LatAm: Rising rates will limit IPO activity

Slowing growth in Latin America will create big challenges for equity capital markets in the region, say bankers. 

While stressing the positives, equities bankers concede that they have low expectations for new deals, in particular from Brazil, which until recently drove regional volumes. Slow growth, economic policy uncertainty and, above all, high and rising interest rates will diminish investor appetite for equity risk, they say.

Increased interest in Mexico – the only big regional market that is expected to increase its rate of GDP growth in 2015 – has seen some equity issuance in recent months but bankers say Mexico alone is unlikely to compensate fully for the depressed activity elsewhere in the region.

There has been a flurry of IPOs and follow-ons from issuers such as Grupo Hotelero Sante Fe, Fibra Macquarie and Terefina, which performed well, but overall volumes were not huge.

Brazil’s Central Bank increased interest rates to 11.25% immediately after the presidential election in October, and most observers expect at least another 100bp of rises in the current tightening cycle as inflation has exceeded the central bank’s target of 4.5% plus two percentage points. That will further slow Brazilian growth and also heighten the already tight hold that fixed income has on local investors.

“With interest rates already high, and getting higher,” says a DCM banker in São Paulo, “there is almost no incentive for local investors to put any incremental investment liquidity into equities – the incremental potential return has to be that much higher. In fact many are reallocating their portfolio weightings to be even more dominated by fixed income.”

ECM bankers looking for the positives see some optimism from international investors’ demand, as the decline in the real and the Bovespa could bring an interesting re-entry point from EM equity investors that had been underweight Brazil.

“The Brazil equity market has suffered from increased volatility driven by the recent political events, but international investors are looking again and have been closing the underweight positions that they had been holding for a while,” says Mariano Gaut, co-head of debt and equity capital markets origination for Latin America at Citi in São Paulo. “Investors were significantly underweight and then we got to a point where earnings suggested a rationale for moving towards closing that underweight. We have actually seen positive net flows into Brazil through our equities desk again.”

There have been more outperforming equities in Brazil – despite the recent slump in the Ibovespa – than many realize, he says.

“There have been many outliers, both positive and negative, in terms of performance in Brazilian equities. Brazil is such a large EM equities market that investors can pick names and specific strategies. In smaller markets you tend to see investors having to play the index but the liquidity in Brazil allows for more targeted strategies and some stocks have performed very well and offered very attractive returns in recent months.”

Any increasing investment to Brazil from these international investors is likely to target specific growth segments and stocks: infrastructure and exporters that will benefit from the recent devaluation in the real. It will also depend on broader fund flows to emerging markets and Latin America as a region, and will remain sensitive to global monetary policy shifts, specifically in the US.

Many hurdles

The levels of primary issuance from Brazil will therefore have to overcome many hurdles to be successful and the pipeline, which has been building as the market remains inactive (there was an IPO for a pet company Ourofino in October that raised $172 million-equivalent but with only 10 investors and one of those buying 50% of the issued shares – and pricing late on a Friday night – bankers argue it was effectively a private placement executed through a public format). JBS foods, Ouro Verde and Par Corretora have all filed IPOs and JBS, in particular, is believed to be keen to go to the market before the end of the year.

Bankers predict a bifurcation of the primary market with fewer larger deals that are able to convince investors of a very strong growth story – and so both industry- and company-specific. Size is likely to be necessary to attract international investors, for liquidity reasons and to generate technical, index-following demand.

However, with the hurdles for fresh issuance so high there are expectations that companies frustrated by lack of equity funding from the private markets will tap private sources to enable them to proceed with growth plans. Advent International’s announcement of a $2.1 billion fund that will look for private equity opportunities throughout the region demonstrates the renewed interest in private equity investment in the region.

“We have noticed increased fund-raising activity for private equity and other alternative asset managers,” says Gaut. “The activity is at levels that we haven’t seen for a few years and is driven by a much longer investment horizon than public investors. One difference this time round, however, is that I would say most funds are looking across Latin America – with Brazil being part of that regional strategy, whereas in the past there had been relatively more Brazil-specific funds raised.”