Foreign Direct Investment and Cross-Border Acquisitions • Foreign Direct Investment often involves the establishment of production facilities abroad. • Greenfield Investment • Involves building new facilities from the ground up. • Cross-Border Acquisition • Involves the purchase of an existing business.
Why Firms Invest Overseas? • Trade Barriers – Farley/NB • Labor Market • Intangible Assets • Vertical Integration • Product Life Cycle • Shareholder Diversification
Trade Barriers • Government action leads to market imperfections. • Tariffs, quotas, and other restrictions on the free flow of goods, services and people. • Trade Barriers can also arise naturally due to high transportation costs, particularly for low value-to-weight goods.
Labor Market Imperfections • If there exist restrictions on the flow of workers across borders, then labor services can be over or underpriced relative to productivity, major debate – flow freely, or protect? • Labor rates are varied dramatically across the global society.
Intangible Assets • Coca-Cola has a very valuable asset in its closely guarded “secret formula”. • To protect that proprietary information, Coca-Cola has chosen FDI over licensing. What risk in franchising? Piracy? • Since intangible assets are difficult to package and sell to foreigners, MNC’s often enjoy a comparative advantage with FDI. • Pepsi, Nike and Intel
Vertical Integration • MNCs may undertake FDI in countries where inputs are available in order to secure the supply of inputs at a stable accounting price. • Vertical integration may be backward or forward: • Backward: a furniture maker buying a logging company. • Forward: a U.S. auto maker buying a Japanese auto dealership. • What about horizontal integration?
Product Life Cycle • U.S. firms develop new products in the developed world for the domestic market, and then markets expand overseas. • FDI becomes important when products become mature in their home country and lower costs becomes an increasingly important consideration for the MNC to enter other global markets.
exports imports exports imports Product Life Cycle The U.S. production Quantity consumption New product Maturing product Standardized product Less advanced countries consumption Quantity production New product Maturing product Standardized product
Product Life Cycle • The Product Life Cycle theory was developed in the 1960s when the U.S. was the unquestioned leader in R&D and product innovation. • Production facilities may be located in multiple countries from product inception; at least supply grows exponentially.
Shareholder Diversification • Firms may be able to provide indirect diversification to their shareholders if there exists significant barriers to the cross-border flow of capital. Farley/NB.
Cross-Border Mergers & Acquisitions • Greenfield Investment • Building new facilities from the ground up. • Cross-Border Acquisition • Purchase of existing business. • Cross-Border Acquisition represents about 50% of FDI flows. • Cross-border acquisitions are a politically sensitive issue: • Greenfield investment is usually welcome. • Cross-border acquisition is often unwelcome.
Political Risk and FDI • Macro Risk • All foreign operations put at risk due to adverse political developments. • Micro Risk • Selected foreign operations put at risk due to adverse political developments
Political Risk • Operational Risk • Uncertainty regarding host countries policies on firm’s operations. • Control Risk • Uncertainty regarding expropriation.
Hedging Political Risk • Geographic diversification • “Don’t put all of your eggs in one basket.” • Minimize exposure • Form joint ventures with local companies. • Local government may be less inclined to expropriate assets from their own citizens. • Join a consortium of international companies to undertake FDI. • Local government will probably not expropriate assets from a variety of countries all at once. • Finance projects with local borrowing.
Hedging Political Risk • Insurance • The inconvertibility of foreign currencies. • Expropriation of U.S.-owned assets. • Destruction of U.S.-owned physical properties due to war, revolution, and other violent political events in foreign countries. • Loss of business income due to political violence
International Capital Structure and the Cost of Capital • The cost of capital is the minimum rate of return an investment project must generate in order to pay its financing costs.
Klocal Kglobal IRR Ilocal Iglobal MNC’s Investment Decision and the Cost of Capital • An MNC that can reduce its cost of capital will increase the profitable capital expenditures that the MNC can take on and increase the wealth of the shareholders. • Internationalizing the firm’s cost of capital is such a policy. cost of capital (%) Investment ($)
Cross-Border Listings of Stocks Benefits: 1. which will lead to a higher stock price and lower cost of capital. 2. Cross-listing creates a secondary market for the company’s shares, which facilitates raising new capital in foreign markets. 3. Cross-listing can enhance the liquidity of the company’s stock. 4. Cross-listing enhances the visibility of the company’s name and its products in foreign marketplaces.
