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Big International Fish In Shallow U.S. Waters

We've all been trained to think globally. And it's a good thing, too: Geographically diversifying an equity portfolio, over time, will dampen risk while enhancing returns. This has held true even in this year's market. Of the 24 major foreign exchanges tracked by Morgan Stanley Capital International, two-thirds have outperformed U.S. exchanges, thanks to slightly better performing stocks and the double-digit

We've all been trained to think globally. And it's a good thing, too: Geographically diversifying an equity portfolio, over time, will dampen risk while enhancing returns. This has held true even in this year's market. Of the 24 major foreign exchanges tracked by Morgan Stanley Capital International, two-thirds have outperformed U.S. exchanges, thanks to slightly better performing stocks and the double-digit slide in the dollar. While U.S. equities are off more than 21 percent year to date (through December 5), Swiss stocks, for example, are down less than 11 percent in dollar terms, Australian stocks are down just 2.7 percent and Austrian shares actually have gained more than 6 percent.

In short, going foreign pays. That said, the challenge is finding the right investment and avoiding — or at least reducing — excessive transaction costs in the process. It's true that the easiest way to gain foreign exposure is buying American Depositary Receipts. Indeed, some 600 industry leaders, based all over the world, have securities listed on major U.S. stock exchanges.

But what might be less well known is that 1,500 foreign stocks trade over the counter through the OTC Bulletin Board and Pink Sheets. And these issues might get a boost from Sarbanes-Oxley. Broker-dealers negotiate the trades of generally less liquid, more speculative securities directly with one another over computer networks and by phone. OTC stocks, of course, generally do not meet the listing requirements (such as minimum net worth) of the Nasdaq or other exchanges, but OTC activities nevertheless are monitored by the NASD.

The bulk of foreign OTC-traded companies are indeed rather obscure. However, the largest 20 are household names in the United States. U.S. investors can take advantage of access to shares that most have assumed were available only abroad and in local currency. These names include the Swiss confectioner giant Nestlé, the famous Dutch brewer Heineken and the Japanese electronic game maker Nintendo.

Yet many foreign companies don't surface on most brokers' radar screens because they are considered, well, foreign. But that bias isn't necessarily well founded. International accounting and reporting standards are by no means materially inferior to our Generally Accepted Accounting Principles (GAAP), which provided little protection for investors from the likes of Enron and WorldCom.

Besides, where a company is domiciled matters less than ever before. Which company is making money, has the better product and is likely to sustain and expand profitability ideally are more essential investment considerations than where a firm's headquarters are. And perusing ADRs, especially those hidden in the OTC market, is a good way to uncover overlooked opportunities, especially now that doubts have been raised about the financial integrity of a number of U.S. companies.

Many advisors are already comfortable with such listed ADRs as consumer products giant Unilever and banking behemoth HSBC, both of which trade on the NYSE. Buying OTC-traded ADRs, however, requires overcoming a bias that goes beyond the xenophobic. U.S. shares that trade over the counter also suffer from a sometimes-deserved image problem.

This is by no means the case, however, for many foreign stocks that come to trade OTC. “These firms are looking for a presence in the U.S., but are not currently interested in gaining a formal listing because of the resources needed to effectively list on the NYSE or Nasdaq,” says Paolo Munafó, a London-based ADR analyst for JP Morgan. Those costs include converting financial statements into U.S. GAAP standards and aggressively marketing the stock.

Companies such as German carmaker Volkswagen and French cosmetics company L'Oreal did not issue their ADRs to raise new capital. Such a move would have required expensive roadshows, new financial statements and cultivating extensive media and analyst interest. Their OTC-traded shares simply represent shares issued in the home country that sit in trust and are made available to American investors. Companies issue them because it enhances their status to be part of the U.S. equity market and broadens their investor base.

