FEATURE: Brazil braces for record year for IPOs

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The equity market in Brazil is on track for a record year for initial public offerings (IPOs) and follow-ons in 2021.

At least 30 issuers are planning to debut on the B3 stock exchange in São Paulo in the first quarter next year, which would surpass the 25 issuers that debuted in the market in all of 2020, according to data compiled by the securities regulator CVM.

Among the issuers expected to sell shares in the first three months of next year are the mining division of steelmaker Companhia Siderúrgica Nacional (CSN), sugar and ethanol producer Jalles Machado and private water and wastewater company Iguá Saneamento.

"I see activity on both ends, both in the number of deals potentially coming to the market next year and also in the number of people that are likely to file in the first quarter," said Matías Santa Cruz, managing director of Latin American equities at Bank of America.

Given the pipeline of IPOs, several banks predict the Ibovespa index on the B3 will soar in 2021 and exceed the previous high-water market set in January this year.

JPMorgan, for one, predicts the Ibovespa will reach 134,000 points by the end of 2021, while Bank of America and Bradesco BBI expect it to rise 130,000 points and Morgan Stanley sees it going to 120,000, according to local press reports.

"We are so bullish on 2021 because, in spite of the chaos of the pandemic, Brazil was able to issue roughly the same amount of capital as 2019," said Facundo Vázquez, the head of equity capital markets in Latin America for Goldman Sachs.

IPO MARKET REVIVES AND THRIVES
High market volatility at the outbreak of the coronavirus pandemic meant most IPOs came to market in the second half of the year.  

Fully 20 of the 25 IPOs that took place in 2020 occurred after July with dozens more potential issuers registering to make offerings later in the year, according to Anbima data.

Nevertheless, total equity sales still reached BRL154.3 billion ($29.6 billion) in 2020, surpassing the previous record of BRL153.6 billion in 2010, according to data compiled by Bloomberg.

"We were almost fully dependent on Brazilian investors to buy the IPOs and equity," said Roderick Greenlees, global head of investment banking at Itaú BBA.

Historically low interest rates in Brazil have encouraged domestic investors to redeploy capital away from low yield, fixed-income instruments and towards equities in 2020, market sources told LatinFinance.

"What we are seeing are different type of products on the equity capital markets front. There is the activity with follow-ons and IPOs, but now we are also seeing increased activity with block trades, convertible bonds and private placements," said Santa Cruz from Bank of America.

Among these, BNDESPar, the investment division of Brazil’s national development bank, earned BRL8.1 billion from the largest block trade ever to take place when it sold most of its stake in mining company Vale in August. BNDESPar followed that up with BRL2.5 billion from a second block trade of part of its remaining stake in Vale in November.

The final months of 2020 also saw the return of foreign investors after the US elections in November and positive results from several coronavirus vaccine trials.

"What has made me very excited with the prospects for next year is that we have seen a comeback of foreign investors," said Greenlees from Itaú BBA. While the foreign investor in Brazil made a comeback late in the year, the data from Anbima, Brazil's capital markets association, shows it won't likely be enough to overcome their absence earlier in the year.

The surge in foreign inflows in November contributed to the biggest monthly gain since 2016 and increased demand for high-profile IPOs and follow-on offerings.  

In December, private healthcare provider Rede D'Or São Luiz moved BRL11.3 billion in an IPO that saw more than half the shares sold to international investors and was the third largest debut on the B3.

Bank of America was among the underwriters on the Rede D'Or IPO and took the number one spot for equity transactions ahead of local bank Itaú BBA and JP Morgan in 2020, according to Bloomberg data.

"The Rede D'Or transaction traded very well in the aftermarket and drew a lot of local and international investor focus and demand, which shows the capacity of the investor base to price deals well and do the homework in the transactions," Santa Cruz said.   

Growing interest from foreign investors also fed through to the secondary market in the last months of the 2020.

Four equity follow-on offerings handled by Itaú BBA on behalf of Burger King, Notre Dame Intermédica, Ânima on the B3 and XP Investimentos on the Nasdaq all received “strong interest” from international investors, Greenlees said.

"Top tier hedge funds, sovereign wealth funds, a lot of these guys have all come back in a big way and in a big fashion over the last few weeks," he said.

REASONS TO BE CHEERFUL
Besides the broader investor base, the backlog of potential IPOs due to cancellations throughout 2020 is also helping stoke expectations for a record 2021.

