American subprime realty credits sparked the first major global crisis faced by the Brazilian capital markets since their rebirth, in 2004. As of November 21, the Ibovespa had lost 51.1% since the start of the year. The crisis has proven to be quite a test, especially for many newcomers who came onto the trading floor in the past four years, taking advantage of an exceptional international liquidity scenario. With share prices hitting rock bottom, one may reasonably think that some may be considering the possibility of going private. But the fact is that there's still a large gap between thinking about it and actually putting such a measure into effect.

Officially, there is no clear evidence that a trend is forming in this sense. The number of buyback offerings for the purpose of delisting public companies in 2008, recorded by the Brazilian Securities and Exchange Commission (CVM), is going on practically at the same pace as last year - eight versus six. Among some law offices, however, the subject is heard in the hallways more frequently

Law reforms, CVM acts, Novo Mercado and dispersion of capital have made buybacks more troublesome

Demarest & Almeida Advogados partner José Diaz says that, in October alone, the office was contacted by three newcomer companies, all of them complaining about lack of liquidity and the pricing of their shares. “These were informal consultations, in which they questioned the legal implications of going private”, he says. Another office sought out to provide information on the matter was Navarro e Marzagão Advogados. None of the companies mentioned went through with the decision to leave the market. “After a good talk, a company realizes that this is not the best way out at this time”, says partner Alexandre Tadeu Navarro.

In the late 1990s and the beginning of this decade, buybacks became the tonic of the Brazilian capital market. No company would make an IPO, given the outpour of news about others intending to leave the trading floor. The terms required by regulators for this type of operation changed significantly in the past few years, however. Buying back shares for a paltry sum, leaving minority shareholders between the devil and the deep blue sea - with the option of either selling at a steep loss or ending up with no liquidity -, is no longer such a simple possibility.

In 2001, a reform in corporate law introduced the concept of fair value for these operations. In its 4th article, Law 10,303 says that a public company's listing can only be cancelled if the public offering is performed at an equal or higher price than the one provided by a evalutation report based on four possible criteria: average weighted price of the share in the past 12 months, net equity value per share, the company's economic worth, or the procedure deemed fit by the buyer to calculate fair price. The same reform allowed stakeholders holding at least 10% of current assets to convene a minority shareholders' meeting to discuss a new assessment, thereby requesting an additional report if they do not agree with the offered value.

In 2002, two years before the market's rebirth, the CVM edited Instruction 361 to regulate the provisions of the new law. The rule provided an additional instrument for minority shareholders to defend themselves against insulting prices at buyback offerings: it required that two thirds of shareholders favorable to delisting agree with the proposed buyback price. Also in Instruction 361, it was determined that, if the IPO took place less than one year ago, the company must buy back the shares for no less than the price offered during the public offering.

In July 2006, the leash was shortened even further: the CVM issued Instruction 436, thereby changing 361, now requiring more detailed information in the assessment report. In the event of economic assessment by discounted cash flow, for example, the sources used, the grounds, the justifications for the data presented, and the equations and calculation methods used to determine the discount rate are some of the required information.

Aside from regulation, the market has also changed since the start of the decade, starting with a dispersion of capital. Several entrepreneurs chose to reduce their stakes, leaving an expressive part of the shares in the market's hands, which considerably expands the costs of a total buyback operation. Meanwhile, in the Novo Mercado (the highest corporate governance level on the Bovespa) - a segment which became the main option for companies that went public from 2003 onward -, the rules are stricter than the law and the CVM require, when it comes to delisting a company. Acknowledged for combining the best corporate governance practices, companies listed here must base buybacks on economic worth - calculated by discounted cash flow -, which considerably reduces the chances of controlling shareholders taking advantage of a beaten-down stock market's low prices to buy back their shares. Those who leave the Novo Mercado are also forbidden from re-entering for two years, unless there is a change in control.

“By leaving the segment, a company is closing the door to a lot of opportunities”, says Mauricio Santos, partner at Souza, Cescon Avedissian, Barrieu e Flesch Advogados. “Today, it would be difficult for a company to go private and hurt someone along the way, because the law provides a series of guarantees to minority shareholders. To the controlling shareholders, this means a considerable raise in costs”, he says.

DENTED REPUTATION — The price of the offering is not the only high price to pay; delisting without palpable justification can damage a company's reputation. Claiming lack of liquidity and bad share pricing to justify a sudden exit from the scene can be frowned upon. “Even after losing a lot, many shareholders are still confident, waiting for the situation to improve, because they believe in the company. To them, a delisting would be frustrating”, says Rodrigo Pasin, partner at Value Consultoria consultancy.

