07 nov Strategic Considerations for Investing in Latin America
By Victorino Bernal & Alex Trueba
With a bevy of strong, emerging economies, technological advances and unceasing globalization, Latin America continues to be an attractive destination for companies seeking expansion and growth. Over the last 40 years, investors have been steadfast in entering the market to benefit from its massive, untapped potential. The region’s proximity and access to major global economic powers, strong trade-ties, rich labor talent pool, burgeoning infrastructure, ever-growing population, and abundance of natural resources, logically makes it one of the world’s most sought-after investment frontiers.
Despite its potential, Latin America also presents unique challenges to foreign investors attempting to establish a successful foothold in the region. Overcoming these challenges requires a careful investment approach that should be strategically and methodically defined. Employing tactics utilized to assess markets in the U.S., Europe, or Asia/Pacific may not necessarily yield effective results in Latin America. Without a detailed constructed transaction strategy, market entry, growth and most importantly, exits can prove cumbersome, difficult and costly.
Economic & Political Assessment
Historically, Latin America has presented investors with fortune and success, as well as uncertainty and volatility. Due to innate economic, legal and political differences within each country, performing extensive market due diligence prior to conducting any transaction is a prudent exercise. Target demographics, consumer habits, distribution channels, access to funding and fiscal policy, can shift drastically from market to market. Anticipating these critical shifts may translate into modifying business models, service approaches, and ultimately, expected rates of returns. Investors, regardless of industry, must remain agile and respond rapidly to changing economic and political landscapes.
An economic and financial evaluation process should be multi-faceted. Investors should consider factors such as historical and future financial trends, cost of labor and production, infrastructure dependability, and supply chain constraints. Regardless of market size, a company’s investment objectives should align with specific local economic characteristics. The profile and core competencies of a potential investor may be best suited with a free-trade economy, such as Panama, or a more industry-specific one, such as Peru or Chile.
The ever-shifting political climate of each market plays a role in determining economic viability and investment appetite. Just this year, Colombia elected it first ever left-wing President. The initial result was a slumping peso and stock dip as uncertainty and concern swirled around the new regime. Investors were quick to divest of assets due to fears of unpredictable changes in a once investor-friendly economic model. Market uncertainty and the potential de-incentivizing of foreign investment still lingers in the back of investor’s minds. For many investors, the recent election of former President Luiz Inácio Lula da Silva in Brazil meant a shift back to a more state-run, left-leaning model. Such perceived dramatic political shifts can create uncertainty and destabilize local economic activity. Keeping a pulse on elections, austerity measures, tax reforms and monetary policy may prevent a promising opportunity from becoming an unfavorable one.
Establishing strategic relationships with proven industry leaders may often help avoid unnecessary complications, mitigate risk, and comply with necessary procedural tasks and laws. A trusted partner, or well-respected advisor with in-depth knowledge of the local business environment proves to be an invaluable resource in evaluating a transaction. These partners and advisors can range from local equity partners to legal and tax advisors who may ease the burdens of complex local bureaucracy and develop acquisition structures to minimize tax exposures. Financial advisors and accountants can advise on proper financial regulations and quantify quality of earnings issues that impact transactions values. These considerations often dictate the ultimate financial outcome of any transaction.
Critical contingent liabilities involving tax and labor exposures should be prioritized and tackled in tandem with an advisor. Corporate, Individual, and Social Security taxes must be considered when preparing to invest or divest. Additionally, many countries in the region derive substantial revenue from Value-Added Taxes (VAT), a consumption tax that is often overlooked by U.S. investors. The financial consequences of failing to quantify tax exposures far outweighs the cost of engaging experienced local tax counsel. Furthermore, as Latin America has continued to grow, labor reforms have become much more prevalent. Understanding your responsibilities to employees and staff, such as severance and pension obligations, must be factored into the strategic calculus.
As with any investment, deciding on the proper mechanism for dispute resolution is critically important. Effective remedies must be defined and clearly understood by all parties. Investors must consider choice of law, governance, potential waivers, and dispute resolution mechanisms. Whether it is a dispute with a private or public sector partner, arbitration tends to be a preferred form of dispute resolution for many investors given the uncertainty of legal proceedings. Investors often look to Miami as a suitable arbitration forum due to the city’s commercial and cultural ties to the Latin America, multilingual and experienced legal professionals, and the cost and convenience of proceedings in South Florida.
