4194
APRIL 19, 2010

TIMOTHY A. LUEHRMAN
JAMES QUINN

Groupe Ariel S.A.:
Parity Conditions and Cross-Border Valuation
On June 23, 2008, a Monday morning, Arnaud Martin arrived at his office in Groupe Ariel’s corporate headquarters in Mulhouse, France. The previous week, Martin had requested additional financial information about an investment proposal from Ariel-Mexico, a wholly owned subsidiary that operated a manufacturing facility and a regional sales office in Monterrey, Mexico. The information had arrived late Friday—too late for Martin to analyze—and was waiting for him
Monday morning. As a financial analyst for a global manufacturer of printing and imaging equipment, Martin examined many cross-border projects, particularly since Ariel had accelerated its move into emerging markets several years earlier.
The Mexican investment proposal called for the purchase and installation of new automated machinery to recycle and remanufacture toner- and printer cartridges. Cartridge recycling had become an important part of Ariel’s business in many markets and promised continued growth.
Many office product retailers operated formal toner cartridge recycling programs, for both the environmental benefits of keeping materials out of landfills and demonstrated cost savings for their customers. Writing in a leading trade journal, one analyst predicted, “We are going to see more and more refined approaches to recycling and remanufacturing [cartridges] in the coming months and years … Both corporate and individual consumers are becoming habituated to it. They have simply come to expect recycling as an option, even for smaller cartridges at lower price points.”
Ariel-Mexico’s Monterrey plant began its cartridge recycling program in 2005. The plant’s recycling process consisted of a sequence of operations carried out almost entirely by hand, with the help of hand tools and a simple machine. The investment proposal called for replacing this process with new automated machinery from Germany that cost an estimated 3.5 million pesos
(approximately €220,000) fully installed. As described in the project summary, Ariel-Mexico expected to realize substantial savings in labor and materials almost immediately. Though the proposed expenditure was relatively small, Ariel required a discounted cash flow analysis for all such investments in its newer foreign markets and a review by corporate headquarters in Mulhouse.

________________________________________________________________________________________________________________
HBS Professor Timothy A. Luehrman and writer James Quinn prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. This case, though based on real events, is fictionalized, and any resemblance to actual persons or entities is coincidental. There are occasional references to actual companies in the narration.
Copyright © 2010 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

4194 | Groupe Ariel S.A.: Parity Conditions and Cross-Border Valuation

Martin was assigned to perform an analysis of the investment proposal and make an “up or down” recommendation to his superior by Wednesday morning.

Groupe Ariel S.A.
Groupe Ariel was a global manufacturer of printers, copiers, fax machines, and other document production equipment. The company also provided consulting and document outsourcing services, with after-sales service contracts constituting about 18% of overall revenue. Company sales for 2008 were projected to be €3.35 billion, down from 2007 due to a global recession. Operating profit was expected to be €61.2 million in 2008, and the company projected a small net loss for the year.
Exhibit 1 presents selected consolidated financial data for Groupe Ariel.
Ariel’s low profitability was typical of the industry in 2008; all of its competitors were similarly affected by the recession. One bright spot in the company’s outlook, however, was its growth in several emerging markets, including the so-called BRIC economies of Brazil, Russia, India, and
China. Ariel had been a global firm for years, but did not move aggressively into emerging markets until 2003–2004. This was later than some of its competitors. On one hand, this meant Ariel’s market share lagged in some markets. On the other hand, Ariel avoided some of its competitors’ earlier mistakes. The company’s international operations were conducted primarily through a large network of subsidiaries, which operated mostly medium-sized regional factories in which printers, copiers and other products were manufactured to suit local tastes. Ariel conducted business in 28 countries around the world, with operations consisting of manufacturing facilities, small research labs, as well as sales and marketing subsidiaries. In 2008, subsidiaries outside the European Union recorded about half of Ariel’s sales and generated slightly less than 40% of pretax income.
Ariel competed in a relatively mature market, and its chief competitors were both established multinational companies—some of which had developed their consulting and other after-sales services businesses to a higher level than had Ariel—as well as smaller players serving niche markets.
While Ariel marketed and sold its products across the full spectrum of industries, it had enjoyed particular success in financial services, health care, and government sectors.

