Private Equity in Mexico
Is Mexico the greatest untapped economic opportunity in the emerging markets?
Is Mexico the greatest untapped economic opportunity in the emerging markets?
Private Equity in Mexico
Matt Malone, Privcap: Hello and welcome everyone to the Privcap webinar on private equity in Mexico. I want to thank you all for joining us. We’ll have a great conversation today and with plenty of insights on private equity in this growing market. We have some great guests with us, a few additions to our original slate as some business matters have come up but we’re happy to have them and they’ll be a great part of the conversation. We have Michael Rogers from Ernst & Young. We have Juan Pablo Visoso from Nexxus Capital, and Juan Savino of the Latin America … American Venture Capital Association with us today. We’re going to start off with introductions but first I want to remind everyone that there is opportunity … a question and answer segment so by all means please send in questions as they come to you throughout the conversation. So first if we could, Mike Rogers from Ernst & Young, if you wouldn’t mind just giving a brief introduction.
Mike Rogers, EY: Sure. Thank you.This is Mike Rogers. I’m the global deputy, private equity leader for Ernst & Young and our practice is a global one which you might imagine given the scope of the firm. And we support our clients on a global basis working with many of the largest private equity funds in the world as well as many local practices that are around the world supporting local private equity. It’s a very significant business for the firm and a growing practice and I’m pleased to be on the panel today.
Malone: Thanks, Mike. Juan Pablo, if you could give everybody an introduction.
Juan Pablo Visoso, Nexxus Capital: Sure. Thank you. My name is Juan Pablo Visoso. I’m a managing director and I’m also the general counsel at Nexxus Capital. I joined Nexxus Capital five years ago. Nexxus Capital is the largest Mexican private equity manager. As a matter of fact, today we have the closing for our sixth fund and it … we’re very happy about that. We have been very active in Mexico. We only do Mexico investments and we, as a group, have been able to take four of our portfolio company’s public. We’re in the way of taking another one public. So we are very optimistic about the Mexican market.
Malone: Thank you, Juan Pablo. And Juan Savino.
Juan Savino, Latin American Private Equity and Venture Capital Association: Hi. Thanks for inviting me to the panel. My name is Juan Savino. I work for the Latin American Private Equity and Venture Capital Association. I’ve been with the organization for over four years and two years and a half of them are as research director. LAVCA is a non for profit member base association. We have more than 130 members which … with $50 billion of asset under management in total. From the research perspective, we track and fundraising investment and exit activity and we have done this job for over five years. So we are also very excited about Mexico. And then in total we have tracked around 730 Latin American companies that have received private equity in the last five years which is a very good number to share with you.
Malone: Excellent. Well, thank you. Let’s move into the discussion. It doesn’t need a lot of setup. Obviously we want to go through some of the dynamics of the Mexican private equity market and I think it probably makes sense to start with sort of the macro picture of what’s going on in Mexican private equity and that will lead into discussions on entrepreneurship across the country and then we’ll talk some about the IPO and exit market. So Juan Savino, if you could give us a little bit of an overview about what PE looks like in Mexico today.
Savino: Sure. Again, at LAVCA we have seen an increasing interest from international investors in the Mexican private equity industry over the last years and that could be explained by a very stable micro economic environment. We have seen an expected time of growth of around three to four percent in the next year with a moderate inflation and that has been driven basically by the strong export profile that Mexico has as well as a growing domestic market.
In terms of the domestic market which has been a topic for many investments in the private equity space over the last years, what we can see is that a grow in domestic market is being supported by … also by demographic data. So a recent report published last year shows that almost ten million people will join the labor force over the next 15 years. In the same period of time it’s also expected to double the middle class household in Mexico to around 40 million people.
So this shows that Mexico really represent a need to long term opportunity for investors seeking this growth opportunities in markets that are not as crowded as other countries in Latin America. So in addition to the macro prospect what we can see is that the private equity is that there is also an improving regulatory environment. So the change in the regulation in 2009 allowing domestic pension funds to invest up to 20 percent of their assets in private equity is a key development for the local industry.
So again, if we see the history of the Mexican economy and the Mexican private equity industry, one of the explanation of the underdevelopment of this industry related to other markets is the fact they have not local sources of capital to finance first time fund managers. So if we look at other, you know, countries in the region, we can see that for instance Brazilian pension fund started to invest in the asset class ten years ago and they have brought the first time managers or the first generation of managers that have raised a second or a third fund and that have built a track record in the last years. The same could happen in Columbia and Peru since 2006.
