How to profit from Latin America’s bubbling tech sector

When it comes to reading and writing about Latin America, it can be hard to avoid the clichs. In the same way that Ireland has cornered the market for friendly people with the gift of the gab, and France for food and romance, Latin America has nailed dancing, passion and football. Of course, like most stereotypes, there's a fair bit of truth in some of them. But, like most stereotypes, there are also plenty of exceptions to the rule. I've met my fair share of quiet, unfriendly Irish people and I have seen lots of Latinos struggle on the dance floor.

Anyway, the point is, these stereotypes and exceptions exist in the world of investing too. Ask someone about Latin American economies and they'll tell you about commodity resources and infrastructure programmes. At a push you might hear about a growing middle class, consumer stocks and tourism investments. I'm as guilty of this as the next pundit. Over the past year, I've mostly concentrated on energy companies, cement makers, farm groups and consumer stocks. So today, I'd like to shine a light on a little-appreciated part of the Latin American economy the tech sector. I've also found an interesting stock that could make investors serious money.

Latin America's emerging tech scene

Quietly, under the radars of most investors, Latin American tech firms have been expanding. I was shocked to find out that tech researcher Gartner ranks Mexico as the world's third-largest IT outsourcer, just behind the Philippines and India. Many American companies have taken advantage of the ready supply of cheap, quality labour across the border, choosing to outsource IT tasks. Last year 130,000 Mexicans graduated as engineers - that's much more than in the US and the most in the Americas.

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Sometimes it's difficult to evaluate statistics like this. After all, perhaps America's engineers are trained to a better standard. But one of the most interesting and convincing recommendations of Mexico's tech ability comes from Chris Anderson, the former editor-in-chief of Wired magazine. In case you haven't read it, Wired is the leading tech magazine in the world's most technologically advanced country, America. It analyses emerging technology and predicts how it'll reshape the world. As a result, Anderson is seen as something of a tech guru. And last year, he decided to quit the magazine and set up his own, suitably high-tech, 3D robotics company. And where did he decide to set up one of his factories? South of the border in Mexico, of course.

The move was something of a shock for most people, so he wrote an article in the New York Times, explaining why he did it.

Anderson's firm has its headquarters in the US town of San Diego. Which means it's just a 20-minute drive for him to get across the border to Tijuana, where the Mexican factory is. "Some machine specialists are typically easier to find in Tijuana than in many big American cities. So, for that matter, are accountants experienced in production economics and other highly skilled workers." Cost is another factor, explains Anderson. "Inflation-adjusted labour costs in China have more than tripled in the past decade. Wages in China's southern cities are approaching $6 an hour, roughly what they are in Mexico."

The fastest-growing internet population in the world

Another interesting area is the internet. According to comScore, a US-based digital analytics firm, last year Latin America had the fastest-growing internet population in the world. Unique visitors rose 12% to 147 million in March 2013, but with an entire population of 600 million, it's clear that there is more room to grow. Internet penetration in Latin America currently sits at about 40%, compared to almost 80% in the US. Analysts expect that penetration will reach 60% by 2015.

Within that internet usage there are certain patterns that mark out Latin American use. One is that social media is incredibly important, with Latin American users spending an average of ten hours on social media per month, compared to a global average of five hours. Indeed the region is home to five of the world's top ten biggest users of social media per capita.

Online shopping is another big growth area, with the total number of shoppers growing by 16% per year. The growth in online shopping is expected to continue as Latin Americans increasingly buy their own computers or smartphones, which give them more security than using cyber cafes. Online advertising is another growth area. Digital ad spend almost doubled in Brazil last year, and taken as a whole, the region's online advertising budget is growing at the second-fastest pace in the world.

Obviously there are big differences between countries. One way of measuring a country's internet nous is to look at how many websites it has created. Brazil leads the way with around three million websites registered with the .br domain name. In second place is Argentina with around 2.5 million websites listed as .ar, while Colombia is in third with around 1.4 million websites registered as .co. This suggests that among Latin America, these countries have the most internet-savvy entrepreneurs and local companies. Once you take population into account, Argentina has by far the most locally-registered domain names per capita.

It is not just the locals who are pushing forward with the tech boom.

