Did Eike Batista Burn Ontario Teachers?

Roberto A. Ferdman of Quartz reports, How Brazil’s richest man lost 97% of his fortune in less than two years:

In 2010, Eike Batista announced that he would soon become the world’s richest man, and it didn’t seem particularly hyberbolic. Brazil’s economy was thriving, and investors around the world were lining up to invest in his commodities empire, which consisted of six highly successful public Brazilian companies, including OGX, the country’s second largest oil company, and MMX, one of its largest miners. By 2012, his wealth stood at some $30 billion, making him the seventh-richest man in the world.

And then the last 18 months happened.

Amidst Brazil’s economic slowdown, Batista’s net worth hasn’t merely tumbled—it’s evaporated. Batista isn’t vying for the richest man any longer, or for a place among the world’s top 100, or even among its billionaires. According to estimates by Forbes, his worth has now dropped to an estimated $900 million, a 97% drop.

Most of that is due to the struggles of OGX, the biggest of Batista’s companies. In July the company announced its plans to shutter two of its most productive wells. Last week, a run of more bad news caused the stock to lose 63% of its market value, including a whopping 40% drop on Friday alone. And its financial woes are threatening its very existence. This past June, OGX reported nearly $5 billion in debt and a net loss of over $2 billion during the second quarter. If the company defaults on its heaping pile of debt, it would mark the largest such default in Latin American history, according to Forbes.

But Batista’s financial woes extend well beyond OGX. Much of his estimated remaining $900 million lies in shares of his other publicly traded companies, none of which has managed to turn a profit. Batista, however, pledged his personal wealth to back the plethora of loans made to each, and is now himself scrambling to sell assets in order to pay creditors. Back in March, he relinquished control of his energy company, MPX, and just last month he agreed to sell the Chilean portion of his mining company, MMX, to Inversiones Cooper Mining, and resigned as chairman of his logistics company, LLX, which was bought by EIG Global Energy Partners LLC.

Filing for bankruptcy could buy Batista time to sell off some assets, unload shares of his companies, and settle debts. But the mogul appears intent on fixing his empire without declaring bankruptcy. This past July, Batista declared that he would honor every penny of the billions in outstanding debt. Presently, it looks like the only way to do that is to unwind the commodities empire that once looked unassailable.

Eike Batista's reversal of fortune is nothing short of spectacular. Brazil's fallen billionaire has lost a staggering $25 billion in 18 months. Batista’s flagship company, OGX, is the worst-performing major stock in Brazil, losing 88 percent of its value in the past six months.

Batista is no stranger to precipitous drops but this time it may be harder to come back from what looks like impending defeat. He has drawn in many large investors and creditors, most of whom are staring at losses. He owes some very serious people some very serious money, including $2 billion to the Mubadala Development Corporation, Abu Dhabi's sovereign wealth fund.

Abu Dhabi's sovereign wealth fund invested $2 billion in EBX, the holding company for most of Batista’s assets, in March of last year before the stock market slide in its constituent companies gathered steam. Most of Brazil's big banks lent him money. More conservative shareholders include the Ontario Teachers Pension Plan.

Back in 2007, Ontario Teachers fronted roughly $425-million of the $1.3-billion OGX paid to develop 21 offshore oil areas. Brian Gibson, the then senior vice-president of public equities, said “in order to get returns, we had to look for new assets and OGX was a perfect fit.” Teachers wasn't the only big investor. PIMCO, the world's largest bond fund, bought $500 million of OGX debt.

And according to Bloomberg, Ontario Teachers is currently LLX’s largest shareholder after Batista with an 18 percent stake. Last year, when investors started losing confidence in LLX and other EBX companies, Teachers said it would join Batista in his plans to take the firm private again. EIG, the $12.8 billion private-equity fund based in Washington, recently offered $560 million  to take over control, boosting expectation LLX will complete its main project.

The story of Eike Batista and Ontario Teachers can be traced back to a cocktail party and dinner which Batista attended in 2006. In a Reuters article published in January, Ontario Teachers rewrites ABCs of investing, Jim Leech, President and CEO of Teachers, discussed the origins of this relationship:

In Brazil, Teachers sent its experts into the country for two weeks in 2005 to get the lay of the land. The team came away convinced that a rising middle class would keep powering South America's largest economy ahead.

"I can vividly remember the trip when the fixed income guys, after meetings with all sorts of finance ministers, decided that Brazil was going to get investment grade faster than the world thought it was," Leech told Reuters in a wide-ranging interview from his offices in Toronto, Canada's financial hub.

After the decision was made to focus on Brazil, Teachers began the hard work of building up an extensive network of relationships in the country.

"That's where we met Eike Batista," Leech said, referring to a 2006 cocktail party and dinner attended by Batista, a Brazilian billionaire with a global portfolio of mining and oil properties.

A year later Teachers led a C$1.3 billion private placement in Batista's OGX Petróleo e Gás, an oil and gas exploration and production company that in June 2008 launched the largest IPO in Brazilian history.

