Cross-Border M&A: Mexico Speeds Up While China Slows Down
Latin America offers compelling opportunities to U.S. private equity investors, partly because its economies are squarely in the emerging category and partly because of geography. It’s a short hop to many of these locations, and even the most remote are close to U.S. time zones. But the list of countries and economies within LatAm that represent the best opportunities can be a wildly volatile one. Case in point – Mexico, which for a long time was low on the list of prospects, has bounded to the top, surpassing even Brazil as a place where private equity firms are putting money to work. The region has faced myriad challenges over the past year, including the threat of the Zika virus.
But volatility within the region spells opportunities for many PE investors focused on distressed properties. And investors in the region take the long view, not getting bogged down in short-term issues, such as the Olympics or U.S. presidential politics. The region is also benefitting from developments outside it. China’s loss may be Latin America’s gain, as investors look to countries including Mexico to shorten the chain between production and consumption.
“The whole Latin American economy has been in a downward trend. Brazil is in a recession, and Colombia’s GDP growth has lowered substantially. Chile and Peru have suffered less,” says Ricardo Kanitz, a partner with Spectra Investments, a Latin American-based fund-of-funds with $115 million under management. “It’s hard to know how much lower things will go, but overall it hasn’t been a good time in Latin America on many fronts.”
The economic trends have certainly been tough on the residents of Latin America, but for investors, they create opportunities to purchase companies at depressed valuations. The opportunities, plus the fact that the World Bank declared that 50 percent of the Latin American population will be middle class by 2030, has made investors warm to the region. In 2014, private equity and venture capital funds earmarked for investments in Latin America raised $10.4 billion, which was a record for the region, according to the Latin American Private Equity and Venture Capital Association (LAVCA). Investors put some of the capital to work in 2015, despite macroeconomic headwinds, deploying $6.5 billion through 310 transactions.
While capital is being deployed in the region, activity levels vary country by country. “What’s happening in Peru and Venezuela is much different than what’s happening in Mexico or Brazil, even though many of the countries in Latin America seem to be experiencing challenges today,” says Kanitz.
And where you come from matters. The volatility in Latin American countries can be traced back to their origin. The historical perspective can really frame the situation. “A lot of people don’t realize that these countries were colonies of other countries at some point. The U.S. got a stable system from the U.K., Mexico got more guidance and stability from Spain than Brazil did from Portugal. These countries are still dealing with legacy issues,” says Jeff Jorge, a principal with Baker Tilly and the firm’s Latin American service desk leader. Baker Tilly is a full-service advisory and accounting firm that specializes in helping PE groups and portfolio companies expand abroad.
The rise of Mexico is one new development since Mergers & Acquisitions explored M&A in Latin America a year ago. Mexico, which for a long time was low on the list of investment prospects, for the first time in history has surpassed Brazil as the most popular destination for private equity investment in Latin America. According to data from the Emerging Markets Private Equity Association, a trade organization, private equity fundraising in Brazil took in 26 percent of the total, while Mexico’s percentage rose to a record 29 percent in 2015. This is a huge feat for Mexico. In 2011, funds raised for investment in Brazil accounted for 80 percent of private equity fundraising in Latin America, and funds focused on Mexico comprised just five percent. In 2013, Brazil was still attracting two and a half times as much money as Mexico.
“There is a longer-term trend of Mexico becoming a larger destination for private equity, and the country is enjoying a good moment in the cycle as it’s more closely linked to the U.S. economy and thus is expanding,” says Kanitz.
There are several reasons for the growing interest in Mexico. First, the Mexican government made reforms that have allowed for more investment in the country. Prior to 2009, Mexico’s pension funds weren’t allowed to invest in private equity. Now they can invest up to 10 percent of their assets in PE. The government also worked hard to make Mexico more appealing to outside investors by taking on corruption, labor and tax issues and the drug cartels. Tax inversion rules may also hamper cross-border M&A.
Additionally, the country struggled because so much wealth was controlled by only a few people in Mexico making it challenging for deal makers to find deals. “One of the main problems in Mexico was the economy was controlled by just a few families. It’s a cultural thing, but it’s changing,” says Kanitz.
The fall-off in manufacturing in China has also helped Mexico garner more investment dollars. As it has gotten more expensive and prohibitive to manufacture goods for U.S. consumption in China, Mexico has become a bright spot. “It doesn’t make economic sense to do certain things in China anymore. Lots of companies are investing in Mexico so they can near-shore, or next-shore. It keeps you closer to the client and customer while shortening the chain between production and consumption,” says Jorge.
