Internationalisation Opportunities for the Hong Leong Group - Case Study Example

Report on Internationalization opportunities for The Hong Leong Group: The case of Railways Transportation sector in Saudi Arabia Table of Contents 1. Chapter 1 Introduction 3 Aims & Objectives 4 Overview of the Middle East 4 Transitional Economy 5 Saudi Arabia’s railway Project 6 2. Chapter II Country information 8 The Government Economic Policy 8 SWOT and PEST Analysis 10 Competitors Analysis 11 Economic environment in Saudi Arabia 11 Budget Summary and Allocation 13 Investment Oppurtunities in the Transportation Sector 14 Risks 15 3. Chapter III HLG – Foreign Market servicing strategies 17 Overview of Relevant Functions & Implementation Strategy 19 4. Conclusion 21 5. References 22 Chapter I INTRODUCTION Hong Leong Group, Malaysia (HLMG), is the manifestation of the Vision of one person. Started as a trading company in 1963, with the vision and the untiring efforts of the entire group, today the Hong Leong Group comprises of 14 listed companies in various stock exchanges around the world with a total market capitalization circa USD 12 billion (HLGM, 2001). In line with its aspirations and foresight, the Group gradually diversified into manufacturing and distribution, financial services and properties. Apart from a broad spectrum of financial services, which includes banking, insurance, investment, finance and stock broking throughout Malaysia, Singapore and Hong Kong, HLG is involved in the newsprint and furniture, building materials and motorcycle industry, and the ventilation, refrigeration and air-conditioning industry. The Group also has its presence in the hospitality industry. Now, the HLG intends to diversify and enter countries with transitional economies or the developing nations. It has presence in many countries but has so far no investment and interest in Saudi Arabia. This will report will discuss the feasibility of investing in the Railways Transportation sector in Saudi Arabia. AIMS & OBJECTIVES To study the feasibility of this project, this report will consider an overview of the Middle East, and the economic situation in Saudi Arabia in particular, which is now developing. The existing railways infrastructure in Saudi Arabia, the proposed plans, the government norms for foreign investments, the general government economic policies, and the macro and micro business environment would be dealt with. SWOT analysis of the project would be undertaken keeping in mind the risks involved, the ethical issues, and the foreign entry strategies. These would enable the board of directors to take a decision about investment in the railways transportation in Saudi Arabia. OVERVIEW OF THE MIDDLE EAST As per the IMF report (REO, 2006), growth in Middle East averaged over 6 percent. It outpaced the global growth and the inflation and interest rates remained at historically low levels. Even after external debt repayments, the official reserves rose. Most oil exporting countries are cautious with the budget as they expect the oil prices to decline. Their high savings leads to global imbalances. High oil prices have boosted regional liquidity and there is a boom in the stock markets as well. The per capita GDP growth in the region has more than doubled between 1998-2002 averaging nearly 4 percent a year during 2003-05. Despite this, unemployment rates have not reduced. IMF strongly suggests oil-producing countries should invest in infrastructure and human capital. TRANSITIONAL ECONOMY H.E. Ibrahim Al-Assaf, Minister of Finance, Saudi Arabia, at the Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries, in 2004 at Washington, DC observed while industrialized countries have eased their economies out of latest recession, the developing countries’ performance is also significant (Al-Assaf, 2004). He reiterated that transitional economies should have an equitable and sustained economic growth and this can be achieved with an improved social and physical infrastructure. The developing nations need to rely on their own generation capacity, and they should be allowed to participate in their development strategies. Kumar (2001) agrees that enhanced physical infrastructure is essential for growth and attracts foreign direct investment (FDI). Government of different countries, in order to attract FDI, offer various investment and tax incentives. An improved investment climate subsidizes the cost of total investment by foreign investors, which increases the rate of return. Infrastructure could include transportation like road and railways network, ports and airports. Saudi Arabia is a developing nation with promising growth. The chart below shows the FDI in emerging markets, low income and in oil exporting countries. Amongst the oil exporters, the GCC countries accounted for most of the foreign investment inflows in the last two years. This has been due to privatization in transportation and telecommunications sector, investments in petrochemicals, gas and other infrastructure projects. In view of this, investment in Saudi Arabia would be possible as far as the government rules are concerned, and investment would bring returns. http://www.imf.org/external/pubs/ft/reo/2006/eng/01/mre0506.pdf SAUDI ARABIA’S RAILWAY PROJECT Railways as a means of transportation has several advantages. It