Being involved in a merger or acquisition is almost always complex, irrespective of where you stand. Be it from the buyer, seller, intermediary or adviser’s standpoint, there are many aspects to a transaction and incentives that are oftentimes very different based on where you sit at the table.
When multiple countries are involved, though, the complexity just can’t compare. On the Buyer’s side, you’re no longer solely trying to understand the Company and its sector if not the business, its sector, and its entire ecosystem.When evaluating the investment, you need to add a whole new chapter on evaluating the country as well.
What are the drivers of the economy as a whole? How stable is the currency? What makes locals tick? How relevant are the competitors and their respective owners? Who’s who in this country? How does the tax code works? What limitations might there be in sending out dividends to home country? How politically stable is the country? How does the political system works? What safeguards are in place to ensure its stability in the future? What’s the labor market like? Who will run the division, a local or someone sent from the home office? What are the pros and cons of each options? Can our organization manage a business abroad? Etc.
On the Sell-side, potential deal breakers can emerge when negotiating with a Buyer from another country out of misconceptions, miscommunication or, simply, failure to grasp that local flavor. Miscommunication is oftentimes at the root of many issues facing in such negotiations. So is the lack of understanding of the other side’s point of view. That last factor is not exclusive to cross-border transactions, though, but can be enlarged by it.
For example, think of a large corporation negotiating with the owner of a family business – both within the same country. It is not uncommon for both sides to misinterpret what the other said or did, just because the final objective of running a business can be very different for a corporate group and for a family business. Whereas a corporation might be looking for efficiency, judging an investment by the returns it will produce, a family-run business oftentimes ends up venturing into new areas because it serves the purpose of the family, irrespective of its financial outcome, risk profile or expected IRR.
Now add to the mix different currencies, political systems, languages, tax codes, labor laws, etc. and you’re getting a preview of what cross-border transactions look like.
And then comes the cultural barriers…
Send someone to live abroad for awhile and you can be sure that they’ll experience the famous cultural shock in some degree. Even worse yet, come back to your home country after living abroad various years and high are the probabilities that you’ll be hit by that same cultural shock, possibly even harder.
In short, the root cause in both cases lies in that the country you’re moving to does not operate as you expected. You don’t understand why people behave the way they do and, most likely, neither do they get you. [As a side note, moving back home can be even harder because you have a framework well defined based on your years of living in your home country before moving out. As a result, you (1) expect things to work as they did before and people to act as you remember it and (2) probably don’t realize that you’ve evolve in those years abroad and have adjusted to the other cultures you’ve been exposed to.]
Anyways, if cross-cultural differences are tough on people, imagine their impact on business ventures. There is a reason why Cross-Cultural classes are in the curriculum of more and more business-oriented academic programs. Even if it seems like a waste of time to most students when taking them (at least that was the general impression when I was doing my MBA), one can glean some important points on a matter that can only become more and more frequent with the globalization of the economies.
To put it simply, the more you think the target country is similar to yours, the harder the shock and the higher the probability of failure. Take the USA and the UK for instance. Both countries speak English. Sure, American English and British English have some differences but with very little effort, you can communicate. One could therefore think of a US firm expanding to the UK as a piece of cake – and many do.
Well, that’s where one would be wrong. The language might be similar, the ways of communicating are not. Just look at a courtroom footage from both countries and you’ll notice, for example, a tendency to dramatize things in one country – as an effective mean to prove a point – that is virtually nonexistent in the other.
More than just conflict-resolution, the effectiveness of motivational tools and techniques, hiring and firing processes, sales methods – even celebrations on big wins – etc., all vary from one country to the next and all need to be taking into consideration in the evaluation and execution of an investment abroad.
Distance has not much to do with this either. Take France and Germany for example. The two countries are neighbors and yet their business cultures are extremely different.
It’s not just about culture
But culture is not the only determining factor. Take a look at Central America, the countries of Guatemala, El Salvador, Honduras, Nicaragua and Costa Rica have a long-standing history of working together. Treaties define commercial arrangements for the region with a tendency to consolidate more and more the region as one unified block. One could argue that people working in Central America generally know how to deal with their peers and understand the cultural differences between each country.
