Exchange rate exposure: The fall of Yen currency

The yen has dropped to its lowest point against the US dollar in seven months (BBC news). The dollar rose to 80.24 Japanese yen late Wednesday from 79.71 yen in 21^st Feb 2012. According to BBC news, one of the reasons for the fall is    Part of the reason for the fall is the Bank of Japan's surprise increase of its stimulus measures. Another reason is the strengthen of USD.  

The fluctuation of Yen/USD exchange rate affects upon Japan’s multinational companies and multinational companies operating within the country. The bulk of Japanese exports and imports are denominated in U.S. dollars rather than Japan's local currency, the yen. Japanese exporters are likely to receive dollar revenues but incur most of their costs in yen. Likewise, Japanese importers make dollar payments though sales are likely to be denominated in yen.  

The fall of Yen against US Dollar have energized Japanese manufactures and the economy since Japan is heavily dependent on exports. The weak Yen make exporters cheaper overseas and therefore more competitive. For instance, car manufacturers such as Toyota, Honda and Mitsubishi, have been some of the benefits by the weak yen as it makes their products more competitive abroad. If the Yen’s strengths, it will be a worst hit for Japanese exporters. “Toyota, for example, bases its earnings on an exchange rate of ¥105: every ¥1 appreciation against the dollar costs the firm ¥35 billion ($350m) in annual operating profit. Almost 60% of the companies on the exchange's main market are trading at less than their book value.” (The Economist, 2008). An amount of cash, which Japanese exporters have received, will increase as the result of Yen’s fall. The fall also supports the demand of Japanese products and services so the market shares of Japan firms will increase. Generally, weak Yen have benefited Japanese exporters. However, some industries like automobile industry have to import raw materials, components from outsiders, the fall would incline the costs of those imports, and effect cost advantages. Even companies do not directly import raw materials from international markets, the fall indirectly take away cost advantages through their suppliers who use imports.              

In contrast, the fall brings the advantages for Japanese export companies while make disadvantages for Japanese import companies as well as foreign export firms. This is the drawback because overseas products’ price has been higher than domestics’ price. Profit, which importers and outsiders gain, will be less. Moreover, the weak Yen influences customer demand. The cheaper price of products and service of domestics will make customer switch from overseas products to domestics’ one. Market share of those companies will decrease as well. Foreign companies will lose their Japan market share.

The decline of Yen also effect multinational companies which operating in Japan especially US firms. The Japanese investment requires Yen currency. One, Yen drops against Dollar, the cost of international investment will decrease. However, returns and profits from Japanese subsidiaries have been decreased when foreign companies convert from Yen into USD.               

Multinational tax management: transfer pricing

Kad industrial SA Vietnam Co., Ltd is a entity which has produced clothes to fulfill contracts which parent company in U.S has signed with other foreign partners. This project has generated nearly 14.4 billion accumulated loss which causes the loss is determined by the price below the cost of outsourcing. Analyses of data records, the losses are mainly formed by the depreciation of machinery and equipment in production costs 1.5 times compare to plan. Through the actual inspection process, Da Nang Taxation Department identifies all machinery and equipment of this plant is imported from an old production facility in the U.S. and is included in the value of capital contribution by the parent company. Clearly, productive machinery and equipment is not as declared by the company, but the tax office is difficult to clarify the "suspected case" unit prices below the cost of outsourcing business, because not determine the market price the number of contribution of capital equipment.

Transfer pricing is easily mistaken as cheating on prices they are two different behaviors. However, I think transfer pricing is considered as more sophisticated price cheating because result of the two behavior of fraudulent transfer pricing and prices are leading to the determination of tax liability for state which does not comply with the provisions of the law. However, the price cheating is a fraud which company itself may conduct but transfer pricing can only be done by more than one parties. Inform lower import prices compare to actual prices to evade import tax rates or higher sales prices than sales invoices, revenue accounting to evasion of value added tax (VAT) evasion that corporate income tax (CIT). This  is considered as the price fraud.

