Mexican might: with inflation low and the economy stable, Mexican corporates tap markets worldwide.

As the U.S. economy slowly gains ground after a slow period, Mexico is pulling itself along. Nearly 90% of its exports head to the United States, products ranging from automobiles to refrigerators to resources like oil and agricultural goods. As a result, the Mexican economy has grown solidly as the U.S. recovers. Interest rates in Mexico have fallen by 52% in the four years since 2000.

Good behavior pays. In January, U.S. risk ratings agency Moody's raised the country's foreign-currency debt rating, which was already investment-grade. Moody's cited Mexico's performance on foreign debt, which makes the country less vulnerable to swings in the global economy. Monetary policy also kept inflation under control.

For Mexican companies seeking financing, stability means better terms, whether they seek stocks, bonds or loans. Lower interest rates normally prompt lenders to give companies longer maturities on the debt they issue. With things finally going well--if not red-hot like some in the region, particularly commodity-rich South American economies selling to Asia--Mexico, Inc. will enjoy better reception in domestic and international bond markets if balance sheets stay healthy.

"I see the Mexican markets as strongly active to lower inflation, which we perceive to be more permanent," says Benito Soils, general director for Moody's in Mexico. "With the sovereign, what we have seen is that there is not that close of a relation that we have seen before." Poor sovereign ratings can hurt a private company's chances of getting international financing on attractive terms.

Risk-ratings agency Standard & Poor's considers Mexico's recovery to be stable, even improving, says Eduardo Uribe, managing director for corporate and infrastructure ratings for Latin America for the agency. "That's because manufacturing is growing and people are sending more to the United States markets; interest rates are lower, which means lower borrowing costs, and commodity prices are better, like mining and steel."

For some Mexican companies, lending terms in the domestic bond market are just not good enough to keep them in the country. "The problem has to do with duration and maturity," says Octavio Ornelas, managing director of finance and treasury at Petroleos Mexicanos (Pemex), Mexico's state-owned oil company. As a government-run entity, Pemex cannot sell stocks on the exchange, just bonds. It used to sell bonds only abroad but in 2003 began selling short-term debt in the Mexican market, normally in instruments in US$45 million increments. For a company that expects to spend $130 billion over the next decade, that's not enough, so it's back to the international markets.

The petroleum giant believes that a healthy Mexican economy and high, stable oil prices are good news for both Pemex and Mexico. The markets agree. The company sold $1.75 billion in dollar-denominated perpetual bonds, largely to Asian and European investors, in September 2004. Perpetual bonds are non-redeemable, which means they do not have a maturity date but pay interest to the holder forever--truly long term. And the company is not stopping there.

"We have a lot of options, the dollar, the euro ... Asia will be very eager to have another transaction," says Ornelas. "My guess is that the only market we haven't tapped is the yen market. We're analyzing that." By 2005, the company expects to get half of its financing in international markets and half in Mexico.

Pemex needs the money. Its capital expenditures (capex) were $6.90 billion in 2001. By 2004, it was up to $12 billion, of which $11.10 billion went to exploration and production. Of those billions, 86% alone was spent on drilling and building, a very capital-intensive part of any global oil business. In 2005, Pemex will need to spend another $11.20 billion, again focusing on developing supplies. The company needs to steadily increase its output production of crude oil and natural gas to feed a power-hungry Mexican economy.

"The important thing is that Pemex has been changing in a very important and dramatic way [how] we are financing our capex program," says Ornelas. Only three years ago, the company financed the entirety of its investments using foreign financing. In 2005, it will finance 50% abroad and 50% in Mexico.

Dollar-denominated revenue tends to make it easier for Latin American companies to issue debt in greenbacks. It's natural for companies to match their liabilities with their revenue: A company earning dollars over the long term should try to sell debt in dollars over the long term. Since Pemex sells oil abroad, a lot of which goes to the United States, revenues are denominated in dollars. That's also the case for ICA, a Mexican construction company that builds across Mexico and the United States. ICA is heading up a consortium of companies that will build a $750 million power generator for Comision Federal de Electricidad (CFE), Mexico's state-run power company. The consortium borrowed $450 million from international banks and sold a bond in the United States for $230 million, says Jose Luis Guerrero Alvarez, executive vice president and chief financial officer of ICA. Once built, the CFE will pay the consortium back.

"In Mexico, I don't know if they fully understand how to finance projects of this character, especially when construction is involved," Guerrero says. "It shows that a construction company can seek financing in the international capital markets."

Free trade is forcing emerging markets and their political leaders to do a better job, Guerrero says. "The government and the corporate sector of a country that is open to international business are obligated to be more efficient and more productive," he says. "International competition is stronger. The only thing that protectionism does is make things more expensive and less efficient."

Hot stocks. Bonds haven't been the only tools for financing in Mexico. Stocks have been hot, too. In fact, earlier this year, the Mexican benchmark stock index, the IPC, came within one percentage point of its all-time high. Why such demand? Look to Chile and Poland for the answer. Chile and Poland are two emerging-market countries that allow their private pension funds to invest in equities. That's a wise move. Chilean equity markets over the last five years have traded at a 31% premium over the rest of Latin America in terms of price-earnings multiples, while Polish stocks have carried a 49% premium over Central and Eastern European and African markets, according to U.S. financial institution Citigroup. During that time, Mexico has traded at an 8% premium.

