Mad on Mexico

In the two years since the peso crisis, Mexico surprised the markets with a miracle comeback. Led by the United Mexican States (UMS), the country’s issuers have wooed back their old customers, and won many new ones. Last year the government’s external debt team, led by Martin Werner, under-secretary of finance, kept Mexico in the headlines ­ with good news for a change. In the most dazzling move, the UMS pioneered a Brady bond reduction and issued the region’s longest maturity with a $1.75 billion 30-year global exchange.

The government’s efforts laid the groundwork for Mexico’s beleaguered corporate base. Bond issuers now face the markets with renewed investor confidence and a full sovereign yield curve. For this year, Mexico needs to refinance $5.8 billion total sovereign and corporate debt, according to Joyce Chang, director of emerging market research at Merrill Lynch.

As Werner and his team consolidate their market successes, they have attracted a larger pool of investors. “We’ve seen a real broadening of the investor base in the last year,” says Chang, pointing to the significant spread tightening in the UMS Global 01, which came to market at 450bp and now trades a 154bp, as one example.

Chang attributes the new acceptance of Mexican debt to a variety of factors: positive economic events in Mexico; exchange rate stability; and continued high yield demand which favours bellwethers such as Mexico.

Others note the influence of the crossover investor more in the structure than in the pricing. “The crossover investor, which are mostly high-yield funds, are probably more picky about the credit and the yield,” says Jim Garvey, an emerging market fixed income analyst at Santander Investment. “If anything, they’re making the deals better structured.”

Equity investors can expect more Mexican IPOs as the country’s economy slowly recovers from a deep recession. The economic indicators are promising, although domestic consumption is low. Most analysts predict GDP growth will reach around 4%-4.9% by the year’s end. Once the uncertainty about the outcome of July’s municipal and legislative elections subsides, local stock prices should rebound slightly. Meanwhile, Merrill Lynch is recommending an overweight position in Mexican bonds, and expects a pick-up after the July elections.

Overall, there was a bull market for Latin debt last year. Returns from Mexican debt averaged around 35.14% according to JP Morgan’s Emerging Markets Bond Index. Given the rise from the dead, estimates of Mexican debt returns this year are substantially lower.

“Pricing started at a very low level last year; spreads were still very wide. This year, if you’ve done 15%, you’ve done very well since you’re starting at a higher base,” notes Santander’s Garvey. “Through February pricing was relatively tight since the market was so favourable. There’s more of a buyer’s market right now.”

Given the mere $1.4 billion the Mexican government faced in market-based refinancing this year, corporates will likely take the lead as top issuers in Mexico. Last year, however, was a banner year for the government.

In 1996, the UMS issued $14 billion in debt as part of a strategy to establish reliable benchmarks in straight Mexican debt in both dollars and other foreign currencies. In the first quarter, the government dabbled in foreign currency markets with a DM1.5 billion seven-year bond and a ¥40 billion samurai. By March the government started to turn heads with its first global, a $1 billion five-year bond with 9.34% coupon. By the end of the first quarter, the UMS had issued $2.6 billion in bonds which stretched out its debt profile from five to seven years.

But that was just the beginning. In May, Mexico launched 30-year bonds in a $1.75 billion Brady bond exchange, which impressed the markets. The exchange, arranged by Goldman Sachs, were launched with a spread of 552bp and paid 11.5% semi-annually, 12.4% at the re-offer due 2026.

The operation reduced outstanding Bradys, achieved a tighter pricing than the stripped yields on both discount and par bonds, and allowed the government to repay $650 million in short-term debt and thereby save $170 million in interest costs through the life of the bond. That same month, the UMS also issued a ¥100 billion samurai through Daiwa Securities for 10 years.

In July, Werner decided to make headlines again. The UMS issued a $6 billion FRN, which allowed the government to pre-pay $7 billion of a $10.5 billion debt held with the US Treasury. The $6 billion issue equalled all government issuance so far in the year, including government agencies and oil monopoly Petroleos Mexicanos (Pemex) The loan/bond hybrid credit, with an enhancement of Pemex receivables which earned it the investment grade, created $11 billion in demand.

The rest of the year, the UMS entered the market for prime opportunities in foreign currencies, such as the DM1.5 billion eight-year bond with a put option in year five issued in September. The mark bond was followed by another Daiwa-led ¥70 billion issue for six years. In October, the UMS issued a $1 billion 20-year bond after it bought back some Bradys. Later in November, Mexico issued a L500 billion five-year Eurolira.