Operations in Monterrey: Ariel-Mexico
According to Ariel’s CEO Alphonse Helmont, “We were attracted to Mexico for the same reason we built operations in Brazil and other emerging markets. We wanted to diversify our operations and believed we needed to establish a strong presence in places besides Europe and the United
States.” He added: “Certainly there is risk [in these countries], but their economies are dynamic and
Ariel must be present. … You can see our competitors feel the same way!”
A key characteristic of Ariel’s printing and imaging products was their durability, which Ariel’s executives felt conveyed a competitive advantage in emerging economies where Ariel positioned equipment as offering a lower total cost of ownership. In particular, the company’s marketing material claimed a working life 10 months longer than its closest competitor, with 30% lower service costs. CEO Helmont observed: “We demonstrate to our customers that we have a local presence and we are the lowest total-cost provider. This creates loyalty and solid market positions in Mexico and other of our newer markets.”
The manufacturing facility in Monterrey was located near a small research and design facility, also owned by Ariel. While many product specifications for Ariel’s equipment were formulated at the
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Groupe Ariel S.A.: Parity Conditions and Cross-Border Valuation | 4194

corporate offices in Mulhouse, France, it was customary for regional subsidiaries to conduct finetuning research and design activity to tailor the product more closely to local consumers’ preferences.
Thus, it was common for a popular printer or fax machine whose basic design was conceived in
Mulhouse to be “localized” for size, color, weight, and/or range of features by local design staff.
Most of the products produced in the Monterrey plant were sold in Mexico and were distributed through large office-product retailers, department stores, as well as small specialty shops.1
Manufacturing inputs were sourced locally, and virtually all of the plant’s employees were Mexican citizens. In the summer of 2008 gross output at Ariel-Mexico was running at only about 80% of planned capacity. Nevertheless, plant records indicated that there was a sizable increase in demand for recycled printer and toner cartridges. Ariel-Mexico’s Programa de Reciclaje de Cartuchos (“Cartridge
Recycling Program”) was started in 2005 to provide low-cost recycling services to all its distributors and customers. Under the terms of users’ service contracts, when cartridges reached the end of their useful lives, they could be returned to the Ariel facility in exchange for a significant discount on the purchase of a like number of new cartridges. Ariel pledged to recycle and remanufacture all returned toner and printer cartridges. Ariel-Mexico also had voiced its support for political efforts to pass legislation that would mandate recycling of printing cartridges used by most Mexican businesses and government offices. In 2009 the company planned to launch a pilot program to recycle selected competitors’ cartridges.
As the number of cartridges returned for recycling increased, Ariel-Mexico management needed to hire and train more employees to carry out the hole-piercing, drilling, vacuuming, and toner/ink evacuation required to recycle cartridges. “It’s taking more and more of my payroll to handle recycling,” said Ernesto da Silva, the Monterrey plant manager. “We’re happy to see the cartridges coming back in, but the extra volume will become a problem when other operations return to full capacity.” Cost Savings from the Proposed New Equipment
The new equipment could process the Monterrey plant’s projected volume using four employees rather than 10, resulting in savings of both direct labor and training costs. Under very favorable circumstances, only three workers would be required. It would also eliminate some human error, which currently resulted in cracked or damaged cartridges which had to be destroyed rather than reused. The new equipment would occupy significantly less space in Monterrey’s over-crowded plant; this space would be freed up for other productive uses. It also would require only minimal maintenance expenditures compared to the equipment it replaced, and no significant change in working capital. Exhibit 2 compares projected operating data for the existing recycling process and the proposed automated process, assuming future Mexican inflation of 7% per year.
The new equipment would have a useful life of 10 years and would be depreciated under the straight-line method for both tax and financial reporting purposes. Salvage value was likely to equal disposal costs at the end of the useful life. The manual equipment being replaced was very simple and, properly maintained, would last many more years. In June 2008 it had a book value and tax basis of 250,000 pesos and three years of straight-line depreciation remaining. However, its market value was thought to be lower, at about 175,000 pesos. After considering Groupe Ariel’s consolidated tax position, Martin determined that his analysis would use Mexico’s federal corporate tax rate of
35%.
1 Roughly 12% of printing and imaging machinery manufactured in Mexico was exported to the southern United States, where

Ariel had no manufacturing presence.

