Brazil Getting Too Hot? Torrid Pace of VC Deals Has Some Talking ‘Bubble’

(Reuters) – Facebook’s $1 billion purchase of Instagram this month crowned a new poster child for the tech boom and made a hometown hero out of Mike Krieger, Brazilian co-founder of the picture-sharing company.

The next challenge for Krieger’s aspiring cohort of local tech entrepreneurs: to hit it big without leaving Brazil for Silicon Valley or an Ivy League dorm room.

Their task is getting easier. Brazil’s buzzing tech sector has venture capital funds snapping up stakes in local Web startups at an unprecedented pace.

The main draw for investors is Latin America’s biggest consumer market. Brazil already spends $13 billion a year online with just 40% of the country using the Internet — about half the U.S. rate, but rising quickly.

The Internet’s biggest names have been ramping up their presence in Brazil even as broad investment has stagnated in recent months as economic growth slowed.

Facebook tripled its users last year in Brazil, now its third largest market. Netflix launched a streaming service in the country, and Amazon is expected to enter the market this year, according to industry sources.

Venture capital investments in Brazil nearly tripled last year by informal estimates. The flood of new capital has turbocharged the valuations of local startups to levels that has some observers warning of a bubble.

Ground zero for Brazil’s tech sector is cosmopolitan Sao Paulo. But smaller hubs have formed in second-tier cities such as Recife, Campinas and Belo Horizonte, an old mining city where faded downtown buildings have been converted into lofts filled with Internet startups.

There is no official data available for venture capital funding in Brazil. But a database compiled by Diogo Gomes, an online entrepreneur and blogger, shows that Brazilian tech startups landed just six venture capital investments in 2009. In 2010 he registered 17 capital injections and by last year the number had climbed to 45.

“At the beginning of 2012, no foreign venture capital fund had yet invested in Brazil. Now there are more than a dozen, the biggest funds in the world, desperately looking for investments here,” said Julio Vasconcellos, chief executive of deal website Peixe Urbano, one of Brazil’s most successful startups.

In January, Morgan Stanley Investment Management and T. Rowe Price Associates made an undisclosed investment in Vasconcellos’s company. It was the startup’s third cash injection in just over a year.

SHORTAGE OF QUALIFIED WORKERS

Still, some analysts warn that the same bottlenecks throttling other industries could threaten Brazil’s nascent tech boom, which already confronts a lack of skilled workers, suffocating bureaucracy and a soaring cost of living.

Brazil also lacks a strong entrepreneurial ecosystem with inexpensive legal services, easy promotion and young talent,
according to Dave Goldberg, who runs online survey company SurveyMonkey.

“If there is a lot of capital coming in without all of these other [elements] in place, you’ll inflate the value of things,” said Goldberg, who was in Sao Paulo from Palo Alto to establish a Brazilian foothold for his company.

“Some people think it’s already happening, that valuations are starting to get out of control,” he said.

Capital is coming from U.S.-based funds such as Benchmark Capital, Tiger Global and Redpoint Ventures, Europeans such as Atomico Ventures and even regional ones like Argentina’s Kaszek Ventures or Brazil’s Monashees Capital.

Over the last 12 months, Redpoint poured $19 million into the travel site ViajaNet, Atomico raised $8.7 million for the auto parts retailer Connectparts and Tiger and Monashees put $4.4 million into Baby.com.br.

All that cash has set off warning bells.

“The excessive liquidity is causing problems for the industry. Companies have started to lose focus in their business and focus instead on readying themselves for investments,” said Mariano Gomide, an entrepreneur who organizes the country’s top e-commerce conference, E-merging.

“There is a bubble,” he said, estimating Brazilian Internet assets could be overvalued by 30% to 40 percent.

MATURING INDUSTRY

But others say the venture capital industry has learned its lesson from the Internet bubble of the 1990s.

“Nobody is willing to pay prices way higher than the value of the assets and risk not getting returns,” said Clovis Meurer, head of Brazil’s Venture Capital Association.

Kaszek Capital, a $100 million fund that has invested in 16 startups in Latin America, more than half of them in Brazil, says prices are still reasonable.

“In general we see good opportunities to invest in companies with fair valuations,” said Nicolas Szekasy, a partner at Kaszek. “We find excellent entrepreneurs that are going after interesting markets.”

Investors seem more worried about a shortage of talented programmers, trained engineers and seasoned entrepreneurs.

“It is not enough to just have money. You need people who have done it before and can guide the new guys,” said Goldberg of SurveyMonkey.

By Esteban Israel, Reuters

Image credit: Revellers from the Grande Rio samba school take part in the second night of the annual Carnival parade in Rio de Janeiro’s Sambadrome Feb. 21, 2012. Photo by Sergio Moraes, Reuters

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