A Second Chance

The Reform of the Novo Mercado is underway.

It’s an excellent opportunity to analyze the facts that have taken place in the Brazilian capital market for the past 20 years and make use of the knowledge acquired through practice to set the right direction.

Let’s not exhaust our readers’ patience with excessive numbers to describe what we already know, but some of them are worth mentioning: there are approximately 350 companies with some liquidity listed in the Brazilian Stock Exchange. BM&FBOVESPA itself estimates that there are some 10,000 companies in Brazil that could go public. Countries such as India and Canada have more than 6,000 companies, what confirms such potential.

Meanwhile, IPOs have dried up in the country. After their rebirth in 2004 (under the auspices of the Novo Mercado) until the peak of BRL56 billion in 2007, the number fell back to zero. No significant IPO (except for few honorable and small examples) has taken place in the country in the past three days.

The numbers don’t lie: today, our capital market, and particularly the stock market, is a fiction. It does not fulfill its social function of channeling private funds to the productive sector.

The cynical interpretation of this scenario always points to the “stratospheric interest rates” and the macroeconomic instability as reasons for the situation. There’s nothing more false than that – it’s an attempt to deny the market’s own rationale. The market is a “machine” that prices risk factors. Macro factors, such as the GDP, inflation rates, interest rates or even the impeachment process affect both buyers and sellers, pushing prices downwards or upwards. This adjusts the return rates to the systemic factors, bringing some attractiveness to equities. That is, unfavorable perspectives should not lead to the inexistence of a market, but to a drop in prices.

As we have already addressed in this section, the reason for the primary stock market to not work properly is the existence of an additional risk factor that affects buyers and sellers of shares on an asymmetric basis: the risk of expropriation. If one buys 10% of a company and eventually gets less than that percentage of its economic value, ends don’t meet. Buyers and sellers are kept apart and the market does not work.

That’s the current reality of our market. Curiously, we experienced this same situation in the 90’s, when the globalization led companies to close their capital and change control with average premiums of some 700%. That is, controlling shareholders earning 8 times more per share than minority shareholders.

Once again, curiously, that was exactly the premium paid by Potash Corporation when it bought 10% of Fertilizantes Heringer’s capital, in the beginning of 2015. By the way, Heringer is a company listed in the Novo Mercado! The segment that should supposedly protect shareholders and treat them with equity. Why are the shares held by Heringer’s controlling shareholders worth 8 times more than the market shares? The answer to this question leads us to the core of the problem affecting our capital market.

The truth is that complacency has brought us back in time. The Novo Mercado, established based on a visionary view by the former Bovespa, was considered, at that time, by the same cynics that now talk about the stratospheric interest rates, as a midsummer night’s dream. It was an unattainable vision, disconnected from the Brazilian reality. But the dream came true and, from 2004 to 2014, virtually 200 companies listed in BM&FBOVESPA’s special segments, what represented a crucial renovation of our capital market. The adhesion to the Novo Mercado and to the Level 2 became the sine qua non condition for IPOs in the last decade – when 76% of the IPOs were in the maximum governance level. Attempts to measure the “premium” that investors would pay to be protected by the segment ranged from 26% to infinite, as the alternative was the total lack of offers.

But, unfortunately, we got stuck in the past. The Novo Mercado was created as a checklist – a list of rules conceived to address the problems of the 90’s. Additionally, in a country characterized by a strict adherence to form, instead of essence, it only takes time for well encouraged lawyers to find gaps in the standards that prevent them from attaining their objective. That’s exactly what happened.

The tag along right, major flag of the 90’s, has become irrelevant taking into account the jurisprudence totally in favor of controlling shareholders adopted by regulators and self-regulators. The alignment of interests, sealed with the ‘one share, one vote’ principle in the Novo Mercado in 2001 and the reduction of the ceiling of preferred shares from two thirds to half of the social capital in the Law 10.303 in that same year, was decimated with the creation of Gol’s “super preferred” shares – a company listed in the Level 2! The protection of tender offers at their “economic value” went out of the window due to the inability of making appraisers accountable for their opinions and preventing evaluation reports from being mere rented spreadsheets fed by data provided by the offering shareholders and supported by the use of the Excel’s “Goal Seek” feature. Whether right or wrong, the Arbitration Chamber has become an inaccessible black box to most investors. Finally, all the efforts to renew the capital market were brought into discredit with the perception that it’s very easy to delist from the Novo Mercado… the company only needs to make an offer, with no requirement that the proposed price is accepted by a single shareholder.

