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PwC: What private companies should know about emerging markets


What should private companies know about expanding into emerging markets?

What should private companies know about expanding into emerging markets?

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  • 1. www.pwc.comProfessionalGrowth with PwCEmerging Markets
  • 2. AgendaEmerging MarketsThe Business Case - Vanessa Iarocci & Eric CastonguayStructuring & Tax Planning - Mark WaltersFacilitating Banking & Trade - Reesa Shurgold (HSBC) 2
  • 3. Executive Summary• Canadian private companies are missing the mark in emerging markets• Weak growth prospects in “the west” and high growth prospects in “emerging markets” mean that companies have a choice to stay and stagnate or go and grow ◦ Emerging markets are longer merely a story of basic products and low cost manufacturing• This is not your average expansion strategy. A cautious and calculated approach is necessary because emerging markets are not, at all, like “the west” ◦ High political risk ◦ Significant deal barriers ◦ Cultural differences 3
  • 4. Missing the markCanadian private companies do not have astrong track record in the BRIC region 4
  • 5. “Canada may not be taking full advantage of the opportunities posed by rapidly growing emerging markets.” Conference Board of Canada, 2011
  • 6. Our foreign investment track record is dismal Acquisitions into BRIC regions Canadian FDI balance in Brazil, India, % of total acquisition value by country China 14% 35,000 32,733 12% 30,000 % of aggreagate deal value (2000-2011) 1.5% of 10% 25,000 BIC FDI (2000 balances Canadian $ (millions) 8% 20,000 6% 15,000 4% 10,000 2% 5,000 0% Canada United United Germany Australia 152 0 States KindgomSource: Capital IQ, PwC Analysis 1990 2010 1.5%PwC
  • 7. Most Canadians are second-movers that “go it alone” • The majority of Canadian-led deals in the BRIC region are into China (42%) & Brazil (38%) “You need to be a first mover ◦ Low penetration in “other” because in an environment emerging / frontier markets where there is a lot of political risk, folks that come in early can actually • Canadians are typically not first help shape the political and movers regulatory environment to ◦ Others have “laid the be tailored towards them.” groundwork” Ian Bremmer, Eurasia Group ◦ Most deals are majority stake acquisitions rather than minority stakes or joint ventures (JV)PwC
  • 8. Most activity involves large public companies in anarrow band of industries • Public company buyers dominate, Private Company Buyer Market Share private companies are on the 40% sidelines 35% • Narrow band of industries targeted % of transaction volume 30% ◦ China 25% › Real estate (Hong Kong) 20% › Financial services (retail banking, asset management, 15% insurance) 10% ◦ Brazil 5% › Resources 0% › Real estate 2007 2008 2009 2010 2011 › Infrastructure Source: Capital IQ, PwC Analysis › Financial services (retailPwC banking, asset management)
  • 9. Go & Grow or Stay and Stagnate?Western growth prospects are low, emerginggrowth prospects are high
  • 10. The macro environment today suggests a period of slow growth isupon the developed world economies… 2010 2011 E 2012 E 2013 ECanadian real GDP 3.2 2.3 2.0 2.5 GDP growth(quarter/quarter % change) rates below historical normsUS real GDP 3.0 1.8 2.2 2.6(quarter/quarter % change)Canadian net exports (124.4) (144.2) (148.8) (151.0)(billions, C$) Persistent tradeUS net exports (421.8) (411.8) (401.2) (385.3) deficits(billions, US$)US CPI 1.6 3.2 2.6 2.2(all items) Negative real interest ratesUS 10 Year bond yield 3.21 2.79 2.09 2.71US Unemployment rate 9.6 9.0 9.0 9.5Canadian real disposable 3.6 1.5 2.2 2.0 Unemploymentincomes (year/year change, and disposable%) income metricsUS real disposable incomes 1.8 0.9 1.1 1.5 dismal(year/year change, %)Source: BMO Economics, Canadian Economic Outlook, US Economic Outlook 10
  • 11. Governments have run out of ammunition…Country Implied Austerity Measures (US $mm)France 104,569Germany 42,020Greece 23,044Ireland 58,800 Welcome to the age of austerity!Italy 33,714Japan 484,573Portugal 15,552Spain 88,719UK 152,348US 1,155,000Source: Eurostat, IMF, PwC Analysis 11