So we are very excited about the opportunity in Mexico because these local pension funds will have given $4 billion of fresh, you know, capital to the market and also … like although that has been probably deployed to real estate infrastructure mainly, we believe that, you know, like we have around 15 pension funds for this in the Mexican market right now which has more than $140 billion of assets to allocate to this asset class.
So that gives an idea of, you know, the importance of this Mexican market is covering right now and that’s for me the reason why it’s driven so much interest from international investors.
Malone: Great. Thank you. And Juan Pablo, obviously you mentioned a listing today. I guess what is your take on the macroeconomic and politic forces driving the … in the country today?
Visoso: Yes. As I expressed before, we are very optimistic about the opportunities in Mexico. Mexico has had a pro-business government for the past 25 years or more and the same type of policies that have been slowly been enacted in Mexico are going to continue but now we see a government with the political ability to pass in congress very important amendments to some laws that have not been amended in many years. So we’re going to see an increase in the … We expect to see an increase in the UDP in Mexico because these reforms are going to be very important to foster growth in the economy.
And one of the important things I would also like to mention is that this amendment that they made some years back to allow the pension systems to invest in Mexico were very positive, but the pension managers in Mexico have been very careful to select managers that do have some track record. If you look at the hard facts, they have only funded eight private equity groups in Mexico which is a very small number, and they have been very careful and very selective to avoid any bad results that could hurt politically the asset class and result in the pension systems no longer being able to invest.
So we believe that the market is not overcrowded. We don’t see that it will become overcrowded in the short term because at the end of the day the managers of the pension funds here in Mexico are part of big financial groups that have been investing in private equity for the past 20 to 30 years. So what we’re seeing is there is very … they are very educated about this asset class and we believe that they are doing a very good job here.
So we believe that is very positive and that the outlook of the Mexican economy considering what Juan just said about the increase of the number of people joining the workforce and the resulting increase in the disposable income of the middle class. I mean when we first raised our Nexxus 1, the GDP per capita was around $3,000. Today it’s closer to $11,000. So there you see a hard fact of how the disposable income of the middle class has grown substantially and there is a lot of opportunity of investing in companies catering to this growing middle class.
Malone: Thanks, Juan Pablo. What … And this is for anyone. What challenges does that growth present in the country right now as well? There are obviously plenty of opportunities. Anything structurally that, you know, would likely need to be addressed or that is … would be helpful to further fostering private equity in the country?
Savino: Sure. Again, it’s … If we look at the … I think that one of the biggest challenges if we look at Mexico related to other countries in Latin America, we see that it’s still the private equity … the penetration of the private equity as a percentage of GDP is very low. If we see in the screen like the evolution of the activity, all this excitement that we are talking about like around international investors is not being translated into activity specifically.
So what I think that one of the biggest challenges is to like reduce that gap of the … in terms of the communication that the private equity industry is doing well and also it has all the macroeconomic condiments in order to receive funds, international funds. And that is important because if you compare these … the penetration of product in Mexico with other countries what we will see is that we still have to like develop that industry for international investors as well.
And so again, I think that one of the biggest challenges from the investors … from the investment side is the fact that we have to communicate like the success stories around the Mexican industry and try to reduce, you know, like ideas that we generally have around Mexico that have changes in the last couple of years.
Malone: Thank you.
Visoso: Just what Juan was saying, I think it’s important that we do a good job of communicating what is happening in Mexico during the last six years of the former government. There was a big headline raised of people just talking about the security issue but at the end of the day, I mean in the Nexxus portfolio we have more than 1,000 points of sale and we have had no significant event in any of these companies.
So that’s something that the Mexican government needs to do to control this headline raise and to be able to convey the real message of what’s really happening here.
Malone: Great. Well, thank you. Let’s move on to the question of entrepreneurship. But before I do, I just want to remind everyone listening in that we … that you can ask questions. We’ll have time for Q&A at the end of the webinar so please submit your questions as they come to you.
But let’s move on to the question of entrepreneurship and perhaps, Mike Rogers, you can pick up on this. And I think it would be helpful to our audience to get a picture of the nature of, you know, businesses in Mexico and the general notion of entrepreneurship and then also the role that PE plays in improving those companies whether from an operational basis providing capital and so forth. So Mike, can you provide a little perspective on that?
