Exam 18: Cross-Border Mergers and Acquisitions:

The methodology for valuing cross-border transactions using discounted cash flow analysis is substantially different from that employed when both the acquiring and target firms are within the same country. True of False

In globally integrated markets, it makes little difference whether the ß is calculated by regressing the target firm's (or a similar firm's) historical returns against the returns for a broadly defined global index, U.S. equity market index, or a broadly defined equity index in the target's country.

Nestlé Buys Majority Ownership Stake in Chinese Candy Maker Acquisition often is a more desirable option to a startup in a foreign country. Cross-border acquisitions require substantial patience. The size of the Chinese consumer market makes growth potential highly attractive. ______________________________________________________________________________ After being in negotiations for two years, Swiss giant Nestlé, the world’s largest food company, announced on July 15, 2011, that it had reached an agreement to pay $1.7 billion for a 60% interest in candy maker Hsu Fu Chi International. The remainder of the firm would be owned by the founding Hsu family. This transaction constituted the biggest deal yet for Nestlé in China and one of the biggest in China by a foreign firm. The deal represents Nestlé’s second major purchase in China in 2011, after the firm agreed to buy 60% of the Yinlu Foods Group in April. The agreement called for Nestlé initially to buy 43.5% of the firm’s shares from independent shareholders (i.e., non–founding family and noninstitutional investors) for 4.35 Singapore dollars (equivalent to $3.56 per share), a 24.7 % premium over the six months ending on July 1, 2011, and a 16.5% stake from the Hsu family. Hsu Fu Chi’s current CEO and chairman, Mr. Hsu Chen, would continue to manage the firm. Nestlé paid 3.3 times revenue, as compared to 2.4 times what U.S. food manufacturer Kraft Foods paid for British candy company Cadbury in 2010. However, the deal was less expensive than Mars’ takeover of Wrigley at 4.2 times sales in 2008 and DANONE’s purchase of Dutch rival Numico for 4.5 times sales in 2007. Nestlé justified the multiple of revenue it paid by noting that the investment in Hsu Fu Chi provides an opportunity to become the top player in this high-growth market. In addition, Hsu Fu Chi provides a platform for future acquisitions that could in concept be relatively easily added to its Chinese confectionary operations. Despite having had a presence in China for more than 20 years, Nestlé has found it difficult to grow its distribution system organically (i.e., by reinvesting in its existing operations). As of 2010, Nestlé operated 23 plants and two research centers with more than 14,000 employees in the country, with annual sales of $3.3 billion. Nestlé’s existing product portfolio in China at that time included culinary products, instant coffee, bottled water, milk powder, and other products for the food service industry. With the addition of Hsu Fu Chi, Nestlé’s sales in China jumped to $4.2 billion. Nevertheless, its market share in the food business still lagged that of rivals Unilever and DANONE. With its revenues in China growing at 8% to 10% annually, Nestlé has stated publicly that it intends to derive at least 45% of its total annual revenue from emerging countries by the end of the decade, as compared to about one-third in 2010. Founded in 1992, Hsu Fu Chi has four factories and 16,000 employees in China and is the leading manufacturer and distributor of confectionery products in China. With an estimated 6.6% market share and annual sales of $800 million, the firm makes chocolate, candies, and pastries popular in China and had annual sales of $800 million at the time of the transaction. Profits rose 31% in 2010 to $93 million. Located in the southern Chinese city of Dongguan, the firm operates an extensive distribution network and has numerous retail outlets, which should facilitate the distribution and sale of Nestlé products in China. Hsu Fu’s annual revenue is growing three times faster than Nestlé’s global annual sales. The firm’s direct distribution network forms a large barrier to entry for competitors. With Hsu Fu Chi listed on the Singapore stock exchange, the deal helped unlock value for Hsu Fu Chi’s independent shareholders. As with many Singapore-listed Chinese firms, Hsu Fu Chi’s independent shareholders had seen little appreciation of their holdings in recent years and had found it difficult to sell their shares, given the limited daily trading volume in the market for the firm’s shares. Daily trading volume in the shares averaged about 0.1% of the firm’s market cap. Despite having similar profit margins, Hsu Fu Chi traded at a ratio of 22 times trailing earnings, compared with 28 for comparable firms. With the founding family owing 57% of the shares and Baring Private Equity Asia owning 15%, there were few independent shareholders to whom to sell shares. As the controlling shareholder, the founding family had little incentive to buy out the minority shareholders except at a significant discount from what investors believe is the firm’s true value in order to take the firm private by buying out the public shareholders. Consequently, the independent shareholders had ample reason to support the Nestlé proposal. Hsu Fu Chi, which currently generates all of its revenue in China, may need Nestlé to expand overseas. The firm has stated that it wants to enter the international market, but it may not have the requisite resources to do so. Nestlé’s strong international network and name recognition may make such expansion possible. -Nestle is assuming that it will be able to grow its share of the Chinese confectionary market by a combination of expanding its existing Chinese operations (so-called organic growth) and by acquiring regional candy and food manufacturers. What obstacles do you believe Nestle could encounter in its efforts to expand in China?