High premiums in Chile and Poland are partially due to healthy debt structures but also because deep-pocketed pension funds are injecting liquidity into their respective stock markets. In January, Mexico's private pension-funds managers, known as Afores, got the green light to invest in stocks in both Mexico and 16 overseas markets. The funds have grown to more than $40 billion since their inception in 1998. But new rules give the 15 pension funds the power to free up a small percentage of their total assets, equal to $5 billion, to purchase equities. Considering that the funds grow by $6 billion a year, even more money could find its way into stocks.

In the short term, Mexican pension funds will not invest heavily in their own domestic equities market. Share prices soared in 2004 and are unlikely to rise much higher for now. In May 2004, it was announced that Afores could tap equity markets; the stock market climbed 30% by year end after. "The market has gone up enormously in anticipation of these funds coming into the market," says Geoffrey Dennis, managing director for Latin American equity research at Citigroup.

Share prices must correct before they become good buys again, says Dennis. High-priced stocks will likely be a tough sell, especially since interest rates began to climb by the end of 2004. Furthermore, pension funds are accustomed to buying only fixed-income instruments, many of which will become even more attractive as interest rates rise. The funds will need time, too, to hire staff and make contacts in the stock exchange.

In the long term, Dennis says, having pension funds investing in equity will curb volatility in the market. That could make equity financing for companies more attractive. Pension funds will likely snap up undervalued shares first, a practice known as bottom fishing. That should keep stock prices from falling too hard. Secondly, pension funds will inject more liquidity into the Mexican stock market. "Over time, Mexico's premium will go up in the general direction of Chile," Dennis says. "You cannot overplay the long-term impact."

While regulators gave the Afores permission to invest in 16 stock markets around the world, none of those bourses were in Latin America. But that doesn't mean they can't invest in Latin American stocks. They can do so easily enough from Spain, where the Latibex exchange in Madrid lets Latin American companies list equity denominated in euros.

Such an exchange gives investors the chance to invest in Latin American companies without dealing with exchange-rate risks and costs associated with buying directly into Latin American markets. The euro-denominated exchange also gives companies an alternative to trading in dollars on U.S. markets, which have long been the choice for Latin American companies seeking international financing. There are 34 Latin American companies listed on the Latibex, 15 of which make up the Latibex Top Index. Of those, four are Mexican: America Movil, Telmex, Modelo and Alfa. The remaining are Brazilian and Chilean companies, which are now investment opportunities for Afores.

Picking up. Other Mexican companies have listed on this six-year-old exchange, like Grupo Elektra, a Mexican retailer. "For us, the Latibex market is very important because it's an alternative to New York. That's why we listed," says Rolando Villareal, director of investor relations at Elektra. "The response has been fabulous." The Latibex is rather quiet for now because liquidity is low compared with other investment alternatives. But trading volume should pick up, says Villareal.

The Latibex is a relatively young market and liquidity should grow. Low liquidity levels for short periods are fine for a company like Elektra, which has lots of cash to spend on assets that will make it grow.

Elektra might consider an aggressive growth strategy, one that would be financed by bonds. But Elektra's cash flow is very strong, Villareal says. When a client enters an Elektra store and decides to buy on credit, he's usually going to buy through Elektra's in-house bank, Banco Azteca. The price one pays for a new television set goes straight to Elektra in cash. "We are growing on our own cash," Villareal says.

Other companies are doing well on their own, too. Cemex, a Mexican cement maker, bought U.K. concrete company RMC Group for $5.80 billion. It sold U.S. assets to finance the purchase. "Cemex is doing great with its acquisition and loan refinancing," says Howard Kleinman at U.S. corporate law firm White & Case in New Yorks. That's good news, even considering that the Mexican and U.S. economies are not growing as strongly as others in the region. But Kleinman says he feels good about Latin America and about Mexico in particular. "We are seeing a situation where you speak to everybody in the area and people are optimistic," he says.

With pension funds entering the scene, the number of initial public offerings should rise in Mexico, says Nikolaj Lippmann, a senior portfolio manager at Bankinvest, a Danish fund that invests in Latin America. Companies have been gearing up to take advantage of the increased activity on the Mexican stock exchange. "We have seen a number of companies take their shares away from New York and move them down to Mexico," Lippmann says. "You will see pension funds being much more active."

Over the long term, better financing terms for the region is what development is all about. "First we get a developed local market with local savings and pension funds, and then we expand it, and then we integrate that into the rest of the world, and then suddenly I'll lose my job because being a Latin expert is no longer as necessary as it was in the past," he says. "Investors will make a lot of money in that process."

GUSHER

Mexican state oil company Pemex's financing in 2004.

                In US$ billions

international   64%        domestic      36%

bonds            4.3       bonds          2.4
ECAs             0.6       bank loans     0.4
bank loans       0.03

total            7.7

SOURCE: Pemex

ECA = export credit agency financing

Note: Table made from bar graph.

FORREST JONES--MADRID