relieves traffic congestion of vehicles, is economical and generates less pollution compared to motor vehicles. Railways are effective in timely movement of large volumes of cargo over long distances. While it requires initial high investment, the cost of operation is relatively low. The Supreme Economic Council, Saudi Arabia has recently approved the Saudi Landbridge and the Makkah-Madinah Rail Link (SRO, n.d.). HLGM has experience in a wide range of industrial activities. HLGM could bid for The Saudi Landbridge project, as the industrial climate in Saudi Arabia is conducive to investments, which is the reason this project is being strongly recommended. The project cost is yet to be finalized but it is expected to be about SR 10 billion. The landbridge would be the first rail link between the Red Sea and the Gulf. It would involve 950 km of new tracks between Riyadh and Jeddah and another 115-km line between Dammam and Jubail as well as upgrading the existing rail link between Riyadh and Dammam. This project, which is expected to take three years to complete, would boost Saudi industries, and change the existing shipping patterns in the region. The new railway line will reduce the travel time between Jeddah and Riyadh by about five hours. Cargo trains between Jeddah and Dammam will be able to cross within 24 hours. Ghafour (2005) stated that it would be the largest BOT scheme ever undertaken. Chapter II COUNTRY INFORMATION Saudi Arabia is the lifeline of present and future economies and is now entering a new phase of development. Saudi Arabia today holds 25% share of the total Arab GDP and is the world’s 25th exporter/importer (SAGIA, n.d.). This country is about one-fourth the size of United States, is spread over 2,150,000 square kilometers (830,000 square miles), occupying almost 80 percent of the Arabian Peninsula. The Kingdom is at the crossroads of Europe, Asia and Africa. The Kingdom is very rich in minerals with large deposits of limestone, gypsum and sand, and has the richest reservoirs of oil in the world. The total Saudi population as of September 2004 was 22.7 million, with a population growth rate of 3.24%. Foreigners form 27.1% of the population, which is due to the interest of foreigners in the Saudi investment sectors. Labor force of foreign nationalities comprises of about 75.67% as of 2004, which indicates the major role that foreigners play in the workforce of Saudi Arabia. GOVERNMENT POLICY Saudi Arabia’s macroeconomic policy has strengthened dramatically, which reflects higher oil prices and mature macroeconomic policies. The growth in GDP and the rising stock market prices are indicators. The stock market is open to foreign investors through open-ended mutual funds. Tax reforms and foreign investment laws make the business environment conducive to investment. These reforms are aimed to accelerate non-oil activity, generate employment oppurtunities, and reduce the economys vulnerability to oil price shocks (IMF, 2001). All these reforms have led to a tangible increase in FDI. Nevertheless, the economy remains vulnerable to downside oil price risks. If the global oil prices weaken, it would additional burden on fiscal and external balances, which can have a negative effect on growth. The government is prepared to tighten the fiscal policy further depending on the oil price development. The government recognizes that is has to mobilize non-oil revenues through improvements in tax administration, and various other reforms. Upto November 2005, because of licensing by SAGIA, Foreign investors, from 82 countries, contributed 57.8 percent, i.e. SR 87.9bn of the total licensed investments (Jarallah, 2006). Saudi Arabia attracted SR97.7bn cumulative foreign direct investments in 2005, with no investment record from Malaysia. The Saudi government envisages the doubling of the per capita income in five years to about $27,000 in the eighth Five-Year Development Plan (2005-2009). Apart from others, huge investment is expected in the transportation sector. Economic policies have been liberalized in order to attract foreign investors. The president of Saudi Railways Organization (SRO), stressed the importance of an integrated railway network linking major cities of the Kingdom (MENAFN, 2006). ADVANTAGES AND DISADVANTAGES OF INVESTMENT IN SAUDI ARABIA (SWOT AND PEST ANALYSIS) The Kingdom of Saudi Arabia is an emerging economy and is the largest free market economy in the Middle East. The investment environment in the Kingdom reflects traditions of liberal, open market private enterprise policies. Its Foreign Investment Laws allows 100 percent ownership of projects and real estate. It enjoys political and economic stability and has a modern excellent infrastructure. The Kingdom is endowed with natural resources. It does not impose restrictions on foreign exchange and repatriation of capital and profits (MFA, 2005). It has a stable currency and KSA is amongst a few countries in the world that allows companies to carry forward losses indefinitely. This relieves the businesses of tax burden until they start making profits. There is no personal income tax and labor cost is low. KSA is fully committed to increasing private sector participation in economic growth and railways is one such sector. Challenges include security concerns due to threats of war and