Knock ’em down, build ’em up

IN 2014 Brazilian builders had a bumper year. Stadiums had to be ready in a dozen cities for the football World Cup in June, airports spruced up to welcome foreign visitors, and roads built to whisk them to venues. In Rio de Janeiro work was beginning in earnest on preparations for the Olympic Games it will host in 2016. President Dilma Rousseff was seeking re-election, and boosted the federal government’s infrastructure spending in the run-up to October’s tightly contested poll. Construction firms’ revenues had already been rising by 11% a year, in real terms, for the past ten years.

However, in September a police investigation found that some of this growth was thanks to padded contracts that at least six of Brazil’s biggest construction firms, with combined domestic revenues of 19 billion reais ($8.8 billion) in 2013, had for years been signing with Petrobras, the state-controlled oil giant, in exchange for kickbacks to politicians. Around 30 construction executives are now awaiting trial on charges of corruption or money-laundering, including the boss of UTC Engenharia, Brazil’s seventh-biggest builder. Credit to the industry evaporated. Several firms, including OAS and Galvão Engenharia, respectively the third- and sixth-largest, defaulted on some of their debt and have sought bankruptcy protection.

Uncertainty surrounding the police dragnet is affecting the entire industry. The assumption, right or wrong, is that everyone is embroiled, says a senior banker. Bosses of untainted companies gripe about everyone being tarred with the same brush. Marco Rabello, the chief financial officer of Norberto Odebrecht, Brazil’s industry leader, which has not suffered any accusations, admits that “image” is currently the industry’s biggest problem.

Making things worse, Ms Rousseff, having scraped by in the election, is now having to make drastic cuts to close a yawning budget deficit. Her flagship “Growth Acceleration Programme” of infrastructure improvements has been slashed. Brazilian companies of all kinds are bracing for a recession: investing in new buildings is the last thing on their bosses’ minds. Odebrecht’s domestic order book will be thin this year, Mr Rabello admits.

It is not all doom and gloom, however. For one thing, many big construction firms have been reducing their dependence on government contracts—and indeed on Brazil. Just 6% of Odebrecht’s revenue now comes from the Brazilian public sector; nearly three-quarters is generated abroad. It is part of a consortium which, earlier this month, won a $1.9 billion contract to build Panama City’s second metro line. Geographic diversification, together with low debt and net cash of 1.5 billion reais, helps explain why Standard & Poor’s has maintained Odebrecht’s credit rating one notch above the Brazilian government’s.

At home, too, there is promise. Companies that weather the Petrobras storm will be well-placed to snap up market share from battered rivals. In particular, points out Frederico Estrella of Tendências, a consulting firm, well-run, midsized companies may pounce on a chance to join the big league. This week it emerged that C.R. Almeida, a second-tier construction firm, is eyeing stakes in airport projects, including some still under construction, owned by UTC Engenharia and OAS.

So far, foreign construction giants are not rushing in to fill the void left by collapsing domestic ones. They first want to see how the Petrobras probe plays out, says the local boss of one such firm. Some, like OHL of Spain, have quit Brazil in recent years, exasperated by its impenetrable tax system, suffocating bureaucracy and onerous local-content requirements. After its name was mentioned in reports of the police investigation, Skanska of Sweden accelerated its plans to quit (it denies wrongdoing). Other foreign firms have been scaling back. Bechtel, an American giant, used to have about half a dozen big projects on the go at any one time in Brazil. Now it is down to just one: an extension of Rio’s metro.

Brazil still needs plenty of roads, railways and other public works. The World Economic Forum ranks it 107th out of 144 countries on the quality of its infrastructure. And although the government and its agencies, such as the BNDES, the national development bank, have tightened their purse-strings, investment banks and private-equity firms are setting up funds to back public works.

Chinese money is on the way, too. On a visit to Brazil this week, Li Keqiang, China’s prime minister, signed commercial agreements worth $53 billion, including a number linked to infrastructure. On top of that, ICBC, a Chinese state bank, pledged to funnel $50 billion to Brazilian roads, railways, power grids and the like. Chinese lenders are keen to invest in these, even though China’s ambitious construction firms, like other foreign builders, have in the past had their fingers burned trying to break into Brazil’s heavily regulated market. Those Brazilian firms which survive the current shake-out can look forward to a recovery in orders, with little foreign competition to trouble them.