The amount of Latin American debt issued this year was less than spectacular compared to last year’s slew of phenomenal deals.
Ironically, though emerging markets suffered from volatility in 1998, there were still big deals to be had in Latin America, many of which seemed to push the envelope in terms of size and structure. During the first half of this year, however, while the emerging markets began a modest recovery, deals coming out of Latin America were much more modest.
“There has been a reasonable number of deals, and a lot of good, very solid deals, but fewer blockbuster deals,” said Paul Tregidgo, head of capital markets for Credit Suisse First Boston.
Despite a number of splashy transactions this year-including Brazil’s $3 billion swap and Chile’s first bond in eight years-by mid-year, bankers and investors both were extremely cautious and anticipating worsening conditions. In June, word that the US Federal Reserve was inclined to increase interest rates was enough to temporarily freeze new bond activity in Latin America. If the Fed raises interest rates by even 25 basis points, said a Salomon Smith Barney report, all Latin markets will be affected, particularly countries like Argentina, which has large borrowing requirements. That’s exactly what Alan Greenspan did at the end of June when he pushed US short-term rates up by a quarter point.
Other factors also have dampened market enthusiasm for new issues. Those conditions include Brazil’s need for government reform, Chile’s recession, corporate defaults in Argentina, more non-performing loans among Colombian banks and the expected bankruptcy of Mexican steel company Ahmsa. “The potential for disaster has been huge,” said one banker, wishing to remain anonymous. “One of the great characteristics of the first half has been the number of good deals to get done in a very tough market.”
One such deal was the $3 billion swap for Brazil, whose story adds even more irony to the year. In January, the decision to abandon the tight currency band and let the real devalue by 8.6% upset markets everywhere and led the central bank governor at the time, Gustavo Franco, to resign. But by April, Brazil’s combination swap/cash deal touched off a day or two of absolute market euphoria.
How did the lead managers time the market?
Their decision was based partly on the fact that Colombia had issued a similar plain vanilla deal a few days before. That transaction, a 10-year issue worth $500 million, was launched under a tighter spread than Colombia’s five-year, $500 million issue launched in March. The 10-year deal was priced at 495 basis points over US Treasurys, compared to the five-year’s spread of 630 basis points over. It was a signal that the time was ripe for plain vanilla instruments-perhaps including one from Brazil. “It was a good signal that Colombia’s deal went well,” said Francisco Pujol of Morgan Stanley Dean Witter, joint manager with Salomom Smith Barney on the Brazil swap.
The euphoria generated by the Brazilian deal, which was surprisingly oversubscribed, and the improvement in Brazil’s macroeconomic figures buoyed Brazilian corporates so much that investors rejected a bond offering from the National Development Bank (BNDES) designed to help Brazilian corporates survive the crisis.
In the third week of May, BNDES had announced it would sell $3 billion or more of 10-year bonds in order to pool the outstanding debt of 90 eligible companies, providing higher value and diversity to investors in the wake of Brazil’s lingering recession. But as the economy improved, investors indicated they were confident Brazilian companies would revive. And BNDES was forced to cancel its offering when orders failed to reach the required $1 billion. It was also reported that some companies eligible for the debt consolidation program were angered by the proposal since it implied that those involved were suffering from poor management and not worthy of investment.
Another blowout similar to the Brazilian exchange took place on the local Argentine market later on. Between May 6 and May 13, the Argentine government offered the holders of more than $25 billion in peso- and dollar-denominated government notes to exchange them for new two-year and five-year dollar-denominated Argentine Treasury bonds (Bontes).
The government received over $10 billion in exchange, but officially exchanged $3.9 billion. The deal, led by JP Morgan and Deutsche Bank, gave investors the option to own more liquid straight bonds and helped establish further development of the domestic benchmark curve. Most importantly, Argentina reduced its debt burden going forward by $500 million for 1999 and by $1 billion for next year.
“It was a transaction designed to extend maturities and conserve the cash flow of the government,” said Gabriel Bochi, vice president of Latin American capital markets at JP Morgan.
On the corporate front, the most outstanding transaction so far has been Repsol’s acquisition of YPF, which generated enthusiasm in the oil and gas sector and provided a window of opportunity for Argentine oil and gas companies to hit the market and ride the wave. Perez Companc certainly did. With a better credit rating than the sovereign, the Argentine company quickly issued a seven-year, $200 million deal that was priced at about 200 basis points tighter than comparable government bonds.
In a February bond issue, YPF achieved an even tighter spread on its 10-year bullet bond for $225 million. It priced inside comparable sovereigns by 340 basis points. Merrill Lynch was the lead manager on both deals.
In March and May, JP Morgan brought two noteworthy corporate deals to market, including the first bond issue from an emerging markets corporate to be denominated in euros. On March 26, Telecom Argentina increased its five-year bond from 125 million euros to 150 million euros upon solid institutional demand. Then on May 11, the bank acted as sole lead arranger and placement agent for the first-ever Europeso deal, a private placement from Nafin in the amount of one billion pesos, or about $108 million.
Additionally, the deal extended Mexico’s domestic bond yield curve beyond one year to three years.
Though sovereign issues from Argentina, Brazil, Colombia, Chile, Costa Rica, Mexico and Uruguay during the first half of the year established new benchmarks for their respective corporate sectors, many corporates have chosen not to tap the markets. While economic conditions prevented them from doing so during the first half, concerns about Y2K likely will affect their plans for later this year. The end-of-the-millennium anxiety building throughout the global financial community is affecting market sentiment. “The Y2K issue is a definite concern,” said Jaime Valdivia-Hernandez of MSDW. “It’s an ever-present issue in discussions on market outlook.” In fact, he said, activity may slow down even more as the end of the year approaches.
Editor’s Choice, Sovereign Bond: Brazil
When considering the field of sovereign bonds for the first half of the year, the most remarkable deal was Brazil’s $3 billion swap/new issue combo that joint lead and deal managers Morgan Stanley Dean Witter and Salomon Smith Barney brought to market in late April. The deal was significant for a variety of reasons. Not only did it usher the sovereign back into the capital markets after a vacation of 12 long months, but it also trumpeted in a new period of investor confidence in the emerging markets following the real’s devaluation in January.
“Who would have thought that by April 22, Brazil would be putting $2 billion new debt into the market?” said one banker from a competing house. “This was by far the most exciting deal of the first half.”
The government swapped $1 billion worth of the new five-year globals priced at 675 basis points over US Treasurys and yielding 11.8% for approximately $1.04 billion (original aggregate principal) of EI Series L bonds due 2006 and almost $406 million of Series A-L IDU bonds due 2001. The Brady bond purchase yield for the EI bonds was 12.8% with a price of $805.23. The purchase yield for the IDU bonds was 11.78% with a price of $953.39.
The deal’s exceptional performance stunned most everyone. The fact that the government was able to raise $2 billion in cash was a fantastic achievement, considering Brazil’s bonds had been yielding 18% to 20% beforehand.
The deal drew cash orders totaling an astounding $6 billion from more than 300 accounts.
Some say investors threw caution to the wind.