For all this, Brazil has thrown away one of the most important intangibles created by Bovespa (what may have made its own IPO feasible). Ask how much an investor would pay for the premium of a company listed in the Novo Mercado and the answer would probably be very close to zero. We have asked that to our members, on a non-scientific basis, and that was the answer.

At the same time, we have been watching the ‘exporting’ of our capital market. Large and traditional companies have been going private (Souza Cruz is a remarkable example). A more frightening reality is that now we see the ghost of the reincorporation in the operation carried out by JBS. By analyzing the justification of the company for such operation (probably correct from its point of view), we find some concrete and some not so concrete reasons. The so-called “Brazil cost” should not be relevant in a decision like that. Efficient markets apply the risk-free rate weighted according to the region where the company operates, and not according to its country of incorporation (or even worse, according to the origin of investors). The fact is that the Brazilian market probably pays “less” for JBS’ shares than the Irish or the US markets will. However, the reason is that mentioned above: the risk of expropriation.

Our complacency has created the perception that not only abuses are frequent in Brazil, but also that investors are not compensated for the damages they may suffer. We challenge the reader to mention two cases of minority shareholders that have been effectively indemnified by listed companies and controlling shareholders in the past 10 years in Brazil. There is not a single case. The abuses against Petrobras will be just another brick in the wall: suits filed by shareholders are likely to be judged in the United States long before minimally relevant decisions to compensate minority shareholders are taken in Brazil. The consequence? The exporting of our market.

Therefore, the reform of the Novo Mercado is urgent and necessary. Despite all the “macro” setbacks we are subject to, all those who believe in our market and in its capacity to leverage the economy and the Brazilian society or that depend on it in professional terms (including analysts, managers, bankers, executives, and regulators) must debate over the lessons learned and collaborate in an effort so that the Novo Mercado is once again what it was during a decade, reopening our capital market.

Amec has unequivocally positioned itself in the Public Consultation carried out by BM&FBOVESPA, closed on May 16th. Our position is available in our website. But the process continues. Those who have not collaborated must reflect on the issue and make their voice heard.

And now we come to the most important audience of all: the companies. According to the regulations of the Novo Mercado, eventual changes to it must be approved by two thirds of the listed companies. In 2010, under the leadership of Mr. Armínio Fraga, BM&FBOVESPA tried to update the rules, but efforts were frustrated by a wave of contrary votes in the bottom of the ninth. Based on our interactions, many companies voted against the changes without a deeper reflection about their merits, following the guidance of corporate pseudo leaderships that are contrary to the necessary developments to renew our capital market.

We need to wake up the good companies, that is, the companies of the Novo Mercado that went public consciously and not only simply because their bankers showed them a 1 billion-check amid the bubble. We need companies that have experienced the cultural change and understand what it is to be a listed company that raises public funds and knows that investors must be treated with transparency and equity. These are the companies that perceive a competitive advantage in having access to the market and that seek long-term partnerships.

Accordingly, it’s important that the good companies reflect on the issue. That they talk with their controlling and minority shareholders and analyze the topic based on a long-term mindset.

In essence, the good companies must not join the consolidated leaderships of companies that live in the past. Those companies based on a varguista[1] vision, according to which the capital market was only a weak leg of their capitalization tripod (the other two legs being the “industry’s captains” and the cheap public money). These companies will always be contrary to the creation of an equity-based market because they have nothing to gain from it. They will continue to treat investors as second-class citizens that are called only to pay the bills when things go wrong. It is important to give them the cold shoulder because they represent the past.

Investors and companies of the future, unite. It isn’t always that life offers us a second chance.

[1] Based on the principles defended by the late President Getúlio Vargas, in the 1940’s. About this topic, we recommend the outstanding speech delivered by Ney Carvalho, available in https://youtu.be/QFsCdSNT0dw?list=PL_hym_FCqXW1_9Q2qACY-BgGSsw76WNEf.