terrorism. Besides, domestic labor shortage prevails as about 75.67% of the labor force comprises of foreign nationalities. Politically, while the King is the premier authority, the ‘Shoura’ council is the important decision making body. It has a mature political system. About 16.08% of the literate population holds higher education certificates (SAGIA). Improved education and vocational training is a key part of the government strategy, apart from improvement of the primary health care for health and social affairs. COMPETITION ANALYSIS The board members would find it interesting to note here that several small and medium American companies have expressed enthusiasm to enter the Kingdom’s transport industry through the railway project (SREP, 2005). Germany is keen to participate in Kingdom’s Railway Expansion (Ghafour) and Russia too is ready to contribute to Saudi Railway Projects (Interfax, 2004). If HLGM decides to bid for it, we shall be competing against leading international companies who are specialized in operating high-speed trains. Nevertheless, the authorities clarify that they would not give preference to those having technology or experience. The government is strongly committed to this project as this would create a new dimension to land transport. Since sound financial background would be one of the considerations, HLMG stands a fair chance with its expertise in various fields. ECONOMIC ENVIRONMENT IN SAUDI ARABIA The current economic boom in Saudi Arabia has both positive and negative sides to it. The Gross Domestic Product (GDP) in 2005 rose by 22.9 per cent in nominal and 6.5 per cent in real terms (Dunkley, 2006). The budget surplus at SR 214,000 million is the biggest ever that the Kingdom has seen. There is no external debt and most of the domestic debt is intra-governmental, mostly to the state pension funds. While nominal GPD is expected to slow down in 2006, Riyadh Bank still expects an expansion of about 15 percent as the oil prices increase. In 2007, easing of oil prices would be offset by capacity increases gradually coming on stream. The budget for 2007 forecasts a hefty 39 per cent jump in revenues to SR 390,000 million. At the same time, spending will rise by 19.6 percent mainly on social services like education, and health sectors. Private sector real GDP is estimated to have expanded by 6.7 per cent in 2005. Revenues are expected to reach SR390 billion (US$104 billion) in 2006 and a surplus of SR55 billion (US$14.7 billion) is anticipated (Arab News, 2005). Inflation remains tightly controlled despite the economic boom. An IMF Survey (2006) strongly suggests that favorable developments in Saudi Arabia offer the country chance to strengthen its economy. Consistent structural reforms over the past several years have led to economic diversification and privatization. This in turn has created more employment oppurtunities for Saudi nationals and enhancing the economy’s resilience to price shocks. The IMF acknowledges that the strength of the financial system will benefit from the ongoing liberalization through enhanced competition. The reforms would create a business environment conducive to attract more private sector finance and FDI. The chart below shows how the fiscal balance had a deficit in 2001 and in 2005 the GDP was estimated to be 16.8%. This chart demonstrates the financial strength that the country has gained over the years. www.imf.org/external/pubs/ft/survey/2006/010906.pdf However, the board of HLGM should be cautioned because inflated share valuations are common in most oil-rich countries. In addition, the threat of inflation remains although the cost of living index grew by only 0.4 percent in 2005. The budget summary for Saudi Arabia is as per the table below: BUDGET SUMMARY (SR000 million) 2003 2004 2005 2006 Revenue 170 200 280 390 Expenditure 209 230 28 335 Surplus/deficit -39 -30 0 55 Source: Riyadh Bank BUDGET ALLOCATIONS (2005-06) (SR 000 million) 2005 2006 % change Education and manpower training 70.1 87.3 24.5 Health services and social development 24.3 31.0 27.6 Municipalities 10.7 13.4 25.2 Transport & Communications 8.9 11.5 29.2 Water, agriculture and infrastructure 19.2 22.5 17.2 Specialised credit institutions 10.0 na na Total of the above 143.2 165.7 15.7 Total expenditure 280.0 335.0 19.6 na: not available Source: Riyad Bank (cited by Dunkley in MEED Middle East Economic Digest). INVESMENT OPPURTUNITIES IN THE TRANSPORTATION SECTOR The Saudi government policy is to use it oil revenues to expand general services and improve its infrastructure. The new Supreme Economic Council (SEC) has been created to speed up economic reforms and ensure stability for investors (MFA). The government emphasizes on development of human resources to attract the foreign investors. A separate Human Resources Fund has been created for skill training for the Saudi youth. The financial infrastructure is sound and is based on the financial standards and payment systems comparable to major industrial countries. The banking sector too is strong which is backed by sophisticated technologies apart from management expertise. With these, the Kingdom is an attractive investment decision. SAGIA helps foreign investors to prepare feasibility reports. Electricity, water, and fuel is available to foreign investors at a low price. According