Brazilian IPOs: innovation or desperation?
Recent Brazilian IPOs have incorporated novel support structures in an attempt to generate demand, but some ECM bankers warn that the movement away from traditional bookbuilding might damage, rather than help, the troubled primary issuance market.
In mid-April, Biosev priced a R$814 million ($407 million) IPO that incorporated put options to guarantee that investors would not lose money in the first year. The share price of R$15 had been set before the sale, eschewing the traditional bookbuilding process. Put options were sold for R$0.25. The company raised roughly R$9 million in option proceeds, indicating that about 37 million of the 53.7 million primary shares were bought with an option in place. It was the company’s second attempt to list and BTG Pactual replaced Santander and Banco Votorantim as bookrunner, alongside Banco do Brasil, Bradesco BBI, Itaú BBA and JPMorgan.
More contentiously, in mid-July CPFL Energias Renováveis priced its R$1.04 billion IPO at the bottom of its R$12.51 to R$15.01 range. BTG Pactual – which was a late addition to the list of bookrunners, alongside Bank of America Merrill Lynch and Itaú BBA – guaranteed that it would buy 56% of the shares at the bottom of the range if demand fell short. Pension fund Previ also committed itself to take R$400 million at this price.
Sound investment
Although the guarantee structure created initial positive news for the deal – along the lines that if BTG Pactual was supporting the trade it must be a sound investment – competitors argue that the practical implications of the structure soon weakened the investment case. The deal duly priced at the bottom of the range, and unconfirmed reports suggest that BTG Pactual ended up with a very large proportion of the shares, which it has placed into its private equity operation.
"A guarantee like this essentially makes the deal’s floor the ceiling as well," argues one ECM banker who worked on the transactions, who says that investors soon realized that they might end up owning a stock with a huge overhang created by a large BTG Pactual-owned block of shares. "There wasn’t normal distribution on this deal. BTG Pactual ended up owning quite a bit and when we received orders they came with a tail: investors were qualifying what they wanted in terms of size and price, but adding in what they needed to see as a minimum float and liquidity to the stock. That’s a whole new dimension. No one wanted to be the only public market buyer and be faced with a big future overhang." The banker says the guarantee became a big hindrance to the bookbuilding process as investors perceived they might end up in an IPO that had the after-market characteristics of a private placement.
ECM Bankers tell Euromoney that Biosev and CPFL Renováveis – which had both previously attempted to list on at least one occasion – were driven to list at this time because both companies had minority shareholders with put options against the controlling shareholders that could be used if an IPO hadn’t been conducted within a certain timeframe. If true, this explains the motivation of the companies to adopt these structures (CPFL Renováveis was unable to give an interview as the company remains in the enforced IPO-related quiet period), but the strategy for BTG Pactual – and Previ – is less clear. BTG Pactual and Previ hadn’t responded to interview requests as Euromoney went to press.
"We are seeing crazy structures like this pop up because the Brazilian new-issue market is overbanked," says a New York-based ECM banker.
A São Paulo-based ECM competitor says BTG Pactual’s decision to offer the guarantee to win a place on the transaction has led him to speculate about whether the bank has a problem with its deal pipeline. However, while the action was certainly aggressive and did seemingly create practical problems with the bookbuilding process, there is a straightforward explanation: the bank was happy with its guarantee commitment and believes that it will make money from its ownership over time. It is also a transaction with very specific circumstances and as such, was defended by one banker who didn’t work on the deal who said special structures could be justified. None of the bankers Euromoney has spoken to suggests that CPFL Renováveis is not a solid company and BTG Pactual’s record in private equity investments certainly makes it possible that the stake will ultimately be profitable.
Step back
However, regardless of its ultimate return, the gamble of the guarantee structure is a damaging one for the ECM market, according to one competitor. "Since 2004, there have been 148 IPOs in Brazil and only two have had this kind of guarantee," he says. "It has taken us Brazilians some time to move away from the practice of firm commitment auctions for blocks of shares that was promoted by [Brazilian development bank] BNDES in the late 1990s. Since 2002 the best practice of bookbuilding along US lines has been working well – it’s good, it allows the market to set the price. I have been speaking to colleagues in other ECM practices and they agree 100% that this is a step back."
A banker involved in the deal says: "I think that BTG Pactual was unhappy with the outcome – they didn’t intend to own as much as they do and this will probably clip their wings for a little while in terms of committing to do this for other issuers. The market doesn’t naturally go there, but the question for me is whether Itaú – or the other Brazilians – are now prepared to follow suit. I think most people look at this as a negative data point – not a positive one – and conclude that this deal will take this structure out of the market – at least for a little while, until BTG manages to sell it down."
A source close to Itaú BBA reports that the bank’s leadership was "upset with this situation and don’t believe that it is a good transaction to market and is not something that would help get additional [ECM] business in Brazil".
Another banker, speaking a day after the CPFL transaction priced, said he was asked at an IPO pitch whether his bank would be willing to put such a guarantee in place: "What I told them was that it was a bad transaction for the company – I honestly don’t know if CPFL [management] are thinking: ‘Thank God we got that done’, or are they thinking: ‘What a mess. I wish there had been another way we could have got this done’ because they don’t have a natural shareholder register right now – they have a forced investor. But one thing is for sure, other issuers are now going to ask us about this."
Valuation problems
However, these recent innovative structures are not expected to become a permanent feature of Brazilian IPOs and should remain confined to only those companies that have a very strong motivation to bring deals to a market that isn’t conducive to IPOs. "It’s not a good marketplace right now," says one banker. "We have had large capital outflows between January and June and volatility is still too high to price deals effectively." However, it is still the perennial problem of differing valuation expectations between sellers and investors that is the thorniest and most fundamental problem. One investor told Euromoney that guarantee structures are a poor substitute for a proper and realistic valuation of a company. An ECM banker says: "The valuation expectations of sellers and investors in Brazil are two barges that are still drifting ever so slightly far away from each other and we, the underwriters, have one foot on both barges, struggling to hold them together."
