Ethanol Giants Struggle
To Crack Brazil Market
Family Owners Hesitate
To Sell Out to Big Players;
Visit From Google Guys
By ANTONIO REGALADO and GRACE FAN
September 10, 2007; Page A1
RIBEIRÃO PRETO, Brazil -- Nowadays, plenty of investors want to talk to Cícero Junqueira Franco. Together with two sons and numerous cousins, he controls a great deal of something the world wants: ethanol.
Mr. Junqueira Franco, a founder of Companhia Açucareira Vale do Rosário, a steam-belching mill that crunches sugar cane into sugar and ethanol, has received offers from several suitors. These include a $775 million bid for his company from New York-based commodities giant Bunge Ltd. But Mr. Junqueira Franco, whose family arrived in Brazil in the 1700s and still owns prime tracts of sugar-cane land in São Paulo state, says he'll never sell.
The Journal's Antonio Regalado reports on the sugarcane that's worrying U.S. corn farmers as a competitor for the ethanol market. (Sept. 10)
"Why would I?" asks the 75-year-old Mr. Junqueira Franco, his shirt partly untucked and face flushed after a big lunch with his family.
Thanks to high oil prices and worries over global warming, multinational companies are straining to find ways into Brazil's booming market for biofuels -- renewable fuels made from crops such as corn and sugar cane. The U.S. and other countries hope to substitute as much as 15% of domestic gasoline for ethanol over the next decade. With ample land, low production costs and ethanol-production experience, Brazil is viewed by many as the country best able to sate world demand.
A clutch of potential investors have descended here, including commodities giants, hedge-funds and energy companies. Even the founders of Google Inc. came to have a look. But the global millions are colliding with an earthy reality: families like Mr. Junqueira Franco's that have controlled Brazil's sugar-cane wealth for decades, even centuries. Many don't want to sell; others are asking sky-high prices for operations riddled with problems.
The standoff is preventing some big foreign players from getting into Brazil's promising ethanol market through acquisitions, forcing them to develop their own projects from scratch. Yet resistance to outsiders could affect how quickly larger amounts of cheap Brazilian ethanol can begin flowing into the world's auto fleet. Big companies, which have better access to credit and capital, could also help consolidate, modernize and expand Brazil's ethanol industry.
FUEL FIGHT
• The Situation: Multinational giants want to get in on Brazil's booming biofuels business, but the families behind the country's sugar-cane riches aren't eager to sell.
• The Allure: Brazil's sugar-cane ethanol is more efficient to make than U.S. corn ethanol -- and could be more competitive with gasoline prices.
• The Bottom Line: Brazil needs billions of dollars of investment to expand production and build the pipelines and ports necessary to become the world's ethanol supplier.
Frustrated investors are easy to find. Archer-Daniels-Midland Co., the largest U.S. ethanol producer, has been shopping here for more than three years. Global sugar traders such as Australia's CSR Ltd. and Germany's Südzucker AG have met with high prices and lengthy negotiations. India's largest sugar and ethanol maker, Bajaj Hindusthan Ltd., announced plans a year ago to spend $500 million to acquire mills. After several months of courting mill owners at their expansive ranchlike fazendas, the company has struck out. "I have been to a lot of nice houses," says Prem Bajaj, a Bajaj business-development executive.
Many family-owned mills appear to be troubled. The domestic sugar and ethanol industry is informally managed and highly fragmented, making it less than ideal for outside investment. Often, millers don't have reliable accounting books and are plagued by tax disputes and debt, Mr. Bajaj and other investors say. Such issues can be difficult to resolve in Brazil's slow-moving legal system.
Pitfalls for Outsiders
Labor and environmental pitfalls also loom for outsiders. Most sugar cane is still cut by hand -- grueling work that has enriched mill owners for centuries, but could expose international companies to liabilities. Global bank HSBC Holdings PLC got unwelcome publicity for loans it had made to Pará Pastoril e Agrícola SA, a mill in the state of Pará that was raided by a government antislavery task force earlier this year.
According to Brazil's Ministry of Labor, officials "rescued" 1,108 workers laboring under "degrading" circumstances that included 13-hour work days and poor sanitary conditions. An HSBC spokesman says the bank "is committed to social responsibility," but declined to comment on any specific clients. Officials at the mill, known as Pagrisa, have denied wrongdoing both publicly and on their Web site.
