Mexico Energy Reform

Excerpt from WorldTrade Executive's
North American Free Trade & Investment Report
By Jorge Jiménez (López Velarde, Heftye y Soria)

On April 8 Mexico’s President Felipe Calderón submitted to the Mexican Senate a long-expected set of bills for the so-called “energy reform.” After testing the waters with the public and the media for several weeks with a campaign promoting strategic alliances for deepwater exploration and production, the Government decided for a rather moderate reform for the Mexican petroleum industry.

Instead of opting between a liberalization of the market and the strengthening of Pemex as a national oil company, the proposed reform seeks to obtain the best of both worlds: it opens up certain midstream and downstream activities to private investment, and provides Pemex with the flexibility and the tools to boost its infrastructure projects dealing with exploration and production. The reform leaves the Constitutional principles of ownership of the hydrocarbons and the prohibition of granting concessions and executing risk contracts untouched, with which it increases the spread of support along the ideological spectrum in Mexico. However, the reform also proposes to allow Pemex to enter into “performance-based” contracts, something that to this date has not been possible.

The reform contains these features:

• Contractual flexibility for Pemex to contract services outside of the currently burdensome and in many cases impractical framework of the government procurement laws.

• Adjusting Pemex to international corporate governance standards, by incorporating independent directors to its Board and providing the Board true management autonomy, as opposed to the status quo where Pemex plans are determined by the Ministry of Finance quasi-exclusively on the basis of short-term tax collection maximization and revenue production considerations.

• Liberalization of the transportation, distribution and storage of liquids and petrochemicals, subjecting such activities to the jurisdiction of the Energy Regulatory Commission.

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Venture Equity in Mexico 2007; Projections 2008

By Venture Equity Latin America
Published by WorldTrade Executive, Inc.

Venture Equity Latin America's Year End Report for 2007 shows $717M invested in Mexico via 17 acquisitions in 2007. Areas attracting large investments in Mexico in 2007 included the transportation, finance services, and production sectors, where investments focused on steel production and chemical and industrial manufacturing. Of note was the increase in larger investments in Mexico during the second half of 2007, which provided a strong end to the year and continued growth from the prior year's activity. Investments in Mexico increased considerably from 2006 levels, rising from $388 million to $717 million.

Of the 17 investment deals over the course of 2007, Advent International and Nexxus Capital accounted for much of the activity and Nexxus' deals were focused on consumer financing and healthcare. Advent made three diverse investments in Mexico, two of which were for undisclosed amounts but one was for $317 million for Grupo Gayosso, Mexico's largest funeral services company and this was the largest disclosed amount for a Mexican deal in 2007.

Over the course of 2007, it became apparent that interest in Mexican transportation was once again on the rise in private equity circles. The interest was been spurred in part by the fact that Mexico- often overshadowed by developments in Brazil - now enjoys a decent economic state and a growing middle class. Although, this has not dispelled concerns about the future of Mexico's markets and doubts do remain. "We need an evolution in the market and the country," said Gómez Pimienta, president of the Mexico Fund, a $1 billion closed-end mutual fund based in Washington. "The lack of IPOs is leaving us with a limited menu." Looking ahead to investment activity in Mexico for 2008, the effects of the 2008 Mexican tax reform could be pivotal as the new rules are in effect from January 1, 2008. This is one area that will need to be monitored as 2008 progresses to see if the new tax rules negatively impact the size and number of investments from foreign investors, mainly investors from Canada and the United States.

The biggest change ushered in by the new tax reform regulations is the introduction of a 'flat tax' and this tax could influence investments in Mexico as it could mean greater tax burdens for some investors, while increasing the required amount of paperwork and record keeping time that other investors must devote to each deal so that they are in line with the new requirements. It is also to be seen over the span of 2008 whether this new tax will deter potential investors abroad from making investments in Mexico due to the additional financial and regulatory burdens imposed by this tax. Given the state of the US economy at the end of 2007 and the weakness of the dollar overseas, it is not clear yet if this new flat tax might create additional unwanted strain on US companies looking to invest in Mexico.

Two of the largest investment sectors to be impacted by this new tax could be the real estate sector and the mining and natural resources sector as these are main areas of investment for Canadian and US investors and multinationals during business in Mexico. For more details on Venture Equity in 2007 in Latin America, see the VELA Year-End Report,

Venture Equity Latin America’s 2007 Year-End Report Announced

Fund raising and private equity investment in Latin America set new records in 2007, according to the just released Venture Equity Latin America’s 2007 Year-End Report.

Fundraising for the region reached a total of $4.4 billion in 2007, showing the ongoing confidence that investors have in the region. The report documents deals of $7.4 billion, and exits worth $5.4 billion.

