Is Your Overseas Subsidiary a Cash Cow?

Healthy overseas units can be a good source of capital for distressed parents, a turnaround expert says.

When executives at U.S.-based, middle-market companies decide to expand into international markets, management’s aim is usually to set up manufacturing and distribution facilities closer to burgeoning economies. What many managers may not realize, however, is that they also may be constructing a cash lifeline for their domestic operation, says Mark Podgainy, a director with turnaround specialist Getzler Henrich.

Indeed, when middle-market companies become financially distressed, managers tend to look inward and focus on troublesome issues within the domestic operations. They often ignore foreign subsidiaries, leaving their oversight to country or business unit managers. But healthy overseas subsidiaries can be a good source of cash for distressed parents, Podgainy told CFO.com. To transform a subsidiary into a cash cow, however, executives have to do their homework.

These days, in global hot spots like China, India, Argentina, and Brazil, corporate cash returns are generally higher than they are in the United States, says Podgainy. One explanation for the high cash generation is the high gross domestic product growth rate in those countries.

For example, the World Bank reports that by the end of 2007, the GDP growth rate in the United States will remain flat at 1.9 percent. Meanwhile, China’s GDP rate will hit 9.6 percent, while GDP growth in India and Argentina will register 8.4 percent and 7.5 percent, respectively, by the end of the year.

And while Podgainy admits that it’s tempting to think about boosting a sputtering company by siphoning off cash from a foreign subsidiary, the parent must first determine if the cross-border arbitrage makes financial sense to the organization as a whole.

The management team has to consider, for example, if the subsidiary must reinvest the cash to stay competitive; whether repatriation taxes negate the benefit of a cash transfer; if a cash transfer is cheaper than borrowing domestically; and what kind of currency risk is involved in the transfer.

If the arbitrage economics are favorable, there are several ways to pull out cash from an overseas subsidiary. Each has its shortcomings, however. For instance, the subsidiary could distribute a dividend to the parent. But some countries disallow repatriation of funds via a dividend or mandate stacks of documentation to set up a private dividend. In fact, China does not allow money to flow out of the country until it completes an annual audit, added Podgainy.

A parent also might charge the subsidiary a regular management fee. But some countries, particularly China, frown upon that practice. And although a loan agreement could be set up between the subsidiary and parent to extract cash, the parent might run into trouble with its domestic lenders.

Some commercial lenders include credit-agreement restrictions that limit a U.S. company’s borrowing activity to domestic funds. The reason: The lender may have no rights, or access, to overseas collateral should the parent default on its domestic loan payments. The Chinese government imposes currency conversion restrictions on money flowing out of the country that disallow inter-company loans in anything by local currency. That means if the exchange rate doesn’t benefit the parent, the loan may be too expensive.

A U.S. parent might also want to consider reworking a subsidiary’s back office as a way of extracting cash. Consider a U.S. product maker that has a distribution center in India. The overseas subsidiary incurs an outstanding debt to the parent for the products it distributes. By tightening the accounts payable terms, like the parent might do with a unrelated distributor, the parent would be able to decrease the days sales outstanding of its subsidiary, and increase the rate of cash flows into the U.S. company, explained Podgainy.

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