The disadvantages of exporting include high transportation costs, exchange rate fluctuations, and possible tariffs placed on imports into the local country.

Firms investing in industries or countries whose economic cycles are highly correlated may lower the overall volatility in their consolidated earnings and cash flows.

Greenfield operations represent an appropriate entry if which of the following is true?

A sometimes overlooked challenge is the failure of the legal system in an emerging country to honor contracts.

In cross-border M&As, acquirer shares often are less attractive to potential targets because of the absence of a liquid market for resale or because the acquirer is not widely recognized by the target firm's shareholders.

In emerging countries where financial statements may be haphazard and gaining access to the information necessary to adequately assess risk is limited, it may be impossible to perform an adequate due diligence. Under these circumstances, acquirers may protect themselves by including a put option in the agreement of purchase and sale. Such an option would enable the buyer to require the seller to repurchase shares from the buyer at a predetermined price under certain circumstances.

Nestlé Buys Majority Ownership Stake in Chinese Candy Maker Acquisition often is a more desirable option to a startup in a foreign country. Cross-border acquisitions require substantial patience. The size of the Chinese consumer market makes growth potential highly attractive. ______________________________________________________________________________ After being in negotiations for two years, Swiss giant Nestlé, the world’s largest food company, announced on July 15, 2011, that it had reached an agreement to pay $1.7 billion for a 60% interest in candy maker Hsu Fu Chi International. The remainder of the firm would be owned by the founding Hsu family. This transaction constituted the biggest deal yet for Nestlé in China and one of the biggest in China by a foreign firm. The deal represents Nestlé’s second major purchase in China in 2011, after the firm agreed to buy 60% of the Yinlu Foods Group in April. The agreement called for Nestlé initially to buy 43.5% of the firm’s shares from independent shareholders (i.e., non–founding family and noninstitutional investors) for 4.35 Singapore dollars (equivalent to $3.56 per share), a 24.7 % premium over the six months ending on July 1, 2011, and a 16.5% stake from the Hsu family. Hsu Fu Chi’s current CEO and chairman, Mr. Hsu Chen, would continue to manage the firm. Nestlé paid 3.3 times revenue, as compared to 2.4 times what U.S. food manufacturer Kraft Foods paid for British candy company Cadbury in 2010. However, the deal was less expensive than Mars’ takeover of Wrigley at 4.2 times sales in 2008 and DANONE’s purchase of Dutch rival Numico for 4.5 times sales in 2007. Nestlé justified the multiple of revenue it paid by noting that the investment in Hsu Fu Chi provides an opportunity to become the top player in this high-growth market. In addition, Hsu Fu Chi provides a platform for future acquisitions that could in concept be relatively easily added to its Chinese confectionary operations. Despite having had a presence in China for more than 20 years, Nestlé has found it difficult to grow its distribution system organically (i.e., by reinvesting in its existing operations). As of 2010, Nestlé operated 23 plants and two research centers with more than 14,000 employees in the country, with annual sales of $3.3 billion. Nestlé’s existing product portfolio in China at that time included culinary products, instant coffee, bottled water, milk powder, and other products for the food service industry. With the addition of Hsu Fu Chi, Nestlé’s sales in China jumped to $4.2 billion. Nevertheless, its market share in the food business still lagged that of rivals Unilever and DANONE. With its revenues in China growing at 8% to 10% annually, Nestlé has stated publicly that it intends to derive at least 45% of its total annual revenue from emerging countries by the end of the decade, as compared to about one-third in 2010. Founded in 1992, Hsu Fu Chi has four factories and 16,000 employees in China and is the leading manufacturer and distributor of confectionery products in China. With an estimated 6.6% market share and annual sales of $800 million, the firm makes chocolate, candies, and pastries popular in China and had annual sales of $800 million at the time of the transaction. Profits rose 31% in 2010 to $93 million. Located in the southern Chinese city of Dongguan, the firm operates an extensive distribution network and has numerous retail outlets, which should facilitate the distribution and sale of Nestlé products in China. Hsu Fu’s annual revenue is growing three times faster than Nestlé’s global annual sales. The firm’s direct distribution network forms a large barrier to entry for competitors. With Hsu Fu Chi listed on the Singapore stock exchange, the deal helped unlock value for Hsu Fu Chi’s independent shareholders. As with many Singapore-listed Chinese firms, Hsu Fu Chi’s independent shareholders had seen little appreciation of their holdings in recent years and had found it difficult to sell their shares, given the limited daily trading volume in the market for the firm’s shares. Daily trading volume in the shares averaged about 0.1% of the firm’s market cap. Despite having similar profit margins, Hsu Fu Chi traded at a ratio of 22 times trailing earnings, compared with 28 for comparable firms. With the founding family owing 57% of the shares and Baring Private Equity Asia owning 15%, there were few independent shareholders to whom to sell shares. As the controlling shareholder, the founding family had little incentive to buy out the minority shareholders except at a significant discount from what investors believe is the firm’s true value in order to take the firm private by buying out the public shareholders. Consequently, the independent shareholders had ample reason to support the Nestlé proposal. Hsu Fu Chi, which currently generates all of its revenue in China, may need Nestlé to expand overseas. The firm has stated that it wants to enter the international market, but it may not have the requisite resources to do so. Nestlé’s strong international network and name recognition may make such expansion possible. -Why do you believe the independent and non-institutional shareholders in Hsu Fu Chi, whose shares were listed on the Singapore stock exchange, were willing to sell to Nestle? What were their other options?

M&A practitioners utilize nominal cash flows except in circumstances of high rates of inflation, when real cash flows are preferable.

