SME Times is powered by   
Search News
Just in:   • Banks to recycle inward currency notes only after 48 hours on corona threat  • China's Shenzhen city bans eating of cats, dogs  • British Airways expected to suspend 36,000 staff  • Wall Street tumbles amid deepening coronavirus fears  • COVID-19: LinkedIn offers free job postings for critical roles 
Last updated: 19 Jan, 2020  

Rupee.9.New.Thmb.jpg Investment Strategy 2.0

Rupee.9.New.jpg
   Top Stories
» Markets tank 1,200 pts on Corona crisis
» Indian IT sector set to face hardship
» Startups hit as investors get extra cautious
» Feb core sectors output up by 5.5 pc
» Developing nations to lose $800 bn in export revenue in 2020
TAPONEEL MUKHERJEE | 19 Jan, 2020
Recently, market commentator Saurabh Mukherjea pointed out the formalisation in various sectors of the Indian economy leading to the emergence of one or two giants in each industry, thereby creating a market structure where a larger share of the profits sits with fewer firms. The price action India witnessed last year with the BSE Sensex soaring even as BSE Small-Cap index failed to keep up would provide further credence to the theory.

The above-mentioned ability of large firms to capture larger profit shares and investment dollars would imply that there is value in considering a business that can create "accretive" growth platforms that, in turn, can create future giants. Essentially, now is perhaps the time when investors, including local conglomerates and foreign funds, must look at sectors that still have structural demand but are constrained by poor capital allocation and, more importantly, lack of access to capital. The trifecta of deal sourcing, deal-making, and truly creating operating efficiencies can be a game-changer.

Primarily, the major focus for funds in India has been on carve-outs or traditional buyouts of companies in India. In a carve-out, the fund primarily acquires an asset that perhaps a large conglomerate is divesting. Alternatively, the traditional buyout business has seen investors take a stake in an existing business. Going forward, creating "platform companies" that can be growth accretive platforms is a strategy worth pursuing. The focus of the "platform companies" will have to be not just growth, but growth that can drive the levers of value creation through volume expansion and margin improvement at the same time.

Quite simply, one can think of the value of businesses as the present value of the free cash flows a firm generates. The free cashflow is essentially the difference between the "return on capital" and "cost of capital". The phenomenon Saurabh Mukherjea talks about is the fact that smaller businesses in India have struggled to generate a significantly higher return on capital over and above their cost of capital. And this is where investors need to step in to create growth-oriented platforms that can generate profits through creating efficiencies.

While creating such platforms, the focus must remain on using growth and related scale advantages to expand margins and indeed, create pricing power, lower cost of borrowing and improve operating leverage. Fundamentally, improve free cashflows significantly.

The ability to create platforms that can be profitable and generate value will stem from the capacity to truly expand margins and lower the cost of capital through acquisitions and growth that do help in achieving the two objectives. The phenomenon of large efficient companies capturing more significant market share is amongst other factors driven by the virtuous cycle of a lower cost of capital allowing them to do "projects" that offer a lower return and yet the project still helps them reduce their cost of capital further -- thereby creating a cycle of growth, margin expansion and profitability.

To illustrate the above point, suppose there are two companies A and B. Company A has a cost of capital of 10 per cent while that for Company B is 14 per cent. A project that offers a return of 12 per cent is not only profitable for company A but may even assist in synergies that may help further lower the cost of capital for company A. What the "inners" as such have been able to do is to continually work towards growth that has assisted them in creating more substantial free cashflows, thereby allowing them a lion's share of sector profits.

Value accretive investment platforms are a phenomenon quite visible in the West. While their merits and demerits can be debated, the fact remains that when done well, they have created significant value. The IACs and AB InBevs of the world have demonstrated that growth-oriented accretive platforms can generate value for all, including for both the end consumer and shareholders.

Creating such platforms will also allow investors to have a higher level of control on the debt structure of the business. Issues around debt have hurt investors and businesses alike in India. When one adds to the mix that Indian debt-markets are still evolving, one realises that a good investment thesis in India will require much more thought, control and execution around the capital structure. Identifying high-demand sectors is a good start, but unless in the long-run one can ensure that the return on capital is higher than the cost of capital, high growth may not always guarantee high investment returns.

In the quest for the next phase of growth and returns, growth accretive platforms deserve focus. However, success will need time and operational diligence. The winners of tomorrow may be decided in no small extent by the capacity to be hands-on and create the next phase of free-cash-flow generators.

(The views expressed in this article are personal and that of the author. The author heads Development Tracks, an advisory firm. You can contact him at taponeel.mukherjee@development-tracks.com or @Taponeel on Twitter)
 
Print the Page
Add to Favorite
 
Share this on :
 

Please comment on this story:
 
Subject :
Message:
(Maximum 1500 characters)  Characters left 1500
Your name:
 

 
  Customs Exchange Rates
Currency Import Export
US Dollar
66.20
64.50
UK Pound
87.50
84.65
Euro
78.25
75.65
Japanese Yen 58.85 56.85
As on 02 Apr, 2020
  Daily Poll
Ease of doing business improved in last one year
 Yes
 No
 Can't say
  Commented Stories
» China's forex reserves reach USD 2.85 trillion(4)
» Package for SMEs, others on cards, indicate Sitharaman(1)
» Private banks, NBFCs to continue EMIs, if not informed(1)
» The big bang RBI stimulus(1)
» Appoint distributors, expand your business(1)
 
 
About Us  |   Advertise with Us  
  Useful Links  |   Terms and Conditions  |   Disclaimer  |   Contact Us  
Follow Us : Facebook Twitter