So, even though cultural differences might not be the real issue in the cross-border deals in this region, macroeconomic and geopolitical factors definitely are.
Looking back to 2014, the Costa Rican Colon went from trading at CRC 500 to $1 on March 1, 2014 to CRC 550 three days later. This basically means that things got 10% more expensive pretty much overnight.
This sudden devaluation has been reflected in minimal wage increase and in consumer prices over the following months. Importing goods suddenly got more expensive and every processes depending on imports of raw materials got impacted.
Meanwhile, less than 1,000 miles up north, in Guatemala, the Quetzal hasn’t move much in over 15 years, other than a few bumps in the post 2008 crisis. Move a little further up North or down South and you’ll get to Mexico and Colombia. Both countries have suffered a drastic currency devaluation in the recent years leading to an economic halt in many sectors.
Let’s take another example on the political side. Look at Nicaragua and you’ll find its headed by a man who’s been over 20 years at the helm of the country (broken in 2 periods of 11 and 9+ years) and who looks like he is here to stay, choosing no less than his wife as running mate for the next elections. We’re talking about a government that counts with the open support of the governments of Venezuela and Cuba, to name a few. Compare contrast with other countries in the region that have it in their Constitutions to limit their presidents’ eligibility to only one turn.
Now let’s talk a bit about regulations. The countries in the Central American region have signed various treaties and conventions, basically defining free trade agreements as well as, in some cases, facilitating migratory matters for its inhabitants. Nonetheless, each country still acts independently and might even interpret those regional agreements distinctly. That means that doing business in Guatemala or El Salvador, for example, could be based on a same rule set in some cases or very different basis in others.
Take pharmaceutical products as an example. The regulations allow for mutual recognition of drug registrations across the region, meaning that, if and when properly applied, registering a product in 1 country would allow you to sell it in all 5. Nonetheless, when actually entering those markets, you’ll find that you can sell it at the price you want in some markets but will have to set your sell price below a threshold set by the government in others – El Salvador in this specific case.
These few – easy to grasp – examples only briefly touch the topic of cross-border complexities that are involved in considering an investment in another country, irrespective of the many considerations proper to the target company itself.
Would you feel comfortable investing in Nicaragua and its strong, established, left-wing, guerrilla-originated government? Some do, others don’t, others would consider it, but only with the proper protections in place.
Would you feel comfortable absorbing a Guatemalan company that carries a large bank debt in USD? Most Guatemalans are OK with that because they have faith in their currency, understand the way their economy works, and feel that the Quetzal is a hard currency. However, a Mexican or Colombian firm buying a company in Guatemala may have a harder time accepting the idea given the recent history they’ve experienced back home with their currencies getting hit hard lately. A loan contracted in USD in either country pre-devaluation would resulted very expensive to repay now.
In my opinion, there are no right or wrong answers here… generally speaking.
It’s mostly a matter of where is your risk appetite, how relevant is that opportunity for you and your group, and what drives this transaction… If you have outgrown your home markets and have identified an opportunity in another country that is accretive, perfectly aligned, shows good margins, and is in a country that is politically stable, has a growing economy, and is investor-friendly, then, at first glance, it sounds like a good opportunity.
The key of this post is – first and foremost – that you need to go the extra mile to make sure you understand the country you’re about to invest in and to understand the possible changes you’ll need to make to make it work.
Another takeaway is that if, when evaluating the Target, you see business practices that seem unusual, inquire thoroughly and try to understand if its a country-wide practice or a Company-specific issue. The former being a matter of adaptation, the latter, a red flag.
Also, make sure you not only understand the risks but also the rewards. Check if the opportunity fits the risk profile you’d like for your investments, keeping in mind, that, frequently, risk is rewarded with higher possible returns. Just like a junk bond yields higher rates, a riskier country could generate higher returns… naturally, knowing that both could also simply end up in large write-offs.