What should private companies know about expanding into emerging markets?

1. www.pwc.com
Professional
Growth with PwC
Emerging Markets

2. Agenda
Emerging Markets
The Business Case - Vanessa Iarocci & Eric Castonguay
Structuring & Tax Planning - Mark Walters
Facilitating Banking & Trade - Reesa Shurgold (HSBC)
2

3. Executive Summary
• Canadian private companies are missing the mark in emerging markets
• Weak growth prospects in “the west” and high growth prospects in “emerging
markets” mean that companies have a choice to stay and stagnate or go and
grow
◦ Emerging markets are longer merely a story of basic products and low
cost manufacturing
• This is not your average expansion strategy. A cautious and calculated
approach is necessary because emerging markets are not, at all, like “the west”
◦ High political risk
◦ Significant deal barriers
◦ Cultural differences
3

4. Missing the mark
Canadian private companies do not have a
strong track record in the BRIC region
4

5. “Canada may not be taking full advantage of
the opportunities posed by rapidly growing
emerging markets.”
Conference Board of Canada, 2011

6. Our foreign investment track record is dismal
Acquisitions into BRIC regions Canadian FDI balance in Brazil, India,
% of total acquisition value by country China
14% 35,000
32,733
12% 30,000
% of aggreagate deal value (2000-2011)
1.5% of
10% 25,000 BIC FDI
(2000
balances
Canadian $ (millions)
8%
20,000
6%
15,000
4%
10,000
2%
5,000
0%
Canada United United Germany Australia
152
0
States Kindgom
Source: Capital IQ, PwC Analysis 1990 2010
1.5%
PwC

7. Most Canadians are second-movers that “go it alone”
• The majority of Canadian-led deals
in the BRIC region are into China
(42%) & Brazil (38%) “You need to be a first mover
◦ Low penetration in “other” because in an environment
emerging / frontier markets where there is a lot of
political risk, folks that
come in early can actually
• Canadians are typically not first
help shape the political and
movers
regulatory environment to
◦ Others have “laid the be tailored towards them.”
groundwork”
Ian Bremmer, Eurasia Group
◦ Most deals are majority stake
acquisitions rather than
minority stakes or joint
ventures (JV)
PwC

8. Most activity involves large public companies in a
narrow band of industries
• Public company buyers dominate, Private Company Buyer Market Share
private companies are on the 40%
sidelines 35%
• Narrow band of industries targeted
% of transaction volume
30%
◦ China
25%
› Real estate (Hong Kong)
20%
› Financial services (retail
banking, asset management, 15%
insurance)
10%
◦ Brazil
5%
› Resources
0%
› Real estate 2007 2008 2009 2010 2011
› Infrastructure Source: Capital IQ, PwC Analysis
› Financial services (retail
PwC
banking, asset management)

9. Go & Grow or Stay and Stagnate?
Western growth prospects are low, emerging
growth prospects are high

10. The macro environment today suggests a period of slow growth is
upon the developed world economies…
2010 2011 E 2012 E 2013 E
Canadian real GDP 3.2 2.3 2.0 2.5 GDP growth
(quarter/quarter % change) rates below
historical norms
US real GDP 3.0 1.8 2.2 2.6
(quarter/quarter % change)
Canadian net exports (124.4) (144.2) (148.8) (151.0)
(billions, C$) Persistent trade
US net exports (421.8) (411.8) (401.2) (385.3) deficits
(billions, US$)
US CPI 1.6 3.2 2.6 2.2
(all items)
Negative real
interest rates
US 10 Year bond yield 3.21 2.79 2.09 2.71
US Unemployment rate 9.6 9.0 9.0 9.5
Canadian real disposable 3.6 1.5 2.2 2.0 Unemployment
incomes (year/year change, and disposable
%)
income metrics
US real disposable incomes 1.8 0.9 1.1 1.5 dismal
(year/year change, %)
Source: BMO Economics, Canadian Economic Outlook, US Economic Outlook 10

