The man who built Portugal’s biggest nonfinancial company must now ask himself if it has become too much of a conglomerate and needs to be broken up.
By David Lanchner
August 2001
Institutional Investor Magazine
From modest origins as a producer of wood laminates for homebuilders, Sonae SGPS has grown in just four decades into Portugal’s largest nonfinancial company, with 2000 sales of E5.75 billion ($4.9 billion). Its interests now encompass real estate, retailing, telecommunications and tourism as well as wood products. Behind this remarkable transformation is Belmiro de Azevedo, who as chairman and CEO since 1965 - and majority owner since 1984 - delivered generally stellar returns to shareholders for years.
But in the past 18 months, Sonae’s share price has tumbled some 70 percent, while the PSI 30 index of leading Portuguese stocks has declined 44 percent. Moreover, most of the holding company’s listed subsidiaries, Modelo Continente (retailing), Sonae.com (telecoms), Sonae Imobiliària (real estate) and Sonae IndÏstria (wood products), have likewise seen their share prices fall.
Sonae has been beset by a world of troubles. The European telecom bubble burst, thoroughly splattering Sonae.com: In the first quarter of 2001, its net losses increased 69 percent from the same period a year earlier, to E15.9 million. Modelo Continente, dominated by supermarkets and hypermarkets selling groceries, is heavily exposed to wobbly Brazil. This hurts, as Sonae’s retailing arm accounted for 63 percent of the holding company’s sales and 55 percent of its E546.2 million in earnings before interest, taxes, depreciation and amortization in 2000. Sonae IndÏstria, meanwhile, has been investing heavily in plants even as the market for wood products has turned down along with the global economy. And de Azevedo’s newest venture, developing resorts, hotels, fitness centers and travel agencies in Portugal, continues to lose money.
In addition to the current setbacks, investors are concerned about the seeming lack of synergies among Sonae’s disparate businesses. “People are no longer convinced that Sonae SGPS is worth more than the sum of its parts,” says Manuel Preto, an analyst at Santander Negocios. Investors are also frustrated that the 63-year-old de Azevedo retains majority control. “Now that investors are focusing on sectors rather than countries, they don’t want to put money into relatively illiquid stocks in a small European country like Portugal,” points out Preto.
A chemical engineer by training who plays squash every morning - he’s said to be fiercely competitive on and off the court - de Azevedo has a passion for business theory and frequently attends programs at top U.S. business schools.
Here he discusses the not-so-theoretical problems facing Sonae with Institutional Investor Staff Writer David Lanchner.
Institutional Investor: Sonae is an authentic conglomerate. Why do you prefer what some would call an antiquated business model?
De Azevedo: In a small country it has permitted us to grow. We’ve used the revenues from mature businesses to finance growth businesses, allowing us to increase profits 81-fold since 1984, soon after we began diversifying out of wood products. The holding company also gives our subsidiaries pooled negotiating power when it comes to purchasing everything from financial services to utilities to cars. Most of the companies in Portugal are either our partners or our customers or our suppliers. That network helps all of our businesses.
But where do you find synergies to exploit among such a diverse collection of enterprises?
Our real estate arm builds and rents the shopping centers where our retail stores are located. By using our retail outlets to sell handsets and subscriptions from our mobile phone arm, we captured 22 percent of Portugal’s wireless telecommunications market in only a year and a half of operations. The conglomerate - I prefer the term holding company - worked very well until recently for both the creation of economic value and shareholder value.
But the conglomerate model doesn’t seem to be working so well now.
It’s true that most of our businesses have reached a critical mass. They can survive on their own, and as we expand outside of Portugal in areas like retail and wood products, the synergies we’ve employed at home become less practical. But we’ve changed radically in the past [de Azevedo has demerged and then remerged the wood products arm], and we are considering how new conditions might force us to change again. Organizing our businesses under the umbrella of a diversified group still makes a lot of sense. But if there is one thing I don’t want to be known for, it is stupidity. If there is a good case why we should not remain as we are, then we will change the structure and spin off our different businesses.
What factors explain the Sonae stocks’ poor performance of late?
For one thing, analysts believe that our real estate and retail businesses are overexposed to Brazil. Also, both the group and our telecom subsidiary have been hard hit by the dot-com crash. In the wood products business, we have just finished a big spending program, building new factory capacity at a time when the economic situation in the world is deteriorating. We believe in all these businesses, though, and we’re very confident, even if we are not very comfortable at the moment. That doesn’t mean we are happy with the underperformance of our stock, and we’ve initiated a full review to study how we might boost value.
What can you tell us about that review?
We only started to study our options this June, but we will focus on eliminating the discounts to our sum-of-the-parts valuation [model]. We’re unlikely to alter our holding company structure, but we will make significant changes. One may well be stock market listings outside of Portugal for the holding company and the listed subsidiaries. With the advent of the euro, small exchanges like Lisbon’s are dying. At its peak the value of the Portuguese bolsa was 150 percent of GDP. Today it is barely 80 percent. On the strategy front we’ve got to convince investors that when Sonae makes an investment - much as when Warren Buffett or General Electric does - it increases, rather than limits, potential value.
If you’re looking to boost the value, why not increase the free floats of Sonae SGPS or the subsidiaries?
That could be part of a solution, except for one factor: At present our shares are too cheap, and one thing I will never do is sell a cheap share. That would dilute the value of shares owned by investors who have been with us many years, including myself. Besides, the only real way to significantly push up the share price just by increasing the free float is to put yourself in a position where you can be taken over, which is not something I want to do at this point.
Although analysts believe your retail arm is overexposed to Brazil, a country in the midst of an energy crisis, you want to increase investment there. Why?
This is a country with enormous growth potential, and shopping malls, hypermarkets and supermarkets are only just developing in Brazil, so now is the time to invest. We intend to spend E650 million there between 1999 and 2004. That’s a lot of money, but the risk isn’t as high as the analysts think. We are not investing in financial assets. So a spike in inflation or a devaluation will not affect us for too long.
How do you intend to revitalize your wood products arm?
We’re the No. 1 company in the world in particleboard, but margins are getting thinner, so to stay competitive we need to copy the American model of having pulp and paper operations as well as particleboard. The first step will be bidding for a controlling stake in state-owned Portuguese pulp and paper group Portucel when it is privatized - hopefully by the end of the first quarter of 2002. I am also looking for industrial and financial partners to reorganize our forestry products and lighten our capital structure on a wider world scale and become much bigger.
What’s the financial state of your telecom arm?
We’re not in bad shape at Sonae.com. At E100 million, we paid too much for our UMTS [third-generation wireless] license, but it was still the cheapest auction in Europe if you measure cost on a per capita basis. It is very difficult to justify that investment given the much lower expectations for third-generation telephony, but it’s now sunk. Now we have to be very creative about how to reduce our costs. Already, we have decided to share infra-structure costs with one of our two main competitors, Telecel Vodafone. There is likely to be consolidation in the sector, but we are well prepared to keep our key position in mobile telephony.
Are you are trying to develop any new businesses?
It is difficult enough managing all the things we are trying to do right now.
