Levindo Santos, Senior Partner at G5 Partners
Carlos Macedo, Founding Partner at Córtex Consultoria
A new wave of IPOs in Brazil
The public equity market generally has a direct correlation with economic growth cycles. Particularly during periods of economic development, equity markets undergo a value creation process in which companies play a leading role, leading to the increase in share prices of publicly listed companies, as well as in the number of companies that enter the market though initial public offerings (IPO).
After facing one of the most severe recessions in its history, which began in 2014, Brazil started to show signs of economic recovery in 2017. This process was accompanied by a gradual reduction in interest rates and a substantial appreciation of the shares listed on its stock exchange.
Graph A: Selic x Ibovespa
From 2014 to 2016, as the Brazilian economy suffered the effects of the recession, only 6 companies were able to tap into the local stock exchange, through IPOs that only raised slightly over R$1.5 billion. In the following three-year period, the effects from the economic recovery allowed 18 new companies to launch their IPOs, raising more than R$37.4 billion in funds from local and foreign institutional investors, as well as from individual investors.
Graph B: Volume Raised x Number of Offerings (IPOs)
As 2020 arrived, the level of optimism in the country reached levels rarely seen, and this was directly reflected on the B3 Stock Exchange. On January 23, 2020, the Ibovespa hit a record high of 119 thousand points and the country’s first IPO in 2020 was launched just one month later. The general expectation was that the number of companies to go public would surpass the number of offerings in 2007, when this type of transaction reached its historic peak. However, the covid-19 pandemic, unleashed at the end of March 2020, crashed global markets, bringing insecurity and the suspension of IPO plans for many companies. At the end of the first half of 2020, as the initial signs of economic resumption began to be perceived around the world, along with the indications for vaccines against covid-19, stock markets began to strongly recover. In Brazil, even though the handling of the pandemic situation, until now, has brought more uncertainties than answers, the local stock exchange has also benefited from the global optimism and ended 2020 with strong recovery in prices and an impressive number of IPOs: 28 companies entered the equity market, raising R$43.7 billion. Three factors, which are directly related, were responsible for this scenario:
The first factor was the interest rate, measured by the Selic, which was at its lowest historical level in 2020: 2% per year. At this level, investors are practically forced to search for other alternative investments with higher risks, such as shares, to increase profitability.
The second factor was the expansion of the individual investor base. The lower Selic rate, combined with the evolution of investment platforms (such as XP) led to an increase in the amount of people interested in investments in stocks and other higher risk assets. As a result, the individual investor base on the B3 Stock Exchange almost quintupled, from 619,600 investors in 2017 to more than 3 million in December 2020.
The third factor was that local institutional investors have been taking on a leading role in recent years, replacing large global investors. In addition to offering more stability for the capital that is available, this shift improves the dialogue between companies and their investor base.
In this context, and in continuation to the trend that began in 2017, more than R$40 billion in fixed income assets were reallocated to other higher risk assets during 2020, particularly to the equity asset class. Even with the Central Bank increasing the basic interest rates, this new preference for higher risk assets, which including stocks, is expected to last.
What to expect?
According to the banks that have been coordinating the equity offerings, the IPO and follow-on cycle in Brazil should continue to gain momentum in 2021, possibly challenging the record set in 2007. Since the start of 2021, 15 companies have gone public, the highest number for a first quarter. The next “window” for equity offerings, which starts in April, could bring more than 40 companies to the stock market, with an expected total issue volume of R$50 billion, and this would set another record for a single window period. Follow-on offerings are also expected to be executed by companies that are already listed, which could add an additional R$20 billion in issue volume.
If the number of IPOs is impressive, the diversity of sectors accessing the market since 2020 is also remarkable. The B3 Stock Exchange is well represented by construction and energy companies, all of which have conducted successful IPOs in the past. However, many companies from other sectors that are still underrepresented are entering the market, such as healthcare (Rede D’Or), education (Cruzeiro do Sul), specialized retail (Petz, Grupo Soma, Track & Field, Quero-Quero and Pague Menos), technology (Neogrid, Locaweb, Bemobi and Mosaico), in addition to companies that operate predominantly digital business models (Méliuz and Enjoei).
This movement proves that, unlike other times, when companies from non-traditional sectors had to overcome obstacles to access the stock market, investors now have appetite for issues in almost all industries. A final barrier which still needs to be overcome is the minimum size required for a company to access the stock market. Investors continue to prefer larger companies, but this tends to gradually change, allowing the local stock market to become even more representative of the economy as a whole and effectively a more democratic space.
The risk of short-lived success stories
It is essential to keep in mind that IPOs represent a corporate milestone and must be carefully prepared, as well as be strongly consistent, with the company’s strategic objectives. The number of IPO that have been canceled since October 2020 (a total of 19) calls for attention and raises a flag. Market fluctuations are common, particularly during times like these, in which there are strong uncertainties and economic fundamentals are still fragile, both domestic and on the international scale. However, certain cancellations were due to investors’ perception that many companies had little consistency and were only taking advantage of a “heated” window opportunity. This may also be true for IPOs that were successfully executed in the past if these companies show that they were not prepared for the challenge, therefore frustrating market expectations. This type of situation, if escalated, could be damaging.
To avoid making the same mistakes of past IPO “seasons”, when many companies were unprepared and tumbled shortly after accessing the market, causing great harm not only to investors but to the market’s credibility, it is essential that business owners, investors, financial agents, and regulators act with maximum criteria and responsibility. Otherwise, new short-lived success stories, of companies that were simply not prepared to sustain their IPO investment thesis, could put at risk the development of our still incipient capital market. Therefore, every IPO must be carefully planned and designed according to each company’s strategic objectives, in addition to receiving support, understanding and commitment from its shareholders and the executives who will lead the corporate transformations required by the process. Both professional and non-professional investors have appetite for investment thesis that are consistent, well-grounded, and that offer growth potential, all of which are key ingredients for the success of an equity offering.
One of the fundamental challenges is to ensure that the company’s shareholders actively and consciously participate in the entire IPO decision process. Developing a well-grounded view of the company’s values, creating mechanisms for corporate relationships, and defining the IPO’s structure and terms are particularly important aspects. The company must also reaffirm its commitment to maintaining a constructive dialogue with investors and market analysts, supported by a governance structure that guarantees compliance with laws and regulations, in addition to being guided by transparency and accountability principles after the IPO. Under these conditions, a company’s relationship with the capital markets, and particularly the stock market, can be long-lasting and successful.