Print this article | Return to Article | Return to CFO.com
As more U.S. companies expand overseas, new sources of capital are opening up.
Randy Myers, CFO Magazine
October 1, 2011
When heavy-equipment maker Caterpillar went looking for capital to finance its growing operations in China, it had plenty of options. It could have used some of its nearly $11 billion in cash, borrowed from one of its global banks, issued debt or equity in the highly liquid U.S. markets, or borrowed directly from a Chinese bank. Instead, it chose to issue bonds denominated in renminbi in Hong Kong's developing CNH (Chinese yuan in Hong Kong) market.
McDonald's has also issued CNH, or, as they are known colloquially, dim sum bonds. And others are looking to follow suit (see "China's Currency Conversion," July/August). Deutsche Bank earlier this year surveyed 44 multinationals and found that two-thirds were considering issuing CNH instruments. The reason: the recent average 2.6% cost of funds was about 400 basis points lower than a two-year renminbi loan from a mainland China bank.
As emerging markets become an increasingly important component of the global economy — businesses invested more in developing than developed economies for the first time last year, according to the U.N. Conference on Trade and Development — options for financing overseas growth are broadening. In many cases it makes sense for CFOs to tap local sources of capital. Consumer-facing firms can get a boost from recruiting individual investors who consume their products to buy shares; companies can eliminate some foreign-exchange (FX) risk by funding projects with local currency debt; and many investors in emerging markets take a longer-term approach to holding shares than U.S. investors do, which can stabilize share prices.
But the availability of emerging-market financing risks falling behind the overall pace of globalization. Capital markets outside the U.S. are in many cases still shallow and relatively illiquid. And U.S.-based banks are pulling back on global expansion, not thrusting forward.
"In an ideal world, we'd love to finance globally, even though lately most of our corporate financing has been done in Canada," says Kelly Marshall, managing partner of Brookfield Asset Management, a Toronto-based alternative asset manager focused on property, renewable power, and infrastructure assets with approximately $150 billion of assets under management. "We'd love to issue in sterling, and we've actually had a look at the yen market, as well. We look to wherever we can finance ourselves most efficiently."
The progress in developing-market economies is not limited to China. A number of Latin American countries, including Chile, Peru, Colombia, and Mexico, have seen their capital markets mature with the debut of private pension programs. These programs are hungry for commercial paper that can diversify their investment portfolios. In addition, many institutional investors in emerging-market countries are by law required to invest domestically.
"Local markets have become deeper, and there is an appetite for finance deals that wasn't there 10 years ago," says Gerardo Mato, CEO of HSBC Global Banking-Americas, a unit of UK-based bank HSBC. "In Latin America," he adds, "Mexico and Brazil are the biggest markets, and deepest in terms of liquidity. They have developed many instruments that give flexibility to companies willing to issue debt." Colombia is also maturing, Mato says.
Like many U.S.-based manufacturers, $16 billion Jabil Circuit has acquired an increasingly global footprint over the past decade. It now has more than 21 million square feet of manufacturing capacity at 55 sites on four continents, with about 80% of that capacity in low-cost, mostly emerging-market, economies.
Thus far, it has funded most of its overseas expansion with internally generated cash flows and intercompany loans financed, in turn, by debt offerings in the U.S. It also maintains a $1 billion multiyear credit revolver in which three of the four lead banks are based in the U.S. But treasurer Sergio Cadavid foresees a day when this U.S.-centric approach may no longer make sense.
"We're trying to become more intelligent and opportunistic in the emerging markets where we do business," Cadavid says. "For example, we've been studying the Hong Kong market closely for two years. We've even considered the possibility of listing on the Shanghai Stock Exchange."
Cost and Speed Advantages
Banks, of course, play an active role in emerging-market finance. Below the parent-company level, for example, Brookfield Asset Management controls three other public companies, one focused on real estate, another on renewable power, and the third on infrastructure. Each of those companies finances its assets on a discrete, stand-alone basis. At that level, Brookfield has been much more active in financing within emerging markets, and a variety of banks have played important roles.
In 2006, Brookfield led a consortium that bought HQI Transelec Chile, the largest electricity-transmission company in the South American country, for $1.55 billion. The financing package included bridge loans from two global banks, Citibank and HSBC, as well as from Canada's Scotiabank. In other deals, Brookfield's affiliates have borrowed from Brazilian banks. In fact, Brookfield managing partner Marshall says that the balance sheet of every asset the company owns around the world includes some local financing.
In contrast, raising money at home for emerging-market assets can be expensive, Marshall says, not just because of the cost of managing foreign-exchange risk but also because distribution costs can be higher, as domestic banks consider emerging-market financing a premium service. "In local markets, the transactional costs are lower because the investment banks there are not looking to be paid premiums to operate in those markets," Marshall says. "At the same time, you're automatically hedging away your FX risk."