  • 12. Putting austerity into perspective ! 3,000 2,500 Implied Austerity 2,158 Inflation Adjusted (US$ billions) 2,000 1,500 1,000 Vietnam War, 698 Korean War, 454 Iraq Invasion, 597 500 Race to the Moon, Marshall Plan 237 S&L Crisis, 256 115 0 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030 Year Source: PwC Analysis, Bianco Research LLC 12
  • 13. In contrast, emerging markets are expected to expand rapidlyCanada France Ireland UK Russia Germany 3.1 2.5 2.6 1.5 1.6 1.9 -0.9 0.2 1.8 1.3 1.4 2.2 4.0 4.3 4.5 3.5 2.6 2.1 #2 #5 #9 #3 #16 Russia #4US Greece 2.8 3.0 3.2 -4.5 -3.0 0.7 #1 #17Mexico Japan 5.5 4.2 4.0 4.0 1.4 1.8 #12 #6Brazil China 7.5 4.6 4.7 10.3 9.5 9.0 #11 #10Spain -0.1 0.5 1.2 India #8 8.6 8.6 8.5 #15 South Africa Italy United Arab Emirates** AustraliaKey 2010e 2011f 2012f 2.8 3.4 3.9 2.7 3.1 3.6Outlook GDP growth 1.1 0.9 1.2 2.1 3.5 4.6 PwC Med-term risk ranking* #14 n/a #7 #13 *PwC ranking of medium-term risk premium; **Based on March 2011 Economist Intelligence Unit projections Source: PwC Economics, IMF 13
  • 14. By 2050, China, India, Brazil and Russia will be in “the top six”GDP by country, 2009 - 2050 2009 2050 60,000 Emerging economy GDP at Market Exchange Rates (constant 2009 US$bn) 50,000 40,000 30,000 20,000 10,000 0 Indonesia Australia Germany Turkey Italy China India Japan Russia Mexico France Nigeria Spain South Korea Brazil Vietnam US UK Canada Saudi Arabia Source: PwC Forecasts PwC 14
  • 15. This is not just more of the same. It’s no longer merely a story ofbasic products and low cost manufacturing • India, China, ASEAN and Nigeria will add1.3bn urban residents between 2009 and 2050 Urbanisation • The cities of the world will require tremendous investment in infrastructure to support this growth • Shanghai and Mumbai alone will generate 25m more middle class households by 2025, Emerging but the new middle class will not be constrained to the world’s megacities middle class • This will create substantial opportunities in consumer goods, while straining the agricultural capacity of the world Changing • China may no longer be the world’s factory. Many emerging markets now have lower labour labour rates than China, and countries like Thailand and India could become more markets competitive relative to China • Within the BRIC, the key area of competition is around innovation • Between 2005 and 2009, over 2,000 companies in emerging markets began investing Emerging abroad. Some are becoming industry leaders (e.g. Embraer from Brazil) competitors • These companies will become stronger, and could be joined by as many new multi- nationals • Currencies in Brazil, Vietnam and Indonesia are all expected to depreciate relative to the Currency movements RMB, making these countries more competitive as a low cost manufacturing destination 15
  • 16. Not your average expansionThe emerging markets are not, at all, like “thewest” – a unique approach is required 16
  • 17. Market entry has a high chance of failure because it involves a large number of difficult choices... Key Decisions Choices Some Considerations 1. Customer focus • Willingness to pay Affluent segment Mass market • Cost of customer educationBusiness model • Minimum efficient scale 2. Product • Cost to deliver Global products Local branding / pricing • Potential for defensible advantage offering • Market knowledge/ risk appetite 3. Supply chain Local Export License Local R&D • Local ecosystem footprint production • Tech. exchange in the proposition 4. Investment • Regulatory requirements JV Acquisition Go-it-Alone • Management bandwidth vehicle • Execution vs. partner risk (IP, control) 5. Partner type State-owned/ Small private Private • Need to navigate regulations vs.Execution affiliated sector conglomerate commercial behaviour • Balance of power in partnership 7. Location • Proximity to raw materials and Cost-advantage Employee friendly customers • Liveability 8. Management • Global career development Foreign Local • Adaptability • Retention 17
  • 18. ...in an environment that is “not like the West”... Why deals in emerging markets are different Government Growth Culture Governance Valuation
