Transactions in focusCorporate Development Network

Spotlight on M&A in Mexico

As the M&A environment continues to evolve and become more specialized, corporate transaction leaders must focus on aligning deal strategy with corporate strategy and act as effective strategic advisors to their boards. They are actively managing portfolios, divesting non-core assets on accelerated time lines and pursuing acquisitions to transform and grow their market share.

Our Corporate Development Network connects senior transaction leaders from the largest, most active corporate acquirers across Europe. Our network’s members meet regularly to discuss changes in the transaction climate and share their own recent deal experiences and perspectives on potential opportunities and M&A strategies.

In this issue of Transactions in focus, we explore Mexico — one of the most dynamic emerging markets. We will be setting out the advantages and opportunities for investors in this rapidly growing economy, as well as some of the special challenges that remain.

I hope you find these insights useful.

WelcomePär-Ola HanssonDeputy Leader EMEIA Transaction Advisory Services, and Chairman of the European Corporate Development Network

Stockholm, Sweden+ 46 8 5205 9677par-ola.hansson@se.ey.com

About EY’s Corporate Development NetworkOur exclusive Corporate Development Network brings together senior corporate development leaders from market-leading multinationals across Europe. Joining the network gives you the opportunity to build personal and professional relationships with other corporate transaction leaders. Together, you will share insights on transaction practices and challenges that will help your organization to achieve its growth potential.

We are committed to building and connecting the global transaction community. We hope that you can be a part of our network.

For details on joining the Corporate Development Network, please get in touch with your local network leader or contact:

Franziska Suessmilch Transactions Advisory Services Marketing + 49 619 6996 27620 franziska.suessmilch@de.ey.com

Olivier HacheManaging Partner Transaction Advisory Services EY Mexico and Central AmericaMexico City, Mexico+ 52 55 5283 1310 olivier.hache@mx.ey.com

Jon ClarkLead Partner of the European Corporate Development NetworkLondon, UK+ 44 20 7951 7352 jclark5@uk.ey.com

Your key contacts

Transaction considerations in MexicoAs one of the most dynamic rapid-growth markets in the world, Mexico is already one of Latin America’s most indispensable economies. While Brazil might be considered a darling of investors, Mexico may soon eclipse it. The country, with a population of 117.6 million people (2013) and foreign direct investment (FDI) of US$12.7b (2012), could be on course to overtake Brazil and become the region’s largest economy within a decade.

Mexico benefits from more nearshoring by its North American neighbors, and its transition from a “maquiladora”1 assembly line to a more nuanced provider of engineering and design. However, some of the uniqueness of its family-owned business culture can still raise concerns among some investors.

Progress through the decadesMexico has come a long way since the 1980s and early 1990s, when it was primarily known for its maquiladoras, or manufacturing hubs, along the US borders. During this period, inflation rates reached 180%.2 Although manufacturing still accounts for 80% of Mexico’s economy, it is now looking to grow and move on to the next stage. It is focusing on the development of research and skills in design and engineering for sectors such as automotive, aviation and medical devices. Meanwhile, its financial outlook is significantly more stable, thanks to a series of economic reforms carried out in recent years.

In Mexico’s current buoyant market conditions, the country has seen a near 300% increase in its foreign exchange reserves. At the same time, public debt has fallen to 31% of GDP, down from 42% in 2010. Mexico is set to attract nearly US$22b in FDI in 2014. The country has seen a record high of nearly US$35b in FDI in 2013.3 According to Banco de México, Mexican firms invested US$25.6b outside the country in 2012, 111% more than in 2011. Brimming with confidence, these firms are now looking beyond their borders, eyeing opportunities in the US and Europe.4 Mexico also boasts attractive labor demographics, with a population of nearly 118 million and a median age of 27 years.

MexicoPopulation

117.6m (2013)FDI

US$12.7b (2012)GDP

US$1.2t (2012)Source: CIA World Factbook, US Embassy in Mexico.

1 A US or other foreign assembly plant located just below the Mexican border employing labor at a much cheaper rate than is possible north of the border. These factories assemble products that are then shipped north, tariff-free, back to the US.

2,3 Mexican Ministry of Economy; General Directorate of Foreign Investment.

4 “Mexico: catching the wave,” Capital Insights issue 8, EY, 2013.

