The 2013 Meeting of the Latin American Corporate Governance Roundtable Session 1: Trends and Factors Impacting on Equity Market Growth in the Region Professor of Corporate Governance University of Sao Paulo (USP) Founding partner of Direzione Consultoria Papers available at http://ssrn.com/author=443083 Quito, June 20th, 2013
Equity Markets in Latin America What has changed in Latin American Equity Markets in the past 15 years? (1/2) Topic Late 90 s (97-99) 2013 (latest data) Progress (1-4) Market capitalization of listed companies Total value of shares traded Low (28% of GDP) Very low (11% of GDP) Intermediate 4 (50% of GDP) Colombia as best in class (15% to 60%) Low (22% of GDP) Brazil as best in class (15% to 40%) 3 Number of listed companies Very low (4.1 listed companies per million inhabitants) Very low (2.5 listed companies per million inhabitants) 1 No best in class 4 Substantial progress 3 Some progress 2 Lack of progress 1 Deterioration 2
Equity Markets in Latin America What has changed in Latin American Equity Markets in the past 15 years? (2/2) Topic Late 90 s (97-99) 2013 (latest data) Progress (1-4) Market concentration Very high (Share in total market cap of top 10 most cap firms: 55%) Very high (Share in total market cap of top 10 most cap firms: 64%) 1 No best in class Free float level Low (25% of all outstanding shares) Low (23% of all outstanding shares) 1 No best in class Ownership concentration Very high (72% of all shares held by the 5 largest shareholders) Very high (76% of all shares held by the 5 largest shareholders) 1 No best in class Companies with dispersed ownership Virtually Nonexistent Rare but existing (9% of companies with 5 largest shareholders holding <50% of voting shares ) 3 Brazil as best in class (0% to around 7%) 1 Deterioration 3 Some progress 2 Lack of progress 4 Substantial progress 3
IPO Market in Latin America IPOs in Latin America: number of deals in the past 10 years 128 143 3 12 IPOs in Latin America and the housing/credit bubble prior to the financial crisis IPOs in Latin America S&P/Case-Shiller Home Price Indices in the U.S. (lagged 1 year) 164 24 190 38 205 197 81 166 144 146 140 13 20 26 21 18 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 61% (155 out of 256) of the offers during the 2004-2007 IPO wave possible reasons: 1. Easy credit conditions and asset bubble worldwide 2. Macroeconomic stability in Latin America (coupled with commodities boom) 3. Companies (fuelled by investment banks) making use of a window of opportunity resulting from hot/mispriced markets 4. Improved investor protection at the country-level (through regulation or selfregulation such as Novo Mercado) 5. Improved corporate governance practices at the firm-level Items 4 and 5 deal with structural changes to what extent they have been the cause of an increase of IPO activity in the region? 4
Revenues (000'US$) IPO Market in Latin America IPOs in Latin America: size of companies that decided to go public 1.200.000 1.000.000 Revenues of Latin America companies that went public at the end of their IPO year from 2003 to 2012 (000'US$) Median Mean 1.197.036 Median revenues (US$) of companies that went public Latin America U.S. (2010-2012) 217 MM 95 MM 800.000 600.000 400.000 200.000 142.313 306.862 190.934 488.013 275.915 439.147 168.680 254.872 471.840 93.264 92.761 547.693 216.858 Share of small firms* among companies that went public Latin America U.S. (2003-2009) 17% 44% 0 Argentina Brazil Chile Colombia Mexico Peru Latin America Sources for U.S. data: Where have all the IPOs gone? Gao, X., Ritter, J., Zhu, Z. 2012. Available at http://ssrn.com/abstract=1954788 The JOBS Act: One-year anniversary An overview of implementation after one year and an analysis of emerging growth company trends. Ernst & Young. 2013. * Small companies are defined as those with revenues below USD 50 million. 5
IPO Market in Latin America The Brazilian Case 1. Accounting for 56% of all IPOs in the region (143 out of 256) 2. Around 3/4 taking place in the 2004-2007 IPO wave (106 out of 143) 3. Around 1/3 involving companies from the real estate and financial services industries (47 out of 143) 4. 52% of all capital raised went to the 20 largest IPOs, 15 of them nonindependent companies (carve-outs, demutualization, etc.) 5. Only 0.5% of medium and large companies are currently listed on the stock exchange (400 firms out of 66,000*) *Source: IBGE (Brazilian Institute of Geography and Statistics) statistics from the Business Demography 2010, available at ftp://ftp.ibge.gov.br/demografia_das_empresas/2010/demoemp2010.pdf 6