Rogers: Sure. Thank you very much. And I think that the question is a good one. The entrepreneur is certainly alive and well in Mexico. It’s a thriving environment and growing as you heard from the previous discussion, principally around, you know, the consumer space, oil and gas, and some other major industries. But you know, one of the things that has been sort of a tantamount, historical, you know, way of approaching entrepreneurship in Mexico has been through family business and we’ve seen that over the years these family businesses … many of which have grown from small companies into large entities in the traditional way, that ownership was transferred in markets like Mexico was through passing this business on to other family members. And what we’ve seen is that with, you know, social mobility and a lot of different, you know, socioeconomic changes going on in the world, you know, maybe sometimes the children of the business owner, the patriarch, don’t want to own the business or in some cases these businesses were started many generations ago and they’re more at a point where some of that connectivity has been lost. And so there’s still ample opportunity for these companies to grow but what they really want to do is, you know, transist [sic.] some ownership, hold onto some family component to it, have maybe a majority but sell a minority stake in a business and get capital that they need to really grow.
And as was discussed previously, there’s ample opportunity within the Mexican market but then more broadly, the Mexican businesses are selling around the world, becoming more globalized and certainly selling within the other affiliated, Spanish speaking markets, particularly in Latin America. And so you’re seeing companies that have great ideas, have had great founders, family businesses, that need growth capital to continue to … you know, to go.
And there is a funding gap as has been talked about a little bit. It’s not an ample flow of capital going into the countries yet. There’s not as well developed capital markets as there might be in Europe or in the U.S. And so private equity plays a critical role in sort of coming in, providing the opportunity for these companies to get the capital they need, but not just capital. I mean, they’re providing, you know, discipline, financial discipline, expertise, maybe management talent, etcetera. They’re bringing a lot of operational skills to the table and helping these companies become more professionalized. And what that is developing in our eyes … And we just released our most recent study on how the private equity companies create value in Latin America and so we’ve got some real fresh data points on this. But what that’s sort of generating is a two tier model if you’d like where there’s … some of the local funds in Mexico have worked with, begun working with, put ownership stakes into some of the maybe smaller entities within Mexico and ultimately, those might be secondary candidates for some of the global firms that are certainly making a more interested … taking a more interested position in Mexico.
And in fact, we have a capital conference barometer that we do globally with Ernst & Young. We have two forms of it. The first one is from a private equity perspective which ranked Mexico fifth most attractive market in the world based on the respondents within private equity and then we do a global study that has over 1,600 respondents and they actually ranked Mexico fourth in terms of most attractive on a global basis. And this is in comparison to China, India, Brazil, many of the other attractive merging markets.
So I think we have a unique combination right now of, you know, a very, very robust environment for entrepreneurs in Mexico. A certain amount of interest certainly on a global basis from private equity to come in and play a role in a nice niche in terms of what they can do to help support these companies not only through, you know, originating the transactions and sort of partnering on the front end, but helping them with the valuation creation phase in the middle and ultimately realizing value on the back end in terms of profitable and attractive exits.
Malone: Great, Mike. Thanks for that perspective. Juan Pablo, could you speak a little bit to how GPs are, you know, working with Mexican business owners to improve those companies talking about some of this professionalization that Mike referred to and some of the operational improvements?
Visoso: Certainly. Yes. When we started doing this business it was very hard to get things going because nobody knew what private equity was about and when we first approached entrepreneurs or family businesses they were asking us at what rate we could loan them money and they really didn’t understand the private equity. But because of the success stories that have been happening in the Mexican market that were family owned and were then taken public and everybody has knowledge about these stories, it has been easier to get access to good deal flow and for family business to really understand what private equity is about.
So when we get into start negotiating a deal what we do is we negotiate a very thorough deal in which we make it very clear to our potential partners that we are not just the money, that it’s going to come in and put some money for growth and then leave and just come to quarterly board meetings. What we explain to them is that we are very active investors. That we are going to be spending a lot of time with them. That we are going to be investing a lot of time and a lot of money in institutionalizing the company. That we’re going to be participating in all major decisions. That we are going to be appointing some of the key executives of the portfolio company, certainly the CFO. And that we are going to have a member of our team spend a lot of time with them, especially in the operation side.
So we start generating this communication with the potential partner where if they really want a partner and not just an investor, we will partner with them but it must be very clear for them that we are going to be spending a lot of time with the company and that we are going to be participating in the major decisions. For example, here in Nexxus in the same building where we are, we have five our portfolio companies and we interact with those five and with the others on a daily basis.
So what we believe is very important is for an investment to be successful is for you and your partners to realize that you are going to be spending a lot of time with the portfolio companies, that you’re going to be taking part in some of the major decisions, and that you’re going to be helping them improve the company. At the end of the day what they need to perceive is that all the interests are aligned and that whatever action that you take, that you’re taking that action in good faith in order to make the company a stronger company.
