Partnerships with the private sector help Copasa grow Cesar Felicio, de Belo Horizonte August 21, 2009 Text: A- A+ Print After seven years of losses, Copasa, a state-owned company from the Brazilian state of Minas Gerais, recorded a net income of R$241 million in the first semester this year and entered into the first partnerships with private companies to expand its operations. Copasa acquired 20% of a company created by Foz do Brazil, formerly Odebrecht Engenharia Ambiental. The Special Purpose Entity (SPE) will construct and operate for a period of 15 years facilities for water catchment and treatment of effluents from the pipe factory under construction by Vallourec & Sumitomo in Jeceaba, Minas Gerais. The acquisition of the stake was relatively cheap—R$20 million—but is nonetheless strategically important. "We agreed to become Odebrecht’s partner in the search for other private clients, in operations similar to the one in Jeceaba, and also to take part in future water and sewage concession auctions," said Márcio Nunes, who began his career in the electricity sector and, since 2005, has been Copasa’s CEO. According to Nunes, the partnership with Foz do Brasil is not Copasa’s only partnership with private companies; it has a similar agreement with Cowan, a Minas Gerais State construction company. Copasa also hopes to enter into long-term service agreements with steel industries that, in general, collect water and treat effluents on their own. Copasa has already started negotiating with Usiminas, whose main steel plant is located in Ipatinga, Minas Gerais. A Usiminas spokesperson informed Valor that it has not decided to outsource the activity yet and that, right now, there are no negotiations in progress. The executive believes that, in the medium term, concession auctions for municipal services will resume, and Copasa has already decided to bid outside Minas Gerais State as a minority partner in consortiums. This way, it hopes to avoid possible legal problems that could arise since it is a state-owned company. The company also bets on reciprocity: it would not like to compete with other state-owned companies, such as Sabesp and Sanepar, in eventual Minas Gerais concession auctions. Created as part of the National Sanitation Plan—Planasa in the 1970s along with the other state-owned companies that provide water and sewage services, Copasa changed abruptly in 2003 when Governor Aécio Neves (PSDB) took office. Neves nominated Mauro Ricardo Machado Costa, currently the São Paulo State Finance Secretary, to lead the company. Mauro Ricardo was in charge of the company for two years, when José Serra (PSDB), his political mentor and current São Paulo governor, was elected mayor of São Paulo. From then on, Copasa has been managed as a private company: a strict policy of cutting service has marginalized delinquency: this June, only 1.57% of connections had past-due accounts. Tariffs increased and employees started working with individual performance goals. "We no longer seek to please everyone, since we implemented a rigorous private management structure," said Nunes. 2002, during the Itamar Franco administration, was the last year the Company recorded losses. With Márcio Nunes maintaining Mauro Ricardo’s management model, average annual growth of the Company’s net operating revenue has been 16% for the last five years. This year, the Company’s growth should slow to 10%, unrelated to the global economic crisis. In the beginning of the year, a court injunction prevented the Company’s 9.05% readjustment until the state sanitation regulatory agency is created and implemented. The bill creating the regulatory agency moved slowly through the Legislative Assembly, and was approved in the second half of July on the eve of a recess. To apply the non- retroactive tariff adjustment, Copasa must wait for legislative approval of the agency’s executive officers and their investiture, which shouldn’t happen before the second half of September, so the tariff adjustment will not be possible before October. "This will cost us approximately R$100 million in revenues this year, which is almost 10% of our investment, " said the Company’s CFO, Ricardo Simões. "We were expecting revenues to grow 15% in 2009. With this problem, we should only see an increase of 10%," said Nunes. If confirmed, Copasa’s revenues should reach R$2.2 billion. In 2008, the Company’s net operating income was R$2.060 billion and, in 1H09, it posted R$1.07 billion in service revenues. According to Simões, three factors were key to mitigating the effect of non- readjustment on the Company’s balance sheet: expansion of the physical network, with 336 thousand new water connections and 700 thousand new sewage connections in the last 12 months; the appreciation of the real against the dollar, decreasing expenses with foreign currency-denominated debt; and the increased percentage of income distributed as dividends, reaching 35% of net income. This accounting change generated a R$20 million tax credit in the semester. Simões says that the injunction against readjustment did not impact the Company’s investment policy. Out of the R$1.045 billion expected for the year, R$411 million was invested in the first semester. Sewage received the lowest investment: out of the R$674 million expected for the year, only R$196 million was invested in the first six months. "Low investments in the first semester are due to the intense rains, which negatively affects sewage works. This was already expected," he said. According to Copasa’s CFO, the main consequence of not readjusting the tariff could be reflected in loan operations for the concessionaire’s future operations. For 2009 and 2010, the financing sources are already guaranteed. Furthermore, the Company could receive R$1 billion from the Federal Savings Bank (CEF) and the Brazilian National Development Bank (BNDES) – the lines have already been approved. For 2011, the Company is negotiating an international loan in the amount of €100 million with the German government agency KfW for sanitation of the Paraopebas River basin, and is also awaiting R$400 million from the Ministry of Cities to start Accelerated Growth Program (PAC) works. In the short-term, Copasa will try to expand sewage collection in Minas Gerais, which is proportionally very low: Copasa collects sewage from only one in three Minas Gerais residences. Of the 611 cities where it operates, the Company does not hold the sewage concession for 417. Nunes believes that this is due to political resistance among the mayors, even with the Company’s sewage tariff at 60% of its water tariff. "We do not profit from collecting sewage; we only turn a profit collecting water. But we have focused our investment on expanding sewage collection as part of our environmental commitment. What Copasa can’t do is lose money, and our profits are guaranteed by water," he said. Sanitation in Minas Gerais is even more complex due to the lack of municipal investments to expand these services, which serve over 200 cities statewide. Copasa does not have a concession for several mid- and large-sized Minas Gerais cities such as Sabará, Nova Lima, Uberlândia, Uberaba, Juiz de Fora, Governador Valadares, Poços de Caldas and Sete Lagoas, among others. .