11. Governments have run out of ammunition…
Country Implied Austerity
Measures (US $mm)
France 104,569
Germany 42,020
Greece 23,044
Ireland 58,800
Welcome to the age of austerity!
Italy 33,714
Japan 484,573
Portugal 15,552
Spain 88,719
UK 152,348
US 1,155,000
Source: Eurostat, IMF, PwC Analysis
11

12. Putting austerity into perspective !
3,000
2,500 Implied Austerity
2,158
Inflation Adjusted (US$ billions)
2,000
1,500
1,000 Vietnam War, 698
Korean War, 454
Iraq Invasion, 597
500
Race to the Moon,
Marshall Plan
237 S&L Crisis, 256
115
0
1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030
Year
Source: PwC Analysis, Bianco Research LLC
12

13. In contrast, emerging markets are expected to expand rapidly
Canada France Ireland UK Russia Germany
3.1 2.5 2.6 1.5 1.6 1.9 -0.9 0.2 1.8 1.3 1.4 2.2 4.0 4.3 4.5 3.5 2.6 2.1
#2 #5 #9 #3 #16 Russia
#4
US Greece
2.8 3.0 3.2 -4.5 -3.0 0.7
#1 #17
Mexico Japan
5.5 4.2 4.0
4.0 1.4 1.8
#12
#6
Brazil
China
7.5 4.6 4.7
10.3 9.5 9.0
#11
#10
Spain
-0.1 0.5 1.2 India
#8 8.6 8.6 8.5
#15
South Africa Italy United Arab Emirates** Australia
Key 2010e 2011f 2012f
2.8 3.4 3.9 2.7 3.1 3.6
Outlook GDP growth 1.1 0.9 1.2 2.1 3.5 4.6
PwC Med-term risk ranking* #14 n/a #7
#13
*PwC ranking of medium-term risk premium; **Based on March 2011 Economist Intelligence Unit projections
Source: PwC Economics, IMF
13

14. By 2050, China, India, Brazil and Russia will be in “the top six”
GDP by country, 2009 - 2050 2009 2050
60,000
Emerging economy
GDP at Market Exchange Rates (constant 2009 US$bn)
50,000
40,000
30,000
20,000
10,000
0
Indonesia
Australia
Germany
Turkey
Italy
China
India
Japan
Russia
Mexico
France
Nigeria
Spain
South Korea
Brazil
Vietnam
US
UK
Canada
Saudi Arabia
Source: PwC Forecasts
PwC 14

15. This is not just more of the same. It’s no longer merely a story of
basic products and low cost manufacturing
• India, China, ASEAN and Nigeria will add1.3bn urban residents between 2009 and 2050
Urbanisation • The cities of the world will require tremendous investment in infrastructure to support
this growth
• Shanghai and Mumbai alone will generate 25m more middle class households by 2025,
Emerging but the new middle class will not be constrained to the world’s megacities
middle class
• This will create substantial opportunities in consumer goods, while straining the
agricultural capacity of the world
Changing • China may no longer be the world’s factory. Many emerging markets now have lower
labour labour rates than China, and countries like Thailand and India could become more
markets competitive relative to China
• Within the BRIC, the key area of competition is around innovation
• Between 2005 and 2009, over 2,000 companies in emerging markets began investing
Emerging
abroad. Some are becoming industry leaders (e.g. Embraer from Brazil)
competitors
• These companies will become stronger, and could be joined by as many new multi-
nationals
• Currencies in Brazil, Vietnam and Indonesia are all expected to depreciate relative to the
Currency
movements RMB, making these countries more competitive as a low cost manufacturing destination
15

16. Not your average expansion
The emerging markets are not, at all, like “the
west” – a unique approach is required
16

17. Market entry has a high chance of failure because it involves a
large number of difficult choices...
Key Decisions Choices Some Considerations
1. Customer focus • Willingness to pay
Affluent segment Mass market • Cost of customer education
Business model
• Minimum efficient scale
2. Product • Cost to deliver
Global products Local branding / pricing • Potential for defensible advantage
offering
• Market knowledge/ risk appetite
3. Supply chain Local
Export License Local R&D • Local ecosystem
footprint production • Tech. exchange in the proposition
4. Investment • Regulatory requirements
JV Acquisition Go-it-Alone • Management bandwidth
vehicle
• Execution vs. partner risk (IP, control)
5. Partner type State-owned/ Small private Private • Need to navigate regulations vs.
Execution
affiliated sector conglomerate commercial behaviour
• Balance of power in partnership
7. Location • Proximity to raw materials and
Cost-advantage Employee friendly customers
• Liveability
8. Management • Global career development
Foreign Local • Adaptability
• Retention
17

