Latin America’s golden moment
Latin America’s financial community should have a spring in its step when it gathers in Guatemala later this month for the Inter-American Development Bank’s annual meeting. The region is buoyant and, aside from concerns about the political direction of a handful of countries such as Bolivia, Ecuador and Venezuela, the future appears bright.
Nowhere is the excitement greater than in the investment banking industry. The M&A, equity and debt markets are all booming at the same time – an unprecedented situation.
In M&A, for example, Brazilian steel maker CVRD’s $18 billion takeover of Canada’s Inco, which was finalized in January, heads a growing trend of multi-billion dollar acquisitions by Latin companies of developed market rivals.
In equities, there was a surge in activity in 2006, 34 IPOs, compared with 20 in 2005. This year there might be even more transactions, with most of the listings taking place in Brazil.
In the debt world, barely a week goes by without a groundbreaking deal in size, pricing or structure. Late last month, for example, Caribbean telecoms company Digicel launched a $1.4 billion transaction, the biggest-ever high-yield corporate bond from the emerging markets. It beat the $1 billion raised by Mexican glassmaker Vitro priced just a month earlier.
In the Digicel transaction, the company’s biggest shareholder, Irish entrepreneur Denis O’Brien, raised money in the US high-yield market to buy out minority shareholders and provide capital for growth. The deal left the company 8.5 times levered, an unheard of level in a region where even half that amount usually raises eyebrows.
The Digicel LBO is indicative of a new era in Latin American investment banking. Financial services in the region are finally beginning to resemble those in the more developed markets of the US and Europe. So leveraged buyouts, private equity, structured credit and other forms of non-traditional financing are gaining greater acceptance. This is partly because the region’s macroeconomic stability allows for sophisticated financing techniques, partly because companies are becoming more expansive, partly because the growing local and international investor pool is seeking yield-enhancing opportunities and partly because investment banks are keen to push high-margin products.
The last point should not be underestimated. Fees in traditional businesses such as sovereign debt underwriting are shrinking even as investment banking in the region is becoming more lucrative. In order to keep their revenue base growing, banks will focus their attention on non-vanilla products. Fees in sovereign bond underwriting, for example, can be less than 10 basis points; in complex high-yield deals, more than 100bp; but in structured pre-IPO financings they can exceed 1,000bp. Banks that put in their own capital as part of an M&A bid can make even more when their stake is sold.
The investment banks, therefore, are all assessing how best to tackle opportunities in the region. Some, such as UBS, are taking the quick-fix acquisition route in the most important markets. Last May the Swiss bank paid up to $2.6 billion to buy Brazilian brokerage Banco Pactual. Others, such as Merrill Lynch, have restructured their entire Latin American franchise to make it a more comprehensive business. Others, such as Goldman Sachs, are taking a more piecemeal approach. The US bank is, for example, building an equity brokerage in Brazil to complement its strong M&A business in the country. All banks are hoping to make hay while the Latin sun shines.
But they need to be careful. Even allowing for its growth, Latin America is a small slice of the global profits pie. Take Citi, Latin America’s biggest investment bank. In its fourth-quarter 2006 results, for example, the region accounted for less than 15% of the bank’s net income in its global corporate and investment banking business. Compared with Asia ex-Japan, for example, net income from the region lagged, though it outstripped EEMEA and western Europe. Latin America generated $228 million in net income compared with Asia ex-Japan’s $322 million.
Banks need to be wary of risking too much capital in the region. It doesn’t take a history lesson to know that Latin America can be volatile. A global liquidity crunch or sudden political or financial crisis in Brazil could lead to all but the most committed players scaling down or even making a shame-faced exit.
The investment bankers gathering in Guatemala know that they need to take advantage of Latin America’s golden moment while it lasts.