Buying in Asia: Bargain Prices With Strings Attached

A lot more than cheap selling prices must be weighed in considering acquisition of an economy-battered Asian business. With Asian currencies tumbling against the U.S. dollar in the past year, many U.S. investors are in search of bargain-basement deals. For U.S. investors that are willing to forego short-term profits, now could be an ideal time to invest in Asia. In fact, Securities Data Corp. reported that U.S. acquisitions of Asian businesses in 1998 reached a value of $8 billion, double that of the previous record year. Clearly, many U.S. companies are taking a long-term view of the Asian market by searching for inexpensive opportunities in a region that is experiencing significant economic and political troubles. Dealmakers are learning, however, that the task of performing due diligence in Asia has been made problematic by the region’s economic uncertainty and political instability. As neither financial nor political analysts can predict the duration of the current economic crisis, U.S. companies are wise to pursue Asian acquisitions, mergers, and joint ventures with caution. Awareness of the issues and guidance through them is the key to turning an Asian m&a opportunity into a successfully completed transaction. Following are suggested areas that deserve particular scrutiny during the acquisition review process. Foreign Currency Considerations The value of local currencies in many Asian countries has plummeted since mid-summer 1997. Accordingly, buyers should carefully analyze the impact on the cost of supplies sourced outside of the region, and the strength of Asian customers’ buying power and ability to pay existing and future debts. This devaluation also makes it difficult to assess existing asset values such as inventory, since the reported local currency value of the inventory may be consistent with historical levels but may contain significantly less “real” value if not adjusted for today’s dollars. Typically, a large percentage of an Asian company’s inventory is sourced from Western countries, and these suppliers are demanding that trade payable terms include a more stable currency, such as the U.S. dollar. This subjects an Asian company to significant exchange losses when the local Asian currency is declining and its payables are denominated in U.S. dollars. These currency factors must be considered in evaluating the sustainable earnings of the target and the relevant working capital and cash flow requirements. Asian Customers Are Ailing Cost of debt, cost of Western materials, and other costs outside of Asia have risen dramatically for companies in this region. As a result, Asian customers of acquisition targets and joint venture partners may be as financially strained as the target, and should be reviewed carefully during due diligence. In one recent Asian joint venture, the receivables of a significant customer increased from an average of 60 days to well in excess of 180 days, resulting in an intense drain on cash flow and reserve levels for the target. Accordingly, investors should carefully review the financial standing and recent payment history of customers in order to project the potential post-closing impact of this situation. Cultural Differences May Cause Concern Communication in another country goes beyond merely understanding and speaking a different language. Grasping the Asian culture and way of doing business is essential to completing a successful acquisition in this region. Asian business is often not conducted in the same manner as in other parts of the world; in Asia, companies operate on the principles of trust and understanding, and agreements may often be verbal. It is important that in understanding this difference between cultures, no attempt is made to challenge or change Asian business philosophies. By anticipating these cultural differences, U.S. acquirers will develop stronger, more trusting relationships with Asian targets. This will result in a smoother, more efficient due diligence process. Inadequate Information/Unidentified Issues There is often some restriction on access to the Asian target company’s records. This is either due to a limitation in scope imposed by the target company’s management, or because of a lack of information maintained by the target. During due diligence reviews in the U.S., there is usually open access to a company controller or product manager. In Asia, however, there is typically an individual assigned to manage the information-gathering process and restrict to whom this information should be available. Asian companies are particularly concerned with confidentiality, especially if only part of the operation is to be sold or transferred to a new joint venture. As a result, it is often more difficult to review auditor work papers and to gain access to the right people in the company. Again, it is important that an acquirer work within the target’s process and be respectful of any cultural differences. In one recent joint venture, access was denied to the Asian parent company’s financial records. The reserves and write-offs related to the target, however, were recorded at the parent level and were not visible on the target’s financial statements. In situations such as this, it is usually necessary to sign confidentiality agreements in order to gain access to company records. Advisers who need to review sensitive information should request written permission from the target company to share any relevant information with the potential buyer, in particular intercompany account details, budgets and forecasts, accounts receivable aging details, and inventory aging reports, among others. Different Accounting Practices Prevail The accounting practices in some Asian countries may be entirely unrecognizable to Western organizations not acquainted with the region. Although Hong Kong and Singapore adhere to roughly the same practices as the U.S. and Europe, accounting and reporting practices in the rest of the region are not designed or controlled by any independent standard-setting organization. Often it’s the need for tax revenue that dictates changes in accounting and reporting practices. The government of Indonesia, for example, recently required that local companies capitalize and amortize any exchange rate losses instead of taking an immediate hit. It is likely that the motivation was the potential for tax revenue. As a result, largely insolvent organizations may not appear to be so on the books, which has become increasingly more relevant given the economic woes in Indonesia. As another example, in Korea, firms have an option to choose between two accounting methodologies – one aggressive, the other conservative – and to switch every year based on their profit outlook. This makes it exceedingly difficult to compare a company’s operating performance year-to-year. As a result, it’s often necessary to staff your due diligence team with individuals who understand the local country’s accounting methods and how they apply to U.S. GAAP (Generally Accepted Accounting Principles) in order to appropriately scrutinize target company financial statements.