"We're a first mover. It's the relationships and the networks that are really the value of what we have created," said Leech, a graduate of Canada's Royal Military College with a penchant for clear mission statements and steely discipline.

Now that Teachers holds billions of dollars in Brazilian investments, it aims to harvest seeds planted in other emerging economies as long ago as 2005.

A strong believer in pressing a "first-in" advantage, Leech is not about to name the geographies that Teachers is targeting. They will come from a tight list of less than a half a dozen where the fund has quietly built up networks like the ones that made it a market leader in Canada after it was freed from government control in 1990.

The need for secrecy is paramount in an increasingly global industry where investors vie for a first-in or homefield advantage for as long as possible before markets become too competitive. In India or China, investors battle for a toehold, and prices have become steep. Leech suggests he's looking elsewhere.

"Our strategy is very much concentrated on those areas where we think there are growth opportunities, but more importantly where we can grow our own network to get the same type of competitive advantage that we think we have here on our home territory," said Leech, who earned an MBA at Queen's University in Kingston, Ontario, after leaving the military.

"I guess what I'm trying to say is you plant the seed and you nurture it and it pays off many years later," he said. "You know it's serendipitous, but if you aren't there you are not going to be a part of it."

Planting seeds in emerging markets is risky business but it's part of the long-term strategy of many large Canadian pension funds. Ontario Teachers has been successful at cultivating key relationships and is often "first mover" on deals around the world.

Nevertheless, the question remains did Ontario Teachers make or lose money with Eike Batista?  In April, the Globe and Mail reported that Teachers trimmed its ties to Batista, joining the legions of investors paring back ties to his struggling financial empire.

But in this case being "first mover" carried huge advantages. Jim Leech, President and CEO of Ontario Teachers, shared this with me:

"We made a huge amount of money partnering with Batista not withstanding his recent demise. As Kenny Rogers says: You got to know when to hold 'em and when to fold 'em."

And Wayne Kozun, senior vice-president of public equities, added this:

"We are still a large shareholder in LLX but we had substantially larger positions in a few other of his companies. I don't have an exact figure but the alpha and absolute returns that we have earned partnering with Batista is easily in the ten figures in USD or CAD. If you look back through our annual reports from the last few years you will get a good idea of our holdings in his companies and when we sold some of our positions. Our Relationship Investing group has done an excellent job managing these positions."

Indeed, Teachers' Relationship Investing group has done an excellent job managing these positions. Other investors haven't been as lucky:

Mr. Batista has maintained a brave face through the losses, reminding investors that his companies still have billions of dollars of available cash. He has also taken to social media to fight back, telling his 1.3 million Twitter followers that anyone who bet against him would be “caught with their pants down.”

Jack Deino, a fund manager at Invesco, appears willing to take that risk. After acquiring a big position in the bonds of the oil concern OGX, he sold his entire stake a year ago after the company announced the major production shortfall.

“Batista built his businesses with a whole lot of salesmanship and hype,” Mr. Deino said. “I feel like I’ve been burned and won’t be touching any more of his ventures.”

Many investors share Mr. Deino's sentiments but it's important to remember that Batista's empire was sunk by more than hubris:

OGX's failure - and the subsequent unraveling of EBX - reflects Batista's initial success in overselling investors on oil discoveries that proved to be more difficult to recover than they expected.

But the story is not so simple. His empire also fell victim to the sudden end of both the global commodities boom and a wild exuberance for emerging markets - two forces that attracted investors to Batista's vision.

"Was there hubris? Was there selling a dream with little regard for the real risks? Sure," said Aldo Musacchio, associate professor at Harvard Business School in Boston. "But at the same time it was more than that. A lot of the people who invested with Batista were not fools, and his rise and fall has followed that of Brazil."

Batista agrees, to a point. In a July 19 letter published in two Brazilian newspapers, he said his empire's implosion all began with OGX. The company, he wrote, "is the origin of the crisis of credibility that has hurt my name and resulted in the clouding of the accomplishments and conquests" of EBX.

Batista stressed he was not alone in believing that OGX would succeed: "I had offers to sell a large or even controlling stake in OGX based on a $30 billion valuation." When he wrote the letter, OGX was worth $723 million.

Delcídio Amaral, a former gas and energy chief at Petroleo Brasileiro SA, the Brazilian state-led oil producer known as Petrobras, said there was no doubt Batista believed the oil was in the ground.

"He was well intentioned but wrong," said Amaral, who is now a Brazilian senator. "Nobody spends billions of dollars to build offshore oil-production ships if you're trying to pull the wool over people's eyes. It would be insane."

Mr. Batista was well intentioned but he got caught up in the "Brazilian boom" euphoria and got burned when the cycle turned. Many of his investors are staring at huge losses. Ontario Teachers isn't one of them. They got in early and made a lot of money in this partnership. They remain a large investor in LLX but have pared other investments in Batista's dwindling empire.

Below, Bloomberg's Alexander Cuadros and editor-at-large Matthew G. Miller examine how Eike Batista lost 99 percent of his personal fortune, falling from a worth of $35 billion to an estimated $200 million. They speak on Bloomberg Television's "Market Makers."