Mexico? Maybe. - Investment Outlook - June 2002
Tapping the potential of Mexico’s hotel industry requires more patience and capital than appetite for risk.
By Staff -- HOTELS Magazine, 6/1/2002
There are few gold mines left in Mexico’s maturing hotel industry. Although hotel analysts and consultants contend that the United States’ southern neighbor has more potential than any other Latin American nation, they are not talking about the 30%-40% ROI potential dot.coms once promised. The rewards for trekking the long and complex road through hotel development in Mexico are more likely to be the standard 15%-20% ROI and a chance to carve out a niche in a market of nearly 100 million people.
These returns reflect the fact that Mexico is growing up. Its story is all in the numbers: inflation under 4.5% annually, the lowest point in 10 years, interest rates a little over 5% and renewed interest from international investors, including Citigroup, which recently acquired Banamex for US$13 billion. UK, Spanish and Dutch banking groups have followed suit. Standard & Poor’s investment grade rating of Mexico’s sovereign debt is just one more testament to perceived economic stability. But “perception” is the key. Like other Latin American countries, Mexico has the stigma and promise of “what if.”
Plan of Attack
Then safest, most direct route to tapping Mexico’s latest round of potential will be via limited-service concepts in secondary cities. Mexico City’s powerful Grupo Posadas has already proven how successful this approach can be. Benefitting from the insider’s track open to a domestic company, Grupo Posadas used a brand family anchored by its mid-tier Fiesta Inn to become Mexico’s dominant hotel company with 67 hotels open. Gastón Azcárraga, chairman and CEO of Grupo Posadas, sees mid-market hotel opportunities expanding to keep pace with demand in Mexico’s growing middle class. “Formerly, Mexico’s middle class grew when times were good and nearly disappeared when times were bad,” he says. “Now, this is a market of 50- to 60-million people with real purchasing power. If it does not continue to grow at this pace, it will at least remain stable.”
Of the 30 hotels Grupo Posadas hopes to open each year, one or two projects will be in its casual luxury Fiesta Americana brand; a few additions may be made to the eco-luxury Explorean brand; and several more to its Brazilian “Caesar Business” operations. But the majority of new properties will be core Fiesta Inns.
| The Upside
A better investment climate. Like Mexico’s President Vicente Fox, FONATUR’s executive team comes primarily from the business world. “They know how to bring in investment,” says investment advisor Felipe Espinoza. It also helps that the government is spending US$7.9 billion on new highways that should benefit many in the hotel industry.
Economic stability. “Fifteen years ago, if anyone would have said Mexico’s inflation would be at 4% and interest rates at 5%, people would have laughed. But that is the situation,” says Posada’s Gastón Azcárraga. How long it will last is the question. Pointing to Mexico’s performance in recent years, most contend that a slow down is a more realistic threat than a currency collapse or return to high inflation.
Population. A middle class of 60 million people is enticement enough for mid-tier chains. Although the middle class has tended to expand and contract (some would say disappear) in answer to Mexico’s economic swings, Azcárraga, Hilton’s Nelson Diaz and industry experts see enough fundamental strength in the domestic economy to support if not expand this massive consumer base.
NAFTA. Approved by the United States, Canada and Mexico in 1993, the North American Free Trade Agreement (NAFTA) continues to drive cross-border business opportunities. It is one reason for aggressive hotel development in key cities along Mexico’s northern border and should continue to draw business travel from the United States. “NAFTA will take Mexico to a different level over the next 20 to 30 years, with a more mature economic policy and fewer of the kinds of experiments that got this country into trouble previously,” says Azcárraga. Some companies already saw the downside when borderline factors cut back or closed in the fourth quarter of 2001.
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| The Downside
Access to capital. Most international companies will have rely on local partners to access the insider’s track to financing. And, even then, it will take a lot of proof before Mexico’s banks take on any more hotel projects.
Ownership rights. Mexico’s real estate laws generally make owners wary of “tenants” with pure management contracts. It is much harder for outsiders to make deals, so expect to commit to a 50-50 position, if not full ownership, to keep your brand in the market long term. Companies looking for management contracts should get everything spelled out in writing, including delicate issues such as access to bank accounts earmarked for daily operating expenses. Marriott’s Nick Ward sees a new generation of owners emerging, like the owners of the Ritz-Carlton Cancun. “The company is very sophisticated. It owns other hotels and other real estate. The new breed of owners has traveled, knows the market and is very supportive of the requirements to maintain a luxury property,” he says.
