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Brazil's IPO window remains ajar despite string of cancellations

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Brazil's IPO window remains ajar despite string of cancellations

A series of IPO withdrawals in Brazil after a resurgence of market activity has raised concerns on the stability of the country's financial environment, but analysts say the window for further equity offerings remains open.

Following the first half of 2020 that marked a sharp decline in Brazil's market activity due to the coronavirus pandemic, appetite for IPOs have resurfaced in the middle of the year. Better-than-expected economic forecasts as well as an environment of low interest rates and controlled inflation have contributed to this resumption.

According to data from S&P Global Market Intelligence, 2020 could be a record year in terms of the number of completed Brazilian IPOs, which is set to approach or even surpass the figure reached in 2007.

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However, conditions have again become sour in the last few months for some companies seeking funding in the equity market. At least seven companies have cancelled their planned listings in October, on top of five others in the previous two months.

Among financial entities, the casualties include Caixa Seguridade Participações SA, the insurance subsidiary of Caixa Econômica Federal, which was set to have the biggest local IPO this year with an estimated 10 billion reais offering. Another company that had shelved its IPO plan was BR Partners, which would have been the second listed investment bank in Brazil next to Banco BTG Pactual SA.

More recently, Paraná Banco SA withdrew its planned IPO, stalling a supposed comeback to the local stock exchange four years after delisting.

All of these institutions cited market volatility as a primary driver for their IPO cancellations.

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'Locally, a layer of uncertainty'

The uncertainty in the Brazilian market has been fueled by the drawn out U.S. presidential elections, but also by fears of a second wave of the pandemic, two primary concerns among investors, according to William Jackson, Capital Economics' chief emerging markets economist.

But Brazil is also littered with domestic unease, Jackson said. "In particular, investors seem increasingly concerned that Brazil's government may seek to avoid austerity next year, raising concerns over longer-term fiscal sustainability."

Brazil's debt is one of the highest among emerging markets, hitting 90.6% of GDP in September as spending measures tied to the pandemic ramp up. Recently, fiscal uncertainty has risen following the government's announcement of a social cash transfer program that serves as an extension of pandemic-related efforts for the low-income population.

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.

Traders now see interest rates rising as early as 2021, which could push investor attention away from equities to fixed-income securities, providing a narrower window for public listings.

In addition, foreign portfolio investments have not been returning to Brazil this year, according to Frederico Sampaio, chief investment officer of equities at Franklin Templeton Investments Brazil. "The level of participation of foreign investors is lower recently, which means that the local market is absorbing these offerings."

"There are two things that are not helping the Brazilian market," Sampaio said, citing the country's declining growth trend since the Dilma Rousseff's presidency as one factor. "[Another] is the dilution of its weight, for example, in the MSCI [Emerging Markets Index]." Recent data from MSCI puts Brazil's weight in the index at below 5%, which, according to the executive, is well below 10% from about a decade ago.

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Not a unique trend

With these uncertain conditions, investors are increasingly nitpicking on IPOs' valuations. For some companies, "they are small offers, they were not in hot sectors, and they were small in size. They are not attracting enough attention," Sampaio said. But investors have also shown aversion for big valuations such as that of Caixa Seguridade.

"The recent discussion is on how much the [buyer] is willing to pay and how much the seller is willing to sell," Sampaio noted. Such was the case for BR Partners, whose IPO asking price was reportedly not met by demand from investors.

However, Sampaio does not view the string of cancellations among financial entities as unique for the sector. "Banks, they are cheap everywhere. If you take a look in the details, the financial conditions of local banks are quite strong."

For Jean Lopes, a primary analyst at Fitch Ratings, Caixa has no need to compromise its asking price for the operations it plans to divest. Following the withdrawal of its insurance unit's IPO, Caixa even announced that it looks to sell a 15% stake in digital banking arm Caixa TEM through a U.S. IPO as early as 2021.

"In our view, all possible IPOs follow the same rationale, as the bank has sought to identify areas with potential for sale or IPO that are not part of its core business," Lopes noted. "In addition, these transactions will most likely only be viable when market conditions are favorable, since currently there is no pressure on Caixa's capitalization and liquidity that would justify a sale at a potential low price."

As for BR Partners, "its business model differs from recent IPOs and follow-on offerings made by banks such as Banco Inter SA and Banco BMG SA, which could create challenges in analysts' calculation for the pricing process," Lopes said, although noting that the rating agency could not comment about investors' perception on the company's IPO process.

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Through the IPO window, a speck of light

For Capital Economics' Jackson, all these factors contribute to much dimmer prospects for the country moving forward. "As for the longer-term outlook for Brazil, I think there are reasons to be relatively downbeat," the economist said. "Either the government will need to turn to a long period of austerity or it will have to turn to more distortive policies, or so called financial repression, to deal with this."

Sampaio echoed the sentiment, noting that "to regain [the attention of investors], the country needs to move forward with the agenda of reforms."

However, both analysts also believe that all is not lost for Brazil's IPO market. "I think there's still some optimism about Brazil's prospects, seeing it as a viable prospect," Jackson said. "Although it was hit hard by the virus, case numbers have come down significantly from their peak. And the overall economic hit has been relatively small, at least by Latin American standards."

"I don't see a change in the basic, most intrinsic situation that is fostering the local markets, which is low interest rates for a long term," Templeton's Sampaio noted. He also emphasized the upcoming municipal elections in November, which would temper politicians' opinions on fiscal matters. "The market worries about the headlines, and sometimes they forget about the political cycle."

Sampaio expects to see a recovery in the markets despite the "noise regarding the fiscal decisions." However, he also emphasized the importance of continued indications that the government will abide with its spending ceiling. Economy ministry officials and President Bolsonaro have made reassuring statements in this sense over the past few weeks. "That was enough to justify a downward movement of the interest rate curve and help sustain the market," said Sampaio.

These points of view are reflected in a recent statement from Caixa President Pedro Guimarães, who said there is a new window of opportunity for its insurance unit's IPO early next year. In February, concerns on the second wave of the pandemic, elections and internal talks will already be priced, Guimarães said.

As the executive emphasized, "we just need tranquility."