The battle for Brazil

It is hard to feel much sympathy for investment bankers. Still, a twinge of pity for Wall Street’s finest is understandable as they stew in waiting rooms in Brasília or pound the corridors of corporate Brazil hunting for mandates. Business is slower than it has been for years, competition is tougher and clients more discriminating than ever. Fees have come crashing down.

Last year, Merrill Lynch earned a fee of 46 basis points when it underwrote a $4.34 billion secondary offering of shares in Petrobras, the national oil company. Merrill’s peers derided the paltry fee. This year, the scorn is reserved for Citibank Salomon Smith Barney, which underwrote another secondary offering of Petrobras stock for $701.7 million and charged the government just 19 basis points for its trouble.

That deal highlighted several truths about the state of investment banking in Brazil. Consolidation in the industry has done nothing to temper competition. On the contrary, the battle for market share and league table rankings has become so fierce that Salomon reckoned it worthwhile to offer rock-bottom fees. Investment banks are struggling to use big deals as loss-leaders to win them more lucrative, if smaller-scale transactions in the private sector.

Furthermore, because of its size, Brazil is a critical battlefield in the fight between old-line investment banks and their rivals, the big integrated banks offering the full range of financial services.

Luiz Chrysostomo, head of investment banking for JP Morgan in Brazil, explains why banks are ready to fight hard for market share in Brazil. “If you are out of Brazil you are out of the Latin American league tables,” he says. “Banks pay to establish a franchise by having a big product platform with sophisticated products and establish long term relationship with the client.” Since there are few mandates around, banks have to be aggressive.

League tables clearly matter. BNDES, the national development bank, which managed the Petrobras issue for the government, selected a shortlist of banks from a league table of equity underwriters it ordered from Thomson Financial Services. JP Morgan did not make it onto the list.

Salomon apparently decided it would do whatever it needed to win the Petrobras deal and establish its credentials in Brazilian equity underwriting. It was not alone, merely more aggressive than its competitors. Goldman Sachs entered a competing bid of 50 basis points, slightly lower than Morgan Stanley’s offer.

Officials at BNDES were not as thrilled as one might expect at the trend toward low fees. The bank prefers that its transactions get a bookrunner or underwriter’s full attention and support, which always cost investment banks dearly. In the end, the Petrobras issue went well, with the stock going mainly to pre-sold clients in Brazil and overseas.

Few Mandates Around
With the Brazilian privatization bonanza petering out, there are few substantial mandates around. M&A and equity business has dried up, victims of the economic slowdown, power shortages and a plunging exchange rate. Brazilian companies are not looking overseas much either, and therefore do not need Wall Street’s cross-border expertise. That leaves the central bank, which manages the government’s finances and awards international bond mandates.

Armínio Fraga, a former Wall Street fund manager, now runs the Brazilian central bank with a team of former investment bankers. Daniel Gleizer, head of international affairs at the central bank, likes to describe his approach as “tough but fair” – an assessment bankers share.

However, the Republic is not much of a cornucopia either. Brasília still has a big deficit to finance but now does most of its borrowing locally, and only refinances maturing international debt. In any case, there is not much international appetite for Brazilian risk these days, although Jorge Arruda, who heads Nomura’s São Paulo office, says that the Samurai market still offers rich pickings (see article page 20).

The pressure is on bankers to come up with original ideas or bring clients exclusive deals. Gleizer says he has a policy of rewarding good ideas with decent fees. Yet Moysés Pluciennik, president of GloboCabo, the cable TV company, says “It’s very rare for someone to come to us with an idea we had not thought of before. Coming with a deal is another thing. Where banks are great is when you have an idea, they can make it better and think of things you had not thought of.” But the main reason for retaining an M&A adviser is still to hire first-class negotiating skills. Over the years, GloboCabo has signed equity partnerships with Microsoft and Bradesco, and BNDES. Pluciennik says, “We still need banks to close.”

Keeping Them in Check
Bankers complain that although Brazilian companies reward creativity, they like to keep their advisors in check and pay less than average fees. Indeed, corporates are known to take one banker’s ideas to a rival willing to execute for less. João Teixeira, head of M&A at Dresdner Kleinwort Wasserstein in Rio de Janeiro, says “There are two situations in the private sector. First, when the client thinks it can do most of the work alone. Banks will work in this case to establish credentials and build relationships. Or there is the second situation when the client wants you to do the job. Growth of the business is only possible in the second case.”

Private-sector clients are exploiting the battle between the traditional investment banks – Morgan Stanley, Merrill Lynch and Goldman Sachs – and the new generation of financial powerhouses. These generalists – led by Salomon and JP Morgan – will pitch aggressively for investment banking business because they hope to make money using their balance sheets and offering the full spectrum of banking services.

Goldman Sachs and Morgan Stanley are mulling over the idea of setting up brokerages in São Paulo. Morgan Stanley has already applied for a banking license to deal in foreign exchange, fixed income and intends to lead manage local issues later. It already structures equities and equity derivatives. Perhaps working as brokers or structuring fancy derivatives will help them make up for the slide in investment banking fees.