Recently, a senior analyst covering Latin America was lured by an investment bank from New York to São Paulo. The analyst may not have seemed an obvious choice for a position in the Brazilian banking capital being neither Brazilian nor a Portuguese speaker. For the analyst, the salary was the driver, for the bank, it was expertise. The story, a reversal of the normal flow, is symptomatic of the full-tilt Brazilian capital markets where levels of equity issuance have been the third highest on the planet this year (after the US and UK). This embarrass de richesse is not without its downsides, as investment banks trying to hire have discovered.
Equity capital markets have been leading the charge in Brazils capital markets. In 2005, nine companies launched IPOs on the Bovespa exchange raising $2.1 billion; last year, 26 such deals raised $7.1 billion and the Ibovespa, the most widely quoted benchmark, was up 33%. By mid-May this year, there had been a further 21 IPOs. Better still for investment banks, transaction fees have remained enticingly high at some 3-4%, partly because first time issuers are more concerned by getting good service and being heard in a deafening marketplace than a low fee from investment banks. That has seen them cluster round the execution banks with proven track records, particularly the two giants Credit Suisse and UBS-Pactual.
The good news is that the ECM boom looks healthier than previous such swells. For a start, economic stability is more deep-rooted with a balance of payments surplus, low inflation and an appreciating currency. Fitch and Standard & Poors both raised Brazil to one notch below investment grade last month [BC: May]. Confidence that corporate governance standards have really improved is stimulating interest, enabling smaller companies to issue. That has introduced IPOs from a broader swathe of sectors than the last wave in the 1990s, which was driven by privatisation and thus concentrated in energy, utilities and commodities. The financial sector and credit institutions, real estate and biofuels will continue to be strong and popular, predicts Alexandre Bettamio, managing director and head of investment banking for UBS-Pactual in Brazil. Companies in healthcare, education, agro-industry, meat processing, logistics and tech have all been able to sell equity of late.
Equitys dominance has somewhat eclipsed the debt market. Even so, there is growing liquidity and depth in these markets despite Brazils sub-investment grade rating. The emphasis has been moving away from the government and towards companies, which are issuing bonds to refinance and lengthen outstanding debt and improve profiles. The debenture market is deep and becoming longer and for companies they would prefer to issue in reais than dollars, says Bettamio. CVRDs $18 billion syndicated loan was re-financed mostly through the debt market without a hic-cough.
In this febrile environment, banks are finding it tough to get enough bums on seats as hiring becomes the priority of investment bank CEOs. Its particularly important to be seen to have lots of staff as the latest smear tactic by your competitor is to whisper in the ears of Treasurers that you are under-resourced and will not be able to execute their deal well, says one investment banker. Investors too are complaining of levels of service. Investment banks are busy. They are completely under-staffed as well, believes Gilberto Nagai, equity fund manager at ABN Amro in São Paulo.
The biggest scarcity in the market is experienced people. This is the biggest barrier to entry for newcomers, agrees José Olympio Pereira, managing director and head of Brazil investment banking at Credit Suisse. Its not only the challenge of hiring new staff but retaining the ones that you have. As local banks and foreign newcomers try to carve out a niche, they are offering juicy packages with one or even two year guarantees to lure names, according to headhunters. You have to offer a guaranteed bonus industry or you lose the guy. Compensation has become de-linked from performance, sighs Pinho Neto of Unibanco.
Local banks are having to swallow hard to compete on an even footing. Itaú BBA, which has the most successful local franchise, says the banks culture accepts this. The market is very competitive with everyone fighting for space. Were doing well and recognise that this industry has very competitive remuneration. You have to be able to pay what the market pays, says Setúbal. You need a track record and reputation and it helps if you have a nice franchise in the country, adds Pinho Neto.
Bradesco has been slower off the marks, but recent deals shows we can compete in this area, says Cypriano, who believes the bank will have a strong presence in two or three years. Nevertheless, Bradescos focus on training staff internally, except in specialist areas, means that it is likely to miss the boat in this wave.
Just how long this wave will last is anyones guess. The equity markets have factored in good news at an astonishing speed and some issues are starting to meet resistance. Telecom company GVTs February IPO was up over 27% and educational services company Anhanguera in early March over 21%. But shares of meat packer Friboi slumped 12.5% the day after pricing and Atmosfera, an upscale laundry company, had its IPO pulled. A couple of bank deals have also suffered in after markets.
Critics say both Friboi and Atmosfera were richly priced and that the latter did not have a strong case for coming to market. UBS, which was the lead on both issues, points out that Fribois share price has largely recovered it was trading at R$7.5 in mid-against the launch price of R$8 -- and that controlling shareholders at Atmosfera did have a robust business model but did not want to accept a lower price despite changed market conditions. And the setbacks must be put in context, says Bettamio. The bank had captured 13 of the 26 IPOs issued by mid-May, he points out. That makes it the leader in the equity market this year, dethroning perennial Credit Suisse.
In some cases, in some sectors, prices are a little above what might be considered a rational price for the asset, believes Setúbal. He adds that the market is adjusting and taking care of any price incongruities. The pace of issuance is likely to slow somewhat and yet the high quality of companies that are coming to market, the performance of shares in the secondary market, growth in revenues together with continued investor appetite for these deals suggests that we are still at an early stage in the cycle and we will see more such deals, Setúbal believes.
ABNs Nagai believes that for fund managers, theres a lot of pressure to buy in the primary market as it is: very difficult to make significant amounts of money operating only in the secondary market. Not only that, but investment banks are parsimonious with good deals but dumping poorer ones in the market. If the deal is very hot, the amount of shares we receive in the IPO is very small, meaningless. If it is not a very good deal, we receive a lot of shares but they dont perform well, complains Nagai.
Its not only individual stories but sectors that have, at points, seemed to lose touch with reality. Biofuels, although mostly transacted through private equity, and the real estate have both look over-heated. Although the real estate market has cooled somewhat after an effusive 2006, IPOs are still coming at a torrid pace, with seven so far this year. Investment bankers insist that the companies theyre bringing to market are not me-too IPOs. Others beg to differ. It has been looking overheated. The pricing of real estate IPOs last year implied a rate of growth that will be a bit more gradual, says Pinho Neto. There are too many issues in real estate, complains Nagai, who says that investors need to be extra picky.
Part of the long-term argument for real estate is that the mortgage market is on the cusp of some very good times. The development of this market is the next big challenge and opportunity for Brazilian banks. They are pouring over a variety of business models to figure out how to expand lending in what is likely to represent the final lending wave in the country.