Analysis: Brazil IPOs face uncertain future as buyers stay wary

SAO PAULO Thu Jan 17, 2013 12:12am IST

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SAO PAULO (Reuters) - Investors have a message for initial public offering candidates in Brazil: be careful how you price your IPO or it will founder.

The woes of logistics company Vix Logistica SA, which on Tuesday called off plans to go public, raised red flags for potential issuers in a market that only weeks ago looked poised for a comeback year. The company cited "unfavorable" market conditions and weak investor demand for its decision.

Companies looking to go public face a delicate balancing act -- how to offer adequate risk and return to investors as growth in Latin America's largest economy remains weak.

Stung by a string of deals that failed to deliver the promised returns, investors are being extra cautious in Brazil, casting a dark cloud over a pipeline of some $6 billion of potential IPO transactions in 2013.

"The business flow in Brazil remains somewhat risky," said Nick Field, who manages $24 billion in equities for Schroders Investment Management in London. "Companies with IPO plans will have to come up with an attractive price to lure buyers - no one wants to pay a lot for any new issue."

Among companies considering offering shares in Sao Paulo are Banco do Brasil SA's (BBAS3.SA) insurance and pension unit and the customer loyalty program of airline Gol Linhas Aereas (GOLL4.SA). There is also talk among bankers that Votorantim Cimentos SA, Brazil's No. 1 cement maker, is preparing a $3 billion IPO.

But Brazil's once-hyped IPO market may not rebound as swiftly as some bankers hope, given the risk of overpriced deals, flagging economic growth and the impact of heavy state interference in some sectors of the economy.

Foreign investors, traditionally the largest buyers of Brazilian IPOs because of their strong shareholding culture, are watching from the sidelines while they question the quality of stock market debutantes. And local pension funds have stayed away from IPO hopefuls with poor earnings visibility, an insufficient track record, or vulnerability to a downturn.

"People are highly selective these days," said Oliver Leyland, who manages over $1 billion in equities for Mirae Asset Global Investments. "There's a conservative approach to IPOs in Brazil, very distinct from the scenario of a few years ago."

A THING OF THE PAST?

Taking risks through an IPO, the mechanism that small and sometimes inexperienced companies use to raise capital, is becoming a thing of the past in Brazil. Only three companies held IPOs in 2012, down from 11 each year in 2010 and 2011 and a record 64 in 2007, according to Thomson Reuters data.

IPOs have suffered as many investors ran for the exits after President Dilma Rousseff put pressure on banks, mobile carriers and power utilities to cut prices. Wary investors said the government campaign, while well-intentioned, has stirred doubts about Rousseff's willingness to respect contracts.

"It was a tough situation that will likely keep us on the cautious side for a bit longer," said Julian Mayo, who manages $2.5 billion in equities at London-based Charlemagne Capital.

One of the toughest challenges that Brazilian IPOs face may be attracting foreign investors as the economic recovery looks uncertain and risks of policy activism to kick-start growth remain high, Schroders' Field said.

Foreigners snapped up more than three-fourths of Brazilian IPOs between 2006 and 2008, a share that fell to a decade-low average of 45 percent last year, Thomson Reuters data showed.

The IPO boom of 2006-2007, which raised 48.2 billion reais ($24 billion) for controlling shareholders of 118 companies, made countless millionaires overnight. But the foreign investors that bet on some of those companies didn't fare so well.

Since then, about 20 of those companies were gobbled up by rivals or went bankrupt, data compiled by Thomson Reuters show.

Another challenge is the competition that Mexican IPOs pose now that the region's No. 2 economy is growing at a faster pace than Brazil. A couple of "emblematic" IPOs in Mexico could be launched early this year, luring some investor attention away from Brazil, bankers at Credit Suisse Group said last month.

GAP CLOSING

Well aware of the challenges, companies and investment banks are fine-tuning their IPO strategies, said Fabio Nazari, head of equity capital markets at BTG Pactual Group, Brazil's top equity underwriter last year.

The gap between what companies want for their shares and what investors are willing to pay will narrow as more solid IPO stories are marketed, growth gathers momentum and low global interest rates fan risk-taking, Nazari added.

Jean-Marc Etlin, managing director for investment banking at Itau BBA, agrees. "That gap is closing now that companies are more willing to review their stance on pricing," he said.

The current environment of record-low interest rates should encourage investors to park more money in stocks, fueling demand for new offerings, said Sebastien Chatel, the New York-based co-head of equities for investment bank Brasil Plural.

Chatel estimates that investors are obtaining inflation-adjusted returns of 1.5 percent for a standard fixed-income investment in Brazil. When taking into account taxes, that return could be negative in some cases. IPOs offer an alternative for investors hungry for positive returns.

"Dedicated equity funds are in standby mode, waiting for the best opportunities," BTG Pactual's Nazari said. "There's considerable money waiting to be allocated in the short term. IPOs will play a role there."

Brazil's benchmark Bovespa index .BVSP has gained 10 percent since mid-November, a trend that could make new share offerings look more appetizing, the bankers added.

SHUN REGULATED INDUSTRIES

If IPO activity in Brazil does end up rebounding this year, investors are likely to see bigger deals than they did in 2012, ensuring greater liquidity, Brasil Plural's Chatel said.

The planned offering by Banco do Brasil's insurance and pension unit BB Seguridade could fetch up to 5 billion reais, sources with knowledge of the deal told Reuters. The IPO of Gol's loyalty program unit should lure investors seeking to tap into buoyant consumer demand in Brazil, bankers added.

Investors are looking for opportunities linked to Brazil's consumption and infrastructure boom in areas less likely to suffer heavy government intervention, Nazari said.

Brazilian regulators, the group representing the investment banking sector and BM&FBovespa are campaigning to get more companies to go public. Brazil has less than 400 publicly traded companies, though BM&FBovespa executives say that number could rise to 1,000 within the next five years.

That may sound overly optimistic after a grim 2012, when the European debt crisis, sub-par economic growth and Rousseff's activist policies weighed heavily on the market.

Weak demand led six Brazilian companies to pull IPO plans last year. Two of the deals that were completed priced below the suggested price tag, while all three that went public traded below their IPO price for most of the year.

"Had some of those companies been willing to price their issues at a reasonable discount, the story could have been different," said Neil Denman, who oversees $500 million in assets for London-based Polar Capital.

(Editing by Todd Benson, Kieran Murray and Phil Berlowitz)

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