  • 19. Numerous companies have achieved growth through emergingmarkets, but some companies have also faced difficultiesExamples of successes Examples of difficulties Phased approach to de- “In the late ’90s, we decided not toInfrastructure risk entry; continuous enter China, and missed a substantial localisation of operating opportunity. Now, it’s too late” activities Automotive component manufacturer “Suzuki re-entered the Indian market Incorporating emerging in 2006, after it severed a decade long markets into a global ties with Chennai-based TVS MotorA&D supply chain to lower Company in 1999-2000, after the five- costs and gain access to year non-compete clause expired“ demand The Economic Times, 17 Dec 2009 Strong partnering inAuto India “Danone ends troubled Wahaha venture --- China partnership was Toyota plagued by disputes over drinks business; cash payout will settle legal Investing to provide global service cases “Others levels to high-end customers in Wall Street Journal, 1 October 2009 ChinaPwC 19
  • 20. Section 2 – The challengeWe draw a number of key learnings from our experience withmarket entry • Align people. Get involved early to begin learning and developing relationships. Ensure senior management stays involved and focused on the long-term rational • Utilize light touch models. Test the market (e.g. exports, licensing) • Don’t change the core. Understand what’s critical to the success of your core business model and first replicate that in new markets. Limit localization decisions to non-critical parts of the business model (but do make sure the business is tailored to the local market) • Phase investment. Understand the timing of demand growth, the economics of your cost to serve and the key step changes in capacity. Plan around capacity but build in flexibility • Don’t be afraid to walk alone. Be clear about what you get from and provide to a partner. Understand the benefits and risk that a partner brings • Invest in local deals capabilities. Be aware that deals in emerging markets are different and harder than they are in home markets. Invest in emerging markets deal execution capabilities if you’re going to pursue an acquisition • Learn from Private Equity. Adopt relevant lessons from Private Equity from investment strategy to evaluation and exit 20
  • 21. There are lessons to be learned from private equity tode-risk market entry Investment strategy Criteria for consideration Partnering/ co-investment Portfolio of investments with Think about exit from day 1 Treat with caution (be clear uncorrelated risks (e.g. (how to get out if things go why you’re partnering and do multiple countries) badly) so carefully) Investment evaluation Strategy Development Create investment model Management and the board early as a living document develop strategy together Private Equity (how much money will it (e.g. Work closely with model make?) emerging market managers) Discussions Financial management Governance Getting financial systems right and regular monitoring Impersonal and fact-based Focus on cash (can be in the (emerging market accounting (avoid over-excitement) longer term) systems are generally less sophisticated) 21
  • 22. “It is not the strongest of the species that survives, nor themost intelligent that survives. It is the one that is the mostadaptable to change.” Charles Darwin
  • 23. Structuring into BRIC CountriesEfficient tax planning 23
  • 24. Emerging Markets – Proposed structures Canco Canada BRIC Branch Issues: • Registrations • Limits on activities • Staffing • Banking – Foreign Exchange 24
  • 25. Emerging Markets – Proposed structures Financing Canco Equity Debt Canada BRIC Local Financing BRIC Operating ? Company Issues: • Similar issues to setting up branch Plus • Choice of legal entity • Minimum capital requirement • Repatriation limits • Withholding tax 25
  • 26. Emerging Markets – Proposed structures Financing Canco Equity Debt Canada Foreign Holding Company Equity Debt BRIC BRIC Operating Company Issues: Selection of foreign holding company • Treaty network • Substance – Mind and Management • Tax rate on local and foreign source income 26
