VZCZCXRO6374
PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #4451/01 2331505
ZNR UUUUU ZZH
P 211505Z AUG 07
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 8491
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RHEHNSC/NSC WASHDC
RHMFIUU/CDR USSOUTHCOM MIAMI FL
RHMFIUU/CDR USNORTHCOM
RUEHC/DEPT OF LABOR WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SECTION 01 OF 04 MEXICO 004451 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR A/S SHANNON 
STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH 
STATE FOR EB/ESC MCMANUS AND IZZO 
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD 
TREASURY FOR IA (ALICE FAIBISHENKO) 
DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND ALOCKWOOD 
NSC FOR RICHARD MILES, DAN FISK 
STATE PASS TO USTR (EISSENSTAT/MELLE) 
STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA) 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PINR PGOV MX
SUBJECT: A LOOK AT MEXICO'S NASCENT PRIVATE EQUITY INDUSTRY 
 
------------------------ 
Summary and Introduction 
------------------------ 
 
¶1. (U) A strong private equity (PE) and venture capital (VC) 
industry has long been seen as an important vehicle for 
economic growth, the development of small- and medium-sized 
businesses, and job creation.  Recent reforms measures and 
relative political and macroeconomic stability have made 
Mexico a more attractive market for PE groups.  The amount of 
funds PE/VC firms raised in Mexico increased from 
approximately $347 million in 2004 to more than $1 billion in 
2006, according to the Mexican Private Equity Association 
(AMEXCAP).  That said, most funds focus on companies in their 
growth stage -- leaving a funding gap for start-ups and early 
stage companies.  Additional measures are needed to 
strengthen and grow the PE/VC industry.  In particular, work 
is needed to build Mexico's cadre of entrepreneurs, improve 
laws and regulations that affect PE/VC investments, encourage 
effective and knowledge management teams, increase the 
availability of exits, improve rule of law, and promote 
judicial, labor, educational, and bankruptcy reform.  End 
Summary. 
 
-------------------------------- 
Positive Momentum Is Underway... 
-------------------------------- 
 
¶2. (U) Mexico in recent years has enacted significant reforms 
to reduce legal impediments to PE/VC investment and to 
enhance transparency and disclosure.  The Securities Market 
Law -- which went into effect last year -- significantly 
improved corporate governance and minority shareholder rights 
through the creation of a special corporate category called 
an Investment Promotion Corporation (SAPI).  A company that 
registers as a SAPI can avoid some of the requirements of 
publicly traded companies for three years in return for 
adopting the "Best Practices of Corporate Governance" code 
and giving more power to minority shareholders.  In 2006, 
Mexico established a new fiscally transparent trust structure 
known as the FICAP to allow venture funds to incorporate 
locally.  High management fees charged by banks and brokerage 
houses that administer the trust and some lingering concerns 
about FICAP's corporate governance structure have greatly 
limited their use, but the creation of this domestic tax 
pass-through vehicle was an important step nonetheless. 
(Comment: PE/VC funds pooling resources from several 
investors incorporate using corporate forms considered as tax 
pass-throughs, in which tax is applied directly to the 
investors rather than the fund.  End Comment.) 
 
¶3. (U) These reforms, together with relative political and 
macroeconomic stability in Mexico, have generated growth of 
domestic and foreign-owned PE funds focused within Mexico's 
borders.  Mexico has approximately 40 active funds, the 
majority of which are subsidiaries of foreign companies.  The 
amount of funds PE/VC firms raised in Mexico increased from 
approximately $347 million in 2004 to more than $1 billion in 
2006, according to the Mexican Private Equity Association 
(AMEXCAP), and there is optimism that deal flow will continue 
to increase over the next few years.  That said, most funds 
focus on companies in their growth stage -- leaving a funding 
gap for start-ups and early stage companies (i.e. there is 
very little VC in Mexico).  According to a 2006 AMEXCAP and 
Deloitte survey, the industrial sectors that receive the 
largest investment from PE funds are real estate, consumer 
products, and manufacturing, and most investments are in 
Mexico City, Monterrey, and Guadalajara. 
 
--------------------------------------------- --- 
... But Investment Environment Holds Back Growth 
--------------------------------------------- --- 
 
¶4. (SBU) While the accomplishments discussed above are 
significant, Mexico must address the following obstacles to 
 
MEXICO 00004451  002 OF 004 
 
 
strengthen and grow its PE/VC industry. 
 
Lack of Investment Culture 
-------------------------- 
 
¶5. (SBU) The lack of an investment culture is routinely cited 
as one of the top factors hindering the development of 
Mexico's PE/VC industry.  Mexico's history with PE/VC is 
limited, and knowledge about the financing and benefits of 
PE/VC is still wanting.  Hortensia Contreras, the Director of 
Investment Capital at Nacional Financiera (strictly protect), 
told econoff that progress in fostering a venture oriented 
entrepreneurial culture has been slow because many companies 
in Mexico are family-owned, and risk-averse owners do not see 
the need for PE.  Carlyle Mexico's Andres Obregon (strictly 
protect) added that it is not just the entrepreneurs, but 
also their accountants and advisors who are unfamiliar with 
the PE/VC model. 
 
¶6. (SBU) Contreras told econoffs that Nacional Financiera 
(Nafin) is working with Mexican universities to "catch the 
next generation."  She noted how many universities (e.g. 
UNAM) produce excellent academics and researchers, but not 
entrepreneurs.  Obregon echoed Contreras' comments about the 
importance of working with universities to build a culture 
that fosters PE/VC and entrepreneurship.  He noted how the 
major VC funds in the U.S. are located in areas with a high 
concentration of top-ranked universities (e.g. California and 
Massachusetts).  He highlighted the need to improve public 
education in Mexico, noting that PE does not affect 
education, but education affects PE through entrepreneurship 
and innovation. 
 
