Shares of Centrais Eletricas Brasileiras SA (NYSE:EBR), or Eletrobras, as it's commonly known, surged on Tuesday and were up more than 46% at noon EDT. Powering the stock was a proposal by the government of Brazil to privatize the utility. Investors saw this as a sign that the company would be able to cut debt and operate more efficiently, which could help it generate higher returns in the future.
According to reports, Brazil's Mines and Energy Ministry plans to propose that the country sell control of Eletrobras. Currently, the federal government owns a 41% stake in the entity as well as a majority of voting shares. That stake could be worth as much as $3.8 billion for the government, which would give it the cash to help bridge its current budget deficit so it can avoid another credit rating downgrade as it attempts to pull out of one of its worst ever recessions.
By relinquishing control, Eletrobras would be able to operate as a free market entity as opposed to a tool of the state. That state control has been problematic in the past given that the previous administration, for example, used the company to fight inflation and spur growth by keeping rates low, which resulted in heavy losses over the years. However, once in private control, the company will be able to improve its operations and balance sheet, which would benefit outside investors.
The move to privatize Eletrobras is a positive one not only for the company's investors, but the Brazilian market because it shows how serious the new administration is about enacting free market reforms. That said, given today's spike in Eletrobras, the upside from here might not be much higher in the near term. That's because the country's Mining and Energy Minister stated in an interview that the government would likely issue new shares as part of a privatization deal, which would dilute existing investors. Because of the uncertainty surrounding the size of that future dilution, investors are better off watching this stock from the sidelines and considering other top Brazilian stocks instead.
David Gardner has no position in any of the stocks mentioned. Matthew DiLallo has no position in any of the stocks mentioned. Tom Gardner has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.