Emerging Markets: The Show Must Go On!

Emerging-market stocks have been butchered over the past few months amid fears that the Federal Reserve will begin winding down its bond-buying program. Should this be considered the end of the famous emerging-markets story?

Before attempting to answer this question, one should first consider who is bailing on emerging-market stocks: foreign institutional investors, who are known to be short-term in nature.

Meanwhile, corporations are the longest-term investors, so it would be interesting to see what companies are doing. Are they also fleeing emerging markets, or are they piling in?

A lot of corporations are investing in the emerging markets through various means, such as increasing their stakes in foreign subsidiaries and using mergers and acquisitions to gain access to emerging-market consumers.

Lets look at a few examples.

Multinational corporations increasing stakes in subsidiaries
Unilever
(LSE: ULVR  ) is one of the largest consumer companies in the world, with 2012 revenue of more than 51 billion euros and presence in more than 190 countries. It has more than 400 brands including famous ones like Lipton, Knorr, Dove, and Axe. Unilever derives more than 55% of its revenue from the emerging markets.

Unilever spent $3.3 billion to increase its stake in its Indian subsidiary Hindustan Unilever from 52.5% to 67.3% at a P/E ratio of 35.

Unilever Pakistan bought out its minority shareholders for $500 million and delisted from the Karachi Stock Exchange. The shares were valued at about 36 times 2012 earnings.

GlaxoSmithKline (NYSE: GSK  ) is a health care and consumer company based in London with 2012 revenue of 26.4 billion pounds. The health care division has products related to major diseases like cancer, asthma, infections, etc. The consumer division includes brands like Sensodyne, Boost, Horlicks, and Lucozade. U.S. is the biggest market for GSK, which generates 45% of its revenue in the country.

GSK recently increased its stake in its Indian subsidiary from 43.2% to 72.5% at a P/E ratio of 35. GSK spent 568 million euros for the bigger stake.

McGraw Hill Financial (NYSE: MHFI  ) is a $4.5 billion financial intelligence company providing credit ratings, risk solutions, and analytics. It is the parent of Standard & Poor's, the worlds largest credit-rating agency. S&P ratings account for 45% of McGraw Hill's revenue and 55% of its profit. The other divisions are S&P Capital, S&P Dow Jones Indices, and the commodities and commercial division.

MHFI recently acquired an additional 15% stake in its Indian subsidiary Crisil to raise its stake to 67.8%. It spent $214 million for the investment, and the open offer was at a P/E ratio of 45. Over the past five years, CRISIL's revenue have increased at a compound annual growth rate of 19.3%, which makes it future prospects look bright.

M&A activities
Companies use M&A to acquire emerging-market business and access to upwardly mobile consumers.

Diageo (LSE: DGE  ) is the world's largest producer of spirits. Some of the popular brands from the house include Johny Walker, Captain Morgan, Guinness, and Smirnoff. Emerging markets account for 42% of Diageo's revenue.

Diageo has invested a lot of money in these markets through acquisitions. Here are some of the acquisitions Diageo has made in the past few years.

  • In 2013 Diageo acquired United Spirits, India's largest spirit-manufacturer, for $521 million.
  • In 2012 Diageo acquired Ypioca, Brazil's best-selling brand of premium cachaca, for $453 million.
  • In 2011 Diageo acquired Turkish liquor company Mey Icki for $2.1 billion.

Kraft Foods (NASDAQ: KRFT  ) is a food conglomerate with 2012 revenue of $18 billion. In 2012 Kraft split into two independent companies: the North American Kraft Food Group and the global Mondelez International.

Kraft bought out Cadbury in a $19.6 billion deal in 2010. The primary reason for the purchase was the fact that Cadbury provided the entry and scale into the emerging markets that Kraft needed. The valuations for the purchase look high, but the companies believe the growth opportunity offered in these markets should compensate for the hefty price tag. Multinational corporations are taking advantage of their low capital costs and the higher growth potential of emerging markets to make long-term investments in their subsidiaries and acquire companies.

These are companies with fantastic track records, and it's safe to assume that a lot of thought went into their multibillion-dollar investments in these markets. And you actually have an advantage over these companies: You can take out your money whenever you want.

So it's a simple and smart strategy to align with companies that are smartly investing in high-growth markets, looking at their long-term potential, and growing with them.

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