Brazil’s equity markets entered 2011 with great expectations thanks to the country’s strong economic prospects. However, by the end of the year the tone was much more muted, due to lowered economic forecasts and the destabilising effects of the eurozone crisis on capital markets around the world. No listings were brought to Brazil’s stock exchange, BM&FBovespa, after July, the last one being Abril Educacao’s $238m initial public offering (IPO), while follow-on placings quietened down towards the end of the year. Only 32 transactions took place in Brazil in 2011, including 11 IPOs, down from a total of 42 transactions and 12 IPOs in 2010, according to data provider Dealogic.
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But despite mounting troubles in Europe, the Brazilian equity market is expected to fare well this year, driven by specific economic sectors and, more generally, by macroeconomic policies expected to focus on boosting gross domestic product (GDP), rather than on containing inflation. Further, companies based in the fastest-growing areas of Brazil may be in a position to enter the equity capital markets soon, according to some analysts. Brazil's north-eastern region has recently been growing at a much faster rate than the country’s average, with the capital of the Pernambuco region, Recife, experiencing double the average GDP growth rate of the rest of the country.
This translates into a healthy number of potential equity deals, with 20 existing IPOs filings with the Brazilian securities commission and between 20 and 25 possible new applications, according to private conversations the stock exchange has had with local companies, says Cristiana Pereira, Bovespa’s institutional and issuer relationship officer. Bankers expect that about 20 IPOs will materialise this year.
The type of issuers expected to be more active this year are typical of a fast-growing emerging market, and are companies that service the rising middle class and will be responsible for the modernisation of the country’s creaking infrastructure.
Setting Brazil apart
But the Brazilian story is even more compelling than just any other developing economy, says Carlos Constantini, head of research at Itaú BBA, because not only is the country's middle class growing, it has also gained the ability to leverage its expanding income thanks to access to less expensive credit. “Everywhere else we’re seeing increases in GDP per capita but in very few countries we are seeing this coupled with decrease in income inequality; people having access to credit, to banking products, being able to use leverage,” says Mr Constantini. “Unlike other emerging markets, Brazil has been experiencing a decrease in income inequality, which is very healthy. This is not what is happening in China or India.”
The growth of the consumer market has generated much debate in Brazil over the big wave of new banking clients accessing credit. Mr Constantini points to the fact that low-income classes, which are defined in Brazil as class D and E according to a series of indicators, have almost no alternative to credit that does not see them ending up with unsustainable charges. These social classes would typically have a gross monthly income per household of less than 2040 reais ($1143) for class D and 1020 reais for class E.
“If you are D and E in Brazil, your alternative for leverage would be one of those consumer financing companies which will charge you as much as 15% a month for 30-day loans,” says Mr Constantini. “People hardly use their leverage potential because it’s very expensive, it is destructive. As you move to a C class, you have access to banking credit products ranging from 2% per month – still high by developed markets standards but a fraction of what they were previously facing – to 5% per month. And it is longer term, it can go up to 72 months.”
Energy drive
The oil and gas sectors will also drive issuance in Brazil this year, on the basis that the recent vast pre-salt oil reserves found off the country's shores will attract further investment in the field. It is the sector that generated the world’s largest ever equity placing, issued by state-controlled oil giant Petrobras in 2010 following the oil discovery. Of the $70bn issued, most was taken up by the state and state-owned banks, but private investors still had a very sizable $26.5bn of the placing available to them.
Indeed, the largest equity deals in 2011 came from issuers related to the consumer, infrastructure and oil and gas sectors – as did most of the equity offerings. The largest offering was steel conglomerate Gerdau’s $2.48bn placing, with the second largest IPO came from health insurance Qualicorp’s $676m IPO, a company from an under-represented sub-sector on the exchange. Deals that cater to the consumer and infrastructure-related stories will continue to raise interest this year, say bankers, as will offerings from sectors that have great economic potential but are relatively new to the equity capital markets.
Looking beyond 2012, the growth of the equity markets seems even more promising, according to Christian Egan, CEO of Itaú Securities, the brokerage arm of Itaú BBA. “At Itaú BBA, we bank 3500 corporate clients in Latin America; we have corporates with more than 200m reias in yearly revenues, which are 100% owned privately by Brazilian capital, growing above GDP for the next years – we think that we have about 900 companies that can be potential IPO candidates over the next five years,” he says. As of mid-January this year, there were 373 companies listed on the Bovespa.
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A decade of growth
Brazil’s equity market has grown over the past decade. With the formal introduction of the Novo Mercado in 2000, which imposed corporate governance and transparency standards above the ones required by Brazilian legislation, international investors started looking at the country in a different light. Emblematic was the listing of Natura Cosmeticos in 2004, which was very well received by investors. “The landmark Natura IPO showed that we had companies that acted like public companies under a private framework, [but] which did not have the opportunity to tap the market and find a more stable source of capital such as equity,” says Fabio Nazareni, head of equity capital markets at BTG Pactual.
