Oil rig floating of Rio de Janeiro
Troubled waters: OGX, an oil start-up, has lost nearly 90 per cent of its share value over the past year

In 2010, when 60 Minutes came to Brazil to do a piece on the “World’s Next Economic Superpower”, the US television programme chose Eike Batista as the ambassador for the country.

“You know, in the last 16 years, Brazil has put its act together. This is it. Hello, time for Americans to wake up,” Mr Batista said with trademark brashness.

In retrospect, the discovery by primetime TV of Brazil’s economy should itself have been a sell signal for investors that a long boom in Latin America’s biggest economy, fuelled by high commodity prices and credit, was peaking.

It was also a high-water mark for Mr Batista. In only a few years he had amassed a paper fortune that until last year was estimated by Forbes to be worth about $30bn through the listing of his X group of mostly start-up companies. This year, the bubble surrounding the group burst after his oil and gas explorer, OGX, repeatedly fell short of production targets, sending his wealth plummeting to about $11bn in March.

Although its fall from grace has been the most dramatic, Mr Batista’s X group is just one of a number of Brazilian “national champions” – large private and state-controlled companies that have been big recipients of subsidised state credit – that are in retreat with the end of the country’s rapid economic growth and the global commodity super cycle. They include Petrobras, the state oil company, Vale, the world’s largest iron ore miner, and even the institution that bankrolled them – BNDES, Brazil’s development bank.

The travails of Brazil’s largest companies are an alarm bell, if any were needed, of the limitations of a Chinese-style model of the state picking corporate winners.

A member of the Brics group of emerging nations that also included Russia, India and China, Brazil was last year one of the slowest growing large economies in the world, expanding less than 1 per cent compared with 7.5 per cent in 2010. Critics of President Dilma Rousseff say Brazil needs to revisit the type of big bang reforms that began under former President Fernando Henrique Cardoso during the 1990s, when the country tamed inflation and privatised state-owned enterprises.

They say Ms Rousseff, who faces elections next year, needs to put precious investment dollars to better use, such as in infrastructure, if she is to revive an economy still recovering from the excesses of her predecessor, Luiz Inácio Lula da Silva. She needs to restore competitiveness if Brazil is to avoid losing market share even in core sectors, such as agriculture, to new producers, such as in Africa.

“If you look at the Brazilian national champions they are getting whacked,” says Chris Garman, an analyst with Eurasia Group. “The government’s focus is shifting.”

It was not until the mid-2000s, as Brazil’s economy gained steam on the back of rising commodity exports to China, that Mr Lula da Silva, a former unionist firebrand who took office in 2003, embarked on a new phase in creating local corporate heroes. Using BNDES, the government pumped money into meatpacker JBS, enabling it to go on an overseas buying spree that eventually created the world’s largest beef producer by sales. Petrobras was anointed sole operator of Brazil’s giant new offshore oil discoveries and embarked on the world’s biggest corporate capital expenditure plan, worth more than $200bn in five years, with orders to use locally produced equipment. Next came Mr Batista’s companies, pulp and paper groups and others.

Mr Batista started building what he claimed would be the largest port in the Americas, Porto do Açu, in Rio de Janeiro state, to serve the oilfields off the southeast coast of Brazil.

He listed OGX, his oil start-up, in 2008, and it remains the flagship of his empire even though it is increasingly unclear how much of its “net potential resources” of 10.8bn barrels of oil equivalent will be recoverable. He also created OSX, an oil services company to build equipment and platforms; MPX, an energy company; and CCX, a Colombian coal company.

The “X” in the names of his companies was supposed to signify their potential multiple returns. But misfortune struck first on the home front, when his son Thor killed a cyclist last year while driving the family’s Mercedes-Benz McLaren sports car.

Soon thereafter, doubts began to emerge about OGX’s performance after disappointing results from its first wells. In the past year it has lost nearly 90 per cent of its share value, sparking a crisis of confidence in the group. Mr Batista has been forced to offload control of his energy company, MPX, to Germany’s Eon. He had to enlist the help of influential Brazilian financier André Esteves, whose bank BTG Pactual, has extended him a $1bn credit line, and to privatise LLX, the logistics arm that owns Açu as well as CCX, among other measures.

Mr Batista’s story fits into the broad model of Brazilian financial history, says Aldo Musacchio, associate professor at Harvard Business School, who is releasing a book, Leviathan Evolving, about state capitalism in Brazil and elsewhere.* During each commodity boom, Brazil prospers, leading investors to believe the old story that the “country of the future” is about to materialise. “OGX was one of those stocks people chose to bet on, the bet was on Brazil but they chose to do it through OGX,” he says.

Along the way, the government also bought into Mr Batista’s sales pitch. Although BNDES does not break down its loan portfolio by company, it has lent Mr Batista’s companies more than R$6bn ($3bn) while another state-owned bank Caixa has contributed R$2.2bn, according to estimates by Valor Economico, a newspaper.

Like OGX, Petrobras’s honeymoon under Mr Lula da Silva also proved shortlived as it increasingly became a tool of government policy. Last year, it reported its first quarterly loss in 13 years and announced the sale of assets in the Mexican Gulf as it struggles to raise cash under a government policy of keeping petrol pump prices low in Brazil to control inflation.

“Brazil has always had some form of state capitalism …but one big change is the government using enterprises as a mechanism to try to influence markets,” says Sergio G. Lazzarini of the Insper Institute of Education and Research and co-author of a report comparing Petrobras with foreign state-run oil majors.**

The report shows how Petrobras’s policies as a national champion, such as its requirement to use local content, often run counter to its own and its minority shareholders’ financial interests.

