Latin American companies have charged into the primary equity market like bulls out of the gate, making the most of the region’s relative economic stability and hoping to tempt investors hunting around for new names. Companies in Chile, Mexico and especially Brazil, armed with strong financials, compelling stories – and the need for cash – have barreled into the local and international markets at a pace not seen for years.
International equity investors are eager to put idle cash to work, particularly in companies that can claim some exposure to Latin American consumer markets. And in a sign that retail investors in the region are warming to equities, all the recent offerings have included strong participation from individual investors in the companies’ home countries, giving issuers the diverse equity base they are seeking and adding some much needed liquidity to the region’s stock markets.
Latin American companies and banks have taken on $21.09 billion in debt over the last 18 months as interest rates fell. They now need to deleverage their balance sheets, as well as finance acquisitions and investments.
Beginning in April with Companhia de Concessões Rodoviárias (CCR), a Brazilian toll road operator that came to the market with the year’s first (secondary) equity offering, and continuing at a brisk pace through the end of June, a steady stream of Latin American companies has raised more than $1 billion through equity offerings. This stands in sharp contrast to negligible activity in the markets over the last year several years. Not a single IPO came to market in Latin America last year.
But the window of opportunity remains frustratingly narrow. Investors, while pleased to see new names in the market, are not going to pay any price for Latin American shares – even if they still look relatively cheap. Investing in Latin American equities is a high-risk undertaking that until recently has delivered only losses from plunging markets, crashing exchange rates and double-crossing majority shareholders. Now, concern over the possible impact of increasing US interest rates weighs heavily on the market. The window is closing rapidly for companies that want to hit the market before interest rates start rising and before the markets shut down for winter vacations in the southern hemisphere and the summer hiatus in the north.
“Now the market is open for issuers, and deals can get done and will get done, but they will get done at the right price” says Frank Hegeman, head of Latin American investment banking at Deutsche Bank, which has a mandate from the Chilean utility Gener. “Investors are very cautious and sensitive to price, and to the terms at which the deals get done. There is not an overwhelming desire to buy stocks at all costs.”
Although markets across the region rallied strongly last year – the MSCI Latin America index rose 67% in 2003 and São Paulo’s Ibovespa index climbed 97% in dollar terms – the longer-term record is poor. Investors who piled into the Brazilian equity market at its last peak in 1998 have lost heavily, with the stock index down 35% in dollar terms since then. This year, Mexican equities have performed well, with that country’s benchmark index rising nearly 15% through mid-June, but indices in Brazil, Chile and Argentina are all deep in negative territory. Under these conditions, only companies with truly convincing stories, strong management and a good reputation for disclosure and corporate governance have made it to market.
The biggest success story was the May IPO by Cencosud, the Chilean supermarket and home improvement chain that is expanding its Argentine operations. The company, privately held since 1960 by founder Horst Paulmann, raised $331.8 million from international and local investors in an offering led by bookrunners BBVA Securities, BHIF, Celfin Capital, and Santander Investment Securities. The offering was five times oversubscribed. Cencosud recently acquired the Argentine supermarket chain Disco from troubled Dutch company, Royal Ahold, for $315 million in an alliance with several private US-based private equity funds and the International Finance Corporation.
Lawrence Golborne, Cencosud’s CEO, says the company began preparing for an IPO late last year because it both needed the money to help finance its expansion and because it thought conditions were favorable. The company watched successful secondary offerings last year by La Polar, another Chilean retailer, and Corpbanca, a bank. “Essentially, we thought it was a good moment for us to go to the market,” says Golborne.
Cencosud could have placed the entire offering with Chilean pension funds, but wanted to develop a more diverse base of investors that included foreigners as well as locals. “For us, the intention was to broaden ownership as much as possible,” says Golborne. “This is good for liquidity and we wanted to do it in both markets to have strong financial support.”
