IFM Lesson 3

8/12/2019 IFM Lesson 3

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METHODS TO CONDUCT IB

Acquisitions

Firms acquire other enterprises in foreign countries as a

tool of penetrating foreign markets.

The overseas acquisitions by Indian corporates which

started of on a small scale, have now reached to globallyvisible levels.

Report of the Boston Consulting Group (BCG) on the

emerging multinationals in the world puts 21 Indian

companies among the top 100 such multinationals.

Only China with 44 companies is ahead of India.


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METHODS TO CONDUCT IB

The BCG research has shown that 88% of the emerging

market global players in India are driven by the need to

gain access to new markets and profit pools.

Overseas markets are expected to bring higher margins,

revenue and volumes, besides opportunities for furthergrowth.

The acquisition of RPG (Aventis) in France by Ranbaxy

makes it the countrys largest generic supplier.

Tata Motorssells its passenger car Indica in the UK

through a marketing alliance with Rover and has acquired

a Daewoo Commercial Vehicles unit giving it access to

markets in Korea and China.


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Acquisitions by Indian companies overseas

Company Acquisition Price(in USD million)

Reliance Industries Flag Telecom, BermudaTrevira, Germany

212

95Tata Motors Daewoo, Korea 118Infosys Technologies Expert Information Services, Australia 3.1Bharat Forge Carl Dan Peddinghaus, Germany NARanbaxy RPG (Aventis) Laboratories, France NAWockhardt CP Pharmaceuticals, UK 18Cadila Health Alpharma SAS, France 5.7Hindalco Straits Ply, Australia 56.4Wipro Nerve Wire Inc, US 18.5Aditya Birla

Dashiqiao Chem, China

8.5


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M & A and PE of INDIAN COMPANIES


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M and M M and M acquired a 70% stake in Ssangyong and

out of the total cost of acquisition of $ 463million (about Rs 2,105 crore), $ 378 million willbe in in new stocks and $ 85 million will be incorporate bonds.

The acquisition would help M and M launchSouth Korean company's flagship SUV models -Rexton II and Korando C - into the Indian market.

Mahindra-Ssangyong deal will provide a new

growth avenue for Ssangyong and furtherstrengthen M&M's dominant

position in the UV segment.


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Vedanta - Cairn buyout

Billionaire Anil Agarwal-led Vedanta group's $8.6 billion acquisition of Cairn India has

become the biggest M&A deal ever in the

Indian energy sector.

The Home Ministry, while giving the security

no-objection certificate (NOC), highlighted

eight areas of concern, including 64 legal

proceedings against Vedanta and

its subsidiaries in various courts.


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GVK Power $1.26 billion acquisition of

Hancock Coal

GVK Power acquired Australia's Hancock Coalfor $1.26 billion, in one of the largest overseas

acquisitions by an Indian infrastructure entity.

The deal will offer the Hyderabad-basedcompany option for long term coal supply

contracts for the purchase of up to 20 million

tonnes every year. This can support around

7,500 megawatts of power

generating capacity.


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Adani Enterprises $2 billion acquisition of

Abbot Point coal terminal

The deal will help the Adani Group ship out coalfrom an Australian mine it has acquired last year.

This deal marked the third overseas acquisition in

nine months by the group that runs the country'sbiggest private port and is India's largest coalimporter.

According to Adani Group, the deal was one of

the largest port acquisitions in the world and thegroup had now emerged as the largest Indianinvestor in Australia now.


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MNC

An MNC is an enterprise that manages production or

delivers services in more than one country.

By practice, a MNC has its top management corporate

office in one country, called the home country, and

operates in several other countries, called the hostcountries.

Examples of MNCs are General Electric, Wal-Mart,

Kentucky Fried Chicken, Honda Motors, McDonalds,

Boeing, Microsoft, Apple, Adidas, Siemens etc.

By definition MNCs must have substantial direct

investment in foreign countries and must be engaged in

the active management of the overseas assets.


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MNC

Typically a MNC develops new products in a home

country, transfer the technology to its subsidiary or a

joint venture and manufactures them in the host country

which will invariably be a third world country, thus

gaining trade advantages and economies of labour,

material and taxation benefits.

Access to low cost production and cost optimization is a

key to the success of a MNC.

