Petrobras Common Shares to Beat Preferred, ING’s Conrads Says

By Alexander Ragir

Sept. 1 (Bloomberg) -- Petroleo Brasileiro SA’s common shares will outperform preferred stock after the gap between the two shrank to the narrowest in seven months on the government’s proposed oil law, said Eric Conrads, a hedge fund manager at ING Investment Management.

Petrobras common shares traded at a 20 percent premium to preferred stock after they sank 4.5 percent yesterday on speculation the company’s plan to sell additional equity to finance exploration will dilute minority holders. International investors will start buying common shares as they realize the dilution concerns are “overblown,” Conrads said.

“It’s a good time to start building the trade,” said Conrads, who helps manage about $12 billion in emerging-market assets at ING Investment Management in Mexico City. He said he’s adding U.S.-traded Petrobras common shares while short-selling the preferred in a so-called pair trade.

Brazilian President Luiz Inacio Lula da Silva is seeking to increase state control of the nation’s oil reserves through exploration rules he unveiled yesterday. As part of the plan, Petrobras said it may sell new shares. The plan sent Petrobras common shares to their biggest retreat in six months.

International Investors

International investors tend to buy the common shares, which carry voting rights, rather than the preferred shares because they are the more-typical class of stock in the U.S. market, Conrads said. The preferred shares, which fell 3.6 percent yesterday, are the more traded class of stock in Brazil.

The common shares fetch 37.53 reais in Brazil while the preferred stock trades at 31.38 reais. In the U.S., common-share ADRs trade at $39.64. The preferred-share ADRs fell to $33.20. The gap between the common and preferred shares traded in Brazil had swelled to 27 percent in April, the widest since at least 1994, according to data compiled by Bloomberg.

Short-selling is when traders sell borrowed stock on the expectation prices will fall, allowing the investor to pocket the profit after buying it back later at a lower price.

Billionaire George Soros’s hedge-fund firm, Soros Fund Management LLC, made the opposite trade recently, according to an Aug. 14 filing with the U.S. Securities and Exchange Commission. Soros’s fund sold 22 million U.S.-listed common shares of Petrobras and bought 5.8 million shares of the company’s U.S.-traded preferred shares, according to the filing.

Even though it makes sense to buy the preferred shares as a long-term investment, the common shares will outperform in coming weeks as foreigners become “more bullish” on Petrobras, Conrads said.

Upgrade

The U.S.-traded common shares were raised to “outperform” from “neutral” at Credit Suisse Group AG, which cited proposed changes to regulations and valuation.

“Petrobras is one of the most promising oil companies in the world,” Emerson Leite, a Sao Paulo-based analyst at Credit Suisse, wrote in a report yesterday. Given a proposed share sale by Petrobras and capital injection from the government, the spread between the two classes of shares may widen, he said.

The government plans to transfer rights of 5 billion barrels of oil to Petrobras in exchange for securities, Cabinet Chief Dilma Rousseff said yesterday.

The Rio de Janeiro-based company plans to spend $174.4 billion in the next five years, including more than $30 billion earmarked for the development of the offshore fields.

Petrobras common shares rose 37 percent this year, trailing the 50 percent gain in the Bovespa stock index, after declining the past three months on concern lending curbs in China will hurt demand for raw materials such as oil.

“Once you have a bit less noisy news coming out of China, these types of stocks will come back,” said Conrads. “And it’s no surprise that Petrobras needs financing and that there was dilution risk. I think it’s a bit overblown.”

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