A while ago, I had breakfast with a very smart investor in emerging market equities. He was in South Africa seeing government officials and companies. Given the gloom so prevalent in South Africa, he was surprisingly constructive. His main complaint was about South African corporate management teams who “felt the need to diversify away from South Africa’s socio-political risks by taking on significant balance sheet risks”.
This was an insightful comment. The result of the widespread concerns around policy stability and long-term growth rates in South Africa is that a number of companies have chosen to diversify their operations by expanding offshore.
This is not a new story – we saw the same thing play out in the late 1990s and early 2000s as a range of companies including Old Mutual, DiData and AngloAmerican sought greener pastures abroad.
Neither Old Mutual nor DiData managed to make value-accretive acquisitions. Over the course of the next decade or two, both retreated home. Anglo American has had a mixed history.
In the last five years, we have a few examples where the capital allocation has been extremely poor. The current poster child is Sasol. Over the past five years, Sasol has invested more than $12-billion into the Lake Charles Chemical Project (LCCP) in the US.
In May 2019, the company announced further cost overruns at Lake Charles. Shortly thereafter, the company delayed the release of its results. Including their current capital write-offs for the LCCP, Sasol has impaired assets of R37-billion since 2011. All indications are that further capital write-downs will be needed for LCCP, given the repeated delays in getting that project up and running. The net result is that Sasol now faces significant balance sheet pressure with a material risk of a credit downgrade if the company does not materially reduce debt.
A second example is Mediclinic, which has invested heavily in the UK, Switzerland and the Middle East in recent years. In late May 2019, it took an impairment of almost R7-billion (or £405-million). In Switzerland, the combination of declining tariffs and regulatory changes that push patients away from inpatient procedures has put downward pressure on Mediclinic’s revenues. In Abu Dhabi, it failed to understand the business model when it made the Al-Noor acquisition.
The third recent problem child is Woolworths, which made the bold move to buy David Jones in 2014. At the time it paid roughly R21-billion, funded by debt between South Africa and Australia. Then, CEO Ian Moir eagerly touted the benefits of south-south synergies and the value of the properties David Jones held in Melbourne and Sydney. In early August 2019, Woolworths announced an A$437.4-million (R4.3-billion) write-down in the value of David Jones, bringing total write-offs in its Aussie acquisition to R11-billion.
All three companies have seen sharp depreciation in their share prices relative to their peers. In sharp contrast, we have several examples of companies which have focused on their SA businesses over the last five years – and reaped the benefits of fixing their local operations.
Though it has been helped greatly by a surging platinum price, AngloPlatinum (Amplats) has also been engaging in self-help for years. A decade ago, Amplats was loss-making and facing significant balance sheet pressures. Today it has honed its portfolio to focus on lower-cost assets, notably South Africa’s largest open cast mine, Mogalakwena. It has also repaired its balance sheet and restarted its dividend in 2018.
The second positive example is Life Healthcare. It has extricated itself from its problematic Indian venture, Max Healthcare, in the last two years. In that period, the company has degeared, and pursued several SA-based avenues of growth, such as new outpatient models, complementary services and radiology. The company has a strong focus on cost control, which is in sync with the weak economic dynamics in South Africa. In addition, it is well attuned to the shifting regulatory dynamics in SA.
My third example is Pick n Pay. Twenty years ago it got distracted with its Aussie venture, Franklins. It under-invested in South Africa and subsequently gave away market share to Woolworths at the upper end and Shoprite-Checkers at the middle and bottom end. It also lost margin, as Shoprite proceeded to fundamentally disrupt its business model which relied on suppliers to provide funding and distribution.
A decade ago, other retailers openly admitted that they followed Pick n Pay’s pricing. The result was that both rand depreciation and increases in soft commodity prices quickly translated into higher consumer food prices. In the past five years, this has utterly changed. In 2013, Pick n Pay finally appointed a strong external CEO, Richard Brasher. He has spent the last six years ruthlessly cutting cost out of the business while putting significant downward pressure on food prices. Pick n Pay has slowly regained market share – while helping South African consumers.
My breakfast companion’s argument was that it was his job as a portfolio manager to allocate capital to different geographies. He didn’t want management teams to do it for him. While there are examples of companies that have successfully diversified offshore – notably Naspers and Richemont – there are far more where the experience is questionable. Beyond the examples, already discussed, we could also include Steinhoff.
Perhaps local is lekkerder? BM