In this issue of Transactions in focus, Olivier Hache, EY’s Managing Partner for Transaction Advisory Services in Mexico and Central America, gives an upbeat but balanced assessment of the country’s investment climate and cultural considerations. In this report, he provides insights into the various spoken and unspoken rules that businesses should consider when moving into this promising market or dealing with local partners.

Six reforms in one year

Learning the local rules

A big factor behind Mexico’s increasing attractiveness is the progress of six reforms — the “Pacto por México” — introduced by Mexican President Enrique Peña Nieto since he was elected in 2012. The reforms encompass the labor market, education, banking, tax, telecoms and energy. They are creating opportunities in sectors previously reserved for state monopolies.

Key challenges that face foreign investors are the loss of technically skilled middle management to markets overseas, and some companies’ lack of access to markets. Another is the preponderance of family-owned businesses and the particular problems this introduces. “Creative” taxation and multiple sets of accounts and invoices are especially difficult challenges — albeit ones about which Mexican companies are frequently candid. “Companies will tell you what they are doing, and provide three sets of accounts. The question is how to protect yourself,” Hache says, noting that the complexities of such situations can make it difficult to value transactions. “Sometimes, the liabilities are higher than the purchase price.”

Given some of the inherent problems with bridging this culture gap — such as finding the correct person with whom to negotiate during the due diligence process — many investors prefer to make a direct investment in new build rather than buy an existing concern. For industries such as aerospace, the process of certification can be so complicated that it is easier to “buy on and reshape” an existing business.

Other businesses might consider acquiring complementary assets from private equity (PE). Partnering with PE firms is a potential route around these hurdles. Given the fact that PE is emerging as a force in the transactions market, corporate investors may be looking at this option more closely as they seek to create new prospects for unique collaboration in the M&A market. “In three to five years, you have a business that has been cleaned up by PE. And they know the value they can extract just by cleaning up,” says Hache.

2012r 2013r 2014e 2015e 2016e 2017e

Real GDP growth (% per year) 3.6 1.2 3.9 4.1 4.2 4.1

Consumer price index (CPI) inflation (% per year) 4.1 3.7 3.4 3.3 3.2 3.1

Current account balance (% of GDP) –1.2 –1.9 –1.1 –1.0 –1.3 –1.3

External debt total (% of GDP) 25.1 24.6 24.0 23.4 23.1 22.8

Short-term interest rate (%) 4.4 3.8 3.9 4.9 5.3 5.7

Exchange per US$ (year average) 13.2 12.7 12.8 12.9 13.2 13.4

Government balance (% of GDP) –2.2 –1.9 –2.5 –2.6 –2.7 –2.8

Population (millions) 121.0 122.5 124.0 125.4 126.8 128.2

Nominal GDP (US$b) 1,179.2 1,251.8 1,335.7 1,424.5 1,500.2 1,585.9

GDP per capita (US$ current prices) 9,743.4 10,217.1 10,773.6 11,358.6 11,831.5 12,374.0

Source: Oxford Economics.

Mexico in numbers (recorded and estimated) In some areas, the country is working to develop JVs alongside foreign investors, with the goal of creating Mexican spin-offs. By working to develop its R&D skills, Mexico is nurturing new sectors such as the video gaming industry. This helps to develop local companies.

In the automotive sector, Hache notes that Mexican companies began to take over their US suppliers in the wake of the global financial crisis. Since 2008, Mexico has created large domestic automotive supply companies, and they are now increasingly operating globally. “This is the second tier of companies emerging in Mexico, and they are quite sophisticated,” notes Hache.

Deal drivers Transaction issues

Growth story• Domestic consumption, increasing private investment and strong exports are supporting the

country’s economic growth.

Economic issues

• The significant levels of corruption are a governance issue.

• Labor unions in some industries are strong.

Policy framework

• With the latest tax reform, most sectors are expected to be open to domestic and foreign investors.

Cultural issues

• Family businesses constitute the largest group of companies in the economy.

• Lack of succession plans remains within the owning families.

• There is a lack of knowledge about the opportunities offered by PE.

Financial system

• The country has a well-capitalized and well-regulated financial system, with a strong capital market and credit expansion.

Business issues

• The quality and transparency of financial and accounting information is inconsistent.

• Accounting records are often driven by tax rules, rather than being used as a tool for managing the business.