The motivation to internationalize the operations stemsfrom the fact of exploiting the advantages of competitive

positioning.


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MNC

Ethnocentric MNCs are those that adopt home oriented

policy and seldom distinguish between domestic

operation and global operation. However, ethnocentric

focuses on race or ethnicity, especially when the home

country itself is populated by many different races.

Polycentric MNCs operate in foreign countries just to

meet the demand for its products, goods and services in

that country and follow a host market oriented policy.

Geocentric MNCs maintain a balance between theEthnocentric and Polycentric and fit between home

market and host market oriented policies.


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MNC

New MNCs do not popup all of a sudden in a foreign

country.

Location of a MNC is the result of conscious planning by

corporate managers.

Generally, investment flows from regions of lowanticipated profits to those of high returns.

A MNC may have reached a plateau satisfying domestic

demand, which is not growing and hence may be looking

for newer markets.

MNC realizes that foreign direct investment is one of the

ways to expand bypassing protective instruments in the

importing country.


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Factors affecting MNCs mobility

When an MNC attempts to maximize its

shareholders wealth, it is confronted with several

constraints that include environmental, regulatory

and ethical issues.

The environmental constraints faced by a MNC

and its subsidiaries located in a foreign country

include violation in the construction of building as

per the local laws, not adhering to the pollutioncontrol norms as stipulated by the state and non-

disposal of production waste as per the

international standards.


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Operating in many countries, MNCs are subject to

multiple tax controls.

They have to pay taxes to several countries in which they

operate as per the applicable tax laws.

The taxation policies and the tax rates are exceedinglycomplex and differ from country to country.

Apart from taxation regime, each country enforces its

own regulatory constraints pertaining to currency

convertibility clauses, earning remittance restrictions,

and other regulations that have a direct bearing on the

profitability of a subsidiary company located in the host

country.


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Since countries have different tax rates, MNCs choose

low tax countries to save, invest, and produce.

Governments may compete to attract MNC enterprises

by offering them lower tax rates and other incentives.

This is called tax competition. Since high tax countries lose lucrative businesses, they

would like to harmonize the tax rates, especially within a

free trade zone or special economic zone.

Both domestic and foreign source income of US

companies are subject to income tax. The US government

taxes both domestic and foreign source incomes of US

based MNCs.


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Another important issue is the ethnic constraints faced

by the MNCs.

A business practice that is considered to be unethical in

one country may be totally ethical in another country.

Margin calls in the forex trade is considered as unethicalin India, while it is perfectly legal in US and all other

European countries.

Payment of bribes by the US based MNCs is considered

an illegal practice in the US. Bribes to government

machineries are a common occurrence in all the third

world countries to conclude a contract or seek favour

from them.


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When MNCs enter a foreign market to sell its products,

the demand for these products is dependent on theeconomic conditions of the host countries.

Classic example is the collapse of the Asian marketduring the year 1997-98. The South Korean Wondepreciated by more than 20% against the dollar,whereas the Indonesian Rupiah depreciated by about80% against the dollar.

When MNCs establish subsidiaries in foreign countriesthey are exposed to all sorts of political risks.

The extreme form risk is the host country changing therules of the game and the affected parties have verylimited options.


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Enron

Enron project : No competitive bidding for the projectthe deal

was negotiated exclusively between the Maharashtra governmentand Enron

Project cost and power tariff higher than other power projects inIndia

Maharashtra State Electricity Board promised to buy all the high-priced power produced by Enron, whether there was demand ornot, and even if cheaper power were available from its owngenerating plants.

These contracted annual payments to Enron would amount to halfof Maharashtras entire budget expenditure. DPC was assured apost tax return of 16 percent on capital investment, and there was

no limit on the capital expenditure Enron could make. Indian economists calculated that the after-tax rate of return would

actually be 32 percent, about three times the average rate in the US

Counter guarantees from the state and central governments forpayments which would have been due to DPC from the MSEB.


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Enron

Contract shields Enron from Indian jurisdiction as all

disputes must be settled under English law in England. Assurance was given that the project would not be

nationalized

Project authorities carried out no environmental impactassessment

Enron paid USD 20 million as educational gifts. Criticsconsider these payments to be bribes to clear the project.

Power purchase agreement between the DPC and MSEBwas initially kept secret from the public.