IPO Market in Latin America Why companies are not using primary equity markets as an engine for growth in Brazil? The supply-side of equity 1. There is an alternative (cheaper and less stringent) source of finance: the BNDES 2. Controlling owners may fear losing absolute discretion over all decisions as well as suffer excessive pressure from a market that is increasingly viewed as focused on the short-term 3. The increased transparency required from listed firms could affect a sort of competitive advantage in delicate subjects such as: Tax (reduced scope for tax evasion) Political donations (especially for those depending on government bids) 7
Primary equity markets as an engine for growth Aside the macroeconomic issues, why demand for equity is not as high as before 2008 in Brazil? The demand-side for equity 1. State interventionism at the industry-level (Electricity, Financial Services, etc.) as well as at the company-level (Petrobras, Vale, Banco do Brasil, Oi, etc.) 2. Corporate governance problems with listed companies: Frauds (Agrenco, Banco Panamericano, Banco Cruzeiro do Sul) Huge derivative losses due to improper risk management (Sadia, Aracruz) Controversial restructurings involving Novo Mercado firms (Cosan, Tenda) Dismal performance of high-profile companies ( X Group, HRT, etc.) 3. Evidence that some companies are more interested in corporate governance as a marketing tool than as a new approach for the business: Partial failure of Novo Mercado reform, 1/4 still refusing to disclose compensation as required by the CVM 2009 regulation, etc. 8
Next steps What can be done? Next steps to facilitate capital formation through primary equity markets in Latin America 1. Increase the transparency requirements of medium and large privately-held firms in order to reduce their competitive advantage raise the standards 2. Stock exchanges should foster a market structure that helps SMEs, favoring a long term investor model rather than replicating the trading model currently prevailing in developed markets (based on HFT, decimalization, etc.) 3. Continuous acculturation programs for privately-held firms are essential. Entrepreneurs should be convinced that good governance is valuable for their business, rather than mere formalisms required from third parties: Effective corporate governance enhance competitiveness by improving top level decision making and reducing the chance of negative surprises This creates long term value for their companies and society Some ideas for further investigation in Latin America 9
END alexfea@usp.br +5511 993-425-459 http://ssrn.com/author=443083 10
Mean return of equity IPOs in Latin America IPOs in Latin America: overview of the past 10 years Profitability of companies that launched their IPOs in Brazil ROE Comparison of the mean Return of Equity (ROE) three years before and after the IPO by year for companies listed on BM&FBOVESPA Mean three years before IPO Mean three years after IPO 25,0% More pronounced difference for companies that listed in 2007 and 20,0% in the first semester of 2008, at the peak of hot markets... 16,4% 20,7% 18,6% 19,4% 15,0% 14,2% 13,4% 10,0% 9,2% 10,6% 10,1% 10,2% 7,9% 6,1% 5,7% 6,8% 5,0% 3,7% 3,9% 0,0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 0,9% NA 11
Mean return of assets (ROA) IPOs in Latin America IPOs in Latin America: overview of the past 10 years Profitability of companies that launched their IPOs in Brazil ROA 10,0% Mean Return on Asset (ROA) int the three years before and after the IPO for companies that went public in Brazil in the 2004-2012 period 9,4% 9,0% 8,0% 7,0% 7,3% 6,0% 5,0% 5,0% 4,0% 3,0% 4,3% 3,3% 3,7% 3,5% 2,0% 1,0% 0,0% IPO-3 IPO-2 IPO-1 IPO IPO+1 IPO+2 IPO+3 12
Mean Return of Equity (ROE) IPOs in Latin America IPOs in Latin America: overview of the past 10 years Profitability of companies that launched their IPOs in Brazil ROE 16,0% Mean Return on Equity (ROE) in the three years before and after the IPO for companies that went public in Brazil in the 2004-2012 period 14,7% 14,0% 12,9% 12,0% 10,0% 10,2% 8,0% 6,0% 6,0% 5,5% 5,8% 6,8% 4,0% 2,0% 0,0% IPO-3 IPO-2 IPO-1 IPO IPO+1 IPO+2 IPO+3 13
