Escape From New York

ADRs used to be a vital source of capital for companies, but now many equity issuers in Latin America are staying local.

Brazil’s flag flies proud at the NYSE.

Companhia de Saneamento de Minas Gerais (Copasa) is a company on the go. Providing water to Minas Gerais, Brazil’s second largest state, Copasa has graduated from posting consecutive deficits in the 1990s to being lauded as one of the country’s most profitable utilities. In early February, the company cemented its turnaround with an initial public offering (IPO) attended by political bigwigs and other luminaries. To attract discerning investors, though, Copasa issued on the São Paulo Stock Exchange’s Novo Mercado, rather than on the New York Stock Exchange. Citigroup and Unibanco underwrote the deal.

Even though IPOs are through the roof in Latin America, the issuance of American Depositary Receipts (ADRs) – once a mark of distinction for equity issuers – is happening less often. Furthermore, a number of Latin American companies already holding residence on the Big Board have vacated the premises.

With seven IPOs in the first three months of 2006, this year’s crop of equity offerings promises to be richer than 2005. “You’ll see a bigger dollar volume, a bigger number of issues, and a bigger number of IPOs,” from Latin America, predicts Sebastien Chatel, head of Latin American equity capital markets at UBS.

Nicolás Aguzín, head of Latin America investment banking for JPMorgan, agrees, seeing as many as 30 IPOs from the region this year. “It’s a huge pick up - this is the most active year ever,” he says.

But fewer of those will be coming to New York as ADRs.

Several factors are contributing to the decline: local capital markets are increasingly vibrant, corporate governance is improving and the advent of the Sarbanes-Oxley Act in 2002 has made US listings more difficult and costly.

Gilberto Mifano, chief executive of Bovespa, the São Paulo Stock Exchange, says that in the past, listing ADRs was “almost obligatory” for Brazilian companies on his exchange. Through the mid-1990s, companies on the Bovespa would issue ADRs to prove they could meet the stringent requirements of the US Securities and Exchange Commission (SEC), and that they were therefore worthy of foreign capital. “It was the equivalent of an ISO certification,” he explains.

By contrast, investors viewed shares listed exclusively on Latin America’s local exchanges as having lax disclosure and corporate governance.

But while Mexico and Brazil have developed markets accessible to foreign investors, other countries in the region have not. Chatel at UBS attributes this lag to capital controls. Countries like Colombia and Argentina, which restrict the flow of capital across their borders, are less likely to attract foreign investors.

Banco Macro Bansud from Argentina did a $278 million issue at the end of March. While the issue was a follow on in Macro Bansud’s home market, the bank chose to sell $191 million-worth of ADRs at the same time as an IPO in New York because international investors wouldn’t go into Argentina, says Chatel, who worked on the deal.

In general, investing locally used to be a giant pain. For example, just a few years ago, in Brazil it took between 60 and 100 days to wade through substantial red tape and set up a domestic trading account. Today setting up an account takes less than 24 hours, and can be done online.

Additionally, US investors can get exposure to local listings through a swap agreement with a bank. “You have a prime brokerage account with the bank,” says Chatel, “they buy security and give you the performance.”

Meanwhile, for international companies, the disincentives for listing in the US increased dramatically after the Sarbanes-Oxley Act took effect in 2004. The paperwork alone required for compliance with the new law, some investment officers say, could be a full-time job.

On the Mexican Stock Exchange, half a dozen companies pulled up roots in New York after getting a taste of Sarbanes-Oxley to make the Mexican bourse their main trading venue. It started as a trickle – tile maker Internacional de Cerámica, conglomerate Desc and steel maker Grupo Imsa all said adios to the NYSE around early 2005 – and then turned into a flood when the SEC launched an investigation into Mexican magnate Ricardo Salinas Pliego’s business practices.

Calling the investigation a witch-hunt, Salinas Pliego removed shares in his broadcaster, TV Azteca, and retailer Elektra from the hallowed halls of the NYSE, while also taking his newly acquired cell phone operator Iusacell out of the States. “I don’t believe in US law being applicable to me. Period,” Salinas Pliego told the Wall Street Journal in December.