The governments' new digital cities

Latin American policymakers have long been trying to support these industries like most emerging economies, they dream of following in the path of Singapore and turning themselves into knowledge economies'. In Chile, the government has been thinking of a way to lure internet entrepreneurs down to remote Santiago, one of the world's southernmost capital cities. The result is 'Start-Up Chile', which offers small tech entrepreneurs a visa and $40,000 of seed capital. "We don't even ask for equity in return", says Matias Mori, executive vice-president of the foreign investment committee of Chile. "We just ask that they stay in Santiago. We believe that the presence of these companies will help our labour force develop new skills."

They say that imitation is the sincerest form of flattery, so no doubt the Chileans were delighted when Brazil launched a very similar looking Start-Up Brasil' programme that offers $100,000 to small tech companies.

In Colombia, the government has established INNpulsam, an organisation that offers advice and seed capital to start-up companies on one hand, while on the other it helps larger companies update their IT systems.

Perhaps the most ambitious plan can be found in Mexico, where the government is building an extensive $5bn creative digital city' in the country's second-biggest city, Guadalajara. It is already a hotspot for Mexico's digital companies, so now the government is building a 600-acre campus that will bring tech firms and academics together in one place. The government hopes that by providing the right setting, everything from superfast broadband to a picturesque landscaped environment, it will encourage more companies to move to the city.

Investors are getting in on the act

Government schemes can help create the right business environment, but ultimately they can only do so much. One of the key elements in the success of Silicon Valley is a strong network of venture capitalists and angel investors who have the guts and the pockets to back scores of failures before hitting on a Facebook or LinkedIn. At present, Latin America is nowhere near that level.

A lot of investment is controlled by conservative family-owned firms. These companies have a fine record of preserving wealth, but their risk-averse nature means that capital does not always flow to the riskiest investments, which are often those that most need it.

Andreu Tobella, the co-founder of Clicab, a Mexican technology firm that has developed a smartphone application that allows people to order safe taxis a major concern in Mexico City feels that Mexico's venture capital scene still needs much development. "In Mexico prospective investors want security. They want to know that a company is profitable before investing more money. As I try to explain to them, for a venture capitalist firm to make really significant profits, it needs to be prepared to take on more risk."

Nevertheless the situation is improving, says Tobella. "Slowly a new generation of investors are adopting more aggressive strategies."

The figures back up Tobella's optimism, as annual Mexican venture capital investment has grown from $211m to $1bn since 2010. The same picture can be seen across Latin America. Last year venture capitalists invested $8bn in more than 200 deals across the region, with around half of those being in the IT sector. Data from the Latin American Private Equity and Venture Capital Association shows that the number of VC-backed IT deals in Latin America grew from just 18 in 2008 to 104 last year. That's faster growth than any other sector.

The Argentinian eBay

With consumers, entrepreneurs, governments and investment firms all pulling in the same direction, Latin America's tech sector looks likely to rocket. So what's the best way to play it?

One of my favourite firms in the sector is MercadoLibre (Nasdaq: MELI),an Argentinian version of online auction house eBay. It is the largest e-commerce firm in Latin America and has customers across the region. Its platform allows people or businesses to trade goods between themselves online or sell them for a fixed price. It has also developed its own online payment system, a bit like eBay's PayPal, and offers classified advertising. The firm extracts commission for these services, which means that it should benefit as Latin American internet use increases and more people begin to shop online.

Last Friday its quarterly results showed that revenue increased 26% to $112m, while the gross value of the transactions completed through the firm's online marketplace rose 33% to $1.73bn.

Now, this business isn't without its problems. It's currently trading near its all-time high and, on a forward price/earnings (p/e)ratio of 40, is very expensive. Moreover two of its biggest markets are Argentina and Venezuela, economies that face serious structural challenges that could wipe out consumer spending power. Another possible threat is that Amazon could decide to increase its Latin American presence and offer consumers a different place to shop online. But despite all this I like the firm.

For starters the p/e of 40 is still below its 12-month trailing average of 50. Moreover, US rival Amazon trades on a p/e of 180. As for countries like Venezuela and Argentina, MercadoLibre is now expanding across the region and will benefit from other markets.