Big fish in small ponds

Big fish in small ponds Credit: Illustration by Alexander Wells

It’s no secret that many of Latin America’s largest companies remain controlled by small, concentrated groups reluctant to relinquish control, limiting these entities’ ability to tap into a bigger pool of resources through the capital markets. This status quo makes public M&A deals a rarity in the region. Christina McKeon Frutuoso considers the challenges faced by lawyers when such transactions do arise.

Anyone who has observed first-hand the Superclásico between Argentina’s Boca Juniors and River Plate will know that battles worth fighting are seldom easy. In any football match, it’s rare for victory to come without adversity, and if it does, it might not have been worth fighting for after all.

The concept of a hostile takeover is relatively new in Latin America. Public M&A deals of any kind are few and far between, thanks to the region’s comparatively nascent capital markets and company owners who are hesitant to go public, but that is slowly changing as ground-breaking deals test regulation and establish precedents.

In 2018, a battle played out among a group of utility companies seeking control of Brazil’s largest power distributor, Eletropaulo, from which Italian utilities company Enel eventually emerged victorious, claiming a 74% stake in Eletropaulo and becoming the first company to make a successful hostile takeover attempt in Brazil.

The 5.6 billion reais (US$1.4 billion) deal tested the mettle of all stakeholders, regulators and lawyers involved. It was complicated by dispute proceedings after a heated bidding war between Enel, Brazilian power company Energisa and Spanish utilities company Neoenergia turned sour.

Brazil’s securities regulator (CVM), the B3 stock exchange (where Eletropaulo is listed) and several of the companies involved held conflicting views about the rules and timetable governing the tender offer. Chilean minority shareholders in Enel Americas even opposed the takeover, unhappy with the company’s proposition to finance the acquisition with a capital increase. Although the sale has now closed, B3, Eletropaulo, Enel and Neoenergia are still in arbitration proceedings.

The degree of minority shareholder opposition combined with the intervention of competing bidders had never before been seen in an M&A deal carried out over Brazil’s stock exchange. “Brazil has regulation applicable to takeover offers, but it had not really been tested before on this scale,” says Cescon, Barrieu, Flesch & Barreto Advogados partner Maria Cristina Cescon, who advised Enel. “The deal took the whole market by surprise: the CVM had to react quickly and revisit the rules of the disputes twice,” adds fellow Cescon Barrieu partner Maurício Teixeira dos Santos.

But challenging circumstances such as these create valuable precedents. Teixeira dos Santos says one outcome of the Eletropaulo sale is that minority shareholders are likely to play a more proactive role in public M&A deals going forward. “If minority shareholders now have the chance to negotiate, they will,” he says. “They will feel now that they have the opportunity.”

The Brazilian blueprint

With the exception of Brazil, most Latin American countries’ stock exchanges are still in the early stages of development. It’s common for company owners to be wary of listing their shares. Many of the region’s largest companies are owned by big family offices that don’t want to relinquish control, or may have concerns about the security risks that come with greater transparency. In turn, there is little to attract investors to the capital markets.

Companies are required to disclose considerable amounts of information in order to list on a stock exchange, which can be a deterrent in Latin America. “Even small private companies in some European countries are required to publish copious amounts of financial and organisational information,” says Cuatrecasas partner Mariano Ucar. “This would be unthinkable to Latin American companies – they view it as a risk to publish revenue, profit and other corporate data that may be exposed to ill-intentioned actors or competitors.”

Brazil’s efforts to cultivate a regulatory environment that encourages companies to list on its capital markets have helped make it a front runner for public M&A deals in the region. Chief among these is the Novo Mercado, a special listing segment of the B3 stock exchange aimed at improving transparency and corporate governance standards at listed companies. It imposes conditions on issuers that are similar to those set down by the US Security and Exchange Commission under the Sarbanes-Oxley Act and is credited with boosting investor interest in Brazil’s equity capital markets.

The Novo Mercado obliges listed companies to comply with a minimum level of liquidity by allocating 25% of their share capital as free float. In turn, this has helped cultivate an environment that makes it easier to contemplate a takeover. The listing segment has been around since 2000 and since then the increased percentage of free float shares has made Brazilian public companies more attractive targets for M&A deals, says Liliana Espinosa, who is chair of Baker McKenzie’s Latin American M&A and private equity group. “The number of listed corporations without a majority-voting shareholder has increased, making the possibility of acquiring share control of listed companies through tender offers a reality.”

Nowadays in Brazil, the companies making initial public offerings (IPOs) or follow-on offers tend to be listed on the Novo Mercado segment. “Unless a company has strong reasons not to opt for the Novo Mercado, it’s impossible for a company not to list on this segment and make a successful IPO,” says Cescon Barrieu’s Teixeira dos Santos. “All the significant IPOs from the past five years have involved Novo Mercado-listed companies. Eletropaulo is a good example: its former shareholders realised it would get a better selling price by showing better corporate governance levels through listing there.”