18. ...in an environment that is “not like the West”...
Why deals in emerging
markets are different
Government
Growth
Culture
Governance
Valuation

19. Numerous companies have achieved growth through emerging
markets, but some companies have also faced difficulties
Examples of successes Examples of difficulties
Phased approach to de- “In the late ’90s, we decided not to
Infrastructure
risk entry; continuous enter China, and missed a substantial
localisation of operating opportunity. Now, it’s too late”
activities Automotive component manufacturer
“Suzuki re-entered the Indian market
Incorporating emerging
in 2006, after it severed a decade long
markets into a global
ties with Chennai-based TVS Motor
A&D
supply chain to lower
Company in 1999-2000, after the five-
costs and gain access to
year non-compete clause expired“
demand The Economic Times, 17 Dec 2009
Strong partnering in
Auto
India “Danone ends troubled Wahaha
venture --- China partnership was
Toyota plagued by disputes over drinks
business; cash payout will settle legal
Investing to provide global service
cases “
Others
levels to high-end customers in Wall Street Journal, 1 October 2009
China
PwC 19

20. Section 2 – The challenge
We draw a number of key learnings from our experience with
market entry
• Align people. Get involved early to begin learning and developing relationships. Ensure
senior management stays involved and focused on the long-term rational
• Utilize light touch models. Test the market (e.g. exports, licensing)
• Don’t change the core. Understand what’s critical to the success of your core business
model and first replicate that in new markets. Limit localization decisions to non-critical
parts of the business model (but do make sure the business is tailored to the local market)
• Phase investment. Understand the timing of demand growth, the economics of your cost
to serve and the key step changes in capacity. Plan around capacity but build in flexibility
• Don’t be afraid to walk alone. Be clear about what you get from and provide to a partner.
Understand the benefits and risk that a partner brings
• Invest in local deals capabilities. Be aware that deals in emerging markets are different
and harder than they are in home markets. Invest in emerging markets deal execution
capabilities if you’re going to pursue an acquisition
• Learn from Private Equity. Adopt relevant lessons from Private Equity from investment
strategy to evaluation and exit
20

21. There are lessons to be learned from private equity to
de-risk market entry
Investment strategy Criteria for consideration Partnering/ co-investment
Portfolio of investments with Think about exit from day 1 Treat with caution (be clear
uncorrelated risks (e.g. (how to get out if things go why you’re partnering and do
multiple countries) badly) so carefully)
Investment evaluation Strategy Development
Create investment model Management and the board
early as a living document develop strategy together
Private Equity
(how much money will it (e.g. Work closely with
model
make?) emerging market managers)
Discussions Financial management Governance
Getting financial systems right
and regular monitoring
Impersonal and fact-based Focus on cash (can be in the
(emerging market accounting
(avoid over-excitement) longer term)
systems are generally less
sophisticated)
21

22. “It is not the strongest of the species that survives, nor the
most intelligent that survives. It is the one that is the most
adaptable to change.”
Charles Darwin

23. Structuring into BRIC Countries
Efficient tax planning
23

24. Emerging Markets – Proposed structures
Canco
Canada
BRIC
Branch
Issues:
• Registrations
• Limits on activities
• Staffing
• Banking – Foreign Exchange
24

25. Emerging Markets – Proposed structures
Financing Canco
Equity Debt Canada
BRIC
Local
Financing
BRIC Operating
? Company
Issues:
• Similar issues to setting up branch
Plus
• Choice of legal entity
• Minimum capital requirement
• Repatriation limits
• Withholding tax
25

26. Emerging Markets – Proposed structures
Financing Canco
Equity Debt Canada
Foreign Holding
Company
Equity Debt
BRIC
BRIC Operating
Company
Issues:
Selection of foreign holding company
• Treaty network
• Substance – Mind and Management
• Tax rate on local and foreign source income 26

