Go West Young Man!

And N Brown Group PLC

British businessmen are attracted by America's size, wealth and deceptively easy access for English speakers with the same unrestrained enthusiasm that the Spanish conquistador was attracted to the legendary El Dorado. And like the conquistadors, for every adventurer that struck gold, there are many more who have perished in the attempt.

The pharmaceutical companies Glaxo and Astra Zeneca, the defence contractor BAE Systems and the technology concern Smiths Group have all been spectacularly successful in America. They are among the few.

Ferranti, an electronics business and constituent of the FTSE 100, was brought low in 1993 following its takeover of the US defence contractor International Signal and Control (ISC). It turned out that ISC had been making its only profits from the illicit sale of missiles to South Africa, Iraq and Chile. The 15-year prison sentence handed down to ISC's CEO did little good  for Ferranti's empty-handed shareholders.

Midland Bank, one of the "Big Four" clearers, was forced into the hands of HSBC 5 years after acquiring Crocker National Bank of California in 1981. Billion pound losses on Latin American loans overwhelmed Crocker and severely weakened its parent, Midland.

RBS's demise was also Made in America. Fred Goodwin boasted that, after acquiring ABN Amro's US operations, he had the sixth largest bank in America. So he did, and it sunk the ship with perhaps 20 billion in losses on subprime mortgages.

HSBC, failing to learn from Midland's US experience, bought Household Finance Corporation in 2002. Household was the second largest subprime lender in the US. HSBC stopped its trading in 2009 while providing $16.3 billion in bad loans and a $10.6 billion write-down on its purchase. HSBC immediately followed this with an $18 billion rights issue, which saved the bank.

The walking wounded include many British companies in the retail sector (thanks to Sarah Butler, The Guardian, 5.12.12 for this list):

HMV extracted itself from the US in 2004 after failing to make a profit from expensive and over-ambitious stores.

WH Smith sold its US airport and hotel stores after the retail meltdown that followed the 9/11 terrorist attacks in 2001.

J Sainsbury sold its upmarket grocery chain Shaw's in 2004 after failing to expand the business sufficiently to take on the US's biggest grocery chains.

Marks & Spencer lost two-thirds of its investment when it sold the fashion chain Brooks Brothers in 2001. It sold its upmarket grocery chain King's in 2006, deciding it did not want to invest enough to expand.

Dixons sold its stake in the US electricals chain Silo in 1993, six years after acquiring it, after losses caused by over-expansion during a recession.

Laura Ashley sold its US chain for a dollar in 1999 after over-ambitious expansion led to a string of profit warnings.

At Body Shop, heavy losses at its US operations in the late 1990s forced it to close its manufacturing operations there.

Now it's the turn of Tesco. Its Fresh & Easy stores have cost the company a billion pounds or so as well as top management time. Tesco's new CEO has put them up for sale.

British managers too often underestimate the strength of their competitors in America. Entrenched American companies have many advantages over their new UK competitors. Not only are they are larger and know the market, but they also benefit from customer loyalty and the best technology. And they have access to cheap financing.

British companies must have something that is very special to succeed in the most competitive market in the world. In the case of Glaxo and Astra Zeneca they had patented drugs, in the case of BAE and Smiths Group, patented technology. And these companies became part American and so behave like Americans. Glaxo has four American board members, Astra Zeneca three, BAE five and Smiths Group one. Shell (with 2 American board members), BP (with 5) and Unilever (with 3) all have big operations in the USA. Tesco, in contrast, has one American on the 15-member Board of Directors, and she was appointed in March 2012 (before that there were none). The CEO of Fresh & Easy is a Brit.

Retailers, by comparison, have little to offer the American consumer. Spain's Inditex, the world's largest fashion retailer, has more stores in the UAE than in the USA - and it has chosen to spearhead its American entry via the internet. Sweden's H & M, the world's second largest fashion retailer, is also moving from stores to the internet in the US. Next, Britain's largest fashion retailer, hasn't a single American store, but you can buy its products online there. It's the cheap way in.

When the savvy investor learns that one of his companies is launching a new business or, even worse, trumpets buying a 'transformational' business in America, he should immediately consider selling his shareholding.  To keep his share, he will have to satisfy himself that:

1. The Chairman is not on an ego trip.

2. The Company has something unique to offer the American consumer and it has spelt out how much it will invest. Open ended commitments often end in tears.

