ARTICLE: The invisible cost of 3% interest rates and the era of defensive M&A in Brazil

During the pandemic, Brazil experienced a rare phenomenon in its recent economic history: the cost of capital was compressed to levels comparable to developed economies.

The combination of a basic interest rate of 3% per year and ample credit supply, driven by instruments such as the Investment Guarantee Fund (FGI), enabled by BNDES, created an environment in which indebtedness ceased to be merely a liability management tool and became a driver of growth.

Medium and large-sized companies accessed lines of credit at CDI plus 1% or 2%, extended terms, gained grace periods and, above all, began to arbitrate their own cost of capital.

With projected returns in the double digits and nominal debt below 5% per year, decisions to expand, acquire, and increase production capacity not only made sense but seemed inevitable. Cheap capital did not distort economic rationale; it merely shifted the decision-making axis to a premise that proved temporary.

The turning point came with the global repricing of money and, in the Brazilian case, with the accelerated return to a structurally high level of real interest rates. Throughout the transition between the Jair Bolsonaro government and the beginning of Luiz Inácio Lula da Silva's current administration, the cost of debt went from low single digits to levels exceeding 15% per year.

The impact, however, went beyond the base rate, as companies began to tighten cash flow and extend commitments, the banking system responded with what is inherent to it: risk repricing.

Spreads have widened, terms have been shortened, and contracts that were originally benign have come to carry effective costs close to 30% per year. In this environment, the mathematics of leverage takes on an exponential character.

A company with debt equivalent to four times its EBITDA can, in two to three annual cycles, see that multiple exceed the actual value of the business. The phenomenon is silent at first, but quickly corrosive.

Equity, which seemed protected by a growth plan, begins to be consumed by the capital structure itself. It is at this point that the mergers and acquisitions market begins to change its nature.

Historically, M&A in Brazil has revolved around two main motivations: strategic expansion and liquidity for shareholders. What we are seeing now is the consolidation of a third vector, less voluntary and more pragmatic.

Companies that were not for sale are now considering a transaction as a mechanism for preserving value. The decision, which was previously based on capturing the best multiple, is now about preventing the book value from converging to zero in a relatively short timeframe.

This movement is still in its initial phase, but it tends to gain traction as maturities, grace periods, and renegotiations agreed upon at the height of the pandemic mature. The dynamic is predictable: the longer a company remains leveraged in a high-cost-of-capital environment, the lower the residual value available to shareholders in a potential transaction tends to be.

On the buyer's side, there is also a significant change. Domestic private equity funds have reduced their appetite, pressured by a high risk-free rate that is reshaping the risk-return relationship. In their place, strategic buyers, especially multinationals, are gaining prominence.

With strong currencies and greater access to capital, these groups see in Brazil a rare combination of market scale, available operational assets, and compressed valuations. The arbitrage between the global cost of capital and the local price becomes one of the most relevant drivers of this cycle.

The impact is not uniform across sectors. Capital-intensive businesses, especially in industry, face a more severe asymmetry between return and financial cost. Projects conceived under the logic of cheap funding end up carrying heavy structures in an environment where cash generation does not keep pace with debt servicing.

Similarly, models that require significant working capital financing, especially those exposed to long payment terms, feel the increase in financial costs more acutely. Conversely, sectors that are less dependent on capital, with greater scalability and less need for incremental investment, weather this cycle with greater resilience.

Consolidation, deleveraging, and the new economic equilibrium.

The most visible consequence of this process is consolidation. As more leveraged companies seek an exit, capitalized competitors and new entrants begin to absorb assets, expanding market share. The result tends to be a more concentrated structure, with a reduction in the number of relevant players in various sectors. Bodies like CADE impose formal limits, but do not alter the direction of the movement.

From an operational efficiency standpoint, there are clear gains. From a macroeconomic perspective, the effect is more ambiguous. Consolidation reduces competitive dynamism, limits the entry of new entrepreneurs and, in many cases, implies the rationalization of structures. In terms of employment and income generation, the impact tends to be negative in the short and medium term.

There is also a less visible, but structural, consequence. The high interest rate environment, coupled with greater tax and regulatory complexity, raises the barrier to entry for new businesses. At the same time, episodes of significant asset losses discourage risk-taking by entrepreneurs who, in another context, would be reinvesting. The result is an economy that loses some of its capacity for renewal.

For companies that are unable to execute a transaction on time, judicial reorganization becomes the adjustment mechanism. Essentially, it's a financial reset: debt reduction, extended payment terms, and preservation of shareholder equity.

In practice, however, the nominal reduction in liabilities often masks a structural deterioration in value: loss of credit, supplier restrictions, increased cost of capital, and reputational damage. Although it may restore operational viability in the short term, judicial reorganization usually shifts the company's focus to managing liabilities and litigation, limiting its growth capacity.

Not surprisingly, studies show that only about 23% of companies manage to survive in the long term after entering judicial reorganization, according to a survey by Serasa Experian.

Given this scenario, the discussion about whether the decisions made during the low interest rate cycle were right or wrong loses relevance. Many companies operated based on assumptions that, at the time, were widely shared by the market. The regime change was faster and more intense than expected. The question now is how to preserve value in an environment that has already changed.

The answer lies in recognizing that time is no longer neutral. In deleveraging cycles, postponing decisions tends to progressively transfer value from shareholders to creditors. Evaluating strategic alternatives in advance, accessing capital markets or M&A rationally, and abandoning the expectation of returning to a previous scenario are now vital for companies that want to preserve their value.

Brazil remains a relevant market, with scale, inefficiencies, and opportunities. But the cost of capital has once again become a disciplining factor and, in this cycle, it is reshaping the behavior of companies and, especially, the very logic of value creation in the country.

*Pedro Grzywacz is the founder and CEO of BM Partners. Since 2020, he has led BM with a focus on building an independent advisory firm, driven by seniority, relationships, and value creation. He is also a board member, entrepreneur, and serial investor.