The main reason leading Kad company to conduct transfer pricing is related to profit maximization. Business in general, multinational corporations in particular, never give up opportunities to maximize profit, including behavior change price, price fraud, commercial fraud, ... Transferring price of goods, services, capital investment across borders will be harder to detect than the others and even fraud cases detected is not easy to dispose because by government of each country often tend to protect their businesses as the national interest. However, maximize profit does not mean maximizing shareholders’’ wealth (Arnold, 2008). Managers might conduct transfer-pricing base on their own benefits. Transfer pricing is conduct in term of the differences in investment climate, business differences on policies, laws and regulations between countries, etc. also create opportunities for the multinational corporations to develop and implement their transfer pricing. The differences in tax policy; especially tax incentives are the main reason. Almost of developing countries are using the main tax incentives is one tool to attract foreign direct investment. However, is attracting FDI good for country’s economics, for instance, in case of Vietnam Kad industrial SA Ltd?  

As stated above, the objective of transfer pricing is to maximize the profit of a corporation based on minimizing tax obligations. For headquarter of SA industrial firm, transfer pricing to ensure that they achieve benefits such as reducing tax liabilities, maximize profits by allowing them to easily transfer their investment capital or profits of the country or moving abroad (even in cases they are holding loss statement).

In addition, the US parent company contributed investment capital by equipment and machines from their US old facilities; the company headquarters also easily change and modernization of technology through the disposal of outdated equipment, obsolete technology for Vietnam firm at high price. Transfer pricing is conducted through the company and overseas partners, so it also allows the US headquarters reduced the risk of product markets, exchange rate risk, etc. Enterprise benefits by shortening the payback period of investment and interest income even in the period the Vietnam subsidiary is the basis of their investment are reporting losses.

In contrast, transfer pricing not only causes damage to the budget of the country receiving the investment, but also distorts the business environment, and detriment Vietnam domestics firms. In short term, the US government may face difficulties in capital investment because the country's capital investment by the private sector tend to flow to the investment-receiving country, Vietnam in which there is lower tax. However, in the long term, the US government has got double benefits as a new market, pollution reduction by not producing in the country, new resources approach. Especially in countries with high taxes, the government is also entitled to their full tax incentives which Vietnam government has given to foreign investors.

For the host country receiving the investment, we cannot deny what foreign investment has contributed when looking at the real economy after 20 years. However, if fully comprehensive analyzed, we have lost more than received.

Raising capital: the limitation of domestics firm: no more funds for Wrexham FC.

Capital is the fundamental issue for company to grow and develop. There are two main external ways to raising funds: equity and debt. Each form has its own advantages and disadvantages. In this blog, I have only concern about equity financing.

Equity financing is less risky than a loan because firm does not have to pay it back, and it's a good option if company can't afford pay since it is in negative year. Instead, company can raise more funds from investors to the business. Then, company will have more cash on hand for developing the business. However, if company keeps not paying returns in a long period, it will be a trouble because investors see no benefits from holding the shares then they will sell their shares and invest in other profitable companies. Because of unguaranteed returns, shareholders may require returns that could be more than the interest rate. Moreover, investors will require some ownership of the company and a percentage of the profits. It will impact ownership of existing shareholders. There is no tax reduction if financing by equity.

Although there are some disadvantages of equity financing, equity is the fundamental source of capital. It would be positive if company raises a lot of funds from investors. It is an advantage of listed companies, especially, international listed company. If company is listed globally, the liquidity of shares, share price and the reputation of company are improves. As a result, cash flows and funds available are increasing.  

In contrast, it is the limitation of domestic firm when it does not be listed in stock market. It cannot raise enough funds if it needs. BBC News (2011), Wrexham FC fell into crisis since it faces tax bill. The company cannot pay the tax by its own internal resource. It needs help from its shareholders and lenders. However, Wrexham FC is non-listed comapny, it limits their capital financing sources. They can only lean on its investors’ help. However, the investors said that there would be no more funds available for Wrexham FC because they have been invested too much.  There is another way to raise funds is debt financing. However, in this negative situation, it must be risky if lenders give away their money because the Wrexham’s ability to pay back is low. They need to look at interest payment ability then no lenders is willing to give money to Wrexham FC except a small amount of fans of Wrexham FC. As a result, Wrexham FC is going to be takeover however, until now no investors is willing to commit the deal. Organization might go bankrupt and destroy shareholders wealth.   

