By Shaun Read
An edited version of this article was published for Subscribers of Finance Week on 29 March 2021
“Here be dragons” is a warning found on ancient maps demonstrating the dangers awaiting voyagers who dared venture beyond the limits of the known world. Today there are a number of South African companies that can attest to the perils awaiting those that venture beyond our borders into unknown territories. Woolworths, Brait, Standard Bank, Old Mutual, Sasol, Shoprite Checkers, Famous Brands, Life Healthcare, Netcare, Ascendis, Truworths, the list goes on. Some estimates suggest that a total of R300 billion of shareholder value has been lost in failed offshore ventures in recent years.
Why has the much vaunted corporate South Africa fared so badly in their offshore forays? The reasons are probably as diverse as the companies that ventured offshore. But if history has taught us anything, it is that it tends to repeat itself. Those that survive the Covid 19 pandemic are likely to feel bullet proof and to once again hunt down offshore assets. So what “red flags” should investors be on the lookout for the next time around?
Big fish small pond
Many offshore acquisitions are motivated by the fact that companies have outgrown their South African market. This is in part due to South Africa’s competition authorities, which actively seek to limit concentration in the market and deem a firm to be dominant once they have reached a 35% market share. Whilst avoiding market dominance is a noble endeavour, it simply ignores that South Africa is too small a market to support multiple competitors in every industry. As a result, companies are that feel they have exhausted their growth potential in South Africa are likely to look to offshore territories. The secondary result is that much needed investment in South Africa is diverted into offshore territories and is often wasted there. If your company has become too big for its boots in South Africa, be careful that it does not end up barefoot when it ventures offshore.
The SAB Effect
Undoubtedly the most successful offshore foray by a South African company was that undertaken by South African Breweries (although AB Inbev may now beg to differ). As a result, many companies have tried to replicate this success. However, many have forgotten that SAB entered in to a global beer market which was very fragmented and ripe for the plucking. Aside from this, the Rand/Dollar exchange rate was considerably better than in recent years. It must also be remembered that many other early adopters such as Pick n Pay (who purchased Franklins in Australia 2001) and Old Mutual (who moved their primary listing to the UK in 1999), were less successful and have returned home licking their wounds.
Beware the “transformational” deal
Offshore transactions are often sold to shareholders as being “transformational” and that they will move the company to the next level. This hype often creates its own dangers and may result in confirmation bias on the part of management. Having committed the company to a grand plan, often after incurring significant transaction costs, executives are tempted to look for the positives that re-enforce their decision and ignore the danger signals.
“If I can make it here, I can make it anywhere”
Closely linked to confirmation bias is “overconfidence bias”. Buoyed by success at home, coupled with the c-suite’s “we can do it” attitude, executives often overestimate their ability to create value in offshore territories and/or to replicate the success they had at home.
However, assuming that foreign markets are the same as local markets is a big mistake. What works at home may not work in offshore territories.
Nando’s initial foray into the UK market sought to replicate the fast food takeaway format that enjoyed success back home. It soon found out that the UK market preferred the fast dining options and now 80% of its food served in the UK is on an eat-in basis.
Australia is another example of where South African companies have failed miserably. The assumption is that because we are on the same latitude, share a common language and play the same sport, we must like the same things. Many who make this mistake have ended up buried in David Jones’ Locker (did I spell that correctly?).
Beggars can’t be choosers
The hunt for first world currency revenue is a constant justification for companies looking to move offshore. The problem is that the Rand does not go a long way in a world where the trillion dollar market capitalisation of Apple is 15 times the annual budget of South Africa.
The net result is twofold. Firstly the universe of affordable offshore assets is limited and many of these are affordable only because they have been though the hands of 3 or 4 previous buyers who have long squeezed the juice out of the asset before we “SAfers” came along. The result is that the acquired offshore assets often lack resilience and are vulnerable to any negative change in market conditions. Take your pick of any acquired UK high street retail or restaurant assets .
