Sunday, 9 December 2012

Germán Efromovich’s offer for TAP


According to Jornal de Negócios, the only bidder for the privatization of TAP has made a revised final offer to acquire TAP which, not surprisingly, is lower than the original non-binding offer since he is the only bidder for TAP. According to JN, the government is disappointed but wants to negotiate which says a lot about whoever is handling the negotiation on the Portuguese government side, as I shall argue below.

Jornal de Negócios states that the Germán Efromovich is offering to assume TAP’s debt of €1,2bn (TAP’s net debt is in fact €1,05 bn, about 60% of which concerns its fleet leasing debt) and to inject €300 mn in the company. He would then pay as little as €20 mn to the government for the (complete?) ownership of the company, but according to Jornal de Negócios he wants to pay even less than the €20mn.

Maybe there are additional details not reported by Jornal Negócios, because typically this type of acquisitions are based on EBITDA (Earnings before interest depreciation and amortization) multiples. But if Jornal de Negócios is correct, Gérman Efromovich’s bid looks very very low – TAP seems much more valuable, as I shall argue below.

Ricardo Arroja wrote a very interesting post in Insurgente about TAP’s privatization, which called my attention because he looked at the balance sheet of TAP. Thus, Ricardo Arroja’s post made me curious and I analyzed TAP’s balance sheet.

Now, first, one correction to Jornal de Negócios. Germán Efromovich is not assuming any of TAP’s debt. TAP’s balance sheet already assumes that debt, i.e., TAP has assets which are worth about €300 mn less than its liabilities (including the €1,2bn debt). Any buyer would likely keep TAP’s debt on its balance sheet since in this way the buyer can maximize the return on investment and optimize his tax bill.

Now everyone assumes that TAP is over-indebted and worries about TAP’s negative equity. But businesses do not need positive equity levels to function. What they need is positive cash flows. TAP has positive operational cash flows and EBITDA and has managed to stabilize debt levels.

More important, TAP’s debt levels do not seem high at all for a company of its dimension. TAP’s interest and leasing costs are a small fraction of the company’s total costs, which means that capital, while important, is not the key variable for TAP’s business.

Perhaps the following example will clarify my point. If TAP uses half of the €300mn capital injection proposed by Germán Efromovich to increase its working capital, and the other half to reduce its stock of debt, its financing costs would fall by about €9mn, or by about 0.4% of the company’s total costs, i.e., by a negligible amount. This signals that while further capital is helpful – and might help TAP expand or better hedge fuel cost risks - , TAP will likely be able to thrive in the future even without any capital injection.

I do not have information on TAP's most recent financial numbers. However, the 2011 balance sheet indicates that TAP is in a situation where slight operational improvements in revenues and slight decreases in costs will result in a marked improvement of its results and reflect favorably on its balance sheet. A 5% increase in revenues and a 5% decrease in operational expenditures will likely result in improvement to EBITDA of about €250 million per year, or about 70%-80% of what Germán Efromovich wants to pay for TAP.

TAP’s EBITDA in 2011 was €106mn. A purchase price based on a multiple of 10 of the 2011 EBITDA seems a fairly run of the mill (modest) valuation for the company. It would mean TAP would be worth about €1bn, which less the €300mn capital injection means a sale price of about €700 mn. But if an improvement in EBITDA of €250 million relative to the 2011 performance is assumed, then TAP would be worth €3.2bn (already net of the capital injection).

But I am likely being conservative here. Gérman Efromovich owns airline companies. This means he is likely to obtain significant synergies between his different airlines.  Greater synergies mean larger EBITDAs, which mean TAP is likely much more valuable for this entrepreneur than the €3bn I estimate above.

In my view, TAP is on course – bar unexpected shocks - to become systematically profitable in the short term. Germán Efromovich will get his investment back very quickly. He is a shrewd investor and if he succeeds in his bid he will have a very high return on his investment.

But he must be innerly laughing at the apparently “naïve” selling side (i.e., the Portuguese negotiators) who are begging him to condescend to give a few more millions of euro or even possibly willing to pay Germán  Efromovich to get rid of TAP.