Weight averages cost of capital: errors when calculating WACC

In order to invest in a project or a business unit strategy, a firm needs to raise capital. The capital can be raised from several sources such as equity shares, bonds, and return earning.  However, nothing is free. Finance providers have taken risks when investing money in a company so they require an acceptable return. Shareholders expect a return on their invested money, and bondholders expect an interest payment annually. At a certain level of risk of project, there is a minimum level of required rate of return (WACC). At least, company is expected to pay interest on its borrowing money, pay its shareholders directly as dividends if it cannot make a capital investment, which will increase returns for shareholders. The more risky project is the more required rate of returns is. Therefore, estimating WACC is very important. Calculating WACC correctly is also every significant because WACC is used as a tool to approve or reject projects. If the cost of capital is calculated incorrectly, then we may be approve projects that will reduce benefits to shareholders, or reject projects that could benefit shareholders. However, how does company calculate accurately? Is there any errors when estimating WACC? 

In this case, I only concern about cost of equity and cost of debt. There are many errors when estimating WACC. For example, Fernandez (2004) identified the common errors in a paper entitled “80 Common Errors in Company Valuation“.  I realize that most common errors come from calculating cost of equity. Why? Because the procedure for measuring cost of debt is quite simple and easy. The normal procedure only require a forecast of interest rates for the next few year, the proportion of various classes of debt and the corporate income tax rate (Moffett, 2009). However, it does not mean there is no error when estimating cost of debt. All is about forecasting the future. There is nothing reliable.

To calculate cost of equity, there are two models: Gordon Growth Model and Capital Asset Pricing Model (CAPM). The first error I think is using unsuitable model. For example, Gordon Growth Model is a purely quantitative model, does not take into account qualitative factors such as industry trends and management strategy and relies on a future constant dividends’ growth This drawback makes the model less flexible and suitable when applying in rapidly growing industries with less predictable dividend patterns, such as software or mobile phone. Gordon Growth Model is only useful to use in mature industry with stable and predictable dividend growth pattern like tobacco industry. Nowadays, with the growing rapidly of most industries and economies, Gordon Growth Model is less relevant. Instead of that, CAPM is alternative suitable one. Until now, it still exist the debate around the effectiveness of CAPM. The CAPM is widely known, studied by a large amount of analyst and executives. Most financial directors use it to assess their cost of capital and the reliability of project. However, it faced a lot of disfavour such as Harry Markowitz’s, James Montier’s and Eugene Fama’s studies (Financial times, 2007). In my opinion, nothing is such a perfect thing in such an imperfect world. So, let us choose the most suitable updated model in a particular circumstance.         

 Considering CAPM is the most effective model to estimate cost of equity and WACC. Nevertheless, applying a good theory and model does not mean company will calculate WACC correctly. It depends on how company applies the model into practices. As mention above,   Fernandez (2004) shows an amount of errors when estimating WACC :

·         Wrong risk -free rate used for the valuation

o   Using the historical average of the risk-free rate

o   Using the short-term Government rate

·         Wrong beta used for the valuation

o   Using the historical industry beta, or the average of the betas of similar companies

o   Using the wrong formulae for levering and unlevering the beta

·         Wrong market risk premium used for the valuation

o   The required market risk premium is equal to the historical equity premium.

o   The required market risk premium is equal to zero.

·          Wrong calculation of WACC

o   Wrong definition of WACC.

o   Debt to equity ratio used to calculate the WACC is different than the debt to equity ratio resulting from the valuation.

o   Using discount rates lower than the risk free rate.

o   Using the statutory tax rate, instead of the effective tax rate of the levered company

o   Valuing all the different businesses of a diversified company using the same WACC (same leverage and same Ke).

o   Considering that WACC / (1-T) is a reasonable return for the stakeholders of the company.

o   Using the wrong formula for the WACC when the value of debt is not equal to its book value

o   Calculating the WACC assuming a certain capital structure and deducting the outstanding debt from the enterprise value

o   Calculating the WACC using book values of debt and equity

In conclusion, there are a lot of errors and their effects that firm needs consider when calculate the WACC. However, it cannot avoid all of those errors because the time is continuous changing. Every data can become the past one every time. Company and the analyst can only determine the exactly results of project when it happened. Company can only reduce those things as much as possible. The suggestion is company’s WACC calculation should pass an acceptable test before applying. It is suggested to use “Corporate capital costs: a practitioner’s guide” of Justin Pettit (2005) in order to minimize the required rate of return. 

