1.5 billion dollars: concessions to convince
Samuel Klein to sell Casas Bahia
For decades, stories about the Pao de Açúcar group and Abilio Diniz, chairman of the board of directors, have overlapped. At 72 - an age that does not combine with being a late father of a 1 month old baby and having a physique molded by an exhaustive routine of exercises - Abílio has been the leading player in every decisive moment of the company. From growing the business created by his father, Valentim, to the family and management crisis that almost led Pao de Açúcar to ruin at the beginning of the 1990s. From removing his brothers and assuming total control in 1994 to selling 50% of the group to the French Casino supermarket chain, which began five years later. In many ways, Abílio personifies the maturing process of a generation of Brazilian business owners. Business owners, who constructed family empires, underwent regenerating crises, discovered professional management and the contribution of foreign partners as a foundation for rebirth and growth. Over the past ten years, he has conducted 11 acquisition processes - and increased the number of his chain's stores fivefold.
Now, at the age of 72, with six children and a personal fortune of 1.5 billion dollars, Abilio is getting ready to take the step that some of his peers in other sectors of the economy have already taken - the one that could make his group of companies as big as the biggest in the world in his sector.
In 2009 - a year haunted by the fear of the financial crisis - no Brazilian entrepreneur was more aggressive than Abilio. Over a period of just six months, he took control of the two largest household appliance and electronics chains in the country. In June, he paid 824 million reais for Ponto Frio, an operation that put him back on top in Brazilian retail, a position he had lost to Carrefour in 2007. A few days ago, after three months of secret negotiations, he acquired control of Casas Bahia, an icon in Brazil's emerging class C market, and owner of 14 billion reais in earnings. "It was the right offer at the right time," Abilio told EXAME. "Now the game gets much more interesting."
And Abilio Diniz will certainly be more powerful. Together, the Pao de Açúcar group companies and Casas Bahia earn nearly 40 billion reais per annum. They are the eighth largest business conglomerate in the country, ahead of Telefônica and BR Foods. They control a 42% share of household appliance sales in the country and nearly 70% of this market is in the southeast. They are the largest Brazilian advertiser, and the largest employer, with 137,000 employees. With 1807 stores spread about 18 states, Abilio and his partners have opened a huge lead over Carrefour, second in the retail ranking - a lead so expressive it has not been seen in over 23 years. "In this business, whoever has scale wins. And we want to be present in every city of Brazil," says Abilio. The market estimates that the merger of the two companies will generate 2 billion reais in savings. Pao de Açúcar executives heard by EXAME believe that could double. "Casas Bahia's technology and logistics area can easily absorb the entire Ponto Frio operation. Likewise, there is room at Pao de Açúcar to assume the Klein chain's administrative services," says a top executive at the group.
Conclusion of the biggest deal in the history of Brazilian retail required Abilio to adjust his typically controlling personality to these new circumstances. More than ever, associations between large and strong companies require the capacity to make concessions. Abilio had already demonstrated his more diplomatic side in the negotiations to buy Ponto Frio, when he convinced Lily Safra he should be chosen as the buyer. At the time, his biggest adversary in the dispute was Magazine Luiza. Abilio paid Lily a visit at her apartment in New York and put his proposal on the table with one condition - she either accepted the offer in the next few hours, or Pao de Açúcar was out. Lily accepted. But it is necessary to take into account that she had wanted to sell her business for years. Not Samuel Klein. He arrived in Brazil more than half a century ago after escaping a Nazi concentration camp. The creation of Casas Bahia was his greatest achievement. Samuel, now 86, was the greatest resistance to be overcome. Abilio's first step was to convince Michael Klein, Samuel's first born and general director of Casas Bahia, to participate in the operation. The first conversation took place nearly 90 days ago - soon after Michael announced he would buy his brother Saul out and assume sole command of the chain. The announcement of peace between the heirs (which cost nearly 1 billion reais) was a sign to the market: the family dispute at Casas Bahia was over and a period of stability at the helm of the chain was approaching. Abilio saw the perfect opportunity. "Brazil is going through a special moment. We came out of the crisis quickly and the opportunities are enormous. Isn't it time to join forces?" he asked Michael over the phone.
The two met one week later. At Abilio's suggestion, the meeting only included four people: he and his son Joao Paulo Diniz, Michael and his son Raphael, who would become president of the company resulting from the merger between Ponto Frio and Casas Bahia. "We had to create a climate of mutual trust," said Abilio. The BOB project, or Big One Bahia, the code name used for the operation, began to take shape.
