Special Reprint of Three recent exame covers stories on the brazilian economy

WHAT COMPANIES ARE COMING NEXT
The list of candidates for IPO in 2011 is big — and full of known names. In the last weeks, EXAME selected some companies that intend to benefit from this positive moment and start operations at the stock exchange. Some are in evidence. Azul, the airline founded by entrepreneur David Neeleman, is getting ready to make its IPO this year. Neeleman has some experience in this subject. In 2002, JetBlue, the American company he created, made its IPO at the American stock exchange and the shares had 67% appreciation on the first day (but had worse depreciation in the following years). Another airline, Webjet, controlled by Paulus family, will do the same. Travel agency CVC planned its IPO for the second half of the year, as well as pharmaceutical laboratory Aché, the largest in the country. Magazine Luiza, the retail chain whose president is Luiza Helena Trajano, is about to end the preparations for its long-awaited IPO. And mining company Vale has already hired the banks that will make the IPO of its fertilizer and logistic subsidiaries. Many companies from very distinct sectors, e.g consumption, retail, infrastructure and oil & gas, are in the list (see the charts).

Why did the year start with so much excitement? There are obviously many reasons for that. What lies behind it is the interest of foreign investors in Brazil – this is the condition required for an IPO to occur, as they represent up to 80% of the demand for stock issuance. The fact that 2010 IPOs were excellent to investors contributed a lot. The shares of companies such as Multiplus, manager of TAM loyalty program, Mills Engenharia and oil exploration company HRT had appreciations of 96%, 78% and 52%, respectively. According to a study made by Renaissance Capital, the IPOs in Latin America presented the world’s best performance of the year. That helped reduce the trauma caused by the bad results of companies that made their IPO in 2006 and 2007. Besides the motivation that came with the good results, the huge capitalization of Petrobras in September brought several projects to a stop, with entrepreneurs fearing that there wouldn’t be enough demand to everyone. No one wanted to compete with the highest stock issuance ever. After the capitalization, things started to move again.

There is also another key factor involved. While Bovespa in general presented a bad performance in 2010, the companies connected to sectors such as consumption were close to their highest numbers. The shares of Ambev and Lojas Renner, for instance, had around 50% appreciation in the year. Then, the investors that want to benefit from the Brazilian economic growth, there are few options for reasonable prices. And these are the attractive aspects of an IPO: when a company starts at the stock exchange, it’s usually negotiated for values lower than the values of other open-capital companies of the competition. In the market language, with a discount in relation to its peers. Drugstore chain Droga Raia was assessed around 15 times its cash generation during its IPO at the end of last year - 25% less than competitor Drogasil, which had already made its IPO. The stock issuance was a big hit, and the papers increased 8% on the IPO day.

For this reason, the companies linked with the income increase of the Brazilian population may draw the attention of investors — no wonder companies such as Magazine Luiza and Camil, the largest distributor of rice in Latin America, are getting prepared for their IPOs. But there are other economic sectors with many candidates for the IPO in the next 12 months. Encouraged by the investments of Petrobras, oil and gas companies are one of these groups. In the next months, two of them, Petroserv and the Brazilian subsidiary of Norwegian Sea Drill, may issue stock at Bovespa to fund their expansion. “Many Brazilian economic sectors are poorly represented at the stock exchange”, says Will Landers, manager of Blackrock’s fund, which has around 7 billion dollars invested at Bovespa. “For instance, there are few infrastructure companies.” Considering the interest of investors, EXAME found out that the Brazilian subsidiary of French cement giant Lafarge will make its IPO at Bovespa.

The private equity fund companies are also in evidence in the list. These funds purchase participations or the control in companies to try to resell them later for a higher price. With a stock market in the current conditions, it’s difficult to resist the temptation of selling shares and profiting. Brazilian Tarpon, with 25% of Arezzo, is the top in the list. Advent tried the IPO of IMC, the company that manages restaurant chains Viena and Frango Assado, in 2009. But the weak demand postponed the plans. Given the present moment, Advent has decided that it’s worth trying again. Gávea, of cousins Armínio and Luiz Fraga, intends to take three of its companies to start operating at the stock exchange, as well as Time for Fun and Azul, the Latin America operation of McDonald’s, purchased in 2007 by a consortium of investors, will issue stock at the New York stock exchange. Finally, Carlyle intends to make the IPO of CVC and, depending on the market conditions, the IPO of health plan management Qualicorp, purchased in July for 1.1 billion reais.