Finally, TAP is one of the country’s largest exporters and plays a key role in one of the country’s leading export industries (tourism). It also is one of the main airlines for connections to Portuguese language countries in Africa and South America (CPLP), some of which are also Portugal’s fastest growing export markets. Portugal’s adjustment requires a huge improvement in external trade for the current or any other adjustment program to succeed. From a macroeconomic policy making point of view one does not want to play around casually with one of the key players in our export industry precisely at this time in History. But none of this appears to be of any relevance to our decision makers.

22 comments:

  1. Some notes:

    1. You say "...typically this type of acquisitions are based on EBITDA (Earnings before interest depreciation and amortization) multiples."

    I've never seen a transaction of this dimension being made based on multiples. Multiples can bring a general idea of the assets value of a company, but there's always a complex financial model on the background with a huge collection of assumptions and known data that paves the way to the final offer.

    Multiples may work fine in a very stable company in a stable context, which is not the case of TAP, where important Capex is needed every year, or the context Portugal.

    2. You say "Germán Efromovich is not assuming any of TAP’s debt. TAP’s balance sheet already assumes that debt, i.e., TAP has assets which are worth about €300 mn less than its liabilities (including the €1,2bn debt)."

    This is wrong, to some extent. Almost sure, debt is to be replaced. Loans of this dimension always bring strong ownership clauses. Unless the financial institutions that are currently providing debt to TAP are already in the bank syndicate that backs Mr. Efromovich proposal, it is much more likely that a complete new debt scheme is underway, with a club of new financial institutions, even if some of the members of the club deal are today providing debt to TAP.

    This happens not only because of ownership clauses, but also because the new lenders never accept some of the guarantee clauses stated in previous contracts. Almost certain, the current contracts have maturities and collateral clauses that makes new debt more subordinated, ie, less entitled to cash generated by the company. Also, maturities never match with new owners plan of expansion.

    This means that the buyer of the assets must get a huge amount of debt to back his proposal. Because debtors don't accept levels of leverage above 5-6x EBITDA - which means 700 million at most, all the remaining cash needs to be put as equity or almost-equity (shareholder loans subordinated to acquisition debt).

    In other words, the 1.2B are to be paid in the closing date and Efromovich is really assuming all TAP’s debt.

    3. Because there are legal obligations that makes the buyer to clean the Balance Sheet, he also needs to inject money in the company - 300 millions being the minimum just to bring equity to zero. Fact: he really needs to pay for the 1200, plus the 300, plus the value of shares. It was really a complete surprise to me that a value higher than zero was written in the Binding Offer. With TAP financials, it was expected the government should pay to get rid of a company going bankrupt in the medium term.

    The fact someone is willing to pay a positive amount for TAP can only be based on an high believe in a strategic plan of development for TAP, which is very good for the remaining stakeholders of the company.

    More probably, during the SPA negotiation, BO assumptions will be brought to the table, and this 20 M converts in nothing.

    (cont)

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  2. (cont)

    4. "Any buyer would likely keep TAP’s debt on its balance sheet since in this way the buyer can maximize the return on investment and optimize his tax bill."

    That is only true if TAP has profits. Tap is running on regular losses, so there is no tax bill to pay. Excess debt in TAP is clearly non-optimal for a group such as the one buying TAP. They should allocate debt where they can save taxes. TAP has still a few years of accumulated losses to reduce their tax bill no nil.

    5. "But businesses do not need positive equity levels to function". The legal framework imposes it.

    6. "More important, TAP’s debt levels do not seem high at all for a company of its dimension."

    Yes, it seems. It current days, 10x EBITDA is undoubtedly an excessive debt. Furthermore, TAP needs to replace planes and buy new ones to accommodate its successful growth to South America markets. This means more debt. With current levels, they cannot get it.

