ANZ's Asian expansion: Divine or doomed?

'I have been a subscriber to The Intelligent Investor since June 2004 and, for some time now, I have wanted to write to you expressing my annoyance and disagreement with Greg Hoffman's continued negative and unbalanced commentary on ANZ Banking Group. His latest sentiments in issue 308, where he paints ANZ as a disaster waiting to happen, was the final straw for me.'

That was the opening paragraph of a typed letter we received this week from a former senior manager at ANZ who had spent decades with the group. He kindly took the time to explain why he feels that Mike Smith and key members of his senior executive team are 'the right kind of people to support its push into the Asia-Pacific Region.'

This gentleman clearly knows more about the senior people within ANZ than we do. And Mike Smith does seem to have obvious bona fides in the Asian banking industry.

Yet The Intelligent Investor's record of spotting flawed or highly risky strategies and alerting our members well ahead of time is a strong one. Here are some examples:

ABC Learning Centres – (Avoid at $6.17 in August 2006) 'ABC also makes no secret that it will continue with its aggressive acquisition and expansion strategy. The company's acquisitions are getting larger and there is always a risk with this strategy that they will pay too much for a business or be unable to integrate it effectively.'

AMP – (Sell at $19.12 in March 2002) 'We could drone on about the numbers but this is a situation where strategic direction is far more important ... Recently, CEO Paul Batchelor spoke of the limitations of the domestic market and the “unique opportunity” AMP has to export its skills around the world ... This “international or bust” attitude is cause for concern.'

Babcock & Brown – (Avoid at $17.74 in September 2005) 'Babcock's market capitalisation is now more than one-quarter of Macquarie's (whose valuation, by the way, is also pretty rich) ... investors are placing too much emphasis on this year's earnings growth.'

Centro – (Avoid at $9.01 in June 2007) 'Centro's strategy has worked a treat in the current economic environment ... But at some point this self-reinforcing scenario will be challenged and then we'll see how shrewd the recent acquisitions have been ... Centro has been Australia's best-performing listed property trust over the past decade, but this company has rapidly transformed into a much different beast, and both the new assets and the new strategy will struggle when the cycle turns. With risks mounting and expectations high, we're happy to sit this one out for the time being.'

Foster's Group – (Take Part Profits at $5.49 in October 2005) '[Shareholders have] been given a greatly expanded corporate empire. And they've seen their boardroom payroll increase by 56%—despite the number of directors holding steady at seven. Although the nameplate over the door has changed from Ted Kunkel to Trevor O'Hoy, the chief executive's office has been blessed with a 60% pay rise. And shareholders have been treated to a 50% increase in annual report clichés—at the very least. But one thing that hasn't gone up by 50% is the value of their shareholding.'

GrainCorp – (Sell at $7.15 in October 2009) 'After this major acquisition, instead of owning the number one player in key domestic markets, shareholders will be exposed to the number four player in the global malt business ... It seems to us that the board has stars in its eyes.'

IAG – (Sell at $5.46 in October 2006) 'The $350m IAG has spent buying Hastings and Advantage is not a huge sum for a business with a market capitalisation of $9bn. But it's a key pointer to the company's future, and it will likely be a drop in the ocean if IAG is to achieve its key goal of “scale” in the UK market.'

Suncorp – (Sell at $21.56 in March 2007) 'It's easy to overpay even for a great business, especially in buoyant conditions like these ... We believe Suncorp will struggle to justify the price paid for Promina'.

Tabcorp – (Sell at $17.13 in February 2005) '...while we don't like the idea of subscribers missing additional profits, we feel even more strongly about avoiding companies bent on growth via acquisitions funded by huge volumes of debt. We're much more comfortable out than in.'

In none of these cases did we have any more insight into the executives than we do with ANZ; we simply formed a view on the strategy's risk versus the share price. And in most of those cases we were criticised at the time from several quarters (including threats of legal action).

Of course this record provides no guarantee of future success. But it does show a few things relevant to our current negative view of ANZ:

1.       A sceptical view of ambitious acquisition-led strategies is often wise (particularly when carried out by an externally-appointed chief);

2.       Such strategies can appear successful for a time, even if they're ultimately disastrous;

3.       No special knowledge of the executives involved is required. In fact, a distance from unusually talented or charismatic chiefs might be a positive in not being drawn into their plans; and

4.       As opposed to owner/managers, the incentives for professional directors and managers – conscious or subconscious – can be to grow the size of the business in order to justify a larger pay packet (and perhaps even more exotic locations for board meetings). For shareholders, what counts is profits and dividends at the per share level.

The first of these points is the most important. Many studies show that most acquisitions eventually destroy value for the acquirer. In competitive takeovers (where premiums are typically paid) you're usually starting off having to justify a high purchase price before any of the unforeseen difficulties arise. And these are the type of deals ANZ has been pursuing in Asia.

But this is a blog post, not a polemic, and I'm interested in hearing your views on two somewhat different questions:

Firstly, how many examples of successful externally-appointed chief executives (particularly foreign ones) implementing an acquisition-led strategy can you think of? (Marius Kloppers at BHP Billiton, perhaps. Steve Jones at Suncorp, maybe?)

Secondly, I'm interested in hearing your views on ANZ's current strategy and its chances of delivering bumper returns to shareholders over the years. Is our current view too pessimistic?