Many AIM companies should be considering international expansion but what should you as an investor be asking those companies heading for the sun?
This article first appeared in Aimzine, www.aimzine.co.uk .
Last month, England’s bid to host the 2018 World Cup was comprehensively rejected by the FIFA selection committee which decided to choose Russia and Qatar to host the 2018 and 2022 competitions respectively. I would love to see the World Cup in England but I don’t think I could have tolerated nearly eight years of build up and hype over what the press will call “52 years of hurt” since the victory in 1966. Just as a pedantic aside, in 2018 it won’t of course be 52 years of hurt because that would imply that we were hurting in 1967 and 1968 and 1969 which of course we weren’t because England were the world champions during those years. The hurt really only started in 1970 but I think that makes the maths too difficult for the mainstream press.
Should we be surprised that England wasn’t chosen? Despite the involvement of the alpha male but cuddly triumvirate of David Cameron, Prince William and David Beckham the overriding factor in FIFA’s decision seems to have been reaching out to markets with growth potential as indeed they did with the first World Cup in Asia in 2002 and the first in Africa in 2010.
So, who can blame them for awarding the competition to Russia, whose increasing strength in the global economy will result in a growing middle-class eager to spend more on leisure activities or Qatar which today at least looks like one of the more stable Middle East economies even if its defence alliance with Iran ought to have raised a few eyebrows at FIFA headquarters in Zurich. As democracy and good governance do not come high on FIFA’s agenda either internally or in its selection process they did not have to resort to selecting duller locations, like England, Belgium or Spain, to host the competition.
As a business decision this looks like one burdened with risk but if FIFA have considered the risks and rewards properly it could turn out to be a lucrative master stroke.
For many companies, it also seems an opportune time to consider overseas markets and the return on capital from investing overseas compared to investing capital in the UK. The slower growth expected in the UK for 2011 due to lower government spending and increased taxes along with historically favourable exchange rates means that there is currently a stick and a carrot for UK companies to consider their capital allocation between the UK and overseas and for those companies which don’t have a strong overseas presence to seriously consider it, assuming of course that they can access capital at all under the ongoing banking constraints and hesitant equity markets.
So during this period it’s worth asking companies you invest in what their plans are for overseas markets.
Having worked in numerous companies with international operations and which expanded overseas either by acquisition or organically, there are a number of questions I ask of companies I invest in or consider investing in. They include;
1. How is the core business performing?
If the core business is not performing well, then any company should deal with those existing issues rather than potentially creating more issues by setting up new operations. You should beware of companies which mention international expansion to potentially mask issues in their core business. Last month, Betfair which only came to the stock exchange in October 2010 at 1,300p has rapidly fallen out of favour to a low of 964p and clearly felt compelled to mention the lure of international expansion in its first results announcement in December.
2. How have various international markets been ranked for targeting?
It’s important for you as a shareholder to know why the company has chosen a particular country over another. Perhaps it is perceived to have lower risk as the company already sells there or has local contacts. There ought to be some clear reason for the choice.
3. How similar are the market dynamics in the new markets compared to existing markets?
Having a successful domestic business is all very well but the factors in other countries may be different so it’s useful to hear from the management team how different those new markets are and what new challenges the company will face and how it will address those.
4. Is it preferable to make an acquisition or set up from scratch, or to go through a local partner and how has this been assessed?
With overseas expansion, a critical factor is to minimise investment and risk, at least in the early stages, until a pilot stage has been successfully negotiated. Seeking a local partner can reduce risk but can also increase complexity and of course will reduce the profits attributable to the company as the local partner will take (at least) their fair share.
5. What are the political, economic and social risks involved in the key markets?
Having the right formula for a successful business is all very well but if the political, economic and social risk turns against the company that success can change very rapidly especially if the overseas expansion has been into a country which doesn’t have an established legal system for business law or if there is extensive corruption and authorities can override normal legal processes.
6. How much capital is being allocated to the overseas expansion and how is it being funded?
For any initiative, the amount of capital required both for investment into assets and also to fund initial losses and working capital is important to know because without this the company cannot quantify its maximum downside. Also as overseas expansion can take some time to become established, the company’s profits may well suffer whilst capital is being invested but producing little return in the early stages. How that capital is funded obviously has an impact on earnings per share and if funded by the issue of equity it can quickly become a drag on the company’s EPS.
7. How long will it take for the business to break even and for cash generation to become positive?
This is applicable for any initiative requiring capital investment but more so for an overseas investment which may take longer and be more difficult to control and therefore have a higher degree of variability from the norm.
8. How will currency exposure be managed?
Although for a company just dipping its toes into international expansion the currency exposure ought to be quite small compared to the company overall, the favourable exchange rates that might give rise to overseas expansion initiatives might well be temporary and soon revert back to the mean. If that happens then the company can soon find that its investment has lost value thereby pushing the breakeven point further out into the future.
9. Who will be responsible for the performance of the overseas expansion?
As an investor you should get comfort that the overseas initiative is being entrusted to someone who has a track record of such activity. In my experience people who have those skills are few and far between as it requires a delicate balance of versatility, pragmatism, stubbornness and diplomacy on top of the usual business skills you’d expect of someone in such a role.
10. Who is the board member responsible for overseeing the initiative and what experience do they and the rest of the board have in international operations?
As mentioned above there is absolutely no substitute for having been there and done it before. An absence of international experience on the board should make you consider the exit as the number of companies who have been brought down by disastrous overseas forays is huge.
It’s highly unlikely you’ll get full answers to all of these questions but it may be that just asking them of the management will make the management team consider issues they hadn’t covered off. And it is my style with companies I invest in, if I don’t get reasonable answers I just keep asking the questions.
Ash Mehta is an independent Finance Director consultant working with a portfolio of growing companies, having recently sold Orchard Growth Partners where he was Founder and CEO. He is also part-time Finance Director of Northbridge Industrial Services plc, an AIM-quoted hire company, and he sits on the Executive Committee of the Quoted Companies Alliance, the representative body for smaller quoted companies. The views expressed are his own and do not necessarily represent the views of those organisations. You can read his blog at www.ashmehta.co.uk and comment on this article by emailing ash@ashmehta.co.uk .
© Ash Mehta
