The unparalleled rise and fall of Strathfield Car Radios

When Andrew Kelly was selling car radios in Sydney's bustling Paddy's Markets, he couldn't have expected to one day feature on the BRW Rich List, nor imagine the collapse of the business that put him there.

Kelly rode the mobile phone revolution, first to success and then to disaster.

And we followed his every step down.

The origins of Strathfield Car Radios 

The first Intelligent Investor office was in the architectural wasteland of Bondi Junction in Sydney's east.

The forlorn environment was well represented by a giant red sarcophagus of a building occupied by Strathfield Car Radio.

Had the remains of Chairman Mao been secretly buried in Sydney's eastern suburbs, this is where one might have found them.

Strathfield's arrival was prescient.

Telstra had released the first 1G phone on its analogue network in 1987, retailing for a staggering $4250. Strathfield, a retailer and installer of car phones, began selling mobile phones that same year.

Andrew Kelly had realised sooner than most that mobiles would be huge and wanted a part of the action.

In 1990, just 1% of Australians had a mobile phone. Ten years later, that figure had increased to almost 50%. Strathfield was riding the wave beautifully.

Recognising that competition would inevitably increase, Kelly carpet-bombed Sydney's airwaves with in-your-face TV and radio advertising.

The company's jingle, 'Drive in and jive away', became a part of the cultural vernacular, a symbol of a sales-driven organisation with a voice as loud as the paint on its walls.

Today, copycat advertising from Harvey Norman and JB Hi-Fi echoes the Strathfield approach.

It was intrusive and effective.

By 1998, Strathfield had 58 stores across the country. About two-thirds of the company's $150 million in annual revenue came from mobile phone sales and commissions.

Automotive electronics, such as alarms and CD players, once the company's bread and butter, were diminishing in their importance.

Through its exclusive relationship with Telstra, Strathfield had become one of the nation's largest mobile retailers.

Flushed with success, Strathfield listed on the Australian Securities Exchange (ASX) in July 1998, issuing 61 million shares at $1.70. Kelly's founding stake had made him wealthy.

With more than 50%, he had his eyes on greater riches. Covering the country in Strathfield stores was how he was going to do it.

The best time to invest in specialty retailers

Specialty retailers like Strathfield can be challenging investments.

Most struggle with high rents, operate in competitive fields and fight to establish a niche that offers even mediocre returns. Investing in them is a bit like sitting on a cracked toilet - a small shift in the foundations can end in disaster.

The best time to buy is when they're in rollout mode, taking a proven, established concept from, say, a handful of stores to hundreds. In 1998 Strathfield was in rollout mode and charging up the S-curve.

The sigmoid curve, as it is formally known, describes how a product or market (or virus, for that matter) progresses through the various stages of its lifecycle.

Understanding the concept and identifying where a company is in its lifecycle is essential to successful investing.

The mobile sector provides a classic example of an S-curve. When Telstra launched its first car phone, few purchased it except 'yuppies', who were disparaged and deemed 'up themselves' for doing so. Marketers call these people early adopters.

This is the emerging phase, when the idea is seeded but yet to take off with the general public.

With product improvements, price reductions and improved mobile coverage came rapid growth. This phase lasted around a decade before growth began to plateau as the market became saturated.

Mobile phone sales are now in decline and, like the pager, telex and fax machine, will likely be superseded one day by superior technology.

A similar dynamic is evident in specialty retailers. With clever management, some can extend their S-curve, but most cannot escape it.

Dick Smith and Roger David stores disappear

Former brands such as Brashs and Dick Smith (both electronics) and Roger David (menswear) have disappeared, and department stores are edging towards obscurity.

Everything has a limited lifespan.

At the time of Strathfield's listing, Kelly correctly believed it was near the beginning of its S-curve.

There was plenty of growth ahead. A year later, it was deep into rollout mode and growing like Topsy, forecasting sales growth of 12% but delivering a figure almost three times that.

New store openings were key. Planning to open 10 stores in the 1999 financial year, Strathfield opened 31 in just six months. The rollout was in full swing.

What analysts call 'same-store sales' or 'like-for-like sales' were also growing. This is a critical measure. A retailer can easily boost sales simply by opening additional stores, but often this negatively impacts per-store sales.

A good specialty retailer will be able to open lots of new stores and enjoy increasing per-store sales growth. The same-store sales metric reveals the performance of existing stores while 'store growth' focuses on the speed of the rollout.

From an investment perspective, a retailer increasing same-store sales while also opening new stores and having them reach profitability quickly is the perfect combination.

By January 1999, Strathfield's store openings were flying and same-store sales had increased by an impressive 15%. Crucially, most Australians had yet to purchase a mobile phone. Here was a stock perfectly placed on its S-curve.

Kelly had proved the model, everything was ahead of it, and it was cheap. At $1.85, with a prospective dividend yield of almost 6% and a price earnings ratio (PER) under 12, well below the All-Ordinaries average of more than 19%, we wanted a piece of the action.

