The Risks That Vibrant Limited Will Be Exposed to - Case Study Example

Table of Contents Table of Contents 1 Executive summary 1 Letter of transmittal 2 Introduction 3 Potential returns from the deal 3 The risks that Vibrant Limited will be exposed to 4 Conclusion 6 References: 6 Executive summary Companies find it advantageous to transform into multinationals as this enlarges their markets while enabling them become more competitive by harnessing the advantages that exist in the new markets. However, entering a foreign market has its share of challenges. First, the company has to contend with the uncertainties of the new political environment it enters in. then there is the problem of foreign currency exposure risks emanating from operating in different currencies. In this regard, this report is aimed at analyzing the decision by Vibrant limited a Canadian company to acquire Pharma limited a Japan based company. In these regard, various foreign currency exposure risks emanating from the acquisition have been discussed including translation exposure, transaction exposure as well as operating exposure risk. In addition, the issue of political risk has been examined. The paper then suggests how Vibrant limited might be able to manage the above risks in a bid to ensure their decision becomes fruitful. It is concluded that though the decision to operate internationally is advantageous for vibrant limited, there is need to put up measures of managing the risks identified. Otherwise, the company may fail to achieve its objectives of moving into Japan. Letter of transmittal 15th September 2014 The Management, Vibrant Pharmaceuticals Limited 35-425642, Brighton 15th Street, Edmonton, Canada. Dear sir/Madam RE: ACQUISATION OF PHARMA LIMITED JAPAN On behalf of Rising Star Consultants, I present the following report regarding the potential acquisition of Pharma Pharmaceuticals Limited Japan by Vibrant limited. The decision to enter the Japanese market is a good one given the exciting nature of the Japanese market as well as the potential expansion of our marketing base which would result in more revenue and hence increased profitability. However, as we enter this market, we need to be well informed of the political risks that exist in the new market and hence convince ourselves that they are manageable. By virtue of operating in two currencies, we will also be exposed to foreign currency risks including transaction, operating and translation currency risks (Maurice, 2005). If unfavorable, all these risks have the potential of eating into our profitability hence watering down our objective of venturing the Japanese market. As such, the report recommends that the company comes up with appropriate measures of identifying, measuring and managing the risks so as to ensure our success in the new market. Thank you for giving me the opportunity to prepare and present this report to you. It is hoped that it will help you make a more informed decision when venturing into the new market. Please contact us if there is need for more information. We look forward to working with you in other future projects. Sincerely, Krieger Colbey, President and CEO. Acquisition of Galaxy Pharma Ltd by Vibrant Ltd Introduction Vibrant Ltd which is a Canadian company intends to acquire Galaxy Pharma based in Japan. Both the companies are pharmaceutical companies. This acquisition has a number of advantages for Vibrant limited mainly because it is expected to widen Vibrant Limited’s market which could see it make more sales and hence profits. However, the transaction also exposes the company to a number of risks including political risk given that these are two different companies with different political systems as well as different culture. As such, it calls for evaluation of Japan’s political environment in a bid to determine the appropriateness of their business environment and whether there are any government policies that might hinder their venturing into the new market. The transaction also exposes the Canadian company to various forms of currency risks including transaction exposure, translation exposure as well as operation exposure. These currency risks are attributed to the fact that Pharma Company reports its accounts in terms of Japanese Yen while Vibrant Company operates in terms of Canadian dollars. It means that the transaction will involve exchange two types of currencies while their operations will still be conducted in the two currencies despite the fact that the financial results will have to be reported using the currency of the parent company. As such, the transaction will involve the above currency risks as stated. Thus, this paper is aimed at evaluating the entire transaction in regard of the potential risks it exposes Vibrant limited to as well as how Vibrant Company can mitigate the risks. Potential returns from the deal The financial position of Galaxy Pharma limited is positive and is hence in line with Vibrant’s vision of expanding into Japanese market. It has been revealed that that Galaxy Pharma limited currently has a profitability of Yen 4,551 million. This is a good sign that the company is acquiring a profitable venture. It has also been revealed that the company has assets worth Yen 8,337 million which also explains the purchase cost. This value is ideal for a stable company while it does not expose the company to too much maintenance expenses or costs associated with failing to utilize the assets to their full capacity. However, the company may decide to increase or decrease the level of fixed assets after assessing its needs on acquisition. The company’s current assets are relatively high at Yen 30,250 million 40% of which is cash. This implies that the company has enough liquidity for discharging its liabilities as they fall due. As stated above, the company’s aim of acquiring Galaxy Pharma limited is to increase its market leading to more sales and hence profitability. Furthermore, it has already been established that Galaxy Pharma is profitable going by the information provided. In this regard, acquisition of the company is in line with this vision given that both the companies operate in the pharmaceuticals industry. As such, the company could use the newly acquired subsidiary as a launch pad for the entire Asian market hence enhancing its profitability. Furthermore, the company can be able to use economies of scale hence gaining a competitive advantage over other companies to stay ahead of competition. The risks that Vibrant Limited will be exposed to As stated above, the acquisition of the