Political Risk in Cross-Border Transactions-CNOOC's Aborted Attempt to Acquire Unocal In what may be the most politicized takeover battle in U.S. history, Unocal announced on August 11, 2005, that its shareholders approved overwhelmingly the proposed buyout by Chevron. The combined companies would produce the equivalent of 2.8 million barrels of oil per day and the acquisition would increase Chevron's reserves by about 15 percent. With both companies owning assets in similar regions, it was easier to cut duplicate costs. The deal also made Chevron the top international oil company in the fast growing Southeast Asia market. Unocal is much smaller than Chevron. As a pure exploration and production company, Unocal had operations in nine countries. Chevron operated gas stations, drilling rigs, and refineries in 180 countries. Sensing an opportunity, Chevron moved ahead with merger talks and made an all-stock $16 billion offer for Unocal in late February 2005. Unocal rebuffed the offer as inadequate and sought bids from China's CNOOC and Italy's ENI SPA. While CNOOC offered $17 billion in cash, ENI was willing to offer only $16 billion. Chevron subsequently raised its all-stock offer to $16.5 billion, in line with the board's maximum authorization. Hours before final bids were due, CNOOC informed Unocal it was not going to make any further bids. Believing that the bidding process was over, Unocal and Chevron signed a merger agreement on April 4, 2005. The merger agreement was endorsed by Unocal's board and cleared all regulatory hurdles. Despite its earlier reluctance, CNOOC boosted its original bid to $18.5 billion in late June to counter the Chevron offer. About three fourths of CNOOC's all-cash offer was financed through below-market-rate loans provided by its primary shareholder, the Chinese government. On July 22, 2005, Chevron upped its offer to $17.7 billion, of which about 60 percent was in stock and 40 percent in cash. By the time Unocal shareholders actually approved the deal, the appreciation in Chevron's stock boosted the value of the deal to more than $18.1 billion. CNOOC's all-cash offer of $67 per share in June sparked instant opposition from members of Congress, who demanded a lengthy review by President George W. Bush and introduced legislation to place even more hurdles in CNOOC's way. Hoping to allay fears, CNOOC offered to sell Unocal's U.S. assets and promised to retain all of Unocal's workers, something Chevron was not prone to do. CNOOC also argued that its bid was purely commercial and not connected in any way with the Chinese government. U.S. lawmakers expressed concern that Unocal's oil drilling might have military applications and CNOOC's ownership structure (i.e., 70 percent owned by the Chinese government) would enable the firm to secure low-cost financing that was unavailable to Chevron. The final blow to CNOOC's bid was an amendment to an energy bill passed in July requiring the Departments of Energy, Defense, and Homeland Security to spend four months studying the proposed takeover before granting federal approval. Perhaps somewhat naively, the Chinese government viewed the low-cost loans as a way to "recycle" a portion of the huge accumulation of dollars it was experiencing. While the Chinese remained largely silent through the political maelstrom, CNOOC's management appeared to be greatly surprised and embarrassed by the public criticism in the United States about the proposed takeover of a major U.S. company. Up to that point, the only other major U.S. firm acquired by a Chinese firm was the 2004 acquisition of IBM's personal computer business by Lenovo, the largest PC manufacturer in China. While the short-term effects of the controversy appear benign, the long-term implications are less clear. It remains to be seen how well international business and