It has been some time since Latin American companies needed – or felt inclined – to raise equity capital. For one thing, a depressed global economy curtailed the need for investment. And until last year, local stock prices were depressed. In any case, Latin American companies traditionally prefer to raise debt finance, which has been relatively easy for the last 18 months. Mexican blue chips have the additional advantage of having a large domestic market that will buy local-currency issues at razor-thin spreads. As economies throughout the region improved in 2003, companies needed to consider new sources of financing. Issuing stock began to look attractive because share prices rose strongly last year, boosting corporate valuations. Those with strong year-end financials, began to push their deals out the door.
Catching A Wind
“There is no point in thinking about raising equity if you don’t have a reasonably favorable wind behind you, conditioned by the macroeconomic situation,” says Nicolaas Millward, head of Latin American equity capital markets at UBS, which has led three Latin American equity issues this year. “US growth has had a major impact on Mexico and global growth has had a major impact on Brazil. The Latin American equity markets had a pretty good run last year, so companies have been making their move.”
One issue that captivated international investors was Natura Cosméticos, Brazil’s version of Avon, which has recruited thousands of women to sell its make-up, lipsticks and scents to their friends. The company’s $240.9 million offering in May, which represented 22% of its total equity, was the first IPO out of Brazil in more than two years. Demand for the shares outstripped supply by 10 times.
Bankers say the market’s appetite for isssuers with a strong identity, able to distinguish themselves from the natural resource, telecom and utility companies that dominate the region’s equity markets helped drive up demand for Natura. Investors are especially attracted to consumer companies. “There have been so many years without any IPOs or new ideas,” says Evandro Pereira, co-head of capital markets at Banco Pactual, one of Natura’s bookrunners along with UBS. “The market is dominated by telcos and utilities, and the market is looking for new ways to trade Brazil,” he says.
Maria Negrete-Gruson, senior portfolio manager at DuPont Capital Management, who bought Natura stock, says she likes the company’s potential, its resilient earnings growth and strong management. “Exports have been the traditional place to hide in Latin America,” says Negrete-Gruson. “You close your eyes and place faith that they will do well. But there are lots of consumers in Brazil. It is a very large space and there should be a way to participate in that.” Natura’s stock closed at R$36.50 on the first day of trading and in mid-June was hovering around R$42.
One of the most notable features of the Natura deal was the number of local retail investors it attracted. Like most countries in Latin America, Brazil’s stock market does not have many domestic retail investors, thanks to high interest rates, poor performance and a history of abuse of minority investors. The result is a relatively illiquid market dominated by institutional investors that own stakes in a handful of large names, mostly privatized companies. The mass appeal of Natura’s products helped pull in a new investor base – a feat that only companies familiar to retail investors can achieve.
Regulators and the São Paulo Stock Exchange have been trying to tempt individual investors into the market for years with little success. This could be changing. Brokerages that joined as selling agents for Natura’s IPO and offerings last year by paper and pulp companies Suzano and VCP negotiated fees that rewarded them for distributing the stock to individual investors. A brokerage that gets 50 orders for R$10,000 ($3,300) will earn more than one that gets 25 orders for the same amount. “The idea is to pulverize the transaction to get as many individual investors as possible,” says Pactual’s Pereira. This technique attracted 1,000 retail investors each in the Suzano and VCP transactions, and 5,000 in the case of Natura.
These numbers may seem small, but they can be meaningful. Almost 15% of Natura’s offering was placed with individuals. While retail investors bought into Brazil’s privatizations of the late 1990s and subsequent offerings by those formerly state-owned companies, the government offered investors tax incentives and pricing discounts to lure them in. Pereira says that the absence of these incentives in the recent deals makes the retail participation that much more significant.
In the case of Natura, international demand far exceeded orders from local institutional investors. But while many foreign investors liked the stock, some said it was too pricey relative to other emerging market competitors. Jeffrey Tang, an emerging markets analyst for Evergreen Investments, a Boston-based asset manager with $150 million invested in Latin America, likes Natura but thinks its IPO was overpriced for an emerging market stock. Natura’s price-to-earnings multiple of 14 is high relative to that of Amore Pacific, a South Korean cosmetics company whose 35% market share is more than double that of Natura. “Natura has potential, but if Amore is trading at eight times, it makes it difficult to decide to buy Natura,” says Tang. “The underlying business is doing quite well, but not that well as to warrant a much higher valuation.”