Cross-Border Listings of Stocks • Risks: • It can be costly to meet the disclosure and listing requirements imposed by the foreign exchange and regulatory authorities. • Once a company’s stock is traded in overseas markets, there can be volatility spillover from these markets. • Once a company’s stock is make available to foreigners, they might acquire a controlling interest and challenge the domestic control of the company.
The Effect of Foreign Equity • While companies have incentives to internationalize their ownership structure to lower the cost of capital and increase market share, they may be concerned with the possible loss of corporate control to foreigners. • In some countries, there are legal restrictions on the percentage of a MNC that foreigners can own. • These restrictions are imposed as a means of ensuring domestic control of local firms.
Stock Valuations – Private MNC Revenue - Cost of goods Gross profit - Operating expenses Accountants EBIT or operating income vs. - Interest Finance EBT - Tax Net income
Stock Valuations – Private MNC Net income Add: Depreciation and amortization = Cash flow from operations Valuation and price per share: X 3 = Normal price (street) X 4, X 5 = add goodwill X 6, X 7 = extraordinary product or market (goodwill)
Stock Valuations – Private MNC Cash flow from operations X 3 – X 5 = Valuation or price of the company Divided by Shares Outstanding = Share Price In sum, if you owned 30% of the shares outstanding, 30% X Valuation = your worth in the company, or your shareholder value.
Stock Valuations – Public MNC Valuation of common stockholders equity = traded share price X shares outstanding. Capitalization. Purchase a controlling interest. Your net worth or valuation of shareholders equity = traded share price X your shares outstanding (held).
Stock Valuations – Public MNC • http://finance.yahoo.com/q?s=DELL • http://yahoo.brand.edgar-online.com/displayfilinginfo.aspx?FilingID=7135174-241034-493520&type=sect&dcn=0000950123-10-025998
Stock Valuations – Public MNC In finance, the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of return. • Expected return and systematic risk (beta),- Reuters. In sum, shareholder = risk free + beta risk. Financial analyst – EPS to P/E plus B risk. • undervalued stock or asset today (usually P/E is low) selling lower than expected rate of return including Beta. • Overvalued (usually P/E is too high – 2001), selling at a price above expected return including Beta.
GM Shareholders • State Street Bank and Trust, GM's largest shareholder, boosted its stake by 400,387 shares. • Capital Research, the second-largest shareholder, slashed its stake by 24% and Brandes Investment Partners, the third-largest, sold 4% of its holding. • Kirk Kerkorian's Tracinda Corp. is the fourth-largest shareholder
GM Shareholders • Southeastern Asset Management is GM's fifth-largest shareholder. Its Longleaf Partners Fund is maintaining its 14.2-million share holding. But Southeastern trimmed its other (non-Longleaf) GM holdings by 145,000 shares. • 5 investment companies control GM, really one Kirk Kerkorian's Tracinda Corp.
Valuation of a Company • EBITDA X 3 • Cash flow from operations X 5 – 7 • DCF of future cash flows (NPV) • Asset buy • Stock buy • Publicly traded stock, higher multiples • Lyle Casbrick • Wall Street Road Shows, White Knight vs. Venture Capital • Real world valuations - problems
Valuation of a Company • Opportunity cost of capital • Risk free plus risk and risk vs. return • Goodwill • Intellectual property • P/E • ROI • EPS • Capital appreciation and dividends • Distressed company, not a going concern • CAPM – discount rate and risk • WACC – discount rate • Due diligence
Cost of Capital • The cost of capital is the minimum rate of return an investment projected generates in order to pay its financing costs. • NPV, IRR and EVA all need to exceed the cost of capital • Weighted Average Cost of Capital – after tax borrowing cost and the cost of equity capital.