IPOs in Latin America Post-IPO stock performance of companies depending on their pre-ipo relationships with their underwriters IPOs with higher degrees of investor-underwriter conflict of interest are associated with market timing and lower post-ipo performance BHAR 1 year after the IPO -5% 1% -31% -56% Low Moderate High Highest BHAR 2 years after the IPO 4% -4% -29% -41% Low Moderate High Highest BHAR 3 years after the IPO -3% -14% -9% -33% Low Moderate High Highest Source: Santos, R., Silveira, A., Barros, L. Investor-underwriter conflict of interest and post-ipo performance: Evidence of market timing and overvaluation of new issues. Working paper. 14
Primary equity markets and growth Top 10 IPOs in Brazil by capital raised from 2003-2013 # Issuer name Capital raised (R$ b) Year Issuer business description Independent IPO? 1 Santander BR 13,182 2009 Carve-out from multinational listed firm NO 2 BB Seguridade 11,475 2013 Carve-out from listed SOE NO 3 Cielo (Visanet) 8,397 2009 Carve-out from financial institutions NO 4 OGX Petróleo 6,712 2008 Family-owned conglomerate ( X Group) NO 5 Bovespa 6,626 2007 Demutualization of stock exchange NO 6 BM&F 5,984 2007 Demutualization of stock exchange NO 7 Redecard 4,643 2007 Carve-out from financial institutions NO 8 BTG 3,234 2012 Founded by Brazilians, sold and bought back from UBS Unclear 9 HRT Petróleo 2,481 2010 Independent IPO YES 10 OSX Brasil 2,450 2010 Family-owned conglomerate ( X Group) NO These offers have collected 42% of all IPO proceeds in Brazil The concentration of Brazil s IPO market on non-independent IPOs has become even more pronounced after 2008 (64% of the capital raised to top 5 IPOs since 2009) 15
Capital raised annually by companies in Brazil (R$ MM) Primary equity markets as an engine for growth The BNDES as a major source of long term finance in Brazil R$ 350.000 Who finances companies in Brazil? The role of BNDES and Capital Markets 4,5 R$ 300.000 R$ 250.000 R$ 200.000 R$ 150.000 R$ 100.000 R$ 50.000 1,0 1,2 1,8 4,2 2,1 Ratio: BNDES disbursements / Total Capital raised by companies on Capital Markets 0,8 0,5 0,5 1,6 1,8 1,4 2,1 1,5 4,0 3,5 3,0 2,5 2,0 1,5 1,0 0,5 Ratio: BNDES / Total Capital Raised on Capital Markets R$ - 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 BNDES: Annual Disbursements Equity markets: IPO + Follow-On Bond Markets BNDES / Capital Raised on Capital Markets - Obs.: In 2010, Petrobras raised US$ 70 billion in a share offer. Brazil's government received about US$ $43 bn in shares in exchange for allowing the company to drill for 5 bn barrels in reserves, I have only counted for around US$ 21 bn that have been actually raised with private investors in the capital market. 16
Next steps Questions deserving further investigation in Latin America (LA) 1. What is the relevance of economic groups in LA relative to the private sector as a whole? How do they finance themselves and what are their corporate governance practices (including RPTs)? 2. Who are the main institutional investors acting as shareholders in LA? How relevant has been the CG issues to their investment decisions? What has been their role in promoting higher corporate governance standards? 3. What are the main forms of control of LA listed companies (families, shared control, state, foreign, dispersed)? Need for an updated empirical overview 4. How diverse and active have been the boards of directors in LA? How this has changed over time and which countries have taken the lead on this? 5. Are underdeveloped capital markets a barrier to entry for small firms (and a competitive advantage for incumbents)? 17
Primary equity markets as an engine for growth How to transform primary equity markets in a true engine for growth? Supply-side of Equity Benefits of being listed > Costs Demand-side for Equity Confidence that results will be achieved and that they will be fairly distributed Firm-level perspective Investors perspective 18
Stock trade concentration The current market structure in developed markets seems to be leading to an increased market concentration Market concentration: Share in total trading value of top 10 most traded firms: 1998-2010 1998-2000 2001-2003 2004-2006 2007-2009 2010 54% 55% 66% 69% 60% 62% 65% 47% 43% 49% 21% 25% 15% 12% 8% NYSE Euronext (US) Deutsche Borse Latin America (Average) Obs.: The Latin America average has been computing based on the market concentration of the following stock exchanges: Buenos Aires SE, Colombia SE, Mexican Exchange, BM&Fbovespa, and Santiago SE. Source: WFE World Federation of Exchanges. 19