While Mr Batista and Petrobras have been affected by market sentiment and government intervention, Vale has suffered from a softer iron ore price and a troubled overseas expansion. The company announced it was suspending its involvement in Simandou, Guinea, after alleged irregularities in a large iron ore project in the west African nation. It has also put on hold an $11bn potash project in Argentina amid a fight with the government there.

Alberto Weisser, chief executive of Bunge, the biggest agricultural trader and processor in South America, says Brazil has become too expensive and has lost its competitive edge. “This is coming from many years of under-investment, especially in infrastructure. There has been too much government intervention,” Mr Weisser said at the FT Global Commodities Summit. “But we are starting to see the right incentives now: there’s a lot of privatisation, especially in ports, railways, logistics. It’s probably 10 years late, but it’s happening.”

To be sure, some Brazilian national champions are doing well. The international expansion of JBS, 23 per cent-owned by the equity arm of BNDES, into the US and Australia at the height of the boom remains intact. And Embraer, the world’s third largest aircraft manufacturer and a recipient of BNDES largesse, is surviving tough times in civil aviation. Nor has Brazil Inc disappeared from the global stage. Brazilian billionaire financier Jorge Paulo Lemann, now the country’s richest man with his large stake in brewer Anheuser-Busch InBev, recently grabbed headlines when he and his partners joined with Warren Buffett to buy Heinz in the US.

Yet, the travails of the larger champions and of BNDES itself are leading many to wonder if the age of picking winners is coming to an end. BNDES has more than doubled its assets since 2008 to R$716bn last year, a rise matched by state-run mortgage bank Caixa. In a shock move, however, BNDES and Caixa were downgraded two notches by Moody’s Investors Service last month, which cited concerns that they had become too heavily exposed to their biggest borrowers. BNDES had lent more than four times the value of its tier one capital to its top 10 clients.

In addition, there are questions over the effectiveness of using a development bank to support large companies. Prof Musacchio says BNDES was among the most profitable of the world’s development banks, at least partly because it was cherry-picking the best credits in the economy. By providing them with subsidised credit, it was undermining the potential role of private banks in the economy.

These loans often tended to be “pro-cyclical” – mining and oil companies received disbursements during a commodity supercycle when arguably BNDES should have been giving more help to other parts of the economy.

The bank normally counters that it does not select champions but simply good borrowers. It says with some justification that it ends up lending to the largest companies because it is the main source of long-term finance in Brazil’s economy. Given the country’s high interest rates, a legacy of inflation, private banks are often unwilling to provide longer-duration loans at reasonable rates. Whatever the case, there are signs that BNDES and the government are drifting away from the flag-waving policies of the boom years to more practical matters. With Brazil’s economy slowing and the country in need of new airports, roads and rail links to host the football World Cup next year and the Olympic Games two years later, the focus of BNDES is changing to infrastructure, analysts say.

“The BNDES is working very hard to really get into these infrastructure projects hand in hand with the private sector and, in particular, with capital markets,” says Joaquim Levy of Bradesco Asset Management and a former national treasury secretary.

So what of Mr Batista and his troubled X group? Help is on the way, albeit from another national champion. Petrobras said it was looking at using his Açu port for its oil fleet.

“This is business, not aid,” Maria das Graças Foster, Petrobras chief executive, insists.

Perhaps, but if there is one thing worse for a government than building national champions, it is watching them fall. Mr Batista may have achieved an enviable status – that of being too big to fail.

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The cash cow sucking up money

After a spate of lousy news since last year, when his oil company first missed its production targets, Eike Batista must have thought things could not get worse. But this month they did. OGX was forced to shut down all three of its production wells in the Tubarao Azul field, its only source of crude, because of damage to two submersible pumps. Repairs on the first well will not be completed until mid-May and those on the second will only start after that.

OGX’s tough times come amid no shortage of bad news in the wider Brazilian corporate landscape, with losses at some companies of historic proportions.

The country’s second-biggest airline Gol reported a loss last year of R$1.5bn, which it blamed on rising competition and high fuel prices, and electricity company Eletrobrás booked a $3.4bn loss after the government renegotiated its power concessions.

But while most of corporate Brazil is going through a cyclical downturn, with some consumer companies still doing well even as banks, commodity companies and others are muddling through, Mr Batista’s troubles seem to be far more serious.

Part of the problem is that OGX, which was supposed to be the cash cow of his X group, is a start-up company in one of the most risky
and capital-intensive endeavours possible: oil exploration and production.

The Brazilian market has little experience of such volatile companies and has meted out harsh punishment to OGX’s every wayward move. “This is a unique company in a sense,” says Ana Paula Ares, an analyst at Fitch. “There are not many comparable companies because this is a start-up.”

Analysts say OGX has $1.6bn in cash and about the same amount in capital expenditure and other expenses this year. The concern is whether it can maintain enough of a cash cushion to ensure investor confidence. It will probably have to draw on a $1bn put option provided by Mr Batista himself and perhaps sell a share in its fields to raise extra cash.

“Cash flow projections for OGX are weaker than prior projections, despite the benefit of a favourable oil price environment and relatively high realised prices on OGX’s production,” Moody’s analyst Gretchen French said.

EBX, Mr Batista’s holding company, says the group has sufficient capital resource to execute its projects, which are proceeding according to their business plans.

OGX is due to begin production from another field, Tubarao Martelo, at the end of the year. Mr Batista will be hoping that this time his luck might finally change.

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* Prof Lazzarini of the Insper Institute is co-author of ‘Leviathan Evolving’

** Prof Musacchio of HBS and Mariana Pargendler of Getulio Vargas Law School are co-authors of the report comparing Petrobras with foreign state-run oil majors

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