Investors wary of Santander's offering of Mexico shares

* Analysts praise 'SanMex' as quality bank in alluring market

* Share sale largest ever in Mexico, No. 2 in U.S. this year

By Herbert Lash

MEXICO CITY/NEW YORK, Sept 24 (Reuters) - Banco Santander SA's sale of shares in its Mexican unit o n T uesday is oversubscribed, sources close to the deal say, even as investors grumble about the stock's valuations.

But analysts praise the bank's profitability and Mexico's outlook.

The sale of a 24.9 percent stake, to be listed mostly in New York as well as in Mexico City, is expected to be well received, equity capital market sources close to the deal told Reuters.

The book on the sale, where the underwriters accept orders from investors for the amount of shares they want, closes on Monday.

The deal is oversubscribed multiple times, one source said. Hedge funds have shown interest, as well as mutual funds, a second source said.

Interest in shares of "SanMex" is important as it is the only offer of its size this year in Latin America and it shows investors are keen for regional deals, the second source said.

The sale will raise up to $4.29 billion - the top end of the deal's range - making it the largest U.S. share offering this year after Facebook and the biggest ever in Mexico.

Proceeds will boost core capital at Spain's largest bank, which has struggled with write-downs from the battered Spanish property sector but is considered relatively healthy.

The deal will increase the banking sector in Mexico's benchmark IPC index, which is tilted toward consumer stocks, and widen the investment panorama in Latin America, where Brazil and its commodity-rich Bovespa index dominate the region.

Banking analysts praise SanMex, which provided Santander 12 percent of its overall profit this year through June 30, based on just 4 percent of the bank's worldwide assets.

Yet foreign fund managers have reservations about the offering, despite the bank's strong profile. One drag is that the Mexican bolsa is already trading at a high price-to-earnings ratio of more than 16 times forward estimated profit, making it an opportune time for the parent to launch the sale but not necessarily the best of times to be a buyer of the stock.

Another concern is that the money raised by the sale will not go to invest in SanMex but will go to help a troubled parent in Spain, said portfolio manager Will Landers, who oversees a $4.7 billion Latin America portfolio at BlackRock Inc.

"So are we positive on the transaction? We're looking at it, we'll see if the valuation makes sense," Landers said. "If it starts to get too crazy then we can always buy it in the after market. It will be a very liquid stock."

Santander Mexico's Class B shares are being offered at 29 pesos to 33.50 pesos per share, and on the New York Stock Exchange at $11.99 to $12.70 per American depositary share, which is equal to 5 Class B Mexican shares.

A small float of B shares already trades infrequently in Mexico. Less than 1,000 shares traded on Monday, starting at 34.50 and falling to 33, or about $12.80 for 5 B shares. The peso strengthened about 0.4 percent on Monday.

Also, a stigma still exists among some investors over emerging market assets because of disclosure and corporate governance practices, though they acknowledge many U.S. banks are not necessarily shining examples at the moment.

"I'm a little bit loathe to venture into a foreign financial in Latin America unless I'm very, very comfortable with the business because disclosure is usually a little bit different and not necessarily as comprehensive" as in the United States, said John Maloney, chairman and chief investment officer at M&R; Capital Management Inc in New York.

The price range of the offer gives the Santander unit a P/E ratio of 12.3 to 14.2, a discount to the 16.6 at which Banorte trades, calculations by M&R; show.

Alejandro Garcia, a senior banking analyst with Fitch Ratings in Monterrey, Mexico, said both Santander and Banorte, the only large publicly traded bank in Mexico that analysts can compare to the Santander unit, have strong corporate governance.

Banking analysts favor SanMex over Banorte, citing its better asset quality, stronger funding and robust core capital.

Santander's unit ranks No. 1 or No. 2 in comparison with its biggest rivals in Mexico, including by such metrics as the bank with the lowest non-performing loan ratio, the best operating return on assets and the second-most efficient.

SanMex has maintained lower impairment ratios than Banorte and most other major banks, Garcia said. In addition, Santander's reserve coverage metrics are also stronger than Banorte's and relatively aligned to those of the two largest and strongest banks in Mexico, Banamex and BBVA Bancomer, he said.

But there are other concerns, too, according to Santiago Arias, a senior analyst at PineBridge Investments in Santiago, Chile. He cites the magnitude of inter-company loans and services provided between the parent and its unit.

For example, some of the Mexican unit's expenses go to the bank's service center in Queretaro, Mexico, which is wholly owned by the parent company and takes all of its profit.

"This could be a source of cash for Spain at the cost of Mexico," Arias said. "It is little things like this that are difficult to get around when forecasting future earnings in different scenarios. According to my models, some 20 percent of earnings could be at risk from manipulation."

Of course, there is potential upside to the stock, too. Santander Mexico will likely enter benchmark indices at some point, giving the shares some momentum, and Mexico is clearly an attractive market because of a young populace and budding economy, making the listing more than welcome, Arias said.

In its prospectus for the offering, Santander cited Mexico's expanding middle class and low credit penetration in a country considered underbanked. The World Bank ranks Mexico as an upper middle income country, with gross national income per capita last year of $15,120, high for Latin America.

A big lure is the fact many Mexicans do not have a bank account. The International Monetary Fund said in its review of Mexico's financial stability in March that bank lending and credit to the private sector are among the lowest in Latin America, well below other emerging markets of comparable income.