Question

What are the motives for direct foreign investments? Assume you have a foreign target in 3 different countries,
what kind of valuation process will you do? Please explain in detail.

Answer 1

Motives for direct foreign investments:

REVENUE RELATED: Attract new sources of demand Enter profitable markets Exploit monopolistic advantages React to trade restriction Diversity Internationally

COST RELATED: Fully benefit from economies of scale Use foreign factors of production Use foreign raw materials Use foreign technology React to exchange rate movements

Valuation 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:

1. Target-specific factors
2. Country-specific factors

a) Target-specific factors

1. 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.
2. 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

1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.