August 14, 2013
Strategy
THEMATIC
Greatness ‘at risk‘: Asian Paints, Titan
and Sun Pharma
Analyst contacts
Saurabh Mukherjea, CFA
Tel: +91 99877 85848
saurabhmukherjea@ambitcapital.com
In our 7 June note, we had highlighted that 85% of successful Indian
firms slide to mediocrity within five years of achieving great success. Gaurav Mehta
We had also laid out a five-part path to decline which seems to be Tel.: +91 22 3043 3255
gauravmehta@ambitcapital.com
followed by most Indian firms. In this note, we highlight specific
markers which investors can use to identify ‘great’ firms which are on Consultant: Anirudha Dutta
the cusp of entering the path to mediocrity. Using Asian Paints, Titan Tel: +91 9820134825
and Sun Pharma as case studies, we point out that these markers anirudha0765.dutta@gmail.com
include overconfidence, abrupt changes in strategy, and tension within
the promoter family/ management.
85% of ‘great’ Indian companies self-destruct
As highlighted in our 7th June note, 50% of the Nifty churns every decade (a
much higher churn ratio than seen in other major markets). Note that 85% of
the most successful Indian companies (measured in terms of superior financial
performance over a six-year period) slide towards mediocrity after a phase of
strong performance. Given investors’ interest in spotting impending signs of
decline in the most successful companies, we have identified and elaborated
upon the following four markers of impending decline:


Three great companies assessed
using Ambit’s markers of decline
Asian Paints
Hubris & arrogance
GREEN
Shift in strategy
Inter-generational
shift
Capital allocation
AMBER
Overall
AMBER
Hubris and arrogance: This is the single largest factor that leads to
deterioration in performance. And this is also one of the markers that is
easily discernible especially if the analyst or investor has been meeting a
particular company management or its promoters over several years –
executives gripped by this malaise love to ‘talk down‘ to investors and/or
outline grandiose visions for global domination. Other indicators are an
obsession with the trappings of corporate success and waning investor
access to the promoter/CEO.
Titan
Shift in strategy: A dramatic shift in strategic stance is another flag to
watch out for and should be of concern if the rationale for the shift is
difficult to decipher or the same is not well articulated by the company.
Our research suggests that instances of such abrupt changes in strategy
are more frequent than investors would like them to be.
Hubris & arrogance
AMBER
GREEN
Hubris & arrogance
GREEN
Shift in strategy
Inter-generational
shift
Capital allocation
GREEN
AMBER
Overall
AMBER
GREEN
Sun Pharma
Shift in strategy
Inter-generational
shift
Capital allocation
GREEN
AMBER
GREEN
AMBER

AMBER
Inter-generational shift or tension within promoters or change in Overall
management: The handover from one generation to another (or from Source: Ambit Capital research
one CEO to another) is particularly sensitive. The run-up to this transition
and the year following the change tend to be marked by tussles within the
firm around capital allocation, key personnel and corporate turf.