In many sectors including fuel production, real estate and energy, private equity investments were on the rise, but it was the fuel production and distribution sector, which dominated and had the biggest investments, mainly due to the global demand for fuel.

One growing trend in the region has been investments in sugar and ethanol and also the construction of ethanol mills. Much of this activity was in Brazil as sugar-cane based ethanol production and related projects had investment totals of around $1.435 billion.

In total Brazil had private equity investments of $5.1 billion in 2007 as compared to $1.3 billion in 2006.

Areas attracting large investments in Mexico during the year included the transportation, finance services and productions sectors, where investments focused on steel production and chemical and industrial manufacturing. Investments in Mexico increased from $388 million in 2006 to $717 million in 2007.

By the end of 2007, there had been 29 fund closings with much of the fundraising activities centered in Brazil, Argentina, Colombia and Mexico.

The report details which fund managers have successfully raised new capital and provides details on deals and exits. More

Bio-fuels in Mexico: Opportunities Increase With New Legislation

Excerpt from WorldTrade Executive's
Latin American Law & Business Report
By Jorge Jiménez (López Velarde, Heftye y Soria)

Mexico has finally enacted and published its new Law for the Promotion and Development of Bio-fuels (Ley de Promoción y Desarrollo de los Bioenergéticos), which is expected to foster the production in Mexico of various types of bio-fuels, and the development of the necessary infrastructure to create a market for its widespread marketing and consumption, including transportation, storage and distribution facilities and systems. The new statute was published in Mexico’s Federal Register (Diario Oficial de la Federación) on February 1, 2008, to become effective immediately. Final enactment came after months of delays from its first approval by the Mexican Congress, following a veto from President Felipe Calderon in 2007, and after the bill was initially passed in 2006. Several of the Executive’s objections were introduced to the bill prior to its final approval.

With this new legislation, Mexico is hoping to see an increase in projects such as some of the pilot infrastructure operations so far developed in Mexico, as is the case, for example, of the Nuevo Leon Bioenergy project in Monterrey, with a 7MW power plant producing from the city’s landfill.

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Venture Equity in Latin America: Impact of US Credit Crisis

Venture Equity Latin America (VELA) recently discussed and listened to presentations on the impact of the US market and credit crisis with a number of key executives involved in Latin America PE/VE at a conference, and most agreed that U.S. economic weakness won’t have a major impact on venture equity in Latin America.
“I’m optimistic” about Latin American venture equity, said Juan Carlos Torres, senior partner at Advent International, a major private equity firm in the region. “I’ve been through so many Latin American crises that this is nothing.”
Steven Puig, vice president of private sector operations for the Inter-American Development Bank said he is “optimistic” about the Latin American economy for the same reason. “We’ve likely seen worse homegrown crises in the past and absorbed those. Dealing with an external crisis is something that could be more manageable.”
Most financial institutions are still liquid and with the level of venture equity funds raised for Latin America so low, there’s plenty of room on the upside, Torres said. While private equity funds raised $60 billion to invest in Asia over the last three years, they took in only $7.6 billion for Latin America.
“Many financial institutions are looking for other markets than Asia, so there is a lot more focus on Latin America,” Torres said. “We had more visits from financial institutions in the last year than in the previous 11,” he said.
There are several good reasons for venture equity investors to choose Latin America over Asia, said Bernard McGuire, director of private equity for the Overseas Private Investment Corp. (OPIC).
One he specified is that it’s easier to put a hedge on a Latin American investment than one in Asia. For example, in Latin America, investors can buy convertible notes, while in India and China they can’t, McGuire said.
Advent certainly isn’t having trouble telling investors the Latin America story. The firm was able to draw $1.3 billion in three months last year for its latest fund, which was heavily oversubscribed, Torres said. That fund drew about 60 percent of its investors from U.S. financial institutions and the rest from Europe and the Mideast.
Advent has seen strong demand from sovereign wealth funds in Asia and the Mideast, Torres told VELA. “About 20 percent of our investors came from there over the last year or two, and I think that will keep growing.”
He said Advent likes to choose its deals by sector. “The advantage of that is you get scale, accumulate knowledge and, most importantly, learn from your mistakes,” he said.
For example, Advent has closed 11 deals in the airport sector during its 12 years in Latin America, Torres said. Those deals covered retail shops in airports, food and beverage operations and airport concessions.
In exiting those investments Advent earned a return ranging from 82 percent for the food and beverage deals to 968 percent for the retail deals.
Other sectors in which Advent is active include financial services and retail, Torres told VELA. And the firm is looking at the energy industry. Why? “It’s a key sector in Latin America that is still fragmented,” he said. “It’s not controlled by large multinationals, so there are opportunities for consolidation.”

