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Investors gear up for acquisitions in Brazilian IT sector

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Investors gear up for acquisitions in Brazilian IT sector

Investors have once again set their sights on the Brazilian IT sector given lower valuations, prospects of faster digital adoption, and recent signs that Latin America's largest economy could be regaining its foothold.

An uptick in monthly preliminary GDP data in May along with a significant drop in market volatility indexes could usher a wave of smaller, targeted investment M&A deals in the financial space, industry experts said. Improved conditions could mark a gradual reversal from the sharp dry up in funding seen at the beginning of the pandemic.

"Current data shows private equities are liquid at the moment and just waiting for some initial signs of recovery to start performing," Venus Kennedy, an M&A partner with Deloitte Brazil, said in an interview.

Deal-making in the industry has been kept alive despite the recent economic downturn and high levels of uncertainty due to the spread of coronavirus. S&P Global Market Intelligence data shows financial companies made 19 purchases in the second quarter of 2020, with Brazilian XP Inc, Credit Suisse and JP Morgan among the most recent reported buyers.

The number of M&A deals saw a sharp drop from the first quarter's 43 transactions, but had a resilient component of IT related acquisitions, which made up more than a quarter of total deals in the second quarter.

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"We've been quite busy, surprisingly," Pedro Kassab, investment banking director with Banco Fator SA, told Market Intelligence. "There were some major disruptions at the beginning, but medium to long term opportunities kept moving as investors tried to build up a pipeline for when the market opens up."

The economy grew 1.3% in May a marked improvement from steep declines in March and April Banco Central do Brasil's IBC-br index data showed. Meanwhile, market volatility receded from decade-long record spikes in late March, according to the CBOE Brazil Volatility Index.

While volatility readings across industries remain higher than before the pandemic, risk metrics such as the probability of default have eased considerably from peaks reached in April.

"I would be surprised if anyone pulls the trigger on a large transaction while volatility is high," Renato Lulia, head of investor relations with Itau, told Market Intelligence in May. "But what you might see is minor transactions, companies going belly up that someone is going to buy."

Investment banking and private equity moves are more likely in the short term, Deloitte's Kennedy said, given strategic company acquisitions would have "a tough time selling their boards on big bets right now."

While those big strategic mergers and acquisitions will probably return by October, highly liquid investors are already lining up for smaller opportunities in the digital space. On July 13, an executive with SoftBank Group Corp., one of the most active buyers of tech companies in the region, confirmed to the Financial Times that they were now ready to resume IT acquisitions.

"Digital is one of the big trends that became ever more important because of the pandemic," Deloitte´s Kennedy said.

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A "bigger, more addressable" fintech market

The fintech industry has long been a sector-favorite pick for venture capital in the last years. As user adoption spiked due to lockdown measures, the case has become stronger for investors with sufficient cash.

"The fintech market has just become bigger," Rafael Pereira, president of the Brazilian Association of Digital Credit, said in an interview. "A faster digitization of businesses makes the tech side of fintech much more attractive right now."

Brazilian online broker XP which tapped nearly $2 billion in its 2019 IPO in the U.S. was the most active buyer in the quarter. Only in June, it scooped up supply chain financing firm Antecipa, insuretech DM10, investment software provider Carteira Online, and an eye clinic in Curitiba.

"(XP's) move shows a company eager to gain market share and is seeing opportunity in what is going on," Pereira said. Prospects of faster digitization combined with cash-strapped fintechs creates the "perfect condition" for industry consolidation, he added.

IT has been a top pick for financial companies in the quarter, attracting private equity boutiques and asset managers such as A5 Capital and Piemonte Holding.

International banks have also stepped in, with JP Morgan Chase & Co. announcing its first investment in the LatAm payments industry through Fitbank Pagamentos. Eletrônicos Ltda. Earlier in June, Credit Suisse bought a minority stake in digital bank Banco Modal SA, in an effort to consolidate its presence in the Brazilian online banking space.

The large local retail lenders have so far remained on the sidelines and appear to be sitting this one out, while they continue to evaluate the impact of lockdowns on their own trillion-Brazilian-reais portfolios.

The pricing gap for opportunities might be closing soon, analysts warn. "It doesn't look like we are going to have competitive valuations for too long," Kassab said, as the market is already pricing in easing measures by the central bank.

As of July 21, US$1 was equivalent to 5.20 Brazilian reais.