As part of the things that we have done in the past when we enter into a portfolio company, in the event they don’t have strong ERP, we encourage them to get us a good ERP. We encourage the company to hire one of the big four accounting firms so that we know that their books are well kept. And we begin a process of institutionalizing the company and making the company more market friendly in the first stage so that they can obtain financing at good rates from financial institutions and later so that they can access to the markets.
Rogers: You know, I think it’s a really interesting point though too about the … aligning the interest on the front end and that is a critical area for making sure you have success in these type of transactions. But what we really see a lot of, you know, in Latin countries in general but very much so it’s prevalent in Mexico is this focus on relationship. And since many of the original PE deals or investments that go in are minority stakes, the relationship that gets built between the fund and the entity itself and the entrepreneur is critical as Juan Pablo mentioned. I think that that’s probably one of the most important aspects of folks that are going in to work with companies in Mexico. It just simply has to be done on a relationship basis because you’ll be a partner and you will be … you don’t … typically they aren’t full buyouts. They’re minority positions or partial positions and so you’ll be a partner with these folks for a long time and if that relationship isn’t built on trust and secured on the front end, then you will have a disappointing path, you know, through the process and ultimately through an unfortunate exit probably.
Malone: Thanks, Mike. Let’s move on to IPO and the exit environment. First is a last reminder about questions. If our listeners have any please submit them now. We’ll start on the questions and answers shortly.
Juan Savino, can you give us if you have some data points on the IPO and exist market what that looks like today in Mexico?
Savino: Yes. Sure. Again it’s … As Juan Pablo was saying, the experience in the Mexican market has already shown that most Mexican companies that have been backed by private equity have outperformed the market. So we still have very good examples, you know, of private equity backed companies that have been successful deals to show. However, what we have seen on the exit side is that the … in private equity backed companies they have been very concentrated both in terms of the exit strategy as well as in terms of the type of sectors and industries that have been these companies.
For instance, in terms of the IPO market we have seen only nine IPOs in the last … since 2004 so that shows that again there is an exit strategy. I think that while Nexxus probably has a very good track record in terms of exiting companies. You’ve seen that in that channel. On the side, the big concentration of the exit have come strategic investors acquired. So I think that that is today the most popular exit channel that we see from our data in Mexico.
In terms of the … Again, in terms of the sectors what we see is that four sectors, manufacturing, financial services, media and telecommunication and retail are the ones that are predominantly in the companies that are exited. So again, we have seen 48 exits since 2001 and almost 60 percent of them came from these four sectors. So just to give a headline, a lot of concentration in terms of the exit channel as well as the sectors that we see the companies are.
Visoso: Yes. I would just like to add that that there have not been so many exits through the public markets in Mexico. As I said earlier, we have already taken four companies public and we believe that in the future we are going to be seeing more IPOs in Mexico both from private equity and family businesses. Let me just give you some hard facts. In 2010 we had three IPOs. 2011 we had four. 2012 we have two. And so far 2013 we have had 11 which I mean is more than we had in the prior three years. And there are six other companies that are going to try to do an IPO that are … that we know of because some of this process are confident. So at the end of the day, this year, we may see something like 15 or more IPOs in Mexico.
There have been some substantial improvements in the regulation in Mexico for public markets and that’s something that it’s very positive. So at the end of the day we do see a developing equity market in Mexico. We believe it’s going to continue growing. And even though there has been some financial instability in the past weeks, the activity in the Mexican stock exchange has not diminished. That there have been some … In the last week there have been five public offerings. Another one it was a construction company. The other one was a hotel company. The other one was an owner of real estate investments. The other one was a bank doing a follow along offering.
So we do realize that things could have been better in the past but we are very optimistic that the market is going to continue being there, that the framework for a good market has been established. And in our mind what we do when we do an investment, we do an investment aiming to go to the public markets and when you have a company that it’s ready to go to the public markets, if the markets are not there or a strategic buyer knocks on your door, you are always ready to sell to them. But we believe that in the future we’re going to see like a 50/50 split between strategic sales and IPOs.
Malone: Great, Juan Pablo. Thank you. There’s obviously plenty more to talk about on all these topics but we’ve gotten plenty of insight thus far. I wanted to leave some time for questions from the audience so I’m going to throw a couple out here. The first is about … from a sector perspective and I guess either … Can any one of you speak to real estate within Mexico and how the new administration will change the way PE looks at the market if it will change it at all? Do any of you haves a particular perspective? I can also … A similar question the energy sector. If there is an opinion on what that sector looks like going forward in the coming years.
Savino: Yes. About the energy sector, I mean everybody will be waiting to see what amendments are going to be made to the law to increase the sectors where private investment will be permitted and today everybody’s watching very closely at what’s going to happen but no … but congress has not started discussions about this. But we believe this amendment will pass sometime this year and yes, there’s going to be a lot of money coming off and we believe for energy and oil and gas specific funds. There are going to be a lot of … or some groups trying to raise money for that specific industry but as of this day there are a lot of limitations that the activity has been very limited.