Sector potential

• Significant opportunities exist in key sectors, such as consumer products, finance, oil and gas, and electricity, as well as construction and infrastructure.

Legal and regulatory

• There is a strict regulation for private investment in certain sectors.

• Approvals for deal completion can significantly delay the process.

• Regulatory rules change frequently.

Regulations have been stimulating

• Tax incentives are being granted in certain industries.

Global orientation

• Executives are seizing opportunities to expand, despite global market volatility.

• Companies are open to foreign partners.

Tax and labor

• A tax reform has been passed to stabilize the tax regime and provide more visibility and stability of the labor laws and tax rates.

Inbound deal drivers and transaction issues

Get local know-how. An advisor who knows the market is crucial. They can help you to understand the general structure of the deal and the cultural aspects.

Embed roots. Key shareholders need to be involved at an early stage in the M&A process. A local management team and local ownership are recommended for the first few years of the operation. Lack of deal experience among company owners and management, lack of access to them and the absence of external advisors assisting the seller may result in an inefficient sales process.

Understand the system. Deal-makers must keep a close eye on the specific set of factors that are unique to Mexico, such as foreign ownership restrictions on certain industries, creative tax structures and labor laws.

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Making it work — six practical guidelines

Mexico is making wavesThe global economy is continuing to rebalance. Many mature markets are becoming more competitive again, while the spotlight is being put on some of the riskier aspects of operating in developing economies as they grapple with slowing growth.

As process challenges conventional wisdom, it also reveals new markets where the risks are more finely balanced with opportunities. Mexico, with its strong trade links with North America and willingness to move ahead with economic reforms, is positioning itself to benefit from these advantages. It is seeking to further its transition from an offshore manufacturer to a more value-added producer of high-end electrical products, equipment and consumer goods.

Still, in Mexico, as in most developing countries, challenges remain. Violence remains a serious problem in parts of the country, and some of the peculiarities of its family-owned business culture can still raise concerns among investors. However, the country is working to overcome these problems and further improve its attractive business climate.

Take time. Long-term negotiation timetables are generally required to close a transaction in the region. Preparing and delivering due diligence information requests can be more lengthy than is the norm in the US and Europe.

Always plan for hands-on integration after the deal. Due to the lack of internal controls and inexperience of management, post-close integration may require careful monitoring and on-the-ground assistance. Integration can be a key issue due to a lack of communication in middle management.

Relevance of personal contacts. Especially in emerging markets, you need to give people the understanding that you invest in personal relationships, and not companies or institutions, and develop them for the long term.

Leading businesses are adopting a range of disciplines around capital in four key areas to build competitive advantage:

1. Preserving: reshaping the operational and capital base

2. Optimizing: driving cash and working capital, and managing the portfolio of assets

3. Raising: assessing future funding requirements and evaluating sources

4. Investing: strengthening investment appraisal and transaction execution

• Stress and distress —e.g., liquidity issues and turnaround plans

• Customer and supplier analysis• Preserving tax assets and

minimizing costs• Refinancing or restructuring debt,

equity and other obligations• Dealing with stakeholder

relationships and pressure• Dispute resolution

• Optimizing asset portfolio • Delivery of synergies and

effective integration• Improving working capital and

releasing cash• Optimizing capital structure• Optimizing tax and corporate

structure

• Fund-raising (equity and debt): IPO readiness, rights issues, PE, private placement and capital markets

• Optimizing funding structures• Asset divestment• Infrastructure projects• Cost- and tax-efficient structures

Focused due diligence to mitigate risk and drive value

Asset valuations

Cost- and tax-efficient structures

Acquisitions and alliances•Planning and structuring transactions to optimize stakeholder return

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Pres

erving Optimizing

Raisi

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Investing

The Capital Agenda

M&A in context: The Capital Agenda

About EY

EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

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About EY’s Transaction Advisory Services

How you manage your capital agenda today will define your competitive position tomorrow. We work with clients to create social and economic value by helping them make better, more informed decisions about strategically managing capital and transactions in fast changing-markets. Whether you’re preserving, optimizing, raising or investing capital, EY’s Transaction Advisory Services combine a unique set of skills, insight and experience to deliver focused advice. We help you drive competitive advantage and increased returns through improved decisions across all aspects of your capital agenda.

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