Gafisa SA (GFA)

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Claudio Freitas

www.zacks.com

Gafisa is one of Brazilian largest builders and incorporators. The company began its successful trajectory in 1954, in Rio de Janeiro, where it began to operate under the denomination Gomes de Almeida, Fernandes. Three decades later, its name was altered to Gafisa Imobili ria and at the end of 1997, with an association from GP Investimentos (the biggest private equity fund in Brazil), which is majority shareholder since 2003 with currently 60% of the shares. It was renamed Gafisa S. A., a publicly-traded company however, it is not yet listed. Gafisa's predecessor company was Cimob Companhia Imobiliária (formerly known as Gafisa Participações S.A.), from whom Gafisa S.A. inherited brand name, assets, liabilities and market position. Throughout its first 50 years of life, the company has realized more than 800 enterprises, including luxury residential condominiums, commercial buildings, flats and shopping centers. In total, those properties add up to around 9 million square meters of constructed area in Rio de Janeiro and S o Paulo.

In 2004, Gafisa decided to expand its operations and focus on construction for third parties. As a result, Gafisa is now present in many different Brazilian cities including Manaus, Belem, Macae, Salvador, and Campinas. In 2005, Gafisa announced a partnership with Equity International Properties (EIP), a leading North American company in real estate sector, which belongs to Equity Group Investments (LLC) and is headed by Samuel Zell, a well known real estate investor. EIP invested R$ 135 million in the Brazilian company and thus came to hold 32% of its shares. In 2006 the company made its IPO, being the first Brazilian listed company in the construction sector.

Gafisa has been growing in recent years due to the continued economic recovery in Brazil. Brazil has a long tradition of extremely high interest rates. As a result, mortgage loans were not available at all in Brazil in recent years. Until three or four years ago, most of real estate deals were negotiated cash, or through some medium term credit lines from Government Banks or agencies. This situation has been changing dramatically in the last two years. The Brazilian central Bank started to cut domestic interest rates on September 2005, since then local rates went from more than 19% to 11.25% currently. In the medium term, we expect Brazilian domestic rates to converge to international standards. However, Brazilian Central Bank decided to stop to cut basic interest rates in the very short-term. After the August Bank meeting, an official report was released with strong comments on domestic inflation pressures. In October, it was decided to leave rates unchanged for the first time in two years. We understand this is just a short term situation, as Brazilian real interest rates remain among the highest in the world. Nominal rates are as high as 11.25%, while expected inflation for 2007 is just 4% per year.

The short-to-medium- term outlook for the company remains promising, mainly considering the good economic moment in the key Brazilian market. We believe that the continued improvement in the Brazilian economic environment will make Brazil reach investment grade within the next twelve months, thus leading to a multiple expansion for Brazilian stocks.

During the last three years the mortgage market started to develop. At the same time real estate developers and builders moved to "go public" to finance their expansion. Brazilian real estate developers are still betting on a local housing boom, despite the worldwide credit crunch that originated in the U.S. subprime mortgage market. There is momentum for the Brazilian real estate industry right now, but there is no boom and Brazil is not even close to a boom, given the small credit portfolio in real estate. Total outstanding mortgage loans in Brazil are equal to only 2% of gross domestic product. Below we can see a graph comparing different countries and the size of each mortgage market as a percentage of GNP. With the convergence of interest rates we expect the size of the mortgage market to approach the market of Mexico in relation to GNP. While mortgages are a small part of bank's business today, it will be a big opportunity for future growth.

As we can see from Gafisa's third quarter results, the company has been taking advantage of this positive business environment and has been growing quite fast to consolidate among the market leaders of the construction/incorporation business in Brazil. Additionally, Gafisa has been focusing on the lower income segment of the population, where we believe the long-term growth lies. Gafisa is trying to increase its geographic diversification by investing in many areas of Brazil, outside the main urban centers of Rio de Janeiro and Sao Paulo. Finally, Gafisa has a huge inventory of land already acquired, construction in progress, and finished units. During the third quarter, total inventory increased 85% from the same period 2006. We understand this inventory will translate in huge future profits, as long the Brazilian market remains heated and the mortgage business keeps on increasing.

Finally, Gafisa has been growing through acquisitions in order to consolidate its leading position in the Brazilian market. In October 2007, the company announced the acquisition of a 70% stake in Cipesa, a leading homebuilder in the State of Alagoas in northeast Brazil. Gafisa also announced that it entered into a definitive agreement to acquire 100% of AlphaVille Urbanismo S.A. AlphaVille is the largest community development company in Brazil, and the only one with nationwide presence. We do believe that this recent acquisition further solidifies Gafisa s position as the nation's leading homebuilder. After this deal, Gafisa will expand its reach into new geographic markets, and combine both companies' capabilities in order to grow its residential, condominium, and community developments.

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