politics can coexist between the world's major economic and military superpower and China, an emerging economic and military superpower in its own right. Cross-border transactions often require considerable political risk. In emerging countries, this is viewed as the potential for expropriation of property or disruption of commerce due to a breakdown in civil order. However, as CNOOC's aborted effort to takeover Unocal illustrates, foreign firms have to be highly sensitive to political and cultural issues in any host country, developed or otherwise. -The U.S. and European firms are making substantial investments (including M&As) in China. How should the Chinese government react to this rebuff?

The decision to buy political risk insurance depends on the size of the investment and the perceived level of political and economic risk.

Arcelor Outbids ThyssenKrupp for Canada's Dofasco Steelmaking Operations Arcelor Steel of Luxembourg, the world's second largest steel maker, was eager to make an acquisition. Having been outbid by Mittal, the world's leading steel firm, in its efforts to buy Turkey's state-owned Erdemir and Ukraine's Kryvorizhstal, Guy Dolle, Arcelor's CEO, seemed determined not to let that happen again. Arcelor and Dofasco had been in talks for more than four months before Arcelor decided to initiate a tender offer on November 23, 2005, valued at $3.8 billion in cash. Dofasco, Canada's largest steel manufacturer, owned vast coal and iron ore reserves, possessed a nonunion workforce, and sold much of its steel to Honda assembly plants in the United States. The merger would enable Arcelor, whose revenues were concentrated primarily in Europe, to diversify into the United States. Contrary to their European operations, Arcelor found the flexibility offered by Dofasco's nonunion labor force highly attractive. Moreover, by increasing its share of global steel production, Arcelor's management reasoned that it would be able to exert additional pricing leverage with both customers and suppliers. Serving the role of "white knight," Germany's ThyssenKrupp, the sixth largest steel firm in the world, offered to acquire Dofasco one week later for $4.1 billion in cash. Dofasco's board accepted the bid, which included a $187 million breakup fee should another firm acquire Dofasco. Investors soundly criticized Dofasco's board for not opening up the bidding to an auction. In its defense, the board expressed concern about stretching out the process in an auction over several weeks. In late December, Arcelor topped the ThyssenKrupp bid by offering $4.2 billion. Not to be outdone, ThyssenKrupp matched the Arcelor offer on January 4, 2006. The Dofasco board reaffirmed its preference for the ThyssenKrupp bid, due to the breakup fee and ThyssenKrupp's willingness (unlike Arcelor) to allow Dofasco to continue to operate under its own name and management. In a bold attempt to put Dofasco out of reach of the already highly leveraged ThyssenKrupp, Arcelor raised its bid to $4.8 billion on January 16, 2006. This bid represented an approximate 80 percent premium over Dofasco's closing share price on the day Arcelor announced its original tender offer. The Arcelor bid was contingent on Dofasco withdrawing its support for the ThyssenKrupp bid. On January 24, 2006, ThyssenKrupp said it would not raise its bid. Events in the dynamically changing global steel market were not to end here. The Arcelor board and management barely had time to savor their successful takeover of Dofasco before Mittal initiated a hostile takeover of Arcelor. Ironically, Mittal succeeded in acquiring its archrival, Arcelor, just six months later in a bid to achieve further industry consolidation. -Why do you believe that Dofasco's board was concerned about a lengthy auction process? discussion of the Mittal-Arcelor transaction.