Lack of Legal Assurances 
------------------------ 
 
¶7. (SBU) The legal uncertainty associated with Mexican 
judicial processes is a another impediment to PE/VC.  The 
judicial system is generally considered to be slow and 
unreliable.  According to Joaquin Avila, the Managing 
Director of Carlyle Mexico (strictly protect), judicial 
corruption is also a problem. 
 
Local Regulations and Laws 
-------------------------- 
 
¶8. (U) Additional measures to improve laws and regulations 
affecting PE/VC are needed.  For example, while the FICAP 
allows companies to incorporate in Mexico, the new trust 
mechanism's high costs and inefficient structure have 
resulted in it hardly being used.  At the same time, 
incorporating abroad remains prohibitively expensive for 
smaller funds.  Currently, Mexico does not recognize U.S. 
partnerships and limited liability companies as fiscally 
transparent for tax purposes.  This prompts many fund 
sponsors to incorporate in Canada, which is considered a tax 
pass-through.  According to a local consulting company, 
Mexico does not recognize funds incorporated in the U.S. as 
tax pass-throughs because of a lack of understanding about 
U.S. partnerships, pass-through entities, and disregarded 
vehicles.  Some argue that if investment vehicles are 
considered a tax pass-through under their host country law, 
the Mexican government should recognize them as pass-through 
entities as well. 
 
¶9. (SBU) Contreras told econoff that the problem of minority 
rights of shareholders was solved with the new Securities 
Market Law, but Obregon noted that there was still a tendency 
to focus on getting a "51% slice" of the company, and not on 
the "size of the pie."  A 2007 report from the Latin American 
Venture Capital Association (LACVA) noted that there are some 
concerns that the prevalence of family and other ties will 
dilute minority shareholder voices. 
 
¶10. (U) Many investors have argued that Mexico should 
 
MEXICO 00004451  003 OF 004 
 
 
increase tax incentives for PE/VC investing.  Some say that 
such incentives should favor only positive investment 
outcomes and not reward losses. 
 
¶11. (U) Some investors have called for Mexico to lift 
restrictions imposed on institutional investors for putting 
money in this industry, noting that pension funds are an 
important source of U.S. venture funds.  The President of 
AMEXCAP earlier this month said publicly that allowing 
pension funds to invest in PE would not only help workers 
retire with a dignified pension but it would also finance a 
productive activity. 
 
Ineffective Management Teams 
---------------------------- 
 
¶12. (SBU) According to KPMG's 6th annual Latin American 
private equity survey, one of the primary causes for deal 
failure involving PE transactions in Latin America is 
ineffective management teams.  Contreras told econoff that a 
key to a fund's success in Mexico is high involvement of the 
fund managers in their investments.  She added that funds are 
trying to create more local management teams to ensure 
understanding of the Mexican culture, political, business, 
and legal environment. 
 
Need for Exit Strategies 
------------------------ 
 
¶13. (SBU) A vibrant VC industry requires not only investors 
willing to fund the deals, but also plausible exit strategies 
for those investors.  Contreras told econoff that exits are 
still a problem because most companies are still too small to 
do an initial public offering (IPO).  She said the government 
created a private non-regulated middle market company to 
help, but that Mexico must do more to develop strategies that 
facilitate exits. 
 
Need for Structural Reforms 
--------------------------- 
 
¶14. (SBU) Avila told econoffs that economic reforms that 
improve Mexico's business climate are needed to strengthen 
the PE/VC industry.  He specifically mentioned the need to 
improve rule of law and for labor and bankruptcy reform. 
 
---------------------------------------- 
The Government's Role in Promoting PE/VC 
---------------------------------------- 
 
¶15. (SBU) The Mexican government -- with the support of 
several leading Mexican government financial institutions, 
including Nafin, Bancomext, Banobras, and Focir -- 
consolidated its investment into a fund of funds to more 
efficiently disburse public investment into private 
sector-run PE/VC funds.  This "Fund of Funds" (Corporacion 
Mexicana de Inversiones, CMIC) started operating in August 
¶2006.  Contreras told econoff that Nafin now invests only 
into this fund, and that it has about $200 million committed. 
 Seven new funds have been approved for $100 million and 12 
funds, worth $1.5 billion, are being evaluated. 
 
¶16. (SBU) Obregon told econoff that the government should do 
more to develop the PE/VC industry in Mexico, but he added 
that the scope of what the government could do is somewhat 
limited.  He said that Mexico needs people who are willing 
"to go out there and pound the pavement" looking for deals -- 
something that will only happen if the person will directly 
benefit from his/her work.  In the context of fostering 
PE/VC, Obregon said that it would be useful to bring 
experienced venture capitalists to Mexico from the U.S. on a 
regular basis. 
 
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Comment 
 
MEXICO 00004451  004 OF 004 
 
 
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¶17. (U) Many Mexican officials and economists understand the 
benefits of having a vibrant PE and VC industry.  Mexico is 
an increasingly attractive market for PE investment, but 
progress on reforms is needed if this industry is to grow 
enough to translate into the desired impact on jobs and 
economic competitiveness.  In this context, the importance of 
improving Mexico's educational system cannot be understated. 
Advancements in this area are needed to give the country's 
youth the skills they need to further contribute to Mexico's 
body of research and development, take advantage of 
opportunities from NAFTA and globalization, and reduce 
widespread poverty. 
 
 
Visit Mexico City's Classified Web Site at 
http://www.state.sgov.gov/p/wha/mexicocity and the North American 
Partnership Blog at http://www.intelink.gov/communities/state/nap / 
BASSETT