Perhaps overconfident after five calm years of economic stability and steady growth, several Mexican companies bet hard on derivatives tied to the value of the country’s peso and were caught unprepared for the storm that blew in from Wall Street. From June 30, 2006 to June 30, 2008 the Mexican peso appreciated steadily and smoothly against the dollar. During this time many Mexican companies entered into profitable derivative contracts linked to the rise of the peso. However, as panic induced by the U.S. financial crisis spread, investors scrambled to trade foreign holdings for dollar denominated assets, inducing a sharp decline in the value of the Mexican peso. Several Mexican companies were unprepared when the country’s currency devalued sharply by 29% between September 15 and October 15, 2008.
The Wall Street Journal reported that the CFO of Controladora Comercial Mexicana S.A. de C.V. (BMV: COMERCIUBC), one of the companies worst affected by this crisis, was literally on vacation during late September as the world’s financial markets starting showing stress fractures. He reportedly returned from Europe on October 1, 2008 to find the family-controlled retailer on the brink of bankruptcy.
On October 28, 2008 La Comer (as the company is colloquially known in Mexico) reported third quarter 2008 losses on derivative contracts totaling US$0.5 billion, or 12.5% of 2007 revenues.
The company’s attempts to seek bankruptcy protection in the Mexican court system have been denied. Mexican press sources have reported that La Comer is using extrajudicial proceedings to restructure its multi-billion dollar debt obligations with a list of creditors that includes among others Banco Santander S.A. (Madrid Stock Exchange: SAN), Goldman Sachs Group, Inc (NYSE: GS), Barclays PLC (LSE: BARC), and JPMorgan Chase & Co. (NYSE: JPM), all of which acted as counterparties to the company’s derivative contracts. La Comer’s total debt stands at US$2.5 billion, more than 90% of total assets.
Will Landers, a Latin American money manager at Blackrock Inc (NYSE: BLK), explained to press sources that this issue highlights a need for better regulation and that “from an investor's standpoint there's got to be more disclosure.”
La Comer’s annual report for 2007 offers almost no description of the risks related to the company’s exposure to exchange rate fluctuations. The report discloses that in 2007 and 2006 it reported net gains of MXP 360M (US$ 27M) and MXP 26.6M (US$ 2M) on derivative contracts, but includes only one brief sentence that explains that the company’s financial standing could be affected by a devaluation of the peso relative to the dollar. By contrast, annual reports from other listed Mexican companies included several pages of detailed descriptions of risks relating to currency fluctuations as well as specific calculations of potential losses on derivative instruments linked to exchange rates. For example, one company reported that a ten percent decline in the value of the peso would translate into losses of US$ 250M on derivative contracts.
La Comer's CEO, Chairman, and Vice-Chairman, as well as three other members of the company's board are members of the founding family. Only three of the company's twelve directors can be considerate independent of management and controlling shareholder. The company offers almost no disclosure of information relating to its governance and executive compensation policies. Further, unlike rival retailer Wal-Mart de Mexico S.A. (BMV: WALMEXC), La Comer does not have an environmental management system and does not report its environmental performance, an indication of sub-par management and disclosure. Apparently the Gonzalez family, which owns 72% of La Comer's shares expected investors to trust their management acumen. The company's current troubles are a lesson in the value of transparency.
Given La Comer’s bottom of the barrel governance profile, it is not surprising that the poorly managed company would be caught so unprepared and be so severely affected by recent shocks.
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