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Three common elements in the cross-border merger and acquisition

Describe about the International Business Finance and Trade for Domestic Company.

A. Discussion on merger and acquisition

Cross border merger and acquisition is a deal between foreign and domestic company for business purpose. A firm takes initiative for cross for merger and acquisition to get new business opportunity in a wider market. Changes in global environment such as technology, business regulatory framework and changes in capital market influence the merger and acquisition. One important element of the merger and acquisition is enhancing competitive position of the firm (Zheng et al., 2016). A firm can strengthen global competitiveness by accessing strategic property assets. A firm can use the assets of acquired firm or the firm with it has merged. This M&A policy enable the firm to gain market power by enhancing the market share. The second common element of the M&A policy is the management of the post acquisition transition. Third element is getting financial opportunities through M&A. M&A has some risk factors such as political risk, economic risk, and social risk.

The identified element of merger and acquisition is important concern for a business to enhance the growth opportunity of the firm. Rani, Yadav & Jain (2014) mentioned this term as green field investment. In the view of Otinda (2015), merger and acquisition is the cost effective way to get entry in the new market. A firm can gain competitive advantage about the in the form of technology, brand recognition in the target market. If these elements work in the positive direction for the business, these can accelerate the growth of the firm. The second element that a firm experiences after M&A is the change in strategy and management. M&A integrates two businesses and their culture. The success of M&A depends on the collaboration of two different cultures. Third important element of the merger and acquisition is the valuation of the target firm. Firm can gain financial opportunity by choosing right method of valuation. Different channels of valuation can affect the merger propensities (Rani, Yadav & Jain, 2015). Firm’s access to capital increases with the increase in firm’s value compared to other bidders. A small firm can be benefitted through acquired by a large firm. After acquisition, the share value of a small firm can increase in stock market.

Reflection of the three elements in the TATA Motor’s acquisition of Jaguar Land Rover

The objective of the Tata Motor’s for acquiring Jaguar Land Rover is to achieve global foot print and to enter global automobile market with a large scale. Jaguar Land Rover had a good brand value in the European market. Enhancing competitiveness and promoting growth wee other objectives. Tata motors gained two advanced design studios and technologies being a part of the acquisition deal. Tata motors could use the technology for the productivity improvement of the home country (Karolyi & Taboada 2015). Tata Motors got the opportunity from this acquisition to us the high grade steel used by JLR. The steel was supplied by Corus in the European and US.

Reflection of the three elements in the Tata Motor’s acquisition of Jaguar Land Rover

Tata Motors has strong management practices, which facilitated the acquisition. Tata Motors has strong employee base, who are assets for the company. The organizational culture of Tata Motors follows empowering the employees with dynamic career path (Karolyi, & Taboada, 2015). In-house and external training are organized for the skill development of the employees. Transformational and transactional leadership are followed in the Tata Motors. On the other hand, creative leadership style is followed in JLR. The management of JLR follows this leadership style for collaborative work in the organization. The management accepts innovative responses from the employees and responds to the changing situation readily. Hence, two different cultures have merged to enhance organizational culture. Tata Motors did not want to run the business from headquarter in India. Instead they decided to leave the business in the hands of executives in England.

As stated by Erel, Liao & Weisbach (2012), Tata Motors faced cash liquidity problem and had negative working capital after the acquisition. Moreover, debt ratio has increased in this company overtime after 2008 such that Tata Motors had paying problem of bridge loan of $3bn. Berger, Chen & Li (2012) described that bridge loan is the short term loan that the company has to pay to remove the obligations. Due to facing liquidity crisis, Tata Motors has been facing difficulty in accessing credit and raising fund from the stock market. The acquisition was done in 2008 at the time of global financial crisis. Hence, this company had to face sub rime mortgage crisis and fall in demand for luxury car in the global market (Ahammad et al., 2016). However, this company has able to regain market share during 2012-13. Moreover, Tata Motors gained competitive advantage in cost synergy. Corus was main steel supplier for Tata group, TCS is the main manufacturing and engineering service provider and INCAT is the consultancy and outsourcing service providers of the Tata group. From the view point of valuation of the target company, it was thought that Jaguar is a good company being a reputed luxury brand.

It can be said that the Tata Motors has faced both positive and negative side of the acquisition of JLR. Through this acquiring, Tata Motors got the opportunity to enter into the European market as well as the developing countries such as China, Asia pacific countries such as South Korea.

Interrelationship between cost of capital and availability of capital

Interrelationship between cost of capital and availability of capital

Cost of capital is the opportunity cost of making an investment. Cost of capital reflects the attitude of the investors towards risk. In the view of Aabo, Hansen & Muradoglu (2015), cost of capital is the return expected by the company or a person, who invests capital in the business. There is an interrelationship between the cost of capital and availability of capital. If firm has sufficient fund to invest in a business, it can take risk of investment. Therefore, high return or higher cost of capital is expected from that investment.

