Gaynor: Rocky road to success in Australia

By BRIAN GAYNOR

Over the past 20 years many of our corporations have come badly unstuck in Australia, and in recent weeks Air New Zealand, Telecom, Tourism Holdings and The Warehouse, among others, have had bad tidings to report from across the Tasman.

These announcements have affected shareholder wealth and adversely affect our current account deficit because the dividend-flows from Australia are less than the cost of paying for these operations.

The core question of why New Zealand companies perform so badly across the Tasman is not easy to answer, but it comes down to several issues, particularly entry strategies and management structures.

A good way to answer the question is to look at three retail companies that have adopted different approaches towards the Australian market: The Warehouse (acquisition), Hallenstein Glasson (internal growth) and Michael Hill International (internal growth).

As a starting point, acquisitions are more risky than internal growth but offer greater potential returns. As Air New Zealand shareholders know, the bigger the acquisition, the riskier the transaction.

In theory, an acquisition should be made only if it offers a higher return than alternative strategies.

To succeed, it must meet the performance target investors already expect from the acquiring company. As a premium price is usually paid, the acquisition must achieve an even higher target implied by this premium.

In other words, if investors expect a high growth rate from The Warehouse and it pays a premium for a new acquisition, then these new assets will have to perform at least as well as The Warehouse if the discount retailer is to maintain its sharemarket rating.

Not surprisingly, a number of studies in the United States have shown that acquisition strategies have been relatively unsuccessful. A report by McKinsey & Co concluded that 61 per cent of acquisitions failed because insufficient returns were achieved on money invested.

A Boston Consulting Group report found that, during the pre-acquisition stage, eight of 10 companies had developed no firm plans to integrate the activities of the acquired company after the transaction.

One of the biggest problems resulting from an unsuccessful acquisition is that money and other resources are often poured into the new assets to the detriment of the acquiring company.

But many acquisition strategies work. Several great United States companies, including General Electric and General Motors, achieved their success through a combination of acquisition and internally generated growth.

Lion Nathan's acquisition strategy in Australia has also been reasonably successful.

The Warehouse entered the Australian market by the acquisition route when, on June 20 last, it announced the purchase of Clints Crazy Bargains (82 stores) and Silly Sollys (33 stores) for $A105 million.

Clints and Sollys were expected to achieve earnings before interest and tax (ebit) of $A15 million for the June 2000 year, and the vendors could earn an extra $A24 million if ebit of $A30 million was achieved in the June 2003 year.

The purchase price was a combination of cash and shares, and The Warehouse said the acquisition would be earnings per share-positive in the July 2001 year, even after goodwill amortisation.

After Clints and Sollys reported ebit of $A17.6 million for the 2000 year, the purchase price was adjusted from $A105 million to $A118 million and the potential bonus payment dropped from $A24 million to $A11 million.

Problems appeared from the beginning. The completion of the transaction was delayed because of several minor issues that remain outstanding, and shareholders were given a cautious outlook for the new Australian operations at November's annual general meeting.

But the big shock came at the end of last week, when the company announced that trading conditions in Australia were very difficult and sales and gross margins are significantly below plan because of unsatisfactory inventory management and other integration issues.

The announcement was an immediate reminder of Whitcoulls' purchase of the Angus & Robertson bookstore chain in Australia in the mid-90s.

This transaction was supposed to produce big returns for New Zealand shareholders but fell well short of expectations. Whitcoulls was eventually acquired by Graeme Hart, who subsequently made a near-disastrous investment in Sydney-based Burns, Philp.

The Warehouse's announcement also raised the questions of whether sufficient due diligence was carried out on Clints and Sollys and if the New Zealand company had the most appropriate management structure in Australia.

Greg Muir was promoted from chief operating officer to chief executive to replace Stephen Tindall on January 31, just a few months after the Australian purchase.

As this was the discount retailer's first acquisition, it may have been more logical for Mr Muir to have gone to Australia for a year or so and come back as chief executive with a first-hand knowledge of the Australian retail market.

The Warehouse models itself on the giant United States discounter Wal-Mart, yet when the Arkansas-based group acquired Kuhns Big K, one of its first major out-of-state acquisitions, several senior executives immediately moved to the Nashville head office of the acquired company.

The Warehouse, like most New Zealand companies, seems to believe that acquisition synergies can be achieved without committing a number of senior executives full-time to the process.

On the positive side, the discount retailer has shown in the past, particularly with its 1994 inventory blowout, that it can quickly resolve serious problems.

It will gain some solace from the Wal-Mart Kuhns Big K acquisition, which transformed the Arkansas group from a caterpillar into a butterfly. Senior executives say this enabled Wal-Mart to become one of the most successful companies in the United States.

Hallenstein Glasson and Michael Hill International, have adopted the internal growth process in Australia. The advantage of this strategy is that it allows the new entrant to test the market with only a small financial exposure, whereas in an acquisition the acquirer must make a large up-front payment just to pass the front gate.

Hallenstein opened its first outlet in Penrith, Sydney, in 1993. The group now has 13 stores across the Tasman, with two more due to open soon. Although no figures have been given, directors say its Australian operations are successful and its Melbourne and Sydney expansions have accelerated over the past 12 months.

Michael Hill opened its first Australian store in Indooroopilly, Brisbane, in 1987 and it now has 71 outlets across the Tasman compared with 40 in New Zealand.

The company has always put a great importance on its overseas activities, and the former head of Australian operations, Mike Parsell, is now group chief executive.

The group's internally generated growth strategy has been very successful, and Australia now makes a much larger contribution than New Zealand.

Based on empirical evidence, companies choosing the internal growth strategy in Australia, including Hallenstein Glasson, Michael Hill and Fisher & Paykel, have been more successful than those adopting the acquisition route.

Although it is difficult to pinpoint the exactly why many New Zealand companies are unsuccessful in Australian, several general observations can be made. These include:

* Too many companies chose the acquisition route instead of a lower-risk internal growth strategy

* Purchase prices are too high

* Due diligence investigations are inadequate

* Acquiring companies do not commit enough senior executives on a full-time basis to the integration process.

Combinations of these factors are the main reasons why Air New Zealand, The Warehouse and other New Zealand companies are now experiencing problems across the Tasman.* Disclosure of interest: Brian Gaynor is a shareholder in The Warehouse.*

bgaynor@xtra.co.nz