In January, it is impossible to know for sure the volume of IPOs for the whole year — only projections are made, based on the maintenance of current conditions of temperature and pressure. Some factors can spoil everything and some factors can speed up the pace of operations. In 2010, the year started with promising projections and got weakened because of the debt crisis in Greece and the indecision in Petrobras capitalization. The recent manifestations in Egypt remind that unexpected factors may appear to disturb the plans – as well as uncertainties related to the American economic recovery, the solution to the European debt crisis, the Chinese halt, etc. But other actions can make the year more agitated. In IPOs, success tends to generate more business, a rush to take advantage of a good moment that will not last forever. The same will happen in 2011. If the IPO of Magazine Luiza is successful, will competitor Máquina de Vendas accelerate its plans? Will the IPO of Louis Dreyfus, controller of sugarcane and ethanol power plant Santelisa Vale cause competitor ETH to have its IPO earlier than planned? Will the IPO of Aché take Eurofarma to the stock exchange?

CRITERIA
This “success factor” was one of the main aspects that triggered the spree in 2007. When the investment bankers realized that offering a discount to investors related to the quotation of pioneer Cyrela was enough, they found a way to take a high number of construction companies and developers to the stock exchange, but many of them were real problems. They totaled 15 only in 2007. Is there a similar risk this time? The bankers’ creativity should not be underestimated (one banker said to EXAME that, “depending on the what will happen in the next months, a company that doesn’t even exist now can make its IPO by the end of the year”), as well as the poor judgment of euphoric investors. But, fortunately, there are still signs of rationality. Considering last year’s 11 IPOs, only one (of Droga Raia) was within the price range expected by the salespeople. “The market is more selective, is not open to everything we saw in 2007”, says José Olympio Pereira, co-president of investment bank Credit Suisse. The importance of purchasing large IPOs, of companies whose shares have a minimum daily negotiation, is among the lessons learnt in 2007. The IPOs of companies without these conditions have created a number of zombies in the stock exchange – shares without liquidity and analyst coverage, which end up abandoned. “Today, issuances below 300 million dollars would hardly pass the market test”, says Alexandre Bettamio, president of Bank of America Merrill Lynch in Brazil. Project companies that use the money raised at the stock exchange to simply exist would also have less chances of operating at the stock exchange. But, again, a precaution should be considered — it is impossible to know how the year will end.

The country can have many advantages if such rationality is kept at minimum levels. A solid stock market is an essential pillar to the economic development. For the companies that seize the opportunity properly and not as a simple chance of enjoying the moment and making some money, operating at the stock exchange can mean a unique opportunity of strengthening. For instance, the performance of Hypermarcas since its IPO in 2008 has shown how much a fast-growing company can win with the free access to the stock market. In December, Hypermarcas purchased pharmaceutical company Mantecorp for 2.5 billion reais and used its shares as exchange currency. Stockholders of laboratory Aché decided it’s time to make their IPO to have the same flexibility. “I don’t have this tool, and a publicly-held company has it”, says José Ricardo Mendes da Silva, president of Ache. “With the IPO, we’ll have an additional support to grow faster.” Aché has a cash generation of 420 million reais, and its IPO has all conditions to be one of the most important offering of the year. But BM&F Bovespa estimates that, besides groups like Aché, there are over 15,000 Brazilian medium-sized companies with enough conditions to have their IPO, and it expects 200 of them to actually have it by 2015.

How about the investors? What do they do to avoid past mistakes? In the euphoric moments of 2006 e 2007, flipping shares of companies that were starting at the stock exchange was a common practice, i.e., buying and selling them quickly on the IPO day, being sure that this strategy would bring only successful results. Obviously, this spree would be over soon. (In 2010, in fact, an opposite phenomenon occurred: many of the IPOs that were doing well along the year, such as that of Multiplus and mall operator Aliansce, presented a bad performance on the IPO day.) It’s useless to say that there are no formulas to make money with IPOs. “But buying shares of companies that start at the stock exchange surely involves more risks than investing in known companies”, says Landers, of Blackrock. According to a study conducted by business school Insper, the companies with private equity funds among their partners are more profitable than others, after starting at the stock exchange. The study says that it happens because these funds help prepare the companies for the system of a publicly-held company. But, of course, there are innumerous examples in Brazil of companies that had funds among their partners and ended up as problematic as the others. Edemir Pinto, of BM&F Bovespa, gives a recommendation to small investors: “The IPO is something for experts. If you are bitten by the IPO fly, you should study the company deeply and invest a small amount”. And hope you have bet on the right crop.

