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Coca-Cola Company ("Coca-Cola," "Coke") is a U.S.-based manufacturer and distributor of non-alcoholic beverage. The company recorded revenue of $46.5 billion in FY2011, and earned $8.5 billion in net income. According to the company's website, it sells products in over 200 countries, given the company near-global scope. This also ensures that Coca-Cola has substantial exposure to foreign currencies. This report will discuss a number of international financial aspects to Coca-Cola's business, including foreign currency risk and capital structure.
As Coca-Cola operates in just about every country in the world, there are a very few options for international expansion. The company's Mexican subsidiary is already exporting to Cuba, circumventing Helms-Burton. However, there remains one country where one cannot currently buy a Coca-Cola product, and that is the Democratic People's Republic of Korea (DPRK), or North Korea (Hebblethwaite, 2012). There is increasing wealth in that country, however, as the result of Chinese investment. While the average North Korean cannot afford Coca-Cola, there is a class of party insiders who can. This opportunity can be exploited from Coca-Cola's Chinese subsidiary.
Foreign Currency Exchange Risk
Coca-Cola's sales are divided evenly throughout the world. The largest geographic region is Latin America, at 29%, followed by North America at 22%. "Pacific," including China, Japan, Philippines, and Australia, accounts for 18% of sales; Eurasia and Africa (including India, Turkey, South Africa and Russia) accounts for 16% and Europe accounts for 15%. The company has extensive programs to deal with foreign currency exchange rate risk. In many countries, the local currency is not worth the paper on which it is printed, and is not exchangeable anywhere outside of that country.
The North Korean currency is called the North Korean won and this is not exchangeable anywhere outside of the country. While the currency is officially pegged to the dollar, the unofficial rate is highly volatile and subject to significant inflation. Changing wons into other currencies is difficult. Money earned in the North Korean market might not be able to leave the county, and if it does it would do so in the form of Chinese yuan most likely, though U.S. dollars, euros and Japanese yen are sometimes also taken. The use of foreign currencies is common at venues that cater to foreigners and the country's elite, the same people that would comprise the target market for Coca-Cola in North Korea.
Thus, the foreign exchange rate risk is not much different from a strictly monetary standpoint than it would be in China. Given that the market entry is going to be conducted using a Chinese subsidiary, Coke would likely leave that money in China. Thus, the predominant risk likes with changing from dollars, euros and yen into yuan, rather than in any dealing with the North Korean won.
There are a couple of different approaches to managing currency exchange rate risk. The first is to leave the position unhedged. There is a case to be made in favor of this, especially since the Chinese yuan is involved. Hedging the yuan is difficult because of the lack of international markets in that currency. Also, hedging the yuan might be redundant because of the soft peg that currency has to the dollar. In addition, the total amount in the North Korean market is not expected to be significant relative to the size of the Chinese, European or Japanese markets. Therefore, the amount in question may not be large enough to see benefit from hedging. The total size of the target market is quite small, and would amount to not much more than the equivalent of a small city in China, something that Coke might not worry about hedging. In addition, the use of multiple currencies makes it more difficult for Coke to effectively hedge any one currency as a result of entry into the North Korean market.
The other approach to hedging the company's exposure in the North Korean market is to set up hedges in each of the different currencies it might expect to receive. This could be euros, since the soft dollar peg of the yuan makes that currency less volatile in general, leaving the euro as the most important currency in use in North Korea that is entirely unhedged. A hedge could mitigate the fluctuations in the Euro, although such fluctuations specific to the North Korean market are not likely to be significant given the broad usage base of the euro.
If the company thought it was worthwhile to target a market beyond foreigners and the elite, it would face North Korean won exposure, and might need to find ways to hedge that. The most obvious means would be to convert its won into hard currency -- or hard assets like factories -- as quickly as possible. Even setting up an operating hedge is unlikely to succeed given that there is little relation to the official value of the won and the real value. Runaway inflation is not easily hedged even with an operating hedge -- only hard assets or expatriating the money as quickly as possible would provide Coca-Cola with any certainty.
The North Korean market in general is not attractive, but there is no such thing as an unattractive market for Coca-Cola. The company wants to operate in all markets as a matter of principle. Most of the economy is almost non-existent, but there is some investment coming in from China and that is creating a small target market of wealthy locals (mostly in Pyongyang) and foreigners (mostly Chinese). These are catered to with restaurants, bars and department stores, all of which could sell Coca-Cola products. The market is not growing, however, as political uncertainty is hampering Chinese investment in North Korea (Park, 2012)
Globalization has not reached North Korea. The country has sought to strengthen its economy through building ties to China and opening up free economic zones, but corruption is such a problem that even the Chinese do not want to do business there. The country remains outside of the global financial system, with no serious banking system. Any banking would be done in China only. The same can be said for the currency system. Most wealthy people in Pyongyang do not use North Korean won when they can help it, and many stores there do not take the currency. As a result, Coca-Cola would be a welcome source of foreign currency, even if it the company would only enter the market with the understanding that it would be able to take yuans back to China.
The international banking system exists to provide businesses with the intermediaries needed to raise capital and conduct transactions around the world. Coca-Cola makes extensive use of the global financial system, especially to raise debt capital and to meet operating financing needs. The company also uses financial intermediaries to provide it with hedges such as forward contracts or interest rate swaps that allow it to hedge some of its exposures in foreign markets. Money markets are used to earn interest on short-term cash. Equity markets can be tapped to raise financing, although Coca-Cola went public a long time ago and seldom engages in secondary issues.
To address a North Korean expansion, Coca-Cola's Chinese subsidiary is most likely going to use either internal sources of financing or go through one of its Chinese banks. The high risk associated with this market will bring about higher interest rates than would be charged on ongoing Chinese business and much more than Coke would pay on its ongoing American business. Thus, internal financing through retained earnings might actually be cheaper. The required rate of return would be high, but the funds would not have any specific stipulations, as they would if the company borrowed to finance this expansion. Equity, therefore, is the best way to finance this risky, small-scale move into the North Korean market.
Long-term financing, if the venture is successful raises another set of issues entirely. For example, if the status quo in the country held but people were able to afford Coke, the company would have to set up policies for dealing with North Korean won. It would need to either change won to yuan or a hard currency, or it would need to find a way to hold the value of the won. However, it is likely that the company would need to ensure that it could bring revenues out of the country and back to China, because of the absence of a credible banking system.
Financing with equity from the Chinese operations is a likely option for Coca-Cola. The Chinese operation is one of the largest in the world for the company. Thus, profits from China would be used to build up the North Korean operation. The company would still need to find a way to hedge the value of the won/yuan rate. It would need to work with the black market rate, or simply arrange its transactions so that vendors paid in yuan cash, and Coca-Cola's representatives were given the ability to take the money out of the…[continue]
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