Gabriella Maranesi Najjar, partner at Vella Pugliese Buosi e Guidoni - Advogados (which has a strategic alliance with global firm Dentons), considers the introduction of the Novo Mercado and the enhanced corporate governance standards that came with it as a “turning point” for public M&A deals in Brazil, be they hostile or friendly.

A few other jurisdictions in the region have provisions requiring a minimum percentage of free-float shares – companies must allocate a 10% free float to list on Colombia’s stock exchange, for example – but several do not. The lack of free float means that many of the public companies in Latin America are actually more private than their name would suggest. Because of this, deals involving listed companies in the region are commonly agreed upon between the majority shareholder and the buyer in private first, before a tender offer follows (if required under local law). This is even the case in Brazil, says Najjar, where “most M&A transactions involving publicly held companies frequently take place by means of a private negotiation of the controlling stake, as opposed to takeover bids on the stock exchange. Depending on the specifics of the transactions and the company’s share capital structure, a mandatory tender offer may follow.”

This effectively rules out hostile takeovers (where an entity attempts to take control of a company without the approval of the target company’s board of directors). “It would be very difficult to carry out a transaction in Latin America without the largest shareholder already agreeing to the deal beforehand,” says Carey partner Salvador Valdés. “You need to have full commitment of majority shareholders to guarantee their participation before announcing the deal to the markets.”

In Argentina – where there are thought to be no listed companies with more than 49% of their shares free floating – majority stakes in public companies are concentrated in a single shareholder or a limited number of shareholders generally belonging to the same corporate group. “There are no public companies in the truest sense of the word,” says Marval, O’Farrell & Mairal partner Diego Krischcautzky. “Accordingly, there are no hostile takeovers in Argentina.”

Shareholder activism and increasing scrutiny over the role of a target’s board of directors are putting some pressure this to change, says CMS Carey & Allende partner and chairman of CMS’s Latin American practice, Jorge Allende. “But it’s a huge hurdle in the way of tender offers becoming real auction processes, in which a target company is sold to the highest bidder.”

Lack of precedent

In 2018, Ecuadorian conglomerate Corporación Favorita bought a 73% controlling interest in Grupo Rey, Panama’s only publicly held supermarket chain. It was the country’s first public tender offer in over a decade.

The transaction was even more remarkable thanks to an unusual post-closing put option that only applied to shareholders willing to sell more than 50% of their shares. The architects of the deal had no precedent to follow. “That made it interesting from a legal perspective, because we had no regulation that touched on this kind of deal,” Icaza, Gonzalez Ruiz & Aleman partner Alexis Herrera Jr explains. “For example, there was an issue of interpretation with respect to the formalities that you have to follow when exercising a put-call option.”

More generally, because the legal systems of most Latin American countries are based on civil law, it is harder for deals to set precedents that encourage more deal activity. This is because precedents carry less weight and regulatory frameworks tend to evolve at a slower pace as a result, creating a challenging deal landscape. “It takes longer to pass codes and issue decrees or administrative resolutions in a civil law system than to adapt to the reality of the markets through case law when you’re in a common law system,” sums up Paola Lozano, who is Skadden, Arps, Slate, Meagher & Flom LLP’s Latin America group co-head and leader of the firm’s Spanish language corporate practice.

This means there are more challenges in the deal-making landscape and so new players may not be as confident to participate in less evolved capital markets. “For most Latin American countries, problems arising within these kinds of deals are usually being addressed for the first time,” says Lozano. “This lack of precedent can sometimes deter certain investors.”

Regulation should bring guarantees

There is an argument that too much regulation can stymie deal flow. It can slow things down and perhaps generate additional costs. To give one example, Philippi Prietocarrizosa Ferrero DU & Uría (Peru) partner Rafael Boisset says third-party valuations are a big obstacle for public M&A deals in Peru. Valuators check the price offered to minority shareholders is in line with the shares’ market value. Under Peruvian law, their judgment is binding and can force a buyer to offer minority shareholders a higher price, which in turn can prompt majority shareholders to request adjustments to the price they have accepted. “It gives too much power to a third party who does not necessarily know the context in which the transaction has been negotiated,” says Boisset.

Even Brazil’s Novo Mercado imposes requirements that can present hurdles. “The rules can make it more complicated and expensive to purchase control of public corporations listed there,” notes Baker McKenzie’s Espinosa. “For example, the tender offer requirement related to the mandatory Novo Mercado tag-along provision makes it more burdensome for any corporation to purchase control of a Brazilian publicly held corporation.”

Buyers will need to consider a specific piece of regulation or the stance of an individual regulator. “Sometimes the attitude of the relevant regulators becomes even more important than the regulation itself,” says Icaza Gonzalez Ruiz partner Herrera Jr. “If you have a regulator that understands that its duty is to regulate and not hinder transactions or the relevant market, that generates a very positive atmosphere for M&A deals in general,” he says.

