Does offshore expansion lead to superior returns?

By Damien Wodak, Managing Director and Partner, and
Daniel Selikowitz, Partner, Boston Consulting Group (BCG)

The situation surrounding COVID-19 is dynamic and rapidly evolving, with still unknown implications for the global economy and millions of human lives. No industry will be immune to the impacts of COVID-19, which will present both challenges and opportunities for businesses, particularly those with overseas operations. The crisis will likely have lasting impacts on how businesses operate and broadly play out over three phases – Flatten, Fight, and Future. The Flatten phase, describing the stage when a nation or area is locked down in order to reduce the peak caseload, has prompted some businesses – particularly those providing essential services – to re-localise parts of their supply chain, building resilience ahead of a prolonged Fight phase. The Fight phase will see governments gradually ease restrictions with the aim of restoring a moderate amount of economic activity. While many businesses will be challenged during this period, it may also provide opportunities to prospective dealmakers, with BCG research showing that acquisitions executed in a weak economy tend to have higher returns than deals done in a strong economy.

When a vaccine or highly effective treatment eventually becomes widely available, we will transition to the Future phase. Economic activity will eventually be fully restored; however, it is likely some of the behavioural changes caused by COVID-19 will remain. For example, COVID-19’s disruption to the status quo may make people more willing to engage remotely in the future, potentially providing new opportunities in established industries such as health and education services. At the time of publication, it is still too early to determine how COVID-19 will impact the overall trend of internationalisation seen among Australian companies in recent years.

Section Summary

Australia’s largest listed companies are becoming more internationally diversified, as measured by the proportion of revenue generated in foreign markets. ASX 200²⁹ companies generate 34 per cent of their revenues from foreign sources, more than the largest listed companies³⁰ in the UK (29 per cent) and US (26 per cent), but less than Japan (42 per cent).

The level of internationalisation seen among Australian companies differs meaningfully by sector. In some industries, such as utilities, insurance, consumer staples and banking, companies have tended towards less offshore expansion. Potential reasons include favourable local market dynamics, or offshore expansion being hindered by high barriers to entry or significant regulatory hurdles. By contrast, industries with favourable offshore market dynamics or high cross-border flexibility have an imperative to seek growth offshore. Mining, healthcare and IT are all export-heavy industries in which Australian companies continue to grow their offshore revenues at a higher rate than domestic revenues.

When considering larger ASX 200 companies ($2bn+ market cap), the incentives associated with offshore expansion are heightened when domestic growth opportunities are limited or constrained. Additionally, larger companies tend to be better equipped to navigate barriers associated with operating in a foreign market. It is then reasonable to expect that among the largest firms in a given market, higher international diversification would be associated with superior returns. This is demonstrated empirically among companies with $2bn+ market cap, by internationally diversified³¹ companies outperforming domestically focused³² companies on five-year total shareholder return (TSR). While analysis of the complete ASX 200 dataset and previous academic studies³³ fail to reach a consensus on whether capital markets invariably support international diversification, they suggest that expanding offshore can be a valuable strategy under particular conditions. Like many strategic decisions faced by the board and management of Australian companies, there is no ‘one size fits all’ answer to offshore expansion. Expanding abroad can create significant shareholder value when compelling market conditions, strategic rationale and execution come together.

References:

The analysis undertaken by BCG on ‘Does offshore expansion lead to superior returns?’ uses a cut-off date of 30 September 2019, unless noted otherwise. Company financials from public announcements use financial years, unless noted otherwise.

29. ASX 200 sample includes 127 companies who reported revenue data by geographic region in 2014 and 2019.
30. Where we refer to a region’s foreign revenue mix throughout this report, we refer to the sample of companies within the following indices for which revenue by geographic segment was available in 2014 and 2019: US = S&P 500 (n=247), Japan = S&P TOPIX (n=40), UK = FTSE 350 (n=103)
31. Greater than 10 per cent of revenues in 2019 from foreign sources
32. Less than 10 per cent of revenues in 2019 from foreign sources
33. Studies referenced in literature review, in order of mention:

• Mateev and Andonov, 2016: Do cross-border and domestic bidding firms perform differently? New evidence from continental Europe and the UK
• Barbopoulos et al., 2014: Foreign direct investment in emerging markets and acquirers’ value gains
• Wang and Mathur, 2011: Cost of capital and return on capital: U.S.-based multinational corporations versus U.S. domestic corporations