BRAZILIAN CAPITAL MARKETS - MORE INITIAL SHARE OFFERINGS IN

UNCLAS SECTION 01 OF 02 BRASILIA 000835 SIPDIS SENSITIVE SIPDIS NSC FOR CRONIN TREASURY FOR OASIA - DAS LEE, FPARODI STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA STATE PASS USAID FOR LAC E.O 12958: N/A TAGS: EFIN ECON BR SUBJECT: BRAZILIAN CAPITAL MARKETS - MORE INITIAL SHARE OFFERINGS IN 2006 ¶1. (SBU) Summary: Brazilian companies, always interested in obtaining access to cheaper capital than that on offer by the banking sector, have been turning more and more to equity offerings on the Sao Paulo stock exchange (BOVESPA). One particular slice of the market, the BOVESPA's "Novo Mercado" (New Market),which has enhanced requirements for transparency, accounting standards and protection of minority shareholders, has been attracting substantial new offerings. In addition, a major fixed-line telephony provider, Telemar, recently announced its intention to move its listing from the traditional BOVESPA to the Novo Mercado; it would be the largest company to do so. To qualify, it will have to convert its non-voting shares into voting ones and comply with Brazilian Generally Accepted Account Practices (GAAP),among other measures. While the growth in the IPO market is slow and will not have much short-term impact on the availability of financing options for Brazilian companies, it represents a healthy trend and an attractive option for some companies. End Summary. Growth in the Capital Market -------------- ¶2. (U) Brazilian capital markets are expected to continue to develop in 2006. The market valuation of Brazilian companies grew from 55% of GDP in 2004 to 63% of GDP in March 2006. (By comparison, the market value of Chilean stocks reportedly is 120% of GDP.) The volume of daily trading has grown substantially, from Reals 689 million (US$ 235 million) in 2002 to Reals 2.3 billion (US$ 2.1 billion) in the first quarter of 2006. Foreign holdings increased 10 percentage points over the same four years, from 26% of BOVESPA market valuation in 2002 to 36% in 2006. Overall, Brazilian stocks have been among the best returns in the world for the last two years, with the value of the companies listed on the BOVESPA rising 76% since 2004. ¶3. (SBU) But while the overall numbers look relatively healthy, over the same period there has been little IPO activity. Although between 2001 and 2003 there were only 2 IPOs, although the market is showing some recent growth. It is as yet slow growth, with limited short-term impact on the overall financing picture for Brazilian companies, but, in the first quarter of 2006, 6 companies were in the process of making their initial public stock offerings (IPOs) and another 9 had begun the registration process to do so with the Brazilian Securities and Exchange Commission (CVM). These IPOs would be worth about Reals 7.12 billion (about USD 3.3 billion at current exchange rates). Companies interested in going public are trying to speed through the IPO process in the early part of the year, well before the October elections, which could generate some financial market uncertainty. By comparison, in 2005 there were 13 IPOs worth about Reals 14 billion. ¶4. (U) Unlike the large IPO's of 2005, which included larger players such as Gol (airlines),Natura (natural cosmetics) and Lojas Renner (retail),the 2006 generation of companies are smaller, with less than Reals 150 million (US$71 million) in revenues per year. Maria Helena Santana, superintendent of public relations for the BOVESPA, told the press that "the major change since 2004 has been the size of the companies seeking IPO." She cited the example of Odontoprev, a company that offers dentistry health insurance and dentistry services. When its IPO is completed, Odontoprev will be the first health insurer to be listed on the stock exchange. Odontoprev had Reals 147.8 million (US$70.3 million) in revenues in 2005, 23% growth from 2004. Profits were Reals 12 million and Reals 17.7 million in 2004 and 2005, respectively. ¶5. (U) BOVESPA has identified a trend of smaller companies seeking the capital market. In order to help these small companies, BOVESPA has created and established a special stock market segment to satisfy their needs: called the new market ("Novo Mercado") listing on which requires higher standards of corporate governance. These standards include enhanced protections for minority shareholders (all shares must be voting shares) and increased transparency, including compliance with GAAP. To date only 20 companies, mostly small ones, have listed on the Novo Mercado. BRASILIA 00000835 002 OF 002 Telemar moving to the BOVESPA New Market -------------- ¶6. (SBU) Major fixed-line telephony service provider Telemar has proposed a corporate restructuring. The proposal, draftedin part by financial advisors Rothschild and UBS Warburg, is meant to increase share valuations. To do so, Telemar would move its BOVESPA listing to the Novo Mercado in a bid to improve its transparency and the market's perception of its corporate governance. Controlling shareholdings will be diluted and all non-voting (preferred) stock will be converted to common shares. Currently Telemar is owned by TNL (Tele Norte Leste),a holding company controlled by Tmar Participacoes with 53.8% of the stocks, which in turn is controlled by Group La Fonte, GP Invesments, BNDES (the Brazilian National Development Bank) and the construction firm Andrade Gutierrez. The restructuring plan envisions the creation of a new holding company - OI Participacoes - which in addition to the BOVESPA Novo Mercado, will also be listed on the New York Stock Exchange. Currently, Telemar's stock valuation (ratio of market value to earnings) is about 3.7. The company hopes to boost that substantially through increased transparency. Telemar would be the largest company to list on the Novo Mercado. Big Changes -------------- ¶7. (SBU) According to a study by the consulting firm McKinsey, the Brazilian capital markets, viewed broadly, are in the beginning phase of an important transformation. Based on data from 1993 to 2004, the study found that the capital markets (including bond markets) primarily have been serving government financing needs. That is now changing, according to the report, as consensus has been growing about the need to reduce the government financing needs (as a percentage of GDP),thus freeing capital for private enterprises and redirecting national savings. ¶8. (SBU) Comment: By comparison with the large splashy privatization deals of the 1990s, which saw large parastatals float a portion of their ownership through the stock market, the recent IPOs initially appear puny. They nevertheless are indicative of a healthy and growing trend: smaller Brazilian companies now have greater access to non-bank sources of financing. Over time, this could become a significant change. CHICOLA