Legal redress. Disputes are not only long, but, as in many countries, are difficult to resolve. This applies to situations in which hotels are rebranded during the construction process as well as to the outcome of partnership deals. It also refers to franchise deals. While fast food franchising has made Mexican investors and lenders franchise friendly, it has also promulgated a flurry of copycat concepts. Make sure every aspect of the market and its marks are protected. Issues of property titles, insurance and liabilities should be spelled out in detail.
Time frame. Development takes too long. In a broader sense, sources say time determines potential. It will take time for the new president to get his proposed economic programs in full swing and, although they should have short-term benefits, their real potential is probably years away.
Oversupply. Growth, not planning, was the mantra that drove sprawling resort communities such as Cancun. It remains a risk in some cities that need to expand for fiscal or political reasons. Larger cities, like Mexico City, are in less danger of near-term oversupply. According to Francisco Ruiz, director general of strategic planning and tourism development, the stringent feasibility studies and market analyses required to get a project done in the capital naturally prevent saturation.
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If Azcárraga has geographic targets, he does not discuss them. He insists the only way to approach Mexico’s opportunities is on a case-by-case basis. “We like urban hotels better than resorts because we have more competitive advantages,” says Azcárraga, son of the company’s founder. “We are better able to defend ourselves. Mid- size cities and secondary locations in big cities are targets. But any company that wants to grow here has to examine different alternatives for each opportunity.” A recent example was development of a down-sized Fiesta Inn to create workable numbers for small markets.
Grupo Posadas’ brands will have competition enough from Six Continents, NH Hoteles, Sol Meliá, Accor, Starwood Hotels & Resorts, Marriott International and Hilton Hotels Corp., which sub-leased the Hilton name from UK-based Hilton International. Mexican companies looking to grow include Monterrey’s Optima Express hotels on the limited-service end and Brisas Hotels & Resorts, Mexico City, on the luxury side.
Each has a different read on the opportunities. Hilton’s current focus is to bring Hilton Garden Inn to “the markets within markets” in Mexico City and secondary cities. After seeing many franchisors stymied by overly aggressive expansion plans and unsteady partnerships, Hilton is targeting just six to seven franchise deals this year. “We have to crawl before we can walk. The focus has to be on expanding in the right locations,” says Nelson Diaz, Hilton’s Memphis-based vice president, franchise, Mexico and Latin America.
Hilton says it is willing to wait out detailed due diligence and relationship building to find solid partners willing to do multiple deals, according to Bill Fortier, Hilton’s senior vice president, franchise development. Other goals include taking Embassy Suites into city and leisure locations, and working with Mexico’s Grupo Angelis to maximize its purchase of Camino Real.
Given unequally applied economic pressure, there may be more deals to do. “Regional brands have bigger representation than the international flags in some areas, but the days of the regional brands are drawing to a close,” says Diaz. “Some were hit very hard by last year’s economic shifts.” Whether that translates into portfolio deals depends on the depth of the owners’ pockets and the patience of their lenders.
While agreeing there is clear potential for mid-tier hotels in secondary markets, Nick Ward, senior vice president, development, Latin America and Caribbean for Marriott International, also sees upmarket opportunities in strategic destinations. Marriott’s near-term focus is on expanding its resort presence with the completion of a Ritz-Carlton in Los Cabos and negotiating for full-service Marriott and/or Renaissance resorts in the area. “We could also add a Renaissance—maybe through conversion—in Cancun, which is a broad, deep market,” he says. Market trends show opportunities for Marriott or Renaissance in the northern commercial centers such as Guadalajara and Monterrey, where a Courtyard by Marriott at the airport has done well. This cluster effect would support synergies and reinforce cross-brand strength for Marriott’s flags.
Felipe Espinoza, managing director of his own investment consulting firm, based in Mexico City, calls the luxury market “particularly attractive.” He compares Mexico’s resorts to Levis: attractive, easy, comfortable. Everybody likes them. But, now, he says “the Armanis” are coming to Mexico: Rosewood, Four Seasons, Orient-Express,” says Espinoza. His analysis also identifies opportunities for golf resorts.
Bolder players might aim for luxury conversions in crowded markets like Cancun or pioneering positions in colonial cities. Those with long-term views could try to establish a leadership position in Huatulco and wait for the infrastructure to catch up. Mexico City-based Brisas Hotels & Resorts is among them, testing the waters with a 300-room luxury property converted from a Club Med. “Opportunities determine how we grow, whether in business or resort settings,” says Rafael Millán, Brisas’ managing director and CEO. “We want each of our destinations to be unique, as are our hotels.” Brisas’ high-end clients are more likely to seek out a new experience, avoiding the crowds of mass destinations.