    7. "If TAP uses half of the €300mn capital injection proposed by Germán Efromovich to increase its working capital, and the other half to reduce its stock of debt, its financing costs would fall by about €9mn"

    Obviously, the 300 M at 3% means 9 M. But you are missing the point, because TAP has also capital expenditures that are not supported by 100M EBITDA. Those 300M at 8 years maturity means an average of 40M year less to pay. Furthermore, because TAP has the need to renew its debt at current market prices, the interest cost will rise a lot in the coming years.

    8. "It would mean TAP would be worth about €1bn, which less the €300mn capital injection means a sale price of about €700 mn."

    It's not to subtract, but to add.

    9. "But if an improvement in EBITDA of €250 million relative to the 2011 performance is assumed, then TAP would be worth €3.2bn (already net of the capital injection)."

    It’s an “if”. With lots of companies struggling through an economic crisis and the increase LCC competition, the fast turnaround does not seem very likely. By the opposite, 2011 is probably showing an attempt to redress the bride and also has the savings for the wages cut for public companies.

    The Vendors Due Diligence is not public for us to see the EBITDA corrections proposed by the auditors, but, for sure, there are some. There are always corrections and the corrections always bring EBITDA to lower figures. How much? Who knows?

    10. “In my view, TAP is on course – bar unexpected shocks - to become systematically profitable in the short term. “

    This management team has more than 10 years in the job and they never get to ‘real’ profits, even through years of strong growth in number of passengers. They certainly did a great job creating the Lisbon hub to South America, but that’s not reflected in profits. So, why now?


    11. Finally, we have ANA. The value of ANA is highly dependent on future TAP performance. Government as a single shareholder cannot support TAP needs to development and growth. If TAP stays public, bankrupt scenarios go up in probability. With TAP failure, ANA may be valued easily 500M lower, and that’s a much higher figure than what government could ever expected to receive with TAP privatization.

    If TAP is sold to AVIANCA, ANA buyers get a free life insurance police.

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  4. Dear JCD,

    Thanks for your comments. I do not have time to respond to all issues, but here is my reply to the main issues.

    1. "Mr. Efromovich" is not assuming the €1.2bn gross debt, if he were he would be injecting €1.5bn in TAP and not just €300 mn. You are correct that he may have to offer additional collateral and renegotiate debt contracts with some of the creditors, but the debt remains in TAP.

    2. The fact that he only wants to inject €300 mn shows that he believes that TAP does not need more capital.

    3. Businesses do not have to have positive equity to function. See for example the cases of Ford and General Motors in recent past (I was not referring to legal requirements)

    4. The buyer is keeping the €1.2bn debt on TAP's balance sheet since he is only injecting €300mn in the company, so I don’t understand your talk about tax optimization.

    5. This is an asymmetric information game. I do not have information on TAP's investment plans nor time to analyze them in detail. What I see is that TAP has in the past invested in their fleet through leasing contracts even when they were in a worse financial situation than they are today. Their fleet is relatively new. So I see no reason to assume that TAP will not be able to continue to do in the future what they did up until now (i.e., invest in the fleet).

    6. A key performance indicator for Mergers and Acquisitions is the EBITDA multiple, i.e. a rule of thumb. I do not purport to know the details of this merger. But on that rule of thumb (EBITDA) the TAP deal (in practice, as you recognize, 0 times EBITDA) seems like a steal for Efromovich.

    7. Another basic rule of mergers and acquisitions is that the valuation of the asset for the seller and the acquirer differ. This is not rocket science. It is the “a-b-c” of Mergers and Acquisitions. So the buyer and the seller meet somewhere in the middle. Any acquisition is based on the quantification of synergies. Efromovich owns several airline companies. He is going to extract synergies well above those estimated by me (in airplane purchases, Management systems investment, human resources, tax benefits due to past TAP losses, etc). Thus, the value of TAP to Efromovich is likely well above the €3,5bn I estimated in my post. And he is paying €20 mn for the business. What a sweetheart deal.

    8. To sell TAP for €20 million and on top of it to say that Efromovich assumes €1.2bn of debt is “atirar poeira para os olhos” of the Portuguese public opinion, who are not yet duly informed by the newspapers nor by their decision makers.

    9. But besides that, it is just very poor economic policy making due to the macroeconomic relevance of TAP to the country.


