M&A in Mexico has been fairly subdued in 2018, perhaps in part due to uncertainty created by drawn-out negotiations on trade policy with the US and Canada. Deal activity began to slow down in 2016 at a time when campaign rhetoric from then-candidate Donald Trump targeted America's trade deficit with Mexico. Rhetoric turned to action when President Trump sought to revise the North American Free Trade Agreement (NAFTA), starting in the first year of his administration.
Despite the closing of a number of high-level M&A deals during 2018, 44 transactions were reported during the first three quarters, compared with 57 deals during the same period in 2017. Value was also hit, falling to US$2.33 billion in the first three quarters of 2018, from US$6.26 billion over the same period in 2017 (because many deals are not reported or publicized in Mexico, the actual value of M&A transactions may be larger than the available data shows, but the up or down trajectory of the figures is likely to be reliable). The larger portion of foreign investment during this period continues to come from US investors, followed by investors in Spain and Chile.
Uncertainty surrounding the future of NAFTA has been a significant deterrent for investors. But by the end of August, Mexico's sitting president, Enrique Peña Nieto, had agreed to new trade terms with the US, weeks before Canada also confirmed its participation in the US-Mexico-Canada Agreement, or USMCA (which some have called “NAFTA 2.0”). The Agreement will be enacted if the legislatures in Mexico, the US and Canada vote to approve it.
The new deal
The provisional agreement is welcome news for investors, first because it puts an end to more than a year of uncertainty. JP Morgan initially said it expected the more predictable outlook to increase GDP growth by half a point to 2.4% in 2019. Positively for Mexico, USMCA is also widely seen as a continuation of the existing regime, albeit with some US-friendly tweaks.
One of the most prominent protectionist changes is the tightening of rules in the automotive industry. Specifically, 75% of car parts must be made in the region, up from the current 62.5% threshold, to qualify for tariff-free trade. This is a boon for auto manufacturing throughout the region. But a second stipulation requires that between 40% and 45% of a vehicle be made by workers earning at least US$16 an hour, a measure that is expected to benefit Mexican workers but weaken their employers' longstanding competitive advantage of low labor costs—although by some estimations, as much as two-thirds of Mexican auto exports already meet the rules.
Meanwhile, Mexican pharmaceutical companies are due to have their patent protections doubled from 5 to 10 years under USMCA, and will benefit from an expanded scope of products eligible for protection. In principle, these measures should increase investor appetite for pharma deals. While private equity typically likes to invest in so-called generics manufacturers to capitalize on the market disruption caused by the expiration of big pharma's patents, incumbent pharmaceutical businesses may choose to seek deals to bring down their high R&D costs in light of extensions to their monopolies over drug portfolios.
USMCA does not provide Mexico or Canada with protections from Section 232 tariffs, a trade loophole that Trump has used to impose steel and aluminium tariffs on both countries, and on the European Union. However, a side agreement does protect Mexico and Canada in the trilateral accord from possible auto tariffs under 232.
And while USMCA is subject to a review every six years, the agreement is broadly seen as a positive outcome for Mexico, given the severity of Trump's prior rhetoric and contrasted with ongoing trade tensions between the US and China.
The new guard
The incoming Mexican government headed by president-elect Andrés Manuel López Obrador showed its full support for the pact, with his team actively participating in the negotiations during the transition period (in spite of the obvious concession on wages in the auto sector), mostly due to the stability the agreement affords the country.
One of López Obrador’s mandates when he takes office in December is to unlock economic growth in Mexico's export-oriented economy, where output has hovered around 2% a year for more than two decades. He expects to achieve this by cracking down on corruption rather than raising taxes and public debt.
Estimating the exact effects of the incoming government on business, the wider economy and inbound M&A is difficult at this stage.
Most recently, López Obrador announced he will cancel construction of a US$13 billion airport in Mexico City, prompted by a 70% vote against the airport in a national consultation in which less than 1% of the population eligible to vote participated. The airport, already more than one-third completed, would have been one of the country's largest infrastructure projects in Mexico in recent years. The move caused JP Morgan to revise its previously optimistic economic forecast down to 1.9%. The peso has also now lost all gains made since López Obrador was elected in July, and continues to suffer as a result of announcements made by the Congress of potentially revising fees charged by Mexican banks.
Moreover, it has been reported that López Obrador plans to suspend the auctioning of unleased oil blocks in the Gulf of Mexico for at least two years. He may also review for evidence of corruption the more than 100 contracts already awarded to international companies over the last three years under the energy reforms enacted by President Nieto, who remains in office until December 1. However, López Obrador has sought the advice of well-known businessmen and has announced that he will be close to the business community, in an effort to show that his administration will be more business-friendly than some would expect.
The US midterms
While USMCA offers a reason to be optimistic about Mexico's M&A market in 2019, it has yet to be approved by the governments of all involved in the trilateral pact. There is little reason to believe that Canada and Mexico will not vote the deal through; however, a large question mark hangs over the US. The midterm elections on November 6 resulted in a Democrat-controlled House of Representatives, despite Republicans maintaining control of the Senate. A shift in the balance of power has the potential to block Trump's plans, including USMCA.
If passed, USMCA will give investors enough certainty to support a recovery in Mexican M&A activity in 2019, and could serve as a driver for opportunity in certain industries overlooked in past years, such as agroindustry or logistics.