Feature

Domini Stuart examines the opportunities and risks of investing in booming Western Australia.

WA Update

Western Australia (WA) is one of the most productive and diversified mineral and petroleum regions in the world. Its Department of State Development reported that in September 2010, projects worth $150 billion were either locked in or under consideration.

"In essence, the growth within WA may be so great that it is beyond the capacity of many people to conceptualise," says Ross Goldstein, managing director of Mergers & Acquisitions.

Yet more opportunities are growing out of the state’s links with Asia, and China in particular. Rio Iron Ore CEO Sam Walsh AO FAICD recently told investors that many large Chinese provinces were only just beginning to climb the "steel intensity curve" and that Rio Tinto was poised to capture the growth associated with higher standards of living in emerging nations. Rio is also one of the growing number of businesses looking west to India and Africa.

As the resources sector continues to expand, so too does demand for businesses that support it – everything from legal, financial and information and communications technology services to catering for mining camps, providing marine infrastructure services and marketing heavy equipment or mining-process supplies.

"In addition to this I believe that, as the profile of the WA resources sector develops in a global context, more and more companies will be making Perth their corporate headquarters," says Clinton Bradbury MAICD, senior registrar/owner at West Australian Corporate Register (WACAR) and an acquisition specialist at Ellis Corporate.

"This will bring its own opportunities and over time, as the population increases, there will be even more prospects for businesses with a domestic or retail nature."

Meanwhile, Liz Constable, WA minister for education and tourism, reports that the tourism industry is already generating more than 80,000 jobs and contributes $7 billion to the state’s economy each year.

The state is also home to two internationally recognised science parks – Technology Park Bentley and the Australian Marine Complex (AMC) Technology Precinct.

"Both host an array of enterprises that benefit from the proven opportunities colocation and collaboration bring," says WA commerce and science and innovation minister Bill Marmion. "Technology Park Bentley also houses the Innovation Centre of WA, which helps entrepreneurs and innovators through the commercialisation process. This centre is a central hub for innovation."

A favourable political environment is another drawcard for companies outside the state.

"The WA Government is not as financially stretched as some other state governments and therefore has resources it can dedicate to facilitating private investment," says Carl Adams MAICD, managing director of Momentum Partners. "It is also prepared to pressure the Federal Government on constituents’ behalf."

Feet on the ground

There is certainly a wealth of opportunity on offer, but Bradbury cautions against getting caught up in the activity and excitement. "Directors need to keep their feet on the ground and make smart, long-term decisions," he says.

Craig James, chief economist at CommSec, points out that while WA will certainly benefit from continuing industrialisation and urbanisation in China and India, it won’t all be one-way traffic.

"A high Australian dollar will negatively affect tourism and export- and import-competing sectors in the all states and territories, including those dependent on commodities," he says.

Competition might be greater than anticipated, particularly if similar products can be sourced from Asia. And, Bradbury believes directors in the resources sector are also likely to face an element of sovereign risk.

"This reflects legislative uncertainty around issues such as WA royalties and the interplay with Federal intentions," he says. "It is very hard to manage in this sort of environment as there can be a considerable speculative element."

Cost overruns are a particular danger, made more so by the size of some projects. For instance, Walsh has said that gaining access to sufficient capital and infrastructure and environmental and regulatory approvals make it difficult for Rio to stay on time and on budget.

However, access to resources is likely to present the greatest future challenge.

Energy and water are major concerns and while some infrastructure is in much better shape than in the eastern states, there is still some catching up to be done. Capacity constraints, particularly in the Pilbara, are well known, but CommSec’s latest State of the States economic performance report shows housing has become a serious issue.

"WA is actually the weakest state for housing finance, with trend commitments 28 per cent down on its decade average," says James.

"In addition, WA housing finance commitments in August were almost 32 per cent down on a year ago. While mining is its strong suit, housing activity could be WA’s Achilles heel."

There is also the matter of filling the half million or so extra jobs likely to be created over the next decade. The Chamber of Commerce is predicting a 200,000 shortfall across the spectrum of platinum, white and, in particular, blue-collar workers.

"Directors must critically assess project do-ability in terms of access not only to capital and approvals but also to people," says John Barrington FAICD, managing director of the Barrington Consulting Group. "This is creating a sense of competitive urgency to get major projects underway."

Dangerous assumptions

One of the biggest mistakes a director could make is to assume a company involved in the energy and resources sector will automatically be profitable.

"Even in circumstances where the organisation is involved with high-profile projects, you need to ensure it has the skills and capacity to meet its obligations," says Dean Hely MAICD, deputy managing partner at Lavan Legal.

"Take a close look at the management and if the quality isn’t there, establish steps to introduce whatever is needed to drive the company forward.

"In the resources or mining sector, due diligence around occupational health and safety (OH&S) and environmental issues is critical. You need to be confident the people managing these areas are up to the job or be prepared to bring in external consultants."

Another mistake would be to be lulled into a false sense of security; a buoyant economy won’t cover weaknesses in a business or excess financial leverage.

"Even in a boom, slow cash flow can starve a business to death," says Bradbury. "Cash is always king, and businesses attempting to move into what they perceive as a boom market need to be managed closely to ensure cash flow remains in balance.

