On September 16^th, 2009, the blog model portfolio profiled Companhia Brasileira De Distribucio (CBD), Brazil’s leading food retailer, and elected to invest in a position for the portfolio. I opted to overweight my portfolio in Brazilian securities on the basis of my macro overview of Brazil and its growing importance in the global economy.  I selected  CBD as a vehicle  due to its dominant position as a food retailer in Rio De Janeiro .

Brazil has recently been profiled in the November 13^th  2009 issue of “The Economist” as having the potential to become the 5^th largest economy in the world. 

This parallels the thesis I proposed to readers of this blog back in September 2009.  Certain figures, style and methodologies adopted by the author of their reports so closely resemble mine; a formal acknowledgement of my review, published months earlier, could perhaps be considered appropriate.  (I do not write for financial compensation, so perhaps I'll let this one slip by.)

http://www.economist.com/specialreports/displayStory.cfm?story_id=14829485

http://www.economist.com/specialreports/displaystory.cfm?story_id=14829501

On December 4^th, 2009, CBD announced the largest merger/acquisition in their corporate history. 

The firm has announced a non cash combination with “Casas Bahias”,  the largest appliance retailer in Brazil,


http://www.reuters.com/article/idAFN0414378920091204?rpc=44

The transaction, on the surface, appears to be somewhat complex to the layperson. Investors seeking opinions will also find that virtually no North American coverage exists on CBD, at the present.  No doubt, the majority of domestically oriented investors will simply pass over this profoundly accretive development.


CBD will turn over $2.2 billion of appliance revenues through the vending in of Ponto Frio to the partnership.  In return, it will gain 51% of roughly $11 billion in revenues, through its proportionate ownership of Casas Bahias.  

  

Private firms generally are sold out at valuations well below that of publicly traded firms.  Casas Bahias is a private family firm. Based upon preliminary figures, there will be few who will be able to successfully claim that CBD is paying top dollar. The joint venture looks to carry an initial EV/EBITDA ratio of 8.7X.  This valuation seems modest, for what is clearly a control position in Brazil's largest durable goods retailer.  As the closure of the deal is scheduled for 2010, any incremental revenues and EBITDA to be generated in 2010 will reduce the ratio accordingly.


 

This may be the single most important business combination of Brazilian retailers, in the history of the nation.

CBD is paying for a slight majority control in the business combination through the transfer of real estate, an assumption of debt, and their shares of Ponto Frio (CBD's hard goods subsidiary). An estimate of the value of CBD's assets to be placed into the joint venture is in the range of $2.1 billion US. This places an enterprise value on the combination in the range of $4.8 billion to $5 billion.  While formal EBITDA figures have not been released for the premerged, or "old Casas Bahias", private estimates suggest that the business to be vended in from the Klein family may generate normalized EBITDA of as much as $420 million US in 2009.    



http://webcast.mzdp.com.br/IframeTelaCheia.aspx?codPlataforma=1387


No cash will change hands (at present). Credit ratings may actually improve for the combination.    The presumption is that at some later date, the Klein family (owners of the remaining 49%) will have improved liquidity for the remainder of their partnership.  The founder of Casas Bahias is 77, and is often called the Sam Walton of Brazil.  Estate planning might represent the primary reason for the deal.   The Brazilian equity markets have been very strong in 2009.    I believe that the Klein family, had they sought a public listing for their shares, could have easily floated the shares at a premium of 50% above the assumed valuation.

Casas Bahias is a full 3.9X larger than CBD’s "Ponto Frio" appliance and electronic retailing division.   The hard goods retailer is the largest advertiser in Brazil.  The Brazilian retailing marketplace is largely an oligopoly.  Previous food market shares were largely carved up between CBD, Carrefour and Wal-Mart.  On a go forward basis, CBD’s total revenues (if/as/when and on a wholly owned basis) may be larger than both Walmart and Carrefour’s Brazilian divisions combined.  The hard goods market is carved up among approximately 5 national retailers.   The combination of Casas Bahias and Ponto Frio will have a market share estimated to be larger than the next three largest appliance retailers combined. 