Borrowing from local emerging-market banks can be particularly expedient for short-term financing needs or working-capital requirements. "Often these local banks have access to liquidity, either via their country's central bank or as part of their deposit base, that international banks don't have," notes Robert McMinn, a managing director of Credit Suisse in New York who works with the bank's debt capital markets group. "International banks might have to go through the interbank market, and if there's a liquidity or financial crisis, that interbank liquidity can dry up."
McMinn warns, however, that it's important for companies to be wary of putting too much debt on the balance sheets of their local subsidiaries. From a legal perspective, credit-rating agencies might conclude that the parent company's debt is structurally subordinated because the local debt is closer to the subsidiaries' assets. That could hurt the parent company's credit rating, McMinn says.
Know the Constraints
"The downside to [local financing] is that, in many developing economies, debt markets operate in very narrow bands," Marshall says. "If a company doesn't fall into a certain ratings category — which tends to be what we call investment-grade — you can very quickly go to a situation where no one is bidding for your business."
Shrenik Davda, chief executive of Gryphon Holdings, a boutique investment bank focused on Central Europe, Eastern Europe, the Middle East, and North Africa, says long-term borrowing remains expensive in the frontier emerging markets.
"Licensing standards, authorizations, and approval times to borrow also vary from place to place," Davda warns. Ukraine, for example, is particularly notorious for making companies jump through regulatory hoops. Georgia, by contrast, "is fantastic. They are very investor-friendly and have low corruption. You can set up a company in a matter of days and you don't have to bribe anyone to do it."
China's CNH market remains small for now, in part because foreign companies must still cut through yards of red tape if they want to move the proceeds of a local offering outside of Hong Kong. To transfer funds to an operating entity in mainland China, for example, multinationals must get explicit approval from Chinese authorities on a case-by-case basis. To make the transfer via a shareholder loan or by injecting equity into the mainland operation requires the approval of the People's Bank of China and China's State Administration of Foreign Exchange, and, in some cases, the Ministry of Commerce.
"There are some constraints [in many markets]," admits Credit Suisse's McMinn. "I recently spoke with the treasurer of a major company that was talking about raising money in emerging markets. One of the biggest challenges companies have is the depth of those local markets. In many cases, an offering of $100 million or $200 million is probably at the high end of what you can get done."
Maturities can also be fairly limited. The maturity curve runs from about 2 years to 10 years in most places, whereas in the U.S. it can go from overnight to 30 years.
High local benchmark rates also can be a challenge, particularly where fast-growing economies have governments and central bankers on guard against inflation. "Securities are usually priced over the government curve," McMinn says, "so if you're in Brazil, where the benchmark rate was raised to 12.5% in July, and you then tack on a credit spread, companies will sometimes conclude that the interest-rate difference versus the U.S. is just so high that they'd rather run the FX risk."
The Power of Diversification
It seems inevitable that capital markets in emerging economies will continue to grow. The global stock of loans on the balance sheets of financial institutions rose by $2.6 trillion in 2010, the McKinsey Global Institute reports, with emerging markets accounting for $2 trillion of that increase. Lending by financial institutions in emerging markets has grown 16% annually since 2000, easily outpacing the U.S. and Western Europe.
As developing economies expand, Western companies won't be able to ignore their growing piles of capital. Companies with "direct and privileged sources of financing," McKinsey argues, will have a competitive advantage. Beyond nurturing relationships with major financial institutions in London, Tokyo, and Hong Kong, companies will have to build ties with sovereign wealth funds, pension funds, and other investors outside the world's largest financial centers.
That makes particular sense given the lesson of the credit crisis of 2007–2009, when funding sources in many developed markets dried up. During that period, Marshall observes, Brazil and Chile ranked among the most functional financial markets in which his company was operating.
"It is always advantageous," he says, "to have diversified sources of capital." Those sources are expanding, but companies will need to assess them thoroughly in order to tap them most effectively.
Randy Myers is a contributing editor of CFO.
Small Companies Have Options
Large companies aren't the only ones raising money to expand abroad. Small companies are, as well. They can, of course, look to their own banks for loans, but they can also tap into alternative financing sources such as the Overseas Private Investment Corp., a U.S. government entity specifically tasked with helping U.S. companies gain footholds in emerging markets.
OPIC president Elizabeth Littlefield says companies generating less than $250 million in annual revenues accounted for more than 80% of the new loan, loan-guarantee, and political-risk-insurance projects that the organization underwrote last year.
