Understanding the risks: the pitfalls of doing deals in growth markets

Dairy products

Dairy Products Co: The entire stake acquired stake was written down following the recall of a contaminated product which saw the death of 6 babies. The scandal resulted in several senior executives facing criminal charges and the eventual break-up of the local company

Media

Media Co: The local company re-purchased the stake held by the foreign investor after it became clear that the foreign investor was unwilling to invest further in the business. The local company wanted more capital and the only way of selling a bigger stake was to buy back the capital and find another investor

Forestry

Forestry Co: The company share price plummeted by 75% following a report accusing the company of perpetrating a fraud and overstating the value of its assets. Trading of the company shares was frozen as the allegations were investigated

Banking

Banking Co: This international bank are rumoured to have overpaid for this business and have also invested significant amount post deal. However, they eventually exited the business due to operational weaknesses and not really understanding the market which they entered

Travel

Travel Co: The company pulled out of a full take-over the company, in which they had a minority share, when the local CEO was detained by police under the suspicion of misappropriating funds and for purchasing a successful subsidiary from the government illegally

Telecoms

Telecoms Co: This company is currently involved
in a billion dollar tax dispute with the local government following their acquisition of a local telecoms company. The company were also forced to make a write down in 2010 due to intense price competition following the entry of a number of new operators into the market

Banking

Banking Co: Dominance of local firms forced market exit which involved selling of asset at a significant loss

Beverages

Beverages Co: A court case was filed against its local JV partner for setting up competing ventures and using the trademark outside of the JV. Following a lengthy battle, it was forced to sell its stake to its local partner, leaving them to start afresh in the country

Metal manufacturing

Manufacturing Co: Full production of these two plants was delayed after deal completion due to people and cultural and control issues. Problems included training staff due to language issues, bringing people into the country with the required skills and delays in obtaining import licences

Financial Services

FS Co: Part of a local company was forced to be sold at a loss when it was discovered there were insufficient collateral available for the bonds held

The challenges are the same – pre- and post-deal

Deal risks typically relate to one or more of three key elements: the asset itself, the seller and or the government. Through our past deal analysis and through interviews, we have identified seven of the most common pitfalls facing deal-makers.

By examining a number of deals we traced the root causes of these problems to a set of critical differences in practices and governance between emerging and developed markets. Click on each risk area for common problems

Transparency of financial information

Common problems

• Difficulty understanding financial information prevents necessary disclosure
• Risks are not given enough weight

Root causes

• Managers place less emphasis on financial information, so less is available – e.g. poor accounting systems
• Accounting policies and practices differ from those in home markets – e.g. 2 sets of books
• Managers are less willing to provide information because of concerns with confidentiality
• Deal teams obtain insufficient local advice

Mitigating actions

• Conduct thorough initial review
• Prioritise issues: decide what is important in conjunction with local advisors
• Where possible, obtain exclusivity and spend time building up key data bottom-up
• Put risks in context to take calculated risks

Justifying valuations

Common problems

• Large gaps in expectation between buyer and seller
• Worse than expected performance

Root causes

• Uncertainty over future growth: market demand, distribution channels, and future competitor actions
• Few comparables
• Competition for assets

Mitigating actions

• More research to increase comfort with projections
• Structures such as earn-outs
• Combine conservative short-term Discounted Cash Flow (e.g. scenarios, higher discount rate) with long-term strategic option value

Non-compliant business practices

Common problems

• Tax compliance – “black cash” transactions
• Corruption
• Fraud & misappropriation
• Labour practices & compliance

Root causes

• Less developed/ unenforced business and regulatory environments
• Less formal governance structures

Mitigating actions

• Spend time on the ground with local teams / advisors
• Targeted due diligence covering key individuals and common issues (e.g. tax, labour, corruption)
• Understand if the practice can be managed

Post completion operations issues

Common problems

• Wide range of factors causing worse than expected performance post completion

Root causes

• High requirements of foreign-owned businesses: local operating experience, deep business & finance expertise, foreign language skills, cultural affinity
• Different attitudes to management among local staff
• Living hardships in some markets

Mitigating actions

• Getting the right people in place
• Setting the right pace (address critical areas from day 1; slower thereafter)

Negotiating and contracting difficulties

Common problems

• 3rd party claims against the asset
• Enforceability of agreements
• Local negotiating practices

Root causes

• Less developed legal infrastructure
• Less experienced and less support in doing deals
• Different approaches to negotiating
• Stakeholders whose interests may be difficult to ascertain

Mitigating actions

• Establish local presence
• Adapt negotiating approach
• Prepare before starting the deal
• Encourage seller to use an experienced advisor
• Negotiate with multiple parties

Partnering conflicts

Common problems

• Conflicting views over strategy
• Conflicts of interest outside the venture
• Cultural differences

Root causes

• Misalignment of interests

Mitigating actions

• Choose the right partner by holding discussions with multiple companies identified through a bottom-up screening exercise
• Research any partner extensively
• Consider exit and avoid 50/50 joint ventures when structuring the partnership

Government interference

Common problems

• Government delay or non- approval of transactions (e.g. anti-competition commission)
• Post-deal changes in government positions

Root causes

• Grey regulations
• Changing power within government
• National or regional interests in strategic industries and foreign direct investment

Mitigating actions

• Engaging with multiple levels of government
• Scenario planning