    Ricardo Cabral

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  5. Assuming a debt of 1.06B, and a multiple of 10 on the EBITDA (note that EBITDA includes interest and, therefore, debt should be deducted from valuation), the value of TAP is roughly ZERO. The 300M has nothing to do with valuation before selling, it will influence valuation after the new shareholder injects it in the company and it will benefit him only. Obviously, multiples are just a simplification of discounted cash-flows projections, which probably will be used instead in the 'real world'. And is to be reminded that future sinergies between Avianca and TAP and its impact on projected cash-flows is what entices the potential buyer but should not be considered in the present valuation for the seller.

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    1. You're right. The 300 million doesn't affect the valuation.

      About debt, what's been said in the press is that current debt levels are 1.2B.

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    2. Ricardo Cabral just keeps confusing the concept of EV used in the EV/EBITDA multiples with the concept of Equity used in PE multiples. That's why is math makes no sense and he keeps refering to a 0x EBITDA multiple instead of the 10x EBITDA multiple (at least) that Efromovich is paying...

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  6. "1. "Mr. Efromovich" is not assuming the €1.2bn gross debt, if he were he would be injecting €1.5bn in TAP and not just €300 mn. You are correct that he may have to offer additional collateral and renegotiate debt contracts with some of the creditors, but the debt remains in TAP."

    As I told you, it's more likely that all debt is new. The current amount of debt should be repaid. (I'm not sure about the leasings, maybe those have special conditions). So, you're right. He will injects 1.5 b and that's what he pays to have a company with zero book value. 1500 is not 20.

    "2. The fact that he only wants to inject €300 mn shows that he believes that TAP does not need more capital. "

    He already said that this is just to start. A development plan will implies additional capital. http://economico.sapo.pt/noticias/efromovich-admite-investir-quatro-mil-milhoes-na-tap_158106.html (It's marketing speak, but some new cash will come)

    "3. Businesses do not have to have positive equity to function. See for example the cases of Ford and General Motors in recent past (I was not referring to legal requirements)"

    Portuguese law (the famous Artº 35) doesn't allow for a comfortable future for a company with negative equity. Also, banks will never inject fresh money in a company with negative equity. You can be sure that there's a strong equity cure rule in Mr. Efromovich new finance contracts. TAL leverage should be reduced to 5-6x EBITDA.

    "4. The buyer is keeping the €1.2bn debt on TAP's balance sheet since he is only injecting €300mn in the company, so I don’t understand your talk about tax optimization."

    You cannot optimize taxes if you don't pay taxes.

    "5. This is an asymmetric information game. I do not have information on TAP's investment plans nor time to analyze them in detail. What I see is that TAP has in the past invested in their fleet through leasing contracts even when they were in a worse financial situation than they are today. Their fleet is relatively new. So I see no reason to assume that TAP will not be able to continue to do in the future what they did up until now (i.e., invest in the fleet)."

    TAP already said so. Its growth is limited by it's financial figures. http://www.jornaldenegocios.pt/empresas/detalhe/crescimento_da_tap_depende_de_novos_aviotildees.html

    "6. A key performance indicator for Mergers and Acquisitions is the EBITDA multiple, i.e. a rule of thumb. I do not purport to know the details of this merger. But on that rule of thumb (EBITDA) the TAP deal (in practice, as you recognize, 0 times EBITDA) seems like a steal for Efromovich."

    10-11 are current multiples for infrastructure companies, where cash flows are based in long term contracts with capex levels very low. TAP is very, very far away of that situation.

    "7. ...Thus, the value of TAP to Efromovich is likely well above the €3,5bn I estimated in my post. And he is paying €20 mn for the business. What a sweetheart deal."

    Unbelievable nobody else is willing to to such a sweetheart deal. It seems other competitors NBO went all for negative equity figures.

    "8. To sell TAP for €20 million and on top of it to say that Efromovich assumes €1.2bn of debt is “atirar poeira para os olhos” of the Portuguese public opinion, who are not yet duly informed by the newspapers nor by their decision makers."

