Personal view: Brazil likely to buck trend in global markets

Over the past few weeks and months there has been much public debate about the state of global financial markets. The consensus is that capital markets and worldwide merger activity are likely to deflate.

Our recent experience in the Brazilian IPO market, however, is not only of a robust alternative asset class but also of a model where self-regulation and corporate governance are converging. Companies are not highly leveraged and an entrepreneurial capital culture has created opportunities for investors and issuers alike.

We have been very active in Brazil, which currently is the world’s fifth largest IPO market, counting for 85 per cent of the equity issuance in Latin America in the year to date. Forty-seven IPOs had come to market by the end of August, raising $18.5bn of the $20.5bn raised in Latin America, a 330 per cent increase over the same time frame last year. There are several factors behind this remarkable growth that separate this development from other comparable recent growth stories in the equity capital markets.

Brazil has moved through several economic cycles, from high inflation to a stabilizing period in the mid-nineties, to being buffeted by several international economic crises, to a more recent period where a market-oriented culture and economic policies have fostered development in the capital markets. Many Brazilian companies, as with many Latin American businesses, were traditionally family-owned enterprises with local and sometimes regional interests playing a part. These had a conservative approach to managing their capital. Due to the challenging economic cycles they were forced to adapt in order to survive.

However, as commodity prices have risen, these often underleveraged companies have been quick to see the opportunity to tap the capital markets to create a currency with which to expand nationally and even globally. This, in turn, has created a domino effect where a wide array of businesses, not just industrial and commodity-based companies but newer entrepreneurial ventures, have seen the competitive advantage of going public. They have expanded by building more greenfield projects, they have consolidated or have acquired overseas companies to become true multinationals.

This has led to a very diverse array of sectors represented in the Brazilian IPO market. In contrast to the largely tech and biotech-led US IPO boom of the late 1990s, the market has recently seen listings from companies from as varied sectors as agribusiness, homebuilders and building materials, education providers and suppliers, dental plans, shopping malls as well as companies from the infrastructure sector.

This wide variety, combined with a lowered perceived country risk, has led to demand from international as well as domestic investors. The recent trend in higher demand from domestic investors, who currently account for approximately one-third of demand for Brazilian IPOs, has largely been fuelled by the fast-growing local mutual fund and hedge fund sectors. Overseas demand has grown in part in response to developments in the regulatory environment that have given international investors a greater degree of comfort in Brazilian equities.

For the most part, listing companies have voluntarily adopted the most stringent highest level of corporate governance standards and transparency requirements espoused by the Novo Mercado under the aegis of the Bovespa and the CVM. These increase shareholders’ rights and enhance the quality of information disclosed by the companies. Companies have rightly realized that adherence to these standards has led to the gaining of better valuations in the market and a more solid long-term shareholder base. This is an interesting counterpoint to the recent suggestion that the stringent corporate governance standards set by Sarbanes-Oxley in the US have led companies to look for alternative listing locations.

The rise in equity issuance will have knock-on effects in Brazil and possibly in other Latin America countries. First, as Brazilian companies consider their capital structures after going public, they may now consider debt issuance, especially as the economy grows and interest rates decline. Debt issuance will allow companies to fund larger projects over longer timeframes. The development of a robust secondary market and a local currency yield curve will benefit companies with a wide array of capital structures. Second, with more cash on hand from capital raising, they are more able to engage in M&A activity – including cross-border activity. We have seen this most recently in the acquisition of Inco by Companhia Vale do Rio Doce (CVRD), one of the largest global acquisitions by a Brazilian company.

In addition, a robust IPO market will lead to further international private equity interest in Brazil as there is now a predictable and solid exit option available to financial sponsor investors in Brazilian companies that was not available to them previously. Across Latin America private equity firms are raising new sums of money to invest.

As with the global markets, August saw a pause in volumes in the Brazilian IPO market. But the overall effect has been one where investors are more selective and companies have to consider their options more carefully.

However, Brazil still remains an interesting and dynamic market to watch and one with many lessons for other developing markets.

Rick Leaman is a Joint Global Head of Investment Banking, UBS