27. Emerging Markets – Proposed structures
Financing Canco
Equity Debt Canada
Foreign Holding
Company
Equity Debt
BRIC
Bidco
Issues:
• Set up of Bidco
• Ability to merge/consolidate Target
27

28. Doing Business in Brazil
Forms of investment
• Branch – difficult to incorporate later
• Limited liability company – Sociedade Limitada – LTDA
• Corporation – Sociedade por Acoes – S/A
Repatriation
• Capital permitted
• Dividend – no w/h tax
Corporate tax
• Calendar year
• Rate = 15% plus 10 % surcharge = 25%
• Social Contribution Tax= 9% of profit.
28

29. Doing Business in Russia
Forms of investment
• Rep office – Accreditation
• Branch – Registered
• Full and limited partnership
• Limited liability company
• Joint Stock company
Repatriation
• Dividends – 15% w/h tax
• Initial contribution – tax free
Corporate tax
• 20%
29

30. Doing Business in India
Forms of investment
• Branch, Project and Liaison office
• Wholly owned subsidiary
• Joint venture
• Limited liability company
Repatriation
• Capital may be returned
• Dividend distribution tax = 15% plus surcharge ~ 16.6%
Corporate tax
• Resident company = 30% plus surcharge ~ 33.2%
• Non-resident company = 40% plus surcharge ~ 42.2%
PwC 30

31. Forms of doing business in China
Indirect investment forms
• Processing
• Representative Offices Foreign Enterprise (“FE”)
• Licensing
PwC 31

32. Forms of doing business in China
Direct investment forms
• Equity joint ventures
• Cooperative joint ventures
• Wholly foreign-owned enterprises
• Special purpose vehicles
◦ Service Company Foreign Investment
◦ R&D centre Enterprise (“FIE”)
◦ Trading company in the FTZ
◦ Chinese Investment holding company
◦ Shanghai Regional Headquarters
32

33. Corporate tax in China
Standard rate = 25%
Special reduced rates in selected industries and geographies ranging
from 0% to 15%
33

34. Requirements for initial investment
• Currency conversion is regulated
• Cash or in-kind (within limits)
• Certified by a CPA
• Maintain separate accounts for
capital
• Technology agreements require
approval
• Debt/equity ratio requirement
PwC 34

35. Repatriating capital
EJV – only on liquidation
CJV – agreement of partners and regulatory approval
WFOE – flexible
In all cases – sufficient foreign currency on hand
35

36. Repatriating earnings
Conditions
• Prior year’s losses made up
• All taxes paid
• Director’s approval
• Approval to change currency
May be exempt from withholding
36

37. Suggested Tax Considerations for entering any BRIC
Country
1. Ensure business case is well developed.
2. Establish policies for employees assigned to destination country.
3. Complete due diligence on business partners.
4. Consider use of holding company.
5. Establish policy for the use of IP.
6. Determine optimal location.
7. Develop a capitalization strategy.
8. Develop transfer pricing policies.
37

38. Illustration of BRIC Growth – Auto
Industry
Appendix 1
38

39. Illustration of BRIC Growth – Auto Assembly Outlook
For the first time in history, the number of vehicles produced in developing and emerging markets
in 2011 will be greater than the number of vehicles produced in mature markets.
Global: Light Vehicle Assembly by Market Type Global: Contribution to Growth by Region
2000 – 2017 (millions) 2010 – 2017
60
AP China 38.5% India 12%
50
NA
40
EU
30
SA Brazil 6.4%
20
EE Russia 6.2%
10
MEA
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
0% 10% 20% 30% 40% 50% 60%
Mature Emerging
Source: Autofacts 2011 Q4 Data Release

40. Illustration of BRIC Growth – Auto Assembly Outlook
China’s assembly growth will exceed the combined growth of the remaining BRIC countries.
BRIC: Assembly Outlook by Country
2010 vs. 2017 (millions)
26.8
China
14.4
7.1
India
3.0
5.1
Brazil
3.1
3.3
Russia
1.3
0 3 6 9 12 15 18 21 24 27
2017 2010
Source: Autofacts 2011 Q4 Data Release