Capital allocation: Finally the first three factors discussed above –
overconfidence, tensions within the company and abrupt changes in
strategy - result in poor capital allocation decisions. The inability of these
companies to successfully re-allocate capital is at the core of why 85% of
successful Indian companies slide to mediocrity.
Three case studies: Asian Paints, Titan and Sun Pharma
The two markers that are flashing ‘amber‘ for Asian Paints are its ongoing
shift in strategy (away from paints and towards homeware) and intergenerational tensions. For Titan, the ’capital allocation‘ marker is flashing
amber, as the firm is clearly at a strategic crossroads in terms of how to
reallocate capital. In Sun Pharma, the ‘strategy shift‘ marker is flashing
amber, with the promoter inclined towards larger acquisitions.
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Please refer to disclaimer section on the last page for further important disclaimer.
Strategy
CONTENTS
Executive summary of our findings on Asian Paints,
Titan and Sun Pharma
3
Greatness ’at risk’
8
Where are today's 'great' companies headed?
15
-
Asian Paints
15
-
Titan
23
-
Sun Pharma
31
Issues raised about our 7 June note by investors
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Executive summary of our findings on
Asian Paints, Titan and Sun Pharma
Exhibit 1: A summary of how the ‘great’ firms highlighted in this note stack up on various qualitative parameters
Company Name
Hubris & Arrogance
Shift in Strategy
Inter-generational shift
Capital Allocation
Conclusion
Asian Paints
GREEN
AMBER
Titan Inds
GREEN
GREEN
AMBER
GREEN
AMBER
GREEN
AMBER
AMBER
Sun Pharma
GREEN
AMBER
GREEN
AMBER
AMBER
Source: Company, Ambit Capital research
Asian Paints (the detailed section on this company is on page 15)
Hubris and arrogance: We have not discerned any signs of hubris and
arrogance. The three promoter families have always maintained a low profile and
have kept away from the limelight over the past 20 years. We have not seen any
signs of this changing in spite of the tremendous success of the company.
Shift in strategy: This is the one marker that is flashing ‘amber’. The signals from
Asian Paints is that they are looking at new growth areas and the one area they
seem to have zeroed in on is home improvement solutions. The firm has to this
end acquired Sleek, a modular kitchen company. We have not come across any
cogent explanation for this shift in strategy to focus on a new area. Furthermore,
the fragmented and service-oriented nature of the modular kitchen business
means that there are not many synergies with Asian Paints’ core business. The
question is whether these diversifications are planned to accommodate a growing
number of promoter family members who are in the business today as compared
to, say, 15 years ago.
Over FY04-13, operating cash flows (Rs55bn in total) were deployed almost
entirely towards capex (Rs28bn) and dividends (Rs21mn). There is no debt
currently outstanding on the balance sheet and with surplus manufacturing
capacity available, no major capex is planned over the next 2-3 years. Therefore,
surplus cash is likely to get accumulated at a rate of Rs15bn annually going
forward. As a result, unlike in the past, going forward, there will be a need for
active capital allocation decisions at a Board level. In this context, the first bet in
the form of the Sleek acquisition was small and not a cause for concern. However,
investors need to watch out if the bets become larger and/or more such businesses
are started.
Inter-generational shift or tension within promoters: Here too, we assign the
company an ’amber‘ flag. There are three promoter families who are represented
on the Board. The balancing act is achieved by giving different responsibilities to
different promoter groups with the SBUs being run by professional CEOs. There
are two issues of which investors should be cognizant about: first, in 2010 the
Dani family increased its stake in the company from ~18% to ~21% (source: trade
press). Prior to this, the three families had almost an equal stake in the company.
Second, it would appear that some tension did crop up a few years back (in 2002)
when Asian Paints acquired Berger International (based in Singapore, with
operations across 11 countries). Whilst two of the families were not completely in
favour of the decision, the Dani side of the family, wanted to go ahead, and the
company did go ahead. In the international business, over the last ten years, the
company has capital employed ranging from 24% to 55% of overall capital
employed (vs 26% in FY13) and the return on capital employed has been a poor 6% to +8%. By any yardstick, the returns in the international business have been
inadequate.
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Our discussions (not with the company's management) indicate that the
relationship between the different family groups is “difficult” and the company is
considering other possible diversification initiatives like entering into into the
ceramics business. Once again, to be fair to the company, it has earlier survived a
split within the promoter families.
Capital allocation: With an average RoCE of 34% over 10 years, one cannot fault
Asian Paints’ capital allocation. Its average dividend payout ratio has been 51%
over the same period and general reserves have been capitalised by a generous
issue of bonus shares with unerring regularity. However, the sterling performance
in the domestic business masks the fact that the company's capital allocation in the
overseas business has not borne fruit even after more than 10 years of consistent
investment.
Exhibit 2: Asian Paints’ capital employed and returns generated in the international and consolidated business
Capital employed in consolidated
business (Rs mn)
Capital employed in international
business (Rs mn)
International CE as % of overall CE
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
6,988
8,067
9,075
10,840
12,576
15,118
19,392
24,167
30,844
36,220
3,870
4,226
4,899
4,738
4,871
7,150
6,256
6,491
7,438
9,248
55%
52%
54%
44%
39%
47%
32%
27%
24%
26%
ROCE in international business
-2.4%
-5.8%
2.8%
-0.4%
2.9%
3.9%
6.4%
7.5%
2.5%
5.8%
Consolidated ROCEs
23.4%
24.3%
26.4%
30.2%
38.5%
31.8%
52.3%
41.2%
38.1%
35.3%
Source: Company, Ambit Capital research
Conclusion: The track record of the company favours a continued strong
performance. But there are some issues that are signalling ‘amber’, as discussed
above. Investors should take cognizance of the same and quiz the management to
satisfy themselves so that there are no surprises ahead.
Titan (the detailed section on this company is on page 23)
Hubris and arrogance: Titan has had an outstanding run over the last ten years
under the stewardship of its MD, Bhaskar Bhat. Mr. Bhat is an old hand at Titan
and took over the reins from Xerxes Desai. Inside the company, Mr. Bhat is seen as
an approachable CEO and everyone addresses him by his first name, a rarity in
Indian companies. To the analyst and investor community, Titan's success has
made Bhaskar Bhat and the Titan management more open to the investment
community. In recent years, the company has been a regular at select investor
conferences and has improved its disclosures to investors. None of the arrogance
that usually comes with success and awards is visible in Titan’s management.
Shift in strategy: The company has largely stuck to its core jewellery and watches
business over the last decade. However, over a period of time, it has articulated its
intention to morph into a lifestyle company - it wants to add other product
categories and brands to become a consumer lifestyle company. Whilst it looks for
diversification opportunities, the company has clearly articulated its criteria for
entering into new product categories. The categories that it would look to enter
are ones which have a large market size and are not consolidated, where Titan
can act as the consolidator, and the trust that the Titan and/or Tata brand evokes
will be an advantage. There is no discernible shift in strategy visible yet.
Inter-generational shift or tension within promoters or change in
management: There is no change in promoters, and therefore, there is unlikely
to be any tension that family-run companies usually face. The professional
management is likely to continue without any major upheavals. However, within
the Tata Group, there has been a change at the very top - Cyrus Mistry has
assumed charge from Ratan Tata. Will Cyrus Mistry look to consolidate the various
retail businesses within the Tata Group? The Tata Group has a presence in
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different formats and categories of retailing through group companies, Trent
Limited and Infiniti Retail. Any consolidation will result in tensions which could rock
Titan's performance.
Capital allocation: Titan’s biggest challenge is capital allocation. Over the last
ten years, Titan has invested its capital to expand the watch and jewellery
business. Based on reported segmental capital employed, 58% of incremental
capital over FY04-13 has been invested in the jewellery business. Our discussions
with market participants indicate that Fastrack has required limited capital
allocation since most of the growth has been franchisee-driven.
The watches business faces the challenge of being a tired brand. How will Titan
move up the price points in watches and rejuvenate the brand? The road map it
chooses will determine its capital allocation to the watches business, which will
likely be primarily in marketing and brand building.
Due to the recent regulatory changes (which while temporary, may last a few
years), growth may be muted, margins will come under pressure, and working
capital requirements will increase in the gold and jewellery business. However, the
management has already indicated that the expansion in jewellery stores will slow
down.
Therefore, the challenge for Titan is the deployment of its free cash flows. Will it
aggressively expand the prescription eyewear business? Will it add new product
categories to its portfolio? An indication of the same was seen when Titan
amended its Articles of Association to include multiple categories including sarees,
perfumes, etc. The five-year strategy will likely be rolled out in 2H2013. Based on
the categories that Titan wants to enter into, investors will have to evaluate the
investment opportunity.
Exhibit 3: Titan's capital allocation over FY04-13
FY04-13
Debt repayment,
13%
Increase in cash
and cash
equivalents, 36%
Dividend paid,
17%
Purchase of
Investments Subsidiaries &
Others, 2%
Net Capex in
Others incl.
precision engg.,
4%
Interest paid,
11%
Net Capex in
Jewellery, 7%
Net Capex in
Watches, 9%
Source: Company, Ambit Capital research; Note: Size of the pie which represents total capital available for
deployment is Rs 31.3bn. Of this, net proceeds from issuance of equity/preference shares accounts for 1%,
interest income received accounts for 9% and the balance 90% is cash generated from operating activities.
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Conclusion: Titan's strategic decisions over the next 3-6 months will determine
whether the company repeats the performance of the last decade or slides away to
mediocrity. Moreover, Titan, scarred by some of its failures in the 1990s, is no
longer willing to take bold decisions (as mentioned in our 7th June note). Will this
be its Achilles’ heel over the next decade?
Sun Pharma (the detailed section on this company is on page 31)
Hubris and arrogance: We have not detected any signs from the management
of hubris or arrogance. The promoter families of Dilip Shanghvi and Sudhir Valia
have always maintained a low profile. People close to the company say that Dilip
Shanghvi is almost obsessive about his privacy and in his attempts to avoid
publicity.
Shift in strategy? This marker is flashing ’amber‘: Sun’s growth and Dilip
Shanghvi’s reputation have been built on by successfully acquiring and profitably
integrating ten firms over the past decade or so. However, with the exception of
the latest acquisition, DUSA, Sun has hitherto focused on acquiring small
businesses which are in trouble and then turning around their performance. Our
concern is that Sun’s acquisition strategy now seems to be changing, as the firm
becomes more confident of its own abilities.
Exhibit 4: Major M&A deals in the US for Sun Pharma
Year
Deals
Deal Value
(US$ mn)
1997
Caraco
8
2005
Formulation plant in Bryan
NA
2005
Assets of Able Labs
NA
2008
Chatten Chemicals
52
2009
Caraco acquired some
products of Forest’s Inwood
business
NA
Increased generic product offerings
2010
Taro
NA
Dermatology and topical product
manufacturing plant in Israel and Canada
2011
100% ownership of Caraco
50
Privatisation
2012
Acquired DUSA Pharma
230
2013
Acquired URL Pharma's
generic business*
100-120
Comments
Dosage form plant
Dosage form plant in Ohio
Dosage form plant in New Jersey and
Intellectual property for the products
Import registration with Drug Enforcement
Administration (DEA); API plant approved by
DEA in Tennessee, US
Entry into dermatological treatment devices
Adds 107 products to the US portfolio
Source: Company, Industry, Ambit Capital research. Note: * indicates Ambit estimate
This is one marker which is clearly flashing ‘amber’ for investors. Unlike many
successful companies which diversify into unrelated areas, Sun has remained
focussed on the pharma sector itself. However, what has changed is its appetite for
larger M&As. Over the past few years, Sun has articulated a more aggressive M&A
strategy towards expansion of its branded generics business both in the US as well
as in other developed and emerging markets. News reports related to multibillion-dollar acquisition by Sun Pharma also makes us nervous.
A seasoned strategic advisor to the Pharma sector says that “After the Protonix atrisk penalty, there is a high probability that Sun Pharma will pursue a big acquisition
to show that the US$550mn payment is not a significant setback. The only question
is whether it will be a sub-US$1bn acquisition or a multi-billion-dollar affair. If it is
the latter, I would be worried as I don’t see Sun having the management bandwidth
to integrate a large European or American acquisition…In a way, the unsuccessful
bid for Bausch & Lomb is a sign of things to come.”
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Inter-generational shifts or tension amongst promoters/management: We
have not detected any signs of differences amongst the promoter families.
Moreover, from all accounts, it appears that Dilip Shanghvi has been focussed on
strengthening the management bandwidth over the past few years at Sun Pharma.
The most prominent moves in this regard have been to appoint Israel Makov, the
former chief of Teva, as the Chairman of Sun Pharma, and to appoint Kal
Sundaram, the former head of GSK Pharma in India, as the head of its US
business.
Despite this apparent deepening of management bandwidth, industry participants
highlight that Dilip Shanghvi remains utterly central to decision-making on almost
every issue of significance within the group. “Dilip Shanghvi takes every single
intellectual property decision Sun has to make, he determines capital allocation and
he decides which markets the firm should enter. Everything in Sun hinges around the
promoter…that might be why Sun ended up paying for Protonix. Sun had a strong
case for Protonix and yet they ended up having to pay…Can Sun Pharma really
become a global player with this sort of dependence on the promoter?” asks the
recently retired CEO of a rival pharma company.
Capital allocation: Sun has consistently generated higher-than-sector RoEs and
RoCEs over the past ten years. The focus on the then niche chronic therapeutic
segments in India back in the nineties has largely paid off given the rather staid
growth in the acute segment. This has enabled the company to steadily increase
market share to 4.9% in FY13 (vs 3.2% in FY07), making it amongst the largest
branded formulations players in India. The international business growth has also
helped sustain the high RoEs, given its presence in high-margin areas such as
injectables and dermatology (through Taro).
Conclusion: Given Sun Pharma’s extremely strong track record, investors have
largely shrugged away concerns arising from the large acquisitions that Sun may
commit to. However, the decisions arising from these future capital allocation
questions do raise flags regarding the strategy going forward. Investors should
quiz the management as to what is the threshold beyond which the management
would be uncomfortable raising debt for a large acquisition.
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Greatness ’at risk’
We have stopped flying commercial.
In our note dated 7 June 2013 (Why do ‘great‘ Indian companies self-destruct?),
we attempted to build a framework to analyse why ‘great’ companies self-destruct
with metronomic regularity. In this note, we discuss:

