Li & Fung

Li & Fung needs to focus on its core businesses - and get rid of the rest

Instead of building a conglomerate, the firm should extract value from sourcing operations

PUBLISHED : Thursday, 03 April, 2014, 11:09am
UPDATED : Friday, 04 April, 2014, 12:27am

Investors should be sceptical of any company that heavily depends on a strategy driven by acquisitions and restructuring, but Li & Fung's appetite for deal-making, which chief executive Bruce Rockowitz claims offers "huge synergies", is looking less credible by the year.

While outsourcing and trade generate revenues, Li & Fung's own business model may be dying, and the Fung brothers and Rockowitz may be incapable of transforming it because they are stuck in their old habits.

Today, the company's shares trade at half their price two years ago and continue to languish at their lows despite improved performance. Investors have downgraded the forward price-earnings ratio from 26 times to 16.

During a difficult business turnaround, shareholders deserve the best managers, not necessarily family members

The glory days of bolting on numerous cheap acquisitions in exchange for more earnings are becoming more difficult to replicate.

Li & Fung's recent results announcement included a proposed spin-off that should have been done years ago instead of ignoring analysts' call for an easier-to-understand business structure.

Still, it doesn't go far enough. The company should sell its non-core businesses. But before doing so, senior management needs to decide what the core business is - and convince investors it can focus on operations.

Management's response to a 42 per cent fall in core operating profit from 2011 to 2012 was a spurt of 10 acquisitions last year valued at US$541 million, with an aggregate turnover of US$557 million.

And if that was not enough for most teams to effectively integrate, they included a global licensing agent in Europe with a portfolio of brands.

Rockowitz still suffers from a credibility gap from when he sold 15 million of his 58 million shares in the company in January 2011 - before its steep descent. He claimed a need to diversify his assets - a poor explanation that only invited widespread investor scepticism.

Management needs to demonstrate commitment to its strategy before investors will buy the stock.

Li & Fung's results announcement for financial 2013 does not show how value will be created from a sluggish economy and consumer spending in the United States.

While net profits improved 17 per cent year on year, turnover only grew 3 per cent. Its trading operations produce 62 per cent of its core operating profit, and the US makes up 70 per cent of trading turnover.

But one revealing measure is that sales per worker have fallen and stagnated from about HK$7 million in 2009 to HK$5 million in 2011 and then HK$5.7 million last year.

Li & Fung's latest restructuring proposal separates its operations into three groups - sourcing, logistics and global brands. The divisions appear logical, but management has not explained how a brand management and marketing business is relevant.

Brand ownership and licensing only reinforces the company's persistent reputation among analysts that it is eager to justify irrelevant acquisitions.

As part of the proposed restructuring, Spencer Fung, the company's chief operating officer and the eldest son of co-founder Victor Fung Kwok-king, will succeed Rockowitz as chief executive.

Unfortunately, as with too many family-controlled Hong Kong companies, Li & Fung cannot seem to shake the habit of bringing sons and daughters into top management. During a difficult business turnaround, shareholders deserve the best managers, not necessarily family members.

Li & Fung originally promised investors a window into China trade. Now it has become an overrated mix of unrelated businesses that management insists on hyping like a failed diva.

A management buyout or outright sale of non-core businesses such as global brands would be a first step towards refocusing the company.

Major acquisitions are difficult enough for many organisations to turn into successes, and Li & Fung's tendency to make small deals frustrates analysts and investors.

Sourcing is a thin-margin business at best. The firm is best known as a sourcing agent for American retailers including Wal-Mart Stores. But as a middleman in all of its businesses, it is plagued by the same problems confronting Asian traders.

Improved technology, widespread internet and increasing trading volumes are enabling suppliers and customers to deal directly with each other. Chinese e-commerce companies like Alibaba are rapidly changing the way products are bought, sold and transported.

Li & Fung's future will be determined by how it adapts and extracts value from sourcing. It should cease conglomerate-building.

Peter Guy is a financial writer and former international banker