Tuesday, May 29, 2007

MaxiTrans: Competitive Strategy & Risk Analysis


MaxiTrans’ main business activity is the manufacture of many kinds of freight trailers, such as the T-liners, flat tops, container skeletons, dry freight, and temperature controlled trailers. They also engage in the sales, rental, and finance (lease or purchase) of new and used trailers. Other business activities include the supply and distribution of parts, service and repair, appraisals (for insurance, trade-ins, and repairs valuations), and the manufacture of urethane foam and body panels. Truck-trailer is an important component of various industries, such as infrastructure, food and agriculture, transport and distribution, and resources (mining).

Industry Life Cycle

The trailer manufacturing industry is currently in the mature growth stage. Analysts predict that road freight activity will continue to grow at 3% annually1 up to the year 2020, so we would expect the trailer industry to grow in the same direction. This represents a slow but steady growth characteristic of mature industries. The mature characteristics of MaxiTrans’ business will be clearer in the analysis of its cash flow statement [See Part D]. Industry growth is also cyclical and its cycles are closely related to the economy as a whole.

Industry Competitive Structure

There are very few major players in the freight trailer industry, including MaxiTrans. Economies of scale dictate that competitive power is concentrated in the hands of a few large manufacturers, and the industry structure can be said to be oligopoly. Other smaller manufacturers concentrate on niche markets and are not a threat to MaxiTrans’ main line of business.

Trailer Industry: Five Forces Analysis

The customers of MaxiTrans are generally price takers. Since each customer only constitutes a small fraction of MaxiTrans’ customer portfolio, they have a relatively low bargaining power. The bargaining power of suppliers is also low. MaxiTrans is such a major player in the industry that it can pressure the suppliers to lower price of supplies and raw materials. The threat of entry to the industry is low. This is caused by high barriers to entry, such as economies of scale leading to cost advantage, a well-established distribution network, and established customer relationships. The intensity of rivalry is moderately low, because there are only few players in the freight industry. There are, however, some incentives to gain market share. Threat of substitutes from other means of transportation is also low, because freight trailer is an indispensable component of the land transport industry. [For an in depth full Five Forces Analysis see below]

MaxiTrans: Competitive Challenges

With the slow pace of growth of the market, MaxiTrans has turned to concentric diversification in order to grow market share and drive revenue growth in the domestic mraket. The company has acquired of several companies within the past four years [see Appendix B]. A key strategic challenge for MaxiTrans will be its ability to find suitable acquisition targets and to integrate these companies into the operations of the group as a whole. The recent underperformances of some acquisitions (e.g. Hamelex White and Colrain) suggest that all is not running smoothly. The challenge facing MaxiTrans will become clearer in the analysis of the income statement and profitability [see Part B, E].
In the short run, MaxiTrans may find its industry in a cyclical downswing being adversely affected by the macroeconomic conditions such as higher fuel prices and the drought, as well as a slowdown in economic growth as the Australian economy reaches full productive capacity.


Threat of Entry

The threat of entry into the trailer industry depends on the existing barriers to entry. Maxitrans is a dominant player in the industry. Economies of scale is present in manufacture, research, marketing, distribution, and service network, leading to a cost-advantage. Maxitrans also has a well-established distribution network, while possessing a large capital. There is some research and development, though it not substantial relative to the total of other operating expenses ($763,000 of $18 million). This implies the newcomer must enter the market big to be competitive. Moreover, Maxitrans has established relationships with major customers, such as Safeway, Reflex Papers, etc. Altogether, the entry barriers to the trailer industry are quite high, thus reducing the threat of entry.

Intensity of Rivalry among Existing Firms

The intensity of rivalry is moderately low. The only other notable player in the freight trailer industry is Barker Trailers. Increasing GDP figures3 ($873,197m in 2003-04, $896,568m in 2004-05, and $922,637m in 2005-06) indicates Australia’s economy is still performing well. Along with Australia’s strong economic performance the industry may be experiencing some growth. Thus, firms theoretically can produce better results by just keeping up with the market. However, the industry is already in maturity stage in terms of the industry life cycle. So there are some incentives to gain market share, especially if the firm possesses the amount of capital needed to acquire another firms.

The two main driving forces behind MaxiTrans’ strong performance are its reputation and distribution network. MaxiTrans attempts to differentiate its trailers than its competitors through brand recognition and research and development. Its distribution network supports this strategy by somewhat selling the trailers as differentiated products. With respect to distribution, MaxiTrans is targeting the domestic market with the exception being China. The Chinese market was penetrated in 1996 through a joint venture with Chinese THT, called MTC.

