Mexico could see M&A comeback

Mexico could soon see a surge in M&A deals as local firms look to pool resources with partners to take advantage of a wave of bankruptcies that are expected in the country as it enters its fifth month of the coronavirus crisis.

“Where M&A is concerned, we’re undoubtedly seeing an interesting period ahead,” said PC Capital managing director and cofounder Pablo Coballasi.

Mexico recorded only 143 transactions from January 1 to July 24, down 18% year-on-year, while reported deal value was down 42% to US$4.69bn.

“What we’re seeing today certainly helps push negotiations towards deal closings, for both buyers and sellers, as expectations are becoming more aligned in the context of a more sober outlook that has tempered growth in all but a few industries,” Coballasi added in a COVID-19 Mexico impact report prepared by TTR.

Transaction volume has trended upwards from a low of just 11 deals in April, 16 in May and 25 in June, but it looks to be a weak July with just 11 deals by the third week, TTR reported.

Low investor confidence

Víctor Manuel Frías, a specialist in corporate and commercial law at Mexican law firm Greenberg Traurig, said in the same report that going into the crisis, domestic policies promoted by President Andrés Manuel López Obrador (AMLO) were already taking a toll on investor confidence.

The pipeline of new investments in the country was sparse, as foreign investors remained reserved, but companies that already had a presence in the country were sticking to their plans, Frías said.  

“We were facing an outlook of slow economic growth,” Frías said. “The government’s policies were not directed towards the strata that promotes M&A.”

Since March, said Arturo Pérez-Estrada, corporate M&A specialist at Greenberg Traurig, the Mexican economy has gone from slow to stagnant, much as it has in other markets, particularly in the US, and companies have become very conservative in the face of weak signals of support from the government. 

Pérez-Estrada added, for example, that the instability in the regulatory framework around state-owned oil company Pemex and federal utility CFE driven by the current administration has become a larger threat to the private energy sector than the pandemic itself, adding there were many energy deals on the table in 1Q20, most of which are now in the doldrums. 

But the pandemic has taken a toll across all sectors, Pérez-Estrada said, with the majority of companies reorganizing themselves and putting their expansion plans on hold.  

The drop-off in interest in making deals from the US is evident in the following table provided by TTR showing a sharp turnaround in inbound M&A volume from US buyers. 

“The signing of the new free trade agreement [USMCA] was good news, and of course there will be winners in the downturn, from e-commerce to last-mile logistics and manufacturers of health and cleaning products, but almost everybody else is facing obstacles and preserving cash,” Pérez-Estrada said.

Financial services were the most active subsector for M&A tracked by TTR with volume up 26% year to date over the same period in 2019, while internet deals, the second most active subsector, have fallen 21%.  

Technology follows, with volume down 64%, and then transport and logistics, which is on par with deal volume in the corresponding period of 2019. Acquisitions led by US-based buyers are down just 6%, TTR data shows. 

Frías, however, argued that technology infrastructure is still attracting investors from traditional broadband and mobile tower assets, to remote work tools and entertainment – the latter undergoing a transformation to reach consumers directly by bypassing cable companies.  

Pérez-Estrada sees growing demand for financial services technology as well, with the lockdown accelerating the shift towards digital, as much to meet the need of consumers to shop online as for vendors to accept online payments. 

Opportunities to be found 

“Where M&A is concerned, we’re undoubtedly seeing an interesting period ahead,” said Coballasi, despite the sharp drop in activity this so far this year. “We’re still seeing strong investment interest, and there are still opportunities to do some very interesting deals.” 

Transactions led by financial investors are complicated, while strategic investors are focused on survival, he said. “We’ve seen increasing activity in recent weeks, however, and the phone hasn’t stopped ringing,” he said, with the steep rise in bankruptcy-related transactions of late expected to grow in the latter part of the year.

Coballasi cited the sale of an important local pawn shop chain to First Cash Financial Services subsidiary First Cash Empeño, closed March 31, as a key example of established players with significant cash reserves acting with confidence to deepen their presence in the Mexican market, something PC Capital is observing among foreign and domestic bidders alike.

“What we’re seeing today certainly helps push negotiations towards deal closings, for both buyers and sellers, as expectations are becoming more aligned in the context of a more sober outlook that has tempered growth in all but a few industries,” Coballasi said. 

“If you had a company that in the past was struggling financially, it may have been difficult to attract a buyer, since bidders would have been more focused on companies that were growing, to benefit from that growth,” he said. 

“Today, the world is different, however, and in the current environment, where few companies are growing, peers have an incentive to team up to face the challenges together, benefit from economies of scale, lower costs and improve profitability with lower overheads,” he added.

“We’re also seeing well-capitalized Mexican companies looking abroad for acquisitions in the US and in the EU, taking advantage of low valuations across the board in industries that have demonstrated resilience and those that are certain to bounce back.”

He added that Mexican companies in the entertainment, advertising, retail and automotive industries are among those that are looking at opportunistic deals abroad.

Private equity surge

Though transactions led by private equity funds are down 30% so far this year, the capital tapped in the deals has surged 164%, according to TTR. 

Coballasi said that calls to PC Capital are pouring in from companies seeking a sale, or a capital injection.

He said that companies that were in good health prior to the crisis will most likely return to good health, and the case is strong to invest now to tide them over through the worst of the crisis.

According to Coballasi, this investment strategy makes as much sense for private equity investors as it does for strategic buyers, adding that PC Capital plans to deploy its new US$100mn fund with investments of between US$5m and US$25m in financial services and fintechs that draw Mexico’s unbanked population into the formal financial system. 

He added the group looks to invest in environmentally sustainable activities across a range of industries, and in mass market consumer products. 

Handling the crisis

Though it is now clear that Mexico is set to suffer economically, the general outlook of those commenting in the TTR report believe the country will rebound, as it has time and again in crises. 

According to Sergio García del Bosque, managing director at the Mexico unit of global M&A investment solutions bank Seale & Associates, the country’s geographic position, its strong manufacturing base and favorable relations with the US and Canada, especially in the context of trade and diplomatic tensions with China, engender optimism, regardless of the political party in power.

García, however, said that once the loan deferment programs granted by Mexico’s banks begin to expire, it will become apparent that some companies will not survive, while others will need to go to the negotiating table to avert insolvency. 

There is a strong incentive for the banks to play ball, however, as they do not want to lose their money, which favors reaching agreements of some kind, García said. 

But a surge in bankruptcies and distressed M&A is expected in 4Q20 and 1Q21, said the Seale executive.

“Right now we’re in the eye of the hurricane and beginning to see a flood of deals in the pipeline; it’s part of the circle of life and we just need to tighten the screws where necessary and adjust,” said García.