flags that the company's performance direction may be changing trajectory, for
better or for worse,

three companies that have had a great run over the last decade - Asian Paints,
Sun Pharma and Titan Industries - and the flags that investors should watch
out for, and

issues raised about our 7th June note by investors.
The flags or markers are not sufficient to say that a company's performance is set
for a dramatic change but they provide sufficient reason to do more research, to
understand and to ask appropriate questions to arrive at a conclusion.
Exhibit 5: The five-stage framework
Source: From the book ’How The Mighty Fall’
To summarise what we highlighted in our 7 June note, 50% of the Nifty churns
every decade (a much higher churn ratio than seen in other major markets). Note
that 85% of the most successful Indian companies (measured in terms of superior
financial performance over a six year period) slide towards mediocrity after a
phase of strong performance. Thus, only 15% of successful companies are able to
sustain a strong performance over decades. This is not surprising given that it is
extremely difficult to maintain disciplined capital allocation decade after decade.
Whether a company invests capital in new projects/ acquisitions/ diversifications or
hoards capital, can often be value-destructive.
So why do successful India companies self-destruct? In our 7 June note, drawing
inspiration from the frameworks put down by Jim Collins, William Thorndike and
the Conference Board, we laid out a five-step framework which 85% of successful
Indian firms use to drag themselves towards mediocrity (see the exhibit above):

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Stage 1 - Hubris and arrogance: The company is on top of its game.
Operating margins, RoCE, growth, valuation multiples, etc., are at all-time
highs. Captivated by the success in its core business, the management starts
believing its own press. Success and adulation intoxicates the top brass.
Arrogance sets in. The company loses sight of the factors which made it
successful in the first place.
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
Stage 2 – Unbridled expansion: In search of more growth and more
adulation, the management begins an expansion drive which is often
inorganic. The firm ’overreaches‘ into new geographies and product lines
where it has no real experience or expertise. Sub-par capital allocation begins.

Stage 3 – Stuck in a rut: Often cost discipline and/or product excellence
erodes and prices are then raised. Profits, return multiples and valuation
multiples start sliding. Company politics thrives. The leader becomes
increasingly autocratic and announces 'recovery plans' that are not based on
accumulated experience.

Stage 4 – Grasping for solutions: The company thrashes around and looks
for a solution even as profits and financial strength continue to slide. Senior
management jobs are on the line. Often a new leader comes in and
sometimes he tries to fire silver bullets (eg. a 'transformative' acquisition, a
blockbuster product, a cultural revolution, etc). However, a new leader (ideally,
someone from inside) who takes a long, hard look at the facts and then acts
calmly to put in place a measured recovery strategy with sensible use of cash
and capital at its centre, could be the saviour.

Stage 5a – Capitulation: The firm is sold or fades into insignificance or, and
this happens rarely, shuts down.

Or Stage 5b – Recovery: The firm turns the corner and begins the long, slow
climb to recovery.
However, as clients pointed out when we met them to discuss the 7 June note,
what investors need is a set of markers which suggest that a successful firm has
embarked upon this slide to mediocrity (as opposed to still being on the upward
portion of its arc to greatness). The main aim of this note is to list these markers
and then illustrate them with case studies (Asian Paints, Titan and Sun Pharma). In
the third section of the note, we have addressed some of the other questions
raised by investors on the framework we presented on 7 June.
Greatness ’at risk‘: Markers to watch out for
How can investors assess when the greatness of a supremely successful company
is ’at risk‘? After all, as we have seen with the Bharti-Zain deal or the Apollo
Tyres–Cooper Tire deal or with Hero’s divorce from Honda, the Indian market
rarely gives investors a second chance once that critical announcement which
results in the loss of ’greatness‘ is made.

Bharti has underperformed the Sensex by 4% (1% in CAGR terms) since the
announcement of the Zain deal on 15 February 2010. In the three months
following Bharti's announcement, the stock was down 7%.

Apollo Tyres has underperformed the Sensex by 30% since the announcement
of the Cooper deal on 12 June 2013.