  • 27. Emerging Markets – Proposed structures Financing Canco Equity Debt Canada Foreign Holding Company Equity Debt BRIC BidcoIssues:• Set up of Bidco• Ability to merge/consolidate Target 27
  • 28. Doing Business in BrazilForms of investment• Branch – difficult to incorporate later• Limited liability company – Sociedade Limitada – LTDA• Corporation – Sociedade por Acoes – S/ARepatriation• Capital permitted• Dividend – no w/h taxCorporate tax• Calendar year• Rate = 15% plus 10 % surcharge = 25%• Social Contribution Tax= 9% of profit. 28
  • 29. Doing Business in RussiaForms of investment• Rep office – Accreditation• Branch – Registered• Full and limited partnership• Limited liability company• Joint Stock companyRepatriation• Dividends – 15% w/h tax• Initial contribution – tax freeCorporate tax• 20% 29
  • 30. Doing Business in India Forms of investment • Branch, Project and Liaison office • Wholly owned subsidiary • Joint venture • Limited liability company Repatriation • Capital may be returned • Dividend distribution tax = 15% plus surcharge ~ 16.6% Corporate tax • Resident company = 30% plus surcharge ~ 33.2% • Non-resident company = 40% plus surcharge ~ 42.2%PwC 30
  • 31. Forms of doing business in ChinaIndirect investment forms• Processing• Representative Offices Foreign Enterprise (“FE”)• LicensingPwC 31
  • 32. Forms of doing business in ChinaDirect investment forms• Equity joint ventures• Cooperative joint ventures• Wholly foreign-owned enterprises• Special purpose vehicles ◦ Service Company Foreign Investment ◦ R&D centre Enterprise (“FIE”) ◦ Trading company in the FTZ ◦ Chinese Investment holding company ◦ Shanghai Regional Headquarters 32
  • 33. Corporate tax in ChinaStandard rate = 25%Special reduced rates in selected industries and geographies rangingfrom 0% to 15% 33
  • 34. Requirements for initial investment• Currency conversion is regulated• Cash or in-kind (within limits)• Certified by a CPA• Maintain separate accounts for capital• Technology agreements require approval• Debt/equity ratio requirementPwC 34
  • 35. Repatriating capitalEJV – only on liquidationCJV – agreement of partners and regulatory approvalWFOE – flexibleIn all cases – sufficient foreign currency on hand 35
  • 36. Repatriating earningsConditions• Prior year’s losses made up• All taxes paid• Director’s approval• Approval to change currencyMay be exempt from withholding 36
  • 37. Suggested Tax Considerations for entering any BRICCountry1. Ensure business case is well developed.2. Establish policies for employees assigned to destination country.3. Complete due diligence on business partners.4. Consider use of holding company.5. Establish policy for the use of IP.6. Determine optimal location.7. Develop a capitalization strategy.8. Develop transfer pricing policies. 37
  • 38. Illustration of BRIC Growth – AutoIndustryAppendix 1 38
  • 39. Illustration of BRIC Growth – Auto Assembly OutlookFor the first time in history, the number of vehicles produced in developing and emerging marketsin 2011 will be greater than the number of vehicles produced in mature markets.Global: Light Vehicle Assembly by Market Type Global: Contribution to Growth by Region2000 – 2017 (millions) 2010 – 201760 AP China 38.5% India 12%50 NA40 EU30 SA Brazil 6.4%20 EE Russia 6.2%10 MEA 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 0% 10% 20% 30% 40% 50% 60% Mature Emerging Source: Autofacts 2011 Q4 Data Release
  • 40. Illustration of BRIC Growth – Auto Assembly OutlookChina’s assembly growth will exceed the combined growth of the remaining BRIC countries.BRIC: Assembly Outlook by Country2010 vs. 2017 (millions) 26.8 China 14.4 7.1 India 3.0 5.1 Brazil 3.1 3.3 Russia 1.3 0 3 6 9 12 15 18 21 24 27 2017 2010 Source: Autofacts 2011 Q4 Data Release
  • 41. Trends across emerging marketsAppendix 2 41
  • 42. This is not just more of the same. Emerging markets will undergodramatic changes as the result of five key trends Urbanisation Currency Emerging movements middle class Emerging markets macro trends Changing Emerging labour competitors markets 42
