Latin American equity comes of age
As liquidity dries out, Brazilian equity listings have dwindled which could make room for companies in other countries. Though the South American giant remains the primary regional player for ECM, its numerous small and mid-cap company listings are now but a memory of more exuberant times. Christopher Langner reports.
As usual the slowdown was as intense as the acceleration. After three years in which deals jumped from 15 in 2004 to 72 last year, Brazil's equity markets have struggled in 2008, just a couple of sizeable deals have priced so far.
Receding liquidity has changed the landscape. From the beginning of Brazil’s IPO boom, the biggest driver for deals was foreign capital: overseas investors snapped up 75.4% of all the equity offerings between 2004 and 2007. So when the US subprime crisis hit and investors retrenched, they took with them a lot of the momentum of the Brazilian equity market.
The market is now closed for the numerous small and mid-cap listings which were the norm when EM equity funds were rife with liquidity. Companies with good growth stories, offering sizeable deals and a promise of decent liquidity, can still find a place in the market, but even they are subject to investor moods and have to price competitively.
So while the market is open, 2008 will clearly not be remembered as another record year in equity issuance in Brazil – or even Latin America.
Yet ECM bankers remain optimistic that a number of good deals will price, with larger average sizes compensating for the fewer companies listing new stock. Brazil's fall from grace could make room for countries which have been less prolific in the equity markets lately, such as Mexico, Chile and Colombia. That does not mean, however, that Brazil will not continue to dominate the scene, albeit at a lesser extent.
The country has become a huge revenue driver for investment banks, especially the Swiss banks. UBS and Credit Suisse have been surfing the Brazilian IPO market like no other bank, with UBS having special reason to celebrate, its acquisition of local shop Pactual having proved a timely and savvy deal.
The numbers speak for themselves. In 2006, UBS alone underwrote US$3.9bn of equity issuance in Latin America. Until October last year, with Pactual fully integrated, the bank's total already stood at US$8.7bn, all originated in Brazil.
As a result, the share commanded by LatAm deals within UBS's global equity underwriting business has grown from 8% last year to 14% this year. The bank also jumped to the top of the equity league tables ahead of arch-rival Credit Suisse, which had led the rankings since 2005.
Outside Brazil, Mexico shows the most promise. The local market recorded only three equity deals last year as the local debt capital markets gained depth and liquidity, making it easier and more cost-effective for companies to sell debt than equity. But since last December local investors have become pickier with debt transactions, buying almost exclusively high-grade deals.
As a result, junk-rated companies that until recently had no trouble financing themselves in the debt capital markets are finding it harder and more expensive to raise money that way. Appetite for equity deals, however, remains healthy, and pension funds will happily embrace any new stock issuance. "We would love to see more equity deals. There is appetite, but no offerings," said a local pension fund manager based in Monterrey.
In fact, for 2008, ECM bankers in New York say they have a bigger pipeline for Mexico than they did last year, albeit still far from the exuberant numbers seen in Brazil in the past three years.
Another promising spot is Colombia, though limitations on foreign investment still haunt local issuers. The federal government itself, which put the limitations in place, could be the one to drive the local equity markets. The country could see more privatisations in the wake of the very successful sale of Ecopetrol's shares last year. The state-owned energy company company raised Ps5.8trn (US$3.1bn) with the sale 4.09bn shares at Ps1,400 each, in a deal largely focused on retail. The government allowed instalment payments for IPO bids, and Colombian citizens were able to buy the shares even in supermarkets and retail bank branches. Preference was given to unemployed and unionised workers.
The deal simultaneously cleared two problems for the government: it allowing the partial privatisation of the energy company; and it sidestepped the political liability of a sale to another foreign company. Therefore, the model can be expected to be applied to other asset disposals. First in line is utility ISA.
Chile issuance is expected to be subdued, as it was last year, when only three new listings were recorded. Local bankers expect a similar performance this year, as debt financing is still by far cheaper in Chile.
