Latin America Equity Issue: Sabesp's R$14.8bn follow-on
A clean transition
In an arduous process of privatisation, the Brazilian state of Sao Paulo laid the groundwork for securing universal access to water and sewage treatment services until 2029 through the R$14.8bn (US$2.7bn) all-secondary follow-on completed in July by water utility Sabesp.
Securing a strategic investor that could validate valuation, provide management expertise and help raise funding for an ambitious five-year R$70bn capex plan was instrumental to the process.
Brazilian energy-focused investment conglomerate Equatorial Energia was the sole bidder with an agreement to invest R$6.9bn at R$67 per share in a process that began in early 2024.
With the deal suitably anchored, BTG Pactual, Bank of America, Citigroup, UBS and Itau as global coordinators completed the placement of 220.5m shares at R$67, an eye-popping 18.3% discount to the R$82.02 last sale ahead of pricing. Equatorial purchased 102.5m shares to give it a 15% stake, locked up for five years, with the remaining 118m shares sold to institutional investors.
Given the large discount, the public tranche understandably was more than 30 times subscribed, though banks concentrated allocations in the hands of long-only investors. More than 300 investors participated, with the top 25 allocated about 45% and the top 50 two-thirds, evenly split between domestic and international accounts.
Sabesp shares closed the year at R$88.50, a close to one-third gain for investors.
While seemingly a giveaway, the Sabesp privatisation underscores the carrot-and-stick approach needed to fully transition the utility from state ownership to public equity markets.
When Sao Paulo governor Tarcisio Gomes de Freitas secured approval in February 2023 to move ahead with the privatisation, Sabesp’s shares traded around R$50.
"Dialogue was key in the process," said Natalia Resende, secretary of environment, infrastructure and logistics for the state of Sao Paulo. "We held public hearings. We spoke with more than 250 investors about gaps in regulation and dividends."
Higher levels of corporate governance and a strategic investor were needed to achieve the desired goals.
The transaction also faced political challenges, with Brazilian president Luiz Lula da Silva’s political party filing a motion with the Supreme Federal Court on July 16 (two days before pricing) to suspend the privatisation. The court rejected the motion on grounds that the requirements were insufficient.
Investors also may have secured a discount but future returns in the form of dividends are tied to Sabesp expanding provision of its services. The architecture underlying the investment programme is a single contract encompassing 371 municipalities that outlines rate increases tied to execution of capital improvements.
The state, which saw its stake reduced to 18% from 50.3%, invested 30% of the proceeds into an investment fund to make rates more affordable for low-income consumers, with dividends for the next five years also going into the fund.
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