Hero MotoCorp’s stock was down 10% in the three months following the
announcement of its divorce with Honda on 16 December 2010. It has trailed
its peer, Bajaj Auto, by 13% since the deal announcement.
Our discussions with companies, corporate financiers and investors, point to four
qualitative ’red flags‘ which we believe are signals that a great company is on the
cusp of losing its greatness:
1. Hubris and arrogance: Hubris and arrogance is the single largest factor that
leads to deterioration in performance. And this is also one of the markers that is
easily discernible especially if the analyst or investor has been meeting a particular
company or its management or promoters over several years – executives gripped
by this malaise love to ‘talk down‘ to investors and/or outline grandiose visions for
global domination. One of the memorable lines that this analyst has heard is from
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the CFO of a mid-sized company who started off a meeting with a group of fund
managers by saying, "We have stopped flying commercial."
The other way to gauge the step up in hubris over time is if first the promoter, then
the CEO and then the CFO pulls away from interactions with market participants
(leaving the job largely in the hands of an IR manager), not because the company
has grown its scale and complexity, but because the senior management believes
that communication and discussions with stakeholders is no longer important.
Spotting hubris and arrogance is about spotting the incremental change in
behaviour.
2. Shift in strategy: A dramatic shift in strategic stance is another flag to watch
out for and should be of concern if the rationale is difficult to decipher or the same
is not well articulated by the company. For example, a carbonated drinks company
turning its focus on health drinks seems like a rational strategy as the world
focuses on health. But for a steel company to articulate the virtues of electric arc
furnace (EAF) in a power-starved and high-power-cost country is not
understandable and more so when the country has no scrap reservoir. Similarly, if
the market leader in paints suddenly decides that its primary growth focus will
henceforth be home decoration, it is time for shareholders to re-examine the
investment case for holding the stock. Instances of such abrupt changes in strategy
are not as rare as one would like them to be.
3. Inter-generational shift or tension within promoters or change in
management: The handover from one generation to another (or from one CEO
to another) is a particularly sensitive time. What will gen-next's priorities be? More
often than not gen-next wants to make an impression and make its own mark,
which also means a shift in strategies and big capital allocation decisions. The
tensions that mark the handing over from one generation to the next, in many
cases, also manifests itself in tussles between different power centres within the
same firm.
Whilst every generation wants to make its mark or carve out its own empire, within
different promoter groups it is often about who will control what, particularly in
successive generations. One of the more respected CFOs in the Indian corporate
sector says that promoters have to learn to change their roles over a period of time
from entrepreneurs to managers to investors.

An entrepreneur is someone who starts a venture and is completely hands on
in almost every major decisions of the company. The company then is usually a
one-man show.

As the company grows bigger and also goes public, the entrepreneur has to
evolve into a manager, where he/ she is one of the shareholders and is
managing the business on behalf of all stakeholders.

In the last stage, the entrepreneur-manager becomes an investor and the
company passes on to professional hands with an oversight by the board. The
entrepreneur's interests are represented at the Board level. This stage usually
comes after two or three generations, although in the Indian context there is a
reluctance to part with managerial control.
Giving up control (i.e. entering the last stage) is easier said than done, as seen in
company after company. A company that has managed this transition successfully
is, for example, Dabur. Among large companies, Bharti is one where the Mittals
have made the transition from entrepreneur to manager to investor, although
anecdotal evidence suggests that they still retain significant control over day-today decision making.
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A change at the top is more often than not also accompanied by a change in
strategy, once again fuelled either by the environment or very often by the desire
of the new incumbent to make his mark. A very good example of a major shift in
strategies as the person at the helm changes is ICICI Bank (when N Vaghul
handed over charge to KVK Kamath and then when Mr Kamath handed over
charge to Chanda Kochhar). Note that we are not commenting on the efficacy of
one person's strategy over the other or on the need for the change in strategy
under the then given circumstances. The point we are making is that more often
than not, a change at the top – either in the CEO’s office or in the promoter family
– leads to a change in strategy, and the change has an impact on the stock price.
The table below highlights how stock price performance was impacted with
management changes and in many of these cases the management changes were
also accompanied by significant changes in strategic direction. There are times
when a successor also benefits from decisions taken in his predecessor's time and
then of course there is the macro environment, which has a large role to play in
corporate performance in the near term.
Exhibit 6: Management changes at various Indian entities
Month of
change
Relative share price
perf (pre)*
5yr
3yr
1yr
Relative share price
perf (post)#
1yr
3yr
5yr
Company Name
Management changes
Aditya Birla Group
K M Birla**
Jan-95
NA
24%
45%
4%
3%
-3%
P Jayendra Nayak
Jan-00
NA
NA
-20%
103%
33%
45%
Shikha Sharma
Jun-09
22%
22%
7%
48%
6%
NA
Axis Bank
Bajaj Hindusthan
HUL
ICICI Bank
Infosys
ITC
Kushagra Nayan Bajaj
Apr-07
60%
10%
-89%
25%
-16%
-31%
MS Banga
May-00
25%
22%
-21%
15%
-2%
-17%
Douglas Baillie
Mar-06
-20%
-34%
9%
-53%
7%
-8%
Nitin Paranjpe
Apr-08
-27%
-10%
2%
25%
-4%
10%
Chanda Kochhar
May-09
-6%
-5%
-13%
44%
7%
NA
Nandan Nilekani
Mar-02
NA
30%
-23%
30%
13%
7%
Senapathy Gopalakrishnan "Kris"
Jun-07
2%
-2%
-9%
-7%
6%
2%
SD Shibulal
Aug-11
-3%
5%
-10%
0%
NA
NA
YC Deveshwar
Jan-96
23%
-4%
-14%
33%
45%
24%
Arun Kumar Purwar
Nov-02
3%
12%
29%
37%
13%
8%
2%
-19%
-41%
72%
25%
16%
SBI
O.P.Bhatt
Jul-06
Pratip Chaudhri
Apr-11
14%
11%
24%
-12%
NA
NA
Tata Steel
B Muthuraman
Jul-01
-12%
-5%
2%
43%
42%
26%
Titan Inds
Wipro
Bhaskar Bhat
Apr-02
-3%
-9%
33%
7%
39%
43%
Vivek Paul
Jul-99
NA
NA
87%
242%
30%
12%
post-Vivek Paul
Sep-05
-19%
-15%
-22%
-10%
-17%
-6%
Source: Company, Bloomberg, Ambit Capital research; Note: * indicates 1-year, 3-year and 5-year share price performance relative to Sensex
preceding the change in management. # indicates 1-yr,3-yr & 5-yr share price performance relative to Sensex post the change in management,**
indicates the performance of Hindalco Ltd-the largest company in the Aditya Birla Group
4. Capital allocation: Finally, the first three factors discussed above –
overconfidence, tensions within the company and abrupt changes in strategy result in poor capital allocation decisions. The inability of these companies to
successfully re-allocate capital is at the core of why 85% of successful Indian
companies slide to mediocrity. Since most Indian promoters do not want to return
surplus capital to shareholders, they have to make significant fresh capital
allocation decisions. These decisions bring the following ’paths‘ into play:

Ambit Capital Pvt Ltd
The acquisition is very large as compared to the present size of a company and
results in the debt:equity ratio shooting up. For example, Tata Steel's
acquisition of Corus lifted the acquirer’s debt:equity from 0.9x to 1.4x, Havells’
acquisition of Sylvania lifted the acquirer’s debt:equity from 0.1x to 1.5x, and
Apollo Tyres’ acquisition of Cooper Tires lifted the acquirer’s debt:equity from
0.6x to 3.8x.
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Strategy

The size of the capex is very large as compared to the current size of the
company. For example, TVS’s expansion into Indonesia accounts for almost
40% of the company’s standalone net worth as at end-FY13. Tata Steel’s
Kalinganagar project will account for ~75% of the capital employed of the
Indian business (post completion of Odisha Phase I). Judging by press reports,
Tata Motors, spent over US$1bn, ~0.6x FY08 shareholders’ equity of the
standalone entity, in creating the Nano.

