Author: Henrik Dagmalm
Profitable international growth – cross-border M&A
Globalisation is emphasising the potential of the economic shift from west to east by uncovering growth opportunities in the emerging markets. From a European perspective, production led the way to low cost countries and was followed shortly by sales missions being set up. Nordic enterprises have exploited growth opportunities in the emerging markets for decades but the majority of investments are in organic growth and the development of partner networks for sales or production. Cross-border M&A in the emerging markets has strong potential for rapid growth. But the “risk and reward” theorem is calling for sound best practice and risk management in order to get a return on investment.
1. The economic shift from west to east
In terms of business growth and growth rates no other trend in modern time has created more momentum in global business than globalisation in general and the economic shift from west to east in particular. The east is in this white paper defined as the territory between Ljubjana and Manilla and between Bolshevik and Surabaya.
An era of immense product quality ended when former authoritarian states in the eastern bloc allowed glimpses of free market economy to attract manufacturing work from “the free world”. A dishwasher could now be purchased for one third of its price and it would serve your household one third of its previous lifetime. When moving production, from the west to low cost countries, went beyond the “tipping point”, it became obvious that customers in the west had become customers also in the east. The labouring working class in the east was becoming middle class and increased consumption contributed to high growth rates – one of the key drivers for profitable international growth. Even though growth rates have dipped in recent years, some of the emerging markets are still offering higher numbers than many industrialised countries. But are the reduced growth rates attractive when considering the ever present level of risk?
2. Low cost countries + risk = low cost production
The other key driver for profitable international growth is the opportunity of low costs. The clothes and fashion industry has been chasing low costs longer than any other industry. This mission has transferred high volume manufacturing from the west to the Baltics, from China to Vietnam and from Pakistan to Afghanistan. Unless the fashion industry completely re-invents its production concept, it’s bound for Africa next.
The opportunity of low costs naturally needs to be considered from a quality control perspective; time and resources for assuring the quality of production may limit the potential.
One interesting case in “low cost production positioning” is the PKC Groups investment in a 1 500 employee factory in Serbia in 2013. In order to leverage more competitiveness and cost efficiency in the group, the establishment of a production unit in Serbia was the result of researching and analysing opportunities globally. Link to company announcement.
The investor’s capacity for managing risk pro-actively is crucial for the success in getting a return on investment in the emerging markets.
3. Rapid market entry through M&A
Organic growth in emerging markets takes time, conviction and methodology. A growth strategy based on M&A in the emerging markets has the advantage of offering instant access to a certain market and very likely synergy effects that will be pushing costs down on mid to long term. International growth in the emerging markets through M&A also requires significant efforts to be successful as well as sound methodology.
Finnish stocklisted Technopolis has a proven track record of fast and profitable international growth through M&A. The first acquisition in Estonia 2010 created a strong growth momentum in the company group. Link to company announcement The successful venture in Estonia led the way to more acquisitions and in six years the export revenue has increased to an estimated 65MEUR overall.
4. Best practice – M&A in emerging markets
Apart from the obvious capacity for making transactions a great deal of the success factors are related to language skills and comprehension of the relevant business culture. Due diligence tends to be emphasised by Nordic enterprises when making transactions in the emerging markets and invariably extends to in-depth “human resources due diligence”.
From a tactical point of view, best practice for finding M&A targets in the emerging markets is to do extensive screening to identify the most fitting candidates. To the contrary, don’t settle for the obvious short list of targets that are publicly for sale. The value of finding a suitable target with potential (rather than “a bride already dressed”) can be leveraged substantially in the emerging markets. In order to leverage from the potential in acquiring or merging with a company that isn’t publicly for sale, in the emerging markets, communication with the targets is key as well as being able to “read between the lines” in a business culture context.
When contacting a target in the emerging markets, with an M&A agenda, the dialogue needs to be adapted and move between deal structure, LOI criteria, negotiations and MOU with flexibility. One of the key challenges is to transfer verbal commitments and agreements into written form. This “elephant” is preferably “eaten in one chunk at the time”. Your comprehension of the local business culture will, in this regard, be put to “the acid test”.
5. Risk management in cross-border M&A
Since the element of risk being part of the nature of the emerging markets environment and the core challenge to overcome to be reaping the rewards, pro-active and wide management of all internal and external factors that may affect the success of the venture cannot be emphasised enough. However, there are two risk management components that stands out in this context.
- “Red flag” analysis. A great deal of time and resources can be saved in the closing phase by putting in the research work that is required to identify any “red flags” that may disqualify an M&A target in the emerging markets. Compliance issues, corruption and undue business conduct as well as unsuitable social networks are red flags to any profitable market entry project.
- Careful due diligence. Obviously all types of due diligence need to be performed extensively in transactions in the emerging markets. But the main reason for making this part of the M&A process (in the emerging markets) crucially important is the fact that the seller don’t have the culture of keeping simply comprehended and open books. The input data for the valuation will have to be validated, as a rule of thumb.
Next step for your company!
Profitable international growth can only be achieved at satisfactory levels when pro-active risk management is applied to the opportunities of high growth rates and low costs. Organic growth and growth through M&A in the emerging markets offers the same potential in the long term. Your choice between the two growth strategies should be based on then structure of the value chain of your industry and the time frames your company has for revenue streams from the emerging markets.
Henrik Dagmalm is a Partner and CEO at Excedea Sweden. Henrik has been a management consultant since 2006 and has primarily advised Swedish companies on international growth and public funding. His experience in the field spans from 25 successful international growth projects to 200 winning public funding projects related to international growth – all targeting Russia & CIS, Eastern Europe and Asia.
Should you have any comments or questions related to M&A in the emerging markets, please contact Henrik at firstname.lastname@example.org or +46 709 88 66 67.