Why do offshore expansions keep failing?

Why are investors so terrified by Mr Price’s planned purchase of German retailer NKD? You don’t have to search far and wide to find an answer – many South African businesses have a history of sailing off to new shores, only to be washed back up a while later, thoroughly soaked.

The number of failed ventures is legion; so why do successful local businesses keep going offshore against a consistent pattern of bad bets? 

For starters, “its genesis is because of the limitations of our local market”, says Mark Barnes, former South African Post Office CEO and founder of Purple Group. 

“I would argue the primary motivation is to diversify the risk of the local market. And unfortunately, when you’re doing that, you are a ‘forced buyer’, and so you take undue risk.” 

Purple itself was in 2008 badly burnt by its offshore brokerage venture Global Trader Europe, which was placed in administration after a major client couldn’t meet its margin calls, thanks to the global financial crisis. But Purple also owns the incredibly successful local trading platform EasyEquities, which is now reaping the rewards of 11 years of hard (organic) slog.

Executive incentive structures

Barnes doesn’t think history is a great predictor when it comes to business deals, though he notes that desperation to “escape” the South African market can push executives to make bad decisions. “If you say, ‘I’m diversifying at any cost’, that’s wrong.”

Others see the primary motivations as more inwardly driven, directed by management and the board. It’s no secret that companies often have “flawed” remuneration models, according to Benguela Global Fund Managers’ Zwelakhe Mnguni. 

Executive incentive structures can be a key motivator for growth at any price.

Says Muneer Ahmed, chief investment officer at Aeon Investment Management: “Say if management are incentivised to grow at all costs, then they’re bound to make silly acquisitions so that they can grow, but at the expense of shareholders.”

Both Ahmed and Mnguni point to the possible ego boost of a successful offshore expansion as a reason CEOs might push their companies to venture abroad. While you can sugarcoat it as overconfidence, Mnguni calls it “arrogance”.

The cookie-cutter approach

A part of that overconfidence is the belief that if you can make it here, you can make it anywhere. 

This is a key factor for Alan Pullinger, the former CEO of FirstRand and RMB. As a merchant banker, Pullinger has seen a deal or two – FirstRand, though, has been fairly conservative in terms of its own offshore purchases; its last really big deal was the acquisition of UK bank Aldermore in 2017.

He is cautious about expanding into both developed and developing markets.

“They think: because we can run a business here, we’re really good at running businesses in emerging markets. I don’t think that logic holds. Some industries in this country are actually First World,” says Pullinger. 

“I’m sceptical if someone says, ‘I run a good business in South Africa, I’m going to go to Vietnam.’ That looks very exotic compared to what we’ve got in the domestic market.”

Some companies can replicate their success abroad – Mnguni points to the uniformity of mining, for example. But in the retail sector, he believes, there are just too many varying factors. 

Aeon Investments CEO Asief Mohamed says: “These are different markets with different regulations. So, you can’t replicate the business model that easily. You’ve got to cookie cut accordingly.”

Mnguni stresses the irrationality of trying to break into developed markets in the hopes of squeezing growth out of them. “This ‘we can fix it’ hubris ignores the reality of mature markets characterised by rigid labour costs and fierce competition.”

The old fixer-upper

Barnes can see very few motivations for acquiring rather than building a new business. It’s a view that is more than justified by Purple’s latent success.

Yet, companies are still tempted to buy established businesses as a way to kickstart their foreign expansion; a fast-track to the finish line that can end in disaster.

That’s because, inevitably, buyers are expected to pay a premium for a business, which in some cases, they could have built themselves, albeit slowly. 

Pullinger emphasises how problematic this is. “If you overpay, it actually doesn’t matter if you turn it around or if you fix it. You’re just not going to get the returns.” 

And fixing it can often be a huge part of the deal. Sometimes, it’s only after hands have been shaken that the true, and dishevelled, heart of a business is revealed. 

Mnguni lays the blame at the foot of supine board members who simply rubber-stamp executive aspirations. 

“We’ve had a lot of these disasters primarily because the boards are not asking the right questions, and they are being sold a story and they have no means of evaluating that story,” Mnguni adds. 

Fixing up a business can take significant capex and management time. No wonder disastrous deals can turn a formerly successful enterprise into a capital sinkhole. 

Pullinger agrees that company boards need to be careful of deals that seem too good to be true, especially in foreign regions where executives are less familiar with the playing fields. What management – and non-executives – should be asking themselves is: “Surely if there were people there who thought it was a decent business, they would have snapped it up? Why have they let it go to me?” 

No place like home

Last, foreign expansions can lead to business failure not just because they fail, but because the local business is dragged down, too.

Mnguni gives the example of Spar and its purchase of the Polish Piotr i Paweł chain in 2019. Spar was a good business that was capital light, but its foreign expansion resulted in a large loss of local market share as a result of losing out on the home-delivery convenience wave. In the process, the deal cost shareholders R4.5bn.

Both Mohamed and Ahmed say they would be “100% concerned” about the state of a local business in their portfolio if its foreign counterpart started flailing, “because then you end up having the local management spend half the year overseas”. 

If you don’t have the managerial capacity to take on a foreign expansion, Pullinger warns, your company will be stretched thin and unable to sustain success anywhere, including locally. 

It sounds elementary, but all the experts Currency spoke to note how often boards and executives are susceptible to these failings. 

“These are very highly paid individuals that we’re talking about. And if they’re making big mistakes like this then, you know, they need to put their necks on the line,” Ahmed says. 

Mnguni, for one, is infuriated.

“I think we shouldn’t be averse to litigating against company management – including the board,” he says. 

Pullinger is slightly more understanding. “Away games are tough. You’re going to this new stadium, and no-one is shouting for you.” 

While Barnes cautions against being quick to judge this latest case of South African corporate wanderlust, there’s no denying that the graveyard of supposedly great deals is chillingly full.

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