Extreme risk aversion: This is the opposite of the points made in the preceding
bullets. Here a great company stops innovating, stops experimenting with new
concepts, and stops launching new/improved products. As a result, its success
attracts imitators – often with disruptive products or disruptive business
models. The new entrant then increases the intensity of competition in the
sector and pulls down the incumbent’s profit margins and growth rates. Whilst
Infosys’s unwillingness to invest its cash hoard (now amounting to US$4.0bn or
0.6x its shareholders’ equity) is legendary, other Indian companies have also
fallen into the trap of doing too little. For example:

Punjab Tractors in the late 1990s owned the leading tractor brand in India
(called ’Swaraj‘). The company sold a premium priced tractor and asked
for payment in advance. As it became complacent with its leadership
position, Mahindra & Mahindra (M&M) moved in by launching a much
cheaper tractor with a much longer payment cycle. Subsequently, Punjab
Tractors’ margins fell sharply and its working capital cycle expanded
rapidly. As Punjab Tractors’ share price fell by 81% from its peak, guess
who bought the firm – M&M.

Six years ago, Hawkins’ topline was Rs1,735mn whereas that of its rival
from south India, TTK Prestige, was Rs 2,814mn. TTK Prestige then
launched a raft of new products, expanded aggressively into north India
and opened ’Prestige Smart Kitchens‘ stores across India. Now, TTK’s
revenues and profits are 3.2x and 3.9x that of Hawkins, respectively.
Capital allocation is a tricky one in the sense that clearly one knows what is good
or bad only with the benefit of hindsight. For example, as described in our 7 June
note, most experts thought that the Corus acquisition was a more sensible decision
for Tata Steel than the acquisition of JLR by Tata Motors. However, as highlighted
in our first note, Tata Motors was better prepared for its acquisition of JLR whereas
Tata Steel's break from its stated strategy of raw material security was perplexing,
as Corus obviously did not have any raw material security. Our view, while based
on the facts available at the time of the acquisitions, of course, has benefitted from
hindsight.
That said, a few points can be made clearly on the back of our 7 June note and on
the back of our 31 July capital allocation note: (a) Companies which return cash to
investors – through dividends, buybacks, etc – have significantly higher RoCEs than
those that don’t; (b) Companies which make large capex decisions or make
acquisitions have materially lower RoCEs; while (c) Companies which hoard cash
have significantly lower RoCEs than RoICs (see the exhibits that follow).
For the BSE200 universe (ex-financials), we look at the use of cash flow from
operations by each of these firms over the last ten years towards capital
expenditure, acquisitions, payback to shareholders (dividends plus share buybacks)
and cash retained on balance sheets.
We then contrast the FY12 median RoCEs of the first quintile of firms based on
their expenditure on each of these items versus the average RoCE for the universe,
i.e. the top quintile on cash returned (dividends plus buybacks) as a proportion of
cash flows from operations over the last ten years, top quintile on capex as a
proportion of cash flows from operations, etc.
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Exhibit 7: Capital allocation decision impacts RoCE – FY12 RoCEs of top quintiles
based on use of cash
Median FY12 ROCE
Universe
Cash returned (Q1)
Capex (Q1)
Acquisition (Q1)
Cash retained (Q1)
0%
10%
20%
30%
40%
Source: Bloomberg, Capitaline, Ambit Capital research; Note: This is pre-tax RoCE
These results indicate that firms that have indulged in excessive acquisitions or
excessive capex have had mediocre return ratios (‘excessive’ here refers to being in
the top quintile of BSE200 firms in terms of capex or acquisitions). This suggests
that whilst organic and inorganic expansion may be necessary for a firm to
expand, overdoing it comes at a cost. On the other hand, firms that were generous
in returning surplus cash to shareholders in the form of dividends or buybacks
have materially higher RoCEs (‘generous’ here refers to being in the top quintile of
BSE200 firms in terms of returning cash through buybacks and dividends).
Some may argue that looking at the FY12 RoCEs is misleading given that these
may be cyclically depressed return ratios. To take care of this issue, in the next two
exhibits, we reproduce this analysis for two different time frames: FY03-FY12
period and FY03-FY07 period.
Exhibit 8: Capital allocation decision impacts RoCE – FY03-12 median RoCEs of top
quintiles based on use of cash
Last ten year median ROCE
Universe
Cash returned (Q1)
Capex (Q1)
Acquisition (Q1)
Cash retained (Q1)
0%
10%
20%
30%
40%
Source: Ambit Capital research, Bloomberg, Capitaline; Note: This is pre-tax RoCE
Ambit Capital Pvt Ltd
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Strategy
Exhibit 9: Capital allocation decision impacts RoCE – FY03-07 median RoCEs of top
quintiles based on use of cash
Median ROCE (FY03-FY07)
Universe
Cash returned (Q1)
Capex (Q1)
Acquisition (Q1)
Cash retained (Q1)
0%
5%
10%
15%
20%
25%
30%
35%
Source: Bloomberg, Capitaline, Ambit Capital research; Note: This is pre-tax RoCE
As would have been expected, the inferences remain unchanged. Firms that were
generous in terms of returning cash have had significantly higher RoCEs than the
rest of the firms. On the other hand, firms that were either too conservative in
capital deployment (as evidenced by hoarding of cash) or were too aggressive in
capital deployment (as evidenced by excessive capex, excessive acquisitions) have
had lower RoCEs as compared to the rest of the firms.
The one result, however, that appears counterintuitive is that firms that chose to
retain cash on their balance sheets without using it either for profitable expansion
or payback to shareholders have not been penalised for doing so, as reflected in a
healthy RoCE. The reason for this, in our view, is that higher return ratios in the
first place eventually lead to healthy cash flow generation (for it to be retained on
the balance sheet). This, thus, masks the damaging impact that unnecessary
hoarding of cash on balance sheets has on return ratios. In order to understand
this impact, we would be better served to look at the difference between RoCEs
and RoICs for these firms.
(We calculate RoCEs by dividing the pre-tax operating profit, including interest and
dividend income, by total capital employed. Calculation of RoICs, on the other
hand, involves dividing pre-tax operating profit, after subtracting interest and
dividend income, by total assets excluding cash and marketable investments. Thus,
whilst ROIC denotes the return only on business capital, RoCE denotes return on
all capital - that deployed towards business as well as that held in cash and
marketable investments.)
Exhibit 10: The cost of hoarding cash - RoCEs lower than RoICs for the top quintile
on cash retention
Return ratios (pre-tax)
Cost of retaining cash
40%
Cost of
hoarding
30%
20%
10%
0%
Median FY12 ROIC
Median FY12 ROCE
Source: Ambit Capital research; Note: The return ratios are pre-tax; whilst for RoIC calculation we remove
interest plus dividend income and cash from numerator and denominator respectively; for RoCE, we retain
these; the difference thus accounts for the cash drag to RoCEs
Arguably, the over 10% median differential between RoICs and RoCEs of the top
quintile of cash hoarders could be erased by returning the cash to shareholders,
