Author Archives: Robert

Western Credit Exposure to Russia

A recent blog-post in the Council on Foreign Relations highlighted how Western (and, in particular, European) countries are drastically reducing their credit exposure to Russia given recent Ukraine-Russia tensions (see French Banks Play Russian Roulette):

Domestic Bank Exposure to Russia

 

This trend in and of itself is not very surprising, nor is the speed at which domestic European banks are cutting their exposures. What is more striking to me is the size of the U.S. exposure to Russia–it’s higher than everyone else’s save for France. In addition, I was surprised that France’s exposure to Russia is so high relative to Germany and certainly relative to the UK. The CFR blog-post goes on to mention that much of France’s exposure to Russia is illiquid, putting it in a pretty sticky situation should things go further south.

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Multinationals Struggle in Emerging Markets: Wash, Rinse, Repeat

A recent article in the Economist highlighted the struggles of developed-country multinationals in emerging markets (see Emerge, Splurge, Purge). Multinationals struggling in emerging markets is nothing new. The surprising part to me is that we still haven’t learned our lesson from years of mistakes. Every wave of emerging market investment seems to be justified by some variant of the “this time will be different” meme—i.e., the opportunities are limitless and the risks are diminished. We’ve witnessed this type of behavior in the investment run up before the 1997-98 Asian financial crisis; the irrational exuberance leading up to the 2007-08 global financial crisis; and now, in the period of central bank easy money and yield chasing in the wake of the global financial crisis. But now, every time the Fed utters the word “taper”, markets in the emerging world wobble and multinationals suddenly discover that profitability in emerging markets has failed to live up to expectations. According to the Economist:

American firms made a 12% return on equity in 2012…But having grown fast, profits are now falling…There has been a long bout of share-price underperformance…Western firms with high emerging-market exposures [have] lagged the broader S&P 500 index by about 40% over three years…The emerging-market rush may end up like a giant version of the first internet boom 15 years ago. 

The decline has been broad-based. Current laggards include some of the world’s largest, and best known, companies. For example, Proctor & Gamble’s global margins are half of its U.S. margins, and its performance in emerging markets is especially weak. Not only that, but Western multinationals have struggled in the previously high-flying BRIC economies—China, India, and Brazil, in particular.  The root of the problem:

During a boom every firm thinks it can be a winner, leading to excess investment and saturation. The more capital-intensive the industry is, the greater the pain in store for its weakest members…most Western businesses have low gearing… Without their emerging-markets pep pill many firms would have dire revenue growth. The developing world has supplied 60-90% of the growth of Europe’s big firms in recent years.

One comment here: Growth is not the same thing as profitability. And managers often conflate the two. But beyond the obvious pursuit of growth, expressions of managerial hubris, and increased market volatility, multinational managers often make poor decisions about the underlying risks they will take on in emerging markets. Globalizing companies tend to systematically overestimate the benefits of entering emerging markets while underestimating the costs. This is because developed country multinationals bear heightened political, economic, regulatory, and cultural risk in emerging economies. And those risks are not adequately priced. As I’ve written before (see So You Want to Do Business In a Developing Country? or U.S. Banks Pin Hopes on Emerging Markets):

There are many compelling reasons that companies look to developing countries for growth. Less-developed countries hold the promise of large, fast-growing consumer markets (e.g., the BRICs); an abundance of cheap labor; and access to otherwise unavailable natural resources. Managers are often lured by this unbridled potential. But there is a reason these countries are considered “developing” – largely because of the under-developed state of their institutional environments… Although developing markets hold jaw-dropping potential, it often remains just that. Realizing potential from developing markets is incredibly challenging. Companies often find that the institutional (cultural, political, and economic) environments in the developing markets they enter…are so vastly different from anything that they encounter in their own domestic market (or even in other developed markets) that the costs involved in navigating them exceed even their most conservative estimates.

The takeaway here is that ventures into emerging markets should be considered with appropriate risk pricing tools. Judging by the recurring bouts of poor multinational performance in emerging markets, we haven’t quite reached that goal. But maybe, just maybe, next time will be different.

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Motorola – Google’s Addition by Subtraction?

Google recently announced the sale of Motorola Mobility to Lenovo for $2.91 billion. It acquired Motorola only two years ago for $12.5 billion (see After Big Bet, Google Is to Sell Motorola Unit). Many have interpreted this move as an admission of failure in the hardware space. According to the New York Times:

Motorola was Google’s biggest acquisition by far…Yet Motorola has continued to bleed money, troubling shareholders and stock analysts, and its new flagship phone, the Moto X, did not sell as well as expected…Selling Motorola is an acknowledgment that Google is better off focusing on its core competencies — making software and selling ads — particularly as the profit margins for phones are shrinking over all.

Some analysts even went so far as to describe the decision to buy Motorola as “the extravagance of being a company with over $350 billion in market cap” and the sale as “slipping the millstone off your [Google’s] neck.”

Maybe that’s partially right. But it’s not the whole story. And the New York Times provided an excellent analysis demonstrating how Google didn’t quite lose as much money as the headline numbers might suggest (see Did Google Really Lose?).

But even if we concede that the sale was not as bad as headlines suggest, there’s still much more strategy involved in the sale.

First, you have to understand the deal in the context of the competitive marketplace for Android devices - that is, with Samsung in mind. Don’t forget, Samsung is, by far, the largest manufacturer of Android devices. It dominates the market, with upwards of 65% market share. It is the 800-pound gorilla of Android hardware, and it can therefore exert a lot of power over Google.

It is in Google’s best interest to have as many makers of Android devices as possible. This reduces the power of any one manufacturer individually, and increases Google’s power vis-à-vis those manufacturers. In fact, one of the reasons (among others) that Google acquired Motorola was to have a captive manufacturer of Android devices, reducing Google’s dependence on Samsung, and any threat to Google posed by Samsung. For example, if, in the extreme, Samsung decided to stop manufacturing Android devices, Google still had a viable manufacturing partner in Motorola.

With that as background, we come to the interesting part of this sale.

Google is selling Motorola Mobility to Lenovo, bolstering a manufacturer of Android devices, especially in the U.S. market (where Motorola is strong and Lenovo weak). In addition, Google has retained all of the relevant intellectual property (patents) owned by Motorola Mobility, not only assuring some licensing income, but also preserving the right to reenter the hardware market at a later date should the need arise. That is, should something happen with one of the current Android manufacturers (e.g., Samsung, HTC, LG, Lenovo), Google has the know-how to reenter the handset game.

So overall, you can’t take this sale simply at face value. It may, at first glance, seem like a huge loss for Google. But there is more to it than a wholesale admission of failure. If you dig a little deeper, it looks like a pretty sound strategic maneuver. Now if only I could say the same for the Nest acquisition…

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