A recent case illustrates how the market can be tough on a company that suggests the possibility of abandoning the game when they're losing the match. In 2007, Gol was not at all satisfied with the price of its shares. The airline crisis, triggered a year before, had made the sector too uncertain. If in May 2006 the company was worth R$ 16.2 billion, in September 2007 it had plummeted to R$ 8.2 billion - a 49.4% decline. In October, the Asas fund, Gol's controlling shareholder, announced their intent to buy back part of the company's shares in the market, and delisting was among the possible developments of this operation. There was no lack of criticism to the possibility raised by the airline. “The market indicated to Gol that a crisis in the industry and cheap shares were no justification to go private. Just by considering the possibility, the company's reputation was tarnished”, recalls Navarro. He says that the controlling shareholders of some companies even made confessions to him: “If I had known things would turn out like this, I wouldn't have jumped on this wagon.”

The option of going private a short time after the IPO can be associated with the image of young newlyweds who decide to divorce at the first bump in the road. “This is not a decision that should be made on impulse, like some companies did when they went public”, he says. It's assumed that the decision in favor of an IPO is part of a long-term strategy. Companies who make that choice should be aware that their lives won't be marked only by favorable winds; they must be prepared for eventual thunderstorms. “The feeling that remains is that the company went public just because of the ample supply of money at the time and, now that the well has dried up, they'll gather up their things and leave”, says Sérgio Goldman, of Bulltick Investimentos.

Leaving the market can also mean a loss of competitiveness in relation to major competitors who remain public. With a lower capital cost, listed companies can offer better prices and grow more. “Public companies are more liquid, not only for the investor, but also at times of crisis they are able to raise funds more rapidly”, Pasin says.

SELF-ASSURANCE — All of these arguments do not mean that delisting is an abominable alternative. Leaving the market is a legitimate option for the controlling shareholders and, in some situations, such as during a corporate restructuring, it's quite justifiable. But if the problem is economic in nature, the crisis must be profound and affect the company's operation - and not just its share prices - in order to justify the decision.

“If the company has to cut costs to the bone and won't need capital for the long term, going private can be a good choice”, says Pasin, who was also consulted by a newcomer about the impacts of an delisting operation. “Because this company's problem was an undervaluation of its shares, and not cash issues, they decided not to take the matter forward”, he explains.

It's certain that undervaluation is a most uncomfortable contingency for companies. It's not at all pleasant to ascertain that the market is giving the company a lower value than their store of cash, for example. But there are less aggressive means to express the perception that share prices are too low. One of them is buying back shares using the company's cash, up to the limit determined by the CVM. “The controlling shareholder shows trust in the company and doesn't spend as much as in a buyback”, says Marcelo Magalhães, partner at Deloitte in the corporate finance area. Another way out can be increasing private capital, such as was done by Rossi and Even. In October, the construction companies' controlling shareholders injected R$ 150 million into each company, from their own pockets, by subscribing new shares. “The controlling shareholder shows trust in the business, thus encouraging minority shareholders to do the same”, says Magalhães.

For Reinaldo Grasson, partner at Deloitte in the corporate finance area, the insecurity faced by newcomers is part of the natural learning process. Keeping to the fundamentals of the business is the crux of the matter. “Share prices are merely a reflection of the market's current situation. If the foundations are solid, share prices will once again reflect that in the medium term”, he says. Fragile foundations may even justify delisting, but going private, in and of itself, will not solve these problems. Like every meaningful decision, this one needs to be made for the right reasons.

Freeze outs unlikely If it happens again, a wave of companies going private post-Novo Mercado will tend to be much less traumatic to investors than in the late 1990s. In fact, this month of December marks the tenth anniversary of a historic shareholders' battle, between the investors of Lojas Renner and the company's controlling shareholder at the time, JC Penney. The operation led to use of the term “freeze out”. In the final month of 1998, the American retail giant acquired control of Renner, paying about R$ 70 per lot of one thousand controlling shares. To the minority shareholders, JC Penney made an offering to buy back 70% of preferred shares at R$ 25 per lot. The idea behind a “freeze out” is to buy back minority shareholders' shares gradually, leaving the remaining shares with no liquidity. Without alternatives, the minority shareholders end up agreeing to sell their stakes for low prices. The case motivated a series of changes in the Brazilian regulatory framework. Instruction 299, published on February 9, 1999, forced companies to disclose all transactions involving more than 5% of their capital, whether controlling or not - until then, such disclosure was limited to acquisitions of controlling capital. Also in conformity with the instruction, controlling shareholders who purchase 10% of outstanding shares are forced to make a public offering in subsequent operations involving 5% or more of the company's capital. Furthermore, it was determined that, if within two years after a buyback offering, another offering is made at a higher price, the buyers must make up the difference to minority shareholders.