Brazil: Time to go back to IPO textbook?
It could be nine months between Brazil’s last IPO and its next, leading investors to urge banks to do a better job of reining in candidates’ pricing expectations.
This year has been unique for the Latin American fixed-income and equities markets. More than $30 billion of bonds have been issued in the former while the latter can point to a couple of follow-on transactions.
Despite the different output, both share similar strengths: they have pent-up supply from the risk aversion that affected Latin American capital markets in the second half of 2011; the region’s strong economic fundamentals and positive ratings outlook offer investors diversification from assets in developed markets; this year money has been flowing into dedicated Latin American funds – both equity and fixed income; and with the growth in investment-grade companies in the region, cross-over investors are driving strong liquidity for Latin American deals.
So, what’s the difference? A few DCM bankers insinuate that bookrunning discipline has been stronger in the fixed-income market. Some bond deals have been brought to market that pushed investors too far – particularly on the lesser credits – on pricing or deal-specific weaknesses, but, by and large, they highlight that deal flow has been excellent, with execution facilitated by large demand for most bonds.
And it’s true that the few equity deals that have reached the marketing stage have had some unfortunate weaknesses that the bookrunners could, and perhaps should, have prevented. But the key problem compounding the bookrunning issues is price discovery – relatively simple in fixed income, but a possible minefield in equity transactions.
Brazil has the biggest pipeline in Latin America but probably the largest gap between sellers’ expectations and investors’ valuations. The Bovespa, trading at about 10.5 times earnings, is cheap compared with the rest of Brazil.
However, sellers don’t want to sell at that rate and believe there should be an emerging-markets premium – and they are right to point out that the growth potential in Brazil is stronger than in Europe or the US. But investors, burned in past waves of Brazilian IPOs, are not in the mood to be generous with multiples.
It is unlikely that an IPO will price in Brazil before early April, by which time it will be nine months since the last. That’s a long time for banks to be without revenues from one of their highest-margin businesses, particularly with the high cost of Brazilian bankers. And there will be no deals in April unless buyers and sellers can bridge the valuation gap.
So what needs to happen? Investors say the banks need to do a better job at reining in IPO candidates’ pricing expectations. It’s not their job, they say, to make a CFO realistic about their company’s value – it’s the banks’. But with the competition for mandates so fierce, there is a pessimism and weariness among investors about the banks’ ability to have that conversation.
The temptation, they say, for one bank to high-ball the valuation to win the mandate is irresistible. It’s a symptom of an over-banked market, say some, who think rationalization would help. There are too many banks chasing the same deals and, during the bake-off, how better to differentiate yourself with the client than to say: "You should get P+10%"?
And then the process happens again – a company is paraded around the investment community with a range that will never be hit. It’s getting to the point when some automatically discount below the range. That’s not a healthy market.
Yet the best chance for a deal to price well is to start the price low and build up. IPO bookrunners should begin with an eye-catching valuation that creates buyers’ interest, build the book and then raise the price from the operational safety of over-demand.
As soon as banks do the reverse – lowering the price to find demand – they signal lack of control and the deal is in serious jeopardy.
Will this happen? It’s possible. Equity bankers – the good ones anyway – are by nature optimists. Add in the huge pressure to get some deals done, and maybe one bank will take a risk by not getting involved in a race to the top in terms of valuation. Instead, it will make a sober, realistic price and explain the strengths of a transaction where appetite is raised before valuations.
It would differentiate that bank in the minds of the IPO candidate’s senior management – as well as in the eyes of the investor community. And it might just work.