thus forcing the RoCE up towards the RoIC.
Ambit Capital Pvt Ltd
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Where are today's 'great' companies
headed?
In our first note, we had stated that in our subsequent notes we will try and answer
the question on which of the currently 'great' companies are likely to see a decline
in performance over the next few years. In this section we look at three companies
- Asian Paints, Sun Pharmaceuticals and Titan Industries. The three companies
have had a strong run over the last decade and more and they are clearly at the
top of their game. Using our framework, we analyse what stage of the lifecycle are
these companies in and how do they measure up against the flags that we have
highlighted in the first section of the report.
Asian Paints
"It is the task of leadership to create and nurture an environment in which a
multitude of talented minds work in harmony so that mutual competence is
reinforcing rather than debilitating.''- Champaklal Choksey
“When the rules of the game shift constantly, lessons learnt yesterday are not
enough to meet the challenges of tomorrow. Staying ahead calls for a refreshingly
newer paradigm and a leadership willing to trust its `feel' rather than search in
`vain' for facts.'' - Champaklal Choksey
Asian Paints is India's leading decorative paints company with a dominant market
share. Over the last 15 years, the company's revenues have increased to Rs110bn,
at a CAGR of 19% and net profits have increased to Rs11bn, at a CAGR of 19%. In
these 15 years, the company's market cap has recorded a CAGR of 29% as against
the Sensex return of 11%. Currently, the stock is trading at 33.0x FY14E
(Bloomberg consensus). Out of 40 analysts covering the stock, 7 analysts have a
BUY rating, 17 have a HOLD rating and 16 have a SELL rating on the stock. We
have a BUY rating on the stock.
Exhibit 11: Asian Paints has delivered 23% share price CAGR vs 10% by the Sensex
over the past 20 years
7000
6000
5000
4000
3000
2000
1000
Sensex
Aug-12
Aug-11
Aug-10
Aug-09
Aug-08
Aug-07
Aug-06
Aug-05
Aug-04
Aug-03
Aug-02
Aug-01
Aug-00
Aug-99
Aug-98
Aug-97
Aug-96
Aug-95
Aug-94
Aug-93
0
Asian Paints
Source: Bloomberg, Ambit Capital Research.
Ambit Capital Pvt Ltd
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Strategy
500
450
400
350
300
250
200
150
100
50
-
Exhibit 13: Asian Paints’ historical P/B multiples
32x
27x
22x
17x
Jan-02
Oct-02
Jul-03
Apr-04
Jan-05
Nov-05
Aug-06
May-07
Feb-08
Nov-08
Sep-09
Jun-10
Mar-11
Dec-11
Sep-12
Jul-13
12x
500
450
400
350
300
250
200
150
100
50
-
11x
9x
7x
5x
3x
Jan-02
Oct-02
Jul-03
Apr-04
Jan-05
Nov-05
Aug-06
May-07
Feb-08
Nov-08
Sep-09
Jun-10
Mar-11
Dec-11
Sep-12
Exhibit 12: Asian Paints’ historical P/E multiples
Source: Company, Bloomberg, Ambit Capital research
Source: Company, Bloomberg, Ambit Capital research
Exhibit 14: Asian Paints’ market cap has increased by
69x over the past 20 years
Exhibit 15: Asian
trends
500
450
400
350
300
250
200
150
100
50
0
Paints’
sales
and
sales
growth
120,000
28%
100,000
25%
Asian Paints' market cap (Rs bn)
Source: Bloomberg, Ambit Capital research
Ambit Capital Pvt Ltd
22%
13%
-
10%
Sales (Rs mn)
FY12
20,000
FY10
16%
FY08
40,000
FY06
19%
FY04
60,000
FY02
Apr-13
Apr-12
Apr-11
Apr-10
Apr-09
Apr-08
Apr-07
Apr-06
Apr-05
Apr-04
Apr-03
Apr-02
80,000
Sales growth (%)
Source: Company, Ambit Capital research
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Strategy
Exhibit 16: Asian Paints’ EBITDA and EBITDA margin
EBITDA (Rs mn)
19%
14,000
120%
18%
12,000
100%
17%
10,000
80%
16%
8,000
60%
15%
6,000
40%
14%
4,000
20%
13%
2,000
0%
12%
-
EBITDA Margin (%)
Source: Bloomberg, Ambit Capital research
PAT (Rs mn)
FY13
FY12
FY11
FY09
FY10
FY08
FY07
FY05
FY06
FY04
FY03
-20%
FY02
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
FY05
FY04
FY03
FY02
20,000
18,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
-
Exhibit 17: Asian Paints’ PAT and PAT growth trends
PAT growth (%)
Source: Company, Ambit Capital research
We will now see how the company stacks up against our various flags/ markers.
To emphasise, this is not a complete research report on Asian Paints and so we
have not analysed in detail the strength or the financials of the company and have
refrained from commenting on near-term outlook and valuations.
Hubris and arrogance: We have not discerned any signs of hubris and
arrogance. The three promoter families have always maintained a low profile and
kept away from the limelight over the past 20 years. We have not seen any signs
of this changing in spite of the tremendous success of the company over the last
decade and more. People close to the promoter groups say their behaviour
towards various stakeholders remains unchanged. An interesting comment by a
close observer was that no one in the family plays golf.
Shift in strategy: This is the one marker that is flashing ’amber‘. Whilst the
decorative paint market continues to expand in India, the signals from Asian Paints
is that they are looking at new growth areas and the one they seem to have
zeroed in on is home improvement solutions. Asian Paints to this end has acquired
Sleek, a modular kitchen company. We have not come across any cogent
explanation for this shift in strategy to focus on a new area, away from its core
area. Furthermore, the fragmented and service-oriented nature of the modular
kitchen business means that there are not many synergies with Asian Paints core
business. The question is whether some diversifications are planned to
accommodate a growing number of promoter family members who are in the
business today as compared to say 15 years back. Whilst the promoter families
currently have around 15-17 members in the middle and senior management, 15
years ago, this number was only 10-12 members.
Over FY04-13, operating cash flows (Rs55bn in total) were deployed almost
entirely towards capex (Rs28bn) and dividends (Rs21mn). There is no debt
currently outstanding on the balance sheet and with surplus manufacturing
capacity available, no major capex is planned over the next 2-3 years. Therefore,
surplus cash is likely to get accumulated at a rate of Rs15bn annually going
forward. As a result, unlike in the past, going forward, there will be a need for
active capital allocation decisions at a Board level. In this context, the first bet in
the form of the Sleek acquisition is small and not a cause for concern. However,
investors will need to watch out if the bets become larger and/ or more such
businesses are started. As often happens, companies whilst diversifying also suffer
from a lack of adequate management bandwidth.
Ambit Capital Pvt Ltd
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Strategy
To be fair, this is not the first time that Asian Paints is considering diversification
options. In the late 1990s, based on the announcement in their annual report
(FY94), the company had planned to get into granites. Thankfully the decision was
not pursued further although we do not know why they had considered an entry
into granites and why they did not pursue that course. Therefore, the benefit of
doubt will be in favour of the management for the time being.
Inter-generational shift or tension within promoters: Here too the issue is
flashing ’amber‘. There are three promoter families who are represented on the
board of the company. The balancing act is achieved by giving different
responsibilities to different promoter groups with the SBUs being run by
professional CEOs. There are two issues about which investors should be