Natura listed on the Novo Mercado, a section of the São Paulo stock market reserved for companies that meet corporate governance standards that are more stringent than those required by law. Aware of Brazil’s uninspiring tradition of weak corporate governance, investors, particularly foreigners, want to put money into companies that make a commitment to fairness and equitable treatment of shareholders. “There is a growing willingness to attribute a premium to companies that are willing to adopt better corporate governance practices,” says Pereira.
The $183 million equity offering by Mexican homebuilder Urbi Desarrollos Urbanos, led by UBS and Bancomer in April, was the first internationally distributed IPO out of Mexico since 2000. Millward of UBS, says that the deal, which was four times oversubscribed, was a relatively easy sell since Urbi operates in a sector that investors know well and like. Many emerging market investors already own shares of two other listed Mexican homebuilders, Ara and Geo. Mexico has a severe housing deficit and low interest rates, so the outlook for the construction industry is correspondingly strong.
Millward says Urbi had several competitive advantages that helped lure investors out of the other two companies. “It is the biggest company in the sector by most metrics and its financial performance is better by a long shot,” he says. “This attracted a very high-quality investor base in Europe and the US, and some people had to downsize their existing holdings in Ara or Geo if they were heavily invested in the sector.” Around 70% of the deal was sold internationally, but there was widespread interest from retail investors in Mexico.
Homex, another Mexican homebuilder, went public in late June. The company’s shareholders include Chicago developer Sam Zell, as well as US and Mexican private equity funds.
The equity pipeline in Chile also looks relatively promising. Among likely issuers are the country’s largest retailer D&S – set to sell about $300 million in equity – the airline LanChile, which has announced a secondary offering by its control group, and utility Gener.
As one might expect, pension funds have become crucial players in the primary equity market. According to UBS, pension funds already have 15% of their portfolio invested in domestic equities – the highest level since 1997. Yet the funds remain highly liquid, with more than 25% of their $50 billion in assets parked in low-yielding but highly liquid money market instruments, ready to be deployed at the right opportunity. “There is huge liquidity among local investors,” says Alfonso Vial, managing partner at IM Trust, a Chilean investment bank.
Latin America’s family-owned companies, traditionally unwilling to share ownership with outsiders, are slowly recognizing the need to raise capital from the public to finance expansion. LanChile – controlled by the Cueto, Piñera and Hirmas-Eblen families – announced in March it would sell up to 10% of the company, but volatile market conditions, including a dramatic rise in oil prices hurt its stock and forced the company to put off the offering. “For all these big transactions, the companies are looking for some window of opportunity,” says Vial. “It’s a very finely tuned process. The liquidity is here, that’s clear. It’s the fine-tuning that’s more difficult and finding the best moment to have the lowest possible discount.”
One other Brazilian company managed to get its deal out the door. América Latina Logística, a Curitiba-based railroad and logistics company privatized by the government in 1997 and currently owned by the private equity firm GP Investimentos and other investors raised $190 million in June. Pactual and Merrill Lynch managed its IPO. Gol, the discount Brazilian airline, in late June sold $321.9 million worth of non-voting shares in a simultaneous international and domestic market sale led by Morgan Stanley and Merrill Lynch. Gol sold American Depository Shares at $17 each.
There still is plenty of money to be put to work. Tender offers for several large Latin American companies such as BBVA Bancomer, the Mexican bank, and Apasco, the cement company, have led to the delisting of some the region’s larger stocks. Investors want new, top-quality companies that have a solid track record and a proven ability to do well in difficult times. “There is a lot of money but it will only come at a fair price,” says Millward. “If the price is wrong, investors won’t buy it.”
Companies need to keep in mind that investors, particularly foreigners with deep pockets, have high expectations. They demand that management acts in the interests of all shareholders, not merely those of their controlling families. “Management cannot control the market,” says Evergreen’s Tang. “What it can do is make sure that it works for the shareholders, that it makes corporate governance issues clear, and that it doesn’t do anything that will make us think twice about investing.” LF