Chapter 18 Cross-Border Mergers and Acquisitions:
Analysis and Valuation
Answers to End of Chapter Discussion Questions
18.1 Discuss the circumstances under which a non-U.S. buyer may choose a U.S. corporate
structure as its acquisition vehicle. A limited liability company? A partnership?
18.2 What factors influence the selection of which tax rate to use (i.e., the target’s or the
acquirer’s) in calculating the weighted average cost of capital in cross-border transactions?
18.3 Discuss adjustments commonly made in estimating the cost of debt in emerging countries.
18.4 Find an example of a recent cross-border transaction in the business section of a newspaper.
Discuss the challenges an analyst might face in valuing the target firm.
18.5. Discuss the various types of adjustments for risk that might be made to the global CAPM
before valuing a target firm in an emerging country. Be specific.
18.6 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.
18.7 What are the primary factors contributing to the increasing integration of the global capital
markets?
18.8 Give examples of economic and political risk that you could reasonably expect to encounter in
acquiring a firm in an emerging economy.
18.9 During the 1980s and 1990s, changes in the S&P 500 (a broadly diversified index of U.S. stocks)
were about 50 percent correlated with the MSCI EAFE Index (a broadly diversified index of
European and other major industrialized countries stock markets). In recent years, the correlation
has increased to more than 80 percent. Why? If an analyst wishes to calculate the cost of equity,
which index should they use in estimating the equity risk premium?
18.10 Comment on the following statement: “The conditions for foreign buyers interested in U.S. targets
could not be more auspicious. The dollar is weak, M&A financing is harder to come by for
financial sponsors (private equity firms), and many strategic buyers in the U.S. are hard-pressed to
make acquisitions at a time when earnings targets are being missed.”
Solutions to End of Chapter Case Study Questions
Ireland-Based Drug Maker Actavis Buys
U.S. Pharmaceuticals Firm Forest Labs
Discussion Questions
1. Using the common motives for cross-border deals discussed in this chapter, speculate as to the reasons
Actavis acquired Forest Labs.
2. What alternatives to acquisition could Actavis have pursued? Speculate as to why a takeover was the
preferred option?
3. Speculate as to how Actavis’s takeover of Forest Labs may have created shareholder value?
4. Do you believe firms should be allowed to engage in tax inversions?
5. Why is Actavis organized as a holding company in Ireland?
6. Speculate as to why investors for both firms responded so favorably when news of the deal was
announced?
True and False Examination Questions
1. Globally integrated capital markets provide foreigners with unfettered access to local capital
markets and local residents to foreign capital markets. True or False
2. Factors contributing to the integration of global capital markets include the reduction in trade
barriers, removal of capital controls, the growing disparity in tax rates among countries, floating
exchange rates, and the free convertibility of currencies. True or False
3. Like globally integrated capital markets, segmented capital markets exhibit different bond and
equity prices in different geographic areas for different assets in terms of risk and maturity. True
or False
4. Arbitrage should drive the prices in different markets to be the same, as investors sell those assets
that are undervalued to buy those that are overvalued. True or False
5. Investors in segmented markets will bear a lower level of risk by holding a disproportionately
large share of their investments in their local market as opposed to the level of risk if they invested
in a globally diversified portfolio. True or False
6. Firms investing in industries or countries whose economic cycles are highly correlated may lower
the overall volatility in their consolidated earnings and cash flows. True or false
7. Excess capacity in many industries often drives M&A activity as firms strive to achieve greater
economies of scale and scope, as well as pricing power with customers and suppliers. True or
False
8. Firms with significant expertise, brands, patents, copyrights, and proprietary technologies seek to
grow by exploiting these advantages in emerging markets. True or False
9. Quotas and tariffs on imports imposed by governments to protect domestic industries tend to
discourage foreign direct investment. True or False
10. Appreciating foreign currencies relative to the dollar increase the overall cost of investing in the
U.S. True or False
11. M&As can provide quick access to a new market; and, they are subject to fewer problems than
domestic M&As. True or False
12. The disadvantages of exporting include high transportation costs, exchange rate fluctuations, and
possible tariffs placed on imports into the local country. True or False
13. Licensing allows a firm to purchase the right to manufacture and sell another firm’s products
within a specific country or set of countries. True or False
14. M&As represent by far the most profitable means of entering foreign markets. True or False
15. A C corporation is the typical acquisition vehicle used by foreign buyers of U.S. businesses due to
its flexibility. True or False
16. There is no limitation on non-U.S. persons or entities acting as shareholders in U.S. corporations,
except for certain regulated industries. True or False
17. Target shareholders most often receive shares rather than cash in cross-border transactions. True
or False
18. While a foreign buyer may acquire shares or assets directly, share acquisitions are generally the
simplest form of acquisition. True or False
19. A tax- free reorganization or merger is one in which target shareholders receive acquirer stock in
exchange for substantially all of the target’s assets or shares. The target firm merges with a U.S.