There is almost no overlap of customers.   Ponto Frio was a somewhat upmarket retailer. Casas Bahia focused upon the lower income consumer in Brazil.   Ponto Frio will be able to dovetail onto Casas Bahia marketing prowess. In turn, Casas Bahias will benefit from Ponto Frio's sophisticated back office systems.  The combined firms will be able to wrestle additional discounts from manufacturers.   If there are any flaws in the business logic on the merger, I certainly cannot find them..


Internal forecasts suggest that Brazil’s appliance and electronics total market may grow by a CAGR (compounded annual growth rate) of more than 14.7% per year for the next five years.  A recent two year 10% cut in Brazilian appliance taxes looks to be very timely.

http://www.brazillandinvest.com/index.php?option=com_content&view=article&id=219:brazil-planning-to-cut-taxes-to-stimulate-domestic-consumption&catid=1:latest&Itemid=30

On a 100% ownership basis, 2009 revenues from the new Casas Bahia could exceed $11 billion. Net to CBD, this would represent incremental revenues in the range of $3.5 billion in 2010.  Based upon the assumption that Casas Bahias generates similar EBITDA margins as Ponto Frio, CBD's 21010 EBITDA forecast may have to be revised upwards to the tune of $175 million US. Management of CBD reports that normalized EBITDA margins on the two appliance retailing companies is presently 5%.


In less than a year, Companhia Brasileira de Distribucio has announced two transactions, which may effectively increase the total size of the company by more than 50% 



Ponto Frio was purchased by CBD less than six months ago.  The total transaction was done with a cash outlay of far less than $1 billion US and the smoke has barely cleared on that acquisition.  Ponto Frio is now being used as the primary collateral to enter into a venture with the largest appliance, furniture and electronics retailer in Brazil.



To summarize; CBD has taken a cash outlay of far less than $1 billion US and acquired businesses that can generate more than than $6 billion of annualized revenues in 2010.  Normalized EBITDA on that $1 billion cash outlay could exceed $300 million in 2010, before factoring in the synergies indicated by management.  This is being accomplished without adding financial leverage to the balance sheet of either CBD, or the new Casas Bahias.  



This transaction appears to be wildly accretive to existing shareholders of CBD.

CBD has identified synergies of almost $690 million US to come about, on a business merger with an enterprise value of roughly $5 billion.   The potential savings identifed exceed the present level of EBITDA being generated from the combined Ponto Frio and Casas Bahias. 


Accretion to CBD shareholders could exceed 20%, before taking into account normalized growth rates from the core operations.  To place this accretion into perspective, bear in mind that my 2009 EBITDA forecast for CBD in its present form was just $790 million US.   CBD will only own 51% of the joint venture to start.


The quick increase in CBD’s share price, on the heels of the announcement, seems appropriate.   Should all go well, the appliance division's EBITDA margins could exceed EBITDA margins being generated at CBD's food retailing division.   As CBD generates an industry leading 7% margin on food sales, this would be no small feat indeed.

This business combination has not yet closed.  It is possible that Wal-Mart or Carrefour, CBD’s two largest rivals in Brazil, might opt to come forward with a competing bid for privately held Casas Bahias.   However, Brazil’s economic policies favour domestic firms over foreigners.  I consider it somewhat unlikely that this combination will be upset by a rival bid.

In my previous review, I opined that the Brazilian stock market was dominated by institutional “herding”.

 

Herding is a tendency of institutional investors to simply buy the largest companies in each market, irregardless of individual merits.  In recent years, herding has accelerated in foreign markets, primarily due to the proliferation of index funds and exchange traded funds (ETF).  All ETF’s and index funds specific to a nation pretty much look the same, primarily differing only in expense ratios.   

CBD is now likely to become an investment sought after by “the herd”. The commoditization of large cap companies by indexers, ETF’s and closet index mutual funds (funds that largely mimic index funds, but have a manager named to earn higher fees) should result in a whole new array of foreign interest for CBD.  Too, food retailers typically sell for a rather significant discount to broad line retailers.   Upon closure of the transaction, CBD will clearly be the dominant broad line retailer in a fast growing nation.  A rerating of the company may occur.

Companhia Brasileira de Distrucio is currently a small “large cap” company by stock market capitalization. To put the relative obscurity of  CBD into perspective, no options have yet been listed on the NYSE as yet, for a firm that presently has a market cap approaching $10 billion US.