3. The Company should have already tested the market via a distributor, agent or online. Tesco tested its concept for 2 years prior to opening its first store, and still it failed.

4. The Company hires a top rate American team to run its operations and appoints its American CEO to the Board.

5. The Company can comfortably afford the potential loss from its American venture.

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N Brown Group PLC

N Brown has established itself as the market leader in outsized clothes bought by middle-aged women on-line and by direct mail in the UK. The company has been consistently profitable. It went through a slow patch in the early Noughties as it adopted TV marketing, which was soon abandoned in favour of online selling. N Brown now sources 54% of its sales online, up from 28% in 2008. This is good for the business: it is cheaper to service than other marketing outlets and the order value per customer is 25% higher. The company has ventured into the high street with its Simply Be brand. Initial results are 'promising', but the stores are loss-making. A review is promised for March this year.

N Brown shareholders have enjoyed an annualised return of about 11.7% since 1988, compared to 6.6% on the FTSE 250. But N Brown shares (in blue) are much more volatile than the FTSE 250 Index (in red). (Source: Yahoo - click on the graph to enlarge)

N Brown has been a strictly British concern, with a German operation launched in 2009. In 2010 its CEO announced a trial in America describing the US as "a major market with everything you need for a home shopping business – the infrastructure is there." American orders would be serviced from N Brown's UK base, keeping the cost of the US launch below £1m.

How has the American venture prospered?

In the 2012 Annual Report, the company highlights: Simply Be is doing us proud in America

too. Our US business model remains promising with good margins and 74,000 new customers

joined us last year. The only results provided for the USA include Germany: 

USA and Germany	Revenue	Loss	Loss as % of revenue
2012	8.4 million	4.2 million	50%
2011	4.8 million	2.3 million	48%

 

It must be a concern that the higher the revenues, the higher are the losses.

In the latest Interim Report (October 2012), the CEO comments:

"Sales in the USA increased by 53% to £3.4m. The US customer is in general more casual and conservative than their UK counterpart and we have tested Marisota as an alternative brand for direct mail campaigns with some success, leaving Simply Be to be promoted primarily in the online channel. We anticipate further progress in the second half and a reduced level of losses." No figure for the losses appears in the report.  

Though we have not been provided with the losses for the American venture, we can be sure that they exceed the original 1 million pounds that were expected in 2010. A new CEO, Ms Angela Spindler, has been appointed. The loss of the reigning CEO coincides with the resignation of the Chairman, Lord Alliance, who was founder of the present business and owner, together with his brother, of 44% of the outstanding shares. N Brown has no American director. 

N Brown is cash generating, with its operating cash more than sufficient to pay both the dividend (it yields 3.3%) and the company's modest capital expenditure requirements. Net debt is a comfortable 45% of net equity. Like many companies that regularly generate an excess of cash, N Brown is a serial buyer of businesses.  

The average return on equity of all its new investments is about 15%, well below its average ROE of 21%. Or, to put it another way, its core business is more profitable than the rest. Some - such as branching into men's clothing, use the company's well-honed skills. Completely new ventures, such as Germany and the US and the new stores, are currently a burden. But the dynamics of the home shopping business mean that it takes years to get it right and get it profitable. The same applies to stores. Angela Spindler has been chosen for her background in stores (Debenhams, The Original Factory Group, George and others). 

The valuation model gives an intrinsic value of 361p a share to N Brown. It is currently trading at 397p See below for assumptions. 

5 year earnings	5 year return on equity	5 year equity per share	Average
399p	337p	347p	361p

 

The cautious investor will want to consider: 

1. The possible damage to earnings of the company's ventures abroad and into stores. 

2. Whether the new CEO represents an opportunity to improve the business, or whether she will be tempted to push what she knows best - stores - at the expense of what N Brown does best - home shopping.

 

Assumptions:

Earnings per share growth of 6% pa.

Equity per share growth of 9% pa.

Return on equity of 15%

Discount rate of 11.3% based on:

                                             Weighted cost of debt of 4.3%

                                             Risk premium of 2%

                                             Profit and margin of safety of 5%

Average PE ratio of 15.5. Current PE Ratio 13.5.