Converting Marfrig Debt Into Stock Comes at Steep Cost for Brazil Development Bank

  • Brazilian state lender is set convert $654 million of notes
  • BNDES backed Brazil’s meatpackers as they expanded abroad

For Brazil’s development bank BNDES, boosting its stake in Marfrig Global Foods SA comes with a hefty price tag.

The state lender’s investment arm is set to convert 2.15 billion reais ($654 million) in local notes issued by the meatpacker into stock in late January. That will increase BNDES’s shareholding to 33 percent from 19 percent, but in doing so the bank will pay 21.50 reais for each new share, more than three times the current market price.

The conversion price was based on a deal that dates back to mid-2010, when Marfrig’s shares traded far higher as Brazilian meat companies were in the middle of a state-backed expansion overseas. The wave of deals saw JBS SA spend more than $20 billion to become the world’s top meat producer. Sao Paulo-based Marfrig, JBS’s biggest Brazilian rival, bought 20 companies in five years, including Argentina’s Quickfood SA in 2007 and Brazilian poultry company Seara Alimentos SA in 2009.

Having already injected 1 billion reais of equity into Marfrig from 2007 to 2009, BNDES agreed in July 2010 to buy all of the meat company’s 2.5 billion-real convertible bond offering, helping to finance its $1.26 billion purchase of McDonald’s Corp. supplier Keystone Foods LLC. In 2014, the lender agreed to swap the notes for the 2.15 billion reais of longer-dated bonds which didn’t begin paying interest until a year later, allowing Marfrig to lower the price for converting the securities into shares to 21.50 reais from 24.50 reais.

But Marfrig’s acquisition spree quadrupled its debt between 2009 and 2011. The cash generated by the purchased companies wasn’t sufficient to pay the interest expenses. As a result, the beef producer has posted net losses for the past five years, shut capacity and sold some of the assets it had bought.

Marfrig has delivered the worst returns among more than 300 global peers since the BNDES-backed notes were issued more than six years ago. The region’s second-largest beef producer lost shareholders 64.6 cents on every dollar invested in July 2010, compared with a total return of 44.7 cents from JBS and 87 cents from Minerva SA, another big Brazilian meat company, data compiled by Bloomberg show.

"The outcome of this transaction was not good for anyone," said Adeodato Volpi Netto, the head of capital markets at Eleven Financial Research. Marfrig wasn’t able to focus on efficiency gains and a balanced capital structure as margins were squeezed by financial losses, he said. "Imagining that shares will return to the 21-real level is too far from the company’s reality."

BNDES says it will have received about 1.8 billion reais in interest from Marfrig by the time the bonds are converted, offsetting some of its losses. The bank will also get a second seat in on the company’s board.

BNDES’s participation is "strategic and based on long-term value creation through the improvement of governance, financial discipline and sustainability," it said by e-mail in a response to questions from Bloomberg. The bank said it has sought to be a more active investor and "understands that its participation on boards is an important tool for the development of capital markets."

The looming conversion has spurred Marfrig founder Marcos Molina dos Santos and his wife Marcia Aparecida dos Santos to raise their stake to 39 percent from about 29 percent, according to a regulatory filing, remaining the biggest single investor.

For Marfrig, meanwhile, the conversion will provide financial relief. The company is still struggling to increase cash flow and cut debt, and is spending as much as 300 million reais a year just to service the BNDES notes, about a quarter of its total interest expenses and equivalent to almost three months of earnings before interest and tax.

"The savings will allow us to direct more cash for the company’s growth," Marfrig’s Chief Financial Officer Eduardo Miron said in an interview in Sao Paulo. The company has gradually reduced its leverage over the past few years, which led Fitch Ratings to lift its credit rating in October to BB- from B+, four steps below investment grade. Marfrig is working on a new five-year plan that may be presented in the first quarter of 2017, Miron said.

Marfrig’s $1 billion in notes due in 2023 gained 3.8 percent in the past month, exceeding the 1.4 percent average gain of Brazilian corporate bonds. The stock rose 2.8 percent to 6.58 reais at 11:57 a.m. in Sao Paulo, which compares to a 2.5 percent gain in Brazil’s benchmark Ibovespa index.

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