Matheus Tavares Dos Santos
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Since 2007, the number of publicly listed companies in Brazil has decreased from 400 to just a little over 300.
In the past six years there were only 21 IPOs — an average of just 3.5 public exits per year; by 2019, even Iran had more listed companies than Brazil. Global capital markets are heated given pandemic stimulus packages and low interest rates worldwide, but in Brazil the boom comes with a special feature: in Q3 2020, there were 25 primary and secondary equity offerings, and this year is on track to be the most active in history both in number of deals and dollar volume.
The most important event, however, is not necessarily the reversal of a shrinking public market but the fact that startups are issuing stocks for the first time, a dramatic change for a market previously dominated by industries like commodities and utilities.
Growth versus value: Revert the shrinking market and internet companies
Not only is Brazil’s IPO market roaring, the waitlist is even more impressive: More than 47 companies have filed at CVM (equivalent to the the Securities and Exchange Commission) to issue equity and are waiting for approval. In other words, the IPO is equivalent to more than 15% of the number of publicly listed companies. In the first half of October, six companies were approved to issue equity. Obviously construction and retail names are still predominant as they take advantage of the lower rates, but the main novelty are new entrants in internet and technology.
In the past decade, there were 56 IPOs in Brazil and only two were in the software space, both in 2013. That is a reflection of the profile of the investors who dominate local markets, which are used to allocating assets to companies in sectors like oil, paper and cellulose, mining or utilities. Historically, publicly listed companies in the country were value plays, as few of them had significant exposure to the domestic market and derived a significant share of revenue from commodities and exports.
As a result, companies that focused on the domestic market or on growth were never quite embraced by local investors. Many investors deploying capital in Brazil were mostly foreign and very risk-averse to the dynamics of the domestic market; in 2007, when Brazil went through a similar IPO boom, 70 percent of the demand for equity offerings came from foreign investors.
Along with an undervalued currency, growth companies struggled to find attractive valuations on the local exchange. As a result, growth companies such as Stone Payments, Netshoes, PagSeguro, Arco Educação and XP Investimentos did their IPOs in New York where they attained higher valuations. It’s ironic that there were three times more IPOs of Brazilian growth companies in the U.S. in the past five years than there were in the domestic market in the last decade.
Roaring 20s: New investors and massive portfolio relocations
In September, homegrown startups raised $843 million, the most money in Brazil’s history. It was also the month that Vtex became the 10th Brazilian unicorn, in addition to 21 startup M&A deals, an all-time record. Eventually, these companies would outgrow private markets and the current environment might be just right to kick off that long-awaited transition.
There is a new economy emerging on the brink of a very traditional one, and both are still figuring out how to coexist. In 2019 alone, Brazil doubled the number of unicorns it had, and was the third country in the world that most created new unicorns, behind only the U.S. and China. Many traditional names in Brazil already saw this coming some time ago and have been preparing for it.
Latin America’s digital transformation is making up for lost time
BTG Pactual, the largest independent investment bank firm in Latin America, for example, launched BoostLAB a few years ago, which is BTG’s hub for tech companies. In addition to fostering the startup environment, BoostLAB recently launched a venture debt and fundraising solution for startups to help them make this transition to public markets. The Brazilian Stock Exchange, B3, also launched a special listing category for smaller businesses in which they can list the company without offering equity, helping to prepare them for the market and stimulate shares in less traditional companies.
Unlike 2007, when foreign investors took the lead, local investors drove two-thirds of the demand in equity markets in 2020. The reasons are twofold: For starters, the number of retail investors increased by more than five times in just three years, from half a million (only 0.2 percent of the population) to almost three million.
Secondly, there is a massive portfolio relocation among institutional investors. Only a few years ago, government securities paid more than 14% annually and fixed income returns were enough for pension funds and other institutions to meet liabilities, but, now, with negative rates for the real, there is a colossal relocation from fixed income to equity portfolios. Besides that, XP Investimentos has flooded Brazil with retail investment options that were unthinkable just a decade ago, from distributing venture capital funds to REITs.
As already mentioned, domestic investors are key. Differently than foreigners who avoided local risk by focusing their exposure in traditional industries companies, Brazilians are familiar with local names and dynamics and are willing to invest in the companies with which they already have a customer/consumer relationship. Along with that, foreign investors create volatility, which is not the case for local players who often don’t have the option to pull capital to allocate elsewhere.
All of these factors created the right environment for internet and software companies to seek their fortunes in the local stock exchange. In 2020, there are at least seven startups that have gone public or have filed for an IPO, more than three times higher than the previous 10 years:
- Mosaico
- LocaWeb
- Boa Vista
- Enjoei.com.br
- Meliuz
- Wine
- Housi
Ranging from credit score platforms to online wine sales, not only are their debuts unprecedented, it is the first time that cash-burning companies with net profit losses are filing for IPO, and some of them have yearly revenues of only $10-$20 million.
A short-term boom with long-term consequences
There are obviously headwinds to the heated local capital market.
The most significant one is a 12% GDP deficit given aggressive coronavirus stimulus packages. The debt/GDP ratio could surpass 100%, and in a scenario where rates have to be raised to fight inflation, the debt burden will be quite high. There is an urgent need to pass structural fiscal reforms in order to avoid breaking a constitutionally imposed fiscal ceiling by 2021, but given the municipal elections in Q4 2020, disagreements among members of the ruling coalition and an upcoming presidential election in 2022, there is a chance no significant fiscal reform will be made in the near future, which could be disastrous.
Thus, the capital market boom might be temporary, but the emergence of a new economy in Brazil supported by new local investors and new players is a trend that has been building up for some time. This transition was already prone to happen sooner or later, and the current environment just fast-forwarded the development of the local stock market and opened up space for domestic growth companies.
On the other hand, as this trend was artificially pushed forward, it is necessary to assess if the journey going forward will be consistent or choppy. Are the new retail investors here to stay, or are they just testing a new opportunity in the market? How would they behave in a shock? In a scenario of higher rates, would capital aggressively change back to fixed income? Will the international investor be attracted to the new IPOs, which are a bargain in local currency? How significant and soon will a fiscal reform be passed? These are just a few questions that should be in the investors’ mind when assessing opportunities in the country going forward.
Current and upcoming trends in Latin America’s mobile growth
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