Convincing Michael and Raphael of the deal's benefits was a relatively easy task. In little less than one month, the general outline of the operation had already been drawn up and accepted. Now came the trickiest part of the negotiation: persuade Samuel Klein, owner of 53% of Casas Bahia. "Without his approval, the conversations were over," said Michael. Abilio used the creation of a family atmosphere to seduce the patriarch - as well as a discourse that aimed at showing the association with his company would be the best way out for the perpetuity of Casas Bahia. (Samuel had thought of this for years and saw the need for greater professionalization at the company.) Abilio organized at least two meetings with Samuel, Michael and Raphael to discuss the matter. The first took place at the home of Pércio de Souza, a partner at the Estáter investment boutique and an advisor at Pao de Açúcar. "You have my blessing," said Samuel (the photo on page 198 proves the climate was already one of celebration). For the second meeting between the families, which took place three weeks ago, Abilio offered a dinner at his home with the participation of his wife and children. "It sounds silly, but that type of attitude tightens the bond," he said.
"We are definitely going to go public with this e-commerce company," says Abilio.
For Pao de Açúcar, the purchase of Casas Bahia came up against an insurmountable issue: acquisition of 100% of the company would cost nearly 6 billion reais, money the group would be unable to raise without going into debt. At the same time, another IPO was out of the question since it could further dilute Casino of France's share in the company. The solution was to gain control of Casas Bahia without spending anything. For that, it would be necessary to merge the chain with Ponto Frio, a subsidiary of the Pao de Açúcar group since June. But how could they join companies so different in size without reducing Pao de Açúcar's share in the business (Casas Bahia earns three times more than Ponto Frio)? How could they guarantee Abilio's control of the company, a condition placed on the table since the first conversation with the Kleins? They solution found was to reduce the size of Casas Bahia, leaving a large part of its assets out of the operation. The properties where 260 of the chain's stores and two distribution centers are located were excluded from the bill. A credit portfolio worth 1 billion reais was transferred from the company to the Kleins, along with the family's airplanes and the Bartira furniture factory (230 million reais). Finally, the company's debt of nearly 1 billion reais was absorbed by Ponto Frio. That is how they arrived at the magic number: the two companies were now worth approximately 2 billion reais each (the Kleins will still receive 128 million reais per year for renting the stores to the new chain). Thus, the largest household appliance and electronics company in the country was born, with estimated earnings of 18 billion reais. Contrary to what happened in the latest big business deals involving Brazilian companies - Sadia and Perdigao, Aracruz and VCP and the acquisitions made by JBS-Friboi - the BNDES did not participate.
The business between the two biggest entrepreneurs in Brazilian retail would probably never have occurred if both had not accepted to relinquish some power - relatively new behavior in our model of capitalism. In the case of the Kleins, the concession is obvious: today they are partners of a much bigger company, but they don't control it. In exchange, Abilio agreed, for example, that Pao de Açúcar as well as Casas Bahia would be advised by the same attorney, Syllas Tozzini, from the Sao Paulo law office of Tozzini Freire, Samuel Klein's trusted advisor. (Years ago, the same Syllas Tozzini had defended Casino in negotiations to sell part of the Diniz family's shares to the French chain.) In order to not delay the operation, Abilio waived the internal audit process, due diligence, and proposed an intermediate solution. Since Casas Bahia and Pao de Açúcar had their balance sheets audited by Ernst&Young, the shareholders permitted the exchange of information between the parties (each company would be responsible for its liabilities).
It was in the management of the new company - still without a name - that Abilio made the biggest concessions. Operations will be centralized in Sao Caetano do Sul, in Greater Sao Paulo, where Casas Bahia's headquarters functions today. Day-to-day command is up to the Kleins. Michael will be chairman of the board and Raphael the CEO. (Pao de Açúcar will get one of the vice-presidencies and the CFO.) At 32, Raphael has little retail experience - something unprecedented in companies controlled by Abilio. Five years ago, he was appointed by his father to occupy the position of marketing director at Casas Bahia. For example, it was under his command that the chain launched its e-commerce site at the beginning of the year. Before that, Raphael had spent nearly a decade in the United States, dividing his time between his administration course at Florida International University, in Miami, and management of a Ford dealership in Coral Gables. "I was given an ultimatum to come back in 2004," he said. "The company was growing and it needed people to help."
Abilio made concession in order to close the biggest deal in his life. He waived part of the power on behalf of a larger company
Abilio's tactic - cede a little to gain a lot - is becoming part of the negotiation repertoire of big Brazilian entrepreneurs. That was the strategy used last year by Roberto Setubal, then president of Itaú, to convince Pedro Moreira Salles, of Unibanco, to join forces. In order to create a Brazilian institution with the capacity to compete in the global market, Setubal agreed to have Moreira Salles occupy the chair of co-chairman of the new bank's board of directors. In short, power was shared. This is a logic that privileges growth over absolute power - and it should gain more and more space in Brazil. "Shareholders are learning to make concessions so they can build global businesses," says Haroldo Vale Mota, professor of finance at Fundaçao Dom Cabral. "It is better to have a smaller slice of a company with great scale and high profitability than total power of a company with growth limitations."
