Publish in Analysis - Wednesday, October 31, 2018
Andres Manuel Lopez Obrador (center) announces the cancellation of the $13 billion airport, flanked by his future chief-of-staff Alfonso Romo and future transport minister Javier Jiménez Espriú. (Photo: LopezObrador.com)
Mexico’s next president ruins investor confidence before assuming office.
BY JOACHIM BAMRUD
Forget the honeymoon period normally granted to new presidents. Andres Manuel Lopez Obrador hasn’t even assumed Mexico’s presidency yet and has already ruined his relationship with local and foreign investors.
This week he announced he was cancelling the new, $13 billion airport being built in Mexico City – a move made despite warnings not to do so from technical experts, the local business community, the International Air Transport Association (IATA) and even the Organization for Economic Co-operation and Development (OECD).
“The decision by @lopezobrador on the new airport will be remembered as one of the worst stupidities by a president in contemporary economic history,” tweeted Enrique Cárdenas, a professor at the Iberoamericana University in Puebla.
To top it off, the announcement came after Lopez Obrador (popularly known as AMLO) held a widely-criticized non-official referendum on the subject, organized by his own supporters, with votes from less than 1 percent of Mexican eligible voters, marred by fraud (many voters could vote up to four times each) and manipulating the questions so the voters would favor the cancellation. The vote also contradicted three different polls by El Financiero from August to October showing a majority of Mexicans supported keeping the existing plans.
AMLO used the results of the referendum as the key reason for cancelling the airport, known as NAICM. “The citizens’ will was expressed,” he claimed. “The link between economic and political power is over,” said AMLO’s web site.
The announcement led the Mexican peso to fall and a whopping $17 billion loss in value on the Mexican stock exchange.
DEFAULT, BOND VALUE PLUNGE
The move to scrap the new airport has several consequences, including financial and legal issues directly linked to the project, worsening the airport traffic congestion and the wider implications of AMLO sending a clear signal that he is willing to tear up existing contracts, ignore the rule of law and weaken investor confidence in Latin America’s second-largest economy.
“A careful reading of the indenture governing the $6 billion dollars of airport bonds outstanding indicates that a cancellation of the new airport could create an event of default leading to an acceleration in the payment of all of the bonds outstanding,” says Michael Fitzgerald, chairman of the Latin America practice at law firm Paul Hastings, which advised the underwriters. “Also, the Fibra E interests issued by GACM (the current holder of the airport concessions) would be severely impacted. Those securities have a stipulated interest rate like bonds but are hybrid securities with an equity component. The equity value would be drastically slashed if there is no new airport to support the equity valuation of those instruments.”
The action will clearly knock down the value of the bonds and Fibra E instruments, he says.
“While one might argue, based on the copious risk factors in all of the offering materials, that investors should have been aware of the risk of this cancellation occurring, I think it is fair to say that none of the investors in the new airport counted on this cancellation,” Fitzgerald says. “The cancellation of the new airport will likely have a disastrous effect on the value of the bonds and Fibra E instruments.”
Moody’s downgraded Mexico City Airport Trust NAFIN F/80460 (MEXCAT) $6 billion Senior Secured Notes ratings to Baa3 from Baa1. The ratings were also placed under review for further downgrade.
There is now growing alarm that AMLO may target Mexico’s historic energy liberalization despite pledges not to.
“AMLO’s declarations on the cancellation of the NAICM is a terrible signal,” says Luis Rubio, the executive partner in Mexico City office of US law firm Holland & Knight.
“The problem is that the rule of law has not been followed and that if he has decided to go [after] the airport, he may decide review the energy [reform] as well.”
AMLO has already stated that he wants to stop future oil auctions and instead strengthen state oil company Pemex despite its dismal financial and operational track record. Pemex saw its losses jump from $9.3 billion in 2016 to $16.8 billion last year, thus keeping its position as the worst performer on the Latinvex 500 ranking of Latin America’s largest companies. (In contrast, Brazilian state oil producer Petrobras went from 2016 losses of $4.5 billion to a loss of $134.8 million last year.)
“Taking this decision [to cancel NAICM] is an irresponsible act that AMLO tries to justify [by the] supposed consultation that didn’t follow the procedures under law,” Rubio says. “The signal is that he is willing to carry out any decision, but the economic consequences could be disastrous for the Mexican peso and markets.”
