By Ben Miller
It’s not over till it’s over. But so far, 2012 has proved mildly disappointing for investment banking fees: revenues from equities are down in line with the markets although debt income is holding steady and M&A is on the up.
What happens in September, in particular, will spell out the larger picture for fees this year. Bankers are hoping that an uptick in debt issuance, similar to that seen in the first quarter, will boost DCM revenues.
So far this year, overall fee income appears largely unchanged, with differences in revenues driven almost entirely by the volumes of transactions in each bank’s different business lines. At $1.03 billion through August 17, the total is down versus the $1.35 billion in the corresponding period in 2011 – but not so much as to make catching last year difficult.
“The only fee base that came down was ECM,” says Guilherme Paes, head of investment banking at BTG Pactual, who says DCM fees are the same, and M&A fees are stable but still attractive.
BTG led the overall league table for Latin America through August 17, generating $112 million from DCM, ECM, M&A and loans, or 10.9% of the total pool. The bank was also at the top of the M&A table, with $74 million, as well as the ECM table. In ECM, fees have been affected by a greater number of banks per transaction, as well as many deals not resulting in full fees due to lower-than-expected pricing.
Domestic markets also help. “DCM and M&A markets continue to be much better than last year due to the fees from local markets, which are very strong and always open,” Paes says.
Equity and debt issuance and M&A activity – and their accompanying revenues – will continue to be dictated by global economic conditions and, in particular, by news from the US and Europe.
While Brazil still accounts for most of the region’s investment banking business, bankers say the need now is to push for work in growing markets,in particular Peru, Chile, Colombia and Mexico.
“The revenue base is more affected by Brazil,” says Javier Vargas, co-head of investment banking for Latin America at Credit Suisse. “LatAm ex-Brazilis probably flat, but given the size of Brazil, the overall level is down. Investors are a bit more careful about Brazil these days,” he says. “You have seen different trends for oil and gas and commodity producers. People are looking elsewhere. The overall trend we see is greater concern on Brazil.”
A weaker economic outlook for the region’s largest market is a big concern, which has so far only distorted the outlook for equity fees.
Debt capital markets have driven a sizeable piece of revenue for the sector – totaling $328 million for the year up to August 17, compared with $335 million from the same period a year before. Volumes of business continue to be slightly stronger than last year. Bankers report mostly stable fees for deals, already at low 25–40bp levels.
Forecasts for the rest of the year suggest business volumes somewhere between the first quarter’s DCM explosion and the second quarter’s slowed volumes. “I expect high-yield activity to increase in the second half,” says
Roberto D’Avola, head of LatAm DCM at JPMorgan, noting such sales accounted for about 22% of the volume so far this year. JPMorgan is in a three-way tie with Citi and HSBC at the top of the DCM fee tables, with $33 million. D’Avola reckons that additional economic stability should boost issuance and high-yield bonds will come to the fore. “High yield has a lot of possibilities. Investors will want to get into these names, but they must be names that are showing an improvement in their credit profile,” he says. In particular, July transactions from Peru’s Coazucar and Mexico’s ICA showed encouraging signs of demand for double-B credits.
As long as the news from Europe and the US does not worsen, bankers expect more to come.
The market, of course, is always open for top-quality issuers – as América Móvil showed in August, raising $1.92 billion in the sterling and dollar markets.
High-yield issuers are poised to pop up across the region, D’Avola says. The key will be companies with growth that comes along with good cash generation. He notes additional crossover investment and more participation from LatAm-based investors.
“These are high-growth companies, and their markets are very underpenetrated,” says Eduardo Cruz, head of banking for Latin America at Citi. “They don’t get the benefit of real leverage.”
High-yield bonds could become another alternative for more leveraged acquisition finance in the region, says Cruz, with higher levels of equity being deployed than in other parts of the world, and with LatAm LBOs tending to be at least 50% equity financing, and most of the remainder coming from the bank market. There is room on balance sheets in the region to reduce this, while taking advantage of investors’ demand for high-yield debt.
The M&A puzzle
M&A volume is set to continue at a healthy pace, and overall income is up from last year, as is volume, mostly thanks to a $20 billion deal for GrupoModelo. In June, the families controlling the Mexican brewer were finally persuaded to part with their final 50% holding by AB InBev’s higher-than-expected multiple. The result shook up the league table, though less so the fee standings, where BTG Pactual still leads. The $382 million of transaction income so far this year compares to $356 million for the same period. Fee trends are largely the same, bankers say.
Several trends may drive volume through the rest of the year. Bankers say the market segment has barely scratched the surface of European divestures in Latin America, and there could be many more to follow.
That said, there have also been some interesting additions – ranging from Spanish toll road operator Abertis to Dutch vitamin producer Royal DSM – by Europeans that can still afford to buy. They join interested Asian and US buyers in what is still a very strong intra-regional M&A trend that could grow.
“What we’ve seen over the last few years continues to be valid – Brazilians consolidating the local markets, and foreign players moving into Latin America as a whole,” says Jean-Marc Etlin, head of investment banking at Itaú.
Private equity activity in the region is a third, he says. The larger and cash-rich entities in Latin America looking outside the region is another, smaller trend.