41. Trends across emerging markets
Appendix 2
41

42. This is not just more of the same. Emerging markets will undergo
dramatic changes as the result of five key trends
Urbanisation
Currency Emerging
movements middle class
Emerging
markets
macro
trends
Changing
Emerging
labour
competitors
markets
42

43. India, China, the ASEAN-6 and Nigeria will add 1.3bn urban
residents between 2009 and 2050
Urban population in emerging markets, 2009-2050
6
5 By 2025, India is
projected to have 3 0.9
mega-cities: Deli, 0.6 0.1
Mumbai and
4 Kolkata 0.4 Brazil
0.1
0.2 Nigeria
Billions
0.4
3
0.5
5.2
By 2025, China is
projected to have 5
2
mega-cities:
Shanghai, Beijing,
2.5 Shenzhen,
1 Chongqing, and
Guangzhou
-
2009 urban India China ASEAN-6 Africa Latin America Other emerging 2050 urban
population in markets population in
emerging markets emerging markets
Source: UN, World Urbanization Prospects The 2009 Revision
43

44. China and India will see strong growth in the number of middle
and upper class households, with Shanghai and Mumbai
generating 25m more of these households by 2025
Number of middle and upper class households in key cities*, 2008-2025
Both China and
India will also see
25 large growth in
middle class
consumers in
Number of middle
19.7 second tier cities and upper class
20
households, 2008
Number of households (m)
16.5
14.9
15
12.9
9.9 10.0 9.6
10 8.6 8.6
Number of middle
and upper class
5 3.6 4.1 households, 2025
1.4
0
Sao Paulo Shanghai Mumbai Paris Jakarta London
Rank in
world 4 9 3 24 25 n/a
population
2025
*Sample of growing cities in emerging markets and established European cities
Source: PwC Economics
44

45. Indian and ASEAN labour markets are likely to become more
attractive relative to China
Emerging markets labour costs are lowest in Asian Wage inflation is likely to see India and ASEAN
markets becoming more competitive relative to China
Average hourly labour costs (US$), 2010 Changing labour dynamics, 2010-2015F
100%
25
UK - $24
% growth in labour productivity, 2010-2015
80% Indian and Thailand
20
Average labour costs per hour (US$)
labour markets are
2010
likely to become
more attractive
15 60% relative to China
China
11.3
India
10 40%
6.4 Indonesia Russia
Thailand
5 20%
3.8
2.6 2.2 1.8 Brazil
0.7 Poland
0 0%
Poland Brazil Russia India China Thailand Indonesia 0% 20% 40% 60% 80% 100%
% growth in nominal wages, 2010-2015
Source: EIU, Jan-Feb 2010
PwC 45

46. Emerging markets will produce a large number of new multi-
nationals
New multinationals* in emerging markets by New mult-nationals 2010-2024
country, 2005-2009 Bubble size reflects
800 180% number of new
Growth in real GDP from 2005-2009 to 2010-2014
multinationals between
160% 2010 and 2024
700
CHN
140%
600
120% IND
# of new multinationals
500
100%
VIE
400 80%
60% MAL
300 BRA CHL
POL SIN
KOR RUS
40% ROM
UKRARG
200 MEX
20% HUN
100
0%
0% 20% 40% 60% 80% 100%
-
2005 2006 2007 2008 2009
Growth in number of new multinationals between 2005-2009 and 2010-
China India Other emerging markets 2015
*Note: defined as a company that it undertakes green field investment abroad for the first time
Source: PwC Economics
PwC 46

47. Movements in exchange rates are likely to decrease the cost
advantage of manufacturing in China relative to other emerging
markets
Indexed global exchange rates (relative to US$), 2003-2015F
% change
2.0
2003-2010 2010-2015
1.8 Forecast
Brazil 75.3% (12.6)%
1.6
1.4 China 22.2% 18.5%
1.2
1.6% 9.3%
2003 = 1
India
1.0
0.8 UK (5.4)% 2.2%
0.6
Indonesia (8.3)% (1.3)%
0.4
0.2
Vietnam (16.7)% (6.0)%
0.0
2003 2004 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F 2014F 2015F
Source: PwC analysis, OANDA, EIU
PwC 47

