Mexican stand-off

Mexico has never been a hotbed of private equity activity. But times are changing. In July, regulators eased restrictions that required public pension systems, known as Afores, to provide their entire commitments to funds up-front. Under new guidelines, approved by Mexico’s Ministry of Finance and Credit, Afores’ commitments to certificados de capitals de desarollo (CCDs) must be 20 percent pre-funded, while the remaining 80 percent can be met through capital calls.

“I think the changes are certainly positive. I think it’s slowly getting closer to a fund structure that is more typical in the market,” says Scott McDonough, managing director of Mexican-focused private equity firm Alta Growth Capital. “Part of the reason Mexico’s private equity industry has been under-served is the lack of participation from local investors, so I think the Afores starting to come into that is a positive step in creating a larger industry.”

Until two years ago, these pensions were not able to participate in private equity at all. Afores are prohibited from investing directly in vehicles, which prompted general partners to develop publicly-traded CCDs in 2009.

So far, only local firms have capitalised. As of January, three firms had collected $372 million from the pensions, according to figures released by the Mexican National Commission for the Pension System: $61 million for WAMEX Capital, $98 million for Atlas Discovery Mexico and $213 million for Nexxus Capital IV.

“There’s a new wave of players coming, and we need to praise the authorities for allowing that to happen. We need to be cautious on the other hand, because … it will take 10-15 years for this industry to mature,” Joaquin Avila of EMX Capital says. EMX raised $127 million for Mexican opportunities earlier this year.

But progress won’t be easy. Although macroeconomic indicators are positive – notably a growing middle class and increased demand for consumer products – the Mexican business community has historically been unreceptive to private equity.

“In Mexico, 99 percent of the potential investment universe is family owned … and it’s tough to break free from that,” said Mariano Gonzalez of Beige Group, a placement agent that handles several Latin American funds. “That’ll be the next step and that is what is happening now, actually. Family groups are realising they don’t need to own 100 percent of the company to hold important control over it or for it to prosper … [firms] have a lot of walk-ins now, people saying, ‘Hey, I have a business, I want to grow it, help me.’ That never happened 10 years ago.”

The other catch is that most Mexican businesses remain well below the size threshold that would interest a mega-fund. Even in the mid-market, where the need for growth capital and opportunity for investment is strongest, most company’s EBITDAs fall well below $30 million and this would fail to register on a major firm’s radar, sources say.

Nor is everyone convinced by the new regulations. “The changes made the placement a bit more complex, and in practical terms the Afores would prefer to invest under the prior format of fully-funding the vehicle under the public placement of a trust,” says Eugenio Najera Padilla of DemmaCap Manager. The swiftness of the changes, all made over the last two years, has not given institutional investors enough time to respond, sources said. Many local investors remain uncomfortable with the asset class, especially as most local firms’ track records are either mixed or non-existent.

“There’s been a learning curve for them. And as they’ve started learning, they’ve gotten a little bit more cautious,” McDonough said. “There is still a lot of room to grow.” That’s true for managers, as well as investors.