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
Sunday, 16 January 2011
Thursday, 16 December 2010
The all new whiter-than-white fund manager
Is Fundsmith a new improved fund manager or just a different packaging?
This article first appeared in Aimzine, www.aimzine.co.uk .
There’s nothing I like better on a Wednesday evening than sitting down with a glass of red wine to watch The Apprentice. It’s so warming on a cold evening to be able to righteously mock the young candidates undertaking tasks when they make mistakes that we probably all made at that age but had the good fortune to not have broadcast on prime time TV.
A recent task that was especially challenging was to create a launch advert for a new cleaning product. It sounds quite mundane but that was the point. How do you inject new ideas into a product category that frankly has been advertised to death for the last fifty years? A product category in which there are few, if any, real improvements and in which enhancements are typically product variations such as tablets rather than powder, or a fresh scent. One of the teams produced a TV advert which impressively, but I assume unintentionally, managed to combine sexism, cheesiness, ritual humiliation and a 1960’s style all into a 30 second piece http://www.bbc.co.uk/programmes/p00c2bs6 . I doubt it could have been any better (or worse, depending on your view) if it had been an intentional parody of a 1960’s advert. Worryingly, that team won, or as the Sugar daddy put it, “The other team lost”.
In the real world, this month saw the launch of another apparently new variation of a long established product. Terry Smith launched Fundsmith; a new fund management company. Like selling cleaning products, it’s difficult to make any truly new claims about a fund manager so it all comes down to marketing and advertising messages and Mr Smith has those in abundance.
Mr Smith says that the fund management industry is congested with fund managers ranging from the mediocre to the bad who trade too often thereby eroding investor returns, and that many fund managers are bloated with high fee levels.
Therefore, the Fundsmith whiter-than-white approach will be to run a fund which will have a unique investment process, a long term view and lower costs.
The investment process is that the fund will select a relatively small number of global stocks, probably 20 to 30, and will hold them for long periods with lower levels of trading than other funds, and hence lower expenses being incurred in the fund. It all sounds quite sensible and you begin to wonder why other funds don’t do the same thing. Well, one reason could be that if as a fund manager you’re not buying and selling stocks it can look as if you’re not doing much work at all. In which case how do you justify your fat fees? Another reason is that you want investment ideas which often come from brokers, but brokers aren’t going to call you if you never trade with them. The flow of broker commissions from fund managers can be an important factor as to which fund managers the broker will call from his list.
Clearly some fund managers have done well by this approach of selecting global stocks for the long term. The obvious example is Warren Buffett who has held stakes in companies such as Coca Cola, American Express and Wells Fargo for many years, through his investment vehicle Berkshire Hathaway which was formed over 40 years ago. So, perhaps the Fundsmith investment process isn’t actually so new or unique.
Fundsmith’s claim to be taking the long term view should also be questioned. No long-only fund manager would claim to run their fund on a short term view, although the old joke that a long-term investment is a short-term investment gone wrong probably applies more often than many fund managers would care to admit. A long term view is possible if a fund or fund manager has a track record of performing over the long term but for a new fund it can be difficult to hold out if performance is poor in the short term because the widespread ability that investors have these days of comparing fund performance through online tools makes the pressure on underperforming funds all the greater.
Finally the advantage of lower costs is an interesting one. There is the benefit of lower trading expenses mentioned above. On top of that Fundsmith is charging 1% to 1.5% as an annual fee but that’s no lower than any other fund manager. Infact some fund managers investing in exchange traded funds charge as little as 0.6%. Fundsmith has no initial fee on investment into the fund but, whilst this always used to be a big drag on returns and was usually around 5%, for some time now it has been handed back to investors when they invest through an online funds website.
So, all in all it’s difficult to see any compelling reason for investing in Fundsmith funds as opposed to any other. At least with cleaning products, you can hold your white sheets up to the sun and see that the gravy and ketchup stains have been dissolved away but anyone investing in Fundsmith does not have anything tangible on which to make the buying decision. Many of course will be swayed by Mr Smith’s decision to put his money where his mouth is, but then some might say that he has plenty of both of those assets to play with. Even so, an investment of £25 million isn’t pin money even to Terry Smith.
As with washing powder, it may claim to be new and improved and it might well be, but frankly it’s quite difficult to tell the difference between two white sheets, and right now it’s even more difficult to tell the difference between Fundsmith and other fund managers. If you like the idea of investing to the Fundsmith tune then you could always use their selection criteria (on their website) to build your own portfolio of 20-30 companies or even better still wait for their investment reports to be published and then buy into those stocks directly
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 .