48. Case Studies
PwC has helped numerous companies expand
into emerging markets
PwC 48

49. Case Study 1: Understanding how quickly a domestic supply chain
could be established in India was critical to timing entry for an
automotive supplier.
India market entry
The client’s automotive turbocharger business is a leading global
supplier of turbine wheels. It is a vertically integrated business, with
capabilities in-house to melt superalloys, the key input for turbo
chargers wheels. The superalloy business had recently been
receiving a number of requests from customers in India. The
business was considering an investment in India to satisfy this
demand. The client hired PwC to test the business case.
Our key focus was on understanding the market potential. We found
that while rapid growth in automobiles was driving demand for
turbochargers, this didn’t necessarily equate to demand for super
alloys. By speaking with automotive experts, and procurement
heads at the leading global turbocharger manufacturers, we mapped
likely movements in turbocharger production and the
manufacturers’ sourcing strategies. We then looked at the
investment plans of turbine wheel producers to understand the
timing of local demand.
We recommended a customer-led phased approach to entering
India. The client is currently exploring several options to do so.
49

50. Case Study 2: Assessment of the key competitive factors in the
glassware industry highlighted alternative investment
opportunities in China
China commercial diligence and location study
Libbey is a major US manufacturer of table glassware, covering a
huge range of beverage glasses for home and trade use. The
glassware industry had become more global, and competitors such
as Luminarc of France and Pasabahce of Turkey were expanding
rapidly into international markets.
Libbey had been presented with an investment opportunity in
China, which we helped them to assess through a commercial due
diligence investigation. In glassware, distance from the source of
raw materials and energy prices are key competitive factors. We
considered the cost of this opportunity versus alternative locations,
determined that other locations would offer better long term costs,
materials availability and market access, and then conducted a
search that resulted in a short-list of proposed alternative locations.
After helping Libbey negotiate investment incentives with approval
authorities, the Langfang development zone in between Beijing and
Tianjin was selected, and the plant opened in March 2007 with an
investment of almost US$60million.
50

51. Case Study 3: Understanding the China strategy of the automotive
assembler, and how they planned to address the market was key in
drawing up a list of acquisition targets
China M&A Strategy
Our client was the independent parts aftermarket brand for a US
‘big three’ automotive assembler. In China, most vehicle assemblers
had managed to establish ‘closed loop’ parts distribution systems,
meaning that service centres only installed parts made by the
vehicle manufacturer, but this situation was changing and the client
wanted to quickly establish a presence in the independent
aftermarket, as car owners were increasingly going outside the
closed loop to lower costs.
PwC helped the client to assess how this market could be addressed,
how it was likely to evolve, consider a range of partnering strategies
outside of existing parts distributors, and finally help draw up a
short list of acquisition targets, by first understanding how the client
would address the market, and then assessing targets by how closely
they fit the client’s strategy and how likely it would be for a deal to
close. The work was made more difficult by the generally poor
quality of market information available, which meant that we had to
triangulate information sources to get as reliable a data set as
possible. We then went on to provide financial due diligence
services to the deal.
51

52. Thank you
We want to do business with you.
This publication has been prepared for general guidance on matters of interest only, and
does not constitute professional advice. You should not act upon the information
contained in this publication without obtaining specific professional advice. No
representation or warranty (express or implied) is given as to the accuracy or
completeness of the information contained in this publication, and, to the extent permitted
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anyone else acting, or refraining to act, in reliance on the information contained in this
publication or for any decision based on it.
© 2010 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers
to PricewaterhouseCoopers LLP which is a member firm of PricewaterhouseCoopers
International Limited, each member firm of which is a separate legal entity.

53. Questions?
53

54. Contacts
Mark Walters
Tax Partner
(519) 570 5755
mark.g.walters@ca.pwc.com
Vanessa Iarocci
Director, Consulting & Deals
(416) 941 8352
Eric Castonguay
Managing Director, Consulting & Deals
(416) 815 5094
54