QUALIPORT
Avoid the Agonies of Going Abroad

By Maynard Paton (TMFMayn)
July 5, 2001

Carburton Street, London -- When investing, there are several indicators that your company could be in for a troubled time. Deteriorations in cash flow, diversifications and management upheavals are all good signs that the future may not be problem-free. Another event signalling a rocky investment ride concerns international expansion.

In my opinion, companies aggressively establishing their international presence, especially through sizeable acquisitions, are virtually guaranteed to come unstuck. And the risks of failure are heightened when companies venture into that graveyard of UK corporate activity -- the US.

Unfortunately, the Qualiport knows all about this phenomenon. Portfolio member Emap (LSE: EMA) bought the US magazine publisher Petersen in early 1999 for just under £1b. This week, after two years of fast-declining US sales, Emap sold the American firm for just £366m.

And Marks & Spencer (LSE: MKS) is another, and thankfully former, Qualiport company with a dubious US record. Its 1988 purchase of Brooks Brothers for $750m has underwhelmed shareholders ever since. Thirteen years on, interested parties are now reportedly offering $500m for Brooks.

Gung-ho management

Why do companies have a difficult time with sizeable foreign ventures? Although acquisitions have always presented inherent shareholder risks, the additional management, cultural and logistical issues that a foreign operation brings always test the greatest of boardroom talents. The real danger, as Emap admitted in its latest annual report, is that the domestic business suffers while top-level management focus on the "exciting" international front.

But even with history against them, many companies continue to go down the gung-ho acquisition route to establish a foreign presence. Take Ultraframe (LSE: UTF), the conservatory roof manufacturer and Qualiwatch member. Last week, the company announced the £89m purchase of Four Seasons, the market-leader in conservatories in North America.

At a stroke, out went Ultraframe's very attractive net cash position (of £28m, nearly 10% of the company's market value) to be replaced by net debt (of £60m) and 25% of its prospective profits emanating from a declining US economy. After a few years of struggling with a minor US operation, did Ultraframe's ever-increasing cash pile suddenly prove too much of a temptation for the company's management? Probably.

Take it easy

So, how should UK companies progress overseas? In my view, a slow and cautious approach is required. Small and steady steps to gradually build up an international presence are far better than one sudden and expensive leap. McDonald's (NYSE: MCD) is a great example of a company employing such a cautious strategy.

After starting to export its fast-food chain in the 1970s, McDonald's initially faced a myriad of cultural difficulties. However, by just using a handful of restaurants in each country, the company gradually refined its food, logistics and employment policies to suit the local environment. And only when everything was in place did the burger group start to expand significantly in each country.

Here's an extract from the book McDonald's: Behind the Arches highlighting the time taken to perfect the international operations:

"McDonald's has never lacked for patience in its attempt to export its food system. Other fast-food competitors have pulled out of foreign markets after being discouraged by initial losses, but McDonald's has yet to retreat from any market. In The Netherlands -- where the international marketing effort began -- it took twelve years for McDonald's to make a profit. And on average, the chain has waited nine years for each new international venture to make money."

A similar attitude to foreign expansion exists at Qualiport stock PizzaExpress (LSE: PIZ). While criticised from many quarters for its cautious approach (the company has just two overseas company-owned restaurants), the group's international franchise operation will highlight any foreign problems well before the company doles out big chunks of its own money.

As PizzaExpress Chairman David Page wisely remarks: "We [are] all very conscious of the enormous risk and the bottomless pit that other people have discovered abroad when opening company-owned stores."

Contenders

Looking through the companies on the Qualiport watch list, only Ultraframe, and perhaps Metal Bulletin, (LSE: MTLB) are guilty of any over-ambitious international activity at present. Metal Bulletin made its largest-ever acquisition earlier this year after splashing out £31m for a Canadian publisher. However, unlike Ultraframe, Metal Bulletin already has a notable presence in North America which should restrict any integrational disaster.

But of those Qualiwatchers currently dipping their toes into international waters, perhaps best of the lot is Carpetright (LSE: CPR). The company waited until it had largely saturated the UK before venturing abroad -- a very commendable approach to overseas expansion. And the location of Carpetright's first international store, opened earlier this year? Dublin.

More: Danger: Acquisition In Progress

The author owns shares in Carpetright.