Mexico is brimming with opportunities for private equity firms, thanks to a growing middle class along with sweeping reforms in its pension fund system and key industries, including telecommunications and energy. One private equity fund that has taken advantage of the trends is Citi Venture Capital International (CVCI). Formed in 2001 as a unit of Citigroup Inc. (NYSE: C), CVCI invests in emerging markets and recently agreed to merge with the Rohatyn Group, which is known as TRG Management LP. (Watch the video below.)

CVCI has backed five companies in Mexico, all of which have enjoyed successful exits, including two initial public offerings. Mergers & Acquisitions spoke with CVCI director Alex Manzo, who focuses on investing in Latin America.

Why is this a good time for private equity firms to invest in Mexico?

Mexico is the second largest economy in Latin America after Brazil. The demographics are very attractive. The average age is 28. There is a fast-growing middle class that is expected to double to 40 million households over the next 15 years and a robust growing labor force. The macro-economic picture is stable, with low inflation of about 3.5 percent, and gross domestic product has been growing very well over the last few years, at nearly 4 percent in 2011 and 2012, and over 5 percent in 2010. The equity markets are developing attractively, allowing entrepreneurs in small to medium-size businesses to access more capital than ever before and providing exit opportunities for private equity firms.

How are the reforms of pension funds changing the capital markets in Mexico?

Before Mexico reformed its pension fund system in 1997, it was a pay-as-you-go defined benefit system. Now it has changed to a fully-funded defined contribution plan managed by private fund managers, known as Administradoras de Fondos para el Retiro, or AFOREs. The system is modeled after the Chilean pension fund system. In 1997, there was $4 billion under management in Mexico's pension system. Now the AFOREs manage $140 billion. Before, pension funds were invested only in government bonds. Over time, there has been a diversification of assets into corporate bonds and equities, and pension funds can be more proactive and participate in initial public offerings.

In 2005, the AFOREs introduced a tiered-risk model, based on age, to allow for greater equity exposure for younger pension fund account holders. This increased the overall equity exposure allowed for the AFOREs. Starting in 2009, the AFOREs began investing in local private equity funds through Certificados de Capital de Desarrollo, known as CKDs. This was significant because it allowed for the increase in private equity capital dedicated to the market. In 2011, the AFOREs began investing in structures similar to U.S. real estate investment trusts, or REITs, known as Fideicomiso de Inversi-n en Bienes Raíces, or FIBRAs. This led to a significant number of initial public offerings and amount of capital being raised. All of this is very favorable to the private equity market. It means PE managers can now consider the public markets as a viable exit option. Since 2005, there have been 11 PE-backed IPOs in Mexico. Before, IPOs of PE-backed companies were very uncommon.

How are reforms in other areas, such as energy and telecommunications, affecting dealmaking in Mexico?

Compared with other Latin American countries, Mexico has a low penetration of Internet usage, with about 38 percent of the population with Internet access, compared with 50 percent in Brazil and 60 percent in Chile. There is a significant opportunity to invest in the infrastructure of the telecom sector. With the reform to increase competition of the telecom industry put in place by President Enrique Pena Nieto in June, now foreign companies can own 100 percent of Mexican telecom companies and 49 percent of media companies. From a private equity perspective, investment opportunities can come to fruition.

In energy, there is an ambitious plan currently being debated in Congress that would allow for profit-sharing contracts between state-owned and private entities. This would be very significant and is desperately needed. Mexico's reserves are falling, as is daily production of oil. Petroleos Mexicanos, or Pemex, the state-owned oil company, needs the private sector to come in and invest. If passed correctly, these reforms will bring a lot of investment into the country, but it will take time.

What recent investments in Mexico has CVCI made?

Since 2001, CVCI has invested in five Mexican companies, all of which have had successful exits with good returns. Our first Latin American IPO was in 2005, when Promotora Ambiental (BMV: PASA), a waste management company we first backed in 2002, went public. And our second IPO in Mexico was Fibra Inn (BMV: FINN13), a hotel REIT we backed in 2007, which went public in 2013. We have also invested in a customer relationship management call center, a cable TV company and a specialty packaging company - all of which we have sold. The underlying theme of all the companies we have invested in is that they benefit from Mexico's growing consumer demand. We believe the investment opportunities for PE in Mexico will continue to be in these industries as well as other sectors including retail, education, health care services and financial services - all of which are promising sectors because of the country's growing middle class.

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