Case study of Tata Motors

Tata Motors has took risk of investment in oversees. Tata Motors is listed in the New York Exchange and hence took the advantage to gather funds globally.  Tata Motors planned to raise $1.08 bn funds from differential voting rights. The rule of DVR was that it would carry one vote for every ten shares. The company also decided to raise $330.69 mn funds from the rights issue of equity shares (Agyei-Ampomah, Mazouz & Yin, 2013). Convertible preference shares were to be used for fund raising. Initially, Tata Motor used ordinary share for fund raising. The share value in Indian market was $45.85 per share. After issuing these shares, Tata Motors planned to raise $500-600 mn amount from overseas market through issue of securities.

The acquisition of Jaguar Land Rover was done at $2.3 bn using bridge loan fund of $3 bn. It was expected that the equity capital of Tata Motors would increase by 30- 35% in the year 2008. During 2008, Tata Motors had almost $57.952 mn paid up equity capital. However, the company faced liquidity crisis after the acquisition and failed to raise sufficient funds to meet the liabilities (Arcelus, Gor & Srinivasan, 2013). The main reason of failure was the global financial crisis and mortgage market collapse in US. This situation worsens the market capital of Tata Motors and share price. In order to manage this situation, Tata Motors used underwriting agreement with JM financial consultant, public deposit scheme, $1 bn debt package by British government and addition purchase by sister companies such as Tata Sons, Tat Capital and Tata Investment Ltd.

A. Exposure to currency risk and hedging strategies

Concept of currency risk

In the view of Agyei-Ampomah, Mazouz & Yin (2013), currency risk arise when relative valuation of currencies change. Currency risk is important to be considered as can affect the potential profit or loss from an investment. Current risk is also termed as exchange rate risk. Arcelus, Gor & Srinivasan, (2013) cited that currency risk may arise from the possibility that depreciation of a currency may have negative effect on the company’s asset value, investment and dividend payment on security denominated foreign currency. Barth, Konchitchki & Landsman (2013) mentioned two types of currency risks such as transactional and translational risk. Transaction risk is related to the unprecedented fluctuation in exchange rate over a certain period of time. Translational risk arises when an asset is held in foreign currency. One of the negative effects of the currency or exchange rate risk is fall of a country or organisation in debt trap.

Case study of Tata Motors

Purpose of hedging policy

In order to manage the currency risk, investors often use hedging policy. Currency futures, forward or option are used the hedging instruments. Hedging is used to reduce the extent of risk by fixing the product price in future. Bartram, Burns & Helwege (2013) opined that these instruments are expensive for the individual investors. Hence, a simple hedge against currency risk is the use of exchange traded funds.

Factors affecting the change in foreign exchange rate

There are several factors affecting the currency value change such as inflation rate in US, trade deficit or surplus in US, appreciation or depreciation of US dollar and political instability in Home Country. When inflation rate is high, interest rate in the economy is also high, which further raises the currency value of the US dollar. If the foreign currency depreciates, payment in Brazilian dollar is profitable than on US dollar (Bodnar, 2014).

Exposure to currency risk that Crosswell International faces

1 dollar = 3.200086 BRL (Brazilian real)

This is the current exchange rate between Brazil and US currency, which fluctuates overtime. If the Brazilian company Material Hospitalar purchase health care products from Crosswell international, the trade would be in Brazli real. As price competition prevails in Brazilian market, Crosswell International requires setting the price at low level to gain the market share in Brazil (Carfí & Musolino, 2014). Now, if the transaction deal between two firms is fixed today and transaction will occurred in future, currency value fluctuation may affect the earning of both firms. If US currency appreciates at the time of transaction, revenue earned in Brazil in dollar value decreases. On the other hand, if domestic currency depreciates, capital inflows increase in the US economy and revenue of Crosswell International increases. However, Chang, Hsin & Shiah-Hou (2013) opined that exchange rate fluctuation is difficult to predict.

Dong, Kouvelis & Su (2014) stated that the extent of currency risk faced by a company depends upon the profit margin of the business. The currency risk will be greater for the change in currency value in the foreign exchange market if the profit margin is smaller. If the exchange rate changes by 0.0001, that is exchange rate becomes US$1 = BRL2.199986. Crosswell’s revenue will be affected if the profit margin of the firm is smaller in Brazil. If the transaction settles for 10,000 units of the product and the price for each product is $3, then total revenue is $30,000. It would be priced in Brazilian market at $3*2.199986 = BRL6.599958 at changed exchange rate and total revenue would be BRL65999.58. If exchange rate is as the present time, then total revenue is $3*3.00086*10000= BRL90025.28.  Hence, it can be seen that the revenue fluctuates with change in exchange rate. Moreover, Erel, Liao & Weisbach (2012) opined that short term frequent fluctuation in exchange rate affects firm’s profitability more than that is in long run.

