras.
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, or via both. Private equity investment funds (FIPs) are also used 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 outsourcing, negotiation versus legislation and labour reform, as described in more detail below.
i New law on outsourcing
Under Precedent 331 of the Superior Labour Court, outsourcing a company’s core business is unlawful. A bill has passed, however, to alter Law 6,019/74, which regulates temporary employment, in order to regulate outsourcing of workers in Brazil as well. Although the new legal provisions do not explicitly prevent core business outsourcing, they establish that a company may contract another company ‘providing defined and specific services’ (without specifying whether these services are part of their core business). Precedent 331 has not yet been revoked, and the interpretation and concept of ‘providing defined and specific services’ should be subject to interpretation by the courts. In addition, the unconstitutionality of such Precedent is still pending a decision by the Brazilian Supreme Court. It is worth mentioning that the labour reform (which is currently being reviewed by Congress) has a provision allowing the outsourcing of core business, which, if approved, should bring more clarity to the matter.
ii Negotiation versus legislation
Currently, one of the main labour and employment issues is whether collective bargaining agreements may prevail over the strict national legislation regarding employees’ rights and benefits. The Supreme Court has ruled in favour of ‘negotiation over legislation’ on two important precedents: in 2015, regarding voluntary dismissal programmes; and in 2016, with respect to the possibility of suppressing overtime payment against other benefits. However, since such precedents are from specific decisions that do not have an automatic mandatory binding effect on lower courts (i.e., stare decisis), it should be noted that the Superior Labour Court (which is the highest court for labour cases with respect to infra-constitutional subject matters) is not bound by them, and is currently of the opinion that collective bargaining agreements cannot prevail over the strict national legislation regarding employees’ rights and benefit.
iii Labour reform
A major reform of the Brazilian Labour Code (CLT) is currently being reviewed by Congress. A bill altering over 100 articles of the CLT has passed in the House of Representatives and awaits Senate voting and Presidential approval. If approved as is, such bill will impact many provisions that are relevant to M&A transactions, such as those on the concept of economic group, ‘negotiation over legislation’, succession for labour and employment liabilities, mass dismissal, employees’ termination and outsourcing.
VIII TAX LAW
Law No. 13,259, dated as of 16 March 2016 and effective since 1 January 2017, introduced the current system for the calculation of capital gains realised by Brazilian-resident individuals upon the disposal of assets and rights, and by entities that are not subject to the actual 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 has established a progressive taxation method that replaced the former 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 reais and 10 million reais;
- c 20 per cent on the portion of the capital gain ranging between 10 million reais and 30 million reais; and
- d 22.5 per cent on the portion of the capital gain that 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. This includes tax exemptions and specific tax regimes contemplated by law, 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 (FTJs) 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 FTJs.
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 payments made or to be made in 2017 or later for transactions carried out in 2016; for example, how to apply the new tax rates contemplated in the Law for transactions that have already been concluded in 2016, but for which the purchase price will have to be paid after the effectiveness of the Law (which started on 1 January 2017, as previously mentioned); as well as future payments deposited in escrow accounts or that are contingent upon certain events, such as earn out payments that depend on the calculation of the disposed-of profits of the entity.
The applicability of the capital gain rates set forth 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
In 2016, CADE approved two resolutions that change the terms of the policy related to merger control in Brazil. CADE also issued the new Horizontal Merger Guidelines (Guidelines), which focus on the pre-merger control regime established by the Brazilian Competition Law.8
i Resolution No. 16/2016 (CADE’s Resolution No. 16/2016)
On 31 August 2016, CADE approved CADE Resolution No. 16/2016), according to which non-complex transactions filed under the fast-track proceeding are analysed in up to 30 calendar days, counted as from the date of the formal submission to CADE.
The fast-track proceeding includes transactions that do not result in any actual or potential horizontal overlap or vertical link; transactions resulting in only minor horizontal overlaps, with combined market shares below 20 per cent; and transactions resulting in vertical links in which the parties or their groups hold shares of 30 per cent or less in the respective markets.
CADE Resolution No. 16/2016, which provides a 30-day deadline review for fast-track proceedings, formalises an informal commitment by CADE’s General Superintendency to analyse non-complex transactions within less than 30 days.
ii Resolution No. 17/2016 (CADE Resolution No. 17/2016)
On 16 October 2016, CADE approved CADE Resolution No. 17/2016), which defines new rules of mandatory filing of collaborative agreements between companies that meet the revenue threshold criteria established by the Brazilian Competition Law9. CADE Resolution No. 17/2016 replaced CADE Resolution No. 10/2014, which had regulated collaborative agreements since January 2015.
By stipulating a new concept for collaborative agreements, CADE Resolution No. 17/2016 represents a step forward in the definition of the collaborative nature of agreements subject to mandatory filing, discarding the former criteria based on market share and vertical links.
According to CADE Resolution No. 17/2016, a collaborative agreement is any agreement that establishes a joint enterprise with the purpose of engaging in an economic activity, provided that the agreement stipulates the sharing of risk and profits between the contracting parties, and the parties or respective economic groups compete in the market related to the agreement. CADE Resolution No. 17/2016 defines ‘economic activity’ as the acquisition or offer of goods or services in the market that could, at least theoretically, be exploited by a private company operating for profit. The minimum term of collaborative agreements that triggers the requirement for mandatory filing continues to be two years.
Agreements resulting in vertical supply links between the parties were excluded from the list of agreements subject to mandatory filing.
In 2016, CADE also published the new Guidelines. The Guidelines aim at providing more transparency to CADE’s analysis and at guiding authorities and market agents to employ the best analysis practices during the review of transactions involving competing companies.
The Guidelines reflect the developments resulting from the Brazilian Competition Law, such as pre-merger reviews, and try to adjust CADE’s practices to other jurisdictions, in particular those of the United States and Europe.
Non-competition clauses and new methods that CADE may use to assess the effects of transactions in the market, regardless of the relevant market definition (e.g., counterfactual analysis and simulations), were also considered in the Guidelines.
In addition, the Guidelines also include an analysis of portfolio power, potential competition, maverick elimination and partial acquisitions. In particular, the Guidelines provide that partial acquisitions (acquisitions of a minority shareholding in a competitor company) are relevant to CADE’s review, as they may affect the control or influence exercised in the acquired company. In those cases, the Guidelines suggest that parties should present to CADE documents such as the transaction’s shareholders’ agreement, information about vote and veto rights, and information about the influence that one company may have on the other.
Despite the overall decrease in 2016 compared to recent years, in the second half of last year, the M&A activity started to pick up and continued to increase during the first quarter of 2017. These facts brought a long-term positive scenario to M&A activities in 2017, possibly signalling that investors may take advantage of the current environment to enter or further expand into the Brazilian market.
The current foreign exchange levels may also play a role in incentivising seasoned foreign investors (especially by private equity) to take advantage of investment opportunities in the country.
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 the Operation Car Wash probe, 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 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.
6 Law No. 6,404 of 15 December 1976.
8 Law No. 12,529/2011.
9 According to the Brazilian Competition Law, filing with CADE is mandatory if the parties involved in the transaction meet the following turnover thresholds: at least one of the economic groups involved in the transaction registered gross revenues in Brazil equal to or exceeding 750 million reais in the fiscal year prior to the transaction; and at least one of the other economic groups involved in the transaction registered gross revenues in Brazil equal to or in excess of 75 million reais in the fiscal year prior to the transaction.