Both the 30-year and 20-year globals redefined Mexico’s yield curve away from its exclusive tie to the Brady. In future, the Mexican government plans to reduce its $24 billion Brady bond reserve, but without the drama of the initial exchange. “The exchange was a particular instrument for a particular moment,” says a Mexican finance official.

“The Brady-type exchange was a very interesting experiment which turned out to be somewhat complicated,” says Richard Segal, head of emerging markets fixed income research at Santander Investment.

Given the increase in straight sovereign issues, some have suggested that the Brady is heading for the sunset. For the Mexicans’ part, the Bradys¹ days are numbered. “We still think Bradys distort Mexican risk since they are undervalued by investors,” says the Mexican government official. “Now that we have a good yield curve, we don’t need them any more.”

However, for many investors, they are still the most attractive option. “The Bradys have a historical trading pattern and a much higher yield. For those investors in high yields, Bradys are better,” notes Chang at Merrill Lynch. After such a stellar performance in the market, one would expect the Mexican government to take a more leisurely pace this year. But Werner is full of surprises.

This January, the UMS issued $1 billion in 10-year global bonds led by Merrill Lynch and Salomon Brothers priced at 335bp over treasuries. The issue fell into an empty space in the country’s dollar yield curve, behind last year’s 20-year and 30-year bonds.

The January global took care of most of the UMS’s refinancing needs for this year, although the government continues to look for opportunities in foreign currencies such as lira, Deutschmarks, yen and most recently, sterling. In the first quarter, Mexico issued a $300 million 10-year lira bond, a seven-year samurai for $400 million, a 12-year $900 million DM issue, another samurai for $800 million with a five-year maturity, and a 20-year lira bond for $290 million equivalent.

Last month’s (May) £300 million ($480 million) five-year sterling issue constituted the largest emerging market entry in that market. It was launched at 8.75%, the equivalent of gilts plus 173bp. While the UMS last visited the sterling market in 1991, government agencies Banco Nacional de Comercio Exterior (Bancomext) and Petroleos Mexicanos (Pemex) issued in sterling in 1993.

“We met two goals with the sterling issue: to diversify our investor base and to arrange cheap financing,” says a finance official following the launch. As part of its overall strategy, Mexico will deepen its presence in the European market with further issues, which could also include pesetas and francs. “We’re looking at some 10 different markets where we hope to enter in the medium term,” adds the official.

Later this year the government is expected to announce a new refinancing agreement for its remaining IMF debt. The debt is relatively low at $2.4 billion this year and $2.9 billion next year, but it jumps up to $7.5 billion in 1999. Analysts expect Mexico to restructure half the debt as an extended fund facility and the other half into the market. “Mexico could bring $4 billion to $5 billion by the second half of this year,” predicts Santander’s Segal.

Meanwhile, foreign money continues to flow into the domestic money markets, reaching $3.746 billion in April. Most investors place their money in treasury certificates (Cetes). During April, 90-day Cetes paid a 6.46% premium in dollar terms.

The immediate affect of the UMS aggression in the market on corporate issuance is a debate among analysts. “Some people will say there was no crowding out by so many government issues, but there definitely was that effect last year,” believes Garvey at Santander.

Even so, the establishment of a sovereign yield curve has helped corporate issuers, admits Merrill Lynch’s Chang. “You’ll see more corporates at spreads increasingly more competitive.”

Mexican debt lags behind that of its main Latin competitors, Brazil and Argentina, which both received upgradings in their corporate ratings earlier this year. Mexican companies held their own last year and issued $19.6 billion in new products. Of note, there were two sizeable corporate restructurings with a $600 million bond from cement company Cementos de Mexico (Cemex) and a $700 million bond from media conglomerate Televisa.

Paper conglomerate Grupo Industrial Durango (Gidusa) also exchanged $75 million of its $125 million FRN through Chase Securities. Later the company issued a seven-year $250 million yankee bond priced at 529bp over treasuries to refinance a $125 million floater due in November. Given its attractive pricing, the offer reportedly attracted more than $1 billion in orders.