Cost of Debt Capital • Commercial paper • Line of credit • Short term notes payable • Long term notes payable • Mortgage payable • Bonds payable • Notes are at Face value, and may be sold after underwriting. • Bonds mature at face value, and are traded and valued inversely with interest rate fluctuations.
Cost of Debt Capital • Subordinated debt • Convertible subordinated debt (warrant, options) • Warrant and options trade • Why these securities? • Issued often in start ups.
Cost of Equity Capital • The cost of equity capital is the expected return on a company’s stock that investors require. • Capital Asset Pricing Model (CAPM) = Risk free rate of return plus risk (expected rate of return – risk free rate) x beta. • Beta = systematic risk, which is the risk the this stock does not move with the market.
Cost of Equity Capital - Example: 1. US Beta IBM = 1.0 which is the average B risk level, meaning = to the market. 2. Expected rate of return = 12%. 6% for the risk, then extra volatility (B). 3. U.S. Treasury bill = 6%. CAPM = 6% + (12% - 6%)(1.0) = 12%. Real world = 6% + 6% = 12%. Cost of equity capital = return on investment (ROI) to the shareholder, e.g. share purchase of $100.00, earnings of $12.00 = 12%.
Cost of Equity Capital • IBM MNC, with access to the international markets ensuing diversification i.e. less risk, now has a beta measure of .8. CAPM = 6% + (12%- 6%)(.8) = 10.8%.
Beta • Its returns with that of the financial market as a whole. • Beta can be estimated for individual companies using regression analysis against a stock market index. • Published betas typically use a stock market index such as S&P 500 as a benchmark.
Beta • B= COV (Ra, Rp) Var (Rp) • Ra = rate of return of the asset • Rp = rate of return of the portfolio • Reuters provides Betas • Regression analysis • What security is B = 0?
Preferred Stock • Preferred stock, coupon dividends, may or may participate in common dividends. • Convertible preferred stock • Why preferred stock? • Legally, if in arrears? At liquidation?
Problems • Cost of equity – Chapter 17 • WACC • NPV, IRR, EVA • The real world makes investments, valuations and costs fundamental.
Refinancing Shangai GM • Start-up, growth to maturity and now maturity • Introduction - a little longer than normal - tell some of the GM story, where they are today, in financial and other terms, e.g. unions. tarp etc. Then lead into the core of the case. • Who is GM’s partner? • Back to slide 27.
Refinancing Shangai GM • Why did the CFO refinance – market in China became more diversified, larger and Interest rates had declines. This is the CFO’s responsibility. • Page 1 – groups job, same as CFO – weave a story and present with compelling figures. This is how global finance is conducted. • Page 1 – how is the Company performing during the first few years?
SGM – Refinancing Amount • $ 700 million • SAIC - good contacts with banks in China, mention this as a benefit to MNC and a major foreign shareholder or joint venture partner. • Page 2 – good introduction material. • Page 2 – China and other parts of Asia critical to GM’s plans. Great case for international finance through the eyes of the CFO and board of directors.
Refinancing Shangai GM • Page 2 – middle paragraph, great international financial statement, and a medium luxury car. • Page 2 – how to expand (and grow) internationally i.e. the international financials tools used. Use page 2 to discuss how a MNC used finance for international expansion. • Page 2,3 – loaded with financial strategy of an MNC in Asia and other foreign countries.
SAIC • Government. • Introduction - SAIC • SAIC very active in acquiring shares and joint ventures in the auto industry, including VW, both in auto sales and parts, why?
Refinancing Shangai GM • Page 4 – top financial structure and the two rounds of financing. • Exhibits 3, 4 and 5 – excellent inserts for a visual of the joint venture structure.
Products • Buick Regal • Then the minivan • Henry Ford and Lee Iacocca – any resemblance? • Then to Part II on the outline.
Operating Performance • Page 5 – finance – discuss the operating performance covered in the case. • Exhibits 7,8,9,10 • Exhibits 11,12,13 – good also.
SGM Finance Department • Page 6 – At this juncture in the term – prepare a slide with SGM’s financial organization.