But Francisco Pujol, MSDW vice president, says investors instead took advantage of post-devaluation fundamentals. The economy was showing much sounder numbers, and with the devaluation out of the way, investors were a lot more confident in Brazil, he says.
“We hadn’t had investors screaming for more bonds in quite a while,” said Pujol. “It was nice to see that again.”
The deal drew from a broad investor base.
Mutual funds bought 30% of the bonds, retail, insurance companies and pension funds each took 20%, hedge funds got 13%, and banks bought the rest. US investors took 65% of the pie, Europeans accounted for 30%, Latin Americans bought 3%, and Asians took the remaining sliver.
Jaime Valdivia-Hernandez, MSDW principal, said the Brazilian government had several purposes in issuing the bond, particularly the desire to eliminate some of the Brady debt that had been a “distorting element” in the yield curve. “We tried to wipe out as many Bradys as possible,” said Valdivia-Hernandez. But the $1 billion swap actually didn’t make that big of a dent in Brazil’s total debt. Its outstanding Brady debt tops all other emerging market countries, with $9 billion in C bonds alone.
Analysts expect the government to continue trying to mop up old debt trading way off the curve.
Editor’s Choice, Corporate Bond: Perez Companc
Despite the usual group of sovereigns (and infrequent issuers such as Chile) approaching the capital markets this year to establish new benchmarks, very few corporates followed their lead-at least during the first half of the year. And some say the second half may even be quieter.
But among those that did, perhaps the most-appreciated, best-timed deal of the first half came from Argentine conglomerate Perez Companc. Ironically, it had nothing to do with the sovereign having already issued. The company seized an opportunity presented by Repsol’s announced intention to acquire YPF.
The deal, led by Merrill Lynch, was announced around 4 p.m. on April 30, the day after Repsol’s announcement and it was quickly snapped up by hungry investors.
The seven-year, $200 million 144a eurobond was sold mainly (97%) to US accounts with the remainder going to Latin American investors.
The most remarkable aspect of the deal was how tightly priced it was. With a spread of just 375 basis points over comparable Treasurys, this issue achieved the lowest new issue spread and the lowest all-in yield (irrespective of maturity) of any of the 23 Argentine corporate and bank bond issues-including YPF’s-brought to market this year.
The new bond was priced five basis points tighter than the company’s ’07 bond trading at 380 basis points in the secondary market.
“This was a great deal, a great deal,” said a competing banker. “To get the deal done so successfully in an environment that is not easy for corporates was just terrific. It was one of this year’s little gems.”
The transaction was placed with 15 investors, almost exclusively US-based cross-over investment grade buyers represented by four insurance companies, seven investment advisors, two mutual fund managers and two bank portfolios. “Merrill put it to some investors who understood Latin oils,” said the same banker. “For those of us in the market, it was the kind of deal that everyone wished they would have done.”
Another notable corporate deal was Telecom Argentina’s issue denominated in euros, the first Latin corporate to launch a deal in the new currency. The five-year bond, led by JP Morgan, was priced at 500 basis points over the French benchmark bond and was increased from 150 million euros to 200 million euros.
Gabriel Bochi, vice president of Latin America capital markets at JP Morgan, said the Telecom Argentina name is very well recognized in Europe because of the company’s association with European telecoms and because of its good name in Argentina.
Syndicated Loans:Lean Lending
Lead arrangers toughened the terms for Latin American corporate borrowers this year while lower-tier banks reduced their activity, bringing the 1999 syndicated loan market to a near standstill.
Unlike the bond market, the bank market depends on the willingness of retail commercial banks to participate in the transactions. While lead underwriters may have been ready and willing this year, many of the banks that participate on the lower rungs of these syndications have been decidedly unwilling to commit, given the burn scars they incurred during 1998.
“It’s going to take some time for the banks to recover their confidence,” noted William Craighead, market analyst for Loan Pricing Corp.
Those banks willing to loan have cut their available credit dramatically and raised its cost. Throughout the year, bankers have indicated that the reduction in credit is among the biggest constraints hampering the 1999 bank market. And with widespread concern about market risk following Brazil’s devaluation of its currency, bankers have made credit much more expensive. Sky-high prices have ruled out loans for many companies that previously considered the bank market a viable option. Business that didn’t have pressing financial needs were waiting for improved conditions in the capital market rather than going to the bank market for financing, bankers said.
Tighter, costlier credit in the region has created a sluggish loan market, especially in the first quarter. In February, the market hit bottom and left a deep furrow as activity came to a virtual standstill for at least a month.
One company that got stuck in the pipeline was Argentina’s Transportadora de Gas del Sur (TGS), which wanted to borrow $200 million late last year but ended up having to wait more than a month because of lack of interest by banks. Arranged by BankBoston, Citibank, Deutsche Bank and BBV, the deal was funded in December, but the January devaluation of the real caused many banks to temporarily withhold credit. In the end, the syndicate was not built and the loan was not signed until the end of February.
While activity has picked up since then, the outlook for the rest of the year remains uncertain.
“I don’t think there will be a major improvement in the market for the rest of the year,” noted Sit Sae Way, head of Latin America loan syndications for BankBoston.
Because some companies, such as the Brazilian electric utilities Light and Metropolitana, have had little choice but to use the bank market, loan activity does exist. Their joint deal is a prime example of the change in pricing from early last year to this year.
Both companies had to refinance, and even though the total $1.16 billion package was 20% smaller than last year’s, pricing was considerably higher-more than doubled on both tranches.
Coca-Cola anchor bottlers Panamco and Arica-as well as Empresas La Moderna-were other companies that financed through the bank market, helping bolster the recovery. Mexico’s La Moderna signed off on a three-year, $650 million floating rate note facility which has been one of the largest of the year. Panama-based Panamco signed off on a three-year, $300 million deal and Arica, based in Chile, completed a five-year, $200 million package.
Despite concern that Panamco relies on Brazil for 30% of its gross income, the company’s traditionally strong performance and its relationship with the Coca-Cola Co. provided enough confidence for bankers to accept the deal.
One factor that is helping boost the loan market is the resurgence of the bond market.
Said Craighead: “The reopening of the bond markets has taken some pressure off the beleaguered loan market. Although it will take more time for banks to increase their exposure to the region, the liquidity pressure that has hampered the loan market may be eased as existing loans are refinanced with bonds. If and when that happens, there will be more liquidity for new loans.”
Still, after the Fed raised US interest rates, the question was whether Latin American capital markets would feel the effect, drying up any liquidity that may have benefited the loan market going forward.
Editor’s Choice, Syndicated Loans: Light/Metropolitana
As of mid-year, one loan towers above all others: the refinancing package for Light/Metropolitana of $1.16 billion, signed April 19. Not only is it significant for its size, but also for the number of banks that joined in-34 in all. The deal, which extends financing for another year, dwarfed all others in terms of dollar amount and size of the syndicate.
Although many banks, especially earlier in the year, were determined to limit their exposure to Brazil, this deal proved too enticing, especially since the pricing more than doubled from last year’s original loan and since by mid-April Brazil’s economy was showing definite signs of improving. The package was actually 20% smaller than the original, since the companies had repaid that much. But the other debt was rolled over into the new loan package.