Threat of Substitutes

There are only three ways to transport commercial goods, by air, by water, or by land. Air-freight is expensive even though it is so much quicker. However this can only be done from airport to airport and still requires truck-trailers to transport the goods to the final destination. Likewise ferry and railway transports can only be done from port to port and station to station respectively. Hence the threat of substitutes is relatively low because an alternative land transport is less feasible. Truck-trailer is an indispensable component of the transportation industry.

Bargaining Power of Buyers

There are only few players in the freight trailer industry. Moreover, Maxitrans have many customers and they do not pose a credible threat of backward integration. Hence, they have a relatively low bargaining power.

Bargaining Power of Suppliers

Suppliers to MaxiTrans include parts manufacturer, equipment manufacturer, raw materials (paint, aluminium, steel, etc.). The bargaining power of these suppliers is relatively low because there are many suppliers and MaxiTrans is such a major player that they can pressure them to lower the price of supplies and raw materials.


International Risk - MaxiTrans operates mainly in Australia and New Zealand. Its operations abroad are confined mainly to its joint venture in China, Yangzhou Maxi-Cube Tong Composites Co., Ltd. The operation has been running since 1996, for more than 10 years, and operates in a non-politically-sensitive industry. Even though there tends to be a lack of systematic legal framework for the business environment and that local policy is often subject to change, we feel that the long track record of joint business and the nature of the industry expose MaxiTrans to relatively low international risk with regards to their operations in China. With regards to exchange rate risk, the Chinese Renminbi is a relatively stable currency that is managed by the Chinese government and we expect a gradual appreciation in this currency with little major fluctuations. Overall, international risk is assessed as low.

Domestic Risk - Domestic risks that MaxiTrans is exposed to mainly refer to the risks in Australia’s economy. Australia has a stable and robust economy that has experienced consistent economic growth for the last 15 years. Because of the global resources boom, we expect this economic growth to continue at a stable pace. Inflation is relatively stable, although lately the economy is seen to be approaching full capacity and this may place an upward pressure on wage inflation and thus labour costs for the company. Interest rates are also relatively stable; the Reserve Bank of Australia does not expect more major upward hikes in the future. We do not expect any major interest rate fluctuations to have a significant impact on MaxiTrans’ debt payments. This is discussed in more detail when discussing credit risk below.

Industry Risk - As mentioned in the analysis of profitability, the trailer manufacturing industry is mature and stable, with relatively low rate of structural change. There are high barriers to entry and a few dominant players, of which MaxiTrans is one. The trailer manufacturing industry is cyclical; this will be factored into the analysis of financial risk later. Other risks related to the industry are that raw material prices may rise materially, and regulation, especially surrounding mergers and acquisitions, may change unfavourably. However, on balance, industry risk is assessed as low.

Firm Specific Risk – The trailer manufacturing industry is currently in a state of consolidation; MaxiTrans has been acquiring related companies in the last few years. The key risk of this corporate strategy is that acquisitions will be unable to integrate smoothly into the company. Furthermore, MaxiTrans has to take on significant amount of debt to finance these acquisitions. This has an impact on the long-term solvency and credit risk of the company, since leverage will increase and interest payments will rise as well. This is discussed more thoroughly below. Management’s ability to manage the acquisitions will play an important role in the success of the company.

Overall, firm specific risk is assessed as medium.

Coates Hire - Powering Ahead

1.1 Company Overview

Coates Hire supplies a large number of industries: building construction, engineering and maintenance, mining and resources, manufacturing, government and events. The majority of its revenues (80%+) come from operations in Australia.

Coates also operates overseas in the United Kingdom, with Coates Offshore providing specialised equipment to offshore oil and gas operations, and in Indonesia, operating on the mining and resource sector. Today, Coates Hire corners about 20% of the equipment hire market. It is clear and away the market leader in what is a highly fragmented industry that consists mainly of small companies.

1.2 Industry Overview

Equipment hire industry involves the business of purchasing and leasing out of equipment to industries such as building and construction, engineering, civil construction, building construction and maintenance, mining and resources, manufacturing, government, industrial maintenance shutdowns, and events.

Because the construction industry is highly cyclical (DITR, 2006), and accounts for a large percentage (6 per cent) of GDP, the equipment hire industry tends to follow the peaks and troughs of the construction industry and be cyclical as well. The equipment hire industry also tends to expand according to the growth in construction activity, which tends to follow economic activity.

For industry revenue forecasts, see Appendix A1.

1.3 Key Competitive Forces

Barriers to Entry: Barriers to entry for the equipment hire industry are relatively low. This is because anyone can purchase equipment and start leasing it out to customers with a relatively modest amount of capital, as long as the equipment meets basic standards of quality and safety. As a result, there are a large number of players in a highly fragmented industry. A key emphasis is thus placed on a company’s ability to differentiate itself from other competitors via economies of scale, customer relationships, range of services, and asset management.

