It’s been over two years since Fiat acquired a 35% stake in Chrysler, and 3 months since it acquired its 51% controlling stake. As you may recall from my earlier posts, I was (and remain) skeptical that this deal would succeed due to the challenges associated with deriving value from Chrysler, and integrating it into Fiat’s global operations (see Appearance on Cavuto, Now Introducing Fiat/Chrysler, Can Fiat Pull it Off, Is Fiat Nuts?).

Given the recent downgrades of Fiat’s debt by Fitch and Moody’s, the ratings agencies increasingly seem to agree with my opinion. Here’s a recent article from The Detroit News that discusses some of the reasons why Fitch downgraded Fiat to BB from BB+, outlook negative, earlier this month (see Fitch Downgrades Fiat Over Chrysler).

While the agency acknowledged the marriage of the two companies should ultimately lead to increased sales and greater economies of scale, it expressed concern about the challenge of integrating a still-struggling Chrysler with Fiat when both companies remain under tremendous pressure.

“The current ratings are based on Fiat’s standalone credit profile, but incorporate heightened short-term risks for Fiat from its combination with Chrysler LLC in an increasingly challenging environment for the group,” said Fitch analyst Emmanuel Bulle, citing continuing softness in the European and American car markets. “Chrysler has a weaker credit profile than Fiat, and sustained benefits to Fiat from this deal should only accrue in the medium to long term.”

As I recognized in my earlier posts, there are some strategic reasons this acquisition makes sense, including, as the article states:

“Chrysler’s technology, product range and geographic diversification have become central to Fiat’s strategy…”

But it is important to remember that, even in the best of circumstances, acquisition integration is difficult. Lingering weakness in the automotive sector and broader macroeconomic environment make it even more challenging.

The Economist recently published a Special Report focusing on developing country growth (see The World Economy – A Game of Catch-up for the entire special report). The report focuses on the shift in economic power from developed to emerging economies. As much of the developed world continues to grapple with the aftermath of the financial crisis, the special report argues that the emerging world is catching up. The articles address various topics including the East catching up with the West, changes in the global labor market, trends in global M&A, and the U.S. dollar’s status as the world’s reserve currency.

Within this Special Report, I’d highlight two articles:

1. A Game of Catch-up: Many are beginning to predict that China, India and other emerging markets will catch up with the West at a faster pace than previously assumed.

A “great convergence” in living standards is under way as poorer countries speedily adopt the technology, know-how and policies that made the West rich. China and India are the biggest and fastest-growing of the catch-up countries, but the emerging-market boom has spread to embrace Latin America and Africa, too.

If emerging markets keep on growing three percentage points a year faster than America (a conservative estimate), they will account for two-thirds of the world’s output by 2030. Today’s four most populous emerging markets—China, India, Indonesia and Brazil—will make up two-fifths of global GDP, measured at PPP. The combined weight in the world economy of America and the European Union will shrink from more than a third to less than a quarter.

No country, or group of countries, stays on top forever. History and economic theory suggest that sooner or later others will catch up. But this special report will caution against relying on linear extrapolation from recent growth rates. Instead, it will suggest that the transfer of economic power from rich countries to emerging markets is likely to take longer than generally expected. Rich countries will be cursed indeed if they cannot put on an occasional growth spurt. China, for its part, will be lucky to avoid a bad stumble in the next decade or two. Emerging-market crises have been too quickly forgotten, which only makes them more likely to recur.

The force of economic convergence depends on the income gap between developing and developed countries. Going from poor to less poor is the easy part. The trickier bit is making the jump from middle-income to reasonably rich.

MY COMMENT: I agree that growth in many developing countries has been nothing short of remarkable; however I can’t help but side with the more cautious points in the article. Emerging markets have a long way to go, and their development path are fraught with serious downside institutional (cultural, political, and economic) risks. It therefore remains to be seen if the recent explosive growth in the emerging world is sustainable.

2. South-North FDI: Role Reversal: As I noted in my post India Buys Global, emerging market firm are increasingly buying developed market firms. The motivations include access to markets, basic resources, and advanced technology.

Their (emerging market firms) share of cross-border mergers and acquisitions (M&A) rose to 17% in the seven years to 2010, up from just 4% in the previous seven years, according to a recent report by the World Bank. They are the source of more than a third of foreign direct investment (FDI) in other emerging markets. Typically this sort of FDI is “organic”, which involves setting up a local factory or branch office. By contrast, direct investment by emerging-market firms in rich countries (so-called south-north FDI) tends to be “acquisitive”, which means one company buying another.

The bulk of the emerging-markets’ M&A in rich countries comes from five countries, led by China but also including India. America is the rich world’s main recipient, with Britain not far behind, even though its economy is only around one-sixth America’s size. Other big targets are commodity-rich Canada and Australia.

An acquisition is often the quickest (and sometimes the only) way to gain a foothold in a country.

Emerging-market firms may also want to limit their exposure to their lively but often brittle home market. Growth in the rich world may be slow but the investment climate is often warmer. There are better regulations; the tax laws are easier to live with; the courts are less capricious.

Brands are a consideration too. Building a brand can take years and pots of money; buying an established one is often cheaper. Acquiring a rich-world company can also be a quick way to get hold of technology as well as the tacit know-how that comes with operating a firm in mature markets.

Moreover, a corporate presence in the rich world offers access to cheaper and more reliable financing. Corporate bond markets in places like China and India are still underdeveloped, so a big, globally financed M&A deal paves the way for future capital-raising.

MY COMMENT: As I stated last week, I’m not convinced these investments will succeed, as these kinds of acquisitions are especially difficult. Given that they’ve been fueled by an abundance of foreign exchange reserves, in addition to the typical acquisition integration problems that these firms will face, questions could (and should) be raised about the prices at which they have been executed. Nevertheless, as I mentioned last week, the trend is not only interesting, but also worth monitoring.