The pricing on Light’s portion of the loan, which is $875 million, more than doubled from last year’s Libor plus 350 basis points to Libor plus 925 bps. On the Metropolitana portion, which is $580 million, pricing increased from a range of Libor plus 350 to 400 basis points to Libor plus 850 bps. The terms of the deal were negotiated between the borrowers, the sponsors (AES, Houston Industries and Electricite de France) and the banks that took on the most risk.
“It was a tough process, but we succeeded in convincing all lenders (34) to stay in the deal,” said Paulo Sousa, head of Latin syndications for ABN AMRO, a co-arranger on the Light portion of the project. Other co-arrangers on the Light deal were Banco do Brasil, Deutsche Bank, Societe Generale and West LB. Co-arrangers on the Metropolitana deal were Banco do Brasil, Bank of America, Deutsche Bank, Warburg Dillon Read and West LB.
What undoubtedly prodded any reluctant banks into financing the deal was the amendment structure of the extension, which, in effect, obliged the original 34 to stay in. William Craighead, industry analyst for Loan Pricing Corp., reports that had any of the banks declined to remain in the group, the deal would have failed, since the amendments required 100% approval.
Given the enormous pricing increase, the terms of the deal were generally seen as attractive.
And, given the improved health of the capital markets, it was rumored that this package might well be refinanced later through bond issues.
Two other deals that deserve recognition are the $300 million loan to Panamco and the $650 million loan to Empresas La Moderna. The latter is a three-year, floating rate note facility divided into three tranches, with pricing ranging from Libor plus 650 basis points to Libor plus 700 bps. Closed in late March, pricing on this loan later in the year will adjust to the spread on Mexico’s ’08 global bond. The deal finances the company’s acquisition of Seguros Comercial America.
The Panamco loan, which is a three-year bullet credit, is priced at Libor plus 312.5 basis points for the first three months. Thereafter it’s tied to the JP Morgan Latin bond index with floor and ceiling limits of Libor plus 237.5 basis points and Libor plus 475 basis points, respectively. Because Panamco relies on Brazil for a substantial portion of its operating income, there was some initial hesitation, sources said. But bankers felt comfortable enough with the company’s reputation and its association with Coca-Cola Co. and pushed the deal through.
Public Equity: Barely Breathing
Despite the number of companies waiting to issue equity, the Latin American IPO market has been weak at best so far this year.
Indeed, as of June, the region had only seen two IPOs, three if you count the equity issue of US-based, but Latin America-focused, Internet company StarMedia.
The only two Latin America-based companies to go public during the first half of the year were Mexican retailer Sanborns and Argentine mortgage bank Banco Hipotecario. And each had its quirks. The former was a local issue worth $200 million of shares, while the latter was essentially a $496 million privatization that some bankers described as a private placement.
The truth is that public equity issuance in Latin America has never truly recovered from the blow dealt by the Mexican peso crisis in late 1994. According to Carlos Hernandez, co-head of M&A and investment banking at JP Morgan, in 1994 total equity issues hit a high of about $8.2 billion but soon fell to $1 billion in 1995 in the aftermath of the peso devaluation. And while volumes had jumped back to around at $6.2 billion by 1997, the Asia crisis once again killed any hopes of a recovery, as dedicated equity investors pulled their money out of the region. Between July 1997, when Thailand devalued its baht, and now, Latin America equity funds have faced a constant stream of redemptions, reducing the amount of money they can put into the secondary and primary markets. Outflows in May 1998 alone reached close to $810 million, and between January and June this year they totaled $113 million, according to Salomon Smith Barney.
In April, however, many players grew optimistic over Mexico’s first IPO in more than a year, Sanborns’ $200 million equity offering, which they hoped would encourage a string of Mexican companies to go public. But so far that hasn’t happened. And while the Sanborns deal was oversubscribed, some bankers were skeptical about the source of the demand, considering that the sole underwriter, Inbursa, is also controlled by Sanborns’ owner, Carlos Slim Helu.
In late May, the good news was that dedicated Latin America equity funds were starting to see an uptick in inflows. But nervousness over a possible tightening of US interest rate soon turned off the spigots, with investors redeeming $3.1 million during the week ending June 9, according to Salomon Smith Barney.
While bankers say that a recovery in Latin America’s IPO markets relies to a large extent on what the Federal Reserve does with interest rates, another important factor is stability in the fixed-income market. If investors can get high returns on sovereign bonds, they will not be enticed by equity.
Apart from the return of dedicated money, much also depends on the interest of large global investors, who could bring much-needed liquidity for international IPOs. Still, say bankers, even if global players threw some of their weight behind Latin America’s equity markets, much of that money would likely be invested in the secondary market, where stocks are still trading at below pre-crisis levels. “The appetite for new issues has been at best very limited,” said JP Morgan’s Hernandez.
Of course, that doesn’t mean that a large number of companies aren’t keen to issue equity. Indeed, just by adding up the deals that have been announced or registered, Hernandez estimates that about $7 billion worth of equity issues is waiting in the wings.
“The last few months there has definitely been an increase in companies asking us to come down to pitch and award mandates,” said John Boord, director of Latin America equity capital markets at Salomon Smith Barney. “A lot of companies-both those that had mandates and those that are just now awarding them-are looking at the fourth quarter of this year as a target date to go to market. So the next six months are going to be very critical.”
Editor’s Choice, Public Equity: Banco Hipotecario
Only 13 days after Brazil shocked markets with its devaluation of the real, the Argentine government managed to launch Latin America’s first equity offering in over a year when on January 27 it sold 28% of state-owned mortgage bank Banco Hipotecario. The deal garnered $307.5 million, but the government’s proceeds could reach close to $500 million if investors exercise options attached to the sale.
“The privatization represented the reopening of the equity markets to Latin issuers,” said George Weiksner, head of Latin American investment banking at Credit Suisse First Boston, which acted as joint global coordinator along with Dresdner Kleinwort Benson. BankBoston was the Argentina coordinator.
Most bankers concede that Argentina’s ability to sell any equity at all during such a turbulent period was a considerable achievement, although observers say that concessions were made to achieve that goal.
Still, underwriters managed to sell the issue in the face of a 16.4% drop in the Argentine market as well as a 32.4% decline in local bank stocks between the time marketing began and when the stock was priced.
“My opinion is that it is a remarkable accomplishment given that it is a financial institution and a lot of people had lost a lot of money in Latin America in that sector,” said Carlos Hernandez, co-head of investment banking at JP Morgan. “And that it was done in the midst of a very difficult time.”
To sell the much-anticipated issue-the Argentines had been talking about the sale of Hipotecario for at least a year-underwriters went on a global roadshow that lasted over three weeks, included 22 cities worldwide and 59 one-on-one meetings with investors, according to Credit Suisse First Boston. The marketing effort also included trips to Argentina’s interior, making it the country’s most extensive roadshow ever.