subsidiary of the foreign acquirer in a statutory merger under state laws.
20. To qualify as a U.S. corporation for tax purposes, the foreign firm must own at least 80% of the
stock of the domestic subsidiary. True or False
21. The forward triangular cash merger is the most common form of taxable transaction. The target
company merges with a U.S. subsidiary of the foreign acquirer with shareholders of the target firm
receiving acquirer shares as well as cash, although cash is the predominate form of payment. True
or False
22. Acquiring businesses outside the U.S. involves additional obstacles atypical of domestic
acquisitions. True or False
23. In common law countries (e.g., U.K., Canada, Australia, India, Pakistan, Hong Kong, Singapore,
and other former British colonies), the acquisition vehicle will be a corporation-like structure.
True or False
24. In civil law countries (which include Western Europe, South America, Japan, and Korea), the
acquisition will generally be in the form of a share company or limited liability company. True or
False
25. Payment in transactions involving non-U.S. firms is most likely to be cash. True or False
26. 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. True or False
27. With tax avoidance and fraud common in many countries, the buyer may find that some assets will
transfer encumbered by tax liens. True or False
28. Mergers are legal in all countries. True or False
29. International transactions tend to be highly challenging, as they typically involve multiple tax and
legal jurisdictions. True or False
30. If the acquisition is structured as an asset purchase because the target is only a division of a
foreign company or because the seller agrees to sell assets, the U.S. buyer of the assets must
decide whether to acquire them directly or to use a new or existing foreign company to do so. The
choice will affect future U.S. and non-U.S. tax consequences. True or False
31. Despite accounting practices varying widely from country to country, the seller should not be
required to confirm that their financial statements have been prepared in accordance with
generally accepted accounting principles if to do so would endanger the deal. True or False
32. Product liability claims are generally more frequent and judgments are larger outside the U.S.
True or False
33. Employees receive far greater legal protection in many developed foreign countries than they do in
the U.S. True or False
34. As in the U.S., any representations and warranties in an acquisition agreement are intended to
cause the seller to disclose significant information. However, because of local custom, they are
often more extensive in foreign countries than in the U.S. True or False
35. Bonds of a non-U.S. issuer registered with the SEC for sale in the U.S. public bond markets are
called “Yankee” bonds. True or False
36. The American Depository Receipt (ADR) market evolved as a means of enabling foreign firms to
raise funds in the U.S. equity markets. True or False
37. The Euroequity market reflects equity issues by a foreign firm tapping a larger investor base than
the firm’s home equity market. True or False
38. Language barriers, different customs, working conditions, work ethics, and legal structures create
a new set of challenges in integrating cross-border transactions. True or False
39. In choosing how to manage an acquisition in a new country, a manager with an in-depth
knowledge of the acquirer’s priorities, decision-making processes, and operations is appropriate,
especially when the acquirer expects to make very large new investments. True or False