Upon conclusion of the business combination, CBD could soon become the “go to” stock for institutions seeking direct exposure to retailing in Brazil.   Companhia Brasileira de Distribucio was a large retail food seller, primarily focused on Rio de Janeiro market.  Upon closure of this transaction, the firm will be a true national retailer, and accordingly a proxy for the retail market in Brazil.  Dramatically improved Institutional coverage seems a foregone conclusion.


http://www.reuters.com/article/idAFN1410983320100114?rpc=44

Certain "Bears of Brazil" argue that the nation's equity markets are overvalued. 


Perhaps this may be true of selected investments within a limited institutional "herd"; these are the 20 large cap investments generally considered by retail investors to represent the sum total of Brazilian equity markets.  Those betting on a Brazilian valuation compression may be devastated to learn the following; the nation has far more than 20 publicly traded companies.


Consider that CBD may have just rolled up the two largest names in Brazil's durable goods industry, at a price capable of producing a 30% EBITDA return on cash invested by CBD, without adding the gobs of leverage standard in LBO's (leveraged buy outs); it seems self evident  that plenty of bargains exist in that nation. 


As the #1 and #2 hard goods retailers have been effectively priced at less than 8X my forecast 2010 EV/EBITDA ratios, how inexpensive are the remaining names in this industry?  And what does this suggest about valuations in other Brazilian industries, most still largely "non public"?  


Providing that management at CBD is correct in their assumptions on cost savings, the acquisition of Ponto Frio/Casas Bahias may turn out to be of the great robberies in the business world. 

In the case of Companhia Brasileira de Distribucio, my update is simply an acknowledgement of an important material event, arguably the most important in CBD’s public history.   This non cash, limited debt and non share structure is very unique for a rollup. A successful closing of the Casas Bahias venture will make CBD the dominant durable goods retailer, in one the fastest growing consumer markets on the planet.   Companhia's balance sheet improves upon conclusion of the Casas Bahias transaction. Future rollups of both the Brazilian grocery industry and durable goods retailers by Casas seem likely.  


Inexplicably, the only major international agency to report on the development, to date, is Reuters.  Broad line American agencies seem to have let this announcement, yet again, fall through the cracks. 


The financial impact of this joint venture should, in all likelihood, be fully reflected on CBD's books commencing in the year 2011.  As government approvals are unlikely to be granted before mid 2010, any revenues and EBITDA from the new combination will not be consolidated on CBD's books before that time.   A traditional "uncertainty" discount will be applied to CBD shares until closure of the combination.        


http://www.gpari.com.br/eng/download/apresentacoes/Presentation_Morgan_Stanley_Conference_Miami_Jan2010.pdf



Analysts might wish to revise their 2010 forecasts, sooner, rather than later.


Management has announced a significant beat on the EBITDA front.  It appears that 2009 EBITDA was in the range of $850 million.   This excludes the contribution from Ponto Frio.


2010 may be a banner year for CBD.  Assuming a continuation of growth trends produced in Q4, 2009, and factoring in a successful closing of the Casas Bahias JV, potential consolidated EBITDA could be as high as $1.2 billion-$1.25 billion.   With 127.5 million ADR's outstanding, and $5.9 billion US of total liabilities - cash, this indicates an EV of   $15.42 billion.   My 2010 forward EV//EBITDA estimate might be in the range of 12.3X-12.9X.  

The most optimistic analyst to date has a 2010 revenue forecast for CBD of $20.66 billion.  Consider that the Casas Bahias/Ponto Frio merger could produce 2010  net revenues of as much as $6.8 billion US.  Add  to this CBD's regular retail revenues of as much as $14.6 billion US for 2010.   I'm coming up with almost $21.4 billion of 2010 consolidated revenues on a successful close.  There seems to be plenty of potential for a material improvement in 2010, beyond current expectations.    


The blog model portfolio continues to hold the shares of Companhia Brasileira de Distribucio.  Based upon the preliminary details, and assuming that the deal closes, CBD may represent a multiyear core holding for the portfolio.       


A recent analyst commentary on CBD may be found by linking here.


http://www.cnbc.com/id/15840232?play=1&video=1373969884&__source=yahoo%7Cheadline%7Cquote%7Cvideo%7C&par=yahoo