Financial M&A spikes in Brazil as banks and fintechs vie for IT assets

Nearly a year and a half into the COVID-19 pandemic, Brazilian banks and fintechs are back to shopping.

The pace of M&A deals by financial players has gained momentum once again — following a lull at the onset of the pandemic in 2020 — and has already surpassed pre-pandemic levels. The outlook remains upbeat for the remainder of the year, as a strong drive toward digitization has prompted big firms to accelerate their growth, with technology as the most coveted asset to enhance their capabilities.

"We are seeing a very hot [pipeline] this year," Venus Kennedy, a partner with Deloitte Brasil, said in an interview. "Due diligence has been sold out for, like, five months. We have been very, very busy with deal flow."

Purchases made by financial companies shot up to 66 deals in the second quarter of 2021, up 69.2% from 39 deals reported in the year-ago period. The pace of deal-making has recovered firmly from the dip seen at the beginning of 2020, when deals in the sector hit 10-year lows due to the difficulty of adequately pricing operations.

Experts predict that a strong pace in the M&A market will continue into 2022, with the digital banking space remaining especially attractive for deals. Brazilian financial firms that managed to wade through the crisis came out with strong capitalization, and many of their cost-saving measures implemented during COVID-19 left them appropriately prepared to spend.

As a result, a sustained wave of investments is expected in the financial space. Analysts foresee greater consolidation in the industry as companies grow their operations inorganically to better compete in the digital banking space.

"People are doing a little bit more buying than making," Kennedy said. "We are seeing smaller to middle-sized deals focused on acquiring specific technologies from these kinds of smaller startups and fintechs."

IT is the desired asset

The majority of deals made by financial companies were aimed at scooping up tech operations. The share of acquisitions in the information technology sector stands above 60% of all purchases, S&P Global Market Intelligence data shows. Most of the deals took place in the application software industry, followed by internet software and services.

While the pace of IT deal-making by Brazilian banks and financial firms continues to grow, the growing interest in IT firms is not exclusive to the financial industry.

A survey by Deloitte shows that tech firms are the most targeted assets for a variety of M&A buyers, even beyond the financial industry. Competition to buy smaller, heavily specialized firms can get intense. Brazil's acquiring firm StoneCo Ltd., which is invested by Warren Buffett's Berkshire Hathaway Inc., had a noisy contest in 2020 with IT giant TOTVS SA to acquire enterprise software provider Linx.

In this competition, big financial firms have a lot to gain. The digital banking market has gotten much bigger throughout the pandemic, and new competitors have been increasingly challenging. Online banking is expected to remain a greenfield space for M&A investments.

"We are seeing a lot of M&A in the segment, and it will remain a big thing throughout 2021," said Guilherme Machado, a bank director with S&P Global Ratings. "They are all trying to grow, and small players can be integrated into larger banks."

One of the most active buyers in the market has been the publicly traded investment firm XP Inc. The digital broker tapped Jive and OHM Research, as well as asset manager Capitania Investimentos and other assets, such as Riza M&A advisory firm. It even scooped up an eye clinic earlier in 2020. It has recently launched a SPAC that tapped $200 million in U.S. markets, through which it intends to further acquire companies and expand its addressable market.

Fintechs turn to investments as a means to monetize

Among acquisitions in the financial space, M&A deals targeted at investment brokerage houses have been recurrent. Both for digital and traditional banks, as well as fintechs, the investment business in Brazil is increasingly attractive.

Banco Santander (Brasil) SA completed the acquisition of investment broker Toro, whereas investment bank Banco BTG Pactual SA bought Fator SA Corretora de Valores. Digital lender Nu Pagamentos SA, the largest online bank in Brazil, had acquired digital broker Easynvest - Título Corretora de Valores SA in late 2020.

"My impression is that competition in the investment sector is already very strong," Thiago Batista, a bank director with UBS-BB, said. "With the expansion of XP, large banks have all improved their platforms to try and compete with these new players."

But for digital banks, building up their investment offering is more than just a matter of competition. It can also be a driver of fee income in the future, as many of these challengers are still working on the profitability of their business models.

Many online lenders offer a limited set of financial products, and M&A has allowed them to expand their product offering. "Digital banks are reinforcing their investment operation, or even creating it, to try to monetize," Batista said.