Brazilian Billionaire Stumbles: The OGX IPO

To the surprise of many, OSX Brasil SA, the Brazilian shipbuilding company controlled by billionaire Eike Batista, slashed the size and price of its initial public offering in March, which was expected to be among the world’s biggest this year. Brazilian billionaire entrepreneur Eike Batista appeared to offer to analysts a combination of personal charisma, a life-long track record and boundless self-confidence rather than hard and fast figures. However, fears about his ability to keep afloat so many businesses is naturally high at a time of caution, so the rumoured initial public offering (IPO) of his holding company EBX was viewed cautiously, especially after the failure of his previous IPO. However, Batista has another IPO in his sights.

The dramatic post-initial public offering (IPO) tumble in the share price of a slashed-back deal by Brazilian oil services company OSX has left egg on the face of its owner Eike Batista, Brazil’s most flamboyant entrepreneur and the country’s richest man. Detractors are enjoying their moment of schadenfreude. The question is whether the damage is lasting and suggests investors are shying away from his tightrope walk of high risk, high reward strategies or can it be viewed as a temporary blip? All eyes are now on the rumoured IPO of his holding company EBX. In what was set to be the world’s largest IPO since a previous jumbo Brazilian deal—the listing last October of Santander’s Brazilian subsidiary—OSX announced it would price its shares on March 18th.

The deal was surrounded with hyperbole, stemming from opportunities in Brazil’s pre-salt oil fields, where exploration is frenetic and early results promising as highlighted by the $175bn 2009-2013 investment plan of state-owned oil company Petrobras. Moreover, the early successes of another Batista enterprise, OGX, involved in exploration of petroleum fields, seemed to justify the giddy price talk of its sister firm OSX.

In the weeks preceding the deal, it became clear that investors were resistant to the pre-marketing hype and focused on the insipidness of the company with a complete lack of track record. The offering had to be cut from 5.51m shares to just under 3.1m (in a wide price range between $560-$748) and the price per share quoted in the preliminary prospectus of BRL1,000-BRL1,333 was also slashed to BRL800. In the end, the deal raised 62% less than had been predicted. To add insult to injury, even this dramatically downsized deal received a cold shower. The shares fell from BRL800 to BRL700 on the day of the IPO and had traded up only weakly to close at BRL715 on March 26th.

Even after the placement, Batista was maintaining a breezy external appearance. ‘This is a wind that in the future will generate a lot of gold,’ he said of OSX. However, investors blew him a raspberry, punishing other companies within the Batista empire that day. LLX Logistica shares fell 2.6%, miner MMX lost 2.5% and oil producer OGX tumbled 1.78%.

The poor placement reflected badly on the investment banks that led the deal. Credit Suisse, one of the most experienced banks in handling IPOs in Brazil, led the deal; co-managers were Banco Bradesco and Itaú Unibanco, the two largest private sector banks in the country; the new BTG Pactual, run by the highly experienced André Esteves who started the enterprise after leaving UBS Pactual; and Morgan Stanley of the US. They will forego as much as BRL160m in fees.

What went wrong?
Signs of trouble were evident before the deal was adjusted downward. The Bovespa index has recovered from lows of just under 30,000 recorded in October 2008 and closed at 69,939 on March 29th compared to pre-crisis highs of over 73,500. Even so, there was clearly deal fatigue from investors, at least at the prices investment banks were bringing companies to the Brazilian market.

Resistance to highly priced IPOs could be seen in the performance of the crop of 2010 deals. The three deals that preceded OSX—Aliansce Shopping Centres, Multiplus and BR Property—had all under-performed in the immediate aftermarket. Investors were telling investment bankers that they wanted size, a track record and proven management, and were not willing to underwrite riskier bets. The rejection of OSX epitomises a new results-based approach to Brazilian markets. Investors are looking for proven companies that are generating cash flow with liquidity.

Some investors see investment bankers and a frenzied fight for market share as the root of the problem. They think the Brazilian market is over-hyped and believe investment banks have been scrapping so hard for business that they are finding it hard to deliver when the crunch comes. ‘Underwriters are aggressively pitching companies to go public,’ says Patrice Etlin, managing director at Advent International in São Paulo. ‘That is leading to unrealistic expectations from companies regarding multiples. In 2006-07, investment banks were able to deliver to investors. That is no longer the case. Other markets, such as Mexico, are starting to look more attractive to Latin investors as Brazilian markets have roared back and valuations look rich.’

