Companies from developing countries are now looking beyond their local financial markets to raise funds. How the IFC helps
Senior Investment Officer, Capital Markets Department, IFC
A Frankfurt-based investor buying shares in a Mexican company? This is not as novel as it sounds. Since late 1989, an increasing number of companies located in developing countries (especially those in Latin America) have been obtaining funding in the international capital markets. They had done so, in a limited way, prior to 1982. But many of these companies, with the exception of some in Asia, were unable to obtain external financing during most of the 1980s, largely because the debt crisis in developing countries eliminated investor interest in them. Now, with growing confidence in their countries’ economic adjustment efforts, many companies have returned to selling securities on international capital markets. In June 1989, a Mexican bank—Bancomext—issued a $100 million unsecured bond with a yield close to 17 percent. Since then, several Mexican issuers (including such well-known names as Telmex, Pemex, Cemex, and Nafinsa) have issued securities (e.g., bonds, floating rate notes, and convertible bonds) at increasingly attractive rates abroad, followed by Chilean and Venezuelan companies also eager to tap the international capital markets.
Through such security issues, many developing countries are gradually seeing their securities markets integrated into the vast network of the world financial markets. This is not surprising as these securities issues not only benefit the company but also international investors. Developing country companies are thus increasingly able to diversify their funding base beyond the local financial markets, which still remain limited in size and scope. In addition, the beneficial impact on the economies of developing countries should not be ignored. Such securities issues help introduce new financial instruments to the domestic capital markets and harmonize disclosure and accounting standards. All these developments could lead to a more active local capital market and consequently, increased mobilization of domestic savings.
But it is not so easy for a developing country firm to issue securities abroad. This is largely because (1) securities issued by companies from developing countries generally require more effort in placement and sales to investors compared with a similar undertaking for a company in a developed country. Investors generally prefer to purchase securities of companies they are familiar with, or are well known among investors. Also, the economic and political situation of the country in question is just as important and often needs to be described in detail to potential investors; (2) the company’s accounts and other information are typically not disclosed in a sufficiently detailed manner to meet requirements of institutional investors in the major capital markets; (3) accounting standards used in many developing countries differ significantly from those used in the industrial countries; and (4) in most cases, the terms and pricing of securities issues require the approval of the developing countries’ authorities on a case-by-case basis.
Over the past five years, the International Finance Corporation (IFC) has become increasingly involved in helping companies in developing countries raise financing through international offerings of investment funds and individual corporate securities. This effort gained momentum with the establishment of the International Securities Group (ISG) in mid-1989 to provide investment banking services to corporate clients in developing countries. ISG (now part of the Securities and Syndications Division) serves developing countries and the international, financial, and business communities in the following capacities:
as an advisor to companies in developing countries, encouraging them, when appropriate, to investigate the long-term advantages of issuing securities abroad;
as a partner with some of the prominent international investment banks, in bringing companies from the developing countries to the international capital markets. IFC is actively involved in executing the securities offering, including direct sales to institutional investors; and
as a provider of information to the world investor community on investment opportunities in securities of emerging markets. ISG’s efforts are complemented by IFC’s Emerging Markets Data Base, which provides detailed financial information on over 800 companies listed on the stock exchanges in 20 developing countries.
Initially, IFC attempted to provide companies in the developing world access to the international capital markets through country funds, which invest in a large number of companies in a specific country. This was a logical first step, as the professional fund managers select the companies in which investments are made, and investors themselves do not need detailed knowledge of various companies in each developing country. In addition, foreign investors initially considered country funds “safer” than investing in specific companies, given that these investments are typically diversified across several industries in a given country. Most of the companies in which country funds invest are quoted on local stock exchanges.
IFC has been instrumental in establishing 26 country funds (including debt-to-equity conversion funds), targeting markets as divergent as Argentina, Brazil, Chile, Hungary, Indonesia, Malaysia, Mexico, the Philippines, Portugal, the Republic of Korea, Thailand, and Turkey. In addition, IFC has helped create several multicountry and regional funds. We estimate the total current market value of country funds invested in developing countries at over $10 billion. With country funds having become a well-accepted product, IFC is going a step further by assisting individual companies located in developing countries to issue securities internationally. Investors who were initially only willing to risk investing in developing country companies on a diversified basis through country funds are gradually becoming interested in specific companies.