Brazil's millers face some political pressure not to sell. If foreigners or large companies gain leverage, Brazil's traditional sugar-producing regions stand to reap less from an ethanol boom. Aloizio Mercadante, a powerful senator from São Paulo, recently called the action of millers who've sold "incredible and incomprehensible."
Despite the many hurdles, foreign biofuels companies like ADM believe that getting into Brazil is still a must. U.S. corn ethanol, which is less efficient to make, has been competitive with gasoline due to a 51-cent tax credit on each gallon. And both ADM and competitor Cargill Inc. faced narrowing profit margins in their U.S. ethanol operations last year due to leaping corn prices -- a side effect of greater demand for corn from ethanol producers.
By contrast, Brazil's sugarcane ethanol can comfortably compete with costly oil -- even if oil trades in the low-$40-per-barrel range. ADM's CEO Patricia Woertz says she believes Brazilian ethanol operations would provide "an opportunity for profitable growth" regardless of what happens in the U.S. market. Although a stiff import tariff of more than 50 cents per gallon currently makes Brazilian ethanol costly to import to the U.S., Brazilian ethanol could dominate other markets in Asia or Europe.
[Biofuel Boom]
Analysts say Brazil needs billions of dollars in investment to expand production and to build the pipelines, ports and other infrastructure it needs to become the world's ethanol supplier. There are roughly 210 companies running 368 sugar and ethanol mills. The five largest players generated about 17% of the country's ethanol production last year.
Brazil's ethanol industry is "very disorganized, and consolidation will help," says Clayton Hygino de Miranda, president of the sugar and ethanol division of Brazilian construction conglomerate Odebrecht SA.
In the U.S., where ethanol is made from corn, any company can build a refinery and buy corn on the open market. But because sugar cane's heft makes it costly to transport, and its sucrose content degrades quickly, crops are always planted close to the mills that process them. That makes it difficult to sidestep people like Mr. Junqueira Franco, who owns 3,200 acres of prime plantation land.
Sugar barons' control over the ethanol industry could impede Brazil's effort to create a global market for ethanol. Japan, for instance, has been in talks with Brazil since 2001 to sign a long-term ethanol contract. But the Japanese officials have wavered, expressing concerns as to whether Brazil's sugar families can furnish steady supplies of ethanol. In the 1980s, local producers chasing high sugar prices created an ethanol shortage that left Brazilian drivers of all-ethanol cars without fuel. Having large companies that are focused on ethanol rather than sugar could help prevent supply shocks in the future.
Greenhouse Gas
Brazil has been using ethanol since the 1970s, when the government decided to support the fuel as a way to limit the country's reliance on Middle Eastern oil. Over the decades, the vast nation managed to gradually lower the cost of making the fuel, but gasoline was so cheap in the 1990s that the effort almost died. When oil prices began their steady climb in 2002, however, sugar-cane ethanol became cheaper than gasoline. Ethanol is also winning followers because it contributes less to global warming than gasoline. While burning either fuel produces similar amounts of carbon dioxide, a greenhouse gas, ethanol crops such as sugar cane reabsorb carbon dioxide each time they are replanted.
Some foreign investors have decided to create new cane plantations, or "green fields," far from areas of São Paulo state where Brazil's powerful sugar-cane families dominate. Investor George Soros and Texas hedge fund HBK Group are plowing more than $1 billion into such efforts, as is Brazilian Renewable Energy Co., or Brenco, a start-up backed by U.S. billionaire Ron Burkle and venture capitalist Vinod Khosla.
But it's a lengthy process, taking at least six years before the ethanol is flowing fully. That makes green-field projects unattractive for many investors. And it's difficult to do. Henri Philippe Reichstul, the former CEO of Petróleo Brasileiro SA, Brazil's national oil company, who now leads Brenco, says industry experts are reluctant to leave family companies where they've worked for decades. "For them, it's treason," says Mr. Reichstul, who says he's been hiring some former oilmen instead.
ADM's chief strategist, Steve Mills, said his company needs to capture know-how for growing and processing sugar cane. "The one thing we do know here is that we're going to have to acquire some expertise in the area," says Mr. Mills.
