International investors are warming to Brazilian equities and, with pent-up demand for new equity capital from many highly-levered companies, the prospects for primary issuance are improving.
Mike Simpson, Baring
Mike Simpson, head of Latin American equities for Baring Asset Management in London, says that the change of president in Brazil has led to a normalisation of trading strategies, which was a prerequisite for confidence to return and a re-allocating of capital to Brazilian equities.
“We have been seeing a Pavlovian response in the Brazilian equity markets for the past six years when whatever was bad for [President] Dilma Rousseff was good for equities, and vice versa,” says Simpson. “As we move forward I think the index will trade within a range but we will have equities performing due to reasons other than political risk.”
Simpson also points to the performance of the real, which has stabilized with the arrival of the new administration, lessening the FX risk part of the equation for international investors that measure portfolio performance in dollars or euros.
Leandro Miranda, head of investment banking at Bradesco BBI, spent nearly two weeks in May in New York talking to equity investors. He says the sentiment about Brazilian equities has changed dramatically.
“I have been speaking to long-only equity investors, those that have in the past been very active in Brazil, and I have heard the same message from all of them. They say their attention is now back on Brazil and they have space in their portfolio to allocate to Brazil and it’s time to do so,” he says. “The Brazilian exchange has provided the strongest returns in EM this year and we are getting to an inflection point in the economy.”
Some investors are talking about the Bovespa rising swiftly but Simpson says he, like many international investors, takes a stock-picking approach, with the performance of the Bovespa weighted to certain companies and industries.“I assume the Bovespa is going to be level [in the short-to-medium term], which actually helps my process – I’m looking for the best stocks and if the index goes up then great, a rising tide will help everyone.”
Simpson says the recent follow-on transaction for Rumo, which raised $2.6 billion (with an anchor order of 60% of the book), was a very encouraging data point for potential new equity issuance, with strong international orders and a jump in its share price of 20.4% in the first day of trading.
“We are in a dynamic that if we know that a company needs to raise equity for sensible reasons then the stock will go up,” says Simpson. “Rumo was a very good sign – it was raising equity for capex and to de-lever and there is a lot of leverage in the system that needs to be addressed so I think this type of follow-on deal will be an important driver of the market.”
Matias Santa Cruz, head of LatAm ECM for HSBC, agrees that Rumo was significant. “Although the anchor order was substantial the deal wouldn’t have been able to be done if it were not for the international investors,” says Santa Cruz. “So that dynamic of having the international investors is an important one.”
Historically, international investors have been the majority buyers in Brazilian equity and follow-on transactions, with domestic investors typically buying around 30% of the shares.
Bradesco BBI was the global coordinator on the Rumo deal and Miranda believes that a large number of good companies – in investor-friendly sectors like infrastructure, agriculture, energy, health and education – are waiting to tap the equity markets.
“I see very strong demand and we think there will be many follow-ons in the second semester of 2016 and it’s even possible that we will have one or two IPOs this year,” says Miranda.Simpson is more cautious about the prospect of IPOs and points to the patchy performance of IPOs in Brazil in the past.
“IPOs are always tricky,” he says. “There is an interesting dynamic that every time Brazil has a rally the bankers come out with a lot of IPOs with many of them over-hyped. I think this time around there will be more emphasis on follow-ons – that’s my natural predisposition because you can analyse the company, see the management team and understand whether it’s just an issue of leverage or lack of access to capital, and then it’s a lot less risky.”
Miranda accepts that IPOs in Brazil in the past “have not been so successful in allowing investors to make money” but believes that Rumo is a step in the right direction. He also thinks the new administration’s rumoured desire to privatize state assets to help close the fiscal deficit will be of interest to international inventors.
Simpson agrees. “We would be very interested in privatizations,” he says. “A lot of state-owned enterprises are very good assets with bad management teams, and it is going to be a buyers’ market, so if they put these companies into the right hands it could be very, very interesting.”