cognizant of: first, in 2010, the Dani family increased its stake in the company
from ~18% to ~21% (source: trade press). Prior to this, the three families had an
almost equal stake in the company. Changes in shareholding can over a period of
time become a source of tension.
Secondly, apparently, some tensions did crop up a few years back (in 2002) when
Asian Paints acquired Berger International (based in Singapore, with operations
across 11 countries in South East Asia, the Middle East and the Caribbean Islands).
Whilst two of the families were not completely in favour of the decision, the Dani
side of the family, wanted to go ahead, and the company did go ahead. In the
international business, over the last ten years, the company has capital employed
ranging from 24% to 55% of overall capital employed (vs 26% in FY13) and the
return on capital employed has been a poor -6% to +8%. By any yardstick, the
returns in the international business have been inadequate but the company has
persisted with its growth ambitions.
Our discussions (not with the company's management) indicate that the
relationship between the different family groups is “difficult”, and the company is
considering other possible diversification initiatives like getting into the ceramics or
sanitaryware or electricals business, even as the company remains very upbeat
about its business prospects. Once again to be fair to the company, it has earlier
survived a split within the promoter families.
Asian Paints was set up by four families, and Atul Choksey, the then MD, sold his
family's stake in 1997. This was reported in the press to be the fallout of a major
difference of opinions among the Chokseys and the other three promoter families
(the Danis, the Choksis and the Vakils) on the funding of the company's expansion
plans. Mr. Choksey’s plan for a GDR issue was reportedly rejected by other
promoters as it would have diluted their holdings. After his departure, he had said,
"The sale of shares held by the family was planned as per the desire of my father. I
will be here till a smooth transition is over .... I hope the new management would
be able to deliver goods" (emphasis added). His unsaid fears proved to be
premature as the company subsequently went from strength to strength. Once
again the benefit of doubt should go to the company's promoter groups – they
pulled Asian Paints successfully through Atul Choksey’s exit from the business and
the odds should be loaded in their favour in terms of being able to hold together
the current construct.
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Exhibit 18: Vakil Family Tree - Shareholding (in %) and responsibilities (where
information was available)
Arvind Vakil (family heads
Domestic decoratives business)
Abhay Vakil (Age 62) (2.97%)
Bhairavi Vakil
(0.23%)
Nehal Vakil
(0.25%)
Amar Vakil (Age 61) (1.36%)
Vivek Vakil (Age 26)
(0.33%) (Executive
Trainee – Finance)
Amrita Vakil
(0.27%)
Dipika Vakil
(0.21%)
Varun Vakil (Age 29)
(0.23%) (Manager –
Customer Centricity)
Source: Ambit Capital research; Note: The family trees have been drawn based on the information garnered
and may not be completely accurate.
Exhibit 19: Dani Family Tree - Shareholding (in %) and responsibilities (where
information was available)
Suryakant Dani (family heads
international business
Ashwin Dani
(0.22%)
Hasit Dani (Age 41) (0.42%) (Non exec
director in APNT from 2001-2011;
Presently, Director of Gujarat Organics
Shubhlakshmi
Dani (0.01%)
Wife
Ina Dani
(0.05%)
Malav Dani (Age
38) (0.34%)
Ishwara
Dani
Jalaj Dani (Age 43)
(0.17%) (President International Business
Smiti Dani
(0.01%)
Mudit Dani
(0.02%)
Vita Dani
(0.05%)
Source: Ambit Capital research
Exhibit 20: Choksi Family Tree - Shareholding (in %) and responsibilities (where information was available)
Chimanlal Choksi (family heads
domestic non-decorative business)
Ashwin Choksi (Age 70)
(0.08%)
Margi
Choksi
Rupen Choksi (Age 36)
(0.1%) (ED, Resins & Plastics
Ltd. (Associate of APNT)
Anay Choksi
(0.01%)
Nysha Choksi
(0.01%)
Urvashi Choksi
(0.09%)
Druhi Choksi
(0.01%)
Ashish Choksi
(0.09%) (Not
with the Group)
Ashay Choksi
(0.01%)
Shailesh Choksi
(0.45%)
Prafulika
Choksi (0.22%)
Binita Choksi
(0.01%)
Vishal Choksi
(0.31%) (Was
management
trainee with APNT
Mahendra Choksi
(Age 72) (0.23%)
Jigish Choksi
(0.21%)
(Executive –
Marketing )
Rupal Anand
Bhat (0.2%)
Ami Choksi
(0.05%)
Manish Choksi (age 38)
(0.25%) (President – Home
Improvement, IT & Supply
Rhea Choksi
(0.07%)
Rita Choksi
(0.1%)
Richa Choksi
(0.02%)
Source: Ambit Capital research
Capital allocation: With an average RoCE of 34% over 10 years, one cannot fault
Asian Paints’ capital allocation. Its average dividend payout ratio has been 51%
over the same period of time and general reserves have been capitalised by a
generous issue of bonus shares with unerring regularity. However, the sterling
performance in the domestic business masks the fact that the company's capital
allocation in overseas business has not borne fruit even after more than 10 years
of consistent investment. The encouraging part is that the share of overseas
business in capital employed has reduced over a period of time although it still
remains significant.
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Exhibit 21: Asian Paints’ capital employed and returns generated in the international and consolidated business
Capital employed in consolidated
business (Rs mn)
Capital employed in international
business (Rs mn)
International CE as % of overall CE
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
6,988
8,067
9,075
10,840
12,576
15,118
19,392
24,167
30,844
36,220
3,870
4,226
4,899
4,738
4,871
7,150
6,256
6,491
7,438
9,248
55%
52%
54%
44%
39%
47%
32%
27%
24%
26%
ROCE in international business
-2.4%
-5.8%
2.8%
-0.4%
2.9%
3.9%
6.4%
7.5%
2.5%
5.8%
Consolidated ROCEs
23.4%
24.3%
26.4%
30.2%
38.5%
31.8%
52.3%
41.2%
38.1%
35.3%
Source: Company, Ambit Capital research
Conclusion: The track record of the company favours a continued strong
performance. However, there are some issues that are signalling amber, as
discussed above. Investors should take cognizance of the same and quiz the
management to satisfy themselves that there are no surprises ahead.
Questions to ask Asian Paints’ management
1. Why is the management saying that the paints market in India is maxed out
when the smaller players are finding abundant growth in the same market?
2. Why is Asian Paints targeting the modular kitchens market? What exactly is it
about this business which is prompting Asian Paints to invest in it?
3. What will Asian Paints do with the surplus capital it generates? Can it really
execute in homeware properly? What are the challenges in this business? Who
are the key executives they have deputed to manage this business and what is
their experience? Which promoter family will be responsible for this business?
4. What will the latest generation of the promoters’ offsprings do? Given that
some of them already work in the business, how is this impacting decision
making by executives?
5. Is management grooming the next generation of leaders? How is this being
done?
6. How will KBS Anand’s successor as CEO be chosen when Mr Anand’s term
expires?
7. What is the strategy for the international business? What justifies continued
investments given weak RoCEs to date? Will the company consider divesting its
international business or is it critical from the perspective of supply of raw
materials and bulk paints for India?
8. How do the promoter families decide on who enters Asian Paints and who
does not?
9. Some Indian promoter families have put together a council that meets