to the new strategy, the transportation sector is a key focus area for foreign and local investment oppurtunities. Railways is an important sector where the KSA is seeking private sector participation. Saudi Arabia has a leverage as far as the geographical position is concerned, as it is a hub between the east and west. The government is keen to develop the country as a launch pad for goods and services. The private sector is expected to take the lead in developing mega investment projects as the transport sector has plenty of investment oppurtunities. These will then be offered for both local and foreign direct investment. This will enhance the economic growth of the country. The government assures rewarding returns for investors. Transportation projects are essential because these would lead to development in other sectors like minerals. It would also generate downstream oppurtunities. The transportation sector will benefit from Saudi Arabia’s economic reforms process. It has multi-billion dollar oppurtunities. RISKS Daniel Wagner (2006) of Asian Development Bank is of the opinion that terrorism is an important consideration in formulating investment decisions. While Saudi Arabia carries the potential risk of war and terrorism because of the neighboring countries, Wagner observes that desire for profits has a stronger motivational force than perceived political risk as a disincentive to investment. A Harvard study indicates that higher levels of terrorism result in lower levels of net FDI. A study at Pennsylvania State University reveals that FDI promotes economic development of that country, which has an indirect negative impact on transnational terrorism. Changes in per capita GDP is associated with the level of terrorist activity but Saudi Arabia has consistently shown growth in GDP. Hence, in view of all these, the received risk of terrorism does not appear to be a threat to investment in Saudi Arabia and HLGM could take a decision accordingly. While the construction of the railway line will be mostly straightforward, there could be some challenges as the line will have to pass through the mountains, starting at Turabah, between Riyadh and Jeddab (MEED, 2005). Chapter III HLG – Foreign Market servicing strategies International market entry strategies would differ from region to region but more importantly it would depend largely on the product too. In the case of Saudi Arabia Railways Transportation System, it is not to market a product but to invest in infrastructure. This would require any organization to follow the Kingdom’s norms and implementations strategies. While HLGM is cash rich, it has to prove its credentials in providing services in international markets. Most industrialized countries have expressed interest in the railways project of Saudi Arabia and hence the approach has to be strategically planned. While deciding the foreign market servicing mode, factors internal and external to the firm have to be considered. On the one hand, HLGM should carefully evaluate short or long term profit and other goals. They can install appropriate production and management systems and have local partners for strategic purposes. It can create an independent entity, ownership allocation and operational duties. To reduce financial risks HLGM should go in for joint venture entry strategy. In any case, the government will take a stake in the company, which would be awarded the contract. HLGM has to be aware about possible partners, unintended knowledge transfer, and the rewards and returns in advance. Different suppliers and contractors would be required which HLGM should preferably take the local partners, which would be not only cost effective but also keep local sentiments at bay. The state-owned Saudi Railways Organization (SRO) has awarded the contract to a team of the US Parsons Brinekerhoff (PB) and Saudi Consulting Services (SaudConsult) to carry out a route alignment study on the planned landbridge project (MEED, 2005). This will connect the industrial city of Jubail in the Eastern Province with Jeddah in the west via Dammam and Riyadh. The exercise is to abolish the state monopoly in the railway sector. After a meeting with the potential bidders and investors, prequalification for the landbridge project would be launched. The concession would then be awarded to a private consortium, which could include construction and rail operating companies, equipment suppliers, shipping lines, financial institutions and other interested investors. Considering these steps, HLGM has to make a strategic move. More than 100 local and international rail companies, contractors, equipment suppliers, shipping lines, port operators, and financial institutions have attended the landbridge project day on 23 May 2006. Prequalification on the build-operate-transfer (BOT) scheme will now be launched which will be followed by the release of tender documents to pre-qualified firms. The successful consortium is expected to design, finance, build, and operate the new 950-km line and integrate it with the existing two lines between Riyadh and Dammam (MEED, 2005). The landbridge railway will consist of a single track and a second track may be added, depending on traffic growth in the region. Rolling stock would be diesel powered and the freight trains would operate at a speed of