A bearish outlook on business in the BRICs…
Business in emerging markets
The boom in emerging-market investment by rich-world firms has led to plenty of disappointment
IN 2007 UniCredit, an Italian bank, fought off ferocious competition from other Western lenders to buy Ukraine’s fourth-largest bank from an oligarch for a queasy $2 billion. This week, amid talk of war and default, UniCredit limited withdrawals from its ATMs in Ukraine. At the same time, the shares of firms that are big in Russia, such as Carlsberg and Renault, fell.
The turmoil in Ukraine is one of a host of troubles that Western firms are facing in emerging markets. Slowing growth, falling currencies, weak commodity prices, bad investment decisions and that catch-all of a thousand corporate woes, political risk, have combined to disappoint managers’ expectations. Investors have noticed: rich-world firms with above-average exposure to emerging economies have lagged America’s stockmarket by about 40% over the past three years.
All this is leading firms to re-examine their emerging-market strategies (see article). For many, although the experience has been tough, the prospects are good. But some have wasted enough shareholders’ money, and should head home.
So very 1990s
The corporate world is just as susceptible to fashion as the high street. In the late 1990s the e-commerce bubble seduced all but the most sensible firms. In the mid-2000s the private-equity industry declared that the listed company was dead. But far more powerful than either of those trends has been the belief that Western firms should pile into emerging markets.
The boom dates from the 1990s, when the Berlin Wall had fallen, India opened up and China began to prosper. Firms invested in emerging markets first to manufacture goods for sale in rich countries, and then to sell their products to increasingly affluent new middle-class consumers. The financial crash and subsequent recession in the West only sharpened their enthusiasm for foreign adventures.
The volume of takeovers by rich-world firms in developing countries more than quadrupled between 2003 and 2010, to $180 billion. Rich-world firms have invested some $3 trillion in emerging economies, making it one of the biggest corporate-investment cycles since the railway boom of the 19th century. Parisian cognac distillers, Japanese male-cosmetics firms and cranemakers in Illinois have all jumped in.
These investments have transformed the structure of many firms. In 1999 Unilever said the rich world was its “backbone”. Now most of its shampoos, soaps and soups are sold in developing countries. Boeing sells more planes in China and Latin America than it does in Europe. Salesmen for Germany’s Mittelstand wine and dine clients in Chengdu as well as Cologne. Research operations have been rejigged to create more products for poor people. Executives with emerging-market experience have shot through the ranks.
The developing world promised spectacular riches. But on average the return on capital multinational firms are making in emerging markets has been mediocre—no higher than the global average. Many firms are not getting adequate reward for the risks they are taking. Some have lost a ton of money.
So what went wrong? In their enthusiasm to get into emerging markets, plenty of companies did not take the risks involved seriously enough. Russia’s move into Crimea may have been a shock, but—after a similar move into Georgia in 2008—it was hardly a surprise. Governments tend to play rougher in emerging markets. A Spanish oil firm, Repsol, had its assets in Argentina expropriated (on February 26th it agreed to a compensation package). India’s tax officials have tried to kneecap Vodafone, Nokia and IBM, among others.
Mostly, though, bad management was to blame. Too many firms overpaid for acquisitions. The average valuation in 2007 was double that in 2002-03. Others plunged into markets that were saturated. In Brazil carmakers have at least 20% excess capacity and vehicle sales fell last year. At least 20 of the world’s insurers are squabbling over the tiny slice of India’s insurance market that is not state-controlled. Some industries, such as pharmaceuticals, found their old business models did not work in poorer places and failed to invent new ones.
Chief executives tend to believe that they would be mad to cut their emerging-market exposure. After all, the firms that quit Asia after its crisis of 1997-98 made a big mistake. But foreign firms face far more formidable local competitors than they did then. And struggling multinationals should not assume that when economic growth recovers it will be as fast or as widespread as in the past. A decade of low interest rates and rampant Chinese demand allowed almost all developing countries to grow at turbocharged rates—even those that were badly run. Now the global environment is less forgiving.
Time for a clear-out
To improve their fortunes in emerging markets, rich-world firms need to take two steps. First, they should screen their portfolios for strategic relevance and financial returns. Businesses that have weak returns or are peripheral are candidates to be sold, restructured or shut. The car and natural resource industries have started to do that. A few firms will need more radical surgery. Some bailed-out banks have left; big supermarket chains such as Carrefour and Tesco are in retreat.
Second, multinationals will need to strengthen the operations they retain. By borrowing in local debt markets and shifting more production to the emerging world, they can create a hedge against currency turbulence and ward off protectionism. The strongest firms should consider acquisitions to boost their market shares—but make sure they do not overpay.
Eventually growth in the emerging world will pick up, rewarding firms with strong businesses and persistence. But the stampede of Western firms into those markets will not be repeated. Instead the traffic is likely to go the other way. Emerging economies generate 40% of global GDP, measured at market exchange rates, but their firms own only 19% of cross-border investment and (say consultants at Interbrand) just four of the top 100 brands. In the next decade, more emerging-market firms will snap up rich-world assets. And you can be sure that trend will lead to plenty of duff decisions, too.