Cross-Border Mergers
and Acquisitions:
Analysis and Valuation
Courage is not the absence of
fear. It is doing the thing you fear
the most.
—Rick Warren
Course Layout: M&A & Other
Restructuring Activities
Part I: M&A
Environment
Part II: M&A
Process
Part III: M&A
Valuation &
Modeling
Part IV: Deal
Structuring &
Financing
Part V:
Alternative
Strategies
Motivations for
M&A
Business &
Acquisition
Plans
Public Company
Valuation
Payment &
Legal
Considerations
Business
Alliances
Regulatory
Considerations
Search through
Closing
Activities
Private
Company
Valuation
Accounting &
Tax
Considerations
Divestitures,
Spin-Offs &
Carve-Outs
Takeover Tactics
and Defenses
M&A Integration
Financial
Modeling
Techniques
Financing
Strategies
Bankruptcy &
Liquidation
Cross-Border
Transactions
Learning Objectives
• Primary Learning Objective: To provide students with an
understanding of how to analyze and value cross-border
M&As
• Secondary Learning Objectives: To provide students with
an understanding of
– Motives for international expansion
– Common international market entry strategies
– Planning and implementing cross-border transactions
in developed countries
– Planning and implementing cross-border transactions
in emerging countries.
– Valuing cross-border transactions
– Empirical studies of financial returns to international
diversification
Globally Integrated Versus
Segmented Capital Markets
• Globally integrated capital markets provide foreigners
with unfettered access to local capital markets and local
residents to foreign capital markets.
• Segmented capital markets
– Exhibit different bond and equity prices in different
geographic areas for identical assets in terms of risk
and maturity.
– Arise when investors are unable to move capital from
one market to another due to capital controls or a
preference for local market investments
Developed Versus Emerging Countries
• Developed countries: Characterized by
– Significant/sustainable per capita GDP growth;
– Globally integrated capital markets;
– Well-defined legal system;
– Transparent financial statements;
– Currency convertibility; and
– Stable government.
• Emerging countries: Characterized by
– A lack of many of the characteristics of developed
countries
Motives for
International Expansion
•
•
•
•
•
•
•
•
•
Geographic and industrial diversification
Accelerating growth
Industry consolidation
Utilization of lower raw material and labor costs
Leveraging intangible assets
Minimizing tax liabilities
Avoiding entry barriers
Avoiding fluctuating exchange rates
Following customers
Common Market Entry Strategies
• Mergers & acquisitions (Offer quick access but often
expensive, complex, and beset by cultural issues)
• Greenfield or solo ventures (May offer above average
returns but total investment is at risk)
• Alliances and joint ventures (Allows risk/cost sharing &
access to other’s resources; may facilitate entry; but
must share profits and creates potential competitors)
• Exporting (Cheaper than establishing local operations
but still requires local marketing/distribution channels)
• Licensing (Least profitable and risky entry strategy and
lack of control could jeopardize brand or trademark)
Discussion Questions
1.
2.
3.
What are the differences between segmented and
globally integrated capital markets? How do these
distinctions affect prices of financial assets of
comparable risk and maturity in various countries?
Of the various motives for international expansion,
which do you believe is the most common and why?
Do you believe that some market entry strategies are
more suitable for emerging than for developed
countries? Explain your answer.
Implementing Cross-Border
Transactions in Developed Countries
• Foreign acquirers of U.S. businesses
– Acquisition vehicle: Often use C-corporations, LLCs, or
partnerships
– Form of payment: Most often cash
– Form of acquisition: Share acquisitions generally the simplest
– Post-merger organization: Centralized organization used to
rapidly realize synergies but decentralized operations used
where cultural differences significant
– Tax strategies:
• Forward triangular merger common for tax-free asset
purchases and reverse triangular merger common for share
acquisitions (latter provides continuity of interests and
business enterprise). Both involve acquirer shares as the
form of payment.
• Forward triangular cash merger common for taxable
transactions
Implementing Cross-Border
Transactions in Developed Countries
Cont’d.
