Buy Petrobras Preferred, Sell Common Becoming Top Brazil Trade

By Alexander Ragir

July 10 (Bloomberg) -- The best trade in Brazil may be buying preferred shares of Petroleo Brasileiro SA, the nation's biggest company, and betting its common stock will fall after international investors pushed up prices 19 percent since March.

Common shares of the Rio de Janeiro-based company, the world's fourth-largest oil producer by market value, cost 22 percent more than its preferred, the biggest price difference since at least 1994, according to data compiled by Bloomberg. Petrobras, as the company is known, rose to a record in May after announcing the largest oil discovery in the Western hemisphere in three decades.

The expanding gap prompted hedge funds Ciano Investimentos Gestao, Mercatto Gestao de Recursos and Neo Gestao de Recursos to bet in the past three weeks that prices will converge. Petrobras, the most heavily traded Latin American company on the New York Stock Exchange, is controlled by the government, so common shareholders get no say in company decisions and a sale is prohibited by Brazil's constitution.

``The premium for common shares isn't justified and we can't find any good reason that it widened so much,'' Felipe Taylor, a portfolio manager at Ciano Investimentos Gestao, the $142 million Sao Paulo hedge fund managed by former central bank chief economist Ilan Goldfajn. ``It's a good opportunity to short the common and buy the preferred.''

Short sellers borrow shares and sell them, hoping to replace the stock at a lower price and pocket the difference.

Investors outside Brazil mistakenly assume common shares of Petrobras are worth more than the preferred, even though the securities are virtually identical, according to Credit Suisse Group AG analyst Emerson Leite.

Biggest ADR

American depositary receipts on Petrobras common stock surged 81 percent in the past year, surpassing the 68 percent gain in the preferred ADRs. An average of 17.9 million common ADRs trade daily on the NYSE, more than double the preferred shares. That's the most of any Latin American company, according to data compiled by Deutsche Bank AG.

Petrobras's market value of $249.6 billion makes it the sixth-largest company in the world, according to data compiled by Bloomberg. The only bigger oil producers are Exxon Mobil Corp., based in Irvine, Texas, PetroChina Co., based in Bejing, and Moscow's OAO Gazprom.

The company gained worldwide attention in November when it said an offshore oil discovery may be the biggest since Mexico's Cantarell field in 1976. The Tupi field has 8 billion barrels of recoverable oil, Petrobras said in November, worth $1.1 trillion at current prices.

International Investors

``Foreigners like common shares,'' said Bruno Garcia, who helps oversee the equivalent of $5.5 billion as a hedge fund manager at BNY Mellon Arx in Rio de Janeiro and only holds preferred stock. ``That's all that's going on.''

Common shares at most companies are more attractive to investors because they give the right to vote in shareholder meetings, sell for more in takeovers and pay higher dividends, according to reports by Credit Suisse and Merrill Lynch & Co.

That's not the case with Petrobras, said Leite. What's more, preferred shares get ``priority'' for dividends, according to Petrobras's Web site. The 12-month dividend yield on Brazil- preferred shares is 1.89 percent, compared with the common's 1.54 percent yield, according to data compiled by Bloomberg.

Goldman's `Buy'

Daniella Marques, who manages the equivalent of $1.2 billion at Mercatto Gestao de Recursos in Rio de Janeiro, started selling short the locally traded common shares and buying preferred three weeks ago.

``You have a company that has such a low risk that it would be bought and the dividend is more in the preferred shares, so why would you ever pay 22 percent more for common shares?'' Marques said.

The difference between preferred and common prices of the locally traded shares and the American depositary receipts hit records June 30 after the Sao Paulo-listed common stock jumped by 2 percentage points more from a March 20 low. Goldman Sachs Group Inc. began coverage of Petrobras preferred ADRs with a ``buy'' recommendation on July 7, citing the discount to common shares even though differences are ``largely insignificant.''

The higher level of trading in Petrobras' common ADRs may be boosting the spread. The average three-month daily trading of common ADRs increased 57 percent from a year ago, compared with a 30 percent rise in average volume for the preferred ADRs.

Liquidity Concern

``It would be great to get the preferred shares if there was enough liquidity,'' said Mark Mobius, who oversees about $47 billion of emerging-market equities as executive chairman of Templeton Asset Management Ltd. in Singapore.

In Brazil, Petrobras preferred shares Petrobras trade almost seven times more than the common.

``When we see no reason for the spread widening, we mount a position,'' said Cristina Sarian, who helps manage $850 million at Neo Gestao de Recursos in Sao Paulo and began short-selling Petrobras common shares and buying its preferred shares three weeks ago. ``Nothing's changed with Petrobras, so there's no reason for the premium.''

To contact the reporters on this story: Alexander Ragir in Rio de Janeiro at aragir@bloomberg.net;