40. It is easy to differentiate between political and economic risks, since they are generally unrelated.
True or False
41. A sometimes overlooked challenge is the failure of the legal system in an emerging country to
honor contracts. True or False
42. Unanticipated changes in exchange rates rarely influence the competitiveness of products
produced in the local market for export to the global marketplace. True or False
43. The decision to buy political risk insurance depends on the size of the investment and the
perceived level of political and economic risk. True or False
44. 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. True or False
45. 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
46. 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. True or
False
47. M&A practitioners utilize nominal cash flows except in circumstances of high rates of inflation,
when real cash flows are preferable. True or False
48. Nominal or real cash flows should give different net present values if the expected rate of inflation
used to convert future cash flows to real terms is the same inflation rate used to estimate the real
discount rate. True or False
49. Interest rates and expected inflation in one country compared to another country seldom affect
exchange rates between the two countries. True or False
50. For developed countries, such as Western Europe, the interest rate parity theory provides a useful
framework for estimating forward currency exchange rates (i.e., future spot exchange rates). True
or False
51. The interest rate parity theory relates forward or future spot exchange rates to differences in
interest rates between two countries adjusted by the spot rate. True or False
52. 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. True or False
53. In general, the appropriate marginal tax rate used in calculating cash flows and the discount rate
should be that applicable to the country in which the cash flows are produced. True or False
54. Developed economies seem to exhibit significant differences in the cost of equity due to the
relatively high integration of their capital markets in the global capital market. True or False
55. Whenever the target firm’s projected cash flows are in local currency, the risk free rate is the local
country’s government bond rate. True or False
56. If cash flows are in terms of local currency and the U.S. Treasury bond rate is used to estimate the
risk free rate, the analyst should add the expected inflation rate in the local country relative to that
in the U.S. to convert the U.S. Treasury bond rate to a local country nominal rate. True or False
57. 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.
True or False
58. If individual country’s capital markets are segmented, the global capital asset pricing model must
not be adjusted to reflect the tendency of investors in individual countries to hold local country
rather than globally diversified equity portfolios. True or False
59. An analyst can determine if a country’s equity market is likely to be segmented from the global
equity market if the ß derived by regressing returns in the foreign market with returns on the
global equity market is significantly different from one. True or False
60. Due to absence of historical data in many emerging economies, the equity risk premium often is
estimated using the prospective method implied in the constant growth valuation model. True or
Multiple Choice Examination Questions
1. Which of the following factors contribute to the integration of the global capital markets?
a. The reduction in trade barriers
b. The removal of capital controls
c. The harmonization of tax laws
d. Floating exchange rates
e. All of the above
2. Which of the following is true about segmented capital markets?
a. Exhibit different bond and equity prices in different geographic areas for identical assets
in terms of risk and maturity.
b. Exhibit the same bond and equity prices in different geographic areas for identical assets
in terms of risk and maturity.
c. Exhibit different bond and equity prices in the same geographic areas for identical assets
in terms of risk and maturity.
d. Exhibit different bond prices but the same equity prices in different geographic areas for
identical assets in terms of risk and maturity.
e. None of the above
3. Which of the following is generally not a motive for firms to expand internationally?
a. Desire to achieve geographic diversification
b. Desire to accelerate growth
c. Desire to consolidate industries
d. Desire to avoid entry barriers
e. Desire to enter countries with less favorable tax rates
4. Firms are likely to achieve significant diversification by investing in all of the following except for
a. Different but uncorrelated industries in the same country
b. Different companies in the same industry in the same country
c. The same industries in different countries
d. Different industries in different countries.
e. Different companies in different industries in the different countries
5. Excess capacity in many industries often drives M&A activity as firms strive to achieve which of
the following?
a. Greater economies of scale
b. Greater economies of scope
c. Greater pricing power with customers
d. Greater pricing power with suppliers
e. All of the above
6. Which of the following represent common international market entry strategies?
a. Mergers and acquisitions
b. Licensing
c. Exporting
d. Greenfield or solo ventures
e. All of the above
7. Local country firms may be interested in alliances for which of the following reasons?
a. To gain access to the technology
b. To gain access to a widely recognized brand name
c. To gain access to innovative products
d. A, B, and C
e. A and B only
8. Which of the following is not true of exporting as a market entry strategy?
a. Exporting does not require the expense of establishing local operations
b. Exporters do not need to establish some means of marketing and distributing their
products at the local level
c. Exporters incur high transportation costs
d. Exporters may be adversely impacted by exchange rate fluctuations
e. Exporters may be adversely impacted by tariffs placed on imports into the local country
9. Which of the following is not true of licensing?
a. Licensing allows a firm to purchase the right to manufacture and sell another firm’s
products within a specific country or set of countries.
b. The licensor is normally paid a royalty on each unit sold.
c. Licensors have considerable control the manufacturing and marketing of their products
marketed in foreign countries.
d. The licensee takes the risks and makes the investments in facilities for manufacturing,
marketing and distribution of goods and services.
e. Licensing is an increasingly popular entry mode for smaller firms with insufficient capital
and limited brand recognition.