Brazil's milling families insist they are no roadblock to progress. They note that planned expansion projects, the majority from traditional companies, would ramp up ethanol production by 80% in five years to 9.5 billion gallons annually, an amount of energy greater than what's generated by America's largest oil field, Prudhoe Bay in Alaska.
Others, however, say the industry's structure holds back bigger gains. The industry currently invests far less than the U.S. in research. While the U.S. Department of Energy will spend $385 million on funding next-generation ethanol plants, the state of São Paulo responded by funding a competing program with just $25 million.
The best-positioned of Brazil's proud sugar-cane kings see their own chance to become global players. Yet they are wary of giving up on generations of family work -- or ceding total control of their companies. To avoid a takeover, Brazil's largest sugar-cane miller, publicly traded Cosan Ltd., recently announced a complex restructuring designed to keep founder Rubens Ometto Silveira Mello at the helm. Other companies, open to the idea of taking on minority investors, are also trying to quickly restructure.
Marc McCarthy, who follows Cosan's stock at Bear Stearns in New York, says the move reflects a reality of the market. "If he gave up voting control, boom, they would get taken out."
Buyers are watching the situation closely. Global sugar and ethanol prices slumped this year, and local millers, who have borrowed heavily from banks to fund expansion plans, may be forced to start selling.
Coveted Mill
Perhaps no mill has been more coveted than Vale do Rosário. The hulking facility was built in 1964 after the Biagi family, heirs of an Italian industrialist, convinced the blue-blooded Junqueira clan that sugar cane could be a profitable use for their land. Mr. Junqueira Franco's family sold 15,000 head of cattle to raise cash for the mill's costly crushers and distilling tanks.
Like other Brazilian sugar-cane mills, Vale do Rosário inherited a weakness: an unwieldy co-operative structure that had grown with each generation, with more than 100 relatives holding small percentages of shares. "It's like 'Dallas,' " says former shareholder Marcelo Junqueira, referring to the '80s-era television drama about a scheming Texas oil family.
Dissent grew as investors began flooding into Brazil last year. Some shareholders wanted to cash in, and began shopping their shares to potential buyers.
Amid such fissures, U.S.-based commodities giant Bunge offered to buy the operation for $640 million last July, according to people familiar with the situation. Like rivals ADM and Cargill, Bunge has begun pouring money into corn-ethanol plants in the U.S. and was hungry for a foothold in more-efficient Brazilian sugar cane. A Bunge spokesman declined to confirm the $640 million figure.
But Vale do Rosário's board rejected the offer. Mr. Junqueira Franco, whose two sons run the mills' day-to-day operations, says it was because Bunge wanted outright ownership. Cargill Inc., which flirted with the idea of buying 30% of the company, according to people familiar with the negotiations, was also turned away. "We didn't want anyone to take charge of us," Mr. Junqueira Franco says. A spokeswoman for Cargill declined to comment.
The next takeover bid wasn't friendly. It came from Cosan, Brazil's largest producer and led by Mr. Ometto, scion of a competing sugar family. Secretly negotiating with Mr. Junqueira Franco's relatives, by January of this year Cosan had inked agreements with shareholders representing 50.2% of the company's votes, and formalized a takeover bid valuing the company at around $775 million.
Even after Bunge offered to match Cosan's bid, a group led by Mr. Junqueira Franco and three Biagi brothers still didn't want to sell. "Capital has a hegemonic idea: to own. But we had a different idea," Luiz Biagi reflected recently, while relaxing on a couch in his plantation home surrounded by his family.
The Biagis and Mr. Junqueira Franco had one defense: Under the co-operative's complex bylaws, even the smallest shareholder had 30 days to equal any takeover offer. Over 48 hours of hurried negotiations in mid-February, the Biagi brothers offered up their own Santa Elisa mill to secure a $675 million credit line from Brazil's largest private bank, Bradesco. The money was used to buy out family members who wanted to sell.
Vale do Rosário and Santa Elisa have since agreed to merge, and their simplified structure -- control rests with the Biagi brothers and Mr. Junqueira Franco's family -- is already attracting capital. In late July, Goldman Sachs said it would invest $200 million in the renamed milling company, Santelisa Vale, now Brazil's second-largest.
--Lauren Etter contributed to this article.
Write to Antonio Regalado at antonio.regalado@wsj.com1
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