In the end, the privatization generated enough demand to allow the government to increase the deal’s size by 25%. About 36% of the transaction was sold publicly in Argentina and the rest was placed globally. Buyers included foreign institutional players, Argentine pension funds as well as financier George Soros, whose presence was said to have helped lure other investors into the transaction.
Still, critics say that the deal cannot be qualified as a true public global offering, since much of the transaction was sold to local investors and since the deal was placed in the US under Rule 144a, which limits sales to qualified institutional investors. “Hipotecario was a private equity deal or even a strategic sale if you want,” said one rival banker. “It really wasn’t a deal that was a public offering. It was more like a private placement.”
Critics also point to the bells and whistles attached to the offering. Along with the 42 million Class D shares, the bank lured investors by selling 270,000 five-year options to buy 27 million ADSs at the offering price.
Because of market conditions, however, both options and shares were priced at the lower end of pricing expectations. Options were sold for $50 while underwriters dropped the share price to $7 a share, down from price talk of between $8 and $9. According to bankers, that put the share price at a discount to what were already badly hit financial stocks in Argentina.
Yet defenders of the transaction say that Argentina managed to achieve its goals despite market turbulence. As Frank Lopez, head of the Andean region for CSFB, said: “The easy alternative would have been to postpone the sale, given the adverse conditions. The innovative structure allowed us to complete the deal in the worst market environment.”
Editor’s Choice, Convertible Bond: Telmex
The dry spell in Latin American equity issuance received a welcome relief in June when Mexican telecommunications company Telmex issued the region’s largest-ever convertible bond.
The five-year bond was two times oversubscribed and lead managers JP Morgan and Salomon Smith Barney were able to increase the deal from an initial $750 million to $1 billion, a large transaction even during good times. As John Boord, director of Latin America equity capital markets at Salmon Smith Barney, explains, size was also an essential component to the transaction. “The paradox is that in emerging markets when things are bad you have to do a big deal that is liquid otherwise it doesn’t get done,” he said.
According to bankers involved in the transaction, Telmex intended to launch a regular bond issue but was persuaded to issue convertible securities, partly because they offered more attractive pricing and reduced the company’s borrowing costs by half. Telmex executives decided to do a convertible issue about four weeks before the offering, but once they decided to hit the market the deal was turned around within about 24 hours, say bankers. “We didn’t announce it to the market until Thursday morning,” said Carlos Hernandez, co-head of M&A and investment banking at JP Morgan. “The marketing conference call was at 11 a.m. and the deal was priced at 4:30.”
The bonds carry a 4.25% coupon and can be exchanged for Telmex stock at $94.92. The day before the sale, Telmex ADRs had fallen to around $75.94 on worries about stock dilution.
However, the Mexican stock exchange had rallied during March and April, and Telmex ADRs hit a six-month high of $91.875 on May 10.
With a convertible, Telmex was able to tap a wide variety of investors including equity and fixed-income players. US convertible bond investors, who made up about 60% of the buyer base, were attracted because of a dearth of convertible offerings in the market. There also was demand because a number of companies had been redeeming their convertible bonds in the months leading up to the Telmex offering.
“The convertible market proved to be a good window,” said Richard Biebel, a vice president at JP Morgan. “There hadn’t been a lot of convertible paper and the new issue market had been running at lower levels.”
Bankers also say that the Telmex’s blue-chip reputation and its decent balance sheet made it easier to sell among US investors who aren’t necessarily that savvy about companies in Latin America. “We were able to cross over into that group because it’s Telmex,” said Boord at Salmon Smith Barney. “It has a $20 billion market cap and it would be AA (rated company) if it were in another area code.”
Private Equity:The Right Target, The Right Price
Like most investors focused in Latin America, private equity players have suffered the consequences of Brazil’s January devaluation and the subsequent market insecurity. Business has been slow, to say the least. According to industry observers, only one exit of note occurred during that period: The Exxel Group’s $435 million sale of Argentine electricity distributor Emdersa to US-based GPU.
Still, there have been a number of noteworthy purchases between January and June, although not as many as in previous years. In April, for instance, US buyout firm Hicks Muse Tate&Furst agreed to invest about 100 million reais in Brazilian football team Corinthians.
Meanwhile, Juan Navarro, the president of Argentine private equity firm Exxel, continued his expansion into the food sector despite market jitters, forking out $630 million for supermarket chain Tia as well as another $82.5 million for ice cream manufacturer Freddo.
Yet for venture capitalists, its seems that a lack of acceptable terms, rather than a lack of money, contributed to the inactivity. In many cases, investors have been struggling to find the right targets at the right prices, a problem exacerbated by the battered markets.
While the universe of investment opportunities has expanded as companies have been forced to find alternative forms of financing, company owners and investors often don’t see eye to eye when it comes to price, mostly because of differing sentiments over market stability.
“Things look better in Brazil,” said Fred Smith, co-head of international private equity at Credit Suisse First Boston. “But there is still a hefty amount of uncertainty and sellers aren’t going to adjust to reflect that. That is one of the reasons for the slowdown in private equity.”
Tim Purcell, a managing director at JP Morgan, concurs. “A lot of deals being negotiated either got postponed or delayed because companies found it hard to accept that the value of their business was closer to where the public benchmarks were indicating.”
Yet while public markets have recovered somewhat, it is still not clear whether companies will be able to issue equity any time soon. And as a result, says industry observers, many corporates will still look to venture capitalists for financing. “There is really no talk today of getting equity capital from the public markets,” said CSFB’s Smith. “So the only place you can get equity is from private equity.”
With a floundering IPO market, investors have one less way to exit a business, which is why future deals are more likely to involve industries that draw strategic buyers, such as telecommunications, media and retail.
Whether private equity players are looking for a minority or majority stake, another constraining factor has been a lack of qualified management in the region. “The reality is that management is perhaps the scarcest asset in the region,” said Bruce Catania, managing director at Citigroup’s CVC Latin America. “So you tend to back companies with good management.”
Despite those barriers, most participants say deals are in the pipeline and they expect activity to pick up in the second half of the year. Still, says JP Morgan’s Purcell, don’t expect many exits. That’s partly because many investors only started putting their money to work last year when asset values were higher than they are now. “So even if you wanted to exit your company, I am not sure you would be able to get a price that would cover your investment,” he said.
Editor’s Choice, Private Equity: Exxel’s Exit from Emdersa
Many private equity firms can boast about a number of acquisitions in Latin America. But few can claim to have achieved what is considered the real sign of success in this business: a profitable exit. That was particularly true between January and June.
Indeed, according to industry observers, only one major sale took place during that period, and that was Argentine private equity fund the Exxel Group’s sale of electric distribution company Empresa Distribuidora Electrica Regional (Emdersa) for $435 million.
Nevertheless, selling at a profit in early March when the deal was closed couldn’t have been easy, particularly considering that markets were still reeling from Brazil’s devaluation in January. Still, says an Exxel Group spokesman, the private equity firm managed to hit a 60% internal rate of return on this investment, despite the fact that shares of power distribution companies had dropped 30% around the time of the sale.
