| Earlier this week, property development company Lendlease announced that they were ending their ambitions to be a global construction company and were putting $4 billion of international assets, mostly in the United States and the United Kingdom, on the market. Analysis of the accounts showed that international construction generated billions of dollars in revenue, creating a large pipeline of glitzy development in cities like London, New York, and Milan – but delivered consistent losses to shareholders. On a more pleasing note for investors, yesterday at 2 am, BHP abandoned a $75 billion bid for miner Anglo American (for the moment) in what would have been the largest takeover in Australian corporate history. While BHP is likely to come back in six months, this complicated deal would have exposed the Big Australian to significant sovereign risk in Africa with a long tail of assets with minority ownership stakes, all to access three copper mines in South America. The deal was characterised as “BHP is trying to buy a six-bedroom house, just to get the garage”. In this week’s piece, we will not discuss the Lend Lease separation nor the BHP decision to walk away from Anglo-American in detail, as neither will be the first nor the last Australian company to make questionable offshore acquisitions. Instead, we will examine the factors behind the many poor and the very few good offshore acquisitions made by Australian companies. |
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| Why Do Australian Companies Expand Offshore? The main reason behind most offshore acquisitions for Australian companies is to gain access to new pools of customers greater than Australia’s population of 26 million can provide. Additionally, many Australian companies operate in oligopolies or are constrained from growing rapidly – through either price competition or acquiring competitors – by government regulators such as the ACCC (Australian Competition & Consumer Commission). In the banking or grocery industries, neither Commonwealth Bank nor Coles is able to take market share from competitors by dropping prices, as their competitors will immediately match their moves. Westpac can raise wholesale funds to lend to borrowers at roughly the same price as Commonwealth Bank. Similarly, the price at which Woolworths can buy a bottle of Coke or a box of Cornflakes would be identical to the price the manufacturer charges Coles. Any price war would not grow market share but reduce overall industry profitability. A move by BHP to expand their iron ore operations by buying Rio Tinto or Fortescue would likely be blocked by international regulators and fiercely opposed by their customers, who are Chinese government-owned steel mills. Other reasons touted for global expansion include earnings diversification since business or regulatory conditions in certain foreign markets may not align with those in Australia. For example, Sonic Healthcare is not likely to face simultaneous fee pressures in its pathology businesses in the USA, Australia, and Germany. Similarly, demand for Amcor’s food packaging in Europe is not correlated with volumes of PET soft drink bottles sold in the USA. Wrong Move #1: We are Dominant in Australia, so Naturally we Will Dominate the World This is the most common mistaken assumption made by Australian corporates venturing offshore. There is a tendency to assume that the company’s dominance in the high-margin and often lowly competitive home markets will translate to success in the unfamiliar and frequently cut-throat markets of the USA, Europe and Asia. Arguably, this was the rationale that motivated Wesfarmers to purchase the number two player in the UK hardware market in 2016. In Australia, Bunnings dominates the $50-billion hardware sector with a 50% market share and earns the highest profit margins of any global hardware chain. The UK hardware market, however, is highly competitive with low margins. In the case of Bunnings UK, Bunnings sent in trusted Australian executives who replaced the soft furnishings in the acquired hardware stores with large stainless-steel BBQs, power tools, and log splitters that sell in sunny Sydney to consumers with large back gardens. These items surprised UK shoppers entering a Homebase store in Leeds looking for Laura Ashley homewares for their terrace. Over the two and a half years of ownership, this adventure cost Wesfarmers shareholders A$1.7 billion. The eventual sale of Bunnings UK in May 2018 for £1 was actually a good outcome for Wesfarmers; it avoided significant closure costs and associated store lease liabilities. Another example of assuming that strength in Australia will result in success overseas can be seen in IAG’s entry into the UK insurance market after buying the country’s eighth-largest motor insurer. Ultimately, this adventure cost shareholders $1.3 billion, as IAG found the UK insurance market far more competitive than Australia due to the influence of insurance comparison websites that limited the power of long-established brands. In Australia, IAG, Suncorp, and QBE together have a 70% market share and have successfully limited the penetration of new entrants