Aussie buggers

Wednesday 1st August 2001

New Zealand companies have a long history of self-destructing in the "lucky" country

"We're commeeted to New Zeeland," assures Air New Zealand chief Gary Toomey on the TV. Phew, that's a relief. For a horrible moment I thought we might be down to flying on just one airline serving stale kangaroo sandwiches. Competeetion leeves!

That may be good for consumers, but what investors would like to know is how committed Air New Zealand is to Australia. If it is, you've got to wonder why. The corporate near-suicide over the purchase of Ansett Australia continues a long history of New Zealand companies self-destructing in the "lucky" country.

Take this year alone: Air New Zealand/Ansett lost $400 million in market capitalisation. Tourism Holdings/Britz lost $50 million. Mainfreight/K&S Express lost $30 million. In the past 15 years, at least a dozen companies expanding into Australia have been tangled in "train wrecks" involving monumental financial blunders, serious damage to shareholders' wealth and, in some cases, bankruptcies. As the table shows, the train wrecks and minor failures far outstrip the successes - and even those are mostly moderate. At least $3 billion of wealth has been destroyed in Australia alone, before factoring in the misadventures of some of our major corporates in other parts of the world.

Them's the facts ma'am, and little can be done to change them. But let's say you own shares in a Kiwi company that suddenly announces it is making an acquisition across the ditch, transplanting its "winning" New Zealand business formula into the "lucrative" Australian market. What do you do?

A. Buy more shares, these guys have got the right idea
B. Run for the hills
C. Send off a few questions to the company to try and ascertain whether you're looking at a big win or yet another train crash

It's amazing how many investors chose A when history so firmly suggests B. If you choose C there are a few chairman-style phrases that should prick your ears up. In summary, the three big issues are the propensity of New Zealand companies to overpay for acquisitions offshore, their inability to offer anything different when they get over there, and the challenge of operating in a more difficult market. Here's how the chairman might phrase them:

"We're getting it at a good price"

This is a clanger. Many New Zealand companies have been done over by smarter overseas management teams. Mainfreight paid $12 million for K&S Express, which (it now transpires) was losing about $5 million a year at the time of purchase. The previous owners are probably still giggling into their tinnies over that one. Air New Zealand paid over $A1 billion for Ansett, but the real "entry" price will be more than $A4 billion by the time Air New Zealand upgrades the majority of the Ansett fleet over the next three years. This is higher than Ansett's sales; an unprecedented price to pay for an airline, even before taking into account that Ansett has historically been a weak second player with a myriad of operational and management problems.

I blame it on New Zealand universities. New Zealand business people haven't learned how to value cash flows appropriately or to apply enough common sense when predicting such cash flows. Small companies in particular don't have the in-house expertise to value an acquisition properly. If such low-sophistication companies rely on external advisors they will probably still get it wrong - advisors' fees are normally "success"-based (success being mistakenly defined as the deal going ahead), so there is a huge bias in encouraging the acquisition.

Simple due diligence, making sure everything is as it seems, is another area New Zealand companies fall over on. It pays to be cynical when buying a business from your typical Australian businessman who has grown up in a tough world infested by poisonous snakes, crocs and deadly spiders. I suspect Mainfreight has had a far too cavalier attitude to its Australian acquisitions, an attitude that has seen it get a few nasty surprises when overturning rocks after the operations have been taken on board.

There's another reason for shareholders to worry. Management teams always have an innate bias towards wanting to buy new businesses and expand: the bigger the company, the bigger the pay packets. It is up to the board to try to temper this natural bias. Last year famous investor Warren Buffett (in his role as a director) stopped Coca-Cola from buying the company that owned Gatorade. While many criticised this move, shareholders were probably saved from the value-destruction of overpaying. In New Zealand, I doubt many boards have the expertise and guts to turn down major initiatives from management.

"This is a strategic move"

Run a million miles when companies start mumbling about "having to be in Australia for strategic reasons" or "running out of growth in New Zealand".

It is this simple: Those companies that have succeeded in Australia have generally done so because they have a good product (Bendon, Fisher & Paykel, Cavalier) or a good retail format (Michael Hill, Hallensteins) and because they have worked at it gradually, over many years, rather than going for the glory of an acquisition. Many Kiwi companies going to Australia (BNZ, PDL, Owens, Mainfreight, Air New Zealand, Telecom) have really not had much to offer that was hugely different from what was already being done by Australian businesses. All these companies have chased growth, but without any differentiated products or services enabling above-average returns on capital.

New Zealand needs more international companies, but it needs them to be based on innovative products and technology, not on simply buying operations in different parts of the world (as Fletcher Challenge Paper tried to do, to its shareholders' cost).

The chasing of growth for growth's sake opens up two avenues for losing money - first at the point of acquisition (discussed above) and second, from the fact that business is often harder in Australia than many companies realise.

"We've got an excellent management team"

Many companies make the mistake of thinking their good returns in the New Zealand market come from great management teams when, really, it's the result of the cozy local market. New Zealand industries are often very "concentrated"; there are often only two, three or four players. It is easier to make money when you are the market leader, enjoying the advantages of size and power.

The same company might go to Australia and buy a "beachhead", in the form of a company with less than 5% market share, and be up against five or six big, hairy competitors who can afford to throw their pricing weight around in unique market segments. That's not much fun. Ask Mainfreight, which is battling companies such as Toll Holdings, TNT and Brambles. It lost about $10 million in revenue to competitors in its first six months of ownership of K&S Express.

The vendors of many businesses bought by Kiwis probably understood the weaknesses of their operations all too well, but the New Zealand companies conducted due diligence on a sunny day and assumed that the company's historic below-average returns could be increased through their own fantastic management skills. In reality, results often get worse when the Kiwis walk in the door.

Of course, Kiwi companies can try to buy bigger operations in Australia to make life easier but that often involves "betting the farm". Because Australia is five to six times as big as New Zealand, even a company with a 10% market share can be worth a lot more than the existing New Zealand business.

There are many possible pitfalls to run into when a company expands into Australia. Managers and external advisors have an inbuilt bias towards expanding the business, but this might not be in the owners' interests. The shareholders' backstop is the board. In my opinion, not enough of them take the boring route of staying at home, accepting low growth and giving any excess cashflow back to shareholders to invest in growth opportunities themselves.

Minor Failure

Tourism Holdings - Britz	The Warehouse - Silly Solly's
Telecom - AAPT	INL - Gordon & Gotch, Victorian papers
Tranz Rail - Tasmania rail	Owens - various
Fisher & Paykel - factory build	Carter Holt Harvey - packaging
Tasman Agriculture - Van Diemens

Train wreck

Fletchers - Jennings	DB - Austotel
Air NZ - Ansett	PDL - Oliver Nilsen etc
BNZ - bad loans	NZI - bad loans
Chase - various	Robert Jones - developments
Underground - store roll-out	Telecom - Pacific Star
Corporate Inv - property	Equiticorp - various
Mainfreight - various

Success

GPG - various	Carter Holt - tissue, timber
Fernz - Nufarm	Michael Hill - store roll-out
Hallensteins - store roll-out	Nuplex - ACH
Sky Casino - Adelaide Casino	Bendon - direct distribution
Fisher & Paykel - direct distribution	Frucor - direct distribution
Cavalier - direct distribution	Lion - Bond Brewing
Tower -various

Roger Armstrong is an independent financial analyst.

Disclosure: Armstrong owns shares in Fisher & Paykel

Roger Armstrong
finn.ltd@ihug.net.nz

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