• Acquisitions by U.S. and Non-U.S acquirers of foreign businesses
– Acquisition vehicle: Corporate-like structures in common law
countries; share companies or LLCs in civil law nations
– Form of payment: Generally cash
– Form of acquisition: Share acquisitions generally simplest
– Post-closing organization: Holding company structure if target to
be operated as independent unit or integrated with acquirer’s
existing “in-country” operations
– Tax strategies: Highly complex and vary with local tax and legal
jurisdictions
Implementing Cross-Border
Transactions in Emerging Countries
• Poses challenges not common to developed countries
such as political and economic risks including:
– Excessive local government regulation;
– Confiscatory tax policies;
– Restrictions on cash remittances;
– Currency inconvertibility;
– Expropriation of foreign assets;
– Local corruption; and
– Civil war and local insurgencies
• Managing risk through insurance (e.g., OPIC, World
Bank), contract options (e.g., puts), and credit default
swaps
Valuing Cross-Border Transactions
• Methodology similar to that employed when acquirer and
target in same country
• Basic differences between within country and crossborder include the following:
– Need to convert target cash flow projections into
acquirer home country currency
– Adjusting discount rate for risks uncommon in “within
country” valuations
• Currency conversions made using the Interest Rate
Parity theory if data permit and Purchasing Power Parity
theory if interest rate information unavailable.
Interest Rate Parity Theory
$1 x ($/€)n = $1 x {(1 + R$n)n/(1 + R€n)n} x ($/€)0
Where ($/€)n = Forward $ exchange rate n periods into the future
($/€)0 = $/Euro spot rate
R$n = Interest rate in U.S.
R€n = Interest rate in European Union
1€ x (€/$)n = 1€ x {(1 + R€n)n/(1 + R$n)n} x (€/$)0
Where (€/$)n = Forward Euro exchange rate n periods into the future
(€/$)0 = Euro/$ spot rate
Converting Euro-Denominated into Dollar-Denominated
Free Cash Flows to the Firm Using Interest Rate Parity Theory
Target’s Euro-Denominated
FCFF Cash Flows (€ Millions)
Target Country’s Interest Rate (%)
U.S. Interest Rate (%)
Current Spot Rate ($/€) = 1.2044
Projected Spot Rate ($/€) =
2008
€124.5
2009
€130.7
2010
€136.0
4.50
4.25
4.70
4.35
5.30
4.55
1.2015
1.1964
1.1788
Target’s Dollar-Denominated
$149.59
$156.37
FCFF Cash Flows ($ Millions)
Notes: Calculating the projected spot rate using Interest Rate Parity.
($/€)2008 = {(1.0425)/(1.0450)} x 1.2044 = 1.2015
($/€)2009 = {(1.0435)2/(1.0470)2} x 1.2044 = 1.1964
($/€)2010 = {(1.0455)3/(1.0530)3} x 1.2044 = 1.1788
$160.32
Purchasing Power Parity Theory
($/Peso)n = ((1 + Pus)n/(1 + Pmex)n) x ($/Peso)0
Where ($/Peso)n = Forward $/Peso exchange rate n periods into the future
($/Peso)0 = Spot $/Peso exchange rate
Pus
= Expected U.S. inflation rate
Pmex
= Expected Mexican inflation rate
(Peso/$)n = ((1 + Pmex)n/(1 + Pus)n) x (Peso/$)0
Where (Peso/$)n = Forward Peso/$ exchange rate n periods into the future
(Peso/$)0 = Spot Peso/$ exchange rate
Converting Peso-Denominated Into Dollar Denominated
Free Cash Flows to the Firm Using Purchasing Power Parity Theory
Target’s Peso-Denominated
FCFF Cash Flows (Millions of Pesos)
Mexican Expected Inflation Rate = 6%
U.S. Expected Inflation Rate = 4%
Spot Rate ($/Peso) = .0877
Projected Spot Rate ($/Peso)
Target’s Dollar-Denominated
FCFF Cash Flows (Millions of $)
2008
P1,050.5
2009
P1,124.7
2010
P1,202.7
.0860
.0844
.0828
$90.34
$94.92
$99.58
Notes: Calculating the projected spot rate using Purchasing Power Parity.