There’s no question that Mexico benefits from its proximity to the U.S. “Mexico still has difficult issues to solve, but because of its location, it remains an important market,” says Luciana Aquino-Hagedorn, a partner with Goodwin Procter. “Mexico and the U.S. are particularly close from a business perspective, and that gives Mexico an advantage.”
Lastly, the upheaval that Brazil is experiencing has had a positive impact on Mexico. “There is an ebb and flow in Latin America. The balance equates to some economies improving, while others in the region decline,” says Jorge. “That’s the case between Brazil and Mexico.”
Private equity firms that have been active in Mexico include BlackRock, which raised the largest Mexican private equity fund to date with $756 million in 2014. Credit Suisse also raised two $550 million funds while Nexxus Capital, a Mexico-based fund, raised $550 million. The private equity firms have been very active on the dealmaking side as well.
In June, Nexxus Capital announced it reached an agreement to invest in Fondo de Transporte México, a holding company of subsidiaries in the logistics, cargo, personnel and student transportation sectors. Through all of its brands, Fondo de Transporte México operates more than 4,800 transportation units in 29 Mexican states. In 2015, Mexico saw a record $2.3 billion invested through 88 transactions in 2015, up 80 percent in number of deals from 2014 and 72 percent in amount invested year-on-year, according to the Latin American Venture Capital Association.
The increase in dollars being invested in Mexico is good news for the Mexican workers and the country as a whole, but its important to note that some M&A professionals in Latin America do not expect Mexico to hold the top spot for long. And despite claiming the No. 1 spot, Mexico’s private equity industry remains small. The value of its private equity investment in 2015 was equivalent to just 0.03 percent of Mexico’s GDP.
“Mexico will outpace Brazil for now, but Mexico is a smaller market by sheer spend, GDP and territory mass. We see Mexico strengthening, but Brazil will eclipse Mexico in the next 18 months,” says Jorge.
Brazil continues to face serious issues on all fronts. The impending impeachment of Brazilian President Dilma Rousseff, the unfortunate luck of being ground zero for the Zika virus that is linked to women giving birth to babies with microcephaly and an economic recession has Brazil facing a lot of headwinds today. Understandably, it is not an easy place for general partners, strategic acquirers or limited partners to get comfortable with. Brazil, while a mess in many ways, now provides opportunities for adventurous investors who see opportunities in distressed businesses.
In fact, Spectra Investments, which buys limited partners’ positions in private equity funds on the secondary market in Latin America, is busier than ever buying up stakes in Brazilian positions. “I am buying stakes from LPs that are scared of the region. They are mainly being scared out of Brazil and anyone who could get out of Argentina did already. The political situation in Brazil is messy, investors have been hassled, returns have been low and investors got burned and they want out,” says Kanitz.
Investing in Brazil is not for the faint of heart, however not everyone is running from Brazil. In fact, some investors see this as a good time to get into the country. The theory goes something like this: assets can be bought for cheap, investors will do well on the exchange rate, business owners are incentivized to sell, the impeachment process is almost over. Brazil will get out of the recession and investors will be able to ride their investment in to the height of the market and then sell for a windfall.
“People with experience in Latin America know it’s a good time to buy in Brazil. People are ready to jump at opportunities when they are presented,” says Aquino-Hagedorn. “These are seasoned investors with trusted local partners who feel comfortable in the country. It is a good time to do deals and I know of many deals that are in the works in the country.”
Aquino-Hagedorn, an Argentinian nationalist, says the best deals to make in Brazil today are the deals that aren’t tied to the local economy, but more to the global markets, like agricultural deals or deals in natural resources.
From 2012 to 2015, private equity infrastructure deals have accounted for roughly half of the total amount invested in the Latin America, with large transactions in oil and gas, logistics and distribution, and energy being the largest subsectors in the infrastructure sector. In 2015 alone, 31 percent of the capital raised went to Latin America private equity funds investing in infrastructure projects and assets. This still seems to be the trend in 2016. During the first quarter of 2016, a consortium, led by China’s Three Gorges Corp., the world’s larger hydropower producer, bought an 8,000 mega watt power station in Brazil for $3.7 billion.
In addition to infrastructure, consumer products is another popular sector for investment in Brazil. Brazil’s beauty and personal care market was worth $43.5 billion in 2014—the world’s third largest, according to data from Euromonitor International, an international market research company.
With the growing middle class and one of the largest populations in Latin America, this makes sense. Non-Brazilian-based investors are finding ways to get in at the ground level. In fact, 2015 was the first time since 2000 that foreigners outpaced local investors in investing in the country.
At the end of 2015, New York-based Coty Inc. agreed to pay $1 billion for the beauty care unit of Sao Paulo-based Hypermarcas. In January 2016, Reckitt Benckiser, a consumer goods company based in the U.K., bought Hypermarcas’s condom business for $170 million.