    No it isn't. It's the big problem. 1.2 is there to be paid. Plus 300 to clean the balance sheet.

    "9. But besides that, it is just very poor economic policy making due to the macroeconomic relevance of TAP to the country."

    What's relevant is TAP itself, not the owner of the shares.With a broked owner and strict rules limiting public support to airlines, to sell is the best deal, at least in my opinion.



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  7. JCD,

    thanks again for you good arguments.

    Jornal de Negocios states that the injection is €300mn, not €1.5bn. That is the information I use to make my assertions.

    If Efromovich injects €1.5bn in TAP, then the company's book value becomes approximately €1.2bn not zero as you state in your comment.

    Ricardo

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  8. Dear Ricardo,

    I'm sorry, but the numbers here just don't make any sense...

    Just look at the multiples most other flag carriers are trading at (consensus bloomberg):
    - Air France-KLM at an EV/EBITDA13 de 5.04x
    - Lufthansa at an EV/EBITDA13 de 3.52x
    - IAG at an EV/EBITDA13 de 3.43x

    And do notice we are talking here of EV/EBITDA multiples, not Equity/EBITDA multiples as you seem to assume in your exercise. And that I honestly never saw anyone use in 7 years of financial markets... mostly because it makes no sense to use a number before debt costs (EBITDA) and compare it to one after debt (Equity).

    So even using the 5x KLM multiple, the €100mn 2011 EBITDA at TAP would imply an EV of €500mn. Which given the €1.2bn debt, means equity Equity = EV - debt) at TAP would be negative €700mn! Or negative €500mn if you want to use the €1bn debt you mention in the text.

    So any positive value paid by Efromovich for TAP is already quite an exercise in confidence from his part that it can significantly improve the numbers at TAP, which if anything should be getting worse vs 2011 after negative GDP in 2012 (-3%) and 2013 (at least -1%).

    Best,
    Frederico

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    1. Yesterday, I was about to post something in the line of yr comment - you probably can see it deleted above -, and then I refrain from doing so, because this is plainly embarasing... this confusion between a valuation based in EBITDA (which includes interest) and EV (disregarding debt associated with that interest) is basic stuff! I wonder why Ricardo, which is probably a fine Macroeconomics teacher at UFunchal, drifts away so boldly from his field of expertise ... he's not alone ... in this blog, Pedro Lains, a fine economic historian (but hardly an economist) often discusses a lot of economic matters he obviously doesn't grasp ... Lobo Antunes, the surgeon, asked about the future of the Euro by a journalist, did not decline to answer ... I always feel ashamed for them ... Why? Simple vanity? Maybe Vitor Gaspar could tax vanity and have a lightnin' fast solution for the deficit ...

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  9. Dear MRS, I wonder whether you could be a bit more specific about my writings. Thanks. PL

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    1. Dear Pedro, I definitely don't want to engage in any sort of discussion with you regarding yr writings, simply because I have more interesting things to do and more interesting bloggers to follow. I'm still learning and constantly reminded of Bertrand Russell saying that "The whole problem with the world is that fools and fanatics are always so certain of themselves, but wiser people so full of doubts." But the simple fact that, due to your political motivations (ambitions, even?), you accept to discuss everything, outside yr field of expertise, is something that dazzles me... and definitely doesn't suit you, as a scholar.

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    2. Ora bolas. Se não está para entrar neste tipo de discussão, então não entre. Ser mal-educado e depois recusar-se a fundamentar é que é perfeitamente dispensável.