about 120 km/h while the passenger trains operating speed will be up to 220 km/h. OVERVIEW OF RELEVANT FUNCTIONS AND IMPLEMENTATION STRATEGY The construction of the east-west link will be historic and is expected to be the beginning of a brighter future for the kingdoms rail sector. The SRO will provide the land required for the route. Marketing Marketing will not be a concern because railways is a government project. The government would be responsible for the marketing strategies. The new rail lines are expected to draw a significant amount of freight and passenger traffic from the Kingdoms roads and from international shipping lines on to the track. Freight rate would be kept competitive. The new lines will initially be built as single tracks with long sidings. However, the infrastructure will be upgradeable to double-track if traffic growth demands it. Finance Finance will be under direct control of the parent office so key finance managers would not be required locally. It should employ simple financial control system to avoid misunderstandings. Legal HLGM should maintain good relationships with the local government for smooth functioning. They must strictly adhere to all government rules and regulations and comply with the legal requirements/licenses. The newly formed concession company will be incorporated under Saudi law once approved by royal decree. Human Resources SRO’s core assets and selected staff will be transferred to the concessionaire who will be awarded the contract. HLGM should adhere to its organizational values in all its operations across nations, but flexibility has to be given for the difference in culture in Saudi Arabia. Direct control has to be exercised and communication has to be strong. Employing local youth and managers would be cost effective as labor is cheap in Saudi Arabia and besides they would be familiar with the local business environment. Choosing the right manager will enable it to handle culture shock, different languages, and management. Hong Leong Group has to carefully face the problems of culture shock and fierce competition. By opting for joint venture, it will have increased understanding of the investment environment. Chapter IV CONCLUSION After carefully weighing the advantages and disadvantages, HLGM is strongly recommended to bid for the railways project. It would be a unique and challenging opportunity to enter the Saudi market. Competition is fierce but our Group has sufficient expertise and finance to support the project. The government’s liberal economic policies and total commitment would make the task easier. It has to be a joint venture with the government, which will be mutually beneficial. Saudi Arabia is an emerging economy and its budget allocation for 2006 demonstrates sustainable growth. Risks of terrorism should not be a deterrent; the returns on investment are huge. Taking local support and local partners for various supplies would be the right strategy and business approach. To have an overall control, the key managerial positions could be filled from our existing team. This project would add another country to our profile and it would be a bid against the industrialized and developed nations. This report supports the investment decision. . References: Al-Assaf (2004), Development Committee, World Bank, 07 July 2006 Arab News (2005), 09 July 2006 Dunkley C (2006), "Bursting with wealth: Riyadh is deploying its rising revenues to fund capital spending. The only blot on the horizon is an overheated bourse.(ECONOMY)." MEED Middle East Economic Digest 50.7 (Feb 17, 2006): 43(2). British Council Journals Database. Thomson Gale. 6 July 2006 Ghafour P K A (2005), Germany Keen to Participate in Kingdom’s Railway Expansion, 09 July 2006 HLGM (2001), HISTORY OF THE HONG LEONG GROUP MALAYSIA, 07 July 2006 IMF (2001), IMF Concludes 2001 Article IV Consultation with Saudi Arabia, 09 July 2006 IMF Survey (2006), IMF provides debt relief for 19 countries, Vol. 35, NO. 1, 11 July 2006 Interfax (2004), Russia Ready to contribute to Saudi Railway Projects, 09 July 2006 Jarallah A (2006), Arab Times, Saudi Arabia eyes railway expansion; Industries in solid growth, 09 July 2006 Kumar H (2001), Research and Information System for Developing Countries, Infrastructure Availability, Foreign Direct Investment Inflows and Their Export-orientation: A Cross- Country Exploration, Version 1.2: 20 November 200, 07 July 2006 MEED (2005), "SRO awards rail study.(Saudi Arabia)(Brief Article)." MEED Middle East Economic Digest 49.3 (Jan 21, 2005): 21(1). British Council Journals Database. Thomson Gale. 6 July 2006 MEED (2005), "East-West rail accelerates: concessionaire to be appointed next year.(Saudi Arabia)." MEED Middle East Economic Digest 49.5 (Feb 4, 2005): 24(1). British Council Journals Database. Thomson Gale. 6 July 2006 MENAFN (2006), British Firms Urged to Invest More in Saudi Arabia, 09 July 2006 MFA (2005), Economy & Resources, 09 July 2006 REO (2006), World Economic and Financial Surveys, 07 July 2006 SAGIA (n.d.), Land & people, 09 July 2006 SREP (2005), Saudi Railways Expansion Program, US Firms Eye Saudi Railway Project, 07 July 2006 SRO (n.d), Expansion Project, 07 July 2006 Wagner D (2006), The Impact of Terrorism on Foreign Direct Investment, International Risk Management Institute, 09 July 2006 Read More