This document discusses the risks and potential impacts of international expansion for Australian mining companies. It notes that while expanding internationally can provide access to new markets and resources, there is often an initial drop in financial performance known as the "j-curve effect" as companies adjust to new foreign markets. The magnitude and duration of this downturn depends on the adequacy of planning and commitment level. The document cites the example of Eltin, an Australian mining contractor that overextended itself internationally in the late 1980s and never recovered after facing issues in South America and France. It recommends that investors carefully examine any company's risk management plans and board experience before investing in a firm expanding overseas.

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15RESOURCESTOCKS| november 2006
I
n this current age of globalisation,
diversification can also include a degree
of internationalisation. So, what level of
time and expenditure should Australian
mining companies commit to looking to
explore and/or invest overseas?
It is generally assumed that the
performance of a firm improves as the
firm’s multinational exposure grows. This is
mainly attributed to the ability of companies
to leverage their capabilities in new markets,
and access markets that are less saturated
with competition than their own.
Yet recent empirical studies across
multipleindustriesandcountrieshaveshown
that in the short term, there is an initial
negative effect of international expansion on
performance before the positive returns of
international expansion are realised.
Studies also suggest that any international
expansion beyond an optimal level is
detrimental to performance in the long run.
The initial drop-off in company
performance after it establishes itself
overseas has been attributed by various
authors to an insufficient scale early on in
the company’s global operations, as well
as initial learning costs, and cultural and
foreign market inexperience.
I prefer to describe this under-
performance with a more simple term
– “the j-curve effect”.
In my experience, mining companies
and companies that service the mining
industry generally do tend to recognise
a drop-off in financial performance
immediately after embarking on a strategy
of internationalisation.
The magnitude of the initial downturn
in value, and time for recovery, also tends
to be dependent on the adequacy of
planning and level of commitment. If the
initial commitment is not large enough
and the execution planning not sufficiently
adequate, sometimes companies do not
recover from this drop in value.
Arguably, this was the fate of companies
such as mining contracting market darling
of the 1980s, Eltin.
In the late 1980s and early 1990s, Eltin
embarked on a strategy of diversification
away from its core business of mining
contracting services by developing local
and international mining interests in France
concurrently with large mining contracts in
South America.
Was it avoidable that Eltin did not allow
for the effects of freezing conditions
and the high altitude of the Andes on its
equipment costs and performance?
Local and experienced international
contractors did not make this same
mistake. Eltin never really recovered from
these issues and the political and technical
complications that befell it in France.
Overseas markets, particularly in
developing countries, offer the potential
for mining companies to access high quality
ore bodies at potentially low, long-term
cash costs. The average cash costs for
mining gold in South America is $US155
per ounce and for
West Africa it is
$200/oz, compared
with $268/oz in
Australia.
To say that lower
costs mean higher
share price is not
necessarily true,
even in the long run.
Lower costs need to
be considered in light
of investor appetite
for risk.
The price-earnings
ratio of companies
with exposure to
developing markets
is generally lower than those with most of
their operations based in Australia. A lower
P/E ratio tends to amplify any impact on
the share price of a drop in earnings post-
internationalisation – in effect a double
whammy blow for a company.
I suggest any investor look very carefully at
theopportunityinquestionbeforedecidingto
invest in (or hold on to) shares in a company
embarking on overseas expansion.
If a formal and comprehensive risk
management plan is in place, and the board
has a clear strategy for management of the
risks, then further investigation may be
warranted. A tip would be to look for relevant
international experience at board level.
Perhaps companies should heed the
caution, “It isn’t what you don’t know that
hurts you, but what you know that isn’t so.”
Momentum Partners is a Perth-based
management consulting firm focused on
servicing the mining sector.
Last month, Management Speak looked at the question of
focusing on a single commodity versus diversifying into
multiple commodities, but what of the issue of diversifying
internationally? David Noort looks at the options.
speakmanagement
David Noort, Momentum Partners: Studies also suggest that
any international expansion beyond an optimal level is
detrimental to performance in the long run.
Foreign markets:
Prosperity or peril?
ManagementSpeak
Time post
internationalisation
Shareprice
Optimal
Over
internationalised
Poorly
planned
RS
potential impact on share price
from international expansion
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