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Taxation of Management Fees in Latin America

Latin American subsidiaries of US companies are caught in a bind. Parent companies in the US are being required by transfer pricing rules to charge foreign subs for services, but Latin American tax authorities often don't accept the service fees as deductible business expenses.

A recent article in Practical Latin American Tax Strategies, published by WorldTrade Executive reviews the tax deduction for management services in the major countries and provides some suggestions for ways to meet the deductibility tests. The article was prepared by some of the members of the Latin Tax practice at PricewaterhouseCoopers.

For example, for Brazil the authors note the following:

Expenses recognized by a Brazilian entity are deductible for tax computation purposes if:
1. actually incurred;
2. ordinary and necessary to conduct the business activities of the company; and
3. properly and adequately documented.

In the context of service fees, expenses will only be considered as actually incurred when the services (and related benefits) have been in fact received by the Brazilian Affiliate. In prior decisions, the Brazilian tax authorities and local courts have repeatedly ruled against the deductibility of expenses deriving from intercompany service agreements (particularly those related to cost sharing agreements) due to the lack of proof that the services and related benefits had actually been received by the Brazilian entity. It is indisputable from these cases that the mere documentation that the services were contracted, assumed and paid was not considered as sufficient proof.

Moreover, it should be noted that sufficient documentation is essential to substantiate any claims that the expenses are ordinary and necessary for the maintenance of the company’s activities and source of income, especially in the case of international intercompany service agreements.

For deductibility purposes, the Brazilian Affiliate will have to prove that it actually received an identifiable benefit from each of the charged services listed in the corresponding agreements. In this regard, Brazilian tax authorities may question expenses related to services provided to all beneficiaries of the group (such as the “Allocated Services”), if such expenses only result in benefits for certain Affiliates and do not clearly include the Brazilian Affiliate. That service fees paid to related companies abroad are often subject to special scrutiny by the tax authorities.

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Venture Equity Latin America Developments

As reported in the most recent issue of Venture Equity Latin America published by WorldTrade Executive.

Brazil's Bracor Raises
New Funds with Global
Consortium

Brazilian real estate company Bracor Investimentos Imobiliarios, Ltda.
(Bracor) has raised BRL375 million (roughly US$213.5 million) in new
funds from equity pay-ins from a number of significant institutional real
estate investor groups, according to local investors. Bracor, which is 47%
owned by Sam Zell’s private equity-backed Equity International, has
invited Abu Dhabi-based Royal Group, Saudi Arabia’s Olayan Group,
Morgan Stanley Real Estate, and Berkley Corporation for the funds. Bracor
was founded in 2006 with a US$15 million commitment and invests in
commercial real estate. Carlos Betancourt, a Brazilian, is the other chief
partner in the investment


Bracor is a privately held company headquartered in
São Paulo, Brazil. The company was founded in 2006
by Carlos Betancourt, Equity International, a leading
Brazilian bank, and a leading U.S. real estate finance
company. In terms of its real estate, Bracor is focused
on the acquisition, development and management of
institutional-quality corporate properties throughout
Brazil. These are in turn often leased under long-term
contracts to companies with investment-grade credit.
A historical lack of permanent debt and equity
capital in Brazil has created a market characterized
by a significant supply of institutional-quality real
estate occupied and owned by an array of strong
multinational and Brazilian corporations. Bracor’s
standard approach has been to build a scalable business
and capitalize on still-immature emerging markets
that is trending in four specific areas: the emergence
of permanent debt and equity capital; increasing
monetization of corporate-owned real estate; growing
corporate demand for institutional-quality properties;
and strengthening of lease contracts and a broadening
securitization market.

To Bracor’s advantage, all of these factors are present
in the red-hot Brazilian real estate market. Indeed, in
its own words, there is throughout urban Brazil an
“unmatched pipeline of opportunities”.
Bracor acquires and develops corporate properties,
primarily single-tenant office and industrial assets, and
leases then to high-credit quality corporations like IBM,
Nestlé and Comsat,

Washington State Investment Board Invests
in Latin America Private Equity Funds
The Washington State Investment Board, which has roughly US$63.9
billion in assets under management, last month approved commitments
of up to US$1.5 billion to four private equity funds focusing on buyouts
in the U.S., Europe and Latin America. The system is committing up to
US$700 million to the KKR European Fund III, a large-cap, pan-European
buyout fund with a target size of US$8.8 billion to US$11.7 billion; another
US$750 million to the US$12 billion Warburg Pincus Private Equity X fund;
up to US$25 million to the US$1.3 billion Advent Latin American Private
Equity Fund IV, which invests primarily in Mexico, Brazil and Argentina;
and up to US$50 million to the Avenue Special Situations Fund V, a targeted
US$6 billion distressed debt fund.

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