into the motor vehicle insurance industry. Earlier this week, there was talk in the press that QBE was kicking the tyres of UK-based specialist insurer Beazley Plc, which is looking at a $10 billion deal. This move would concern investors with long memories, indeed QBE investors who are finally seeing the benefits in 2024 of the company cleaning up the problems made in its acquisition spree in the early 2000s. In a similar vein, over the last 30 years, NAB, Westpac and ANZ have all made significant and largely unsuccessful ventures offshore. After leaving the 1992 recession in better shape than their peers, NAB acquired banks in Northern England, Ireland and the USA, based on the strategy that their dominance in Australia would translate into other parts of the English-speaking world. Ultimately, NAB was unable to run the dispersed set of financial services businesses from Melbourne, and this adventure cost shareholders billions. However, This adventure would have been costlier had NAB not sold their Irish banks to Denmark’s largest bank just before the GFC. Lend Lease’s offshore expansion clearly falls into this category, with profit margins made in Australian developments a multiple of what the company earned in the USA and Europe despite decades of trying to crack these markets. Wrong Move #2: Cultural Issues While Australian companies make mistakes investing in the supposedly friendly anglosphere of the UK and the USA, making big acquisitions outside these markets has resulted in more headaches for management teams. Leightons‘ adventure in 2007 in the Middle East, in which they paid $870 million to buy a minority stake in Dubai’s Al Habtoor Group in a bid to ramp up growth, ultimately ended poorly for shareholders. The company struggled to negotiate the complex political waters of the Middle East, an environment far tougher than the UK or the USA for Australian companies and had trouble collecting payments on completed construction projects such as an equestrian centre in Qatar. Finally, in early 2020, the company exited the Middle East, potentially hastened by the weeklong imprisonment without a charge in 2016 by their CEO in Dubai due to a complaint from their joint venture partner. In 1993, Fosters entered the Chinese brewing market, buying a majority stake in the Shanghai, Guangdong and Tianjin breweries. While the size of the Chinese market entranced Fosters, local consumers did not warm to the hoppy taste of the Australian beer and preferred cheaper local lagers. After thirteen years of losses, Fosters’ Chinese brewing operations were sold to Japan’s Suntory for a mere $15 million. Wrong Move #3: Let Buy Growth and Try Something New This version of an offshore misstep generally occurs when an Australian corporate with excess cash is presented with an opportunity to grow earnings by investing in a new technology in a foreign market. Typically, this involves buying assets from local players who have a better grasp of what the assets are worth and the pitfalls involved in running the business. A great example of “Let’s try something new” has been BHP’s investments in US onshore shale gas in 2011 and 2012. BHP acquired assets of US$4.75 billion from Chesapeake and paid US$15 billion for Petrohawk. BHP was flush with cash at the time due to a surging iron ore price. However, extracting shale gas in the US is more of a small-scale modular process than BHP’s massive iron-ore and offshore LNG projects. Furthermore, BHP purchased when oil prices were above $100/bl. Wrong Move #4: Sort of Similar to Something We Already Do This mistake is a close cousin of “let’s try something new” in that the acquisition is made in an area close to the company’s core competency and presented to investors as a low-risk form of offshore expansion. Fletcher Building’s purchase of the Cincinnati-based Formica in 2007 for US$700 million from private equity was touted as a logical extension to the company’s decorative surface laminates business. In hindsight, this acquisition was made at the peak of the US housing construction cycle for a business that faced ongoing production issues due to site consolidation. Slater+ Gordon’s acquisition of Qunidell’s professional services division in 2015 for A$1.2 billion also falls into this category of offshore acquisition blunders. This infamous acquisition made Slater+Gordon the UK’s number one personal injury law firm. However, it also added claims management companies, insurers and insurance brokers – businesses somewhat adjacent to the company’s core litigation practice. Arguably, this move helped equity holders lose 99% of the value of their investment in the company as it both burdened the company with too much debt and bought a business without undertaking sufficient due diligence. Shortly after the purchase of Quindell, the UK government announced plans to limit the proceeds from personal injury claims, and Quindell came under investigation for accounting practices that inflated earnings. In late 2023, the packaging company Orora acquired specialty French glass manufacturer Saverglass from American private equity firm Carlyle Group for $2.2 billion. However, within four