That was the logic of the Kleins' decision - a difficult step for a family company, successfully run for decades. Samuel Klein was a man of vision when he saw a market for retail to explore in the lower classes. His business model - based on credit - was celebrated as innovative over the past two decades. Casas Bahia was even studied at Harvard. It received visits by students from MIT. And it became a chapter in the classic The Fortune at the Bottom of the Pyramid by C.K. Prahalad, of India. Growth in class C seemed to be the password for even faster expansion at Casas Bahia. That is not what happened. Over the past three years, while all Brazilian retail grew, the chain's earnings remained practically stagnant. (In 2009 there should be slight drop.) Why? Part of the explanation is in the fact that Casas Bahia is a product from the years of high interest rates and credit shortages in Brazil. Its charge account policy for low-income consumers filled a gap in the market. It is estimated that at the beginning of this decade, financial operations represented 70% of the chain's earnings. Things have changed. Banks, finance companies and other retailers began to compete for the credit market. And the model, as conceived, stopped making sense. "Suddenly, Casas Bahia stopped having a monopoly with the poor," says an executive who knows the company. "That was when the company began to see its inefficiencies." The most important - or at least the most visible - is in the company's staff of employees, considered too big by specialists. The Klein family chain has 57,000 employees and revenue per employee of 245,600 reais. At Ponto Frio, its 8000 employees generate twice the revenue. Casas Bahia works with a greater stock turnover than its competitors, which increases operational costs. "Executives there have grown accustomed to compensate for these discrepancies by squeezing suppliers," says an executive close to the company.
That is not a habit that should change. As a single entity, Casas Bahia and Ponto Frio have greater scale, and therefore, greater bargaining power than they did on their own. The consequences of this increase in power are spreading about the sector's chain. The new company's concentration is impressive - but it is improbable that competitors, suppliers and clients will not react to this, correcting possible distortions. The strength of the domestic market has been attracting foreign chains to Brazil, such as Elektra and Coppel from Mexico, and promoting the emergence and growth of new retailers. Local chains, like Gazin and Eletroshopping, are growing more than 20% per year by mainly exploring emerging markets, such as in the northeast and midwest. In order to maintain their position in face of a competitor so much stronger than them, they will need to continue growing. Magazine Luiza, the second largest household appliance chain in the country, will open 80 stores over the next few years thanks to the renewal of a partnership with Itaú Unibanco, which yielded 250 million reais to the company. "Pao de Açúcar will take at least two years to absorb Casas Bahia," says Luiza Helena Trajano, president of Magazine Luiza. "Meanwhile, we are going to occupy those places where they are not strong."
Contrary to competitors' expectations, some of the steps for integrating the two chains will already be taken in coming weeks. The five Casas Bahia stores in Rio Grande do Sul will adopt the Ponto Frio banner (Kleins' brand suffers great rejection by the state's consumers). In Bahia, the opposite will occur: the Ponto Frio units will be transformed into Casas Bahia. However, no measure will change the lives of executives in the household appliance and electronics sector over coming months as much as the definition of the new chain's commercial policy. According to Abilio, Casas Bahia's aggressive guidelines shall prevail. Because it buys in large volumes, the company became accustomed to squeezing industry margins to the maximum, even if to do so it was obliged to buy entire production lots. And, since the discount given by suppliers to Michael Klein's chain is on average 3% greater than for other chains, many manufacturers are already reviewing their 2010 budgets. "There could be layoffs," says an executive at one large supplier. "We must main our profitability."
Despite having made two large acquisitions this year, Abilio Diniz is already thinking of new fronts for expansion. The Internet is the one he prefers. The deal reached with Casas Bahia projects the creation of Nova.com, an e-commerce company that unites Extra, Ponto Frio and Casas Bahia on the web. Together, they will earn 1.4 billion reais in 2010 and become a solid threat to the current supremacy of B2W, the company that resulted from Americanas.com's purchase of Submarino. A study conducted by Serasa Experian Hitwise (a division of Serasa that analyzes the interaction of 90,000 people with 60,000 sites in Brazil) shows that, although B2W has practically two times the number of visits as Nova.com - 41.81% to 22.25% - the new company's growth rate is much higher. The sites that integrate Nova.com grew 70.5% from April to November of this year. Over the same period, B2W sites grew 11.1%. "We are definitely going to go public with this e-commerce company," says Abilio. But his plans go even farther: chains of pharmacies, service stations. "You are going to hear a lot about me next year," he says without any modesty.