OSX and connected companies
It is not only the toppy Bovespa market that detracted from the OSX deal. The only asset of OSX is 3.2m acres of shore property in the southern state of Santa Catarina and the company has some BRL750m in debt, points out one analyst.

The OSX IPO has many of the hallmarks of previous Batista floats. The company is part of a mosaic of Batista companies that are complementary and self-reinforcing. The idea behind OSX was to service Batista’s oil prospecting company OGX, which has a market capitalisation of BRL52.7bn even though it has not yet produced oil.

The OGX IPO also came in the teeth of a difficult market in June 2008 but unlike OSX, the deal was a success, raising $4bn. The celebrations were short-lived and shares shed more than 50% in their first two months. Still, the shares have since recovered and are trading at some 35% over the IPO price.

OGX had been sold on the basis of the company hiring some of the most senior and experienced geologists snatched from Petrobras to advise the company on bidding for exploration blocks. Investors anticipate that the company may be able to extract 6.7bn barrels of oil.

In spite of the promise of OGX, some investors are starting to get anxious. Catarina Poderosa, a co-investor at Banif CVC in São Paulo, says her fund sold investments in the company after the recent run-up in price. The firm has been highly successful in its tests for oil but needs to start producing, she believes.

There is the rub with OSX, which very much depends on the promising but unproven OGX story. At the same time that Credit Suisse and OSX rushed out the market announcement that the OSX deal was to be downsized and the price slashed, it also announced that OGX had confirmed its sister company rights to develop platforms and ships. The strategic cooperation agreement stated with OSX would support the demand for exploration and production units which OSX would provide at competitive prices and meet obligations under concession contracts. That begged the question whether the company could stand on its own two feet without such a sure-fire contact and raised questions of conflicts of interest within the Batista empire.

The voodoo you do so well
Batista seems to exert a hypnotic spell on investors. The words most often used to desribe him are ‘enigmatic’ and ‘visionary’. His limitless ambition and persuasiveness have helped him when markets are on their way up, providing investors scope to price his assets with the maximum possible upside. The same lack of concrete results leads investors to punish his companies disproportionately when the mood darkens, explaining the volatility.

The next proposed IPO is for his holiding company EBX, which he said was ‘ready’ once markets improve. In early March, Batista informed the Brazilian market regulator, the CVM, that he was transferring his holdings in energy company MPX; metals and mining company MMX; and logistics operator LLX to EBX, presumably in preparation for the deal.

The holding company, which has stakes in five underlying companies with a combined market capitalisation of some BRL75bn, has always been extremely tricky to value.

The IPO could be worth some $30bn, one analyst hazarded. An investor says Batista is likely to designate Credit Suisse as its lead bank, as was the case in OXS, and that an early version of a prospectus for the deal has already been produced.

Detractors say Batista is stretched too thinly with his conglomerate-style empire, which has steadily moved away from its original mining focus. Batista talks casually about shaking up Brazil’s internet and telecoms sector one day and his plans for developing his beloved Rio de Janeiro the next, they note.

His supporters see a flawless business model where Batista recruits Brazil’s very top managers with alluring salaries and performance bonuses and lets them get on with it. That allows him to concentrate on setting up new businesses, where he is seen as adding value, rather than running existing ones, for which he seems to have little patience.

It is this combination of personal charisma, a life-long track record and boundless self-confidence that analysts have to go on rather than hard and fast figures. His track record is good but far from flawless. Batista has created fabulous wealth for his shareholders but has also tripped up badly. Between 1986 and 2001, he held senior positions at TVX Gold, as well as some 10% of the stock. Shares more than tripled in value but the Greek high court forced TVX to close mines, claiming environmental unsustainability after villagers near the mines rioted. The shares collapsed and Batista resigned.

That means animal spirits and sheer gut feeling is likely to prove the biggest determinant for the success of any EBX deal.

Fears about Batista’s ability to keep afloat so many business is naturally high at a time of caution and after the bruising global crisis. Moreover, there is a growing recognition that his empire is a house-of-cards, in which businesses are mutually dependent and where if one fails the others must surely follow.

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