No one in the Intelligent Investor team had any idea of the disaster it would become.

Things began well enough. In the next financial year, sales rose by more than a third, same-store sales increased 11% and profitability ballooned. With plans to open another 10 stores, Strathfield was in the sweet spot.

The rise of the dotcom boom

Other moves were afoot. Kelly purchased Eworld, a company making software for handheld computers, and engaged in some succession planning.

With the dotcom boom in full flight, he nominated himself as the new general manager and chief executive in charge of 'new opportunities'.

By February 2000, Strathfield's share price had risen to about $3.50 and Kelly made his move, raising $15 million to develop ecommerce business ideas through what became known as Strathfield E-Ventures, with Eworld at its foundation. Kelly was all-in on the dotcom frenzy.

The so-called TMT sector (technology, media and telecoms), of which Strathfield was a part, was the foundation of the dotcom bubble.

When the bubble began to burst, there was no escape. The momentum that had carried Strathfield's share price up to $3.50 began to operate in reverse and there was little Kelly could do about it.

Just a few months after launching E-Ventures, Strathfield announced its profits would be much lower than forecast.

The Strathfield Car Radios share price falls 50%

Kelly blamed it on Telstra, which was not 'competitive with other networks'. He set about refashioning the business.

The Telstra agreement was the first to go, replaced by an open-house model where all three mobile networks were sold in Strathfield stores.

An expansion into home electronics, including televisions and DVD players, was also announced. And just four months after it spearheaded Strathfield E-Ventures, Kelly announced that Eworld would be sold.

By mid-2000, the share price was down more than 50% from its dotcom highs and more than 25% from our original buy recommendation.

Kelly and fellow Strathfield board member Carl Olsen were unperturbed. Both were buying shares on the way down.

Insider buying, as it is known, is usually a good sign for external shareholders. When those who know the company best are loading up, there are usually good reasons to hang on.

The full-year results announced in August 2000 crushed that belief. Sales growth was negligible and net profit after tax dropped 34%. Displaying the natural optimism of a company founder, Kelly called the result an 'aberration'.

Many rapidly growing businesses face near-death experiences. This was Strathfield's.

The company had grown too quickly, with too many unprofitable stores, and had lost focus on what had made it successful.

Cost-cutting begins

A painful but necessary period of cost-cutting began. Of the company's 120 stores, 12 were closed.

The results for the year to June 2001 looked promising. Sales had increased by almost 11% and same-store sales rose more than 6%.

With the share price languishing at $1, we backed the turnaround and Kelly's self-interest in continuing to lead it.

The dawn proved to be false. In its early days, Strathfield had become synonymous with mobile phones. Its stores were where consumers went to get one. Growing competition and an ever-expanding product range undermined that proposition.

Strathfield had lost its brand leadership and, with it, a path to reinvention.

Cashflow, the lifeblood of every business, was becoming a problem. In 2001, Strathfield recorded more than $12 million in operating cashflow.

Two years later, that figure had dropped to an outflow of $14 million. In the 2004 financial year, it bled another $10 million.

With Strathfield on the edge of bankruptcy, the banks weren't interested in providing a lifeline. Shareholders had to step up or see their stakes disappear.

The company issued convertible notes and conducted two rights issues at share prices more than 90% below the original listing price.

Borrowing to survive

In desperation, it also borrowed from a privately owned finance group.

The impact was catastrophic. At the end of June 2002, Strathfield had 72 million shares on issue and was trading at a price of 31 cents. By July 2004, it had almost 300 million shares on issue.

The pie had become smaller and almost four times as many mouths were eating at it. The dilution had pushed the share price down to 12 cents. Strathfield was on life support.

We were as eager for a turnaround as the directors buying shares in the company, but on August 8, 2003, we finally bit the bullet, issuing a clear sell recommendation at 14 cents.

The company struggled on but never recovered.

When the board eventually called in the administrators in 2009, with the company still operating more than 75 outlets but owing $37 million, its shares were trading below a single cent.

Our investment in Strathfield had begun with huge promise and ended in a loss of 93%. It was our first big disaster.

The red flags that should have made us dump Strathfield Car Radios sooner 

1. A shaky business model

Strathfield Car Radios once solved a genuine customer need. Customers could 'drive in and jive away' by combining a car radio purchase with installation. It was a unique pitch that required technical expertise.

In comparison, selling mobiles was a cinch. The mobile networks advertised to get customers to Strathfield's stores. Once inside, staff helped them choose a model, do the paperwork and connect to a network.

Unlike car radios, almost anyone could sell a mobile phone and get it connected to a network. Within a few years, almost anyone did.

Strathfield's advantage was its large store network, but it operated in a sector where barriers to entry were coming down.

Strathfield's moat, as competitive advantage is sometimes known, was shrinking rather than widening.

The company was also exposed to economic slowdowns and, eventually, online sales that didn't require a store visit at all. Its 'lock' on customers was loosening.

