Volume 19, Number 1 Article by Ravi Anshuman March, 2007
Cross-border Investments in Emerging Markets: A Valuation Perspective — Discussion :
Significant amounts of capital are flowing from the developed world to emerging markets. But how do firms in the developed world value investment opportunities and allocate capital in emerging markets? How do they adjust for risk and differences in institutional environments across borders? IIMB Management Review invited a panel comprising management practitioners, academics and other stakeholders to discuss the issues and challenges associated with cross border investment.
Amit Sharma, CFO, IBM India, explained the attractions of emerging markets to transnational companies – higher rates of growth and return, potential opportunity, economic efficiencies through access to resources at competitive prices, incentives from export-oriented governments and the opportunity to diversify risk through geographic expansion. IBM contrasts the financial/economic underpinnings of different countries before investing in them, and defines markets across the globe by the business and not by country boundaries. Sharma also detailed IBM’s recent transformation as a business, where the company divested low growth, low margin, commoditising product lines, concentrating on annuity streams and transactional business, saying that despite risk-assessment and valuation methodologies, the investment or divestment decision was driven primarily by company strategy.
V Ganesh, CFO, Trianz, emphasised that the difference between US/Europe and emerging markets in the use of discounted cash flow (DCF) valuation models lies in the choice of Betas, the cost of capital, the quality of information and the need to factor in several risks. Interestingly, the Emerging Market Private Equity Association Survey of 2006 showed a return expectation of 16.9% from US markets and a premium of 5.8% to 9% over US returns across emerging markets. In a probabilities weighted scenario, the house concluded, the DCF numbers were only indicative and it was critical to reconcile them with ‘gut feeling’.
T S T Ramanujam, VP, Finance, Serviont Global Solutions, a mid-size company in the contact centre optimisation space, recounted his experience of acquiring a software product company in the US. Indranil Chowdhury, CFO, Volvo India, brought in the manufacturing industry perspective, where investment decisions are contingent upon logistics – where the materials come from and where the markets are located, the ability to leverage core technology strengths, processes, manpower resource deployment, fiscal incentives, the regulatory framework, risk evaluation and corporate governance. The application of option pricing techniques in industry practice, the valuation of qualitative factors, and the convergence of valuation complexities between manufacturing and services came in for discussion.
While economic and political factors guide the choice of the investment country, in executing that decision, as H Padamchand Khincha, Chartered Accountant, detailed, companies look into the most efficient mechanism of entering the destination country, and removing capital or income from it. Capital flows, exit options, the tax regime of the destination country and the treaty network play a very important part. ‘Treaty shopping’ involves much expertise since in the actual performance, the contract is broken up into targets which are performed from different countries depending upon the concessions extended. Holding company legislations and Special Economic Zones are means employed by governments to encourage investment.
K Ramakrishnan, CEO, Spark Capital Advisors (India), used vital statistics to look at the critical drivers of capital flow, the investment criteria in different markets, the risk paradigm, mechanisms and models to price risks across countries, and a valuation framework in emerging markets. The booming stock markets and appreciating local currencies vis-à-vis diminishing yields in the developed markets, the low long term interest rates in developed economies presenting a risk adjusted interest arbitrage opportunity, the improvement in economic fundamentals in emerging markets, the relaxed capital controls and remittance regulations and the improved ability among fund managers to facilitate the risk management environment have all contributed to the healthy capital flow.
Reprint No 07107
