An international acquisition of a business is similar to other international projects: it requires an initial outlay and is expected to generate cashflows whose present value will exceed the initial cash outlay. Global consolidation and market share are two possible motivations for international restructuring and acquisition. Some U.S. multinational firms that have acquired internationally during the recent years are Ford Motor Company, Dow Chemical Company and Rockwell International.
As against establishing a new subsidiary, international acquisitions have some distinct advantages: they take less time, and can benefit from customer relations that have already been established. These incremental benefits have to be traded off against the incremental costs of such acquisitions. International acquisitions usually generate quicker and larger cash flows but also require a larger initial outlay. International acquisitions also require aligning the parent’s management style with that of the acquired firm.
The volume of foreign acquisitions of U.S. firms has increased continuously since 1993. European firms have been the most likely targets due to more uniform regulations across countries in the European Union, the rapid change towards privatization in Eastern Europe, and the emergence of a single currency in the Eurozone.
Valuation of a foreign target
The multinational parent would only consider investing in a target if the foreign target’s value can be estimated as positive, i.e., only if the estimated PV of the cashflows it would ultimately receive from the target over time exceeds the intitial outlay necessary to purchase the target. Thus, capital budgeting analysis can be used to determine whether a firm should be acquired. The PV of cashlfows would be made up of the PV of cashflow to be generated by the target for the acquiring firm as well as the PV of the salvage value of the target, which is the expected selling price of the target at a point in the future.
The capital budgeting analysis of a foreign target must account for the relevant exchange rate values. For example, the dollar initial outlay needed by the US firm is determined by the acquisition price in foreign currency units and the spot exchange rate for the foreign currency in HC / FC units. The dollar amounts of cashflows to the US firm is determined by the foreign currency cashflows remitted to the US per year and the spot exchange rate from year to year. Similarly, the dollar amount of salvage value to the US firm is determined by the salvage value in FC units and the spot rate at the time when it is converted into dollars.
Of course, this simple valuation model ignores any withholding taxes or blocked-fund restrictions imposed by the host government and any income taxes imposed by the US government. These aspects that we have studied earlier need to be incorporated to refine this valuation model of a foreign target for the real world.
Expected Cashflows of Foreign Target
Several factors need to be taken into account that reflect conditions in the country of the foreign target as well as conditions for the target itself. These factors may be broadly classified into:
a) Target-specific factors
b) Country-specific factors
a) Target-specific factors
i. Target’s previous cashflows: Since the foreign target has already been in business, it is sometimes easier to estimate its future cashflows than cashflows generated from a new subsidiary. Previous cashflows have to be used as a basis for projecting future cashflows together with future exchange rates.
ii. Managerial capability: On acquiring a foreign target, the acquiring multinational has several choices available for managing the business. Allow the target to be managed as it was before the acquisition, downsize the target firm after acquiring the business, or maintain the existing employees of the target but restructure the operations so that labor efficiency is better than before. The alternative chosen will affect the estimated cashflows generated by the target.
b) Country-specific factors
i. Economic conditions: primarily determine market demand in the target market. If the target market for the acquired firm’s products is in a different country, economic conditions are less relevant.
ii. Political conditions: the more favorable they are, the less likely the target’s cash-flows are variable. Country or political risk will be dealt with when we move on to that topic in a separate session.
iii. Industry conditions: essential characteristics of the industry to which your acquired business belongs are positive growth and limited competition. Industry conditions may decide the country.
iv. Currency conditions: ideally, the target is located in a weak currency country so costs are low, where the currency is expected to strengthen as the target starts to remit profits to the parent.
v. Market conditions: may result in substantial swings in the stock price of the acquired firm and thus affect the price paid for the target, especially in emerging markets.
vi. Corporate taxes: in assessing the value of a foreign target, an MNC must estimate the expected after-tax cashflows that it will ultimately receive in the form of remitted funds to the parent.