($/Peso)2008 = {(1.04)/(1.06)} x .0877 = .0860
($/Peso)2009 = {(1.04)2/(1.06)2} x .0877 = .0844
($/Peso)2010 = {(1.04)3/(1.06)3} x .0877 = .0828
Estimating Cost of Equity for Developed Countries
Developed countries exhibit little differences in cost of equity
because of globally integrated capital markets. Therefore, the Global
CAPM can be written as follows:
ke,dev = Rf + ßdevfirm,global (Rm – Rf) + FSP
Where
ke,dev
= Required return on equity for a firm in a developed
country
Rf
= Local country’s risk-free rate of return if cash flows in
local currency or U.S. treasury bond rate if in dollars
ßdevfirm,global = Nondiversifiable risk for globally diversified portfolio or
well-diversified portfolio highly correlated with the global
portfolio
(Rm – Rf) = Difference in expected return on global market
portfolio, U.S. equity index, or broadly defined index in
the local country and the Rf
FSP
= Premium small firms must earn to attract investors
Estimating Cost of Equity for Emerging Countries
ke,em = Rf + ßemfirm,global (Rcountry – Rf) + FSP + CRP
where
Rf
(Rcountry – Rf)
ßemfirm,global
CRP
FSP
= Local risk free rate or U.S. treasury bond rate converted
to a local nominal rate if cash flows are in the local
currency; if cash flows in dollars, the U.S. treasury
rate
= Difference between expected return on a broadly defined
equity index in the local country or in a similar country
and the risk free rate.
= Emerging country firm’s global beta
= Specific country risk premium expressed as difference
between the local country’s (or a similar country’s)
government bond rate and the U.S. treasury bond rate of
the same maturity.
= Premium small firms must earn to attract investors
Estimating the Cost of Debt
• For developed countries, the target’s local or the acquirer’s home
country cost of debt.
• For emerging countries, the cost of debt (iemfirm) is as follows:
iemfirm = Rf + CRP + FRP
Where
Rf = Risk free rate (see preceding slide.)
CRP = Specific country risk premium (see preceding slide)
FRP = Firm’s default risk premium (i.e., additional premium for similar
firms rated by credit rating agencies or estimated by comparing
interest coverage ratios used by rating agencies to the firm’s
interest coverage ratios to determine how they would rate the
firm.)
Evaluating Emerging Country Risk
Using Scenario Planning
• Risk may be incorporated into the valuation by
considering alternative economic scenarios for the
emerging country.
• Projected cash flows for alternative scenarios could
reflect different GDP growth rates, inflation rates, interest
rates, foreign exchange rates, or alternative political
conditions.
• If risk is included by calculating a weighted average of
alternative scenarios, the discount rate should not be
adjusted for specific country risk.
Discussion Questions
1.
2.
3.
Discuss the primary differences between valuing target
firms’ cash flows in developed versus emerging
countries. Be specific.
Do you agree or disagree with the many adjustments
commonly made to discount rates applied to projected
cash flows of target firms in emerging countries? Be
specific.
In your opinion is it more appropriate to adjust the
discount rate for various perceived risks or to introduce
risk by utilizing alternative scenarios? Explain your
answer.
Things to Remember…
• Motives for international expansion vary widely.
• There are many alternative strategies to M&A for entering foreign
markets.
• Methodology for valuing cross-border transactions is similar to that
employed when both acquirer and target firms are within the same
country.
• Basic difference between valuing firms within the same country and
those involved in cross-border transactions is that the latter involves
converting the target’s projected cash flows form one currency to
another. Also, the discount rate for firms in emerging nations may be
adjusted for risks not normally found in “within country” transactions.
• For developed countries whose capital markets are globally
integrated, a global beta and a global equity premium should be
used to calculate the cost of equity.
• For emerging nations whose capital markets are segmented, a local
beta and equity premium should be used.