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Sanitation market turns to municipal projects

Fourteen auctions may take place this year, bringing R$740m in new investments

01/16/2023

In 2023, the focus of the sanitation market is expected to turn to municipal projects as there is no prospect of large state auctions in the short term. Fourteen municipal auctions are in progress and may take place this year, bringing at least R$740 million in combined investments, according to a survey conducted by Abcon, a trade association of private-sector operators.

In the last two years, the “intermediary” market of smaller water and sewage concessions has drawn interest from the private sector. Small city auctions have attracted fierce competition, with more than 10 auctions and a wide range of competitors. Even new platforms have been created to operate in this segment.

On the other hand, the segment faces a number of challenges to accelerate expansion: regulatory uncertainties, doubts about the financing of projects, and the difficulty of municipalities to structure calls for tender are cited by experts and executives.

One criticism is that the market for municipal concessions move much more slowly than the market would like. “There is a lack of projects. There are many companies fighting over crumbs, and the bids are highly aggressive,” said Yves Besse, CEO of Cristalina. The company, founded in early 2022 with a focus on the segment, has yet to win contracts.

General Water, another company that seeks to expand operations in the segment, ended up directing its efforts to the private-sector market due to the lack of auctions. “We are still interested and analyzing opportunities, but growth has been slow,” said CEO Fernando de Barros Pereira.

But the supply of projects has advanced. Today, there are 101 (of cities and consortiums) in the modeling phase, according to a survey by Radar PPP conducted at Valor’s request. In May 2022, there were 66 projects.

Considering only mature projects – those with a defined model and in the public consultation or bidding stage –, the consulting firm mapped 56 projects, compared with 43 in the first half of 2022. “Since 2020, this market is moving,” said Frederico Ribeiro, a partner at Radar PPP.

In addition, 2023 is a good year for municipal auctions considering the electoral calendar. While states are at the beginning of each governor’s term in office, which generally puts new projects on hold, the municipalities are at the third year of each mayor’s term, which is considered more favorable for bidding as there has been enough time for structuring and the following election campaign, which typically affects projects, have not yet begun.

Despite the great expectation, specialists point out challenges that cast doubt on the segment’s advance. There are at least three types of problems.

The first is the signals given by the new federal administration in relation to the new sanitation law, said Frederico Turolla, a partner at Pezco Economics. In his view, even if there isn’t a change in the rules, there is a lower expectation of inspection for the fulfillment of the universalization goals – which discourages municipalities to get concessions off the drawing board, according to him.

“The regulatory framework brought requirements that depend a lot on government action. We already see a lower interest in projects amid the prospect of flexibilization,” he said.

A second factor that may hinder municipal concessions is the restricted access to federal funds, said Renato Sucupira, a partner at BF Capital. This limitation was imposed by the sanitation law, which aimed to stimulate regionalization.

Under the current rule, cities that make an independent project – rather than within regional blocks – cannot tap financing from federal banks, which hinders their viability. “It’s not an impediment, but it is discouraging,” he said. It remains to be seen how the new government will treat this rule, he added.

Finally, a third obstacle to the segment’s advancement is the difficulty that local governments have in structuring good calls for tender. This is an old problem that not only affects the sanitation market, and explains the high rates of project “mortality” – many of them are paralyzed or discussed in court due to inconsistencies.

“In recent years, we see an improvement in quality, but this is still a problem. In small and medium-sized cities, structuring capacity is often very limited,” said Frederico Bopp, a partner at the law firm Azevedo Sette Advogados.

Despite the challenges, the expectation is that the “intermediary” sanitation concession market will continue to expand. The question is how fast it will advance.

“I believe that the market will continue to grow. I don’t know if at the same speed and scope as Brazil, because I would have to multiply the speed. But it will grow,” said Mr. Pereira, with General Water.

Italo Joffily, founder of Ysanso, another recently created platform focused on mid-sized projects, said that the municipal projects market will not end, even if there are changes in the sanitation framework. “Municipalities were doing concessions before the law. So, if there is a setback, there may be a reduction in speed, but the market remains,” he said.

Today, the company is trying to draw investors to enable the acquisition of contracts and participation in auctions. According to the executive, there are talks with three funds – two from the United States and one from the Middle East. The recent regulatory uncertainties in the sector hinder the conversations, but are not an impediment, he said.

For Mr. Besse, with Cristalina, the advance in the number of models brings a good perspective. “The success of recent auctions, which had high fixed concession payments, is encouraging other cities to build concessions,” he said. The company focuses on projects in São Paulo, Minas Gerais, Santa Catarina, and Rio Grande do Sul.

In addition to auctions, Mr. Joffily notes that there will be opportunities in the secondary market, for example, with large operators selling assets that no longer fit in the portfolio.

