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Capital Ideas for Private Business

Why not Mexico?

By Eduardo Berdegué, Managing Director
San Antonio/Austin Office, Corporate Finance Associates

MexicoOver the past decade, the surprising evolution of the Mexican economy has been greatly overlooked by the impact of crime-ridden headlines unjustly concealing a vastly more encouraging reality of our neighbor to the South.

As indicated by Richard Fischer, Chair of Dallas Federal Reserve in an op-ed piece published by the Financial Times last May, it is a mistake to see a country outperforming the US in many economic areas through the lens of immigration and drug trafficking. “Mexico has a sound macroeconomic footing and is addressing the microeconomic problems still holding it back” adds Fischer, “The same can not be said for the US.”

At 113 million, Mexico’s population is 3 times larger than that of Canada. It has the 11th largest economy in the world, and the 5th among emerging countries, only after the more touted BRIC group. The country’s GDP is expected to grow between 3.5% and 4% in 2012, while inflation is being maintained at around 4%. In comparison, Brazil’s expected GDP growth rate for 2012 is only 2.2% with an inflation rate unlikely to remain under 5% this year. Moreover, Mexico’s Public Debt/GDP (33%) and unemployment rate (5%) are far better than those of most, if not all, industrialized countries.

As a potential market for goods and services, Mexico’s young and vibrant demographic composition (median age is 26), and the steady rise of the country’s middle class to economic prominence (54% of population) is changing many of the stereotypes that helped define the country’s consumption patterns in the past. Much like their peers elsewhere, Mexico’s educated and overscheduled “soccer-dads” travel by plane, spend on cars and gadgets, eat out more adventurously, live longer, and max their credit cards. Unsurprisingly, opportunities abound in the food, education, leisure, health, and financial services sectors among many, many others. Mexico’s imports are $317 billion, 55.5% of which originate in the US.

As a manufacturing base, Mexico has much to offer. For one, proximity to the US and easy access to the Pacific rim countries represent an enviable location that is strengthened with the dozen free trade agreements offering Mexico preferential relations with 49 countries (Mexico is the 2nd country with most trade agreements in the world). The country’s pool of engineers grows by 115,000 each year helping Mexico rank in the top 20 in economic sophistication according to a joint publication of Harvard and MIT. More recently, Mexico’s competitiveness has been positively impacted by continuous labor cost increases in China. In fact, some estimates suggest that if the existing trend of increases in wages, yuan strength, and fuel cost continues, China may lose any competitive manufacturing advantage over Mexico by 2015. Mexico’s exports are $316 billion, 82% of which go to the US.

In spite of such reassuring economic conditions, the challenges facing the government of Enrique Peña Nieto after he takes office in December are not small. Security, actual and perceived, is still an important issue, as are corruption and the ever growing informal market. Moreover, how he maneuvers to get congressional approval to execute a controversial Energy Reform approved in November of 2008 that would open up Mexico’s State monopoly in the oil sector; and how he addresses the financing and construction of badly needed infrastructure will determine whether additional opportunities for foreign investors loom in the horizon in sectors traditionally reserved for national oligopolies.

In anticipation of continued stability and growth, M&A activity in Mexico is regaining the momentum lost after the 2008 crisis but at around $10 billion in transaction value per year, it is still very small in proportion to the size of the country’s economy. Likewise, Mexico’s private equity industry is clearly under-penetrated. Approximately 43 funds, mostly local, manage some $8 billion in assets and, proportionately to each country’s GDP, have invested 6 times less than Brazil’s private equity groups. This is a situation likely to change in the near future as small/middle market focused PE groups and strategic acquirers in the US start to reconsider their view toward Mexico. There are approximately 40,000 firms with revenues of between $7 million and $65 million, many of which are strongly positioned for sustained growth, and would likely welcome partnerships with strategic or financial backers.

MexicoIn spite of the challenges and risks, Mexico appears to be posed to consolidate an economic model of fiscal responsibility and monetary prudence that were unheard of not too long ago. The country’s population is young and vibrant and its middle class growing stronger. It’s privileged location, skilled workforce, and trade partnerships worldwide make it an attractive, low-cost manufacturing base for many industries. As New Growth Fund’s René Fernández enthusiastically put it in a recent event on Private Equity and Investment Opportunities in Mexico organized by the Dallas office of HaynesBoone, “Mexico is in the best shape it has ever been but if the country had a branding chief, he or she should be fired.”

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