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4194 | Groupe Ariel S.A.: Parity Conditions and Cross-Border Valuation

Real GDP growth in Mexico was 4.2% in 2004—the year in which Ariel built its Monterrey plant.
By 2006, Mexico’s real GDP had risen 5.1%, but subsequently dropped substantially as global recession arrived. Other macroeconomic data in Mexico, including bond yields, bank lending rates, and the consumer price index exhibited similar patterns in recent years. Exhibit 3 shows selected macroeconomic and financial market data for Mexico.
Martin had yet to decide whether to perform the discounted cash flow analysis in Euros or pesos, or indeed, whether NPV would be affected by the choice of currency. Ariel’s Euro hurdle rate for such a project, if undertaken in France, would be 8%. However, borrowing costs in France and
Mexico were clearly different: French banks’ prime rate for Euro loans was 4.99%, while the rate in
Mexico on short-term peso loans was about 8.10%. Longer-term peso-denominated corporate bonds were yielding 9.21%, compared with long-term Euro-denominated corporate issues at 4.75%. The spot exchange rate on June 23 was MXN15.99/EUR. Many analysts were on record predicting a real depreciation of the peso against both the U.S. dollar and the Euro over the next five years. For example, one international business publication noted “[Mexico’s] rising external financing requirement and the fading impact of the U.S. stimulus package can only increase pressure on
Mexico’s currency.” The article went on to forecast a rise in the MXN/EUR rate to 20.00 by 2011 and upwards of 25.00 in 2013–2018. Selected macroeconomic and financial market data for France are presented in Exhibit 4.

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Groupe Ariel S.A.: Parity Conditions and Cross-Border Valuation | 4194

Exhibit 1 noted) Groupe Ariel S.A.—Selected Consolidated Financial Data (millions of Euros, except as

2008

2007

2006

2005

2004

Sales
Operating income
Net income

3,345.3
61.2
(0.7)

3,561.8
189.2
85.7

3,576.9
172.9
61.2

3,078.9
163.5
88.2

3,050.3
149.9
85.7

Total assets
Total debt
Equity

2,809.3
660.6
782.6

2,764.9
616.0
819.5

2,899.6
613.0
829.7

3,129.0
578.4
941.0

2,445.5
504.2
865.1

87.6
195.0
17.5

100.0
209.4
20.0

95.1
214.0
19.0

240.9
152.9
48.2

234.1
155.0
46.8

Capital expenditures
Depreciation
R&D expenditures
Earnings/share (Euros)
Dividend/share (Euros)
Return on sales
Return on equity (%)

(0.0)
0.7
0.0%
-0.1%

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1.0
0.7
2.4%
10.5%

0.7
0.7
1.7%
7.4%

1.1
0.7
2.9%
9.4%

1.0
0.7
2.8%
9.9%

5

1.1387
2.2484

564,816
1,115,184
1,680,000
3,360,000

496

Materials/unit
Direct labor/ unit

Materials
Direct Labor
Overhead
Total

Unit volume (000s)

1.0932
1.0567

542,223
524,136
1,566,211
2,632,571

496

1.1697
1.1307

638,197
616,909
1,675,846
2,930,951

546

1.2185
2.4057

664,788
1,312,572
1,797,600
3,774,960

546

2010

Projected Operating Costs, New Automatic Equipment

Materials/unit
Direct labor/unit

Materials
Direct Labor
Overhead
Total

Unit volume (000s)

Projected Operating Costs, Manual Process

2009

Tax Rate: 0.35

1.2516
1.2098

751,158
726,101
1,793,155
3,270,414

600

1.3037
2.5741

782,456
1,544,897
1,923,432
4,250,785

600

2011

1.3392
1.2945

884,113
854,621
1,918,676
3,657,410

660

1.3950
2.7543

920,951
1,818,343
2,058,072
4,797,366

660

2012

1.4330
1.3852

946,001
914,445
2,052,983
3,913,429

660

1.4927
2.9471

985,417
1,945,627
2,202,137
5,133,182

660

2013

1.5333
1.4821

1,012,221
978,456
2,196,692
4,187,369

660

1.5971
3.1534

1,054,396
2,081,821
2,356,287
5,492,505

660

2014

1.6406
1.5859

1,083,076
1,046,948
2,350,460
4,480,484

660

1.7089
3.3742

1,128,204
2,227,549
2,521,227
5,876,980

660

2015

Comparison of Projected Operating Data for Different Recycling Processes (thousands of pesos, except as noted)

