As Farac II, the second toll road package of 11 due for auction in Mexico, nears its September deadline for proposals, it is to be hoped that hindsight has played a key role in what bidders come up with.
The first toll road deal, in October 2007, was a peso-denominated financing package worth Ps37.1 billion ($3.3 billion) – the biggest in Mexico’s history. But since Farac I closed, the international markets have been in free fall. It is unlikely in the present climate that Santander, which solely structured and underwrote the transaction, would be able or willing to front such a large deal again – especially as the initial deal stretched the local Mexican market to its limit.
Investors are still interested in toll road deals but on different terms. This time, as the bidders line up for Farac II’s auction, some notable changes in their financing packages are to be expected.
Despite the limits of the local Mexican market, local-currency financing is the best option. Road tolls will generate peso-denominated profits and the Mexican derivatives market continues to be illiquid. It is right to avoid foreign-currency risk but careful management of the financing process in Farac II could lead to better profits for the banks involved this time around.
First, the auction winners should take care not to flood the Mexican market with a single large deal. Farac II carries a higher construction obligation than Farac I, which means the initial wining auction bid can be lower. Estimates of $2.5 billion are expected to win the auction stage, while the later estimated $1.5 billion cost of construction can, and should, be financed over an extended period rather than flooding the Mexican market all at once.
A staggered, less aggressive, financing package will also give way for more banks to join the deal.
Bidders are now signing up between 10 and 12 banks for their financing. At least eight Mexican banks are expected to come into the debt part of the deal with a handful of international banks. There are also rumours that multilateral agencies including the IADB and the IFC are putting aside funds earmarked for the eventual auction winner.
Not only has Farac I illustrated the need for more banks to join the deal, and to stagger the financing requirements over time, it also carries one more lesson for new bidders.
Less financing should come from the debt markets – instead of $3.3 billion in debt and only $500 million in equity, as was the case in Farac I, a 50-50 split between debt and equity would be more logical for Farac II. In the light of current international capital market conditions and Mexico’s limited local debt market, this shift in funding source is essential.
If the auction winner has truly analysed Farac I and adjusts its pitch for Farac II accordingly, this time around, despite the appalling international market conditions, even better profits are within reach for all the banks involved. Hindsight is a wonderful thing!