Lawyers note the CVM’s position in the Eletropaulo deal. Though not entirely satisfied by its handling of complaints, Teixeira dos Santos commends the regulator’s fast response time and willingness to learn from mistakes. The CVM launched a public consultation straight after the sale closed with view to amending tender offer regulation. It is currently working through the proposed amendments. “We see it as a very open-minded and proactive regulator,” he says. “They want to learn where they went wrong and they are committed to strengthening Brazil’s public M&A market.”

Regulators in other jurisdictions are also rising to the challenge. When Chinese lithium miner Tianqi was negotiating the acquisition of a 24% stake in Sociedad Química y Minera de Chile (SQM) for US$4.1 billion in 2018 – thought to be the largest deal in the history of Chile’s stock market – the Corporation for the Promotion of Production (a government institution set up to promote economic growth) filed a complaint before Chile’s antitrust regulator alleging that the deal held implications for the global lithium market. Though the National Economic Prosecutor (FNE) was not compelled to carry out a mandatory pre-merger control review (since Tianqi previously owned no Chilean assets), its decision to open an investigation into possible anticompetitive effects demonstrated its commitment to upholding fair standards. “The FNE did not ignore the complaints; it looked into matters and engaged with experts within the lithium industry,” says Carey partner Francisco Ugarte. “The deal took longer as a result, but the extra effort was worth it.”

A bigger pond

Ultimately, regulations that level the playing field for everyone are good news for companies doing business in the region, including in the public M&A space, says CMS Carey & Allende’s Allende. But without more public entities allocating a greater proportion of their shares as free float, Latin America’s public companies remain big fish in small ponds.

An evolution towards the deal flow of the US and UK markets is likely to be a slow process, as controlling shareholders start to see the benefit of listing more shares publicly. “[At first] it might seem undesirable for business owners to give up absolute control but tapping into the capital markets can provide access to much larger capital resources, giving Latin American conglomerates more opportunities to grow their footprint and profits,” points out Skadden’s Lozano.

More immediately, certain sectors might see greater public M&A activity as a result of privatisations. The administrations of Brazil, Chile and Colombia are all promising denationalisation of state-owned companies, a good number of which have shares listed on stock exchanges. In 2016, Colombia sold its majority stake in power company Isagen to Canadian asset manager Brookfield for close to US$2 billion, in the biggest privatisation to take place in Colombia in more than a decade, which included an auction over the stock exchange amid public protests about price increases.

Broadly speaking, privatisations are likely to attract a bigger pool of investors to these countries. Companies that are already listed might choose to release more equity through follow-on offerings to tap into investor demand, while privately held companies might be tempted to go public, says Cescon Barrieu partner Teixeira dos Santos, who thinks this could inject some “dynamism” into the public M&A space in the medium and long-term. “The sky really is the limit when it comes to what sort of structures and deals remain to be seen in Latin American public M&A deals.”


Find   a   team   of   lawyers   with   public   M&A   experience.   “Compared   to   private   M&A   deals,   public  M&A  deals  are  a  totally  different  animal,”  says Cescon Barrieu partner Maria Cristina Cescon. “Specialising  in  M&A  in  general  isn’t  going  to  be  good  enough,  as  they  won’t  have  the  necessary  experience of interacting with the regulators.”

Go “hand in hand with the regulator” from day one,  says  Icaza,  Gonzalez  Ruiz  &  Aleman  partner  Alexis   Herrera   Jr.   “Keep   all   regulators,   stock   exchanges  and  authorities  informed  as  much  as  possible  along  the  way.  Maintaining  this  friendly,  transparent  perspective  is  going  to  help  keep  them on your side.”

Work   with   antitrust   lawyers   from   the   very   beginning  to  save  time  and  effort  further  down  the line. “In Chile – thanks to the now-mandatory pre-merger  review  –  and  in  most  jurisdictions,  filings before the antitrust regulator, require a high level of sophistication, so we worked closely with an  antitrust  team  on  the  Tianqi-SQM  deal,”  says  Carey partner Francisco Ugarte.

•  If  it’s  an  acquisition  of  a  large  non-controlling  stake    from    floating    shares,    Marval,    O’Farrell    &   Mairal   partner   Diego   Krischcautzky   advises   launching  a  voluntary  bid  offer,  “which  allows  the purchase price to be freely set by the bidder.” Additionally,     says     another     Marval     partner,     Fernando  Hernández:  “Remember  the  voluntary  bid offer might be subject to conditions, including tender of a minimum number of shares.”

Be prepared for inspection. “Public transactions are    subject    to    more    scrutiny    from    various    stakeholders,”  says  Beccar Varela partner  Tomás  Allende.   “For   example,   you   have   to   plan   in   advance  how  to  deal  with  employees  and,  more  importantly,  with  unions,  who  can  play  a  very  vital  role  in  the  deal  if  they  think  employment  at  the  target  company  is  at  risk,”  he  says. “Unlike  in  private  M&A  deals  in  which  you  can  manage  information  and  expectations,  in  a  public  M&A  deal this is not an easy task, and good, sound legal advice is a must.”