The purchasing power parity theory states that one currency will appreciate (depreciate) with respect to another currency according to the expected relative rates of inflation between the two countries.

The basic differences between within-country and cross-border valuation methods is that the latter involves converting cash flows from one currency into another and adjusting the discount rate for risks not generally found when the acquirer and target firms are within the same country.

For an acquirer evaluating a target firm in another country, the target's cash flows can be expressed in which of the following ways?

Do you see the growth in Sovereign Wealth Funds (SWFs) as important sources of capital to the M&A market or as a threat to the sovereignty of the countries in which they invest? Explain your answer.

Arcelor Outbids ThyssenKrupp for Canada's Dofasco Steelmaking Operations Arcelor Steel of Luxembourg, the world's second largest steel maker, was eager to make an acquisition. Having been outbid by Mittal, the world's leading steel firm, in its efforts to buy Turkey's state-owned Erdemir and Ukraine's Kryvorizhstal, Guy Dolle, Arcelor's CEO, seemed determined not to let that happen again. Arcelor and Dofasco had been in talks for more than four months before Arcelor decided to initiate a tender offer on November 23, 2005, valued at $3.8 billion in cash. Dofasco, Canada's largest steel manufacturer, owned vast coal and iron ore reserves, possessed a nonunion workforce, and sold much of its steel to Honda assembly plants in the United States. The merger would enable Arcelor, whose revenues were concentrated primarily in Europe, to diversify into the United States. Contrary to their European operations, Arcelor found the flexibility offered by Dofasco's nonunion labor force highly attractive. Moreover, by increasing its share of global steel production, Arcelor's management reasoned that it would be able to exert additional pricing leverage with both customers and suppliers. Serving the role of "white knight," Germany's ThyssenKrupp, the sixth largest steel firm in the world, offered to acquire Dofasco one week later for $4.1 billion in cash. Dofasco's board accepted the bid, which included a $187 million breakup fee should another firm acquire Dofasco. Investors soundly criticized Dofasco's board for not opening up the bidding to an auction. In its defense, the board expressed concern about stretching out the process in an auction over several weeks. In late December, Arcelor topped the ThyssenKrupp bid by offering $4.2 billion. Not to be outdone, ThyssenKrupp matched the Arcelor offer on January 4, 2006. The Dofasco board reaffirmed its preference for the ThyssenKrupp bid, due to the breakup fee and ThyssenKrupp's willingness (unlike Arcelor) to allow Dofasco to continue to operate under its own name and management. In a bold attempt to put Dofasco out of reach of the already highly leveraged ThyssenKrupp, Arcelor raised its bid to $4.8 billion on January 16, 2006. This bid represented an approximate 80 percent premium over Dofasco's closing share price on the day Arcelor announced its original tender offer. The Arcelor bid was contingent on Dofasco withdrawing its support for the ThyssenKrupp bid. On January 24, 2006, ThyssenKrupp said it would not raise its bid. Events in the dynamically changing global steel market were not to end here. The Arcelor board and management barely had time to savor their successful takeover of Dofasco before Mittal initiated a hostile takeover of Arcelor. Ironically, Mittal succeeded in acquiring its archrival, Arcelor, just six months later in a bid to achieve further industry consolidation. -Why do you believe that Dofasco's share price rose above ThyssenKrupp's offer price per share immediately following the announcement of the bid?

Product liability claims are generally more frequent and judgments are larger outside the U.S.