Concept of currency risk

The effects of currency risk in business are increase in expenses, decrease in profits. Due to the volatile nature, currency risk makes the financial planning difficult.

Hedging through derivative is common method used by the firms. Different types of hedging are currency option, future and forward hedging. Crosswell International can use ETF in advance. Crosswell should use the ETFS with lowest spending and fees.

Crosswelll may use forward contract to hedge the currency risk. It is used to purchase an asset at a specified time in future at a specified price agreed upon today. In this case, the specified price is said to be as delivery price. When both the company enters into the forward contract, the buyer of the contract expects that the domestic currency will appreciates in future. On the other hand, seller expects that exchange rate will depreciates in future. If Crosswell expects large revenue by collaborating with Material Hospitalar from its Brazilian customers, then Crosswell may expect depreciation in home currency (Gowda et al., 2012)

Crosswell can use put option for hedging. Cross border trading is often delayed hence required to fix the currency value. This company can hedge its long position with put options and a short seller can hedge the position by call options. In the view of Hutson & Laing (2014), Crosswell can choose to buy a single put option, which gives the company right to sell 100 shares of the company at agreed price. If Crosswell has bought a put option with the exercise price of $30 and will make the transaction within five months, the price would be the same during those months.  The price would be fixed during agreed time irrespective of the exchange rate fluctuation. In order to protect itself from downside risk, Crosswell can pay option premium in the form of insurance.

Crosswell can use money market hedging. There are two sources of money market hedging such as transactional and translation exposure. Translation exposure is a bigger issue for the large organisation like Crosswell International. However, money market hedge is complicated to cover translational risk. Therefore, this process can use transactional exposure. The company may face this risk due to two reasons such as payment due or expected receivables in Brazilian currency or because assets /liabilities may be denominated in foreign currency (Karolyi & Taboada, 2015). The risks can be hedged via money market through the following process.

Purpose of hedging policy

Crosswell needs to borrow Brazil Rial by the amount equal to the present value of the accounts receivables. Then conversion of foreign currency is made into domestic currency at the spot exchange rate. After this conversion, the US dollar value on deposit is to be placed at the prevailing interest rate. The firm needs to repay the foreign currency loan with interest, when the Brazilian currency receivables come in (Lambert, Leuz & Verrecchia, 2012).

Challenges faced by exporter to enter into foreign market

Exporter faces significant challenges while entering into the foreign market for export goods and services. A common challenge is barrier to entry into the new market due to having existence of monopoly power in the economy. Monopoly power can block entry through patent rights, licenses. This strategy prevents the development of substitute in the market. Shah, Hasnu, & Butt (2016) cited that legal protection available to the foreign firm creates barrier to business performance. Poor legal protection regarding patent rights, trade marks is disadvantages of the firm. Furthermore, existing competition increases cost of firm to implement strategies in the motive of aiming access of the market effectively. Different consumer choices, cultural, language and logistics may affect the entry of a firm into the foreign market.

Types of risk faced by Crosswell

Crosswell wants to enter into Brazilian market through collaboration with Material Hospitalar. This strategy has been taken to use the distribution channel of Material Hospitalar in the Brazil market. Price competition already exists in the market (Stulz, 2013). Imposition of tariff on the goods increases the price of the health care products. Hence, product price in the market of Brazil is likely to increase. Delay in accounts receivables from the customer is another risk that is likely to be faced by Crosswell. Political instability in Brazil is another risk for the exporter.

Analysis of each risk affecting competitiveness

Imposition of tariff increases product price in the foreign country. Moreover, fluctuations in currency values affect the price. Tariff increases the cost of goods of the exporters. Rise in product price has negative impact on the business. This policy affects the competitiveness of this firm negatively. Increase in price may reduce the demand for Crosswell’s product in the Brazilian market and therefore may reduce the revenue (Uygur, Meric & Meric, 2013).

Account receivable within due date brings competencies in a firm. If Material Hospitalar fails to collect receivables from the customers in Brazil, it pushes the company towards liquidity crisis by reducing cash inflows. Liquidity and insolvency hampers business operation and reduces creditor’s task. Hence, investment and operational capability of the firm are hampered. Furthermore, fluctuations in currency value affect the profitability of the firm. All these factors affect the export of health products in Brazilian market. Negative effect and product may reduce the volume of export in that country (Zheng et al., 2016).

Factors affecting the change in foreign exchange rate

It can be concluded that exporting is to assess the market of a foreign country through supplying goods and services. A firm may face several risks such as currency risks, risk of price rise due to tariff and other legal fees in the foreign country, which affects the business performance of the firm. 

