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Smurfit Kappa – another victim of the revolution

Smurfit Kappa – another victim of the revolution
September 4, 2018
Smurfit Kappa – another victim of the revolution

That trade-off came to the fore last week, when it was reported that the Venezuelan state had seized a paper mill from Smurfit Kappa (SKG), on accusations that the FTSE 100 packager had been engaged in price speculation and destabilising the economy. Pending further inspection, the business of Smurfit Kappa Carton de Venezuela (SKCV) will be under government control for a 90-day period, although management pointed out that the subsidiary accounted for less than 1 per cent of group cash profits at the half-year mark.

You’re left wondering what SKCV did to destabilise the Venezuelan economy, at least beyond the Marxist policies put in place by President Nicolas Maduro and his predecessor Hugo Chavez. But the issue helps to explain why assessing the required rate of return for emerging markets can be a challenge. The return simply equates to the sum of the risk-free rate and the risk premium, but the latter measure needs to be at an adequate level to motivate investors to undertake any given investment. Managers of emerging markets funds routinely assess country-specific risk as a primary component when estimating the cost of capital for investments, although presumably investors are going to need a little more motivation where Venezuela is concerned.

Admittedly, Smurfit Kappa isn’t likely to cry scapegoating on the issue. After all, it’s in pretty good company. In 2017, General Motors announced its departure from the country after it had ceased operations following the Venezuelan government's seizure of the auto giant’s assembly plant. And in May this year, it was joined by US cereal maker Kellogg Co, which has struggled under the twin burdens of hyperinflation and strict price controls.

Venezuela was once among the most lucrative markets in Latin America for foreign businesses, and at the turn of the millennium it was the wealthiest country in the region. But since growth peaked in 2012, its economic output has shrunk by a third and is forecast to contract by another 15 per cent this year. There isn’t enough space here to recount the reasons why the country now finds itself in economic freefall, but over-dependence on a single revenue stream is at the heart of matters – oil revenues account for at least 90 per cent of export earnings. And the state has expropriated vast swathes of the private sector, while providing state subsidies across a range of goods and services, the combination of which has reduced business incentives and increased reliance on imports. Disastrously, this also applies to basic foodstuffs, as failed government agricultural reforms have meant that domestic production of rice, corn and coffee has declined by at least 60 per cent over the past decade.

Venezuela stands as a rather extreme example of country-specific risk, and you would think that the virtual collapse of the Latin American economy would serve as a reminder to politicians about the dangers of excessive government intervention – but evidence suggests otherwise.

Leaving aside Jeremy Corbyn’s plans for the UK economy, it seems almost perverse that a US Senator has introduced a federal bill which, if passed through Congress, would require every US business with revenues of $1bn (£780m) or more to obtain a federal charter of corporate citizenship.

The proposed legislation, the Accountable Capitalism Act, nominally designed to improve corporate governance standards, distinguishes the rights of individuals from those of corporations, thereby compelling the latter to consider the interests of all relevant stakeholders, including shareholders, workers, suppliers, and the community at large. It contains measures likely to garner widespread support, including more stringent conditions attached to director incentives, along with the right of workers to elect 40 per cent of the board members of a given company. Essentially, though, it’s about eliminating incentives that have resulted in increased distributions and capital returns in the US over the past 30 years or so.