Smaller companies can also access capital by partnering with local companies in the emerging markets where they want to do business. In June, for example, Houston-based Synthesis Energy Systems, a $9.4 million company that owns and is developing coal gasification plants in China and the U.S., secured a $5 million strategic investment from fertilizer maker Zuari Industries of India. Synthesis said the capital, provided in exchange for about 2.2 million shares of its common stock, will help fund its efforts to integrate its coal gasification technology into other industrial projects in India. Four years ago, its 95%-owned joint venture with a Chinese company received a loan of approximately $12 million from the Industrial and Commercial Bank of China, representing about half the costs of building its first coal gasification facility in Shandong Province.
Do Your Homework
The U.S. Export-Import Bank also is a source of funds for small companies seeking to boost exports. The bank announced in August that its loan authorizations had hit a record $24.5 billion with two months still to go in its fiscal year. One notable transaction was a $57.8 million loan guarantee benefiting Royal Equipment of Conroe, Texas. The company has annual revenues of less than $100 million and employs about 25 people in the U.S. and another 25 in Australia. The guarantee assures payment from Royal's customer, Downer EDI Mining of Australia, for the remanufacture of 22 off-highway mining trucks.
Royal Equipment CFO Don Wisenbaker says that, in lieu of a loan guarantee, the company could have asked the Export-Import Bank for a direct loan, but that process would have taken longer. While he says that working with the bank was fairly easy, he and his colleagues helped speed the transaction by attending bank seminars before applying, and by meeting in advance with the bank to make sure the company's products and services qualified for assistance. — R.M.
U.S. Regulations: Not All Bad?
Sergio Cadavid, treasurer of Jabil Circuit, sees some important advantages in pursuing financing opportunities abroad. Ideally, he says, the company would take on leverage in the emerging markets where it is actually investing its resources and generating cash. A reliance on domestic financing, he says, provides no direct link between the source of funds and the means of repaying them.
Unfortunately, moving away from domestic funding toward a greater use of local funding in emerging markets has proved troublesome, at least so far. In Shanghai, for example, "it turns out there's a list of exclusive names that will get there first," Cadavid says. "It's not the case that if you want to apply you will get [a] listing [on the Shanghai Exchange]. It's not an open market. It's very restricted."
Cadavid adds that rules and regulations can change quickly in emerging markets, making it hard to know if capital raised there will be available for use in exactly the way his company will want. Brazil, for example, announced in July that it was going to raise taxes on derivatives operations in that country's futures market. Now set at 1%, they could be raised to 25% if needed, Finance Minister Guido Mantega announced.
"It's the same way with China," Cadavid says. "There were things you were able to do in China a year ago that you are not able to do today." As the government fights inflation there, for example, it has substantially reined in bank lending. "The regulations can change before you realize it."
For now, the U.S. remains the most efficient and expedient place for Jabil Circuit to raise capital. "The rules in the U.S. don't change so often," Cadavid says. "They are more reliable." — R.M.
Governments as Financiers
A few additional sources of capital for companies to consider when expanding abroad:
• The Export-Import Bank of the United States helps U.S. companies finance the export of goods and services to international markets, primarily developing markets. (See "Small Companies Have Options," above.)
• Overseas Private Investment Corp., or OPIC, offers loans, guarantees, and political risk insurance to U.S. companies that are seeking to do business in emerging markets but are unable to secure financing or insurance in the private sector. Last year, it committed to about $2.5 billion in new business. "We will take risks no one else will take," says OPIC president Elizabeth Littlefield.
• Many developing countries sponsor similar entities that can provide financing for U.S. companies. Among the biggest are the Brazilian Development Bank and the China Development Bank. The Japanese Bank for International Cooperation also will help finance projects in emerging markets where the output — say, Chilean copper — will be exported to Japan.
To identify the best funding sources, Sergio Galvis, a New York–based partner with law firm Sullivan & Cromwell and head of its Latin America practice, says companies must first identify their top financing objectives. If speed is paramount, for example, working with a government funding source probably isn't the right solution. If mitigating political risk is an issue, by contrast, a government agency could be an ideal partner. So could a local pension fund, since governments will typically be loath to harm those funds. If the ability to spin off the foreign subsidiary at a future date is important, that, too, could argue for local financing independent of the parent company.
Galvis also suggests that companies investigate the protections available to them in foreign markets before deciding on a financing strategy. In Chile, for example, companies can enter into a foreign-investment agreement under Decree Law 600 that provides a series of contractual protections for repatriating investments, converting the local currency into dollars, and assuring nondiscriminatory tax treatment. In countries that don't offer such protections, companies can minimize risk by involving local funding sources and purchasing political-risk insurance.
Finally, Galvis says, companies should be wary of negotiating with foreign governments to win financing terms that are too good. "If you do that, it creates an incentive for the government — or the next government — to revisit the investment and conclude that you got a sweetheart deal. It's better to take a balanced approach." — R.M.