This article first appeared in Aimzine, www.aimzine.co.uk .
There’s nothing I like better on a Wednesday evening than sitting down with a glass of red wine to watch The Apprentice. It’s so warming on a cold evening to be able to righteously mock the young candidates undertaking tasks when they make mistakes that we probably all made at that age but had the good fortune to not have broadcast on prime time TV.
A recent task that was especially challenging was to create a launch advert for a new cleaning product. It sounds quite mundane but that was the point. How do you inject new ideas into a product category that frankly has been advertised to death for the last fifty years? A product category in which there are few, if any, real improvements and in which enhancements are typically product variations such as tablets rather than powder, or a fresh scent. One of the teams produced a TV advert which impressively, but I assume unintentionally, managed to combine sexism, cheesiness, ritual humiliation and a 1960’s style all into a 30 second piece http://www.bbc.co.uk/programmes/p00c2bs6 . I doubt it could have been any better (or worse, depending on your view) if it had been an intentional parody of a 1960’s advert. Worryingly, that team won, or as the Sugar daddy put it, “The other team lost”.
In the real world, this month saw the launch of another apparently new variation of a long established product. Terry Smith launched Fundsmith; a new fund management company. Like selling cleaning products, it’s difficult to make any truly new claims about a fund manager so it all comes down to marketing and advertising messages and Mr Smith has those in abundance.
Mr Smith says that the fund management industry is congested with fund managers ranging from the mediocre to the bad who trade too often thereby eroding investor returns, and that many fund managers are bloated with high fee levels.
Therefore, the Fundsmith whiter-than-white approach will be to run a fund which will have a unique investment process, a long term view and lower costs.
The investment process is that the fund will select a relatively small number of global stocks, probably 20 to 30, and will hold them for long periods with lower levels of trading than other funds, and hence lower expenses being incurred in the fund. It all sounds quite sensible and you begin to wonder why other funds don’t do the same thing. Well, one reason could be that if as a fund manager you’re not buying and selling stocks it can look as if you’re not doing much work at all. In which case how do you justify your fat fees? Another reason is that you want investment ideas which often come from brokers, but brokers aren’t going to call you if you never trade with them. The flow of broker commissions from fund managers can be an important factor as to which fund managers the broker will call from his list.
Clearly some fund managers have done well by this approach of selecting global stocks for the long term. The obvious example is Warren Buffett who has held stakes in companies such as Coca Cola, American Express and Wells Fargo for many years, through his investment vehicle Berkshire Hathaway which was formed over 40 years ago. So, perhaps the Fundsmith investment process isn’t actually so new or unique.
Fundsmith’s claim to be taking the long term view should also be questioned. No long-only fund manager would claim to run their fund on a short term view, although the old joke that a long-term investment is a short-term investment gone wrong probably applies more often than many fund managers would care to admit. A long term view is possible if a fund or fund manager has a track record of performing over the long term but for a new fund it can be difficult to hold out if performance is poor in the short term because the widespread ability that investors have these days of comparing fund performance through online tools makes the pressure on underperforming funds all the greater.
Finally the advantage of lower costs is an interesting one. There is the benefit of lower trading expenses mentioned above. On top of that Fundsmith is charging 1% to 1.5% as an annual fee but that’s no lower than any other fund manager. Infact some fund managers investing in exchange traded funds charge as little as 0.6%. Fundsmith has no initial fee on investment into the fund but, whilst this always used to be a big drag on returns and was usually around 5%, for some time now it has been handed back to investors when they invest through an online funds website.
So, all in all it’s difficult to see any compelling reason for investing in Fundsmith funds as opposed to any other. At least with cleaning products, you can hold your white sheets up to the sun and see that the gravy and ketchup stains have been dissolved away but anyone investing in Fundsmith does not have anything tangible on which to make the buying decision. Many of course will be swayed by Mr Smith’s decision to put his money where his mouth is, but then some might say that he has plenty of both of those assets to play with. Even so, an investment of £25 million isn’t pin money even to Terry Smith.
As with washing powder, it may claim to be new and improved and it might well be, but frankly it’s quite difficult to tell the difference between two white sheets, and right now it’s even more difficult to tell the difference between Fundsmith and other fund managers. If you like the idea of investing to the Fundsmith tune then you could always use their selection criteria (on their website) to build your own portfolio of 20-30 companies or even better still wait for their investment reports to be published and then buy into those stocks directly
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 .
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