Model Portfolio rmcduff:RMG1

Please note: All figures have been converted from Brazilean Real to US dollars at the rate of $0.5798. All estimates are my own, and may differ materially from published analyst reports.

Brazil's #2 and #1 Appliance and Electronics Retailers Merge: Transformative for Compania Brasiliera De Distribuciao (CBD-NYSE, $72.15)

Compania Brasiliera De Distribuciao (CBD), a holding of RMG#1, and a business recently profiled, has announced the largest joint venture in its corporate history.

Management has announced the intention to merge the recently purchased white goods retailer, Ponto Frio, into Casas Bahias, a privately held company.

CBD will add all of Ponto Frio's retail stores, all corporate real estate of CBD and shares. After this non cash consideration has been paid, CBD will own a modest control position (51%) of Brazil's largest appliance and electronics retailer.

Casas Bahias is the 800 pound gorilla of appliance and electronics retailing in Brazil. In 2008, the total white goods and electronics market in Brazil was estimated to be $38.8 billion US. Casas accounted for 27.6% of this market, or $10.6 billion US. Ponto Frio, CBD's appliance retailer, was a very distant #2 in the market, with 2008 sales estimated to be $1.5 billion. On a pro forma basis, combined estimated 2009 sales of the two companies may be in the range of $15 billion US.

The market for appliances and electronics in Brazil is forecast to grow, by North American standards, at what would be considered to be explosive rates.

By 2013 the total white goods and electronics market is estimated to reach sales of $77 billion, vs. $38.8 billion in 2008. This is a potential CAGR of 14.8% per annum.

As a private company, Casas Bahias does not make its financial records available to the public. However, CBD notes that synergies from the combination of the two firms may amount to more than $696 million per year, when all integration is complete. It seems easy to determine where the savings will occur. As a private firm, Casas Bahias did not have access to the relatively lower cost credit enjoyed by CBD. There will be major purchase savings, as well as substantial savings on administrative costs. EBITDA margins on the combined firms should rise.

To place this accretion into perspective, I had previously forecast that CBD, on a stand alone basis, would have the potential to generate roughly $790 million in 2009 EBITDA. As the deal is being done with both real estate as well as stock, current shareholders should benefit a dramatic improvement in EBITDA per share, on a go forward basis. Purchases of private entities are generally far cheaper than purchased of publicly traded firms. I do not know the total stock consideration to be paid in the deal as yet, but potential EBITDA enhancement could be as high as 20%, in the near term, for existing shareholders.

There is a compelling strategic motive for the purchase.

CBD, by taking a 51% holding in Brazil's largest appliance retailer, has eliminated a potential tie-up of Casas Bahias with either Wal-Mart or Carrefour, CBD's two largest rivals. The chairman of Casas Bahias, Samuel Klein, is 77 years old. He is often called "Brazil's Sam Walton". Casas Bahias has built a dominant market share in Brazil, by extending credit to lower income buyers, when traditional banks would not.

Such a joint venture makes sense, if one believes the following.

1. Brazil, as a nation, may benefit from lower overall credit expenses in the future. In the past, Brazil has suffered through periods of extremely high interest rates. However, a growing global recognition of Brazil's forecast GDP growth rate, coupled with the strength of their national balance sheet, could mean that the country's national credit rating will result in a gradual decline in their cost of borrowing. This could flow through to both banks and non bank entities.

Should this prove to be the case, the combined Ponto Frio and Casas Bahias may stand to generate increased credit spreads on their financing plans, in the future. Such a benefit would be incremental to the current forecast synergies.

2. Brazil, as a nation, will grow in stature as an investment market. The country has few publicly traded stocks available as ADR's to foreign investors. Most of these are already represented in institutional accounts. I referred to this in my earlier write-up on CBD, using the term "herding".

After the deal closes, CBD will have a commanding lead over Wal-Mart and Carrefour in Brazil, in terms of market share. There is every possibility that CBD, a little known firm to foreign institutional investors, will quickly become part of the institutional "herd". Prior to institutional purchases, it is common for a flurry of glowing research reports, on both a buy side and sell side, to occur. Having quite recently moved from mid cap to a very small large cap stock, CBD clearly has the potential to become a mid sized large cap company in the years ahead. Institutions need large caps for liquidity purposes, and CBD will soon fall squarely into their sights.

The deal catapults CBD into a completely different league.

The government of Brazil has recently announced a two year $20 billion US plan to encourage low income families to own a home. A key plank of this plan has been the tax cut on stoves, refrigerators and washing machines. The macro outlook greatly improves in both the long term for CBD, as well as the short term.

http://www.brazillandinvest.com/index.php?option=com_content&view=article&id=219:brazil-planning-to-cut-taxes-to-stimulate-domestic-consumption&catid=1:latest&Itemid=30 <http://www.brazillandinvest.com/index.php?option=com_content&view=article&id=219:brazil-planning-to-cut-taxes-to-stimulate-domestic-consumption&catid=1:latest&Itemid=30>

On the heels of big recent move in the share price, some retail investors will be temped to take profits.

My analysis of the accretion potential suggests that the price increase in CBD is fully justified, and will continue to hold the shares.

I seldom report twice on a business.

My personal philosophy is this; a correct initial thesis has absolutely NO need to trumpet results that turn out in line with forecasts. Some investors are accustomed to flurries of weekly updates from buy side research houses, daily updates on blogs from private investors, or perhaps a plethora of reports from analysts lacking conviction in their calls and needing to justify ownership.

Retail investors requiring voluminous reports, on a regular basis, will not benefit from my investment systems and model.

My body of work is dull in comparison. I am a perpetually terrified investor and do not find the process of business ownership to be at all fun. It merely represents a means to an end. Accordingly, inordinate time is spent at the front end of the research process. The objective is to ensure, as best I can, that my selection in large caps turns out to be the best possible company in its sector, consistent with my long term objectives. Therefore, if a business performs as planned, I simply breathe a sigh of relief. Should my initial research report prove to be correct, the business in question generally won't be reported on, until sold.

In the case of CBD, however, such an accretive purchase should be mentioned to existing investors. It's a VERY big deal for a smallish large cap company. In the next several years, the new joint venture has the potential to obliterate my mid term EBITDA and revenue forecasts.

click here to download the company's press release