Bring Cash, Patience
Whatever the sector, any hotel deal that gets done in Mexico results from painstaking due diligence and patience. “One of the biggest surprises for companies who come to Mexico is that hotel development is complicated and it is not cheap,” Azcárraga says. “Many see Mexico as being part of the developing world, which should make development easy. They think everything will be a bargain. The challenge is that Mexico straddles the problems of the developing world and the problems of the developed world. What that means for hoteliers is that development takes a long time—too long.”
It also takes money. Compounding the lack of available bank capital is the fact that neither Mexico’s government nor its cities is inclined to entice city center development with tax incentives.
That is a rude awakening for some developers. Few city center hotels would be built without the stimulus of tax-exempt bonds, other tax shelters or revenue bonds even in the mature U.S. market. “Mexico does not see the need to incentivize hotel development in that way. I cannot think of one project in which that happened,” says Azcárraga. “The disadvantage is that you are on your own in financial terms. The advantage is less competition.”
The charge frequently leveled against the National Trust Fund for Tourism Development (FONATUR) is that its investment incentive programs traditionally funneled development toward mega-tourism projects such as Huatulco and Loreto, while international chains were looking for opportunities in the cities. “Mexican development programs are driven by local or political objectives,” says an industry source. “Cancun worked because of its proximity to one of the biggest tourism generators in the world: the U.S East Coast. You have 60 million people who desperately want to escape winter just two hours away. Huatulco is another matter. There is no infrastructure.How many people will fly to Mexico City, wait hours, maybe overnight, and then fly to Huatulco?”
Without much in the way of public incentives, developers hoping to capitalize on secondary city opportunities “will have to woo the smaller number of developers who have the wherewithal to build new products,” says Christian Charre of Jones Lang LaSalle Hotels, Miami. As competition heats up, Charre warns that brands will have to be flexible in their franchise contracts and able to offer financial assistance if they want to find solid local partners. Espinoza predicts that strong brand will have a good message to bring to owners “who tried to run hotels themselves and now find they cannot pay the bills.” The general consensus is that few messages would be convincing enough to eliminate the need for equity participation.
Resorts opportunities may be harder to find, but they still exist. Charre says “certain” destinations such as Riviera Maya continue to attract “brisk” development. Proposed projects are taking on a different look, moving away from the 1,000-room mega resorts of the first wave to properties no larger than Sol Meliá’s recent 500-room template or luxury boutiques of 100 rooms or less.
FONATUR’s new “Antax” policy may make the numbers more attractive. “Through FONATUR, the Mexican government is promoting investment in tourist destinations and changing the perspective of the hospitality industry’s financial climate. Antax is one clear example because it incentivizes investors by reducing taxes on the land,” says Millán.
Access To Capital
Capital has become a formidable barrier to entry. Burned by investments in the hotel industry in the 1980s, Mexico’s banks have been loath to return to the sector. “The experiences of the Mexican banks during the last crises were difficult ones—meaning that their ability to invest in the sector was reduced,” says Francisco Ruiz, director general of Strategic Planning and Tourism Development with Mexico City’s Tourism Authority. “The best thing developers can do is find a Mexican partner with proven experience in the hotel sector and a high present net worth.”
How much international investment into Mexico’s banks will broaden their lending interest is unclear. Equity participation looks to be five or more years away—even by optimistic standards. The debt side may be the first to respond with rates at LIBOR +2 or +3, 10-year terms and loan-to-value ratios of 50% (and that would be on the generous end for quality projects). Espinoza is more positive. “The recent string of international bank deals should see the banks looking to provide financing vehicles for hotels,” he says. “They will be looking for what every bank looks for: good collateral and the usual guarantees.”
Track record plays an important part. Azcárraga says one of the side-benefits of having gone public is the banks get to know you better. “Being on the BOLSA (Mexico’s stock exchange) works well for companies with market caps of US$5 billion. For a company such as Grupo Posadas (working back to US$100 million EBITDA after a decline late in 2001), the BOLSA is not a place to raise cash. But it does get our information out and makes us more transparent,” he says, revealing the kind of innovative thinking that earned an MBA from Harvard Business School. As the economy matures and becomes more sophisticated, it allows for fewer mistakes, adds Azcárraga, which should mean more willing lenders.
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