There is only thing that I consider the most is why never use the book value of equity and debt when estimating the capital structure weight for the WACC (Brigham Daves, 2010).

Switching stock market listing from one country to others. Is it easy for companies to list their shares on more than one exchange?

The financial globalization motivates companies list their stock abroad. There are several reasons for listing shares on more than one exchange. First reason is to raise capital. A cross-border listing can help a company target new shareholders. The second reason for listing on several exchanges is that it increases a stock's liquidity. Theirs shares become more accessible to global investors, allow investors decide sell or buy share in which market which markets. It will decrease the cost of capital. One of the reasons is to raise awareness of company. More people will know about the company if company lists on more than one market.

The cross listing is believed that it has a significantly positive impact on value of the cross-listed firm in the home market (Miller, 1999). For example, CRH, one of the Ireland’s biggest building material companies is to move its primary stock market listing from Dublin to London, while CRH shares will retain a secondary listing in Dublin.  Shares in the Irish-headquartered group rose 4 percent on the expectation that index funds would now buy its shares (Smyth, 2011).  Why CRH choose London stock exchange as primary exchange instead of Irish? Obviously, London stock exchange is the largest international equity market. The benefits and opportunities come from London stock exchange are more than from Dublin stock exchanges such as more well-known, more investors, more regulated market and etc.  CRH chief executive Myles Lee said: "We believe that these listing arrangements are in the best long-term interests of CRH and will increase the group's attractiveness to a wider international investor base’’. Of course, CEO of one company will say positive thing about organization. However, we cannot deny the positive impacts of listing on London stock exchange.  Furthermore, CRH tends to entry into benchmark FTSE 100 index. It would open a new opportunities for CRH when it becomes a FTSE 100 companies.

In another case, could companies list their shares abroad as expected? Greencore plc, food firm, cancels its listing on the Irish Stock Exchange and move to London stock exchange instead of keeping listing shares on Irish Stock Exchange. Why Greencore plc listed in London stock exchange stead of Irish stock exchange?  It is said that the major activities of Greencore such as its turnover, operating profits and producing assets are held in UK. Almost Group’s shares are now owned by overseas investors. In 2011, the company completed the acquisition of Uniq plc, which has further increased the proportion of its activity in the UK. Why doesn’t Greencore plc list on both London stock exchange and Irish stock exchange? Is it what company want? It is not easy as expected. In order to list on London stock exchange, company has to fulfil the requirement. In Greencore’s case, company has to reach a certain liquidity threshold on London stock exchange in order to listing on that exchange (Irish times, 2011). Unlike CRH, it already has amount of liquidity in London, almost Greencore’s liquidity is in Dublin. In order to listing shares on London stock exchange, Greencore has to move its stock from Dublin to London.

More opportunities more risks and threats there are. In both cases, the moving stock exchange will create more opportunities. On another hand, companies have to face more threats. Companies must comply with more restricted regulator requirement. For instance, company must meet transparency requirement, provide more released information. The cost of listing is also different. Companies must pay higher professional fees.

In conclusion, before listing in stock exchange or switch to greater exchange, company should take the consideration. London stock exchange provides a practical guild to listing which contains major self-questions. Those question help companies know whether they are already to list or not.      

Shareholder wealth maximization: Hutchison to buy Orange Austria

HONG KONG, Feb 3 (Reuters, 2012a) - Hutchison 3G has agreed to buy Orange Austria from France Telecom and Mid Europa Partners, the private equity group in a deal valued at 3 billion euros ($1.7 billion), adding to more than $31 billion of investments in overseas mobile-phone operations.

HUTCHISON WHAMPOA LIMITED
The acquisition is believed to maximize shareholders' value. Hutchison shares rose to the highest level in five months in Hong Kong trading on optimism the purchase may improve its ability to compete against market leaders Telekom Austria and Deutsche Telekom AG’s T-Mobile Austria (Bloomberg, 2012). Hutchison shares rose as much as 3.8 percent to HK$76.20 on the news, bucking a flat overall market (Reuter, 2012b)."In the telecom business there is a real co-relation between market share and profitability," Bertrand Bidaud of Gartner told the BBC. Hutch said the deal would make it Austria's third-biggest mobile phone operator, with 2.8 million customers and a 22 percent market share, and the two units had combined revenues of more than 700 million Euros in 2011.