Enrons financing package for Dabhol Phase II, a complextransaction totaling $1.87 billion, won international praiseas one of the best international project financing deals everput together.


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Transnational Corporations

Transnational Corporations (TNCs) operate world wide without being

identified with a home base. TNCs have no borders and the whole world is their home.

Many of these companies have far more power than the nation-statesacross whose borders they operate.

For example, the combined revenues of just General Motors and Ford;the two largest automobile corporations in the world exceed the

combined Gross Domestic Product (GDP) for all of sub-Saharan Africa. The combined sales of Mitsubishi, Mitsui, ITOCHU, Sumitomo,

Marubeni, and Nissho Iwai, Japans top six Sogo Sosha or tradingcompanies, are nearly equivalent to the combined GDP of all of SouthAmerica.

Overall, fifty one of the largest one hundred economies in the worldare TNCs.

The revenues of the top 500 corporations in the U.S. equal about 60 %of the countrys GDP.

Transnational corporations hold 90 % of all technology and productpatents worldwide, and are involved in 70 % of world trade.


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Globalization of Business

Globalization is defined as the reduction of

transaction cost of trans-border movements ofcapital and goods.

The process of globalization not only includesopening up of world trade, development of

advanced means of communication,internationalization of financial markets, growingimportance of MNCs, population migrations andmore generally increased mobility of persons,

goods and capital. The new global economy of the twenty-first

century has transformed the economic, social,educational and political landscape in a profound

and indelible manner.


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Globalization of Business

India clearly lags in globalization.

Over the past decade, FDI flows into India

have averaged around 0.5% of GDP against 5%

for China and 5.5% for Brazil.

Whereas FDI inflows into China now exceeds

USD 100 billion annually, it is only USD 24

billion in the case of India.

Indias share of global trade is similar to that

of the Philippines an economy 6 times smaller

according to IMF estimates.


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Case Study 2

The internet is a global network connectingmillions of computers.

Unlike online services, which are centrally

controlled, the internet is decentralized bydesign.

The advent of internet has ushered in a new

era in international business and has radicallychanged the world.


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Case Study 2

Questions What are the kinds of developments you see ahead?

Has internet ushered in a level playing field anddemocratized the global market?

With internet expected to penetrate every home in thecontinent, will international business assume greatersignificance.

How does MNCs meet up with the ever growing

challenges of internet and modern technologies? With several and political issues looming large over the

MNCs, can they survive in a hostile host country?


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Domestic Enterprise VM

The valuation can be represented as:

nV = [ E ( C F $ , t ) ]

t = 1 ---------------------

( 1 + k) t

Where E(C F $ , t ) represents expected cash flows to bereceived at the end of period t

n represents the number of periods into the future in whichcash flows are received

k represents the required rate of return by the investors.

The actual cash flows in period t represents the fundsreceived by the enterprise less the finds needed to meet theexpense, taxes or ploughing back into the enterprise forpurpose of modernization, diversification or expansion.


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MNC VMm

E ( C F $ , t ) = [E ( C F j , t ) x E ( ER j , t )]

J = 1 CF j , t is the amount of cash flow denominated in a particular

foreign currency j at the end of period t

ER j , tis the exchange rate at which the foreign currency canbe converted into dollar at the end of period t

MNC doing business in two currencies can measure its dollarcash flows by multiplying the expected cash flows with theexpected exchange rate at which the currency could beconverted to dollars and then summing these two products.

If the MNC does not hedge its transactions in foreign

currencies, the expected exchange rate in a given period canbe used in the process of valuation to estimate thecorresponding expected exchange rate at which the foreigncurrency can be converted into dollars in that period.

If the MNC hedges the transactions, the exchange rate atwhich it can hedge can be used in the valuation equation.


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MNC VM

Consider a MNC with its head quarters in the

US that has an expected cash flow of USD

500,000 from business in the home country

and Rs. 8 crores from business in India at theend of period t. Determine the expected

dollar cash flow of the MNC if the rupee value

is expected to be USD 0.0158.


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MNC VM

E ( C F $ , t ) = [E ( C F j , t ) x E ( ER j , t )]

= (USD 500,00) + (INR 80,000,000 x 0.0158)

= (USD 500,000) + (USD 1,264,000)

= USD 1,764,000

IFM Lesson 3

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