Exxel had built Emdersa by consolidating three electrical distribution companies in Argentina’s provinces, which it bought in privatizations between 1993 and 1996. The idea was to buy into the less competitive privatizations in Argentina’s interior, where the larger international players were less likely to tread.
“Our investment strategy is to buy high quality established companies and make them better. We put in place an aggressive plan vis-à-vis revenues,” said the spokesperson. “In addition, we bring in very good management and usually provoke a change in strategy and vision.”
“It was a good strategy to acquire these small electric distribution companies in regional Argentina, which on a stand alone basis were too small, and put them into one business,” said Tim Purcell, a managing director at JP Morgan.
And although Exxel thought that the most likely exit strategy would be an IPO, it decided to sell the company to strategic players. “As long as we executed our business plan, the companies were attractive not only for an IPO but also for strategic buyers,” said the Exxel spokesperson.
In the end, four companies showed a serious interest in the company, with US energy firm GPU International winning with a $435 million bid. PSEG Global came in second with a bid of around $380 million. Tom Smith, president of PSEG Americas, a wholly-owned subsidiary of PSEG Global, says they submitted the bid because they already had operations in Argentina and wanted to see if they could get Emdersa for a good price.
“GPU decided, confusingly to me, that they were strategic entry assets to the Argentine market and were willing to pay, in our opinion, a strategic premium,” said Smith.
Says GPU communications manager Elaine Davis, GPU’s strategy is to leave the merchant generation side of the business and enter distribution. And this acquisition was part of that strategy. Moreover, she says, that the companies were very well-managed and are experiencing electric demand growth rates of 6% a year. “We paid full price, but not as high as others in recent times,” she said.
Mergers&Acquisitions:Buyout Binge
For those who thought investment bankers were having a rough time in Latin America, a quick look at the region’s M&A market tells another story.
“We are extremely busy,” says Roger Ullman, head of Latin America M&A at Merrill Lynch. “We are seeing our best year ever.” Tim Purcell, a managing director at JP Morgan, seems equally upbeat. He expects the second half of the year to be even busier than the first, as Latin American economies start to grow and the ability to access financing becomes easier.
Who can blame bankers for their optimism?
Despite gloomy market predictions in the wake of Brazil’s devaluation in January, this year has seen all kinds of mergers and acquisitions, including Repsol’s high-profile public bid to take over YPF and Endesa of Spain’s battle for control of Endesa of Chile.
In the bottling and beverage industry, Coca-Cola purchased 50% of Peru’s Inka Kola while Chilean bottler Arica acquired the Latin American bottling assets of UK conglomerate Inchcape PLC. Meanwhile, British Telecom made its first foray into the region in March when it paid $146 million for a stake in Latin American telecom company ImpSat. In the financial arena, Italy’s Banco Commerciale Italiana (BCI) this year bought Peru’s second largest bank, Banco Wiese, while Spain’s Banco Santander Central Hispano took control of Chile’s biggest financial institution, Banco Santiago, although some local politicians seem keen to stop the merger between the two banks.
Of course, there is nothing unusual in such frenzied activity, particularly in Latin America. According to Credit Suisse First Boston, between 1995 and 1997 the volume of total deals jumped from around $22 billion to $76 billion, while total volumes for both 1997 ($76 billion) and 1998 ($87 billion) were larger than the previous 10 years combined.
Privatizations, of course, have driven much of that growth, with about 40% of total M&A volumes in 1998 being attributed to the sale of state enterprises.
So will the rapid pace of M&A activity slow down as Latin American governments run out of assets to sell? Not necessarily. Many investment bankers say that this is the beginning of a second stage in which companies that hurried into the privatization process will now start rethinking and focusing their regional strategies. In some cases, that means increasing their stakes in companies to create regional or international platforms.
Often such acquisitions have involved buying from minority shareholders, such as US institutional investors and local pension funds, which participated in privatizations earlier this decade but now are willing to sell their stakes to strategic players as long as terms are favorable. Bankers not only point to the YPF and Endesa transactions as examples of this trend, but also to what is happening in Brazil’s telecom industry in the wake of last year’s sale of state-owned telecom Telebras.
In May, Spain’s Telefonica made a bid for four of Brazil’s regional cellular operators by offering to buy out publicly held interest in those companies. The Spanish telephone company offered shareholders a 60% premium over the share price, which was in fact lower than the price that Telefonica had paid during the Telebras privatization, said Corrado Varoli, director of M&A at Morgan Stanley Dean Witter, advisor to Telefonica.
“It’s the beginning of a trend in a lot of Telebras companies, where controlling shareholders try to acquire more to have the benefits from the restructuring that’s going to take place,” said Varoli.
Some bankers also see the recent wave of high-profile public bids for companies as a sign of a maturing M&A market. While such deals are still the exception rather than the rule, they illustrate that acquisitions are starting to take on a more open, US flavor despite corporate Latin America’s tightly held ownership structure.
“It’s amazing that people have done hostile deals in Latin America, and that governments have allowed it,” said one banker. “To me those deals show the maturity of the market.
Now foreigners can say ‘okay I understand how this works: if I pay high, I win. I don’t have to worry about the buddy of the cousin and his relationship to the regulator.’ ”
The composition of buyers is also changing, says Diego Recalde, managing director of the M&A group at CSFB. He points to the increase in intra-regional acquisitions as local players such as Juan Navarro, the president of Argentine private equity group Exxel, aggressively expand into other countries.
Today, Recalde says, Latin American players make up about 50% of the buyers, up from 30% only a few years ago. Still, says JP Morgan’s Purcell, Latin Americans’ enthusiasm for acquisitions in other parts of the region is likely to wane simply because financing is less readily available. Instead, he says, local companies will probably concentrate on their core markets and postpone any expansions for now.
Meanwhile, the Europeans who have dominated the buying spree on the international side are seeing US companies enter the region more aggressively. Recalde says that’s because until recently, Europeans were less concerned about the cost of capital and had lower return expectations than US companies-a situation that has changed as Europe’s corporate landscape becomes more like the US.
Editor’s Choice, M&A: YPF
Apart from perhaps Endesa’s battle to gain control of its namesake in Chile, no deal this year has stirred as much controversy and attention as Repsol’s acquisition play for Argentine oil company YPF. Indeed, the transaction is significant in a number of ways. Not only is it large-the total cost to Repsol came to about $15.17 billion when in late June it pushed its stake in YPF to 98.23%-but the deal also means that Argentina will lose its major benchmark stock and thus see a considerable drop in the market capitalization of its local bolsa.
The purchase also is one of the largest, if not the largest, public tender offer for control of a Latin American company ever, an unusual event in a region where public takeover bids are few and far between.
And finally as Roger Ullman, head of Latin America M&A at Merrill Lynch, one of the advisors to Repsol, points out, the transaction represents a dramatic shift in attitudes toward foreign investment in the region.
“When we took YPF public in its privatization in 1993, it was unthinkable for the company to be acquired by a foreign oil company. In fact they built in protections against that. And Repsol had to work within those limitations,” he said.