For a few years, Strathfield's numbers gave it the appearance of a high-quality, growing business. Underneath, it was seriously flawed.

2. A store rollout problem

Retail stores are expensive to fit out, stock and staff. Thanks to leasing contracts, closing them is also costly. In any rollout, choosing suitable locations and quickly closing ailing stores is critical.

Strathfield got this wrong, further exposing its business model weaknesses. The company expanded quickly, incautiously and, eventually, unprofitably.

When the crash came and sales started to fall, inability to cut costs and close stores to keep pace with declining sales exposed the business to the looming cashflow crisis that was its downfall.

3. The gold rush effect

Every bubble is built on genuine promise. It is the excitement around it that does the damage. In 1998, it was a good bet that one day everyone would own a mobile phone.

The excitement over this rapidly growing market was obvious. Its impact on supply was less so.

In any gold rush effect, expected future demand inevitably increases supply. At their cost, investors tend to focus on the demand side of the equation and neglect the effects on supply.

With mobile phone retailers springing up like weeds, industry competition increased and margins declined.

Strathfield stores that were once profitable quickly became loss makers, not because the company overestimated demand but because it underestimated the impact of that demand on inducing supply.

4. Key supplier risk

If bought at sensible prices, Bunnings, Coles and Woolworths can be excellent investments, because their capacity to monopolise demand delivers market power.

If a farmer wants to sell thousands of pumpkins, she can't avoid a supermarket chain. The same goes for Bunnings and its cheap garden hoses and hammocks.

Being a gatekeeper to customers allows these chains to play off suppliers against each other, capturing margins that wouldn't otherwise be possible.

Strathfield had only one supplier - Telstra - and that left it dauntingly exposed. Kelly whingeing about its lack of competitiveness highlighted the problem: if Telstra faltered, so did Strathfield.

It was also dependent on Telstra for its advertising campaigns to drive customers into stores, and on credits and subsidies to support their purchases. Telstra, which cared only for overall mobile connections, effectively controlled Strathfield's destiny.

5. Lack of focus

Famed 1980s fund manager Peter Lynch invented the term 'diworsification' to describe an acquisition or an extension into a new area that reduces the quality of the company undertaking it.

Kelly had enjoyed a good run, jumping first on drivers' desire to have better sound in their cars and then climbing aboard the mobile phone revolution.

His next moves were both examples of diworsification.

Expanding into home office products, acquiring Eworld and launching Strathfield E-Ventures to take advantage of the dotcom hype indicated an overconfident management team needing more focus.

By the time they returned to what initially made the business successful, it was too late.

The aftermath

If you ache for a hard, demanding life, open a specialty retailer and watch your dreams come true.

Take pleasure from the endless, brutal competition, thin margins and astronomical rents. And if you make even average returns, give yourself a pat on the back. In this business, you must be dedicated and talented just to stay alive.

While riches await those who crack the formula of a unique retail concept, few wear the crown. Strathfield was one of a string of business failures in mobile phone retailing.

The major carriers now have their own store networks, and so-called mobile virtual network operators, such as Kogan Mobile, Amaysim and Lebara, piggyback on them with sharply priced retail offers.

Tough, competitive markets consolidate, with the spoils going to the most powerful players in the value chain - in this case Telstra and Optus and, of course, the phone manufacturers, such as Apple and Samsung.

In specialty fashion retailing, recent chain closures include Jeanswest, Seafolly, G-Star Raw and Esprit.

Over the past few decades, only JB Hi-Fi (a truly exceptional business), Flight Centre and, more recently, Lovisa, currently rolling out internationally, have endured and prospered.

Still, qualifications are needed. JB Hi-Fi has only expanded into New Zealand (and should be credited for not trying to go further).

Flight Centre still operates in South Africa, Canada and the UK but has expanded into corporate travel as its leisure business struggles with the shift to online bookings.

And Lovisa remains a long way from reaching its true potential. With its focus on selling disposable jewellery to faddish young adults, there remains a chance it may not.

With a small population, high rents and blistering competition, Australia has been a specialty retailing graveyard. Kelly eventually got the message. As the share price of Strathfield fell, so did his fortune.

But don't feel too sorry for him. In 2000, Kelly purchased a block of land from the Sydney Harbour Foreshore Authority for $52 million and established a joint venture with Multiplex to develop it. His timing was again perfect.

Three years later, Kelly sold down his majority interest, reputedly for $216 million. In 2005, he retired from Strathfield and moved to Hong Kong.

Strathfield Car Radios now operates from a single store in, yes, Strathfield in western Sydney - the location of his first outlet. After non-payment of annual listing fees, the company was delisted from the ASX in August 2013.

No doubt Kelly enjoyed the ride and came out ahead, but we learnt our lesson, steering clear of most specialty retailers until Lovisa joined the buy list at a price of $11.10 in early 2020.

Things have gone well since, but with the Strathfield experience etched into our memory, we'll be the first to get out if the investment case ever veers off course.

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