| Fri 18 Feb 2005, 12:28 | | CE stands by decisions despite analysts' criticism |
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Chief executives can come unstuck by ambitiously buying up their large competitors in pursuit of growth.
Six years ago Aveng CE Carl Grim set his sights on building a large, SA-based construction group with global reach. Through acquisitions, he created a business with revenue of more than R10bn.
Grim`s acquisition spree made Aveng one of the largest construction groups in the country, competing neck and neck with market leader Murray & Roberts. Other established players like Group Five, Basil Read, WBHO and Stocks Building Africa were left trailing.
But there are signs that Grim`s ambitious plan is going off the rails. In the year to last June , Aveng`s headline earnings collapsed by more than 50% on revenue down by 11%.
Nedcor Securities is advising its clients to sell Aveng shares, while recommending a hold for Aveng`s main competitor, M&R. This is despite Aveng`s latest trading statement, which forecasts earnings to recover by more than 40% in the current financial year.
Nedcor Securities construction analyst Gavin Bantam says that at current levels just above the R11 mark, Aveng is overvalued. He puts its fair value at 965c. Nedcor Securities is forecasting a negative total return on Aveng in the next 12 months.
Industry observers argue that Grim is reaping the bitter fruits of an overambitious acquisition strategy. They say his problems reach back to his decision to acquire competitor LTA and integrate it into Aveng`s construction subsidiary, Grinaker. And they blame Aveng`s poor performance on the fact that the merger between Grinaker and LTA has never been properly bedded down.
Grim launched Aveng from a base of four operations - Grinaker, Alpha (Holcim), Bearing Man and Trident Steel. He advanced on three business pillars: contracting, building materials and steel. He sold Bearing Man and bought a few other assets, including steel operation Baldwins.
LTA was a good catch . It was SA`s most profitable construction group, and the only one with 50% offshore earnings, which fitted well into Grim`s vision of building a globally competitive construction group.
But analysts are asking whether the R1,3bn LTA deal was a bridge too far.
Larger mergers often appear good on paper but they can lead to the destruction of shareholder value. Financial Times columnist Michael Skapinker recently pointed out that the proportion of takeovers that end up damaging the acquiring company`s shareholders ranges from 50% to 80%.
`It`s because the acquiring company is paying a premium for its target. In other words, it is paying more for the target than its shareholders would pay if they bought the target company`s shares themselves,` says Skapinker.
He says synergies that are used to justify mergers are often illusory. `Putting the two organisations together absorbs so much management time that day-to-day business suffers,` he says.
As independent entities, LTA and Grinaker were good and powerful brands. LTA, with revenue of R5bn, had carved a niche in mainstream infrastructure projects, including opencast mining, the energy sector and general heavy engineering jobs. Having entered the sub-Saharan market successfully, LTA launched itself overseas, partly through a stake in Australian engineering group McConnell Dowell.
Grinaker`s R3bn revenue was earned largely from traditional building contracting, with a smattering from infrastructure and offshore contracts.
Did Grim fall into the trap of paying a premium for LTA? Says one analyst: `He obviously hoped to double up, but what has transpired is that one plus one equals one-and-a-quarter, not two.`
Aveng made a cash offer of R46/LTA share or 667 Aveng shares for every 100 LTA shares. This was a year where LTA stock was at the lower R30 levels.
Others say Grim had no option but to go about building critical mass for his company. `Though the merger has not gone as smoothly as expected, I think it was a necessary act,` says Ian Robinson, former executive director of the Building Industries Federation of SA. `The industry was overpopulated with medium-sized players and screaming for consolidation.`
Grim admits he has had problems with the Grinaker-LTA integration. But, he says, it`s not a disaster. `Putting together two groups of 10 000 people each is not easy,` says Grim. `Ours has been a difficult but worthwhile process. You have two groups of people who are used to doing things in different ways. You have to adopt one or the other system, or something totally different. It`s easy at senior level, but very difficult at lower levels.`
Grim`s two biggest problems have been dealing with the particularities of the construction business and managing the cross-border commitments of the combined entity.
Industry analysts point out that integration in construction is particularly difficult. This is because contractors are known to be conservative. Critical management layers comprise individuals with highly specialised skills, who often stick to one company for many years.
On top of this, Grim had to deal with pressure on the order book that came from combining offshore activities.
Both Grinaker and LTA were heavily committed to cross-border contracts. The merged entity`s resources were stretched on an order book equalling 129% of annual revenue.
This is a key measure in the construction world. Once the order book tops 90%, there will be capacity problems, which could ruin profitability. The result for Aveng was a loss of R178m in the construction division the year ended June 2004.
Aveng`s offshore problems have been made much worse by the strong rand. Offshore activity accounts for about 50% of total earnings, which are US dollar-denominated and translate into huge currency losses when the rand is appreciating. To make things worse, three African road contracts - risky for any company - went awry, producing significant losses.
Last year Grim ordered a review of all business units, which resulted in the reduction of offshore activity, especially road-building. About 2 500 jobs were lost. Says Aveng deputy chairman Phil Erasmus: `I think he [Grim] has dealt with this rough patch in a mature manner by putting the cards on the table. He is an open and easy-going personality who is able to communicate well with people.`
Despite the problems, Grim remains convinced Aveng has turned the corner. `We are beginning to see the benefits of this decision [the merger] coming through.` The biggest benefit, he believes, is that the combined entity is in a much stronger position to win large tenders. While Grinaker was largely a building company, Grinaker-LTA is far more than that. Grinaker-LTA can tender for the high-speed train project, Gautrain, and stand toe-to-toe with large international construction groups.
Grim says another five years of work lie ahead to make Aveng a globally competitive construction group, with a good and dependable return to shareholders. `I am absolutely committed to this and I am going to deliver the results,` he says.
`Would I repeat the LTA deal today?` he asks. `I doubt if I would have the courage. But having done it, I believe it was the right thing.`
