Mexico looks to MLPs
Attempts to boost infrastructure spending take inspiration from US model
When Mexico opened up its energy sector to foreign investors for the first time in almost three-quarters of a century, it was not banking on oil prices to plunge to their lowest level in more than a decade.
That downturn has taken its toll on the government’s finances, with spending plans ripped up and projects canned.
Now, the government is seeking other ways to boost infrastructure investment, and it has been looking to its northern neighbour for inspiration.
Last autumn, Mexico passed legislation to introduce the Fibra E – a structured investment vehicle that allows energy and infrastructure companies to cash in on mature assets by contributing them to a trust and selling shares in the trust to investors, similar to how a master limited partnership works in the US.
In theory, this means companies can use the money they raise to invest in new projects, and bankers and investors are optimistic that when the first one finally arrives, it could transform the landscape for how Mexican infrastructure projects are funded.
“There’s potential for it to be very important,” said Douglas Adams, head of equity capital markets for the Americas at Citigroup. “There’s limited opportunities to play within the energy or infrastructure sector within Mexico currently, and there’s a tremendous amount of investment that needs to go on post-energy reform. Energy is a huge part of the Mexican economy, yet investors don’t have an ability to invest in it.”
While the Fibra E takes the MLP as its template – the trusts pay no corporation tax and the assets remain in the hands of the sponsor – it also borrows from the success of real estate Fibras in Mexico, in that they will have to pay out at least 95% of taxable income as dividends.
“There’s no question that the real estate Fibra market has shown the depth of investor interest in Mexico for investing in high-quality assets that are generating significant cashflow,” said Adams. “It shows the appetite and the ability to raise a significant amount of capital.”
The real estate Fibra market has raised an equivalent of around US$11.5bn from initial public offerings and follow-ons since Fibra Uno debuted in 2011. Now, there are almost a dozen real estate Fibras in Mexico.
While the intention of the Fibra E is to steer investment capital towards state-owned oil company Pemex and power utility Comision Federal de Electricidad, or CFE, private companies are also likely to issue Fibra Es due to the broad range of infrastructure assets that have been made eligible. Telecoms, airports, roads, ports and even assets that could potentially include prisons have been put on the list, along with traditional MLP-eligible energy assets such as oil and gas pipelines.
Moody’s reckons Mexico’s construction sector could be the main beneficiary, given the types of assets they own and their experience of using other structured products.
“When you look at ICA (Empresas ICA) with all their toll roads or IEnova (Infraestructura Energetica Nova) or Abengoa in Mexico, they have been monetising assets for a while now. They are familiar with Fibra E-type structures, so that’s why we believe Fibra E will be more beneficial for these companies,” said Francisco Vazquez-Ahued, an analyst at Moody’s in Mexico.
Among other companies, Impulsora del Desarrollo y el Empleo en America Latina, or Ideal, is also a strong candidate to issue a Fibra E, given that it owns and operates nine toll roads, two water treatment plants and two prisons in Mexico, Moody’s wrote in a recent report.
Rush in store
Private sector companies are also likely to be first to issue a Fibra E, market watchers reckon.
“My guess is that a number of private companies will be out of the gate before either Pemex or CFE,” said Mike Fitzgerald, a partner at law firm Paul Hastings. “There are a couple of potential Mexican domestic transactions underway; once you see the first one or two out of the gate, there will be a huge rush to try and replicate that.”
Fitzgerald believes the first one could potentially land at some point before the summer.
Jordi Tasias, head of corporate finance at BBVA Bancomer, is expecting to see at least one deal this year, followed by two or three more next year.
“Estimates differ, but we expect around US$10bn in the next three to four years,” he said.
And while Pemex might not be the first issuer to market, it could raise as much as US$4bn from Fibra E issuance as soon as this year, according to analysts at Moody’s.
That would be a boost for a company that previously could only finance new investment through debt-raising or with revenue from existing operations. Yet any deal is likely to take time, given the challenges of structuring a Fibra E for a company of Pemex’s size, said the oil giant’s corporate treasurer, Rodolfo Campos.
“For any sponsor, one of the first considerations that takes a long time to conclude is the selection of assets. These assets need to have predictable and stable cashflows, and the analysis needed to see which ones fulfil these characteristics is a very complex process and not obvious from the outside,” Campos said, speaking at a Latin Finance capital markets conference in Mexico City.
“Clearly, the market has been needing diverse mechanisms to be able to access or express a view about the energy sector,” he continued. “If we analyse the composition of the IPC (Mexico’s benchmark stock index), clearly the energy sector is under-represented and this will be a mechanism to rebalance things, but the process to be able to do it is a lot more complex.”
Hurdles to overcome
Other challenges could stall the market’s potential growth. For starters, tax wrinkles need ironing out. At the moment, any asset that is contributed to a Fibra E is subject to a 35% tax, said Fitzgerald. For traditional real estate Fibras, no tax is applied. That could deter potential new issuance while a debate to remove it staggers through Congress.
“That’s one impediment that is keeping people from really analysing this too seriously right now. The Mexican tax authorities are looking at that and people are lobbying right now, but the tax regulations are not ready yet for this investment vehicle to really take off like [real estate] Fibras,” he said.
Corporate governance concerns may also impede demand from investors, said Moody’s Vazquez-Ahued. Because a sponsor such as Pemex will own and operate the assets, it can decide how much it will pay to lease those assets, creating a potential conflict of interest.
“It has to be very clear how the functions of Pemex as an enterprise and Pemex as an administrator are going to be separated,” said Enrique Solorzano, chief executive officer of Afore Sura, a Mexican pension fund, who was also speaking at the conference in Mexico City. “We are going to pay extreme attention that all participants are positively aligned together.”
Mexico’s pension funds – known as Afores – are expected to be big buyers of Fibra E shares, partly because favourable demographics in Mexico mean the Afores have a growing war chest of cash to invest and a scarcity of domestic assets to buy. Collectively, half of the Afores’ holdings are in government debt, with only about 5% invested in structured products, according to Carlos Ramirez Fuentes, president of Consar, the pension fund regulator.
“The [Fibra E] rules were really written with the Afores in mind,” said Fitzgerald. “This is a stabilised long-term income producing asset, which is just what the Afores like.”
At least 75% of the assets in a Fibra E have to be mature assets that have been in production for more than a year.
Solorzano said he hopes that sponsors are consistent with the types of assets they contribute to the Fibra E trusts, at least initially, so that investors can become more familiar with the product.
“We would prefer Fibras to be homogenous with similar assets that are easier to analyse,” he said. “Although we are open to multiple types of Fibras – of infrastructure, of energy, of transportation – in the beginning, if they are homogenous, it is better than if they are diverse.”
Yield-starved investors outside of Mexico seeking exposure to the country’s energy sector may also look to participate, said Fitzgerald.
“US investors are familiar with the MLP product and there is some thought that Fibra E will attract a lot of them,” he said.
Fitzgerald noted that around 80% of real estate Fibra Fideicomiso Hipotecario’s initial public offering in November 2014 was sold to non-domestic investors who were seeking higher yields.
“From an international investor standpoint, we’re attracted to Mexico because of the various efforts that are being made to bring more private investment-type opportunities onto the public side and make them available in secondary markets,” said James Anderson, a fund manager at Tierra Capital Partners, a Latin America-focused fund that has invested in real estate Fibras.
That demand could help the Fibra E market mirror or even surpass the rapid expansion seen in the real estate Fibra sector.
“The potential size of the market is contingent on the projects themselves. But, in general, because infrastructure projects are multiple times larger than real estate projects, it could very well end up being materially larger than the real estate Fibra market,” said Anderson.