Is bigger better?
03 July, 2015
Senior Portfolio Manager Manuel Greenland analyses Australian portfolio company Bursons' latest acquisition.
In the popular TV show "Dragon's Den", would-be entrepreneurs pitch their business ideas in the hope that wealthy tycoons will provide the capital required to turn these ideas into successful realities. Every day investors play the role of these capital providers, and the management teams of listed companies play the entrepreneurs.
During June the management of Burson Group ("Bursons") asked shareholders for A$218m, an amount equal to nearly half Bursons value at the time, to fund the acquisition of Metcash Automotive Holdings ("MAH"). The acquisition would make Bursons' store and workshop network over three times larger, expand its presence across Australia and grow the company's stable of leading brands.
Bursons is Australia's largest workshop-focussed car part distributor. Starting off in Victoria in 1971 the company has grown to operate 114 stores today. Demand for Bursons' products is resilient as cars need parts regardless of general economic conditions. Bursons has built a solid reputation by controlling the purchasing, distribution, selling and delivery of parts, allowing them to meet customer requirements quickly and effectively. MAH is similarly successful, but its 416 stores serve consumers as well as workshops. It is a successful business that has grown well over time, with trusted brands and an enviable network of stores.
Clearly buying MAH would make Bursons bigger, but would it make it better?
Rather than focus on size, we want to see management allocate capital to enhance the competitive strengths and long-term growth prospects of our portfolio companies.
When combining two businesses, the objective is to create a new company that is worth more than the sum of its parts. The combined Bursons-MAH group could grow sales by sharing customers, and their combined store network would cover all of Australia, allowing them to sell to valuable new national customers. They would also be a significant buyer of auto-parts, improving their prospects of getting better prices and terms when dealing with suppliers. Administrative functions could be shared across the greater business, improving cost efficiency.
The acquisition looked strategically sound, but the best business bought at the wrong price can be a bad investment. We analysed the negotiating positions of Bursons and MAH's seller Metcash, as relative negotiating strength could well impact the price ultimately paid. Metcash needed to reduce their debt and urgently refocus on their ailing core grocery business. Raising cash by selling a valuable non-core asset like MAH was one of Metcash's few viable options in a rapidly diminishing set of alternatives. In contrast, Bursons had a track record of success backing their ability to quickly raise capital and offer cash for MAH. Bursons would likely have had the advantage in the negotiation.
We concluded that Bursons management had identified a rare opportunity to buy a business that would make the company stronger and more profitable in the long run, and we supported their capital raising effort.
Management's most fundamental responsibility is to build long-term shareholder value. The astute allocation of capital underpins this effort and is a key focus in our selecting and monitoring investments.