Despite the headwinds, Brazil is the world’s third largest consumer market for beauty and personal care products. “For many, now may be an opportunistic time to get in at or near the bottom of the cycle,” says Adam Czaia, a managing director with investment banking firm Baird.
Banking on now being the right time to make deals, firms like Baird and Baker Tilly are preparing for the upswing. In June, Baird, a middle market investment bank, created a strategic alliance with BR Partners, an independent investment bank located in Brazil. The partnership will focus on a strategic alliance for investment banking services, with an initial focus on cross-border M&A between Brazil and Europe, and Brazil and the U.S.
“Brazil was an increasingly relevant country for our clients and we evaluated the best approach for accessing this market. We met with several advisory firms and global private equity firms that have a presence in Brazil to better understand the market and we determined that BR was the right fit for us to form a strategic alliance focused on cross border M&A between our respective geographic regions,” says Czaia.
Baird and BR Partners have enjoyed a strong working relationship for the past several years. Most notably, last year the two firms co-advised Affinia Group Inc. on the sale of its Affinia South America business based in Brazil. “It was a challenging, complex transaction, and working together with BR was a great opportunity to pave the way for a more formalized alliance,” says Czaia.
In June 2015, Baker Tilly merged with Global Development Partners (GDP) to add a Latin American presence. GDP, founded by Jorge—a Brazilian national— in 2006, delivers international market entry support to companies with emphasis on the Americas and fast-growing, large emerging economies such as Mexico and Brazil.
“There are challenges for companies trying to enter into the Latin American markets,” says Jorge. Investors need to understand the inner workings of the market, including the culture. “Private equity firms might have the smart money, but most of the time they don’t know how the industry functions in Latin America and they don’t have the experience to make everyone around the table feel comfortable,” says Jorge, adding that due diligence on Latin American companies needs to go beyond the financials and including things like human resources.
U.S. private equity firms that invest in the region agree that it’s not an easy place to do business, but a worthwhile place for investors who have experience. “Investors who try to bounce in and out, and time the market find it a very hard place to invest,” says Chris Gordon, a managing director with Bain Capital Private Equity. “It takes patience and know how to make good [investments] in Latin America. It’s not for everyone.”
Bain has made two investments in Latin America. For its first deal, Bain Capital bought Spanish phone company Telefonica SA Atento’s call center business for $1.34 billion in 2012. Atento is the largest provider of outsourced call-center services to businesses in Latin America.
“Private equity is a good model for Latin America. You need a long-term perspective because you have to be prepared to own companies through a down cycle, and to know that you have a sustainable business,” says Gordon.
In March 2014, the venerable firm made its second foray into the Latin American market. The firm purchased Brazilian health insurance operator Intermedica from its founder for approximately $851 million. It has since completed add-on acquisitions including buying Santamalia, a healthcare insurer with five emergency rooms and two hospitals in Sao Paulo, in June 2015.
“Like the beauty and personal care market, the healthcare market will also be an important industry as the middle class continues grows. As Latin Americans have more disposable income they will need more things like healthcare, personal care items, services that go along with owning cars,” says Gordon.
While Argentina used to be a destination for M&A, but that has been less true in the last 10 years. While that may not change tomorrow, the outlook for M&A activity in the country may get more positive.
The change in the political landscape in Argentina is the first step toward a healthier M&A market. The October 2015 election of a new president, Mauricio Macri, is expected to be a positive change for the country. “A new president and more centered party in government is a good sign for the M&A market,” says Aquino-Hagedorn. “Additionally, there are changes to currency regulations that are positive, but still conditions are delicate. We will have to wait and see how things develop. Everyone is watching this market.” Regulation compliance, including meeting national security standards, is a key element in cross-border deals, as well as the Brexit vote.
Traditionally, industries that have driven the most M&A activity in Argentina have been energy, financial services and mining. Technology, energy and the agribusiness are expected to be sectors where there will be more activity in the future. “Agri is big business in Argentina, it’s a big exporter. This could become a sector ready for more investment,” says Aquino-Hagedorn.
Chile is also ripe for investment opportunities. The country has been stable for a long time and is already receiving foreign investment. “There are good opportunities in Chile. Mining is a very important industry there. It is a good time to buy with a long-term view. We find our clients are really excited about what they are finding in Chile,” says Aquino-Hagedorn.
While Latin America is ripe for investment, the volatility of the marketplace is expected to continue. “Problems will remain in our region. It is more volatile and I don’t expect that to change, but these problems bring opportunities for investors. As the middle class grows, there will continue to be more opportunities for investment,” says Kanitz.