Meanwhile, the legal justification for the cancellation is weak, he points out. “Public consultation … is not a legal cause to revoke the concession nor early terminate any agreement currently in force,” Rubio says.
LAWSUITS & ARBITRATION NEXT?
That could signal lawsuits and international arbitration unless AMLO pays in full what the contractors will be asking for.
“If the contracts are broken, international [arbitration] panels will be formed, something the Mexican private sector is seriously concerned about,” Moisés Kalach, international negotiations coordinator at the Mexican business group Consejo Coordinador Empresarial (CCE) told El Financero.
AMLO’s team announced the creation of a commission to negotiate with the investors and contractors affected by the cancellation. It will include Javier Jiménez Espriú, the incoming transport minister who has rejected all technical warnings against cancelling NAICM.
“There are currently 321 contracts involved on the construction of the new airport,” Rubio says. “There is a whole process to cancel public projects. There is a procedure given by the government procurement law - the decision has to be issued to stop works. If there's not a cause driven by the contractor then the government has to follow up on the indirect cost associated with the project, [including] some of the costs that the contractor has incurred prior to the agreement. A lot of contractors had to establish offices in Mexico. The government would reimburse for those expenses - also for completed works. [But the] agreements don't provide for future loss of earnings.”
Cancelling the construction will cost 100 billion pesos (US$5.2 billion), the head of the government agency overseeing had told El Financiero. That only includes work done so far and another 60 billion pesos (US$3.1 billion) would have to be paid in compensation for undone work.
IMPACT ON FOREIGN INVESTMENT
The decision to cancel the airport despite clear warnings from the private sector led the peso to plunge amidst rising fears that AMLO represents a larger threat against business than anticipated.
“AMLO's approach toward the new airport is the equivalent of [Donald] Trump's approach toward the border wall. Both concepts have popular appeal but fly in the face of practical realities,” Fitzgerald says. “To the extent that investors equate this disastrous decision to other economic objectives undertaken by Mexico in recent years, particularly the energy reforms, there could be a severe and possibly long-term effect on Mexico's ability to attract foreign investments.”
Rubio agrees. “The announcement of the cancellation and the form in which it was made, generates uncertainty [among] investors of large infrastructure projects, “ he says. “The simple possibility of a government deciding to cancel existing contracts, increases the risk of the country and makes it less competitive in comparison with other countries that offer greater certainty.”
Commerzbank analysts said that by scrapping the project, contracts will get broken causing considerable doubt on whether it is safe to invest in Mexico, Reuters reports. Citibanamex, Mexico’s second-largest bank and a unit of Citibank, said the decision went against common sense and sends a “negative signal to the markets about how AMLO will govern.”
SANTA LUCIA AIRPORT
AMLO now plans to build a new airport on the Santa Lucia military base, while keeping Mexico City’s existing one. However, in addition to expert warnings that such a solution will not be safe, there are several major practical hurdles ahead for that solution.
“Contracts currently in force for the construction of the NAICM cannot be transferred for Santa Lucía project,” Rubio points out. “New studies for the project and construction in Santa Lucía will be required under procurement law for all public works [and] additionally new bids are required for Santa Lucía.”
It took more than two years for the experts to elaborate the preliminary studies for the construction of the NAICM and to be ready for the auctions, he says.
IATA had warned that cancelling NAICM would risk Mexico losing long-term passenger growth and billions of dollars. Airlines for America (A4A), the industry trade organization for the leading U.S. airlines, wrote a letter to AMLO voicing support for the continued construction of the airport. “Without the new airport Mexico could lose 20 million potential new passengers per year by 2035,” it said.
Experts say Santa Lucia will not be able to have the scope that was planned for NAICM and thus the AMLO solution of an expanded Santa Lucia and the existing airport will be insufficient.
As if the airport cancellation wasn’t bad enough, there is now growing speculation that AMLO may decide to follow the lead from the late Venezuelan strongman Hugo Chavez, abolishing term limits and holding referendums to advance his agenda, according to a warning from Swiss bank UBS quoted by Milenio.
Under the current constitution, Mexico’s presidents can only serve one six-year term.
Rubio shares the concern by UBS. “The danger is that AMLO’s party has the majority of votes at Congress, and that, therefore, he would be able to change the constitution to be able to extend his mandate,” he says.
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