The U.S. mergers-and-acquisitions market took a body blow in the last two quarters of last year, and its recovery has been slow. But the international game is more vibrant than ever. Foreign direct investment (FDI) surged to the highest level ever recorded in 2007, according to the most recent data from the United Nations Conference on Trade and Development. The developing economies posted 16 percent FDI growth, led by China and Brazil, with inflows of $122 billion and $37 billion respectively. While greenfield projects account for a sizeable slice of FDI in the emerging markets, it’s clear that the M&A opportunities are enticing to global-minded companies.
Investing in a business in an emerging economy poses significant challenges, not least around establishing a value for the asset. Valuing things like goodwill and intellectual property can be a thorny enough problem even in familiar environments, but the difficulties mount in the developing world. A new report from Deloitte Financial Advisory Services identifies four areas that companies should examine closely before signing on the dotted line.
1. Identifying multiple -- and shifting -- risks.
The range of exposures is large, and includes many that may be unfamiliar. Companies may need to assess sovereign risk in countries where leadership is uncertain -- Thailand, for example. Operational risks may take forms that are uncommon in the West; in India for example, one company that wanted to build a manufacturing facility found that it had to contribute to site planning and road building because of the slow pace of infrastructure development.
Infrastructure is a key factor in considering business continuity risks, too. Emerging economies are more susceptible to disruptions and violence, and they tend to bounce back more slowly than developed economies do.
Some of the support systems that companies are accustomed to may be lacking in developing nations. Communications systems may be inadequate. Banks may be government-run or newly privatized.
Once they’ve surveyed the risks, companies should quantify them using methodologies such as probability-adjusted analyses and by applying country risk indices.
2. Relying on the here and now -- not the past.
Sometimes there isn’t much in the way of historical data that companies can call on to calculate their multiples, simply because companies in developing nations have only recently opened up to new ways of doing business. Consumer behavior may be in flux, too. In China, for example -- in stark contrast to the West -- many consumers actually make deposits to their credit card accounts and then use that positive balance to pay for purchases. But who knows how long that will continue?
Companies can pick up tips for how these dynamic markets will shape up by looking at comparable, but more advanced, economies in the same region.
3. Translating value when the usual economic models don’t apply. Assumptions about how economies are structured may not apply in the developing world. U.S. companies are used to the Federal Reserve managing the economy through changes in the bank lending rate. But in China the preferred approach is to adjust the reserve requirement, which can complicate forecasts of inflationary impacts. Currency devaluations and government price controls, as in Argentina during the 1980s and 1990s, can wreck projections.
4. Negotiating differences in culture and communications.
Some cultural factors may raise unexpected difficulties in the due diligence process. For example, the notion of “intangible asset” is an unfamiliar one in some regions. Communication challenges may extend beyond language differences; for instance, non-managerial employees within a company may not have access to corporate e-mail.