After years of threatening, América Móvil became one such acquirer, upping its stake in Netherlands-based Royal KPN from 8.7% to 28% at a cost of around $3 billion. A week before that it had agreed to pay around $1 billion for a 21% stake in Telekom Austria, bringing its ownership to 23%. Cheap exposure to eastern European countries will be a lever to further customer business for América Móvil. It will use its expertise in emerging markets telecommunications in countries to continue to grow regardless of the troubles in western Europe.
“Buying in Europe is not as easy as people think,” says Gerardo Mato, CEO of HSBC global banking, Americas. “It is easier for Europeans to buy in Latin America. If you are cash rich, you are trying to buy companies at very acceptable multiples, and trying to grow it from there. We are seeing Latin Americans interested in buying European assets, and what we are seeing is also a lot of Europeans reassessing whether to sell at current multiples.”
Consolidation in Brazil in several fragmented industries should also be a strong source of future business. Bankers are concerned, however, about regulatory rule changes that would lengthen the approval process for deals.
This could mean a delay in booking fees, as regulations are brought more in line with other parts of the world. In the last week of May, no fewer than 15 transactions involving Brazilians were announced, to slide in before the Conselho Administrativo de Defesa Econômica (CADE) put its rule changes into effect. CADE has streamlined the process in that deals are approved before they close, rather than requesting adjustments or asset sales after the deal has gone through.
This situation – occurring notably in transactions such as Brasil Foods – is now avoided, but the downside is that deals take much longer, with fees booked at the close.
“For the Brazilian activity there are the new CADE requirements which create uncertainty on how long it will take to approve mergers,” Etlin says. “That could create a greater time lag for fee collection.”
Additionally, if global conditions fail to help equity issuers, business will continue to be pushed to the M&A markets as companies tap private sources of capital. If they can advise clients either way, most bankers say it doesn’t matter where the fees come from, though some note a tendency for fewer banks on a typical M&A transaction, thus giving a greater share of spoils than on an equity deal.
Equities, the poor performer
Equity transactions are the only area to show a big drop off in fees and volume. The volume of transactions in 2012 has largely been disastrous again after a rough 2011, especially in Brazil, and in IPOs. The fee pool reflects the low amounts of business done so far this year. Revenue so far this year stands at $236 million, down from $541 million in the corresponding period in 2011.
The solution to the problem remains the same – getting wary international investors to participate, especially in Brazil and pricing deals at the right prices. At present there is a valuation gap between issuers (and their bankers) and the buy-side. Investors simply haven’t made money on deals,especially IPOs.
“I expect high-yield activity to increase a bit in the second half”
Roberto D’Avola, JPMorgan
BTG Pactual’s nearly $2 billion IPO appeared to open the space in April, but few could follow. Although the deal priced in the upper part of its range and there was heavy demand, it later traded down, along with the Bovespa. The same is true of a follow-on from Brazil’s Taesa, with investors drawn in from the issuer’s juicy dividend returns.
“Equity capital market conditions remain challenging,” says Daniel Darahem, head of LatAm ECM at JPMorgan, who notes that by the end of July, total issuance in Latin America had dropped roughly 45% year-on-year. “Despite this decrease, if market conditions allow it, we expect a strong pipeline of multi-billion transactions for the second half.”
Bankers say what’s needed is an oversubscribed deal that goes on to trade well, ideally helped by a more cooperative global environment. Santander Mexico’s IPO may be one such candidate. The Spanish bank’s management has
indicated an October pricing for the deal which could raise as much as $4 billion.
The struggles of its Spanish parent have resulted in a carve-out of one of Santander’s most liquid and attractive assets. Bankers and their clients hope this will add fuel to the pent-up demand caused by investors’ more bullish outlook on Mexico’s economic prospects. “It is a very competitive market, where being an underwriter on key deals is essential for long-term stability,” Darahem says.
Bankers say there are several – perhaps up to 15 – billion dollar-plus deals in the pipeline. If the markets were to open, some should see the light of day. However, the window is tight, with only September and October open for issuers using their second-quarter numbers.
Local demand is also key to completing deals in markets outside of Brazil. Clearly, small deals in places such as Chile don’t seek international investors and price without them. But several large deals this year, including Chile’s Inversiones La Construcción and Bancolombia, have relied on local support. In the case of a July follow-on from Chile’s Cencosud, local demand saved the supermarket operator from an even deeper discount than the 7% it ended up paying.
Ideally, this trend won’t continue and international appetite will return to stronger levels. But bankers hope local demand will push more issuers from the ex-Brazil markets.
“In Peru there isn’t a single stock to play the consumer sector – it just doesn’t exist,” says Alberto Pandolfi, head of LatAm M&A at Citi. “There will have to be companies taking advantage of this to finance themselves. There is going to be a huge appetite for this, and in Colombia too.”
An improved picture for equity markets would do the most to boost fees. But this is only likely to happen in the event of a global economic recovery – a scenario that remains impossible to predict.
“It’s been the most challenging year we’ve had in five years, particularly for Brazilian ECM,” Etlin says. “But it has been partly offset by what could be a record year in DCM.” LF