While oversight has improved by leaps-and-bounds in Mexico, the system is still pretty weak. Even companies that have gone bankrupt have managed to keep their Mexican listing for several years, mainly because their assets get tied up in Mexico’s tangled legal system.

In late-2005, Mexican legislators passed a sweeping stock market law aimed at improving transparency of the country’s 132 publicly listed companies; the law takes effect in June. “All the participants in the market have to work to adjust to the regulations,” says Pedro Zorrilla, assistant director of the Mexican Stock Exchange. “Companies that don’t report can’t operate on the exchange.”

Wall Street Beckons
Chris Sturdy, managing director of depositary receipts at the Bank of New York, which acts as custodian for 64% of all globally issued depositary receipts, dismisses the idea that Sarbanes-Oxley has sent foreign companies packing, saying that those aspiring to be global – or even to simply attract global investors – will continue to want a residence on Wall Street.

“We looked at delistings since 1995, and the rate has not increased,” says Sturdy, adding that mergers and acquisitions are the biggest impetus for delistings. “What has decreased is rate of entry.”

All told, 453 non-US companies valued at $7.1 trillion trade on the NYSE, representing a third of the bourse’s total value. Of these companies, 91 hail from Latin America while another 56 are domiciled in the Caribbean. By contrast, in early 2005, the exchange had hosted stocks from 460 non-US companies.

Companies – especially those headquartered outside of the US – are weighing the benefits versus the drawbacks of a New York City address much more carefully than in the past. Heightened regulation can easily translate into more headaches and higher operating costs.

According to analysis from Financial Executives International, an advocacy group, US firms complying with Sarbanes-Oxley saw their audit bills balloon, on average, by 103% in 2004 versus the previous year. Companies that broke out their Sarbanes-Oxley fees from total audit costs reported a median expense of $1.8 million on that compliance, or half of their entire audit bill.

“The local markets gained a lot of traction, therefore there are less reasons to go to the US,” JPMorgan’s Aguzín explains.

US authorities acknowledge that the financial burden imposed by Sarbanes-Oxley compliance needs to come down. After the act took effect, William McDonough, chair of the non-profit Public Company Accounting Oversight Board tasked with helping companies adjust to the new rules, said he noted a definite improvement in the quality of financial reporting. Still, McDonough conceded that the first round of internal control audits “cost too much.”

Liquidity Lure
In spite of the added cost, global investors like to dabble in ADRs, mostly for the convenience of settling their tabs on a single, liquid exchange. Also, dual listings provide traders with arbitrage opportunities, especially when time zones come into play.

George Hoguet, an investment strategist with State Street Global Advisors in Boston, says that even a huge firm like State Street – one of the largest institutional investors in the US – likes ADRs for their liquidity.

“A well-constructed ADR has liquidity to lower its trading cost,” Hoguet says, explaining that if the firm moves a sizeable chunk of its $7 billion in emerging markets assets into a stock on a small local market, the transaction could easily account for an attention-grabbing 20% of that exchange’s average daily volume. Obviously, low liquidity makes it difficult for such a big player to get in and out of stock positions.

Currently, State Street has local equity investments in Brazil and Mexico, and in the past it has plunked down change in Chilean, Peruvian and Venezuelan markets.

ADRs also attract investors interested in specific sectors, as opposed to regions. For example, thanks to New York-listed shares, telecom investors can compare valuations for Teléfonos de México in the same currency and market that hosts the likes of AT&T and France Telecom. “An ADR attracts not just [emerging market] managers, but sector and global managers,” says Hoguet. “It’s a way to increase global ownership.”

Sturdy, from the Bank of New York, thinks that growing businesses like airports, pharmaceuticals and natural resources will continue to look for global capital, while industries like agribusiness, finance and housing – particularly in Mexico – are logical candidates for depositary receipt programs.

