Private Equity: Rekindling a Latin Love Affair

Funds are again funneling money south, especially into Mexico

Five years ago, the management of privately held Casa Marzam, a Mexican pharmaceutical distributor, saw the writing on the wall. Competition had intensified with the advent of the North American Free Trade Agreement, driving many midsized companies out of business. So the family that ran Casa Marzam hired Mexican turnaround whiz Ernesto Moya to restructure the company and install professional management. Sales and profits were growing nicely by 2001, when the family asked Moya to find a buyer for the business.

Their timing couldn't have been worse. Foreign investors were chalking up big losses from the go-go '90s, when they dumped billions into Latin America only to see a string of economic crises wipe out their assets. Still, Moya knew there had to be investors keen on tapping Latin America's fastest-growing market for prescription drugs. He found one in JPMorgan Partners. Last year, the private-equity and venture-capital arm of J.P. Morgan Chase (JPM ) Co. helped Moya lead a management buyout of Casa Marzam, which has annual sales of $650 million. "There are some very good companies out there for interested investors," says Moya.

Private-equity funds -- which take stakes in privately held companies in hopes of realizing rich returns by later selling them or taking them public -- are cautiously stepping back into Latin America. In 1998, at the peak of the region's private-equity boom, investors pumped $5 billion into Latin companies, many of which subsequently failed. Last year they wagered a scant $710 million. Dallas-based Hicks, Muse, Tate & Furst Inc., which invested nearly $1.5 billion, has shuttered its Mexico City office, as has GE Private Equity, an arm of General Electric (GE ) Co. That's all the better for those that stayed, says Varel Freeman, who manages three Latin funds for Baring Americas Partners LLC in New York: "With less money chasing after the deals, one can buy very good companies."

Sobered by Argentina's debt default and Brazil's election-induced financial jitters, private-equity funds are using a different playbook this time around. Flashy dot-com, media, and telecom companies are out. Dowdy but solid manufacturing and consumer-related plays, such as food products and housing, are in. And nowadays, private-equity funds insist on taking controlling stakes so that they are guaranteed a free hand in carrying out necessary restructuring, even if that means removing dear Uncle Agustín from the payroll. Given the paucity of Latin American initial public offerings in the last five years, they know their most likely exit will be selling to a local or international investor in the same line of business. Funds are seeking returns that fall somewhere between 25% and 40%.

The biggest draw these days is Mexico. With its investment-grade rating, stable economy, and strong links to the U.S., the country is a safer bet than Brazil or Argentina. Mexico logged some $168 million in private-equity deals in 2002, and that figure is on track to double this year. Deals are usually small, averaging $5 million to $10 million apiece. "I don't see a big flood of capital going into Latin America in the short term," says Timothy C. Purcell, Latin America Group head of JPMorgan Partners. "But you will see funds going to certain markets, Mexico in particular."

Purcell himself is taking things slow. JPMorgan Partners has so far invested only $220 million of its $740 million Latin America fund. Typical was a recent deal in June in which the fund took a majority stake in Puebla-based Convermex, a maker of disposable tableware. Convermex is poised to profit as more Mexican women enter the workforce and families eat more fast-food meals.

For investors wary of venturing into Latin America on their own, local partners can provide valuable on-the-ground knowledge. Protego, an investment advisory boutique based in Mexico City, has teamed up with Discovery Capital, based in Norwalk, Conn., to raise $250 million for a Mexico fund that will invest in industrial parks, tourism complexes, housing, and office construction. "It's best to get in while valuations are still reasonable," says Protego director Carlos L. Sales. Or to put it another way: Go South. But go carefully.

By Geri Smith in Mexico City

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