In the case of the auctions of regional blocks, which have been structured by states, with the support of the Brazilian Development Bank (BNDES), the expectation is for 2023 is low. “It is hard to believe that state governments will launch anything. Even in cases of reelection, there are always changes in the teams,” said Camillo Fraga, a partner of the consulting firm Houer.

For him, even the Porto Alegre municipal project, which is already mature, may be delayed, because it is structured by BNDES – Houer is among the advisors of the development bank. Mr. Fraga believes that this auction, which is not on Abcon’s list, could still be held in 2023, which would add R$2.2 billion in new investments.

According to Abcon, besides the 14 projects planned for this year, there are 23 others on the radar, both at the municipal and the state levels, with the potential to generate at least R$14 billion in construction works. Yet, they are still in early stages.

*By Taís Hirata — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Red-hot sanitation market taps tax-exempt bonds

The advance of basic sanitation, a red-hot market since a new legal framework came into effect about two years ago, has been increasingly financed by private-sector funds – and not only in those places that auctioned water and sewage services. The use of tax-exempt infrastructure bonds to finance projects in the industry is growing rapidly and is already at all-time high levels this year.

Individual investors are exempt from paying income tax (IR) over these bonds. Any proposal for issuing the securities must be authorized by the government in order to guarantee the tax break.

This year to last week, the National Sanitation Secretariat passed proposals for the launch of R$3.018 billion in tax-exempt infrastructure bonds by companies in the industry.

Of this total, a little more than a third (R$1.12 billion) has already been approved, and the remainder (R$1.898 billion) is on its way for that – an ordinance must be published by Regional Development Minister Daniel Ferreira.

To offer a glimpse of the pace of requests and approvals, the previous record of tax-exempt infrastructure bonds in the basic sanitation segment was R$2.8 billion for the whole year, in 2021. Companies such as Paraná state’s utility Sanepar, Águas de Teresina and Rio Claro-based BRK Ambiental were authorized in recent months to raise funds through tax-exempt bonds.

Pedro Maranhão — Foto: Divulgação
Pedro Maranhão — Foto: Divulgação

Sanitation Secretary Pedro Maranhão told Valor seven other proposals to issue tax-exempt bonds are under analysis. They total R$13.8 billion, almost five times the combined amount of the projects authorized last year.

In the secretary’s view, new sanitation concessions are not the only factor driving the market. The goal of universalizing sanitation services – 99% of regular drinking water supply and 90% of sewage collection/treatment – by 2033, set in Law 14,026/20, has also speeded up requests from state-owned companies. Besides Sanepar, regional companies like Sabesp (São Paulo), Copasa (Minas Gerais), Cagece (Ceará) and Saneago (Goiás) have issued tax-exempt bonds.

Companies managing sanitary landfills have also started to explore this source of financing. Ciclus Ambiental, for example, is tapping these securities to finance investments in works related to the management of solid urban waste.

In June 2021, the company was authorized to raise up to R$450 million for a landfill in Seropédica, Rio de Janeiro. The funds can be used to put in place a new leachate treatment plant and a 2.8 MW biogas-fired power generation unit.

“We are talking more with companies, trying to convince them that bonds are an interesting financing mechanism,” Mr. Maranhão said. “On the other hand, we did an internal restructuring and managed to reduce to four from eight months the time for analysis of requests filed with the ministry.”

In recent years, even before the approval of the new legal framework, the Brazilian Development Bank (BNDES) and Caixa Econômica Federal had already been losing ground among the sources of credit for basic sanitation. Between 2016 and 2019, they had already seen their share of loans to private-sector water and sewage companies drop to 40% from 58%.

“The demand for investments is so high that diversification of financing is necessary,” said Ilana Ferreira, the technical head of Abcon, an association of private-sector sanitation concessionaires. For her, after starting to raise funds through tax-exempt bonds, the use of the mechanism in the industry skyrocketed. She believes that the next challenge is to lengthen the terms of the securities – the redemption period is still half of that offered by power companies, a market in which the bonds are better known.

Ms. Ferreira sees state-owned sanitation companies issuing more bonds after the economic and financial verification process to keep their contracts, which occurred in March. They needed to prove they were able to universalize services by 2033. Now they need to invest to offer drinking water and sanitary sewer to millions of people.

According to a financial adviser who works structuring projects and asked not to be named, the four privatized blocks of Cedae (Rio de Janeiro) are likely to raise billions of reais through tax-exempt bonds in the coming months.

Other concessions auctioned recently – in Alagoas, Amapá and Mato Grosso do Sul – also raise the expectation of billions of reais in investments in the industry over the next few years.

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