The future of Brazilian capital

One short flight later and we landed in Rio de Janeiro, iconic postcard child of Brazil, painted in pastel colors and white buildings. As we pull up to our beachfront hotel in Copacabana, the beach permeates the air: locals and foreigners flock to enjoy agua de coco by the water on the black-and-white tiled boardwalk. In some ways the beach is the great equalizer: we, as well-off tourists, enjoy the enormous crashing waves as much as residents from all walks of life in this beautiful and unequal society we’ve been so fortunate to explore over the past week.

Our study group strikes a pose on a film set on Globo’s campus.

As we kicked off our company visits, the theme of a self-contained market resurfaced. At Grupo Soma, a multi-brand retail giant in the country, we learned how they are slowly testing expanding outside Brazil in three American cities before deciding to globalize the brand. Globo, the monolithic media conglomerate that reaches 100M viewers daily, is focused almost exclusively on viewership in Brazil.

By now, almost every company has mentioned that Brazilian capital markets are underdeveloped and it is holding back the economy. Individual business owners make decisions not to invest and growth is impaired. The representatives at private equity firm Patria Investimentos cited a lack of local investors and long-term savings as major reasons for this underdevelopment. Moreover, the level of international financing is low. Liquidity is further constrained by historically high interest rates in Brazil that are meant to curb inflation but practically imply that when there are savings, people would rather park their money with the government and enjoy risk-free returns of up to 14%. This all makes sense and is relatively uncontroversial in theory, but in practice, it is expectedly complicated.

Roller coaster rates show a recent historical low of ~6%.

Nevertheless, the low desire for long-term investments has another if not bigger cause: the looming specter of ballooning pension liabilities. While the current system has been in place for decades, the sheer volume of liabilities is hitting a terrifying crescendo: R$300B in 2018, equivalent to 4% of GDP. Combining a young retirement age with a large young population, pension liabilities represent a time bomb in Brazil’s government finances.

Over the week, an underlying tension has become clear to us: the business community we’ve spoken with almost unequivocally supports some sort of pension reform, while many Brazilians most hit by potential change vehemently oppose it. Jair Bolsonaro, Brazil’s current and frighteningly controversial president, has managed to play both sides of the game by making campaign promises to leave pensions alone yet pushing forward reform once in office. The financial services firms we met (Patria Investimentos, Redpoint Eventures, and BNDES) all expressed skepticism about whether reform would pass but agreed that investment capital would be unlocked on a massive scale if it did.

In this scenario, available investment capital would increase in tandem with risk-taking and long-term investing. Brazilians can no longer enjoy a 14% return on savings and short-term lending. They will need to buy risk in other ways moving forward. Increasing willingness to take financial risk almost certainly would energize the start-up ecosystem and the growth of the small-to-medium business sector. Brazil’s massive national development bank, BNDES, believes an important role they play in the economy is counter-cyclical credit availability assurance, especially for small-to-medium business; this role would only increase in importance with a national rise in investment. From the business perspective, this is quite a rosy picture of what may happen if pension reform succeeds.

I get the sense that we are encountering an economy—and country—on a precipice. The option to maintain the status quo is running out. Pension reform is moving through the legislature as both support and opposition reach a fever pitch. Indeed, as we left the BNDES corporate offices in Rio’s downtown business district, we were handed flyers to join a protest against pension reform and other austerity measures. While pension reform may unleash more money to flow through the economy, what is the social cost of these reforms? We unfortunately haven’t gotten a good understanding this week from the business community about the socioeconomic impact on the country. Yet between the ongoing protests and the notorious difficulty of pushing these reforms through, it’s obvious that pension reform won’t be unequivocally good. The country seems paralyzed at this decision moment. Will paralysis continue until crisis precipitates change?

Protesters march against pension reform on March 22, during our study tour.

Yet even in an environment of uncertainty, we met with large companies that recently have taken major risks in order to stay market leaders. Havaianas is taking the plunge to expand internationally – considered a bold move for a largely Brazilian brand – and has an internal disruption engine called “Big Bets”. Cielo is repositioning itself into wraparound IT services from simply payment processing to increase their value prop for clientele. Suzano, Brazil’s dominant pulp and paper company, completely reimagined the way they move their products in-country. They integrated distribution functions to become more agile with customers and gain immense pricing power. After a number of brand acquisitions, Grupo Soma overhauled their supply chain to decrease process volatility and implemented a digital transformation to connect all their brands on a single back-end platform and customers on the front-end. These market leaders have demonstrated substantial risk appetite and willingness to change in order to keep potentially undifferentiated products attractive.

It’s inspiring to see companies this size employing a founder’s mentality. Moreover, it says good things about the economy and these companies’ internal organization that they’ve been able to implement change swiftly and effectively. Yet many of these companies we met are heavy hitters, enjoying the accompanying incumbent advantage and free cash flow that makes transformational change possible. The real test of the Brazilian economy will be when SMEs are able to take big risks like this. Will it happen before, during, or after reform? Only time will tell.

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