Helping companies gain access to the international markets is a three-stage process.
Identifying the appropriate developing country company for securities issues. For countries that are “newcomers” in terms of corporate access to the foreign capital markets, initial securities issues should generally be undertaken by large companies. Such companies usually have significant project-related funding needs and would be best able to appreciate the importance of diversifying funding beyond the local capital markets; they are typically quoted and actively traded on the local stock exchange. In addition, foreign investors are most likely to be interested in larger companies, not only for reasons of name and prestige but also because larger companies are likely to issue securities of sufficient volume to ensure some liquidity in the financial markets. This is an important consideration for investors, since active trading will enable them to sell the securities they initially purchased, with relative ease and at an attractive price.
The company’s track record (e.g., profitability and debt-servicing record) and the nature of its business are also important considerations. Utilities, for example, generate relatively stable income, making such companies particularly attractive compared with other developing country companies, whose earnings and performance are typically volatile. Export-oriented companies (including commodity-based companies) are also good candidates for international securities issues. Export receipts in foreign currency help the company meet debt-servicing obligations even in times of rapid devaluations of the local currency. Above all, it is important to identify companies that are strongly positioned (relative to competitors) in those sectors most likely to benefit from the country’s economic growth.
Arranging the securities issue. Once the appropriate company is identified, one or several financial intermediaries (e.g., IFC and investment banks) proceed to structure the securities, that is, determine the nature and terms of the offering. This process involves discussions with the company’s management to arrange for the financial instrument most appropriate to the company’s funding needs. In some cases, the company needs additional equity to increase its capital base in undertaking a planned expansion. In other cases, the company may have a very low debt-to-equity ratio and may primarily need debt financing. Quasi-equity instruments, such as convertible bonds or bonds with equity warrants, may be appropriate for a company unwilling to issue shares because of the current low valuation of its stocks, but would face a high cost if it were to issue a debt instrument with no equity component.
In determining the appropriate structure for the securities issue, the company’s needs must be balanced against investor preferences. In certain cases, the company may not have the full range of choices in the instruments it is able to issue. Certain companies in highly indebted developing countries may not be able to issue debt instruments at reasonable costs. Investors, quite naturally, will be cautious about purchasing debt securities of a company located in a country with serious debt-servicing difficulties. The same investors may, however, be willing to purchase equity securities, if such securities are inexpensive—that is, in terms of price to earning ratios—and have a potential for significant capital gains.
Once the structure of the offering is established, the instrument must be “priced” by assessing likely demand. Usually, the financial intermediaries are called upon to use their investor contacts and experience in evaluating the price at which an instrument is likely to be sold. But this is often difficult in the case of securities issued by companies from developing countries, since there are few comparable companies whose existing securities issues could serve as the benchmark for determining prices.
When the company agrees to the proposed structure and pricing of the instrument, the financial intermediaries then proceed to place the issue with investors (i.e., sell it). However, before proceeding with the marketing of the issue, approval for the offering must be obtained from the authorities in the developing country in which the company resides, and in certain cases, in the country where the securities are issued. There must also be a clear understanding on the tax treatment of income and capital gains realized by the investors and on the ability to repatriate such gains freely.
Placing the securities issue. Given the risks involved in purchasing these securities, what types of investors participate? Initially, a large proportion of investors interested in securities issues (particularly bonds) of a developing country company tend to be “flight capital” investors—that is, if a company from country X wishes to tap the international markets, one can expect significant participation by investors of this country who hold assets abroad. This is natural given these investors’ familiarity and stronger ties with the company.
As the number of companies in developing countries undertaking such issues increases, however, the core group of investors gradually shifts to international institutional investors, such as pension funds, insurance companies, and other financial institutions. Such investors seek to further diversify their assets and realize a high investment return. As shown by IFC’s Emerging Markets Data Base, the performance of stock markets of developing countries is not, on the whole, strongly correlated with the performance of industrialized markets. Even when the stock markets of the industrialized countries are performing poorly, those of the developing countries could be performing well. This difference in performance enables the equity investor to diversify risk by buying developing country securities. More and more international investors are becoming aware of this advantage.