Mexican airport operator Grupo Aeroportuario del Pacífico took the bait, and its simultaneous $963 million IPO on the NYSE and Mexican bourse in late February was a roaring success. Investor demand for the group, which runs 12 airports in central Mexico, was so strong that lead underwriter Credit Suisse bumped the sale price up to $21 per share from the $18 to $20 range it had originally targeted.

In their first day of trading, the shares – listed in New York under the ticker PAC – soared 35%.

London Calling
Nonetheless, equity issuers can find a global stage outside of New York. Global Depositary Receipts (GDRs), for example, are identical to ADRs except they change hands in European financial hubs like London.

Once a rarity for Latin American companies, GDRs are picking up steam in the region. Since mid-2004, when Brazilian logistics giant América Latina Logística’s IPO included a simultaneous issuance of shares in São Paulo and GDRs, there have been seven GDR issues from the region, including two follow-on sales by América Latina Logística and four multiple-listing IPOs.

Prior to América Latina Logística’s splashy sale, no Latin American company had opted to carry out an IPO with GDRs since Brazilian real estate group Rossi Residencial sold GDRs in 1997. But the market for Latin GDRs is still nascent, points out UBS’s Chatel. América Latina Logística’s listing was a private placement under Rule 144a, and is not traded on an exchange. The difference in time zones also discourages Latin American companies from choosing London over New York.

Latin America’s long-held affinity for a New York address is the exception, rather than the rule, in emerging market equities. Reena Aggarwal, a professor at Georgetown’s McDonough School of Business, points out that US funds investing in Latin America have 45% of their assets in ADRs, with the remaining 55% in local stock issues. By contrast, emerging Asia funds invest less than 13% of their assets in ADRs, and over 87% in local shares. Aggarwal says this difference stems from the bigger role that domestic investors play in Asian equities markets, and the strength of the legal framework in Asia, as compared to Latin America’s weak courts.

In Brazil, the Bovespa’s Novo Mercado has addressed questions of corporate governance by making its residents meet additional disclosure requirements, maintain a free float of at least 25% and adopt US Generally Accepted Accounting Principles (GAAP). Additionally, the Bovespa provides two less-stringent levels of listing for issuers looking to differentiate their stock – Level 1 allows restrictions on foreign ownership and Level 2 has no float requirement.

As a result of these new listings – which were launched in 2001 – the Bovespa has seen trading volume take off, with transactions growing at 20% a year, according to the Bovespa’s Mifano. From a base of 20 million trades a day in 1997, the Bovespa now sees over 100 million today. Mifano attributes some of that increase to retail participation in the exchange, which has increased over the same time period from 16% of total trades to 25% today.

Still, while international investors are only 3% of the participants in the Bovespa, on average they make up 67% of the buyers of IPO stock on the exchange. Local markets, like the Novo Mercado, often focus on creating liquidity, and therefore take aim at smaller companies. While five of the 10 largest Brazilian companies by market capitalization are registered under the Level 1 corporate governance listing, none are listed on the Novo Mercado. Several of Brazil’s largest and most popular companies – such as Petrobras, Ambev, and Eletrobras – aren’t listed on either, nor do they have less stringent Level 2 listings.

In Mexico, Zorrilla points out that it’s often convenient for medium-sized companies to concentrate liquidity in their home market. “Without a doubt, it’s more complicated, more expensive, and more risky,” to have multiple listings, he says.

But local listings still lack the glitz of a Big Apple soiree. When Brazilian drinks giant AmBev debuted on the NYSE in 2000, leggy supermodel Gisele Bündchen rang the opening bell, whereas Copasa’s A-list guest was the clearly less sexy mayor of São Paulo and Brazilian presidential candidate, Geraldo Alckmin.
But the local listing still has a lot of cachet. “If you are a Brazilian company, you don’t need a listing anywhere but Brazil,” says Chatel.

While the Copasa IPO might not be the social event of 2006, Márcio Nunes, the company’s chairman and president, says he’s pleased with the global exposure the utility is getting out of its Novo Mercado address. “It’s a domestic issue with a strong international push,” he bragged to investors during a March conference call.

Proof that Latin Americans can draw a world class crowd, even without a Victoria’s Secret lingerie model on hand.