Although I’ve highlighted only two of the articles in the Special Report, I’d encourage you to take a look at the entire set. They’re worth the read!

A recent NY Times article highlights how U.S. financial firms have been expanding into emerging markets in an effort to boost profits in the face of weaker U.S. earnings and rising regulatory costs (see Emerging Markets Offer Banks Profits, but Headaches Too).

Banks like Citigroup, Goldman Sachs and Morgan Stanley are chasing the potential payoff abroad. The economies of countries like China, India and Brazil are growing faster than that of the United States. Such places also represent an untapped client base, with a growing middle class and a large number of wealthy individuals.

As profits wane on the home front, Wall Street firms are increasingly dependent on the emerging markets to bolster their bottom lines…But the perils can be plentiful, with economic, political and regulatory challenges.

…it can [often] take years if not decades to build up local relationships and understand the country’s customs.

Looking to emerging markets for growth is nothing new. And as I’ve mentioned before, although emerging markets hold tremendous promise, they also bring incredible risk. In addition to the economic, political and regulatory risks companies face in emerging markets, there are also cultural risks (see So You Want to Do Business in a Developing Market).

As I wrote several years ago:

There are many compelling reasons that companies look to developing countries for growth. Less-developed countries hold the promise of large, fast-growing consumer markets (e.g., the BRICs); an abundance of cheap labor; and access to otherwise unavailable natural resources. Managers are often lured by this unbridled potential.

But there is a reason these countries are considered “developing” – largely because of the under-developed state of their institutional environments…

Although developing markets hold jaw-dropping potential, it often remains just that. Realizing potential from developing markets is incredibly challenging. Companies often find that the institutional (cultural, political, and economic) environments in the developing markets they enter…are so vastly different from anything that they encounter in their own domestic market (or even in other developed markets) that the costs involved in navigating them exceed even their most conservative estimates.

The bottom line: Decisions to enter emerging markets should not be taken lightly…

A recent business week article highlights the release of Amazon’s new tablet, the Kindle Fire, and Amazon’s novel approach to capturing profits from its new product (see Amazon the Company That Ate the World, ht Brett).

The article centers on how Amazon focuses less on extracting profits from the sale of the hardware (like Apple) in an attempt to capture profits from sales of complementary content.

Amazon sees the product as an opportunity to direct customers to its world of “content, commerce, and cloud computing.” Apple, by contrast, attempts to capture a majority of its profits from the sale of hardware – pricing the hardware high with third-party content providers appropriating much of the value of the sale of content.

Amazon has priced the Kindle Fire at $199, nearly half the cost of the cheapest iPad. While the Fire lacks some of the functionality of the iPad – think 3G connectivity and video chat – it claims to provide an easy to use interface that ties directly to Amazon’s content.

According to the article:

The stripped-down Fire is more of a sit-back-on-the-sofa-and-shop device. It crystallizes the difference between Apple, which tends to keep prices (and profit margins) high, and Amazon, which likes to start low and drive lower in an effort to knee-cap the competition. The tablet is symbolic of Amazon’s remarkable ability to adapt and reluctance to cede the future to anyone. If the Fire and its inevitable sequels are successful, they will add even more might to one of the fastest-growing retail operations the world has ever seen.

The Kindle Fire is designed to ensure that…purchases go to Amazon. The company has built a tablet-optimized shopping application, with simplified and streamlined pages but none of the clutter of the main website.

Analysts speculating on the new device widely pegged the Kindle Fire at $250 to $300…[but Amazon CEO Jeff] Bezos is able to go lower because he can make his profit on media content and with additional subscriptions to Amazon Prime—which then will drive additional purchases of toys, toasters, diapers, etc.

What I find most interesting about Amazon’s approach to the tablet space is its attempt to flip the business model on its head – making money from the content rather than the hardware. With the remarkable hardware price point afforded by its novel business model, the Amazon Fire represents, to date, the most credible threat to Apple’s dominance of the tablet space. Time will tell whether Amazon can make inroads in its attempt to challenge Apple head-to-head…

A recent NY Times article highlights an increasing trend: emerging market firms expanding into developed markets. Although the trend reflects a broader emerging market phenomena, the Times article focuses in particular on the global expansion of Indian companies (see With Growing Confidence, India Pursues Mergers Abroad).

Recent Indian deals include auto maker Mahindra buying South Korean SUV maker Ssangyong Motor and energy and gas conglomerate Essar buying an oil refinery from Shell. These follow Tata’s widely-publicized acquisitions of Corus Steel and Jaguar Land Rover.

In addition to the typical motivations for foreign expansion including market access and/or access to basic resources, firms from emerging markets often expand in an effort to tap into, and assimilate, state of the art technologies available in developed markets.

According to the article:

Long kept away from the rest of the world by protectionist government policies, Indian companies are increasingly going global. In the last 18 months, Indian companies spent $28.4 billion on outbound mergers and acquisitions, a little more than the $26.4 billion that foreign companies spent on Indian deals

“As Indian companies move into more frontline products, they need specialized technology,” said Rajiv Kumar, secretary general of the Federation of Indian Chambers of Commerce in New Delhi. “They are also seeking market access. And third, they are buying natural resources.”

As I have written in the past, I am generally skeptical of these kinds of moves, as effectively integrating advanced technological knowledge is challenging. Closing the skills gap with advanced countries is no easy task (see Technological Ascendancy). Not only that, but in many of these deals, emerging market firms often overpay for the assets of struggling developed market firms (see Chinese Acquisitions in the Auto Industry, Tata and JLR I, Tata and JLR II, Tata and JLR III, Tata and JLR IIII).

That notwithstanding, it is certainly a trend worth monitoring…