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    3. Ainda bem que comenta em português, porque assim toda a gente que queremos que entenda, entenderá. Não era minha intenção voltar a este assunto, mas é de facto lamentável ver todo o País a comentar a alienação da TAP, baseando-se no artigo publicado neste blog por Ricardo Cabral. Todo o País é certamente um exagero, mas pelo menos a Exame/Expresso, o Jornal de Negócios, o deputado Daniel Oliveira e ... o eclético Pedro Lains (http://pedrolains.typepad.com/pedrolains/2012/12/ensaio-sobre-privatiza%C3%A7%C3%B5es-e-fal%C3%A1cias.html). Sobre os erros metodológicos de Ricardo Cabral, eu já comentei, outros o fizeram com muito mais sapiência do que eu alguma vez seria capaz, os erros são demasiado básicos para perdermos mais tempo com isso ... Ricardo Cabral deveria ler, por ex, Brealey, Principles of Corporate Finance ou, mais conciso, Fernandez, Company Valuation Methods, ou pedir ajuda a um colega de blog e retractar-se quanto antes, para não induzir em erro mais incautos. Já Pedro Lains acaba mais uma vez de me dar razão e pronunciar-se sobre o que não entende, como faz frequentemente, sem sequer perceber o erro em que o colega incorreu. Quanto a si, Luis Aguiar-Confraria, tudo o que disse é injusto e dispensável, mas não lhe chamarei mal-educado. O que quer que pense sobre o assunto, guardarei para mim. Mas fica-lhe bem o espirito corporativista ...

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    4. Faltou-me formular um desejo, à guisa de conclusão: que cada um procure limitar os seus comentários à sua àrea de 'expertise' e evite a vaidade de se querer pronunciar sobre tudo! Todas as àreas do conhecimento são hoje demasiado vastas para pretendermos saber de tudo. Lobo Antunes é cirurgião, e respeitamo-lo tremendamente, Pedro Lains é historiador económico, idem, Ricardo Cabral é professor de macroeconomia, talvez tambem idem ... imagine o que seria se algum de nós fosse dar palpite para a sala de operações de Lobo Antunes ?

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    5. Diz o douto Miguel Ribeiro e Silva, naturalmente seguindo 'a risca a sua maxima de apenas se pronunciar sobre assuntos dentro da sua area de 'expertise':
      "Todo o País é certamente um exagero, mas pelo menos a Exame/Expresso, o Jornal de Negócios, o deputado Daniel Oliveira (...)"

      Deputado Daniel Oliveira, caro Miguel Ribeiro e Silva? Bem, acho que sobre coerencia (e sobre as razoes que voce pode ter para ser manifestamente arrogante), estamos conversados.

      E, claro, continua sem apresentar nada que sustente a afirmacao categorica que faz em relacao ao Pedro Lains. Mas, se calhar, estou a ser demasiado duro: pela amostra, e' bem possivel que argumentar esteja fora da sua area de 'expertise', caro Miguel Ribeiro e Silva.

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  10. "What I see is that TAP has in the past invested in their fleet through leasing contracts even when they were in a worse financial situation than they are today. Their fleet is relatively new."


    One additional comment: TAP's fleet is not relatively new. It's average age is probably around 10 years or more. The long-haul fleet in particular the A340 are quite old. The Portugalia fleet in particular the Fokker 100 are even older, and the ERJ-145 are unsuitable for most routes today. In particular the long-haul fleet where most of the value lies is particularly old and getting to the point of being innefficient versus competition.

    That is why TAP has firm orders on A350-900 scheduled to be delivered starting in 2015. That means a binding contract. I don't know what will be the financing of those orders but it certainly means that increased investment will be needed. In fact the A350s are indispensable to support TAP profitability in the long-haul.

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  11. Caro MRS, Totalmente de acordo com o que diz.

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  12. Caro Ricardo,

    espero que tenha tido a oportunidade de ler o artigo de Pedro Santos Guerreiro hoje no Negócios. E que finalmente tenha percebido o erro na sua avaliação. Alias, julgo que esta frase é especialmente dedicada a si:

    "Surgiram esta semana análises que semearam a noção de que será melhor cancelar a privatização e mandar o senhor Efromovich dar banho ao cão. Essas análises enfermam no entanto de erros e partem do pressuposto de que é possível manter tudo como está ou de que o Estado pode "nacionalizar" a empresa com o capital que ela precisa"

    Só gostava de perceber porque sabendo o Negócios isto, chamou na mesma a atenção para o seu artigo... Mas acho que isso nunca vou perceber...

    Cumprimentos,
    Frederico Torre

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    ReplyDelete