Malone: And in terms of … And this is for anyone. In terms of other sectors where to expect particular activity. What would some likely places be for PE activity in the coming year or two?
Rogers: Well, I could probably add there a little bit. Just, you know, we see a lot of activity in the consumer industries and there’s a lot of interest by private equity, particularly funds that are outside of Mexico that are making maybe some of their first investments into the market. They do see the growing middle class that was commented on earlier by Juan. They see the improving GDP per capita numbers and they know that folks will have more money to spend. They see that trend because of demographics, a lot of younger people coming into the workforce, having capital, having money to spend. And so the consumer industries, from our side, seem to be drawing a lot of an interest from the private equity funds that certainly are outside of Mexico. I think they take great comfort in that.
The other area we hear a lot of interest about and I’d be interested in Juan Pablo’s or Juan’s analysis of this is financial services because as these folks do generate more per capita GDP and become wealthier, they will begin to want to use more sophisticated banking products and those markets are still, I think you could say, underdeveloped in many parts of Mexico.
So those are the two that I see.
Malone: Juan Pablo or Juan Savino, any thoughts on the financial sector?
Savino: Yeah. Just having a bit of information on that, I think that, yeah, not only in terms of the, you know, great offering and companies, we have seen a lot of interest from private equity investors. Also what we have seen as … like deals in the insurance and investment product type of companies as well. And not only, you know, deals but also questions, you know, and international investors coming with … asking about, you know, kind of … and things related to there’s 10 million people like join the labor force and also having, you know, like retirement and life products. It’s something that, yeah, it’s going to grow as well.
Malone: To another question. This goes back to our exit discussion. One question. How visible are the exit options at the time of the initial investment and are the strategic acquisition partners lined up or do they engage later on in the process? And perhaps … Juan Pablo, perhaps you have some thoughts on that.
Visoso: Of course when you do an investment you always look at the door and see how you’re going to exit the portfolio company. In the past, I mean, we have not had any pre-agreed sale to a strategic buyer when we buy a portfolio company. What we generally do is we buy the portfolio company not just to flip it quickly. What we do is we see a lot of value in the portfolio company. We do look for a lot of growth potential and what we try to do is invest the money, try to capitalize on that, try to execute a good business plan and sell it down the road in three, four, or five years.
So of course we try to maintain close contact with any potential strategic buyer and the Mexican market, most of the people know each other and we are always meeting these guys in informal talks but again, our preferred strategic … Our preferred exit is to go to the market and if that’s not possible or down the road we do receive a good offer from a strategic partner, we will always consider that as well.
Malone: Great. Thanks. And I’ll ask one last question which is … gets back to more of the macro picture. What does the panel consider the biggest hurdle to the development of PEVC industry in Mexico? Is it regulatory, limited pull of institutional investors, deal flow, exit environment? And what can be done about it to improve the chances of PE getting more penetration in the country? Anyone want to take that rather large question?
Rogers: It’s kind of a tough question, I think, because, you know, all the things we’ve talked about are moving in the direction of improving the environment for private equity. I mean obviously private equity likes to see, you know, a stable, you know, government, stable political processes, consistent tax treatments, you know, without the risks of terrorists or trade issues, things of that nature. And so I think as was discussed earlier, I think by … Juan Pablo mentioned the governmental transition and the improvements in the sovereign risk if you will of Mexico, I think will just bode well for not only local investors in Mexico but also outside capital that looks in and sees Mexico as a stable place where they can, you know, invest capital, make improvements to good businesses and ultimately, you know, exit on a socially responsible but profitable way.
In fact, the study we just did in Latin America pointed to returns of almost two and a half times what the public markets were over that period of time for the investments on the exits we studied. So there is proof that you can operate here effectively and, you know, do so in a profitable and, you know, make it good for employees and local communities as well.
So I think, you know, just more repetition and more examples of good solutions and good outcomes will only bode well for PE and, you know, VC in the future.
Malone: Great. Thank you, Mike. I think we will wrap it up there. I want to thank all of our panelists for taking part, all of the listeners for tuning in. Since we are talking about Mexico, I also wanted to just let everyone know we have a number of Mexican GPs we’ve interviewed in recent weeks that will be coming live on Privcap’s site over the next couple of months. So certainly keep a lookout for those to gain more perspective on what is a very interesting and growing market. So thanks again to our panelists and for everyone joining us. Have a good afternoon.
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