I learned a tough lesson the morning of October 5th.

Waking up late (the reason escapes me now, I believe I was off work) I noticed my portfolio slightly diverging from the markets enough for me to question what was going on. I run a very concentrated portfolio of individual stocks but it’s still fairly rare to see tracking error (especially at market open) of more than 50bps unless some news or special dynamic is occuring.

A few seconds later I got the notification (PAC down more than 5%), so I flipped to my stock tracker to see how bad it was. Grupo Aeroportuario del Pacífico (PAC) is a Mexican airport operator that trades on the American Market via ADR.

The stock had gapped down from ~$163 to ~$117 at market open. Shit. The government of Mexico had informed airport operators that day that they decided to unilaterally alter the tarrif’s they were charging these operations. This meant there was going to be a direct margin hit on their operating model. Even worse, the government didn’t provide any details on the size of the change and neither did the operators, indicating they would give details in their next quarterly update.

Darth Vader comes to mind “I am altering the deal, pray I do not alter it any further.“

A Warning Shot

Several months prior, Citigroup had been trying to sell its Mexican retail banking operations. There were several bidders but the process slowly over time was showing more and more red flags. Initially quite a few bidders, then Andrés Manuel López Obrador (or AMLO as journalists call him) and the government of Mexico started talking about their requirements. At first fairly reasonable.

But this continued on, and it became evident that Mexico was not going to let the free market decide the outcome of this bidding process. Nonetheless Germán Larrea of Grupo Mexico was the winning bidder and things were looking okay, but dragging out longer than expected. During this entire time Citigroup continued to reiterate to investors that it was pursuing a dual path of direct sale or IPO for its Mexican banking operations.

After radio silence for a while, the government of Mexico expropreated a railway owned by Larrea. Not a good sign.

Sure enough shortly thereafter Larrea backed out of the sale. No surprise, its likely the delay was Larrea trying to negotiate with AMLO’s government on the side on how they would get their cut.

Shortly after Citi announced their intention to IPO the business. It’s likely they knew this was a risk from the start and this is why they always mentioned that path as a possibility.

Good Instincts, Unfortunately I didn’t Listen

After this occured I began to think a bit about PAC. The airport operator was such a fundamentally sound business. A true monopoly with growing demographics and exploding flight volumes out Mexico (a trend likely to contunue). They had amazing returns on invested capital, and growth was structurally guarenteed. It was a true winner and great business. It had also been my best performer by far the past few years up over $200 I believe at one point from my cost basis of ~$85.

More painful even was that it was a stock I discovered myself.

After the Citi issues, I questioned in the $190’s if I should cut the position, was it a risk that the AMLO issue could expand to other industries? Should I cut and run with a great gain? I knew from experience that selling a great business was often a misstep.

I kind of delayed really thinking about this (and by default choosing not to make a change) and paid the price.

Ouchie

I sold all my PAC shares that morning after the gap down at about $115. An overall gain of about 35% + dividends over a few years. Not terrible but not good and certainly not the 25%+ compounded I had before. I had to be decisive and immediately realized the lesson. This was a type of investment I could no longer operate with confidence in.

In subsequent days the stock went back up as high as $135.

At their quarterly report PAC gave details on the unilaterally renegotiated tarrif’s and the stock is now trading at $105 or so. All in all around 5% more of their revenue would be taken directly by the government because they felt like it. Brutal.

At the end of the day my PAC position wasn’t large with respect to the overall size of my portfolio at around 1.5% of AUM prior to the decline, but this was painful.

Going Forward

An important and perhaps obvious lesson here was learned. It is dangerous to invest in countries where rule of law and leadership are not respectful of investor rights. I probably won’t directly invest in a fully Mexican business again in the future after this lesson, or any Emerging Market local businesses for that matter. Now I see why. In theory I’m sure I’ve read the warnings before, but to see it play out in real life is different.

With respect to Citigroup, the entire business is fundamentally so cheap I think this concern doens’t break the thesis. AMLO as well has to keep in mind the impact that continually underminding investors would have on Mexico’s economy.

Citigroup is such a large and important American business don’t expect that AMLO would try to interfere too much with the IPO process. I think at a certain point Citi’s US Government lobbiests would have some discussions with contacts in the AMLO governmenet and give some warning shots on implications of continued meddling. I also expect lobbiests for Citi are fairly well versed in dealing with the realities of the government there. But obviously there is risk.

Hopefully this experience is one I can grow from. A great investment turned into an okay investment and a lesson to look back on.