  • 43. India, China, the ASEAN-6 and Nigeria will add 1.3bn urbanresidents between 2009 and 2050Urban population in emerging markets, 2009-2050 6 5 By 2025, India is projected to have 3 0.9 mega-cities: Deli, 0.6 0.1 Mumbai and 4 Kolkata 0.4 Brazil 0.1 0.2 Nigeria Billions 0.4 3 0.5 5.2 By 2025, China is projected to have 5 2 mega-cities: Shanghai, Beijing, 2.5 Shenzhen, 1 Chongqing, and Guangzhou - 2009 urban India China ASEAN-6 Africa Latin America Other emerging 2050 urban population in markets population in emerging markets emerging marketsSource: UN, World Urbanization Prospects The 2009 Revision 43
  • 44. China and India will see strong growth in the number of middleand upper class households, with Shanghai and Mumbaigenerating 25m more of these households by 2025Number of middle and upper class households in key cities*, 2008-2025 Both China and India will also see 25 large growth in middle class consumers in Number of middle 19.7 second tier cities and upper class 20 households, 2008 Number of households (m) 16.5 14.9 15 12.9 9.9 10.0 9.6 10 8.6 8.6 Number of middle and upper class 5 3.6 4.1 households, 2025 1.4 0 Sao Paulo Shanghai Mumbai Paris Jakarta LondonRank inworld 4 9 3 24 25 n/apopulation2025*Sample of growing cities in emerging markets and established European citiesSource: PwC Economics 44
  • 45. Indian and ASEAN labour markets are likely to become moreattractive relative to China Emerging markets labour costs are lowest in Asian Wage inflation is likely to see India and ASEAN markets becoming more competitive relative to China Average hourly labour costs (US$), 2010 Changing labour dynamics, 2010-2015F 100% 25 UK - $24 % growth in labour productivity, 2010-2015 80% Indian and Thailand 20 Average labour costs per hour (US$) labour markets are 2010 likely to become more attractive 15 60% relative to China China 11.3 India 10 40% 6.4 Indonesia Russia Thailand 5 20% 3.8 2.6 2.2 1.8 Brazil 0.7 Poland 0 0% Poland Brazil Russia India China Thailand Indonesia 0% 20% 40% 60% 80% 100% % growth in nominal wages, 2010-2015Source: EIU, Jan-Feb 2010PwC 45
  • 46. Emerging markets will produce a large number of new multi-nationals New multinationals* in emerging markets by New mult-nationals 2010-2024 country, 2005-2009 Bubble size reflects 800 180% number of new Growth in real GDP from 2005-2009 to 2010-2014 multinationals between 160% 2010 and 2024 700 CHN 140% 600 120% IND # of new multinationals 500 100% VIE 400 80% 60% MAL 300 BRA CHL POL SIN KOR RUS 40% ROM UKRARG 200 MEX 20% HUN 100 0% 0% 20% 40% 60% 80% 100% - 2005 2006 2007 2008 2009 Growth in number of new multinationals between 2005-2009 and 2010- China India Other emerging markets 2015*Note: defined as a company that it undertakes green field investment abroad for the first timeSource: PwC EconomicsPwC 46
  • 47. Movements in exchange rates are likely to decrease the costadvantage of manufacturing in China relative to other emergingmarkets Indexed global exchange rates (relative to US$), 2003-2015F % change 2.0 2003-2010 2010-2015 1.8 Forecast Brazil 75.3% (12.6)% 1.6 1.4 China 22.2% 18.5% 1.2 1.6% 9.3% 2003 = 1 India 1.0 0.8 UK (5.4)% 2.2% 0.6 Indonesia (8.3)% (1.3)% 0.4 0.2 Vietnam (16.7)% (6.0)% 0.0 2003 2004 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F 2015FSource: PwC analysis, OANDA, EIUPwC 47
  • 48. Case StudiesPwC has helped numerous companies expandinto emerging marketsPwC 48
  • 49. Case Study 1: Understanding how quickly a domestic supply chaincould be established in India was critical to timing entry for anautomotive supplier. India market entry The client’s automotive turbocharger business is a leading global supplier of turbine wheels. It is a vertically integrated business, with capabilities in-house to melt superalloys, the key input for turbo chargers wheels. The superalloy business had recently been receiving a number of requests from customers in India. The business was considering an investment in India to satisfy this demand. The client hired PwC to test the business case. Our key focus was on understanding the market potential. We found that while rapid growth in automobiles was driving demand for turbochargers, this didn’t necessarily equate to demand for super alloys. By speaking with automotive experts, and procurement heads at the leading global turbocharger manufacturers, we mapped likely movements in turbocharger production and the manufacturers’ sourcing strategies. We then looked at the investment plans of turbine wheel producers to understand the timing of local demand. We recommended a customer-led phased approach to entering India. The client is currently exploring several options to do so. 49
