"Dealing (And Dealmaking) with Mexican Grupos: a Primer for The

. as appeared in . Published by WorldTrade Executive, Inc. LATIN AMERICAN LawLaw && BusinessBusiness ReportReport Volume 14, Number 09 September 30, 2006 Dealing (and Dealmaking) With Mexican Grupos: A Primer for the Private Equity Investor By Alyssa A. Grikscheit and Javier Fierro (Goodwin Procter LLP) Private equity investors are rediscovering Mexico. panded outside of Mexico. Founded and led by the Many foreign investors active in Latin America experi- Berrondo family, Mabe produces 35% of stoves and re- enced a rocky ride in the 1990s, which led to a sharp frigerators sold in the United States under the GE and downturn in fundraising and investment. When interest Hot Point brands. The Bailleres family is the largest sil- in the region began to revive, the Goldman Sachs BRIC ver producer in the world, the Larreas family is the third report focused many investors on Brazil. But in the first largest copper producer in the world and Cemex is the six months of 2006, Mexico attracted more investment largest cement manufacturer in the United States. The than either Brazil or Argentina. Some of these recent Salinas family has already expanded its network of over transactions evidence a maturing private equity market 1,000 Elektra stores into Guatemala, Honduras, Peru and in Mexico. For example, Advent International’s May an- Panama and recently announced that Uruguay and Ar- nouncement of the acquisition of Milano, a Mexican re- gentina will be next. tail business, has been described as the first middle mar- At first view, the Grupos with their complex and ket private equity deal in Mexico to use significant le- often seemingly inefficient organizational structures verage. Much has been written on the relative merits of may seem like dinosaurs of the past. However, these investing in Mexico vis-á-vis other Latin American mar- conglomerates have endured in part because they kets, as well as on the new Mexican securities law and help their owners overcome the market failures that other attempts at legal reform to attract private equity plague Mexico and other countries with weak in- investors. But very little has been written about a struc- stitutions. Some may argue that Grupos’ survival is tural issue private equity investors are bound to encoun- short-lived and that competitive global trade will ter when investing in Mexico: the Mexican grupos inevitably cause their extinction. Although possible, economicos or simply, “Grupos”. at present these Grupos are far too numerous and Grupos are the large family conglomerates that domi- powerful to ignore when investing in Mexico. nate the economies of Mexico and many other Latin American countries. In Mexico, Grupos have impeded Why do Grupos Exist? competition, keeping near-monopolies in certain indus- Grupos solve many structural issues that exist tries. For instance, there are only two beer companies, in Mexico and other developing economies. In par- two major food processors, two television networks and ticular, the bureaucracy of many emerging market six radio chains. Some Grupos have successfully ex- governments not only leads to higher transaction costs but also breeds corruption. From the perspec- tive of an entrepreneur, the threat of corruption combined with the red tape required to establish Alyssa A. Grikscheit ([email protected]) is a and run a business may seem insurmountable. Partner in the Business Law Department of Goodwin Procter Djankov (fig 1 on page 18) shows the positive rela- LLP. Her practice focuses on private equity, mergers and tionship between corruption and the number of bu- acquisitions and general corporate law. She specializes in reaucratic procedures required to establish and run international transactions involving Latin America and Eu- a business in a number of countries around the rope. Javier Fierro is expecting his J.D. from Northwestern world, with the positions of the United States and University School of Law and his M.B.A. from the Kellogg School of Management in 2007. MEXICO Mexico being on the left and right side of the fig- when such contracts are clearly beneficial to both ure, respectively.1 parties. A Grupo solves this problem by horizontally In 2005, Transparency International ranked integrating both businesses to reduce contractual Mexico 65th out of 159 countries in perception of cor- uncertainty and eliminate the need for external en- ruption, while the United States ranked 17th.2 Ear- forcement. In addition to overcoming weak contract lier this year, the Mexican Congress passed legisla- enforcement rights, Grupos can also lower their cost tion allowing Grupo Televisa, a Mexican media and of capital. Some Grupos will own and operate banks entertainment giant, free access to digital band- and insurance companies