"The best way to mitigate this is with growth by acquisition. Buying a business already established in WA that has the ability to provide immediate, meaningful returns definitely brings greater certainty."

Even in this case, that Perth is so remote from other Australian cities needs to be factored into the equation. It is easy to underestimate the travel burden for senior management and for those with a home and family in another state, the sense of isolation can be heightened by the time difference.

There is no daylight saving in WA and for half the year Perth is three hours behind Melbourne and Sydney.

"It is essential that there is either a strong management team in place or that golden handcuffs, earn-out arrangements or shareholding arrangements tie the seller to the business long enough to ensure a seamless transition of ownership," says Goldstein.

Directors should also give priority to the "softer" side of a merger or acquisition.

"A business may have its policy and procedures in place but you also need to harness the intellectual skills of the management team and win its support," continues Goldstein.

While this is true in any state, in WA a slightly different approach may be needed.

"I think our remoteness has helped to create a unique culture," says Barrington. "There’s an entrepreneurial spirit here, an attitude of ‘just get on and do it’ that isn’t dictated by the major financial centres. A ‘we’ll just fly in and do it our way’ approach isn’t likely to work."

Western Australians also expect a genuine commitment to the state.

"I have attended a few presentations recently and the question of local content in projects is always mentioned," says Bradbury.

"There’s an overriding sense that we need local providers to be commercially competitive. Directors should not come to WA expecting to get exposure to the resources sector and charge bullish prices, but rather with the intention of achieving exposure to a global industry and therefore further opportunities for growth."

Being on a board

The fundamental responsibilities and duties of a director are the same across Australia. However, despite the push by the Council of Australian Governments and the Federal Government for national harmonisation, there are still some state-to-state differences in relevant laws.

"Directors working in the property sector need to be aware of approvals required under a number of Acts, including the Planning & Development Act, the Environmental Protection Act, the Environmental Protection Biodiversity & Conservation Act and the Contaminated Sites Act," says Hely.

"There are some circumstances where directors can be held personally liable."

The dominance of the resources sector means directors who plan to sit on more than one board need to be particularly mindful of their obligations in terms of conflict of interest or conflict of duties.

They should also be prepared to share a board with nominee directors. Many businesses benefit from foreign investment and some investors require a say in the way the company is run.

"Nominee directors have the same obligations as other directors to act in the best interests of the company," continues Hely.

"However, as they’ve been put there by a specific shareholder or investor, they do bring about a slight change in the dynamics of the board."

A wider responsibility

One side effect of any high-growth economy is a widening of the gap between the "haves" and the "have nots".

"Social responsibility is not just a catch phrase here. It’s a real requirement," says Barrington.

"I think there’s a very strong sense of that in the WA business community. People are giving a great deal of consideration to Indigenous employment and positive action on Indigenous issues.

"There is also a very genuine corporate focus on working with state and local governments to develop the state socially, culturally and environmentally as well as economically.

"It’s challenging to do that when you’re moving ahead apace, but my sense is there’s a real intent to do so – and directors coming in from outside WA need to be cognisant of that."

TEN things a director needs to know

Associate director of Perth-based management consultants Momentum Partners, Chris Still, was on the board of a Queensland company when it acquired two businesses in WA. He recommends that any director considering a move west should be sure of the answers to the following questions:

• Does the business fit with the strategy and core competency?
• Will the returns compensate for the risk and generate shareholder value?
• Does the company have the resources to oversee the new business?
• Is the existing management of sufficient quality to meet directors’ expectations?
• Is the financial management appropriate to directors’ needs?
• How will the acquisition be integrated?
• Should we trust the vendor/s?
• Have we done sufficient due diligence?
• How would the company cope if a newly acquired business materially underperformed expectations?
• What are the future financing implications for the acquirer?

The economy at a glance

Economic growth is expected to increase to 4.5 per cent in 2010/11 and 4.75 per cent in 2011/12. This will largely be driven by major construction projects, including the $43 billion Gorgon LNG Project.

Employment is expected to grow by 1.75 per cent in 2010/11 with unemployment falling to five per cent in 2010/11, and then to 4.5 per cent by 2013/14.

The WA domestic economy, as measured by State Final Demand, grew by three per cent in the June quarter of 2010, and 7.9 per cent compared to a year earlier. This represented the strongest annual rate of growth since December 2007.

Business investment was also a major contributor to growth in the WA economy over this quarter, in line with a pick up in activity in the state’s mining sector. This saw investment by local firms increase by 4.1 per cent in the June quarter of 2010 to stand 1.4 per cent higher than a year ago.

The Government has also played an important role in boosting the WA economy in recent times; the impact of fiscal stimulus spending is still being felt. During the June quarter, government investment grew by 7.7 per cent and is now nearly 56 per cent higher than a year earlier.

With the recovery in the local economy gathering pace, the local labour market has improved considerably in recent months. WA’s unemployment rate stood at 4.6 per cent in September 2010 (for November 2010 this was 4.5 per cent) – well below its peak of 5.7 per cent in September 2009.