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Monday, 11 December 2017

Strivers, slackers and shelvers

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Latin America’s equity markets have long been something of a crap shoot for investors, with IPOs regularly pricing well towards the very bottom of the range. Banks, issuers and investors are, however, learning to see eye-to-eye.

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Latin America’s often bumpy relationship with new stock sales has set the bar far higher for initial public offerings than anywhere else in the world.

While companies in North America and Europe accelerate plans to list on the back of a wave of enthusiasm (and premium valuations), those in LatAm must be sufficiently committed to set pricing at bargain basement levels. Even then success is not assured.

The float of Carlyle-backed travel company CVC Brasil Operadora e Agencia de Viagens is a case in point. On December 6 2013 the company was desperate to complete a delayed Rs1bn (US$430m) IPO.

At first glance, 2013 was a positive year for new Brazil stock sales, with 64 IPOs completed worth US$16.3bn, against 70 IPOs worth US$13.3bn in 2012, according to Thomson Reuters data.

But it had also been an uneven one, starting with a bang before tailing off mid-year, after the US Federal Reserve pledged to begin unwinding its easy-money policies. Barring a single, standout sale, the US$5.7bn April IPO of Banco do Brasil’s insurance unit, BB Seguridade, 2013 Brazil IPO volumes would have fallen 20% year-on-year.

Yet Sao Paulo-based CVC was a company in a hurry, and for good reason. It had already shelved its stock sale once before, in 2012, blaming “unfavourable” market conditions. With Brazilian elections looming in late 2014, and with the Fed’s tapering programme set to kick in (as it did December 18), CVC and its private equity backers knew that IPO windows would likely be small and only intermittently open.

There was also a positive incentive to move quickly – the looming 2014 World Cup in June, followed two years later by the Rio Olympics, the largest sporting galas ever held in LatAm. What better time to list shares in Brazil’s largest travel agency?

By any measure, barring the sole mitigating factor that the sale wasn’t delayed a second time, the IPO was a bust. Investors balked at an ambitious price range, set at between Rs18–Rs22 by a bevy of underwriters including Citi, Itau and JP Morgan.

In the end, CVC sold 38.8m shares at Rs16 apiece, raising just Rs621m – less than two-thirds of its original target. Nor did the pain end there. The firm’s stock dipped to Rs12 after the Fed in January trimmed its monthly bond repurchase rate a second time, before regaining its footing.

Tender spot

It would be superficially easy to dismiss the sale as an aberration, but pricing has become a genuine bone of contention in LatAm, particularly for weary investors.

In November, Colombian airline Avianca priced 27.2m American depositary shares at US$15 apiece in a US$409m follow-on sale, below the US$17–$20 range. And the previous month, Brazilian educational group Ser Educacional sold stock worth Rs620m, pricing shares at Rs17.50 each, again well below the proposed range of Rs19.50–Rs23.50.

Of the 10 largest IPOs completed across the region in 2013, seven were priced in the bottom half of the range, with three only making the minimum guidance. The previous year, those figures were eight and four respectively.

Of the 20 largest stock sales completed over that 24-month period, just two priced in the upper end of the range, while of the 117 stock sales priced across the region since 2005, just 37 yielded returns above the benchmark CDI interbank lending range. The rest lost at least half the amount originally invested, according to Credit Suisse research.

However you slice the data, it is hardly a ringing endorsement of LatAm’s primary equity capital markets.

Investors, notably overseas institutions, appear to have become suspicious of any pricing pledge. Foreign investors bought 68% of the available shares of IPOs listed in the three years to end-2008, according to Thomson Reuters. In 2013, that figure fell to 45%.

Neil Denman, who helps manage US$12bn in assets for London-listed investment management firm Polar Capital, has warned that valuations should reflect the added risk of investing in regional stock sales in general, and Brazilian IPOs in particular.

Bankers, naturally, err toward defending the status quo: pricing is after all a delicate balance, requiring underwriters to book a profit while pleasing both shareholder and investor. Yet even they, when pushed, dwell on the damage that pricing mismatches are doing to regional offerings.

Jorge Mariscal, chief investment officer, emerging markets, wealth management at UBS, admitted that while valuations may have been “stretched” in the past, he tips IPO pricing to become “more realistic” and “more discerning” as 2014 develops, with shares “more likely to trade sideways or upward in the aftermarket”.

Santiago Gilfond, head of LatAm equity capital markets at Credit Suisse, noted that fully nine-tenths of Latin American IPOs have in recent times priced within the range, suggesting that there is “[no] great discrepancy on valuations”. And while pricing is dependent many factors, including prevailing conditions, it is also, Gilfond said, influenced by historical relative valuations.

This matters, if only because when one IPO is completed at or close to the bottom of the range, there is a greater chance of the next one pricing down, too. LatAm is far from the only market to suffer from this phenomenon, though it remains unusual in that the past few years have witnessed a flood of new sales that priced low, before slumping further on debut.

That’s not to say that the problem has no clear solution. The region’s pricing problem can be easily fixed through better communication between investors, shareholders, and underwriters. Brazil’s fortunes are flagging, creating more incentive, at least within the region’s largest economy, to pitch deals at levels acceptable to buyers.

Other leading regional economies meanwhile offer potentially greater issuance, and increasingly deep pools of investable institutional capital. Credit Suisse’s Gilfond said that domestic capital sources, notably the US$150bn overseen by Mexico’s rapidly growing Afores pension funds, “have continued to develop with domestic capital formation being a further source of demand for deals”. In other words, even as foreign investors last year cut their relative exposure to new regional IPOs, local capital sources moved to pick up the slack.

Mexican moves

Many expect capital creation to move north and west. While the Brazilian market remained the region’s leading source of new issuance in 2013, followed by Mexico and Chile, it’s the only one of the three to see its overall share of the IPO market dip, while the number of completed stock sales also fell.

Chile IPO volumes more than doubled year on year, to just shy of US$10bn in 2013, with Mexico volumes spiking 40% over the same period, to US$12.5bn, according to Thomson Reuters. Moreover, Mexico became the leading source of equity underwriting fees for the first time in 2013, usurping Brazil.

But whether pricing improves on regional stock sales will only become clear as the year progresses, and as LatAm’s capital markets pull out of their current slump.

The current year began with a whimper in Brazil, where a raft of IPOs expected in the second quarter, including from auto fleet outsourcer Ouro Verde and infrastructure group Invepar, were quietly shelved. No IPOs at all were filed in the first two months of the year with the national stock regulator, CVM.

Nor has Mexico, so far at least, filled the gap. In February, retailer Grupo Gigante delayed its US$377m listing, while other corporates, including Office Depot and Viva Aerobus have also delayed primary capital-raising plans.

Nur Cristiani, Mexico equity strategist at JP Morgan, said in a February 24 research note that the postponed IPOs would be completed “at some point during 2014 as conditions stabilise”. Credit Suisse’s Gilfond said: “We will continue to see new issuance in the region but overall it is likely to be lower than last year.”

UBS’ Mariscal described himself as “moderately bullish” about the state of regional capital-raising going forward. “Mexico, Colombia, Peru and Chile will see corporate demand for funding and investment capital remain strong,” he said.

“We expect at least US$36bn–$38bn in equity issuance in 2014, which would be in line with what we saw in 2013.” The one “wild card”, he noted, was Brazil, which could see issuance spike if late 2014 elections lead to a more market-orientated government; and if common sense can prevail, for the first time in many years, over the pricing of new stock sales.

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