I think Hutchison's buying decision is a right decision at the right time. In the high competition in Austrian market, the best way to gain market share is fight against or consolidate competition, said Bertrand Bidaud (BBC News, 2012) . Hutchison used acquisition to increase its share. "It is definitely a positive for the future development as the acquisition cost can be lower in the current economic climate," said Conita Hung, head of equity research at Delta Asia Financial Group. "It is a good opportunity for those financially strong companies to buy assets in Europe, especially if they believe in the strong growth prospect," she said.

However, I wonder that is it really creates opportunity when Hutchison buy Orange Austrian in European debt crisis circumstance. European debt crisis affects the economic and demand of Austrian. The company could make profitability as its expected? Generally, the deal is believed to be a long-term profitability. "Overall, we do think the deal offers one of the few relatively visible paths to long-term sustained profitability for 3 Austria," Bank of America/Merrill Lynch said.

Not only shareholders but also customers, stakeholders, benefit from acquisition agreement. Orange Austria’s customers will benefit from 3 Austria’s superior high speed data network coverage and quality, while all of 3 Austria’s customers going forward will benefit from superior coverage, quality, innovation and service through the improved spectrum position, retail footprint and efficiencies that the combined businesses will generate (Hutchinson Press Releases, 2012). From my point of view, in this case it is not sure that Hutch corporate objective is stakeholders' capitalism, but absolutely shareholders wealth maximization.

FRANCE TELECOM
For France Telecom, the aim of sale is to exit low-growth mature markets and returning cash to shareholders (Reuters, 2012c). At the moment, the offer has negative effect on market share value of France telecom. Shareholder would suffer lower share value. However, it is not so bad. France Telecom decided to pay back cash to shareholders. Shareholders can determine continue invest in company or not. From my point of view, it would be long-term profitability. France telecom decided to close Austrian, lower growth market and concentrate on its core market or higher growth markets in Africa and the Middle East (Thomas & Jacob, 2012). It would improve the corporate value of organization. In future, it would benefit shareholder value. I conceive that France Telecom's decision is in order to maximize shareholders wealth.

REFERENCE

• BBC News (2012) 'Hutchison to buy Orange Austria as it seeks expansion' [Online]. Available at: http://www.bbc.co.uk/news/business-16866032 (Accessed: 3 Feb 2012)
• Bloomberg (2012) 'Li’s Hutchison to Buy Orange Austria in $1.7 Billion Deal' [Online]. Available at: http://www.businessweek.com/news/2012-02-03/li-s-hutchison-to-buy-orange-austria-in-1-7-billion-deal.html (Accessed: 3 Feb 2012).
• Hutchison Press Releases (2012) 'Hutchison 3G Austria announces the acquisition of Orange Austria from Mid Europa Partners and France Telecom combining the third and fourth player in theAustrian mobile telephony market' [Online]. Available at: http://www.hutchison-whampoa.com/upload_docs/2012/02/Telco/2353/2353_eng.pdf (Accessed: 3 Feb 2012).
• Reuters (2012a) 'Hutchison unit to buy Orange Austria for 1.3bln euros in EV -source', Guardian [Online]. Available at: http://www.guardian.co.uk/business/feedarticle/10074290 (Accessed: 3 Feb 2012).
• Reauters (2012b) 'UPDATE 4-Hutch to buy Orange Austria as Asia firms shop in Europe' [Online] Available at: http://www.reuters.com/article/2012/02/03/orangeaustria-hutchison-idUSL4E8D28Y920120203 (Accessed: 3 Feb 2012).
• Reuters (2012c) 'France Telecom close to deal to exit Austria' [Online]. Available at: http://www.reuters.com/article/2012/01/16/us-francetel-idUSTRE80F0PK20120116 (Accessed: 3 Feb 2012).
• Thomas, D. and Jacob, R. (2012) ' Hutchison seals deal to buy Orange Austria', Fianancial Times [Online]. Available at: http://www.ft.com/cms/s/0/281742ec-4dd4-11e1-b96c-00144feabdc0.html#axzz1lIkIJAum (Accessed: 3 Feb 2012).