months of taking the keys to their new manufacturing plant in southern France and the ink still wet on the sale contract, Orora downgraded their expectations for Saverglass earnings by 14%. What was thought to be an acquisition of a manufacturing company for 8x forward EBITDA has turned quickly into buying a company at 15x forward earnings. Orora’s existing glass manufacturing was geared towards making commodity beer and wine bottles in Australia, and the market dynamics for premium and ultra-premium spirit bottles have proved to be quite different. Wrong Move #5: A Bit of Everything No discussion of poor offshore acquisitions would be complete without including Rio Tinto’s 2007 acquisition of Canada’s Alcan for US$38 billion, which manages to tick most boxes of a poor offshore expansion. This acquisition arguably was made to fend off a takeover from BHP and led to Rio acquiring smelters in exotic places such as Iceland (“Sort of similar to something we already do”) and engineered products and packaging (“let’s try something new”). Ultimately, US$30 billion of this acquisition was written off, resulting in a highly dilutive equity issue in 2009. Mistakes Go Both Ways It would, however, be disingenuous not to mention that foreign companies also make comparable mistakes in buying domestic assets at high prices from canny Australians. Japan’s Kirin Breweries and UK’s SAB Miller have written off portions of the Lion Nathan and Foster’s brewing assets, as sales of iconic Australian beers such as Toohey’s and Victoria Bitter have declined with drinkers turning to smaller craft beers. Similarly, Woolworths South Africa is surely cursing the day Australian shareholders accepted their $2.1 billion dollar offer in 2014 for David Jones. Profits at the troubled retailer have declined by 70% over the past six years, and in late 2022, the retailer was sold to private equity for a mere $100 million. Similarly, in 2015, Japan Post paid $8 billion to acquire logistics company Toll, a company it didn’t understand in an industry it lacked expertise in. This troubled acquisition has so far seen $5.5 billion written off its value, and the international global express business sold in 2021 for $6.5 million. A costly attempt for Japan Post to buy growth prior to its IPO resulted in a transfer of wealth from Japanese taxpayers to Australian shareholders. Offshore Acquisitions that Worked It would be wrong to claim that all offshore acquisitions end in tears for Australian investors. A number of Australian companies have made major offshore acquisitions that have driven earnings growth for a number of years and propelled the company into a major global player in their industry. Amcor has leveraged a range of successful acquisitions to become one of the largest manufacturers of flexible packaging and rigid plastics, ironically making their most successful acquisition from Rio Tinto. Similarly, CSL made major acquisitions in 2000 and 2004 in Switzerland and Germany and is now the largest global producer of blood plasma-derived medicines. Computershare has grown through acquisition to become one of the largest global share registry businesses, successfully buying and improving the profitability of various global banks’ unwanted registry businesses. Sonic Healthcare has made 50 acquisitions in Europe and the US over the past 20 years. Sonic’s shareholders have enjoyed rising profits due to doctors requesting greater numbers of tests per patient and being able to run higher volumes through their increasingly automated labs. The company is now the third-largest medical testing company in the world, with significant market positions in Australia, Germany, Switzerland, the UK and the USA. Sonic’s global lab network has processed millions of COVID-19 antibody tests in 2020. The common theme through these successful offshore expansions is that the Australian companies have focused on a particular niche where the Australian company has some form of comparative advantage. This is very different from buying foreign banks, where the Australian company brings no intellectual capital or technology to the table. Also, Australian companies tend to buy one of the weaker listed companies in a competitive market, such as hardware or insurance, as this is seen as “cheaper” and thus more immediately earnings accretive than buying a market leader. |
| Our take Finally ending its adventure into the very competitive American and British property development market, Lend Lease is unlikely to be the last questionable foreign acquisition by Australian corporates. Management teams are incentivised to grow earnings, and large offshore acquisitions with huge potential markets are often presented as a quick way to achieve this goal. Atlas is very wary of companies announcing major offshore acquisitions, as for every successful acquisition, there seem to be several that end in tears. The common theme is excessively optimistic due diligence, which underestimates the level of competition in new foreign markets. Additionally, it is often very difficult to manage a diverse global business across multiple time zones, from a head office in Sydney or Melbourne. |