Japanese company exposes Vibrant limited to a number of risks including; Foreign exchange exposure It is worth noting that Vibrant limited by acquiring Pharma limited will be operating in an international arena and hence it will add the Japanese Yen into the types of currency it deals with. As such, it will be exposed to foreign exchange exposure which is the possibility of harmful or beneficial effects on the company that may result from a change in foreign exchange rate. This may affect the company’s profits, cash flows or even its market value (Stephen and Stephen, 2014). In this regard, the company will face two types of foreign exchange exposure risks including transaction exposure and operating exposure risks. Transaction exposure involves the potential for a gain or loss in contracted for near term cash flows. This is caused by a foreign exchange rate induced change in the value of amounts due to the acquiring company or the money that Vibrant will owe the shareholders of Pharma limited. In other words, this is the change in the home currency value say Canadian dollar value of cash flows that have already been contracted for. In the case of Vibrant limited, suppose that the current rate of exchange is 120 Japanese yen against 1 Canadian dollar. When the contract is being signed, this is the rate that the two companies will use in valuing the transaction. As such, the company is currently worth 850,000,000 Canadian dollars. This is the amount of money that Vibrant should pay the shareholders of Pharma limited for they to acquire the company (Wang, 2005). However, suppose that one month later when Vibrant is making the payment, the exchange rate has changed to 110 Japanese Yen for 1 Canadian dollar. The shareholders of Pharma limited will still expect Vibrant to pay them 102,000 million Japanese Yen for the acquisition bid. To be able to make this payment, Vibrant will have to remit Canadian dollars 927,272,727. This will be $ 77,272,727 loss to Vibrant limited. The company will also be exposed to operating exposure which is the potential for a change in value of the company that is generally viewed as the present value of all its future cash inflows that is caused by unexpected changes in exchange rates. If the change is favorable, the profitability is likely to improve while if the change is unfavorable, the company is likely to suffer loss. The company is also exposed to translation exposure risk (Josephine, 2008). This is the probability of there being a change in the equity section of Vibrant limited consolidated balance sheet in terms of retained earnings, common stock and equity reserves as a result of changes in the exchange rate between the Japanese Yen and the Canadian dollar. We would recommend that the company adopts international hedging practices in its attempt to mitigate foreign currency risks. Hedging involves taking of a position either by way of acquiring an asset, a cash flow or a contract that will fall or rise in value and offset a rise or a fall in value of an existing position. In this regard, Vibrant Company would be protected from loss (Whitaker, 2004). Political risk By investing in Japan through the acquisition of Pharma Limited, Vibrant limited ought to know of the political risks it might be exposing itself to (John, 2014). These risks may be at the company level or at the national level. At the company level, the company should for instance consider the culture fit between the two companies in a bid to ensure smooth translation. At first, Vibrant limited may retain Pharma’s culture before gradually changing into the Vibrant’s culture if need be. This is because a culture clash is likely to lead to the failure of the entire process due to resistance to change. At the national level, such factors as the kind of business policies adopted in Japan ought to be considered. Though the company may have the financial muscle to acquire Pharma limited, a protectionism policy adopted by Japan may prevent the acquisition from succeeding (Jabez, 2010). Other factors include non-tariff barriers, tariff barriers, level of corruption and nepotism among other related cultural factors. In its attempt to mitigate political risks, we recommend that the company appoints a transitional committee to oversee the transition. The team will be responsible for identification, measuring and managing these risks that may hinder the success of Vibrant limited in Japan. Conclusion It is no doubt that the decision to venture the Japanese market provides Vibrant limited with the opportunity to expand its market base which is likely to lead to more revenue and hence profitability. However, the idea may not be beneficial after all if the company is unable to properly identify, quantify and measure the various kinds of risks it will be exposed to by operating internationally. As such, this paper has identified the various types of risks that Vibrant limited ought to be aware of before finally entering the market (Alan, 2009). By virtue of operating in two different currencies including the Canadian dollar and the Japanese Yen, the company is exposed to various currency risks including transaction, translation and operating exposure risks. On the other hand, by virtual of operating in different political environments, the company is exposed to various types of political risks as identified above. As such, there is need to properly identify, measure and manage these risks using the various measures suggested above of the acquisition is to meet the company’s objectives. References: Stephen, D&, Stephen, P2014, Foreign currency risk management practices in U.S multinationals, Journal of Applied Business Research, vol.13, no. 2, pp.73-85. Maurice, D2005, International Finance, New York, Rutledge. Kirt, C2012, Multinational finance: Evaluating opportunities, costs and risks of operations, New York, John Wiley & Sons. Wang, P2005, The economics of foreign exchange and global finance, Berlin, Springer. John, C2014, Understanding and managing political risk, London, Rutledge. Nicholas, S2014, What risks do organizations face when engaging in international finance activities, Retrieved on 15th September 2014, from; http://www.investopedia.com/ask/answers/06/internationalfinancerisks.asp Whitaker, L2004, The challenges of going global, Financial management, vol. 95, no. 2, pp. 88-97. Jabez, D2010, Management of multinational corporations, New York, Wiley. Alan, S2009, Multinationals financial management, London, Rutledge. Josephine, M2008, International business finance, Sydney, Prentice Hall. Read More