Bring on the Small Caps

After a banner 2007 for Brazilian IPOs, small caps are getting set to issue. Liquidity and costs are against them, but Bovespa Mais hopes for a breakthrough.

Nutriplant seems an unlikely company to keep the bigwigs at the Bovespa up at night. The obscure firm operates in the unglamorous world of agricultural fertilizers from headquarters in the backlands of São Paulo state, and has just 28 million reais in annual net sales. But the miniscule muck-maker is a guinea pig for a cherished plan of the Bovespa.

Nutriplant is slated to be the first listing for Bovespa Mais, a segment of the stock market created two years ago to capture underserved mid and small-caps. The domestically-oriented IPO through lead underwriter HSBC is expected to raise around $30 million equivalent.

Launched in 2005, Bovespa Mais has failed to attract any listings to date. Firms contemplating an IPO have preferred to wait and go straight to the tried-and-tested Novo Mercado, with investment bankers keen to point them in that direction for the fatter fees larger deals yield.

The slow uptake is not unexpected: the now-wildly popular Novo Mercado did not generate listings in its first two years. “This is a challenging period for Bovespa Mais. But it doesn’t mean the concept is flawed,” says Mauro Cunha, head of equities at asset manager Mauá Investimentos. He thinks the segment will succeed and prove valuable for stimulating Brazilian capital markets.

Cost Constraints
If the long-term looks encouraging, there are a number of teething troubles for Bovespa Mais. Perhaps the key difficulty is cost thanks to tough vetting requirements, says Ronnie Herscovici, a partner at São Paulo-based law firm Souza, Cescon Avedissian, Barrieu e Flesch.

Bovespa Mais requirements on disclosure and transparency are nearly the same as on the Novo Mercado, making the cost a much larger percentage of funds raised.

”It’s virtually the same process with very similar financial statements and disclosure requirements, a near-identical supervisor review process and the same deadlines. This makes the process cumbersome and costly,” says Herscovici. In this way, Bovespa Mais has departed from the UK’s small-cap AIM market, from which the Brazilian exchange liberally borrowed ideas, he says. AIM prides itself on flexible rules, and a cheaper and faster listing process than on the main board.

João Batista Fraga, listings and issuer relations executive officer at the Bovespa, argues that it is investors who demand high standards and that as Bovespa Mais is geared to retail and institutional investors, requirements should not be watered down. It is the high standards of the Novo Mercado that have underpinned its success, he reasons.

Boutique Business
Another issue is just how interested investment banks will be in bringing companies to market at a time when the Novo Mercado is providing record levels of work and they are struggling to keep pace with demand. Fraga acknowledges that the big banks may snub Bovespa Mais but insists a number of others are interested.

Indeed, Brazil is well served by smaller boutiques, such as brokers Planner; Gradual; Ágora; and Link, which have worked with the big names on equity deals, says Herscovici. However, they lack the range of experience of full-service banks and remain untested in managing IPOs alone. They will need to get up to speed with substantial investment in staff, an expensive commodity, and systems, he cautions.

And on the other side of the equation, it is unclear just how much investor appetite exists for smaller-cap stocks, whose performance was weak in the second half of last year. Cunha points out that the performance of the IBX 50, representing the largest 50 companies, and the IVBX-2 which captures smaller caps, has diverged. From July through December, the IBX50 outperformed the small-cap IVBX-2 by 25%.

That means most buyers of the stocks to be listed on Bovespa Mais are unlikely to be the large institutional foreign buyers that the Novo Mercado is so dependent on, but long-term Brazilian institutional investors, particularly in the short-term. “It’s not the time for the mainstream market to look at Nutriplant,” given powerful global trends towards more liquid deals, acknowledges Cunha.

Cunha believes there is solid demand from the pool of Brazilian investors. Mutual funds, which already account for 1 trillion reais, and wealthy individuals are both likely to be keenly interested in Bovespa Mais, he believes. “We have a number of funds that are relatively small and want to remain small. They focus on opportunities that are less followed,” he says.

Mauá itself is launching a new concentrated fund that will look at smaller caps. The Mauá Brasil Selection was slated for launch as LatinFinance went to press, targeting institutional buyers seeking higher absolute returns and relatively low correlation with benchmark indices.

All Eyes on Nutriplant
Maintaining liquidity and ensuring that there is basic research on companies to be listed on Bovespa Mais are also key. Bovespa will organize a number of daily auctions rather than permitting continuous trading to concentrate liquidity in blocks, explains Fraga. The exchange has also contracted two research firms, who have appointed lead analysts to follow those companies deciding to take the plunge and list on Bovespa Mais. Fraga declined to name them and it remains to be seen just how good the quality of research will be, particularly when the client is the exchange itself rather than an investor using the information selectively and as a basis for picking a broker.

Finally, there is the question of market manipulation that hangs over all small exchanges, the risk of which is difficult to quantify. The success of the Novo Mercado means that it has already attracted many mid-sized companies and it is possible Bovespa Mais will only attract the scrag end of microscopic deals. Smaller, illiquid stocks are easy to manipulate and more open to insider trading, already a problem in Brazil.

The next six months will be key in gauging just how much momentum can be generated and how kind markets are to the launch of Bovespa Mais. The IPO of Natura in 2004 generated huge and positive publicity for the Novo Mercado and ended a long market drought, with IPOs from GOL and América Latina Logística coming soon after.

Nutriplant was the only small cap registered with the CVM at the start of the year, although the exchange’s Fraga says that he has spoken to many companies that expressed an interest in listing on Bovespa Mais. If Nutriplant succeeds, the diminutive ugly duckling may yet grow up to be a swan.

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

Comments are closed.