Buyers’ Bargaining Power: The construction and resources industries are highly fragmented. This puts a cap on buyers’ negotiating power, which is generally weak. Equipment hire companies which are able to differentiate themselves and provide quality services can increase customers’ willingness to pay. The key threat is for construction companies to purchase their own equipment, rather than rent it. However, except for the largest construction companies, it is generally cheaper to lease equipment from equipment hire specialists.

Suppliers’ Bargaining Power: the industry presents an important number of suppliers, which means that the power is diluted between them. The competition in this industry for suppliers is important, so they have to be efficient.

Internal Rivalry: The industry is highly fragmented, with multiple small companies. Coates is the largest with about 20% market share. Other main competitors include Tutt Bryant Group, Boral, and Boom Logistics (check revenues). The most competitive firms tend to be large. This enables them to achieve economies of scale and provide a larger range of services. It also enables them to supply larger, more expensive pieces of equipment that earn higher margins.

Coates vis-à-vis the Broader Industry: Coates hire is the market leader, and with its size, scale, strong customer relationships and established business practices, it has been able to create sustainable competitive advantages in what is a highly competitive industry.

1.4 Coates’ Strategy

Coates purpose is to provide the best hire solutions on the market. The management defined its vision as “to become a $1 billion company by 2010 of first choice for customers, employees, shareholders and suppliers” (2005-2006 Full Year Results, p.3).

Coates’ strategy focuses on four dimensions:

Superior Customer Value Coates is committed to deliver the best value to its customers. The management believes that apart from delivering reliable equipment Coates should also provide customers with efficient support services and solutions options. The strategy is supported by consolidation of qualified HR and effective IT infrastructure - Coates Hire Enterprise Resource Planning (CHERP) and sales system “Coates@Work.”

The company also provides diverse range of services for its customers, via its multiple subsidiaries (Coates Hire, Coates Prestige, Coates Shorco, Coates Conrent, Coates Offshore). This allows the firm to provide value that other firms are unable to replicate.

This superior customer support service allows Coates to differentiate itself by providing value-added services in an otherwise undifferentiated market. By continuously innovating and upgrading its solutions options, Coates is able to sustain this competitive advantage.

Personnel and Human Resource Development Coates aims to attract and retain the best employees. It offers attractive salary and annual leave packages, provides a range of educational opportunities. In order to strengthen the skills of its management Coates launched two training programs for the management staff, Leadership Development and Frontline Management. Another area of primary focus is safety of employees. By hiring the best talent and giving them superior training, Coates is able to develop a sustainable competitive advantage in its human capital vis-a-vis its competitors.

Fleet management Coates claims (2006) that as a market leader it achieved significant ‘economies of scale’ in fleet management. The quality control is supported by a program “Silver Service”. As a part of financing activities, Coates heavily conducts reinvestments into its fleet. Coates has also developed superior fleet management technology in maintenance and storage. This allows it to depreciate equipment less quickly than its competitors and allows it to achieve lower costs and higher quality.

Business Growth via Acquisitions Coates plans further business expansion. It aims to achieve a sustainable growth by diversification and acquisition. Coates has executed this strategy successfully over the past decade by making multiple acquisitions and integrating them well. For example, (add example) This strategy of acquisition allows the company to consolidate a fragmented industry and build further its economies of scale, as well as derive other synergies from the diversification strategy.

In view of the above, diversity of business and revenue streams, both geographical, market and product, is the main strength of Coates Hire. The main weakness Coates identifies in limited capacity (2005-2006 Full Year Results, 2006).

Strategic Summary

Overall, Coates is a well established firm with a sound strategy and strong track record of executing its strategy successfully. It should continue to expand its market share in Australia as the industry continues to consolidate, and is in a good position to capitalise on opportunities overseas.

Tuesday, May 22, 2007

Stay Hungry, Stay Foolish

"Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma, which is living with the results of other people's thinking. Don't let the voice of others' opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what u truly want to become. Everything else is secondary"
- Steve Jobs @ Stanford 2005 Commencement Ceremony

Stay Hungry, Stay Foolish!

Sunday, May 20, 2007

Mergers and Acquisitions: Acquiring To Gain Market Access

Companies seeking to break into markets sometimes do so via acquisition. If the market is established and there are high barriers to entry, establishing a sizeable beach head through an acquisition is only the feasible way to do so, and can often be a costly exercise.

Take for example DBS Bank which acquired Dao Heng bank in order to gain access to the Hong Kong banking market. Or SingTel which acquired Optus to gain access into the Australian telecommunications market. Both paid high premiums to make the acquisitions, and both parent companies have taken large write-downs to their respective holdings.

A similar seems to have happened with OSIM. Osim acquired Brookstone, and paid a hefty 20x earnings to acquire the company. And now it looks like the acquisition is underperforming. Does the argument of acquiring to gain market access make sense?