OVER THE COUNTER SURPRISE/Unbeknownst to many investors, these established foreign companies trade on the Pink Sheets in the United States.
Company ADR Ticker Country Industry Recent Price [$] Dividend Yield [%] Market Cap [$B] P/E* 2003 EPS Growth Estimate**
Abbey National ABYNY UK Banking 20.0 7.42 14.6 9.4 13.7
BAA BAAPY UK Transportation 8.38 3.96 8.7 16.3 3.7
BAE Systems BAESY UK Aerospace 10.7 5.12 8.1 14.9 74.4
Cathay Pacific CPCAY HK Airlines 7.1 1.65 4.8 49.4 19.1
Fortis FORSY Netherlands Finance 17.4 3.45 22.9 42.1 19.2
Heineken HINKY Netherlands Beverage 37.6 0.68 14.8 24.7 11.8
Hutchinson Whampoa HUWHY HK Conglomerate 35.0 3.04 29.9 21.5 -12.8
L'Oreal LORLY France Personal Care 14.18 0.49 46.77 35.9 14.9
Marks & Spencer MAKSY UK Retailing 32.5 2.85 12.5 16.8 28.2
Nestlé NSRGY Switzerland Food 50.6 1.62 78.4 16.6 17.0
Nintendo NTDOY Japan Entertainment 13.4 0.92 15.0 20.2 -6.4 ***
Peugeot PEUGY France Automotive 44.9 1.77 11.6 7.1 5.6
Rolls Royce RYCEY UK Automotive 10.0 6.24 3.2 58.8 27.3
Seven-Eleven Japan SVELY Japan Food 31.0 0.65 25.3 37.3 8.5 ***
Volkswagen VLKAY Germany Automotive 8.35 6.69 13.2 4.0 5.1
Walmart de Mexico WMMVY Mexico Retailing 24.05 1.42 10.9 24.9 12.5 ***
Yukos Oil YUKOY Russia Energy 134.0 1.24 20.2 6.3 -1.5
*** JP Morgan 2003 estimates.
**First Call Consensus Estimates
* Trailing 12 months
Source:,, and

Ed Cofrancesco, chief operating officer of INTL Trader, an Orlando, Florida-based market maker, says that the largest companies can use OTC-traded ADRs to offer their U.S. subsidiaries local equity for options and employee stock purchase plans and options without having to go to the trouble of issuing shares in the U.S. “They can also serve as currency for potential U.S. acquisitions,” he adds, “as well an indicator of interest in future U.S. equity or debt offerings.”

For the investor, it can be more efficient to buy foreign shares OTC than to purchase them on foreign exchanges. According to Stephen Saker, senior investment advisor at the Orlando, Florida-based International Asset Advisory, “purchasing the unlisted OTC ADRs of large foreign firms avoids stamp duty taxes, which still exist in major markets, custodial expenses paid to the bank actually holding the shares and the cost of the currency exchange necessary to purchase stock on foreign markets.”

Though many of these firms report on a semi-annual basis, investigating their performance is virtually as easy as appraising a domestic stock. Most large international brokerages have desks in the major markets offering proprietary research on these foreign shares. For those brokers lacking such access, both FirstCall and Multex offer subscription and pay-for-view access to thousands of current reports, along with a wide range of consensus estimates.

Extensive fundamental data are also available at no charge on the Web sites of two of the world's largest depositaries, Bank of New York [] and JP Morgan []. And is a superb place for free one-stop research, offering links to virtually every firm's homepage.

The U.S. government's effort to reduce corporate fraud, which is raising the bar for foreign firms to list in the U.S., could lead more overseas companies to shun the exchanges and possibly opt for the OTC market. On the verge of gaining a NYSE listing, German auto manufacturer Porsche decided against it. And French luxury retailer Louis Vuitton [LVMH], which had been trading on the Nasdaq, recently pulled its listing application.

According to Cofrancesco, these firms have decided to stay away because of their concerns about potential litigation. “Do I believe they had something to hide? Probably not,” he explains. “But many foreigners feel our legal system, besides being costly and time consuming, is often biased against them. And the new threat of criminal liability, brought about through the adoption of Sarbanes-Oxley, is disconcerting.”

The new law could actually prove to be a boon to OTC-traded ADRs. While its reach hasn't been fully defined, many observers feel that Sarbanes-Oxley will not apply to these Level I ADRs since the SEC does not require these issues to meet U.S. GAAP. If this proves to be true, then more foreign companies will have more incentive to use the OTC market, making it even more essential for brokers to know about foreign interests washing up on our shores and into our OTC market.

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