10. Greenfield operations represent an appropriate entry if which of the following is true?
a. Entry barriers are low
b. Cultural differences are high
c. Entrant has limited multinational experience
d. Entrant is risk adverse
e. A and B only
11. Which of the following represent common law countries?
a. United Kingdom
b. Australia
c. India
d. Pakistan
e. All of the above
12. Which of the following represent common political and economic risks in entering an emerging
market?
a. Excessive local government regulation
b. Confiscatory tax rates
c. Lack of enforcement of contracts
d. Fluctuating exchange rates
13. The most common form of payment involving non-U.S. firms engaged in M&As is
a. Stock
b. Cash
c. Cash and stock
d. Debt
e. Cash, stock and debt
14. For an acquirer evaluating a target firm in another country, the target’s cash flows can be
expressed in which of the following ways?
a. Expressed in the home country’s currency
b. Local country’s currency
c. In real terms
d. A & B only
e. A, B, and C
15. Which of the following represent common components of the global capital asset pricing model
when applied to valuing firms in emerging countries?
a. Risk free rate of return
b. Specific country’s risk premium
c. Firm size risk premium
d. Emerging country firm’s global beta
e. All of the above
Nestlé Buys Majority Ownership Stake in Chinese Candy Maker
____________________________________________________________________________
Key Points
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.
Discussion Questions
1. What were Nestle’s motives for acquiring Hsu Fu Chi? What were the firm’s alternatives to
acquisition and why do you believe they may not have been pursued?
2. What alternatives did the majority shareholders in Hsu Fu Chi in growing the firm? Speculate as
to why they may have chosen to sell a controlling interest to Nestle?
3. Speculate as to why Nestle used cash rather than its stock to acquire its ownership interest in Hsu
Fu Chi?
4. 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?
5. 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?
6. Do you believe that multiples of revenue paid by other food companies is a good means of
determining the true value of Hsu Fu Chi? Why? Why not?
7. Despite having similar profit margins, Hsu Fu Chi traded at a ratio of 22 times trailing earnings
compared with 28 for comparable firms. Why do you believe Hsu Fu Chi’s share price on the
Singapore stock market sold at a 21% discount from the share price of other firms?
A Tale of Two International Strategies: The Wal-Mart and Carrefour Saga
______________________________________________________________________________________
Key Points
Integrating foreign target companies and introducing improved operating and governance can be a daunting
task.
What works in the acquirer’s country may not be transferable to the target’s local market.
______________________________________________________________________________________
Wal-Mart began expanding aggressively outside the United States in the 1990s. Its principal international
rival at that time was French retail chain Carrefour. After opening the world’s first superstore in 1963,
Carrefour spent the next four decades expanding its grocery and general merchandise stores across Europe,
South America, and Asia.
While the chain grew rapidly through the 1990s, Carrefour has experienced difficult times in recent
years. Carrefour shares have plunged more than two-thirds since 2007. Though having about the same
number of retail locations (9,667 for Wal-Mart compared to 9,631 for Carrefour), Carrefour fell far behind
Wal-Mart’s $467 billion in fiscal 2011 revenue. Wal–Mart’s international sales of $109 billion in 28
countries outside the U.S. almost exceed Carrefour’s total $114 billion in annual revenue, including sales in
France. Wal-Mart’s operating margins of 7.5% are 2 percentage points higher than comparably defined
Carrefour margins. Net income per employee for Wal–Mart was $7,804 per employee, versus Carrefour’s
$1,260.
To understand how Carrefour floundered, we need to look at the global strategies of the two firms.
Intended to offset sluggish growth in France, Carrefour expanded too rapidly internationally as it entered
24 countries during the 10 years ending in 2004. While it succeeded in China, with annual revenue totaling
$5.8 billion, it fell short in a number of other countries. Since 2000, Carrefour has sold off operations in 10