“GO DEEPER!”

This is the motto of Márcio Mello, born in Minas Gerais. Running oil company HRT, this former geologist at Petrobras has convinced investors worldwide that it’s possible to find oil in Amazonas and Namibia.
SAMANTHA LIMA

A VERY PROFITABLE PLAN

In practice, Mello sold at the stock exchange a business plan whose promise is to start the oil production this year and reach 100,000 barrels a day in 2014, most in the State of Amazonas, an area still poorly explored by Petrobras. Although the goal corresponds to around 5% of the current amount produced by this government-owned company, it would create very high profits, just like it happens to several oil companies of such size in the United States. “HRT is a great promise, and Mello is a very creative entrepreneur”, says Carmel Daniele, the British woman who founded CD Capital, the British fund specialized in investments in natural resources and one of the investors in HRT.

Part of the excitement shown by stockholders in relation to HRT is explained by the huge power of oil in the global market. “The strong consumption shows that the barrel price won’t be below 70 dollars”, says Nelson Rodrigues, analyst at Banco do Brasil. According to its business plan, HRT is considered financially viable with the barrel price of 20 dollars. At 57 years old, Mello makes all efforts to nurture the market euphoria. “He’s incredibly prepared and an innate salesman”, says a former executive at Petrobras.

In October 2010, in a meeting with investors that lasted 1 hour in New York, during the roadshow that preceded the debut of HRT at the stock exchange, Mello made jokes, gesticulated and instigated the audience with questions. Around 100 analysts stood up to applaud him. “Besides his technical characteristic, he’s a showman”, says the analyst of a large American bank who participated in this meeting.

Born to a medium class family – his father worked at Banco do Brasil and his mother was a housewife —, Mello graduated in geology at the University of Brasília and soon after that he started at Petrobras, where he remained for 24 years. He was there one of the enthusiasts for pre-salt researches. In those days, he was internally known as “Mr. Go Deeper”, due to his persistence. “Any stupid person would have told Petrobras to drill deeper, and I actually said that!”, he said in a lecture to students at Wharton Business School in a visit to Brazil, in January. In 2000, he decided to leave Petrobras and create two companies of geological studies. Both were sold in 2004 to two small companies in the oil sector, one Brazilian company and one Dutch company (the sale numbers have not been published). Also in 2004, Mello created HRT (High Resolution Technology), which also started as a seismic analysis company. The business directions changed in November 2008, after a telephone call. Mello called his friend Michael Vitton in New York, the American executive managing director of Canadian bank BMO, specialized in investments in natural resources. Mello wanted to introduce one of his clients to Vitton, a small oil company that was trying to raise funds to extract oil in Solimões basin, in Amazon. He got no as an answer. “But I suggested that he should create his own oil company”, says Vitton. “And I offered to help raise the money for that.”

Two days later, Vitton came to Brazil, became Mello’s partner, created an investment fund to support Brazilian private companies and left BMO. In late 2009, Vitton used his contacts to introduce HRT to foreign investors, making the company’s first fundraising by selling 70% participation for 276 million dollars. MSD Capital, owned by Michael Dell (who created computer manufacturer Dell), was among the investors. The next step was to have the IPO. With cash on hand, around 200 employees of HRT – almost half used to work at Petrobras – rush today to start the oil production in Solimões basin and Namibia sea, in Africa, where the wells under the company’s concession are located. HRT estimated reserves correspond to 2 billion barrels - 15% of Petrobras proven reserves.

Despite the investors’ optimism, the oil production activity involves high risks any place in the world. “There are no guarantees that HRT will find oil in the concession areas”, says a consultant. Some people that criticize Mello (unpublished names) say that he’s only appreciating HRT to sell it before the oil appears in its wells. “I’ll look for partners, not buyers”, says Mello. Regarding the doubt about the presence of oil in Solimões basin, where, until last year, only gas was found, Croc entrepreneur usually answers with the help of a Coke can. He pours the soft drink in a glass and explains: “Gas is lighter and, for this reason, stays over the liquid. We have to drill deeper to get to oil, and that’s what we’re going to do”. That’s Mr. Go Deeper striking again.