Secondly, many companies have to incur debt and/or hock the family jewels in order to make an offshore acquisition of any significance. Often debt takes the form of a Euro or Dollar based bond issue. Given that South Africa’s sovereign rating (currently “junk”) has been on a steady downward trends since 2007, in order to make these bond attractive to overseas investors, bond yields are often set at junk bond rates. These debt instruments have to be serviced and eventually redeemed in foreign currency. Any dip in performance of the offshore assets or significant move in the Rand makes redemption of these bonds unaffordable.
Fresh off the boat
We forget that South African companies have only been able to openly access the global stage for the past 25 years or so. For many, their offshore venture was their first, and some cases their last. In contrast, their counterparts in Europe and elsewhere have been merging and acquiring (in its modern form) for decades longer. In the case of Europe and the UK, the intrigue and treachery that we have only read about in history books is hard wired into their DNA. It is no wonder that when we step off the proverbial boat, we fall victim to their charms, flattery, fancy restaurants and then buy the rubbish that we sometimes do.
The panic buy
Much like the inexplicable rush to buy toilet paper during lockdown, companies often panic buy offshore assets when they see their competitors doing so. Alternatively, having announced global expansion plans or under pressure to use lazy capital on their balance sheets, companies grab at the first opportunity that presents itself. Often these assets are at the tail end of their industry life or part of a fashionable wave that is not sustainable.
Beware advisors bearing gifts
Many of the failed offshore transactions were not sourced by executive teams but rather were introduced to the company by advisors and bankers, whose sole interest is to secure a commission or a debt mandate. Having swanned around with management in five star hotels and business class, these advisors and banks are no-where to be found when the paw-paw hits the fan. As the saying goes: “Victory has many fathers. Defeat is an orphan”.
When those advisors suggest your company needs a new look, perhaps make part of their fee payable in 3 years’ time. You will soon see how much faith they have in what they are selling.
Relocation, relocation, relocation
As cynical as it seems, some offshore forays may be motivated by the executive management team looking to relocate to foreign climes. The cost of doing so is much reduced if you can do so on the back of the company’s resources. Typically this is signaled by the executive team advising the need to relocate to “integrate the acquisition” or to base themselves offshore to “implement the global expansion”. This is often followed smartly by increases in salary to compensate for the higher cost of living, housing and education in these offshore territories. Later resignations “to pursue their own interests” are often timed to coincide with the minimum time to acquire rights of foreign residence or citizenship.
Devil is in the details
Many offshore transactions fail for operational reasons, which are often overlooked in the rush to do a transaction. This is due in part to the fact that executives fail to “walk the fields” and have only ever visited the head office or the flagship store of the business they are acquiring. Buying an assets from the top down instead of the bottom up is likely to end in disaster. Understanding the customer experience of the business you are buying is just as important as understanding the balance sheet.
The need for the Devil’s Advocate
An antiquated warning of danger is perhaps best addressed by another antiquated concept: the Devil’s Advocate. Created by the Catholic Church, the role of the Devil’s Advocate was to argue against the canonization of persons identified for saint hood by the church. If the candidate survived the skepticism of the Devils’ Advocate, the path to sainthood followed.
In theory, this Devils’ Advocate role in a transaction should be performed by the independent non-executive directors. However, clearly they are failing in their task having regard to the number of high profile failed transactions. The situation is not helped by that fact that many professional non-executive directors are “over boarded” and serve on too many boards for them to be able properly apply their minds to the details of a transaction. Again, who want to be seen to be torpedoing a “transformational” transaction.
Companies seeking to embark upon “transformational” or “bet the farm” transactions would be wise to establish a separate and independent set of advisors whose sole task is to poke holes in the intended transaction. This concepts already exists in limited circumstances where a fairness opinion is required from an independent party, but extends only to the financial effects of the transaction and not other aspects, such as operational issues. Whilst some may argue against the cost of the Devil’s Advocate concept, there will be many companies contemplating how much pain and suffering this new look approach may have saved them in the long run.
Meanwhile the overseas sellers are rubbing their hands in glee and “throwing another gourmet burger on the barbie” waiting for the next lot of South Africans to come calling.