Brazil Supplement: Equity IPO market: Abandon all hope?

A secondary nosedive for OGX, following a jumbo IPO, adds to the gloom in Brazilian equity.

The jaw-dropping performance of Eike Batista in coming to market with a new petroleum company, OGX, in the teeth of a tough market and raising $4 billion lightened the gloom in Brazil’s equity capital markets in late spring. Cork popping was short-lived. OGX shares shed more than 50% in their first two months with the Bovespa index faring a little better, but still hitting bear territory in July after falling more than 20% in two months.

The OGX IPO had injected some feel good into the market: at least commodities were immune from the market slump, went the argument. But the performance of OGX and softness in book building for a $11.6 billion global deal, the largest follow on ever in the Brazilian market, from market darling Vale, has given the market the willies. The global deal secured only 75% of targeted funds with a discount of between 5.4-6.4% depending on share class and Vale shares plunged some 40% over two months to July, albeit after a large run up.

Primary market data starkly illustrate how quickly things have turned sour. In the first half of 2007, there were 35 equity offerings on Bovespa, of which 30 were IPOs. In the same period this year, there were just 11 offerings, of which only four were IPOs. The only silver lining was a higher average deal amount in 2008, which saw a respectable total of 14.8 billion reais raised compared to just over in the first half of 2007.

Investment banks are having to work harder to build a pipeline, acknowledges Sebastien Chatel, co-head of Latin America ECM at Merrill Lynch. “Before we were called up by companies asking us to pitch and there was a huge amount of investor interest. It wasn’t rocket science.” Merrill is now working on private equity deals on behalf of sellers to ensure they achieve fair value and do not cede too much control. Bankers are also putting together private deals, he notes, adding that it can be tough to make clients appreciate that this kind of deal, which is as labor-intensive as a public equity deal, is worth the same fees.

“We are less bullish on short-term prospects,” concurs Evandro Pereira, head of LatAm ECM at UBS Pactual in São Paulo. “The global scenario has deteriorated further and that makes me cautious.” Long-term, however, the firm remains extremely bullish on LatAm, he adds.

Selective on Sector
Interest in sectors has been skewed. Primary activity in consumer stocks, education and health, all mainstays of the bull market, have vanished. New activity in real estate, which produced 34 IPOs in 2006 and 2007, is likewise moribund. Share prices of many property firms are down by over 50% in the 12 months to July and one, InPar, down close to 75% in mid-July year-on-year, while the shares of mid-sized banks that came to market last year have receded an average drop of 34% since their respective IPOs. Any rebound in primary issuance in these areas looks a long way off.

The gloss has been taken off the consumer play as inflation expectations continue to run ahead of Central Bank predictions, notes Nicholas Morse, head of LatAm equity at Schroders Investment Management in London. Furthermore, earnings downgrades – which have not yet really bitten for consumer companies – are likely, he adds. Finally, interest in smaller IPOs has been drowned out by the clamor for stakes in blue-chips such as Vale, Petrobras and steel firms in an environment where liquidity is king and funds are sticking to large positions in well-known companies.

One example of the change in heart came when Brazilian clothes maker Le Lis Blanc dropped 20% on its debut in April, raising less than half its expected 325 million reais in a deal led by Merrill Lynch and Morgan Stanley after numerous revisions to the offering price and size. Since then, the shares have trended down further and closed at 4.5 reais on August 1 having been launched at 6.75 reais.

In this grim environment, banks are looking to capitalize on Brazil’s natural strengths in commodities, both soft and hard, and hoping that prices stabilize. Offshore oil – particularly pure upstream exploration and production firms and providers of equipment, are IPO-able – Pereira says. Even a small rotation by investors out of Petrobras would provide the needed cash.

But the future for commodity stocks, too, is uncertain. The global downturn and commodity price volatility are hurting just as the Brazilian government is mulling ways to take more tax from the petroleum sector, including relatively radical measures such as setting up a state-owned company to award concessions, and upping charges on the already heavily-taxed minerals sector.

Investors are meanwhile interested in consolidation in agrobusinesses, Pereira says. The sector remains mostly family-owned but is undergoing steady corporatization and professionalization. He predicts IPOs there in the near term.

Finally, infrastructure still elicits interest, Chatel and Pereira agree. If the government IPOs national airport company Infraero, it would be one of the hottest deals in the world, Pereira says, cautioning that the government has yet to make any such decision.

But bankers may be talking up a weak hand. “At the moment, an extremely limited pipeline is being presented to us,” says Morse, adding that he has seen more commodity-related stories and secondary issues of agro-businesses, but does not see any strong sectoral patterns in the deals being touted. He is not that interested in new pitches, preferring to focus on the secondary market and thus on firms whose shares have some history of financials and trading. Morse is wary of getting trapped in less liquid issues and wants to see how a stock performs before he buys, however attractive the story.

Weaker sentiment is highlighted by fund flows into Brazil from emerging market funds, says Brad Durham, managing director at fund tracker EFPR Global. He reasons that it may have been overbought last year, with the country representing the single biggest overweight, and that now managers are lightening their load.

Even the long awaited arrival of Asian and Middle Eastern investors is coming at too slow a pace to prop up the Bovespa. These investors do represent a growing pool of funds for Brazil but account for no more than 10% of buyers in recent IPOs, and tend to insist on deeply liquid names.

This is all bad news for investment banks that have poured cash into Brazil. Although long-term prospects do look favorable, UBS, Credit Suisse and Merrill Lynch have all posted poor results at home and are keen to bolster revenues globally. Bankers say they are in Brazil for the long-term, but history suggests otherwise.

This entry was posted in Articles, Latin Finance. Bookmark the permalink.

Comments are closed.