The two-part transaction germinated last year after poor market conditions forced the Argentina government to scrap a public offering of its 20.3% stake in YPF. According to Salomon Smith Barney, advisor to the government at the time, Argentine then decided to invite 25 oil and energy companies, such as local conglomerate Perez Companc as well as foreign players like BP Amoco and Enron, to make bids for 14.99% of YPF. If the government had offered a larger stake, local bylaws would have required the winning bidder to make a cash tender for the remaining shares. In the end, observers say market jitters over low oil prices and preoccupations with merger activity elsewhere in the oil world meant that Repsol emerged as the sole bidder with an offer of $2 billion.
Those who thought that Repsol wouldn’t be content with just 15% were proved right when the Spanish company made a public offer for 85.1% of YPF. According to Merrill Lynch, Repsol’s $44.78 per share offer brought the transaction value to $13.4 billion, or $17.2 billion if net debt assumption of $3.8 billion is included.
“After the initial sale, a lot of people expected that to happen,” said Christopher Foskett, managing director of M&A for emerging markets at Salomon Smith Barney, advisor to the government for the sale of the 14.9% stake in YPF. “In the first deal they were the only party to submit a final bid, and they moved quickly thereafter to consolidate a control position.”
And as Foskett points out, Repsol also was able to rely on its advisors for sizable financing commitments. To pay for the cash transaction, Repsol has access to $16 billion in short-term loans from a syndicate of banks made up of Goldman Sachs, Merrill Lynch, the CitiGroup, UBS, BBV and Caixa. After the company said that part of this debt would be covered with the sale non-strategic assets, cost reductions as well as an offering of new shares and a euro convertible issue-both of which will be jointly run by Merrill Lynch and Goldman Sachs. In May, Repsol kept its promise by issuing floating rate notes worth 3.23 billion euros, the largest-ever euro denominated corporate bond. In June, the Spanish company also completed a capital increase worth $4.8 billion.
Honorable Mention, M&A: Endesa of Chile
Endesa of Spain’s $2 billion acquisition of Endesa of Chile also deserves mention not only for its size, but also for the drama and uniqueness of the transaction.
After a drawn-out battle with local regulators and an opposing US bidder, Santiago-based Enersis finally took control of Endesa-Chile in May when it bought an additional 30% of the company’s listed stock for around $1.8 billion, marking the largest stock market bid in Chile’s history. That move doubled Enersis’ share in the company and allowed Endesa of Spain, which now controls 65% of Enersis, to take over its namesake in Chile. Later that month, the acquisition of Endesa of Chile’s ADRs in New York completed the transaction, bringing the deal’s value up to the $2 billion mark.
Yet this deal was by no means easy for Spain’s Endesa. Not only did the Spanish energy company have to overcome Chile’s anti-monopoly commission-which after blocking the acquisition finally approved the auction of Enersis shares-but it also had to fight off US-based Duke Energy for control of the Chilean electricity company. It was only after Duke backed down from its $3 billion bid for 60% of Endesa that Enersis was left as the sole bidder for the Chilean power generator.
Adding excitement and complexity to the transaction was the fact that Endesa of Spain had only just increased its stake in Enersis to 65%, up from 32%. That deal also turned out to be a protracted battle for control in which efforts to lift limits on shareholder concentration were initially rejected and then accepted by a group of pension funds and US institutional investors that held Enersis shares.
Tim Purcell of JP Morgan sees these two Chilean transactions as part of new trend in Latin America, where strategic players are taking control of publicly traded companies as a way to gain access to these sectors in Latin America.
“The fact that operators from outside have now tried to gain control by tendering for these shares demonstrates that strategic buyers are prepared to be more aggressive in order to gain access to the Latin American markets,” said Purcell.
Will the market see similar style takeover bids in Latin America? It’s possible, says Purcell, but the target needs a scattered shareholder base rather than one controlling owner. And that may be difficult to find in Latin America, where most privatizations have involved selling controlling blocks to international operators.
Privatization:Shifting Strategies
Over the past decade, governments in most Latin American countries have aggressively sold off prominent state-owned companies as a way to improve efficiency and raise revenue.
But the privatization wave in Latin America is ebbing as companies have snapped up the large public enterprises and regional economic instability has injected further risk in the market.
“Privatization was the name of the game in 1998,” said Corrado Varoli, director of Latin America M&A at Morgan Stanley Dean Witter, “but I think it is much less so in 1999, and certainly going forward.”
Latin America, say industry observers, is now experiencing the corporate consolidation phase, a trend expected to gain speed in coming years. Companies that once took part in the region’s privatization movement are re-thinking their strategies, divesting their holdings, and focusing on core businesses.
Though the pace of privatizations has slowed in sectors such as telecommunications and energy, governments recognize that other public industries such as water and sanitation, hydrocarbons and banks are profit niches too.
The São Paulo Gas Company, or Comgas, is a case in point. The Brazilian government in April raised nearly $1 billion from the sale of Comgas, Brazil’s largest gas distribution company. And in Chile, following the country’s first-ever privatization of a water and sewage company in December, the government sold 42% control of Santiago water utility Emos in June for $960 million.
“The water and sewage business is very hot these day,” said Roger Ullman, head of Latin American M&A at Merrill Lynch. “(Water and sewage) infrastructure is in need of substantial improvements, governments need the money and they don’t want to make these large investments.”
In June, Brazil decided to open its oil industry to foreigners for the first time in over 50 years by selling exploration contracts in 27 areas. BG Exploration and Production Ltd., BP Exploration Operating Co., Chevron Corp., Petroleo Brasileiro SA, Shell Brasil SA and Texaco do Brasil Ltd. are among the 38 companies qualified to bid. There is no minimum price for the exploration areas on sale.
“It is very significant for Brazil that the country is beginning a process of selling exploration properties that will compete with Petrobras,” said Merrill’s Ullman.
While some analysts say that the private sector’s involvement in Brazil’s oil industry may help nudge the government to privatize Petrobras, Jose Carlos Mendonca, head of equity research at Banco de Investimentos CSFB Garantia, says such speculation cannot be confirmed. However, he did say the government “may consider other alternatives,” such as selling the distribution side of Petrobras.
Another key transaction to keep an eye on in Brazil is the privatization of the São Paulo state bank, Banespa, which is scheduled to occur in the second half of the year. Though the minimum price has not been disclosed, there have been reports that the government is expecting to raise approximately $880 million.
Brazilian banks Bradesco and Itau, Spain’s Banco Bilbao Vizcaya and UK’s HSBC have expressed interest in Banespa, pending conditions set by the government.
A number of other banks in Brazil may be put on the auction block this year as the central bank continues to spearhead efforts to reduce the number of state-owned banks. Among these institutions are Paraiban (of Paraiba), Banep (of Bahia), Banestado (of Parana) and BEM (of Maranhao).
Frank Lopez, head of the Andean region at Credit Suisse First Boston, says that for the rest of the year, the sale of public services like railroads and airports also can be expected. The Mexican electricity distribution system, he added, could also prove to be a very substantial asset for the government.