Understanding the economic environment while considering political risk and affiliating with the right strategic partners, is paramount to success in any foreign market. Any investment strategy focused on a country in Latin America should be crafted and developed with these points in mind. Although challenges will recurrently persist, Latin America continues to provide significant upside potential to those who thoughtfully and strategically decide to invest and conduct business in the region.
Lula Wins Brazil Election
Following an initial inconclusive first round of elections in early October, Luiz Inácio Lula da Silva defeated incumbent Jair Bolsonaro in a tightly contested run-off. President-elect Lula da Silva, who previously held the same office from 2003-2010, received almost 51% of the vote, while outgoing President Bolsonaro, seeking a second term, garnered 49%. After originally failing to concede public defeat directly following the results, many worried that the President and his administration would officially contest the results, given his past rhetoric on potential voter fraud. So far, this has not been the case. The outgoing administration has already met with the President-elect’s camp for transition planning. Nonetheless, many took to the streets to protest the results, blocking key roads and highways across the country. The President has urged supporters to backdown and end the blockades. The President-elect will be sworn into office on January 1st, 2023.
América Móvil to Sell Towers
After a successful spin-off of its Latin American cell tower operations in July of this year, Mexican telecom giant América Móvil (AMX) has announced it will likely sell its cellular towers located in Peru and the Dominican Republic to Sitios Latinoamerica (Sitios Latam). AMX will pay Sitios Latam nearly US $350 million to satisfy its cost of rent and it looks to divest of its passive infrastructure assets in the region. Sitios Latam has an inventory of just over 30,000 towers throughout Latin America. Close to 40% are located in Brazil, while the rest of the portfolio can be found in Argentina, Chile, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Nicaragua, Panama, Paraguay, Peru, Puerto Rico and Uruguay. Sitios Latam is listed on the Mexican Stock Exchange as of the end of September.
Petroperú Cash Injection
The Peruvian government has approved a US $1 billion cash infusion to state-owned oil company Petroperú. The government has deemed the capital injection as urgent and necessary to help the company navigate its short-term liquidity issues and long-term expansion goals. In addition to the US $1 billion, the company also extended a US $500 million line of credit to cover short-term obligations and import fuel. Petroperú controls nearly 50% of the country’s fuel market, but its credit rating was downgraded to junk status this year by S&P & Fitch, limiting its borrowing capabilities. As a result of its financial unrest, it was recently announced that Petroperú’s President, Humberto Campodónico, will also resign.
Colombia Tax Reform Bill
What some are calling the most progressive tax reform in Colombia’s history was approved by the Congress on November 4th and will be signed into law. The reform, which President Gustavo Petro hopes will fund social spending to combat income inequality, is projected to increase revenues by nearly US $4 billion annually. These increased tax revenues primarily come at the expense of the oil and gas industry, as well as ultra-high-net-worth individuals. Critics of the bill argue that the new tax hikes will discourage investment into the country, particularly in the fossil fuels industry.
PREPA Selects Sunrun
On the heels of multiple devastating natural disasters that wreaked havoc on the Island’s energy grid, the Puerto Rico Energy Bureau instructed The Puerto Rico Electric Power Authority (PREPA) to explore how virtual power plants (VPPs) could enhance the Commonwealth’s electric system. Late last month, PREPA selected Sunrun to build and operate Puerto Rico’s first VPP. The 17-MW project aims to improve grid dependability and lower energy costs for residents through roof-top solar-plus-battery systems. Sunrun’s aim is to have the VPPs operational by 2024. The project is pending approval from the Puerto Rico Energy Bureau and Fiscal Oversight Management Board for Puerto Rico, but if permitted, would be a positive step in making the Island’s energy system more robust and resilient.
Proposed Chilean Pension Reform
President Gabriel Boric recently unveiled a plan to overhaul Chile’s decades old private pension program established under former dictator Augusto Pinochet. The new reforms would increase social security taxes by 6% and are slated to be presented to Congress in 2023. The new pension system would be a hybrid. The current Pension Fund Administrators, which the President claims have profited greatly while delivering subpar results, would cease to exist and be replaced by new private investment managers. Meanwhile, the new public system will be managed by a state-run entity. According to President Boric, under the current system, 72% of pensions paid are below minimum wage. If and when the law is approved, the newly formed social security system will begin paying out pensions immediately.