Description
Investment Summary
Grupo Mexico (GMEXICOB MM) is a Mexican holding company trading at a 35 to 40% discount to net asset value. There will not be an immediate collapse of the holding company structure; however, I believe that the excessive discount offers an attractive opportunity for investors with a 6 to 12 month horizon. There are several events that should reduce the discount to a more normal 15 to 25%.
NAV Calculation
Net Asset Value Calculation
Value of PCU
Price of PCU 44.87
PCU shares held post transaction ( millions) 110
Value of PCU stake (USD millions) 4,954
Value of Asarco 0
Value of Ferromex
EBITDA 2004E (USD millions) 218
Multiple 8
Enterprise value (USD millions) 1,744
Less: net debt as of 3Q04 330
Equity value (USD millions) 1,414
GMEXICO % ownership 74%
Value of Feromex stake (USD millions) 1,046
Net debt at Holdco's as of 3Q04 (USD mill.) (254)
Net asset value 5,747
GMEXICOB shares outstanding (millions) 865
Net asset value per share 6.64
GMEXICOB stock price (converted to USD) 4.17
(Discount) Premium to NAV -37%
Southern Peru Copper (PCU) Stake- 86% of NAV
Grupo Mexico currently owns 54% of PCU or 43.4 million shares out of a total share count of 80.1 million. However, the company has entered into an agreement to sell its 99.9% stake in Grupo Minero Mexico to PCU in exchange for 67 million new shares. This will bring Grupo Mexico’s stake up to 110 million shares out of a total of 147 million shares. This transaction is likely to close within three to four months. The probability of this transaction closing is very, very high. The transaction has been criticized by some analysts as being unfair for PCU; however, it is because they have not looked at the transaction details and are predisposed to believe that Grupo Mexico acted in its best interests at the expense of minority shareholders. It is a very interesting transaction for both parties since it merges a company with an underleveraged balance sheet and a declining production profile with a leveraged company with one of the highest reserve profiles in the world. And, it is accretive from day one for PCU. The transaction was reviewed by a committee of independent directors. The directors were advised by Goldman Sachs, UBS, and a prominent mining engineering advisory firm. It was a very thorough due diligence on behalf of the independent directors. The transaction needs to be approved by 66% of shareholders. Grupo Mexico owns 54%, and the Pritzker family, whose representative sat on the committee that unanimously recommended the transaction, owns 14%. Combined, they have 68%. In addition, the representative of the Peruvian pension funds, also recommended the transaction. There are no important regulatory or antitrust issues.
Asarco – 0% of NAV
Grupo Mexico, through a wholly owned holding company called America’s Mining Corporation, owns 100% of Asarco. I have valued this business at zero. The company has a long and treacherous history of environmental liabilities. I would suggest those interested to do their own research and speak with the management. But, the summary is that Grupo Mexico, through a series of transactions, has done a good job of ring fencing this company. The ring fence has been tested in the past in court, when a few municipalities tried to sue America’s Mining and Grupo Mexico for environmental liabilities and were unable to pierce the corporate veil. Management recognizes that this is a drag on the Grupo Mexico valuation and is currently working on a plan to spin off Asarco to shareholders. I assign this project a high probability.
74% stake in Ferromex – 18% of NAV
Ferromex is a freight railroad that connects Mexico with the Western US. It is 74% owned by Grupo Mexico and 26% owned by Union Pacific. I have valued the railroad at 8x EBITDA, but I think that it is too conservative. US railroads trade at 9x EBITDA. However, US railroads are not experiencing long term growth and Mexican railroads are still in growth mode given the relatively recent privatization of the sector. Management is not likely to sell this business yet because it believes that the there is still a lot of value to realize. However, ultimately Burlington Northern would be interested in buying the stake. In the short term, the acquisition of Transportacion Ferroviaria Mexicana, an adjacent Mexican railroad, by Kansas City Southern (KSU) should highlight the value of the business. This acquisition is likely to happen soon, and should probably occur at 8-10x EBITDA.
Catalysts
Even though Grupo Mexico will not be collapsed into PCU shares any time soon, the following are some catalysts which will likely reduce the discount to NAV:
• Increased visibility of Grupo Mexico. Grupo Mexico almost went bankrupt in 2002. On the heels of the Asarco/PCU acquisition, the debt capital markets closed down to refinancing. Asarco’s environmental issues emerged. And, the price of copper collapsed. Management shifted its focus to its restructuring and away from the equity capital markets. Many analysts dropped coverage of the company. Now that everything is under control, management will be making an effort to reach out the equity community.
• Closing of the Minera Mexico/PCU merger within three months.
• Purchase of adjacent railroad, TFM, by Kansas City Southern.
• Spin off of 100% of Asarco in mid 2005. This should put to rest once and for all the environmental liability issue.
• Elimination of holding company debt. With the combined PCU and Ferromex dividends, the holding company, will be debt free within nine months. This will add 29 cents per share or 4% to the NAV.
• Other holding company discounts in Mexico, whose primary asset is another publicly traded company, trade at discounts under 20% consistently.
Hedging
The logical way to hedge Grupo Mexico is by using PCU. Every Grupo Mexico share will represent 0.128 PCU shares post transaction. One can hedge only a portion of the exposure in order to avoid being net short. However,it might make more sense to use Phelps Dodge or a combination of PCU and PD to hedge the position. PCU is not very liquid and has a pretty small float. Furthermore, after the Minera Mexico acquisition, PCU becomes the premier copper mining company in terms of size, cost advantage, and interesting low risk growth opportunities. It is likely to attract more attention from the mining analyst community than ever before and should trade at a premium to PD. Another reason not to use entirely PCU, is that in addition to its regular dividend, it will be paying a one time dividend ahead of the closing of the transaction.
Risks
• The PCU/Minera Mexico transaction does not close. This is highly unlikely.
• The Asarco spin off is delayed, and there are negative headlines concerning environmental liabilities at Asarco.
• Grupo Mexico management does not do a good job of communicating with investors and the investor base does not broaden.
• There is a short squeeze in PCU.
Catalyst
Catalysts
Even though Grupo Mexico will not be collapsed into PCU shares any time soon, the following are some catalysts which will likely reduce the discount to NAV:
• Increased visibility of Grupo Mexico. Grupo Mexico almost went bankrupt in 2002. On the heels of the Asarco/PCU acquisition, the debt capital markets closed down to refinancing. Asarco’s environmental issues emerged. And, the price of copper collapsed. Management shifted its focus to its restructuring and away from the equity capital markets. Many analysts dropped coverage of the company. Now that everything is under control, management will be making an effort to reach out the equity community.
• Closing of the Minera Mexico/PCU merger within three months.
• Purchase of adjacent railroad, TFM, by Kansas City Southern.
• Spin off of 100% of Asarco in mid 2005. This should put to rest once and for all the environmental liability issue.
• Elimination of holding company debt. With the combined PCU and Ferromex dividends, the holding company, will be debt free within nine months. This will add 29 cents per share or 4% to the NAV.
• Other holding company discounts in Mexico, whose primary asset is another publicly traded company, trade at discounts under 20% consistently.