Despite these pockets of activity, market volatility in Brazil and across the globe has cooled corporate enthusiasm for massive investment in the region. “In general, the financing environment has been relatively weak in Latin America, and therefore financing has been more difficult to obtain for a lot of the buyers,” said Merrill Lynch’s Ullman. “This has meant that a lot of the more opportunistic buyers have remained on the sidelines; we’ve seen a smaller number of committed and strategic buyers.”
A number of large transactions, such as the 51% sale of Empresa de Telefonos de Bogota (ETB), which is expected to garner over $1.1 billion, have been postponed or delayed. “Some transactions represent sizable dollar amounts in terms of investments, and some companies, given the way the year started, have reconsidered their plan in the region,” said CSFB’s Lopez.
Editor’s Choice, Privatization: Comgas
Despite the negative effects of the Brazilian currency devaluation and the global financial crisis, the Brazilian government successfully executed the privatization of Comgas, a deal that not only garnered close to $1 billion, but also gave international investors in Brazil much needed assurance about the region’s prospects.
A consortium composed of British Gas (95%) and Royal Dutch/Shell Group (5%) in April paid a surprising $988 million for a 67% controlling stake in Comgas, or more than double the minimum asking price of $430 million, and well above the second-place bid of $770 million from US-based Enron. Other interested bidders included Aguas Barcelona and Gas Central from Spain.
Tim Purcell, managing director at JP Morgan, which advised BG, said that the price paid for Comgas and the fact that several world-class operators made attractive bids for the first major asset sold by the government after the crisis, sent a “very strong positive message” in the market.
Lehman Brothers and Unibanco advised the government on the sale while JP Morgan and Dresdner Kleinwort Benson served as advisors to BG and Shell, respectively.
In addition, Comgas marked a key step in the Brazilian government’s 1999 privatization drive, in which it hopes to raise more than $12 billion with the sale of about 30 companies.
Though the investment environment in Brazil after the devaluation may have looked bleak, Comgas’ successful sale demonstrated investors’ confidence in Brazil’s medium- to long-term outlook.
The competition for Comgas came as no surprise. As Roger Ullman at Merrill Lynch points out, any company interested in gas in the Southern Cone would consider Comgas a strategic asset. The Bolivia-Brazil pipeline inaugurated earlier this year, and the clear benefit of owning a gas distribution franchise in São Paulo, one of the world’s largest cities, makes Comgas particularly attractive, he added.
In addition to the potential of the concession area-which holds a GDP about the size of the Argentine economy-Comgas fits perfectly with BG’s strategy in the Southern Cone, said Oscar Prieto, former Latin America new business developer at BG, and now president of Comgas.
“The only missing link in (BG’s) South America gas chain was gas in Brazil,” he said. “That’s why it was extremely important for us to win Comgas. It provided us with a platform to launch our aggressive expansion program.”
MSDW’s Varoli says Comgas is also an important piece of the puzzle in Shell’s Latin America strategy. “They are going to try to use their economic leverage by adding these equity investments to really develop the markets and create value.”
Honorable Mention, Privatization: Emos
Another multimillion dollar deal that deserves recognition is the Chilean government’s sale of the country’s largest water company, Emos, which serves the capital city of Santiago.
Sociedad General de Aguas de Barcelona SA and Suez Lyonnaise des Eaux in June, advised by Citibank, paid $960 million for a 42% stake of Emos, or more than double the minimum price of $420 million.
A consortium led by UK’s Thames Water placed the second highest bid with an $811 million offer. A French and Spanish consortium was the third group to participate in the hotly contested process.
Despite political opposition, the Chilean government was able to stick to its scheduled bid date for Emos and obtain a desirable price, according to Alberto Shilling, assistant director of corporate finance at Rothschild Weise Chile Consult, which served as advisor to the Chilean government on the sale.
Added Hernan Uribe, general manager at Dresdner Kleinwort Benson in Chile: “The price paid demonstrates investors’ confidence in Chile and in the regulatory system of the water sector.”
Bankers say the Emos sale-and that of 40% of Esval, the country’s second-largest water company sold in December for $138.4 million-will undoubtedly help pave the way for future privatizations in Chile’s water sector.
Project Finance:An Improving Picture
In the field of project finance, the fact that any deal got financed at all over the past year was newsworthy, say many bankers. Despite continued growth in Latin American telecommunications, continued privatizations of utilities, and plenty of opportunities to invest in oil and mining infrastructure, there had been a depressing lack of capital markets project financing throughout the region until only recently.
The successful closing of the Argentine gas project Compañía Mega, which took an incredible two years to complete, seems to have turned things around somewhat. There have been plenty of reasons for delay as Asia tanked, commodity prices bottomed out, and much of Latin America fell into recession.
Economics have had an impact on investors as well. For instance, by late June, the Peruvian government had tried unsuccessfully to privatize the Quicay gold deposit on four separate occasions. The asking price was slashed each time from the original $10 billion down to $7.2 billion as of June 14, but still there was no investor interest at all. That the price of gold is so low may well be the reason.
Country risk is involved, too. Take the $400 million PIGAP II natural gas injection project in Venezuela as an example. Financing was lined up in November 1998, but by March the consortium that had been awarded the project pulled out of the deal. According to industry observers, banks were unwilling to commit funds to Venezuela.
Fortunately, global economics have stabilized and oil prices have risen. So while Venezuela or Ecuador may be risky at the moment, the overall climate in Latin America is improving.
Within that context, where will the opportunities be going forward? Deals linked with export flows, say bankers. This would include Compañía Mega as well as Peruvian and Chilean mining projects Antamina and El Tesoro. “The markets are coming back, but there will be a tiering of transactions,” said Bayo Ogunlesi, head of project finance for Credit Suisse First Boston. “Clearly, export-oriented deals will have a much easier time getting done than just purely domestic power projects or pipelines or transmission lines or water plants.”
For the medium and long term, utilities and the oil&gas industry hold tremendous growth potential, according to participants in a US Department of Energy round table discussion held in June. Chakib Khelil, petroleum advisor for the World Bank, emphasized that the energy demand in the region is expected to increase significantly between 1996 and 2010. At the same discussion, it was suggested that regional refinery centers be planned, something that would open up financing opportunities even more.
Editor’s Choice, Project Finance: Mega
When neither the country where the project is located nor the principal market for the project’s exports is rated investment grade, it makes it tough for any project to obtain investment-grade status. But in the end, the $676 million Compañía Mega gas project was able to get off the ground because it made the grade-BBB- from both Standard&Poor’s and Duff&Phelps Credit Rating Co.
“Ultimately, the way we got this thing done was by getting investment grade ratings for the debt,” said Bayo Ogunlesi, managing director and head of project finance for Credit Suisse First Boston, which lead managed the project’s bond financing. But it almost didn’t get done. Lead arranger Citibank and lead manager CSFB spent more than two years to bring to market a deal that had both loan and bond elements.
Back in September 1998, the loan portion was expected to be as much as $400 million of the $676 million, with the capital markets portion exceeding $200 million. As it turns out, the final package includes a $175 million private placement bond issue and a floating rate note (FRN) style loan divided into two tranches.
