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Spain’s Pain is Mexico’s Gain

By Benjamin Shepherd on September 27, 2012

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Spanish banking group Banco Santander (NYSE: SAN) yesterday pulled off a major coup on a day when most of the world’s stock markets were down, successfully completing the initial public offering (IPO) of 24.9 percent of its Mexican unit, Santander Mexico (Mexico City: SANMEX, NYSE: BSMX).

Listing shares in both Mexico City and New York, the bank raised about USD4.3 billion, making the IPO one of the largest this year in the global markets and the single biggest listing of a Mexican company in history.

The listing of a minority stake in its Mexican operations was essentially an act of desperation on the part of Banco Santander, since Mexico has long been its cash cow. Despite accounting for only 2 percent of the bank’s total assets, Mexico usually generates about 10 percent of the bank’s profits. And while earnings on the banks’ Spanish operations have been plunging, falling by more than a third so far this year, earnings in Mexico have risen by about 14 percent over the same period.

So what was Emilio Botin, Chairman of Banco Santander’s Board, and Alfredo Saenz Abad, the chief executive officer, thinking?

They had to raise cash—and quick.

Banco Santander has been under pressure from regulators for more than a year to raise its capital adequacy measures. As the European debt crisis drags on and the Spanish economy remains in a recession, Banco Santander has stubbornly insisted on maintaining its dividend and has generally resisted selling additional shares of the parent bank.

However, with new international banking regulations coming down the pike in the form of Basel III, which mandate higher capital levels, the pain in Spain will only get worse. Banco Santander’s managers came to the conclusion that they had little choice but to begin the spinout of some of the company’s most profitable units. The bank plans to list its units in Poland, Argentina and the United Kingdom to fill in the holes in its balance sheet; it has already implemented a similar dual listing of its Brazilian operation.

While it’s unfortunate that Banco Santander has found itself in this position, it’s also very good for Mexico.

The spin out is a tacit acknowledgement of Mexico’s economic status as an up-and-comer. Over the past two decades the country has successfully navigated a debt crisis of its own, redenominated most of its debt into pesos, licked inflation and ushered in an era of impressive economic growth. The night-and-day improvement in Mexico’s macro economy has allowed microeconomic ventures such as Santander Mexico to become hugely profitable enterprises.

Banco Santander’s latest filings show that net income at its Mexican unit jumped by just over 18 percent in the first half of this year, reaching USD720 million. That impressive growth rate should continue over the coming years, with Santander Mexico planning to spend about USD120 million to expand from its current 1,200 branches to about 1,400 over the next three years.

Assuming the US doesn’t stumble into another recession (the US remains Mexico’s single largest trading partner), Santander Mexico might exceed its current growth rate. Mexican bank credit is expected to post double-digit growth rates over the next several years, a boost for banking stocks tied to this developing market.

Given those rosy prospects, it’s little surprise that the US-listed American Depository Receipts of Santander Mexico have performed well. Over the past two days, they’ve gained better than 6 percent while the S&P 500 has move up only 0.4 percent.

I’m extremely bullish on Mexico and I like Santander Mexico’s prospects. However, investors should remain leery for now about sinking any money into the stock.

Given that Banco Santander IPO’d less than a quarter of its stake in Santander Mexico, it’s likely the parent group would sell off more of its Mexican stake if it needed capital. That would be a highly dilutive move.

There’s a strong precedent for Spanish companies to treat their Latin American subsidiaries like piggybanks during the euro crisis. Electricity ute Iberdrola is just one example of a Spanish company sending money home to deal with its domestic woes. I wouldn’t expect Banco Santander to resist such a step. And with Santander Mexico’s princely valuation, a new share issuance would seriously impact share price.

I’ll closely monitor Santander Mexico and hold off on buying the stock for now. In the meantime, take yesterday’s news as yet another solid sign that Mexico is rapidly maturing and becoming an increasingly attractive investment destination.

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