Silence deafening in Mexican markets

Mexico’s equity markets have succumbed to global malaise and recovery will depend less on commodity prices, as is the case for most of Latin America, and more on improved debt markets and a US recovery.

The slowdown in the US economy is having a devastating impact on the Mexican economy, says Walter Molano, head of research at Connecticut-based BCP Securities. Government spending will increase 16% year on year as a result of new infrastructure programmes, pushing fiscal accounts into the red with the fiscal deficit moving up to 1.8% of gross domestic product, the biggest shortfall during the past six years, he says.

The power of the contagion has taken the country by surprise, admits Pedro Zorrilla, general manager of the Mexican stock exchange. There are a number of differences between this crisis and its predecessors, especially its origins in the developed world and its epicentre focused on the banking system rather than organised capital markets, he adds.

Mexico is used to passing through crises and that leaves it, in many ways, better prepared than developed markets, says Mr Zorrilla. “We understand the nature of crises as we have suffered their impact, and our regulation has been adapted to deal, to some extent, with issues relating to lack of liquidity and transparent valuation,” he says.

Mr Zorrilla says that it is unlikely any company will come to the market with an initial public offering in the first half of this year and it may even be 2010 until the market really restarts, admitting that “the outlook for primary equity markets is very poor”. With depressed valuations it is not attractive for companies to tap markets, and investor interest is largely absent, he points out.

Quiet times

There is unlikely to be new activity in equity capital markets for the next 12 months, agrees Damian Fraser, head of Latin research at UBS in Mexico City, although economic and market volatility makes it tough to make predictions as far as a month ahead let alone a year, he adds. The most likely possibility for new issuance is heavily discounted rights issues from firms that need to pay off debt, he reasons. If offered at discounts of up to 50%, they should ensure investor participation. He points to the recent example of Belgium’s InBev, which carried out a $8.2bn issue at a deep discount to help to pay off a loan to buy Anheuser-Busch.

Other possible early indicators of activity include merger or acquisition activity, says Mr Zorrilla. Bread maker Bimbo, for example has agreed to buy the baked goods unit of Canada’s George Weston for $2.4bn after spending $200m on acquisitions earlier last year. But any such deals will be the exception. Moreover, volumes have slumped and November was the lowest point in the year. That has compelled the stock market to embark on austerity measures.

Pressing matter

With the stock market at a low – the benchmark Bolsa index was down to about 24% in 2008 – refinancing what are often high debt burdens has become a pressing matter for Mexican firms. Mexico’s bond and bank loan markets had been deeper and more liquid than those in the rest of Latin America, and dollar loans more freely available. But US dollar borrowing has become particularly difficult due to the fall in the peso, which dropped by 21% in 2008.

The most dramatic effect has been seen with leading multilatina Cemex. The Monterrey-based cement giant, the world’s third largest, was often presented as the supreme example of a Latin firm that, through tight management and a push across global markets, would be an international leader based in an emerging market.

With ample access to borrowing and an admired business plan, Cemex turned itself into the most leveraged company in Mexico with some $23bn in debt, of which $6.6bn is due by the end of the year. The weak outlook for cement and Cemex’s high levels of debt saw the company pummelled by the downturn with shares reaching 10-year lows last year, giving the company a market capitalisation of just $5.5bn. The shares then recovered sharply after Cemex was able to close a $3.7bn debt financing deal through a roster of five banks: BBVA, Banco Santander, HSBC, Royal Bank of Scotland and just one US-based group: Citigroup. The company also needs to cut expenses and expenditures and is disposing of assets. In November 2008 it sold a business in the Canary Islands for $211m.

Pause for thought

The fate of Cemex is giving other companies pause for thought before jumping into debt-funded activities. Bimbo, which has debts of $1.02bn, needs to worry about downgrading if it pursues its acquisition in Canada. Standard & Poor’s placed all of its Bimbo debt ratings on credit watch, with negative implications after the announcement of its proposed George Weston acquisition.

A small number of companies that do not have healthy financials will need to concentrate on restructuring, says Mr Zorrilla. Industrial conglomerate Vitro has more than $1bn of debt and a rights issue would raise too little money to help, according to Mr Fraser. Others, including Corporación Durango, have already defaulted on selected debt.

The realisation that debt burdens are too heavy was reinforced in October as it emerged that Mexican companies had been speculating heavily on an appreciating peso through derivatives contracts. This tactic had been undertaken by a surprising number of companies, including Cemex as well as Vitro, and ‘small-caps’ Gruma and Posadas.

Mr Fraser estimates that losses will total $4bn to $6bn. The market now has a firm grasp of the situation and there are unlikely to be further revelations, he says. Nicholas Morse, Latin American fund manager at Schroders Asset Management in London, agrees, adding that he was happy that companies were transparent about exposure, but concerned that so many had engaged in speculative practices.

Mid- and small-cap companies not only face difficulties in raising debt, but also liquidity issues. The efficiency of the market is more difficult to maintain, particularly for mid- and small-cap stocks and this has become a key worry for the exchange, says Mr Zorrilla. To help to combat drops in liquidity, the exchange started licensing market makers three months ago to offer full-time pricing in stocks. Five brokers are offering the service in 10 securities.

Buy-back risk

Share buy-back programmes are also a risk in this environment. Companies embarking on such programmes may provide support for their stock, indicating that they believe it is trading below fair value, but programmes do exacerbate liquidity issues, says Mr Zorrilla. However, they are unlikely to be significant as most companies are hoarding cash, points out Mr Morse.

In these straitened circumstances, plans for expansion in what was a hot market have been put on hold. In the first half of last year, the exchange received requests from a number of global banks to open up a subsidiary in the Mexican securities market; these have not come to fruition, says Mr Zorrilla, declining to name the banks. He does not foresee investment banks cutting aggressively.

Mexico has been a profitable market for most investment banks, he points out, and they have their painstakingly built reputation and track record to preserve. But with another setback in the US, everything may change, he concedes.

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