The first is a $195 million, 10-year facility priced at Libor plus 325 basis points that steps up to Libor plus 375 bps. The second is a 13-year, $102 million piece whose pricing starts at Libor plus 345 bps and steps up to Libor plus 400 bps. Because FRN facilities in Argentina are technically considered bonds, Standard&Poor’s reports that this project is 70% debt financed. The private placement consists of 15-year amortizing notes priced at 500 bps over similar Treasury notes.
The three phases of the project include building a natural gas separation plant in the La Loma Lata region, a pipeline from there to Bahía Blanca and a gas fractionation plant at Bahía Blanca. The primary purchaser of the natural gas, project co-sponsor Petrobras, was one of the key participants in the deal. The project’s other sponsors include Dow Chemical (63%) and YPF (27%). Although sources said that Repsol’s acquisition of YPF had nothing to do with the closure of this deal, the announcement did set off a mini-boom in financing activity within the region, especially from within the Southern Cone.
The sponsors have provided for completion guarantees, which help offset construction risk, and the project has obtained insurance to help protect lenders against force majeure events, according to Standard&Poor’s. “In the worst case scenario, if Petrobras defaults or stops importing, it can always sell the product on the international market,” said Ogunlesi, a factor that the credit rating agencies took into consideration.
According to analysts, the loan was priced off the bond issue to ensure a market return and avoid the wide pricing difference between the bank and capital markets which has frustrated many projects recently. Bankers attributed the success of the deal to both pricing and structural factors, noted William Craighead, market analyst with Loan Pricing Corp. He said the bank group that formed the syndication-21 banks in all-is large by recent standards and may indicate a recovery in the project market after many months of relative quiet.
Structured Trade Finance:Wary Dealmakers
Watching and waiting appeared to define the structured trade finance market in Latin America during the first half of the year as players shunned unmanageable risk. Aside from the usual export credit agency transaction, the execution of deals in 1999 has been sparse, say bankers.
“There were a lot of deals being discussed, but either banks or actual customers backed off,” said Charlene McKoin, vice president, structured trade finance at Bank of America.
Though much of this inactivity is being blamed on the Brazil currency devaluation-which forced banks to reduce exposure in the region-observers point out that Argentina’s upcoming elections, Ecuador’s financial crisis, and Venezuela’s political woes have also taken their toll.
But market confidence-and necessity-are gradually replacing apprehension. Bankers expect structured trade finance activity, which improved drastically in April, to pick up in the second half of 1999 as postponed deals start to materialize.
“I think there will be more comfort in the market,” said Ed Hogan, managing director, structured finance at Warburg Dillon Read. “(Issuers) that have been waiting on the sidelines will find either they can’t wait any longer or will find spreads attractive enough to come to market.”
In addition, an increase in particularly export-backed transactions can be expected for the rest of this year and well into next year. “With all the turbulence that we’ve had in emerging markets in the last two years, it’s the only cost effective way, and in many cases the only way, for emerging market issuers to raise money,” added Hogan.
Editor’s Choice, Structured Trade Finance: Pemex
Though few transactions materialized during the first half of 1999, there were a couple of deals-either because of their size or simply because they were completed-that deserve recognition.
Two mammoth oil-backed bonds, issued by Mexico’s Pemex and Venezuela’s PDVSA, both state-owned oil companies, blew the competition away. “There’s no comparison to these deals in terms of size,” said Carlos Costa, an associate director at Standard&Poor’s.
Though size was the determining factor in selecting Pemex’s $2.6 billion bond-after all, most export receivable transaction in Latin America have ranged historically between $100 million and $400 million-the fact that part of the transaction came in February in the aftermath of the Brazil’s devaluation and was still a success also deserves a pat on the back.
Most state-owned oil companies, battered by plummeting oil prices, have opted to issue debt based on export receivables because they can borrow at lower rates than in the general corporate bond market.
“The (Venezuelan) government realized that the cost of debt they would obtain issuing through PDVSA Finance would be significantly less than it would have realized if it had tried to issue sovereign bonds-if it was able to sell them given the turbulent market conditions at the time,” said Michael Morcom, structured analyst at Duff&Phelps Credit Rating Company.
PDVSA last year issued a $1.8 billion oil receivables-backed bond, and in March of this year, through its offshore subsidiary PDV Finance, launched a five-tranche $1.8 billion dollar bond. The issue, led by CSFB and Goldman Sachs, was largely dollar-denominated ($800 million) but also included a euro-denominated section (Eu200 million, or about $212 million), a feature which helped attract a wider investor base.
PDVSA paid a premium of 4.75% over US Treasury notes, and the deal was rated A3 by Moody’s Investors Service.
Still, Pemex managed to launch a similar bond one month prior to PDVSA’s transaction. The Mexican oil company issued a receivable-backed deal in December, a four-tranche $1.5 billion deal led by Goldman Sachs, JP Morgan and Morgan Stanley Dean Witter. Then in February, it issued a $1.1 billion four-tranche deal with a similar structure and same lead managers as the previous issue. At the same time, Pemex topped the transaction off by issuing $100 million of floating rate notes, which were managed by Goldman Sachs.
The debt is securitized by receivables where buyers of Pemex oil pay into an offshore Pemex subsidiary for the oil. The 30-year program was rated BBB by S&P.
Honorable Mention, Structured Trade Finance: Bunge Trade Ltd.
Though not comparable in size to the oil-backed deals, market participants applauded the Warburg Dillion Read-led $225 million 144a issue for Ceval Alimentos, Latin America’s largest soybean processor. The 9.25% collateral export notes, due 2002, were issued by Bunge Trade Ltd., a special purpose vehicle set up by Bunge International, the owner of Ceval.
The unique structure, pricing and the fact that it was the first corporate debt issue in Brazil since the currency devaluation in January is what makes this issue noteworthy.
Unlike a traditional securitization, the deal involved a revolving credit facility, said Ed Hogan, managing director in structured finance at WDR. “Ceval doesn’t need long-term debt, but long term access to short-term debt, and this structure provides that,” he explained.
Proceeds of the notes will be used to provide Ceval with a revolving credit facility from Bunge Trade. During the life of the three-year transaction, Bunge Trade can make advance payments of up to 24 months to Ceval in exchange for export products.
“Therefore, Ceval is able to reborrow money,” said Standard&Poor’s Costa. “That’s a unique feature of the transaction. This is perhaps the most different and distinctive transaction that we’ve rated here in the first half of the year.”
Priced the same day as the Brazilian sovereign bond offering, the Ceval deal was launched at a spread of 425 basis points over Treasurys-almost 300 bps tighter than the sovereign.
The structure of the deal, which is based on Ceval’s export flows, also helps mitigate convertability and transfer risk, said WDR’s Hogan. Meanwhile, the transaction was rated BBB- by both Duff&Phelps and Standard&Poors.
According to both rating companies, the rating reflects the credit quality of Ceval, the strength of its export sales of soybean products and the structure of this program, which helps mitigate sovereign risk.
“What’s remarkable is that there’s no sovereign risk insurance involved,” added Hogan. “The fact that Bunge is a recognized name, combined with the deal structure and the scarcity of Brazillian corporate issues, made for a successful transaction.”