Sunk-Cost Fallacy: MNCs in Venezuelan Socialist Hell

Exciting foreign [currency] escapades await MNCs in Venezuela.

When it comes to all things dealing with "Venezuela" and "business," the correct advice since Hugo Chavez gained power was to hit the road. Get on the A320 and never look back. Apparently, some folks did not heed this commonsense advice for a country in the process of Zimbabwe-fication. While energy companies at least had the excuse of having potentially bountiful sources for energy reserves in sticking around, there were not any country-specific resources many others had.

These include all sorts of US-based consumer goods manufacturers who have persisted in staying in Venezuela. Having substantial plant, property and equipment, they could not readily see beyond the "sunk-cost fallacy" or "Concorde effect" which goes like this: Even if Venezuela turns into an even worse socialist hellhole day after day, we have invested so much money over the years here that we must persist in operating in this `@#$>;!? socialist hellhole." The end result is that the value of the assets of MNCs in Venezuela have to be significantly written down in value to account for the massive depreciation of the local currency.

Earlier on I discussed the incomprehensible Venezuelan foreign exchange system which had four tiers at the time. The trouble is that most American firms have not fully accounted for their foreign exchange losses yet:

At least 40 major U.S. companies have substantial exposure to Venezuela’s deepening economic crisis, and could collectively be forced to take billions of dollars of write downs, a Reuters analysis shows. The companies, all members of the S and P 500 and including some of the biggest names in Corporate America such as autos giant General Motors and drug maker Merck & Co Inc, together carry at least $11 billion of monetary assets in the Venezuelan currency, the bolivar, on their books.

The official rate is at 6.3 bolivars to the dollar and there are two other rates in the government system – known as SICAD 1 and SICAD 2 – at about 12 and 50. The black market rate, though, was at about 190 bolivars to the dollar on Sunday, according to the website dolartoday.com. The problem is that the dollar value of the assets as disclosed in many of the companies' accounts is based on either the rates at 6.3 or 12 and only a limited number of transactions are allowed at those rates. The assets would be worth a lot fewer dollars at the 50 rate in the government system and the dollar value would almost be wiped out at the black market rate.

Needless to say, the Venezuelan socialist government would rather die before giving Yanqui capitalists a dollar per 6.3 bolivars if they decide to flee Venezuela at this late a date. How do you practice mark-to-market accounting for Venezuelan operations? This is at least as intriguing as the notion of stabilizing the country formerly known as Ukraine using emergency IMF lending while it is being torn apart by civil war. The one most accurate is the black market rate of (gulp) 190 to the dollar, but that probably won't satisfy any accounting conventions. The end result is that MNCs cannot accurately reflect their foreign exchange losses just yet. That said, their losses even at 12 or 50 bolivars to the dollar are already substantial:

Diaper and tissue maker Kimberly-Clark Corp recently announced a charge of $462 million for its Venezuelan business, leading to a fourth-quarter loss for the company, after it concluded that the appropriate exchange rate was the SICAD 2 exchange rate at 50 rather than the 6.3 it had previously used.

Using the stronger exchange rates is unrealistic because of how hard it is to repatriate profits earned in Venezuela back to the United States at any rate, let alone those rates, securities analysts say. Citigroup Inc (C.N) says it has not been able to buy U.S. dollars from the Venezuelan government since 2008...

Ford Motor Co (F.N) and oil services company Schlumberger NV (SLB.N)  took big-ticket hits to their quarterly profits because of their Venezuelan operations. Ford took a fourth-quarter charge of $800 million and Schlumberger $472 million. A Ford spokeswoman said that it still values its Venezuela assets at about 12 bolivars per US dollar. But for Ford, the currency system and other conditions are so tough in the South American country that it has made an accounting change that will allow it to ring fence its Venezuela business so that it doesn’t have a direct impact on the company’s operating results. 

Schlumberger, which previously used the 6.3 rate, said it is now using the SICAD 2 rate of 50 as it "best represents the economics of Schlumberger’s business activity in Venezuela." Another S&P 500 company to switch to the 50 rate from 6.3 in recent weeks was industrial gases producer Praxair Inc (PX.N), which took a fourth-quarter charge of $131 million as a result. It also said the switch will hurt its revenue and earnings in 2015

These firms should have taken Carole King's advice a long, long time ago. Something has indeed died inside of Venezuela. It's called sanity.