You need to have a very good [relationship] with the Brazilian domestic community. If you have good [traction with them] you are half-way done with respects to a local offering
Even after Natura’s listing, however, foreign investors that looked at Brazil tended to be specialists and often pursued short-term strategies only. Things started to change in 2007, when Brazil became a more mainstream investment and a record 66 IPOs were executed. In the following years, and after the disruption of the financial crisis, more international investors started taking longer-term positions in Brazil. “Since 2009, Brazil has become not just an opportunistic move, but an investment philosophy,” says Mr Nazareni. “Anybody who did not have a Brazilian [asset] in their portfolio would have had to explain to their investment committee why they were not holding a position in Brazil.”
A persuasive investment story, coupled with the ability for international investors to purchase securities without the need to set up a local base, increased the level of liquidity of the market in Brazil. The fact that most issuers now rely on the Brazilian stock exchange to raise capital, rather than international markets, shows how far the market has come.
Allan Libman, head of investment banking in Brazil for Credit Suisse, remembers how, only about five years ago, the idea of listing metals and mining company MMX on the Bovespa was considered by many to be a big mistake, as an issuer from that sector would have naturally gone to international markets with a particular expertise in their operations, and disregarded the local market at once. “The MMX’s IPO in 2006 was the kind of deal [where] everyone said to the issuer ‘you have to do this in Canada or in the US because they know how to price it’, and we did it in Brazil,” says Mr Libman. Soon after, tapping only the local market started to become a more natural path and of the latest 90 IPOs only a couple were dual listings, the largest being Santander Brasil’s $7.5bn IPO in 2009.
“There is a real trend now for the majority of equity offerings in Brazil to be listed only in Brazil as the number of local asset managers has grown and international investors are able to buy shares without a local presence,” says Pedro Leite da Costa, head of Latin American equity capital markets for Goldman Sachs.
A promising assessment comes from one banker, who compares Brazil’s equity markets to what is happening in Hong Kong, which has grown to be one of the world’s busiest equity markets, and where the majority of listings are local listings only.
At local level
The local investor base has grown too. The Brazilian asset management sector now has about $1000bn of assets under management and its credibility on an international level has matured. Getting its interest on an equity deal is crucial. “These guys play a very important role in any equity transaction; they have been participating in a typical equity transaction for Brazil with 35% of the total pie; they are opinion makers,” says Mr Nazareni at BTG Pactual. “You need to have a very good [relationship] with the Brazilian domestic community. If you have good [traction with them] you are half-way done with respects to a local offering. They’ve been gaining momentum over the European accounts and the rest of the world.”
And there still is room to grow, as the percentage of equity held by funds is still limited at about 10%. On the other hand, it has to be mentioned that physical investors – ie. people, not companies – which have played a significant role in the growth of the local investor base shied away from the market last year in favour of the higher interest rates offered by bonds.
Looking at which banks worked on each equity issuance last year, another obvious trend is apparent: Brazil’s equity capital market is dominated by Brazilian banks. Out of the total 91 bookrunners that worked on the 32 equity issuances in the country, including convertible debt and bought offers, 58 were Brazilian firms, according to data by Dealogic. This includes Santander Brasil, but leaves out Credit Suisse, which represents a sort of hybrid-foreign capital on a Brazilian set-up, which the Swiss bank inherited from Garantia when it bought the Brazilian investment firm in 1998.
Familiarity breeds business
Relationships are key in Brazil. International banks have overwhelmingly larger international sales teams and platforms at their disposal, and a good presence on the ground. However, local firms have the credit relationship with the client and understand the Brazilian 'flavour'. Concerns over foreign firms’ past commitment to Brazil have also been expressed. “Local banks have much more power in Brazil than the local banks have in Asia, for example,” says one banker. “You don’t see syndicates [in Asia] where half of the banks are local banks. In Brazil, local banks have a very strong credit relationship with most corporates, particularly in credit-intensive industries such as retail.”
As for 2012, there are a couple of IPOs expected to come to the market in the first quarter, the first one, by travel company Brasil Travel Turismo e Participações, which could happen as early as the beginning of February. But it is after April that bankers anticipate a higher number of transactions hitting the market, with companies using full-year financials to price their placings. Issuers and banks may wish to wait a little longer to see how things pan out in Europe over the next couple of months and then file and execute transactions in June and July.
Global volatility will continue to have some impact over the Brazilian market, but has not dented investors’ interest in the country. Mr Leite da Costa at Goldman Sachs says: “Brazil has taken a bit of a hit given the difficult global economic environment, but the enthusiasm from international investors continues to be strong.”
