4 Real Benefits from International Expansion
April 16 2012 by John R. Cryan
With sluggish US growth, international business expansion has become a vital strategic pillar for many companies. Yet, an international expansion strategy is fraught with uncertainties, risks and other obstacles. So is it worth it? That is, are companies that grow faster internationally rewarded by investors with better share price appreciation such that the risks are worth taking?
Fortunately, for executives longing to accelerate their international expansion, our capital market research indicates shareholders do in fact reward companies who grow faster outside of the US.
To determine this, we studied 202 current non-financial members of the S&P 500 from 2007 through 2011 that publish full data including detailed international revenue figures. The companies were separated into high, middle and low groups based on their rate of non-U.S. revenue growth and for each group we examined the median total shareholder return (TSR), reflecting dividends and share price appreciation.
The high international revenue growth group generated a 37 percent greater TSR compared to the low international revenue growth group and a 27 percent greater TSR compared to the middle international revenue growth group. U.S. companies with stronger international growth do tend to deliver significantly better returns to shareholders. However, companies that already have a large international presence should not rest on their laurels. We found no TSR outperformance by companies that simply maintained a large percentage of their revenue outside the US. Companies created superior shareholder returns by growing their international business.
The good news for executives aiming to expand their international growth plans is that success is not industry dependent. The high international revenue growth group included companies from over forty different industries including luxury goods leader Coach (COH), packaging giant Ball Corp (BLL) and biotechnology superstar Biogen Idec (BIIB). The diversity of the high performers provides confidence that most companies can succeed abroad if they focus on developing and executing a value creating strategy.
For most companies international growth is a value accelerator. On median, the high international revenue growth group derived several notable benefits from their expansion:
- They grew faster overall: Total revenue growth for the high international growth group was 6 percent and 8 percent per year faster than the middle and low international growth groups, respectively.
- They diversified their revenue stream: The share of their total revenue generated outside the US for the high international growth group increased by 7 percent which was 4 percent and 7 percent greater diversification than the middle and low growth groups, respectively. In fact, nearly one out of five delivered enough growth from their international operations to offset negative growth in their US business and still deliver an overall top-line increase.
- They improved their return on capital: The return on capital for the high international growth group improved by 1 percent which was 1 percent and 2 percent greater improvement in returns than experienced by the middle and low growth groups, respectively. This is in contrary to a commonly held belief that international expansion will lead to declining returns.
- They increased their reinvestment rate (defined as (Capex + R&D)/EBITDA): The high international growth group was able to redeploy 5 percent and 3 percent more of their cash flow than the middle and low groups, respectively.
A well designed growth strategy creates future capital deployment options. It is likely that companies with growing international businesses will be able to continue to redeploy more cash flow.
Rather than having to make trade-offs amongst the three value drivers of Growth, Returns, Reinvestment, the companies demonstrating greater international growth were able to improve on all three dimensions which led to significant shareholder returns.
Lastly, their international growth was likely perceived as “more valuable” to shareholders as not only is current growth stronger in many international economies, many “emerging markets” are less mature so the elevated growth is expected to remain lofty for a longer period of time.
The Case of Two Restaurant Strategies
Consider the strategies of two of the world’s largest restaurant companies. While not direct competitors, Yum! Brands (YUM) and Darden Restaurants (DRI)’s both seek to encourage patrons to consume more meals outside the home. However, their approach to international expansion couldn’t be more different.
While Darden grew 3 percent faster per year from 2007 through 2011, YUM’s TSR was more than four times greater. Why did investors bid YUM’s shares up so much on a relative basis for a slower growing company? After all, most valuation experts would tell you that if all else is equal, more growth should translate into greater share price appreciation.
In this case, all else is not equal. Darden’s revenue was completely US derived. Only recently has the company begun to test an international expansion strategy while YUM has been successfully operating abroad for many years.
YUM’s international growth strategy has been so successful that the company was able to offset an 8 percent revenue decline per year in its US business with robust 14 percent growth per year in its international segments. The company now generates over 70 percent of its revenue outside the US—a twenty percent change in revenue mix in just four years.
To support this bold international growth strategy, YUM has aligned its capital allocation process by increasing international capital expenditures by over 50 percent, while decelerating capital expenditures in the US. In addition, the company has reduced its financial risk by increasing liquidity and reducing its balance sheet debt, potentially allowing the company to bear more business risk inherent in operating abroad.
Shareholders continue to believe in the future of Yum!’s international expansion and thus far they are willing to tolerate the inherent risks of operating abroad so long as it continues to lead to robust growth.
While the nuances of every company’s international growth strategy will differ, our research findings indicate that most companies can succeed abroad if they focus on developing and executing a value creating strategy.
To do so, companies must fully evaluate their ability to generate a combination of positive returns and revenue growth that more than offset the inherent risks of operating abroad. The leading practice in this area is to conduct an elaborate assessment at a granular market by market, product by product assessment of the profit potential,
Ultimately, investors handsomely reward companies who can grow their business outside the US. Therefore it is critically important for executives to evaluate their strategy to ensure that international growth is encouraged and rewarded.