My big mistake

Peru: too much hype

Two years ago, I made a big mistake.

I had heard about Peru’s big infrastructure plans, found a good local company to play the theme with and told New World readers to get involved. Since then Peru’s infrastructure programme has hit the skids and the firm’s price has tanked.

Cementos Pacasmayo (US:CPAC), a local cement producer, has fallen 18% since I tipped it back in 2012.

Now, I’m not beating myself up too much here. After all, the majority of my infrastructure plays have enjoyed healthy gains. But I feel I owe readers an explanation on this one.

I’ve spent the last six weeks in Peru looking for answers. In that time, I’ve interviewed a host of government ministers, CEOs and fund managers and now I’m ready to give you an update on the Peruvian infrastructure story. Today, I’m going to tell you what went wrong and why things are about to turn around.

Peru had so much going for it

When the Peruvian infrastructure programme was announced, it struck a chord with me.

I knew first hand that the country’s existing infrastructure was dire. I also knew that Peru was in great economic shape. That was important because it meant that unlike so many other countries that need infrastructure, it would actually be able to pay for it.

The final reason I liked the theme was that at the time the big question mark about Peru was how it would cope with a Chinese slowdown and lower commodity prices. Peru’s infrastructure story – at least in the short term – was insulated from that.

Unfortunately, not everything went to plan. The programme was hit by delays – a story that was repeated elsewhere in the region – and gradually investors began to doubt if the much-talked-about projects would ever materialise.

When I went to Peru, there was a list of people I wanted to talk to about the programme. Right at the top of that was Javier Illescas the executive director of ProInversion – the government body that is responsible for financially structuring the projects, finding investors and awarding the concessions.

My first question – naturally enough – was “why had it all gone wrong?”

Here’s what Javier told me

According to Illescas, there was too much hype surrounding the launch of the projects.

“The media and the analysts looked at the headline figures and got very excited. But they didn’t stop to think about the practicalities of studying these projects and then structuring them to attract the right investment.”

Illescas moved from the World Bank to ProInversion in August 2012, and when 2013 passed without any major projects being awarded, some press and analysts began to criticise the government and ProInversion.

“In lots of cases it was because they [the media and analysts] didn’t understand the project. If they had bothered to look at our website they would have had a better idea.”

For a top government official it’s strong stuff, but is he right? I don’t know if I got carried away with headline figures, but in hindsight I definitely underestimated the execution risk.

OK, so the government had the need, the will and the money to make these projects happen, but I should have also factored in how good they would be at delivering them. Even Illescas concedes that things could have been organised better. For example, the studies for some projects took far longer than planned.

Speaking with Illescas was certainly helpful, but I knew I wasn’t getting the whole story. So I set up a few meetings with members of the private sector and that’s when the real horror stories started emerging.

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Dismantling a culture of fear

Roberto Santivanez, who runs a leading law firm in Lima, told me one story where a government project was so badly designed that it broke its own rules: “They have very strict environmental guidelines for national parks and actually released a tender for a transmission line without including the right licenses needed.”

Another scare story was told to me by Mario Alvarado Pflucker, the CEO of Grana Y Montero, Peru’s largest construction company: “We bought some land that used to be a car repair workshop and wanted to turn it into a modern office block. Before we could proceed, we had to complete a study on how local birds would be affected and what local passers-by thought. This was crazy because what we were building was much cleaner than what had been there before.”

Throughout the trip, I spoke to a number of businesspeople who’d probably appreciate it if I didn’t mention their names. One topic that came up again and again in our talks was a culture of fear in some government organisations.

“Processes take time because nobody wants to take a risk and sign something that goes wrong later on. You only tend to move forward once you’ve convinced everyone to sign – and that can take a long time.”

Again, I‘ll hold my hands up here. Latin American bureaucracy is hardly top secret. But my enthusiasm for the dynamism of the Peruvian economy perhaps made me believe its public sector was more dynamic than its peers. Needless to say Javier Illescas disputes some of these claims.

“ProInversion is a public-sector organisation but it is more dynamic than other parts of government. Our teams work a lot with the private sector and we also use external advisors so we are learning best practises with the likes of McKinsey or PwC.”

He also disputes claims that the organisation is under-resourced, pointing out that it gets full backing from the Finance Ministry when it needs to pay for something that’s outside the scope of its budget.

Will ProInversion get its act together?

Of course, these types of arguments between the public sector and private sector can be found in any country in the world. But the key question is if the organisation in question can deliver – can ProInversion execute the infrastructure programme that is so important for the country and potentially so important for readers of The New World?

Judging by the last six months the answer is yes. ProInversion may have had its struggles but by anyone’s standards, it’s had a good start to the year.

In March, it awarded Line 2 of the Lima Metro, which will cost around $6.6bn.

That was followed in May by the $2.7bn Talara Refinery project and the $400m new international airport in Cusco.

Then in June, it finally awarded the second Camisea gas pipeline, which should cost around $4bn.

Crucially, with these projects now awarded to private investors the onus of execution is now off ProInversion and onto the international and local companies involved.

So is Illescas sleeping easier now?

“Look we have a long track record of working with private investors to build complex infrastructure projects”, says Illescas. “Investors had no need to worry. But yes the pressure has definitely eased after awarding these concessions.”

Moreover, he expects the success in awarding these deals to help him build up an extensive pipeline of more infrastructure projects.

As for me, I still think that Cementos Pacasmayo is a good way to play the Peruvian infrastructure story.

This article is taken from The New World, MoneyWeek's FREE regular email of investment ideas and news from Asia and Latin America. Sign up to The New World here.

One Response

  1. 15/07/2014, Big Cheese wrote

    Good article, James. Just the sort of self-critical reflective piece that readers are requesting from your colleague Bengt at the moment.

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