Scores of potential issuers cancelled or postponed their planned IPOs during the year in the face of heightened volatility and unpredictability caused by the COVID-19 pandemic.

In March, the government introduced measures to contain the outbreak of COVID-19, which caused the Ibovespa to plunge by more than 45%, or almost 53,000 points, and triggered six circuit breakers in a single week.

Several issuers shelved their IPOs, including federal savings bank Caixa Econômica Federal, which cancelled a BRL15 billion float of its insurance division Caixa Seguridade, and logistics company JSL, which suspended the spin-off of its truck rental subsidiary Vamos.

Continued volatility towards the end of the year also led 10 issuers to cancel or postpone their planned offerings in late October.

Large and small issuers alike were affected by the softening demand from investors in and increased volatility on the B3.

Brazilian department store chain Havan, for example, aimed to raise BRL70 billion to BRL100 billion in its market debut, but it called of its IPO after investors valued the company between BRL50 billion and BRL60 billion.

Homebuilder Lavvi and drugstore chain Pague Menos were also both forced to cut their initial valuations due to insufficient demand and both eventually priced below target.

Part of the reason for the weak demand is due to the large number of broadly similar small- and mid-cap companies filing for IPOs at the same time.

"The small and mid-cap companies, the family-owned businesses, were challenging because there was not enough local demand to support these kinds of capital bases," said Goldman Sachs’ Vázquez.

Construction and engineering firms were the largest contingent of companies to come to market and have struggled to differentiate themselves or stimulate enough demand from investors for their IPOs.

Brazilian real estate developers You, Inc and Alphaville both cancelled their IPOs twice this year citing unfavorable market conditions. Pátria Investimentos-backed Alphaville eventually launched a restricted offering in December.

Cyrela, another real estate developer, saw all three of its spin-offs – Lavvi, Cury and Plano & Plano – price below target throughout the year.

Of the 25 companies to make primary offerings this year, the shares of almost half are currently trading below their IPO price including six out of the first nine to come to market.

"A lot of these mid-cap and small-cap companies were completely mispriced," said an investment banker in New York who asked to remain anonymous.

"Historically, you see a trend in Brazil where the first deals are fairly priced and then everyone wants to add a premium to the previous transaction... What the market is saying today is that we are not buying anymore of those shares," he added.

MAYBE TROUBLE AHEAD
Few market observers rule out further turbulence in 2021 as coronavirus cases continue to climb in Brazil.

The country has reported 7.32 million cases of COVID-19 and 188,259 deaths with 348,787 new cases and 5,460 deaths registered in the last week, according to data collected by Johns Hopkins University.

Earlier this week, confirmation of a new strain of the COVID-19 pathogen in the United Kingdom led more than 40 countries around the world to cancel direct flights and sparked a 2.5% fall in the Ibovespa.

The index recovered some of its lost ground on Tuesday only to see its recovery slowed by an announcement by São Paulo’s state government that new restrictions would be imposed at the end of the year.

"When you look at September, October and November, there were a lot of companies that filed and were pulled or priced at the bottom or below the range... So I don"t know how much of this pipeline will materialize in the first quarter," Vázquez said.

Brazil's growing budget deficit and government debt are other areas of concern among investors. Latin America's largest economy has one of the largest debt burdens among emerging markets and exceeded 90% of GDP in September due to increased spending due to the pandemic.

"Worries about Brazil's fiscal profile have led to a steeper yield curve, pushing expectations for future interest rates higher. The central bank monetary policy committee has said that faced with this situation, it could not guarantee the continuation of currently low interest rates," wrote S&P Global Market Intelligence analysts Steven Baria and Mohammad Abbas Taqi in a report in November.

Nevertheless, few expect the central bank's monetary policy committee raise interest rates within the first half of 2021.

Earlier this month, the committee voted unanimously to keep the rate unchanged into next year and said the economy still requires a large amount of monetary stimulus, which will help maintain the attractiveness of equities over fixed-income instruments.

In the longer term, Santa Cruz said two trends also may help bolster demand for equities. The first is the growing diversity of investors from Brazil and abroad, including those focused on smaller transactions. The second is the "slow emergence" of environmental, social and governance (ESG) criteria in Brazil and its increasing role in guiding investment decisions.

"There are a large number of transactions that could press the button to go to market between January and February. The question is if there is market appetite and whether the market is receptive for these transactions," Santa Cruz said.

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