Argentina saw two deals last year, which actually translates into a pick-up in activity. Since the country defaulted in 2002 only seven equity deals were carried out, including the IPOs of Clarin and Mercado Libre in 2007. With the recent step-up in volatility local banks took a step back as investors continue to eye with suspicion any deals originating in Buenos Aires.
Naturally, if the newly-elected president Cristina Kirchner decided to finally deal with the holdouts from the default and allayed uncertainties about the inflation numbers by offering a new index, investors might be more willing to bet on companies from Argentina, stimulating further activity.
Regardless of how much it grows, however, activity in the rest of the region will continue to be dwarfed by Brazil. Notwithstanding, this new cycle of the equity market in the South American giant will have very different traits. In the past two years, small and mid-cap companies were responsible for the vast majority of the deals as they rode a wave of record liquidity.
As the froth is taken off the market, this year is expected to bring more follow-on deals instead of IPOs. Stocks that showed healthy valuations and paid decent dividends since the IPO are more likely to be well-received by investors in a second market foray. New listings will most likely be of well-established, high-growth companies in deals of more than US$500m, though the smaller transactions of the past may not be completely absent. Issuers will have to be ready to offer a premium to investors in any new deals, though.
This trend became clear with the GP Investments deal, the first one to price in 2008, after three other attempts from different companies were pulled. The Bermuda-based private equity firm raised R$318.9m (US$199m) with the sale of 5.4m Brazilian Depositary Receipts at R$59.00 each, a 1% discount to the price the shares were trading on the pricing day.
Sectors which drove a considerable part of the new listings, such as real-estate, can also be expected to coil back, with new issues restricted to funding of acquisitions as an expected wave of consolidations sweeps the industry. Among the issuers expected still this year is Abyara, which had to pull a follow-on deal late last year as it stock got pummeled ahead of pricing.
As for the US$150m-US$300m offerings – the norm in the IPO market last year – they are likely to have a hard time flying as secondary trading has usually been limited to about 5% of the floating stock. This means a fund with an exposure of US$30m could take up to three weeks to unwind a position if it wished to do so. And many did face that problem last year as they were faced with redemptions and margin calls. As a result, while funds are still interested in the Brazilian growth story, they are far more selective.
The solution for the myriad small and mid-caps which were dreaming of a stock listing may be the Bovespa Mais. This new section dedicated to small companies seeking to fund growth through equity issuance received its first member last month with the IPO of fertilizer maker Nutriplant.
On February 13, Nutriplant raised R$20.7m (US$11.8m) by selling 40% of its stock, or 2.07m shares at R$10 each in a deal led by HSBC. This first deal within the section was not exactly an absolute success – the company was aiming at a higher range of R$14-R$18 per share. But it could pave the way for others to come.
For the past three years investors have witnessed a rapidly changing landscape in Brazil. Every time they thought they knew the Brazilian market a new company from a sector previously inactive on Bovespa would be listed, bringing with it a slew of other issues. Among the upcoming are consumer-products with Hypermarcas, a Brazilian smaller scale version of Unilever, which owns the leading steel scrub pad brand Assolan along with a mish-mash of other products ranging from over-the-counter medicine to cosmetics.
Many bankers expect the healthcare sector to tap equity markets, while consolidation in the highly fragmented market will require equity issuance for financing. The Brazilian giants are likely to seek to float more stock as they consolidate their position as world leaders.
Mining giant Vale, formerly known as CVRD, for example, will probably have to sell stock to fund its ongoing acquisition of Xstrata. The same applies to JBS-Friboi, which became the biggest beef exporter in the world after buying Swift from the US last year, having also acquired companies in Australia and Europe. Gerdau is also working on a US$2.4bn deal to wrap-up the financing of a string of acquisitions and peer Usiminas could come later. From the same sector, Companhia Siderurgica Nacional, CSN, may finally spin-off its Casa de Pedra mining unit to raise cash for acquisitions as it is belittled by these two other competitors.