Assumes 7% Inflation in Mexico

Exhibit 2

1.7554
1.6969

1,158,891
1,120,234
2,514,993
4,794,118

660

1.8286
3.6104

1,207,178
2,383,477
2,697,713
6,288,369

660

2016

1.8783
1.8157

1,240,014
1,198,651
2,691,042
5,129,707

660

1.9566
3.8631

1,291,681
2,550,321
2,886,553
6,728,555

660

2017

2.0098
1.9427

1,326,815
1,282,556
2,879,415
5,488,786

660

2.0935
4.1335

1,382,099
2,728,843
3,088,611
7,199,553

660

2018

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Groupe Ariel S.A.: Parity Conditions and Cross-Border Valuation | 4194

Exhibit 3 Selected Macroeconomic and Financial Market Data for Mexico

Year

Consumer Price
Inflation (%)

2000
2001
2002
2003
2004
2005
2006
2007

9.5%
6.4%
5.0%
4.3%
4.7%
3.3%
4.1%
3.8%

Real Growth
GDP (%)
6.6%
-0.3%
0.9%
1.4%
4.2%
3.2%
5.1%
3.3%

Year-End Spot
Exchange Rate
(MXN/EUR)
9.4
9.5
10.4
12.9
15.3
13.3
14.4
16.2

Source: Mexico Country Reports, Economist Intelligence Unit (EIU)

Date

Short-Term
Bank Lending
Ratea

JP Morgan
Mexico
7-10 Year
Corporate
Bondsb

10-year
Government
Bondsc

7.78%
7.68%
7.50%
7.60%
7.68%
7.82%
7.77%
8.00%
7.94%
8.10%

8.20%
9.35%
8.22%
7.42%
7.50%
7.68%
7.86%
8.17%
7.42%
9.21%

8.47%
9.06%
8.24%
7.42%
7.58%
7.19%
7.82%
8.08%
7.49%
9.12%

31-Mar-06
30-Jun-06
29-Sep-06
29-Dec-06
28-Mar-07
27-Jun-07
26-Sep-07
31-Dec-07
26-Mar-08
23-Jun-08
Sources: a Bank of Mexico

b Thomson Datastream & CEIC c Global Financial Data

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4194 | Groupe Ariel S.A.: Parity Conditions and Cross-Border Valuation

Exhibit 4

Selected Macroeconomic and Financial Market Data for France

Year

Consumer Price
Inflation (%)

Real Growth
GDP (%)

2000
2001
2002
2003
2004
2005
2006
2007

1.7%
1.6%
1.9%
2.1%
2.3%
1.7%
1.7%
1.5%

4.2%
2.1%
1.1%
0.5%
2.3%
1.9%
2.4%
2.3%

Year-End
Exchange Rate
(MXN/EUR)
9.4
9.5
10.4
12.9
15.3
13.3
14.4
16.2

Source: France Country Reports, Economist Intelligence Unit (EIU)

Date

Short-Term
Bank Lending
Ratea

JP Morgan
France
7-10 Year
Corporate
Bondsb

10-year
Government
Bondsc

3.08%
3.27%
3.63%
4.07%
4.42%
4.69%
4.91%
5.13%
4.81%
4.99%

3.73%
4.03%
3.69%
3.96%
4.08%
4.60%
4.36%
4.34%
4.00%
4.75%

3.79%
4.08%
3.72%
3.98%
4.11%
4.62%
4.41%
4.42%
4.11%
4.81%

31-Mar-06
30-Jun-06
30-Sep-06
31-Dec-06
31-Mar-07
30-Jun-07
30-Sep-07
31-Dec-07
31-Mar-08
23-Jun-08
Sources: a Thomson Datastream b Thomson Datastream & CEIC c Global Financial Data

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