Brazil Internet Investments: Lessons
by Kevin McDonald
Brazil Internet Investments: Lessons Learned
Compared with the expectations of two years ago, the
Internet in Brazil might seem to be a commercial
failure. Indeed, dozens of dot-coms have closed their
doors, and investors have lost a lot of money. Many of
the remaining Internet companies have yet to generate a
profit. One year after the fall of the NASDAQ, these
companies are still struggling to raise the capital they
need to survive. A new economy is not replacing the old
one. Instead, old economy companies are adapting to the
Does this mean that all those dot-com start-ups were
a failure? That they were not worth creating? Not at
all. Many of them were successful: they provided
employment, profits for entrepreneurs and excellent
returns for investors. Equally important, they shattered
important myths about investing in Brazil ? and other
Latin American countries.
Understanding these myths and how they were destroyed
is the next step in the evolution of private equity
investing in Brazil.
Myth # 1: There are no reliable exits for
For years, private equity investors have avoided
Brazil because there was no market for selling a
Brazilian company. The Bovespa (São Paulo Stock
Exchange) is not for small companies. And the NASDAQ is
too selective for most foreign firms. Consequently, most
private equity investors stayed away from Brazil,
despite the country's large economy and abundant natural
Internet companies have demonstrated that this
premise is now out of date. Our firm, McDonald Lehner,
has sold twelve Brazilian Internet companies in the past
two years. Most but not all of the buyers - PSINet, IFX,
StarMedia, Vesper, for example - have been foreign
companies that wanted to establish a presence in Brazil.
Many other transactions - including those of Mandic
(Impsat and later El Sitio), Zaz (Telefónica de España),
Matrix (Primus), Netstream (AT&T), and Zipnet (Portugal
Telecom) - have demonstrated that there are good exits
for good companies.
This trend will continue, even though the NASDAQ lost
half of its value last year and many potential buyers of
Brazilian companies do not have the necessary cash or
shares for an acquisition. There are new potential
buyers that are taking the place of those that came
earlier. Already in February of 2001 we have witnessed
the sale of Zip.net to UOL.
We will see other Internet transactions, large and
small, as the sector is consolidated. And there are some
- Iconet, an innovative, corporate ISP in São Jose dos
- BRBusca, an outstanding search engine in Belo
- important domain names such as shopping.com.br and
Myth # 2: roll-ups (consolidations) don't
work in Brazil.
Many successful companies - from high tech to no tech
- have been created in the U.S. via a series of
acquisitions. But investors have feared that a roll-up
will not work in Brazil, where mergers are unfamiliar,
regional and cultural differences prevent integration of
personnel, and physical distances are too great to be
surmounted easily. They point to the difficulties faced
by PSINet and IFX as they integrated the ISPs they
The truth is that PSINet and IFX needed more capital
than they could raise. They were victims of the falling
NASDAQ, not the cause of the crash. And their management
was not responsible for the lack of adequate funding.
Fortunately, neither company is finished in Brazil,
despite the need for more capital. One week ago PSINet
sold Inter.net, its global consumer, dial-up business,
which represented a lot of PSINet's activity in Brazil.
Now Inter.net in Brazil, managed by Clovis Lacerda, can
complete the integration and resume investments that
were started before the fall of the Nasdaq. Meanwhile
IFX, led in Brasil by John Weimer, is also working hard
to improve operations despite limited capital.
An easier consolidation in the same field was
concluded by Terra, which bought Zaz and dozens of
smaller ISPs. Terra integrated them successfully and has
become a market leader. Significantly, Terra had
abundant capital with which to do this work.
There are other opportunities for consolidation in
the Internet field today. One example is the development
of wireless applications for the Internet. In Belo
Horizonte, TakeNET has 20 programmers writing code to
enhance the Internet services of cellular
operators/wireless data operators (RingTones/Icons
applications) and also corporations that need to stay in
contact with a mobile work force (the
business-to-employee or B2E segment). A few other
companies - located in other regions of the country -
combined with TakeNET would make a powerful entity, and
an irresistible target for a larger firm to acquire.
Myth # 3: You need to build the business on a
Pan Latin-American scale.
Many private equity investors have insisted on
establishing a pan-Latin American company, or at least a
MercoSul enterprise. They have imposed this condition
because they consider it necessary for attracting
someone to buy the company. Many entrepreneurs have had
the same vision: open up in Brazil, then expand to
Buenos Aires and either Santiago or Mexico City.
This requirement is expensive, difficult, and
unnecessary. Several firms - UOL, for example - have
tried to cover the region, only to change their plans
after learning the hard way. Other companies - StarMedia
and AOL among them - are still trying, but they are
facing a big challenge despite a lot of time and
It turns out that Brazil is a rich enough market to
support large companies, and that strategic and
financial buyers will pay a high price for a company
that is strong in this one country. In most cases, it is
more sensible to focus right here and let someone else
worry about expanding to other countries.
Myth # 4: Brazil lags behind the U.S., and
cannot produce successful Internet companies.
This view has led some investors to seek high returns
in low-tech fields, and to shun the Internet. The
concept is wrong, because there are businesses that
require local service and are thus best performed by
local companies. We have already seen many local
Internet companies built and sold for an attractive
price. And there are more to come soon.
Brazil today has a variety of home-grown technology
companies, including first-mile service providers
(Alta), hosting companies (ComDomínio), web-development
firms (BHTec), systems integrators (Saga), some ASPs and
web-enabled software developers (MXM), and even B2C
sites (ikids, selling high-quality toys). These
companies will eventually be acquired by larger players,
and for a good price. The Brazilian entrepreneurs are in
some cases only hours behind their foreign counterparts
in terms of technology; they read the same newsletters,
attend the same conferences, and buy from the same
Myth # 5: Brazilian management must have a
Harvard MBA to be reliable.
Many private equity investors looking at Brazil have
chosen to invest with only those local entrepreneurs who
have received a foreign MBA, or who have worked for a
large foreign company for 10 years. They claim the
institutional credentials are essential indicators of
aptitude, commitment, and resourcefulness. As a result,
they have refused many good ventures that later proved
One of our former clients was founded and managed by
three high-school graduates. Private equity investors
were worried because the three did not have MBAs or a
former career with IBM. But the record of the three
founders was astounding. They created one of the largest
ISPs in the third largest city in the world (São Paulo).
They eventually sold their firm to a foreign strategic
buyer who appreciated their accomplishment and thus the
managerial talent of the three founders. The three have
recently formed a new company called WebForce, an
investment and consulting firm, and they are having a
much easier time raising capital this go-round.
Fortunately, there are now many Brazilian
entrepreneurs who have built valuable companies and sold
them to large buyers, thereby gaining credibility for
their next attempt at fundraising. Many of them serve to
remind investors that historical performance on the job
is more important than an institutional pedigree.
This is the playing field for the next phase of
private equity investing in Brazil. This is not a
projection of easier times, but an acknowledgement that
considerable progress has been made in a short time in
terms of defining what will and will not work. The
Nasdaq may be down, but the opportunity for private
equity in Brasil is still just taking off.