Well the problem with doing so is that the acquiring company often pays too much for a second best asset that do not justify the premiums paid. The market leaders are hardly candidates for buyouts. Perhaps a better strategy is to pay a fair price for a smaller player and grow market share organically. Or the competitive nature of established markets may mean that a prospective entrant should stay away altogether.

Osim is likely to make a significant write-down of its acquisition of Brookstone in the future, if it doesn't divest the company at a loss.

Friday, May 18, 2007

A Tale of Two Mergers: Daimler Chrysler and OSIM International

Earlier this week, Cerberus Capital Management acquired an 80% controlling stake in Chrysler. In the process, the automotive manufacturing firm was de-merged from DaimlerChrysler in what has been called a 'divorce on earth', reversing what was hailed a merger that was termed a 'marriage in heaven' when Daimler Benz merged with Chrysler in 1998.

The performance if the merger, in retrospect, was abysmal. Daimler paid $36 billion for Chrysler, only to spin-off the company at a massive loss several years later. In the process, destroying shareholder value and grossly underperforming the market.

As we can see from the charts, in the years following the merger shares of Daimler lost 60% of their value, only recently recovering and experiencing a jump closer to the divestment of Chrysler. What went wrong?

In an earlier post, some comments were cited on why mergers go wrong:

"Mergers of equals seldom work because of ego and wallet issues. The target's top managers are not willing to get demoted, the target's corporate culture doesn't fit well with the buyer, the buyer doesn't have enough spare money to fix the unforeseen issues, etc."

The brand identity of Chrysler and Daimler did not really fit - Mercedes Benz cars are known to be quite a different breed from Chrysler automobiles. Further, there was the challenge of merging a company with two very different corporate cultures - American Chrysler and German Daimler. The economies of scale, collaboration of technologies, and project synergies between the two companies failed to materialise.

In Singapore, OSIM, an international lifestyle products retailer not too long ago made an acquisition of American retail chain Brookstone. And since the merger, OSIM's stock price has followed a similar trajectory to Daimler's after its acquisition:

The stock has crashed from its high of $2 to a dismal $0.70 of late. And there seem to be traits that the company has in common with the Daimler-Chrysler Merger. There are two very different corporate cultures operating here. An Asian corporate culture operating in OSIM, and an American culture in Brookstone. OSIM sells mainly high margin, upscale market products, while Brookstone sells many small, lower margin products. OSIM was also profitable all year round, while Brookstone only during the holiday season. To add to the problem, OSIM's core business suffered a set back earlier this year, when it posted its first quarterly loss in a long while. Also, it is pertinent to note that Brookstone and OSIM are about the same size. This is not a case of a big company making a small acquisition.

Does this seem to be history repeating itself, albeit in a different permutation? Will OSIM's performance continue to suffer up till the point when it decides to divest its stake in Brookstone? Only time will tell. But if I had to bet, I'd bet on this being a historical replay. We all remember what happened after AOL swallowed Time Warner, don't we?

Thursday, May 17, 2007

The Market Often Overreacts

In the middle of last year (2006), the U.S. congress passed legislation banning transaction processing between financial institutions and internet gaming outfits. Several internet gaming stocks were hammered subsequent to the legislation, and I posted a piece on why Cryptologic may not be a good stock to buy.

Well, since that bad news, the stocks of internet gaming stocks have since rebounded. If you had the fortitude to step back from your emotions and realised that the internet gaming market still had lots of room for growth, you would have made some major profits today.

PartyGaming took a major hit since the legislation, but has since rebounded, based on the performance of growth in the European gaming market. Cryptologic as well has shown similar performance.

As the charts show, both stocks have rebounded strongly from their lows. If you had jumped in to PRTY.L sometime after Nov06 you would have almost doubled your money. You would also have made a bundle with Cryptologic.

So, the lesson is, the market often overreacts, and periods of disaster can act as strong buying opportunities.

Tips on Mergers and Acquisitions

"Successful M&A activities occur mostly when the target is a lot smaller than the buyer. This means:

1. The buyer can flood the target with its own staff to impose its corporate culture;
2. The buyer can spend more money to cope with unforeseen issues; or
3. The buyer is only interested in a key technology, a key market, or a key customer, and is willing to write off the rest of the target's business.

Mergers of equals seldom work because of ego and wallet issues. The target's top managers are not willing to get demoted, the target's corporate culture doesn't fit well with the buyer, the buyer doesn't have enough spare money to fix the unforeseen issues, etc.

There are many companies that have pulled off successful M&A exercises. Any time you see an announcement that the company has purchased another company for $X, and the transaction does not require shareholder approval, that's one M&A that is likely to work out. Too many such cases to count, really. But if the target is big enough to require shareholders' approval, it's probably also too big to pull off."