  • 50. Case Study 2: Assessment of the key competitive factors in theglassware industry highlighted alternative investmentopportunities in China China commercial diligence and location study Libbey is a major US manufacturer of table glassware, covering a huge range of beverage glasses for home and trade use. The glassware industry had become more global, and competitors such as Luminarc of France and Pasabahce of Turkey were expanding rapidly into international markets. Libbey had been presented with an investment opportunity in China, which we helped them to assess through a commercial due diligence investigation. In glassware, distance from the source of raw materials and energy prices are key competitive factors. We considered the cost of this opportunity versus alternative locations, determined that other locations would offer better long term costs, materials availability and market access, and then conducted a search that resulted in a short-list of proposed alternative locations. After helping Libbey negotiate investment incentives with approval authorities, the Langfang development zone in between Beijing and Tianjin was selected, and the plant opened in March 2007 with an investment of almost US$60million. 50
  • 51. Case Study 3: Understanding the China strategy of the automotiveassembler, and how they planned to address the market was key indrawing up a list of acquisition targets China M&A Strategy Our client was the independent parts aftermarket brand for a US ‘big three’ automotive assembler. In China, most vehicle assemblers had managed to establish ‘closed loop’ parts distribution systems, meaning that service centres only installed parts made by the vehicle manufacturer, but this situation was changing and the client wanted to quickly establish a presence in the independent aftermarket, as car owners were increasingly going outside the closed loop to lower costs. PwC helped the client to assess how this market could be addressed, how it was likely to evolve, consider a range of partnering strategies outside of existing parts distributors, and finally help draw up a short list of acquisition targets, by first understanding how the client would address the market, and then assessing targets by how closely they fit the client’s strategy and how likely it would be for a deal to close. The work was made more difficult by the generally poor quality of market information available, which meant that we had to triangulate information sources to get as reliable a data set as possible. We then went on to provide financial due diligence services to the deal. 51
  • 52. Thank youWe want to do business with you.This publication has been prepared for general guidance on matters of interest only, anddoes not constitute professional advice. You should not act upon the informationcontained in this publication without obtaining specific professional advice. Norepresentation or warranty (express or implied) is given as to the accuracy orcompleteness of the information contained in this publication, and, to the extent permittedby law, PricewaterhouseCoopers LLP, its members, employees and agents do not acceptor assume any liability, responsibility or duty of care for any consequences of you oranyone else acting, or refraining to act, in reliance on the information contained in thispublication or for any decision based on it.© 2010 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refersto PricewaterhouseCoopers LLP which is a member firm of PricewaterhouseCoopersInternational Limited, each member firm of which is a separate legal entity.
  • 53. Questions? 53
  • 54. ContactsMark WaltersTax Partner(519) 570 5755mark.g.walters@ca.pwc.comVanessa IarocciDirector, Consulting & Deals(416) 941 8352Eric CastonguayManaging Director, Consulting & Deals(416) 815 5094 54