Most MNCs that consider acquiring a specific target will use a quite similar process for valuing the target. Nevertheless, their valuations will differ because of differences in the way the MNCs estimate the key determinants of a target’s valuation, such as cashflows to be generated by the target, exchange rate effects on funds remitted to the MNC’s parent, and the required rate of return when investing in the target. It is possible that depending on the treatment the valuation differs between different acquirers
As against establishing a new subsidiary, international acquisitions have some distinct advantages: they take less time, and can benefit from customer relations that have already been established. These incremental benefits have to be traded off against the incremental costs of such acquisitions. International acquisitions usually generate quicker and larger cash flows but also require a larger initial outlay. International acquisitions also require aligning the parent’s management style with that of the acquired firm.
The volume of foreign acquisitions of U.S. firms has increased continuously since 1993. European firms have been the most likely targets due to more uniform regulations across countries in the European Union, the rapid change towards privatization in Eastern Europe, and the emergence of a single currency in the Eurozone.
Valuation of a foreign target
The multinational parent would only consider investing in a target if the foreign target’s value can be estimated as positive, i.e., only if the estimated PV of the cashflows it would ultimately receive from the target over time exceeds the intitial outlay necessary to purchase the target. Thus, capital budgeting analysis can be used to determine whether a firm should be acquired. The PV of cashlfows would be made up of the PV of cashflow to be generated by the target for the acquiring firm as well as the PV of the salvage value of the target, which is the expected selling price of the target at a point in the future.
The capital budgeting analysis of a foreign target must account for the relevant exchange rate values. For example, the dollar initial outlay needed by the US firm is determined by the acquisition price in foreign currency units and the spot exchange rate for the foreign currency in HC / FC units. The dollar amounts of cashflows to the US firm is determined by the foreign currency cashflows remitted to the US per year and the spot exchange rate from year to year. Similarly, the dollar amount of salvage value to the US firm is determined by the salvage value in FC units and the spot rate at the time when it is converted into dollars.
Of course, this simple valuation model ignores any withholding taxes or blocked-fund restrictions imposed by the host government and any income taxes imposed by the US government. These aspects that we have studied earlier need to be incorporated to refine this valuation model of a foreign target for the real world.
Expected Cashflows of Foreign Target
Several factors need to be taken into account that reflect conditions in the country of the foreign target as well as conditions for the target itself. These factors may be broadly classified into:
a) Target-specific factors
b) Country-specific factors
a) Target-specific factors
i. Target’s previous cashflows: Since the foreign target has already been in business, it is sometimes easier to estimate its future cashflows than cashflows generated from a new subsidiary. Previous cashflows have to be used as a basis for projecting future cashflows together with future exchange rates.
ii. Managerial capability: On acquiring a foreign target, the acquiring multinational has several choices available for managing the business. Allow the target to be managed as it was before the acquisition, downsize the target firm after acquiring the business, or maintain the existing employees of the target but restructure the operations so that labor efficiency is better than before. The alternative chosen will affect the estimated cashflows generated by the target.
b) Country-specific factors
i. Economic conditions: primarily determine market demand in the target market. If the target market for the acquired firm’s products is in a different country, economic conditions are less relevant.
ii. Political conditions: the more favorable they are, the less likely the target’s cash-flows are variable. Country or political risk will be dealt with when we move on to that topic in a separate session.
iii. Industry conditions: essential characteristics of the industry to which your acquired business belongs are positive growth and limited competition. Industry conditions may decide the country.
iv. Currency conditions: ideally, the target is located in a weak currency country so costs are low, where the currency is expected to strengthen as the target starts to remit profits to the parent.
v. Market conditions: may result in substantial swings in the stock price of the acquired firm and thus affect the price paid for the target, especially in emerging markets.
vi. Corporate taxes: in assessing the value of a foreign target, an MNC must estimate the expected after-tax cashflows that it will ultimately receive in the form of remitted funds to the parent.
Most MNCs that consider acquiring a specific target will use a quite similar process for valuing the target. Nevertheless, their valuations will differ because of differences in the way the MNCs estimate the key determinants of a target’s valuation, such as cashflows to be generated by the target, exchange rate effects on funds remitted to the MNC’s parent, and the required rate of return when investing in the target. It is possible that depending on the treatment the valuation differs between different acquirers