This year there are about $2.6 billion in corporate maturities and a large bunch of maturities next year. As a result, issuance will probably accelerate in the second half of the year. Mexico’s second largest media group, TV Azteca, was the first corporate issue of the year with a $350 million bond led by Bear Stearns and Salomon Brothers. Coparmex followed with a $200 million bond for seven years at 450bp.

In February hotelier Posadas issued a $50 million five-year bond led by ING Baring. Posadas immediately traded up from 425bp to 380bp. Later, steel company Alto Hornos de Mexico, AHMSA, sold a $300 million Eurobond led by Santander Investment and Merrill Lynch. Earlier JP Morgan had arranged an export-note programme with five- and 10-year tranches.

In May glass producer Vitro issued $425 million bonds in two tranches. The first $175 million tranche, 375bp over treasuries, matures in 2002. The second $250 million tranche, 425bp over treasuries and priced to a call will mature in 2007. JP Morgan was the arranger.

The pipeline includes steel company Hylsamex and chemical company Alpek, subsidiaries of the industrial conglomerate Alfa.

All eyes on the IPOs

New investors are being drawn to local and international offers as Mexico capitalizes on economic recovery.

Mexico’s economic recovery is stimulating IPO issues, which bring new investors into the country. After the debacle of the peso crisis, both dedicated funds and crossover investors are taking a new look at Mexican equity. “Overall, confidence has returned to Mexican equity, but investors will be selective,” says Carlos Hernandez, head of Latin American equity research at JP Morgan.

Last year Mexican IPOs made the grade by demonstrating their profits for investors which once waited for the secondary market. “The IPOs have proved themselves last year. People realized that Mexican IPOs can make them money,” Hernandez says.

Of the 23 local and international offers last year, notable issues included grocery distributor Grupo Casa Autrey, Consorcio ARA and conglomerate Grupo Desc, which all performed well in the secondary market. But grocery store chain Controladora Comercial Mexicana and cornflour manufacturer Gruma both came at discounts due to unfavourable economic conditions. Gruma was a 144A secondary issue led by Morgan Stanley.

This year, SBC Warburg and UBS Securities led the first international issue from a Mexican corporate, a $70 million IPO from cornflour and tortilla company Grupo Minsa. While Minsa is strong fundamentally, the uncertainty around the government’s decision to cease tortilla subsidies has hurt the stock’s performance.

Consorcio Hogar, a leader in the local housing construction market, was the second international issue this May. The company, the fourth largest builder of public housing in the country, issued $30 million, or 35% of its capital in May. Daiwa Securities led the international tranche with Casa de Bolsa Inverlat on the domestic level. The funds will be used to restructure short-term debt and capital expenditures.

The pipeline includes steel company Hylsamex, chicken producer Bachoco, Cintra, the holding company for Aeromexico and Mexicana airlines, Hard Rock Cafe, leading cable operator Cablevision, hotelier Costamex, Banca Serfin and housing construction company Geo. Femsa’s beer subsidiary might also consider an issue this year as well. Meanwhile, pharmaceutical company Farmacias Benavides planned a $50 million convertible. The local equity pipeline includes Globo, a bakery chain.

On the domestic front, the local market reached its peak in August last year, then fell into a period of correction, rising again around February, says Felix Bonni, director of equity research at ING Baring’s Mexico office. Since early March trading hovers around a narrow range with volumes in the low $100 million-range, says Bonni.

Bonni predicts the local market will experience a pickup following the July elections with slow, steady improvement by the year’s end. “We’ve seen too much concern about the immediate outcome of the elections,” he says.

In its equity analysis, ING Baring relies more on sectoral data, such as manufacturing and retail statistics, than any broad expectations about GDP. “As a number, the attention focused on the GDP is exaggerated,” he comments. While the recovery in domestic consumption and manufacturing wages is still slow, retail sales showed the slightest 1% improvement in March, “the most positive numbers we’ve seen so far”, notes Bonni.

As a result, the continued weak macroeconomic environment will affect domestically oriented companies. Construction companies, for example, have not recovered as quickly as expected. Toward the end of the year, positive economic numbers should also boost the local market.

Foreign investment in the Mexican stock exchange continues to rise as steadily as US Treasury rate rumours permit. By the end of April foreign inflows reached 30% of the exchange, a 1.13% increase from March. Meanwhile, foreign flows into Mexican ADRs increased 16.25% in the first quarter.