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The three companies that will be evaluated for purchase are LG, Sony and Xiaomi. Some of the report will discuss the individual companies, but a large portion of this report will go into discussing the country situations of these companies. They hail from South Korea, Japan and the People's Republic of China respectively. The differences between these Northeast Asian countries can be significant, and it is these differences that should capture the attention of the executive evaluating the decisions. There are two elements of risk that are the most important in this report -- political risk and financial risk. The former reflects the risk that the value of the investment could change based on changes in the political environment in the target country (Investopedia, 2014). Any evaluation of a major purchase overseas will include political risk as a factor, so when the political risk changes, that should increase the discount rate that was applied to the future cash flows. Thus, when political risk increases, the value of the investment declines; nobody is really worried about a reduction in political risk.
Financial risk comes in a few different forms. One of the most important is foreign exchange rate risk, which is quite different in each of these three countries, but there are other risk as well. For example, some countries have enacted currency exit controls, such that investments made into that country are difficult to repatriate. In other instances, there are issues with the amount that can be converted at any given point in time. These different financial risks will be evaluated in the course of this paper as well, concluding with a recommendation about the best country in which to invest -- the choice of company will likely include a number of operational factors that are beyond the scope of this report.
LG was founded in South Korea in 1947, but emerged on the international scene in the 1990s, and it has grown in prominence significantly since then. LG's structure is typical of a South Korean chaebols, consisting of a holding company, and underneath of that several major groups. For LG, these groups are electronics, chemicals and telecommunications. If Dorchester is interested in one of these groups, there are going to be significant political considerations, since breaking up a chaebols is something somewhat unusual and would be more important than a simple acquisition.
Industry data shows that LG holds 4.8% of the mobile market among vendors in the U.S., making them the fifth largest company is a relatively diffuse industry, where the companies below them hold a 46.7% share (IDC, 2014). Thus, the mobile business is important to LG, and would doubtless come at a premium and would bear significant political risk because the South Korean government has invested a lot of energy into building LG and its compatriot Samsung into global telecom and mobile powers. The political risk factor for LG, therefore, has to be considered to be moderate at least.
There are a few different aspects to consider with respect to LG and the financial risk associated with doing business in South Korea. LG has a global presence, which is favorable in that it results in diversification of cash flows around the world, but the company's share is particularly strong in South Korea, and most of its employees are there. Thus, purchasing LG will expose Dorchester to the South Korean won to a significant degree. The won has floated freely since 1997. This coincided with the Asian financial crisis, which led to significant and immediate devaluation of the won. It has been since that point that South Korea has been able to substantially grow its export businesses -- a weak won is good for a company like LG that exports a wide range of good around the world. Free floating currencies are favorable, because they allow companies ample hedging opportunities. While the market in won is only of moderate size, there are still opportunities to hedge won exposure through futures. The only downside is that the won-USD pairing does not get the best spreads, especially on derivate products.
Exposure to the won also means exposure to the Korean central bank and the Korean economy in general. There is an element of destabilization risk, and it would be remiss to note that both the nation and its currency bear a high level of exposure to the uncertain conditions across the demilitarized zone. North Korea is an a state of uncertain leadership and its political stability will affect the South Korean economy, and in particular the South Korean economy, should something bad happen.
Another consideration is the short-term condition of the South Korean economy. The country is facing long-run expansionary conditions, since 1997, but the current state is characterized as "fragile recovery," to the point where further stimulus, either through monetary or fiscal policy may be required (Kim, 2014). Monetary stimulus, including interest rate cuts, would result in further devaluation of the won. One thing that is worth bearing in mind is that the Bank of Korea sets monetary policy in part in consultation with the major chaebols, so it is quite possible that LG is able to have a seat at the table when monetary policy is being set. Monetary policy is also often set with China in mind, since the PRC is the major destination for South Korea's manufacturing and component exports (Kim, 2014). The extent to which a Dorchester-owned LG would have the same privilege is unknown, and if Dorchester only bought one part of LG, it would not have any of LG's privileges.
Overall, South Korea is a moderately favorable country in which to own a company. The economy is relatively stable and modern, and there remains an emphasis on a healthy manufacturing industry. LG is one of the major chaebols that play a large part in the Korean economy, to the extent that they are invited to sit in with the Bank of Korea on discussions about monetary policy. The South Korean won is freely-traded, which allows for currency hedging, and its trade is with the major nations of the region, along with the United States. The foreign exchange rate risk, therefore, is moderate at best. There is some political risk, mostly associated with instability in North Korea and with the decline in privilege that is likely to occur politically, with any LG unit that is no longer a part of the LG chaebol. Such a decline needs to be priced into any purchase.
A last factor is that any acquisition must be a good fit, not just strategically but operationally. Culture in particular is a significant risk factor in foreign acquisitions, and when the cultural fit is poor it can often be difficult to realize the advantages expected. In this instance, Dorchester is choosing between South Korea, Japan and the PRC, so there is no real difference -- they are all challenging cultures for an American company, and all are likely to make for awkward integrations.
As with LG, Sony is a major conglomerate and a wide range of industries. Some of Sony's businesses are photography, televisions, video, storage, computing and entertainment. Sales for Sony are geographically diversified, with the United States as the largest market, followed by Europe and then Japan. Where LG is a chaebol with very strong political ties, Sony is not considered to be part of the Japanese equivalent, the keiretsu. Instead, Sony operates more as a typical multinational, which actually reduces political risk because it is less critical to the health of the Japanese company and national pride than a keiretsu would be.
Japan is a modern, stable economy, a full participant in global trade. Japan has a strong manufacturing base but it moving towards a service economy, certainly moreso than the other two countries. Japan is one of the world's largest economies, both by raw size and on a per capita basis. Japan is therefore the closest to the United States in terms of development. This does not mean, however, that the two countries have a lot of other similarities -- they don't -- and there will definitely be some cultural issues with any acquisition of a Japanese company or subsidiary.
Sony, being a global business, brings with it a different foreign exchange rate risk than LG or Xiaomi. Sony's sales offer a fairly even split between USD, JPY and EUR, with some GBP and other major currencies thrown in. However, the vast majority of costs are in JPY. The majority of sales are in the world's three major currencies, and the other big markets for Sony tend to be in other major currencies -- CAD, AUD, CHF, and the like. This is good news for Dorchester. The U.S. is the biggest market for Sony, which minimizes exposure for that revenue, and the diversified nature of Sony's revenue streams among the world's major pairings reduces the need for hedging. When hedging is required, it will be very easy, as the USD-JPY, JPY-EUR and USD-EUR…[continue]
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