References

Aabo, T., Hansen, M. A., & Muradoglu, Y. G. (2015). Foreign Debt Usage in Non?Financial Firms: a Horse Race between Operating and Accounting Exposure Hedging. European Financial Management, 21(3), 590-611.

Agyei-Ampomah, S., Mazouz, K., & Yin, S. (2013). The foreign exchange exposure of UK non-financial firms: A comparison of market-based methodologies. International Review of Financial Analysis, 29, 251-260.

Ahammad, M. F., Tarba, S. Y., Liu, Y., & Glaister, K. W. (2016). Knowledge transfer and cross-border acquisition performance: The impact of cultural distance and employee retention. International Business Review, 25(1), 66-75.

Arcelus, F. J., Gor, R., & Srinivasan, G. (2013). Foreign exchange transaction exposure in a newsvendor setting. European Journal of Operational Research, 227(3), 552-557.

Barth, M. E., Konchitchki, Y., & Landsman, W. R. (2013). Cost of capital and earnings transparency. Journal of Accounting and Economics, 55(2), 206-224.

Bartram, S. M., Burns, N., & Helwege, J. (2013). Foreign currency exposure and hedging: Evidence from foreign acquisitions. The Quarterly Journal of Finance, 3(02), 1350010.

Berger, P. G., Chen, H. J., & Li, F. (2012, September). Firm specific information and the cost of equity capital. In EFA 2006 Zurich Meetings.

Bodnar, G. (2014). Techniques for Managing Exchange Rate Exposure.Retrieved September, 10, 2014.

Carfí, D., & Musolino, F. (2014). Speculative and hedging interaction model in oil and US dollar markets with financial transaction taxes. Economic Modelling, 37, 306-319.

Chang, F. Y., Hsin, C. W., & Shiah-Hou, S. R. (2013). A re-examination of exposure to exchange rate risk: The impact of earnings management and currency derivative usage. Journal of Banking & Finance, 37(8), 3243-3257.

Dong, L., Kouvelis, P., & Su, P. (2014). Operational hedging strategies and competitive exposure to exchange rates. International Journal of Production Economics, 153, 215-229.

Erel, I., Liao, R. C., & Weisbach, M. S. (2012). Determinants of cross?border mergers and acquisitions. The Journal of Finance, 67(3), 1045-1082.

Gowda, S., Ard, T., Sagula, R., Blinn, A., & Buiten, T. (2012). U.S. Patent No. 8,156,418. Washington, DC: U.S. Patent and Trademark Office.

Huang, Z., & Brass, D. J. (2016). Cross?Border Acquisitions and the Asymmetric Effect of Power Distance Value Difference on Long?Term Post?Acquisition Performance. Strategic Management Journal.

Hutson, E., & Laing, E. (2014). Foreign exchange exposure and multinationality. Journal of Banking & Finance, 43, 97-113.

Karolyi, G. A., & Taboada, A. G. (2015). Regulatory arbitrage and cross?border bank acquisitions. The Journal of Finance, 70(6), 2395-2450.

Lambert, R. A., Leuz, C., & Verrecchia, R. E. (2012). Information asymmetry, information precision, and the cost of capital. Review of Finance, 16(1), 1-29.

Otinda, M. (2015). The Effects of Change Management on Mergers and Acquisitions: A Case Study of L’oreal East Africa Limited (Doctoral dissertation, United States International University-Africa).

Rani, N., Yadav, N. I. I., & Jain, P. K. (2015). Impact of cross-border acquisitions' announcements on shareholders' wealth: evidence from India.Global Business and Economics Review, 17(4), 360-382.

Rani, N., Yadav, S. S., & Jain, P. K. (2014). Impact of Domestic and Cross-Border Acquisitions on Acquirer Shareholders’ Wealth: Empirical Evidence from Indian Corporate. International Journal of Business and Management,9(3), 88.

Shah, S., Hasnu, S. A. F., & Butt, S. A. (2016). The Impact of Working Capital Policy on Financial Performance of Manufacturing Companies in Developing Countries: A Comparative Analysis of Domestic and Multinational Firms. Abasyn University Journal of Social Sciences, 9(1).

Stulz, R. M. (2013). How companies can use hedging to create shareholder value. Journal of Applied Corporate Finance, 25(4), 21-29.

Uygur, O., Meric, G., & Meric, I. (2013). 2007-2009 Bear Market and Corporate Takeovers. International Journal of Economics and Finance, 5(2), 78.

Zheng, N., Wei, Y., Zhang, Y., & Yang, J. (2016). In search of strategic assets through cross-border merger and acquisitions: Evidence from Chinese multinational enterprises in developed economies. International Business Review, 25(1), 177-186.

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