Read This Before Investing In Brazil

by: Holmes Osborne


The CFA Society put out a paper comparing stocks with dual share voting classes and single shares.

Understand that many Brazilian companies allow insiders to have a larger voter share.

Stocks with a single voting class outperformed those with dual-class shares.

Nova Mercado is a push to get Brazilian companies to stop issuing dual share classes. The shares classes available to the public offer less voting shares than the privately held shares. An excellent paper issued by the CFA Society looks at this issue and found that companies without dual-class share structures outperformed those with.

The title of the paper is "An Assessment of Dual-Class Shares in Brazil". The paper was published by Pedro Matos of the CFA Society in Brazil. Historically, Brazilian companies have offered a "preferred" share available to the public with no voting rights and a "common" share held by founders and insiders that has voting rights. The preferred shares are compensated with a slightly higher dividend. Novo Mercado (Portuguese for new marketplace) was enacted by the Brazilian stock exchange in 2000.

As of now, 40% of listed firms in Brazil are one share, one vote. The Novo Mercado stocks had a 6% higher return on assets and .45 higher market-to-book value. That's remarkable. Despite Brazil having the eighth-largest economy in the world, it only has 350 publicly traded companies and is ranked seventeenth in terms of market cap of its stock market.

The paper offers a litany of problems with closely held companies. One is that there can be suspicious related party contracts. Another issue is "inequitable treatment in changes of control or center around family succession events, as well as "low-balling" bids in de-listings". You see that too in the U.S. In an LBO, management will try to take a company private at the bottom of a cycle. In closely held companies, the owners select a board to rubber-stamp their decisions.

An example of a success story is Ultrapar (NYSE:UGP). The energy company was founded in the 1930s, and in the 1980s, an heir decided to award voting shares to twenty members of management. The company went public in 1999 with the old two share classes. In 2011, Ultrapar gave preferred shares voting rights.

An all-time horror story is oil giant Petrobras (NYSE:PBR). The Brazilian government only owns 28.7% of the stock, yet receives 50.3% of voting rights. The authors of the paper speculate that "Operation Car Wash", an incident where top government officials were caught accepting bribes in regards to contracts, might not have happened had the shareholders had more control.

Banco Do Brasil (OTCPK:BDORY) is an example of a one-share, one-vote company. However, the government owns 50.7% of the outstanding stock. Banco Bradesco (NYSE:BBD) is controlled by the founding family through various holding companies and non-profits.

JBS Foods (JBS) is a company that should be on your radar. The company is one of the largest meat processors in the world. It is everywhere - the U.S., Europe, Asia. The shareholding structure is very clean - no dual shares. Here is a good article about JBS on Seeking Alpha.

Back to other companies that you should be leery of. Vale S.A. (NYSE:VALE) is controlled by one shareholder with a 33.1% economic interest and a 53.4% voting interest. Telefonica Brasil (NYSE:VIV) too has dual shares.

The comparisons are incredible when comparing Novo Mercado firms with dual-class share listed firms. The Novo Mercado firms had a return on equity of 8.9% compared to 4.14%. That's quite a margin. The dividend yield is lower (because the stocks trade higher) of the Novo Mercado firms too - 3.44% versus 6.98%.

I suggest you read the paper before investing in Brazil. Many of these firms, like Petrobras and Vale, are considered blue chips. However, their dual shares make them unfriendly for the American investor.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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