which can then provide width while its competitors bid for the new digital scarce capital to other family businesses. Salinas spectrum. Political pundits call the new legislation, Pliego serves as CEO of Grupo Salinas and Grupo Figure 1. Positive Relationship between corruption and bureaucratic procedures Evidence: Grease or Sand? Corruption Index (1 = worst) Source: Djankov et al (2001) Ley Televisa (“Televisa law”). Elektra, two holding companies which own interests Besides corruption, firms in emerging markets in telecommunications, media and retail stores as well typically face weak enforcement mechanisms, weak as a bank, among those TV Azteca, Elektra and Banco capital markets, weak property rights and poor la- Azteca. Banco Azteca was established in 2001 primarily bor markets. Grupos can help address many of these to provide store credit to customers of Grupo Elektra, problems. For example, if contract enforcement is Mexico’s largest appliance retailer. weak, parties may be reluctant to contract, even Table 1. Garza Sadas Family of Grupos Grupo Top Executive Industry Petrochemical, refrigerated Jose Calderon Rojas, Chairman Alfa products, aluminum auto parts, and CEO telecommunications Femsa Eugenio Garza Laguera, Soft drinks, beer and convenience Honorary Life Chairman stores Vitro Federico Sada ,CEO Glass Cydsa Tomas Gonzalez Sada Chemicals, plastics, yarn CEMEX Lorenzo Zambrano Cement 2 LATIN AMERICAN LAW & BUSINESS REPORT September 30, 2006 MEXICO Understanding the Mexican Grupos Dealing (and Dealmaking) With Grupos There are three main common characteristics found As previously stated, dealing with Grupos can be a in a Mexican Grupo. First, the Grupo will typically run thorny issue, especially when trying to exit the invest- several businesses, and often these businesses will oper- ment. Some Grupos may not want to exit their invest- ate within various industries. Second, the Grupo will gen- ment because they want to pass down the business to erally be composed of more than one family, but their their offspring. Other less scrupulous Grupos may use connections run deep. And third, the organizational their political and economic muscle to shift assets to other structure is predominantly based on kinship. investments within the Grupo. On the other hand, a Grupo The Garza Sadas family from the industrial city of on an investor’s side can be a significant ally in an emerg- Monterrey, Mexico provides a great example of the deep ing market. By integrating with a Grupo, an investor will roots the Grupos have in the Mexican economy and soci- gain political power, acquire local knowledge of the coun- ety. The Garza Sadas can be traced at least as far back as try, and avoid contractual problems with other local the late 1800’s when Isaac Garza, Francisco Sada, and firms, all while avoiding expensive research costs. The Jose Murgueza joined together to strengthen their fam- question therefore arises: how to find a suitable Grupo? ily business. Along the years, the Garza Sadas have joined As with any other investment opportunity, finding a Grupo with other powerful families either through joint busi- will inevitably require the investor to do its homework. ness ventures or even through marriages. In fact, some of the top Mexican Grupos (Alfa, Femsa, Vitro, Cydsa, Due Diligence Cemex) today can be traced back to this trio of entrepre- First and foremost, the investor needs to perform a background check on the family. The investor needs to identify red flags such as young and inexperienced fam- Earnouts can be a powerful tool in ily members in key management positions within the company. In addition, the investor needs to review their dealmaking with Grupos. resumes. Are they educated professionals or are they simply in their positions because of their family name? A strong kinship bond within the Grupos sometimes dis- neurs (see Table 1). From the table below, one can also places sound business judgment and good corporate observe the magnitude of the Garza Sadas market power governance. and their diverse industry coverage. The investor should also identify the family patri- In addition to the large public firms that Monterrey arch within the Grupo. Sometimes knowing who holds families tend to operate, there are also smaller private the power within the family may not be readily appar- firms which are the preferred avenue for many Grupos ent because of the complexity of the Grupo network. from the Mexico City area. There are two main reasons Understanding the family organizational hierarchy will why Mexico City families tend to desire several, but prove invaluable when a conflict arises. The investor smaller businesses. First, the family can have majority should also verify whether the Grupo has the political

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