Mexican mezzanine debt: An emerging asset class that’s driving private equity transactions

You own an operationally successful company in an emerging market, but you need money fast because you have U.S. dollar debt obligations and the exchange rate has just gone through the roof. It’s a family owned business, so you are not interested in selling equity and having an outside shareholder or, perhaps more importantly, diluting the ownership. What do you do?

Looking for mezzanine finance, basically high-yield structured debt, might be your best bet. And DEG– Deutsche Investitions- und Entwicklungsgesellschaft mbH (DEG), the German Investment and Development Corporation, might be the door to knock on.

DEG is a subsidiary of KfW Bankengruppe, the German government’s massive development bank, and is charged with investing exclusively in emerging markets and the private sector.

DEG is based in Cologne and has 13 offices around the globe covering Latin America, Africa, Asia and Eastern Europe. At the close of 2015, its portfolio was close to 9 billion euros.

OnFrontiers recently spoke with Johannes Goderbauer, a Senior Investment Manager at DEG based in Mexico City. He explained how mezzanine finance works differently in emerging markets and some of the trends in the Mexican market where DEG has a portfolio of around 350 million euros.

For starters, Goderbauer explained that using the term “mezzanine financing” in emerging markets is a bit misleading because it tends to describe a space in between equity and debt, and presupposes that there is senior debt.

“But when you go into emerging markets, very often ‘mezzanine’ is not really ‘mezzanine’ because there is no senior debt,” Goderbauer explained.

“What the market is talking about when they are talking about mezzanine in emerging markets – most of the time they are just talking about high-yield structured debt.”

As recently as 10 years ago, mezzanine finance or “high yield” financing didn’t exist in Mexico in any institutionalized form, according to Goderbauer. What did exist was family offices which would lend out money in a variety of structures.

“Mexico has a very unequal distribution of wealth and there are a lot of families with a lot of money,” said Goderbauer. “They administer this wealth and they lend. And some of them are very, very good at that.”

Things changed in Mexico for private equity in general, and mezzanine in particular, around 2008, according to Goderbauer.

“The Mexican pension funds were allowed, through a structure called ‘CKD,’ to invest in private equity infrastructure, basically long-term illiquid assets. With that they opened up a whole new source of capital for institutional investments and structures,” said Goderbauer. “The first mezzanine, or high yield CKD, was listed in 2010.”

After that, not much happened with CKDs, which are registered and publicly listed securities on the Mexican Stock Exchange, until about two years ago. Suddenly big international banks, like Credit Suisse and others, came to market with dedicated high yield/mezzanine funds.

Now, there is about $6 billion in the CKD space, and of that about $720 million is dedicated to this high yield/mezzanine structure, according to Goderbauer.

“So 12% of the whole CKD space is in the high yield arena. Most of that was raised in the last two years. It shows you that this is an emerging asset class – high yield/mezzanine structures.”

“A lot of private equity fund managers are noticing that they could do a lot more transactions if they would offer mezzanine structures. Because their potential clients don’t want to accept the dilution of their equity stake, they don’t want so much involvement by the fund managers. They just need money; and need it fast.”