formally, albeit confidentially, to take strategic decisions. Do the three
promoter families have any such decision-making body?
Ambit Capital Pvt Ltd
20
Strategy
Exhibit 22: Background of Board of Directors of Asian Paints
Name
Designation
Age
(yrs)
Ashwin
Choksi
Non-executive
Chairman
70
No. of
years
on
board
43
Ashwin Dani
Non-executive
Vice-Chairman
71
43
Asian PPG Industries
Limited, Resins & Plastics
Limited, Gujarat Organics
Limited, Sun
Pharmaceuticals Industries
Limited, Hitech Plast
Limited, Rangudyan
Insurance Broking Services,
ACC Limited
Abhay Vakil
Non-executive
Promoter
Director
63
30
Asian Paints Industrial
Coatings Limited, Resins
and Plastics Ltd, Vikatmev
Containers
KBS Anand
Managing
Director & CEO
58
1
Mahendra
Choksi
Non-executive
Promoter
72
21
Ultramarine & Pigments Ltd
Amar Vakil
Non-executive
Promoter
61
18
Elcid Investments Ltd.,
Resins and Plastics Ltd.,
Pragati Chemicals Ltd.
Ina Dani
Non-executive
Promoter
71
3
Coatings Specialties (India)
Ltd., Dani Finlease Ltd.,
Hitech Plast Ltd.
Dipankar
Basu
Non-executive
Independent
Director
77
13
Mahendra
Shah
Non-executive
Independent
Director
73
12
Securities Trading Corp. of
India Ltd., Deepak
Fertilizers & Petrochemicals
Corporation Ltd., STCI
Primary Dealer Ltd.,
Peerless General Finance &
Investment Co. Ltd.,
Peerless Securities Ltd.,
Chambal Fertilizers &
Chemicals Ltd., Saregama
India Ltd.
The Indian Card Clothing
Co. Limited, ICC
International Agencies
Limited, Tech-Knit Limited
Ambit Capital Pvt Ltd
Other directorships
Experience
NA
Mr. Ashwin C. Choksi, M.Com., served as the Managing
Director of Asian Paints Limited since 1984. He joined
Asian Paints in 1965 in the materials function of the
company. He rose to the position of Managing Director in
1984 and subsequently became Executive Chairman in
1997 and served until 31 March 2009. He holds a Master’s
degree in Commerce from the University of Mumbai, India.
He started his career in 1967, with Inmont Corp (now
BASF). He joined Asian Paints in 1968 and served as Vice
Chairman and MD from 1998 to 2009. He is the past
President of the Indian Paint Association and is a member
of the Board of Management of Institute of Chemical
Technology. He completed his B.Sc. (Hons) from the
Institute of Science University of Bombay and B.Sc. (Tech)
(Pigments and Varnishes) from U.D.C.T. University of
Bombay. He holds a Master’s Degree in Polymer Science
from the University of Akron, Ohio, and a Diploma in
Colour Science from Rensellaer Polytechnic, New York.
Prior to becoming Managing Director in 1998, he was a
Wholetime Director in the company. He oversaw the
Decoratives India SBU of the company. He was in charge of
the supply chain/sales and marketing activities of the
Decoratives Business Unit of the company. He is a science
graduate from Mumbai University and BS from Syracuse
University, USA.
Mr. KBS Anand served as the President of Asian Paints’
decorative business unit before becoming MD. Mr. Anand
served as Vice President of Sales & Marketing at Asian
Paints. He has over 33 years of experience. Mr. Anand has
been an Additional Director of Asian Paints Ltd since April
1, 2012. Mr. Anand holds B.Tech., P.G.D.M. degrees.
Mr. Mahendra Choksi has considerable knowledge and
experience in the Chemical industry, particularly in
‘Synthetic Resins’. Mr. Mahendra Choksi was DirectorProduction & Process Engineering till 1 March 1973 in
Asian Paints Limited. He joined the Board in 1992 and prior
to that held the position of MD in Resins and Plastics
Limited till 31 August 2002.
Mr. Amar Vakil holds a degree in BS from Rensselear
Polytechnic, U.S.A. Immediately after his graduation, he
joined Resins and Plastics Limited in 1974 and worked in
various positions till he retired as Managing Director. He
was the Hon. Secretary of the Colour Society for two years
and was one of the founder members of Indian Resin
Manufacturers Association.
Mrs. Ina Dani is a graduate in Fine Arts from M.S.
University, Baroda. She is also connected with various
social activities. She is a Trustee of Light on Yoga Research
Trust founded by Yogacharya BKS Iyengar. She was earlier
on the Board of the company between 31 March 1999 and
23 July 2001.
He holds a Master’s Degree in Economics from Delhi
University. He retired as Chairman of State Bank of India
(SBI) in August 1995. Mr. Basu served on the Boards of
several apex financial institutions of India (e.g. IDBI, Export
Import Bank of India, GIC of India Ltd., NABARD, etc.).
After retirement, Mr. Basu served as a member of the
Disinvestment Commission set up by the Government of
India from 1996 to 1999. During 1997, he was a member
of the Narasimham Committee on Banking Sector Reforms.
NA
He was the MD of The Indian Card Clothing Co. Limited
from 1985 until his retirement in 2001. Earlier, Mr. Shah
was the Managing Partner of the India operations of the
multinational trading cum-finance companies of The PanAfrica/The Plenum Group. Mr. Shah was also Chairman of
several panels of the Textile Machinery Manufacturers’
Associations. He holds a Bachelor’s degree in Electrical
Engineering from University of Mumbai and a Master’s
degree in Industrial Engineering from New York University
21
Strategy
Name
Designation
Age
(yrs)
No. of
years
on
board
Deepak
Satwalekar
Non-executive
Independent
Director
65
RA Shah
Non-executive
Independent
Director
82
12
S Sivaram
Non-executive
Independent
Director
67
12
S Ramadorai
Non-executive
Independent
Director
69
4
MK Sharma
Non-executive
Independent
Director
70
1
Other directorships
Experience
Infosys, Tata Power,
Piramal Enterprises, IL&FS
Transportation Networks,
NSE
Mr. Deepak Satwalekar holds a degree in Technology from
IIT, Bombay and an MBA from The American University,
Washington D.C. He has been a consultant to the World
Bank, the Asian Development Bank, United States Agency
for International Development (USAID) and the United
Nations Centre for Human Settlement (HABITAT). He was
holding the position of Managing Director & CEO of HDFC
Standard Life Insurance Co. Ltd., before his retirement in
November 2008. Earlier, he served as the Managing
Director of Housing Development Finance Corporation
(HDFC) from 1993 to 2000.
Mr. R. A. Shah is a Solicitor and Senior Partner of M/s.
Crawford Bayley & Co. He specialises in a broad spectrum
of Corporate Laws in general, with a special focus on
Foreign Investments, Joint Ventures, Technology and
Licence Agreements, Intellectual Property Rights, Mergers
and Acquisitions, Corporate Laws, Competition Law and
Insider Trading Regulations. He is a member of the
Managing Committee of Bombay Chamber of Commerce
and Indo German Chamber of Commerce and is a member
of the Governing Council of ASSOCHAM.
Piramal Health Care Ltd.,
Colgate Palmolive Ltd.,
Pfizer Ltd.,Procter &
Gamble Hygiene &
Healthcare Ltd., Clariant
Chemicals Ltd., The
Bombay Dyeing & Mfg. Co.
Ltd., Abbott India Ltd., BASF
India Ltd., Century Enka
Ltd., Wockhardt Ltd.,
Godfrey Phillips India Ltd.,
ACC Ltd., Deepak
Fertilizers & Petrochemicals
Corporation Ltd., Lupin Ltd.
Apcotex Industries Limited,
GMM Pfaudler Limited
Tata Consultancy Services
Limited, Tata Industries
Limited, Tata Technologies
Limited, CMC Limited,
Hindustan Unilever,
Piramal Enterprises, Tata
Elxsi Limited, Tata
Teleservices (Maharashtra)
Limited, Tata
Communications Limited,
Tata Advanced Systems
Limited, BSE Limited, Tata
Lockheed Martin
Aerostructures Limited,
Tara Aerospace Systems
Limited
ICICI Lombard Insurance
Company Limited, Thomas
Cook (India) Limited,
Fulford (India) Limited, KEC
International Limited,
Wipro Limited, The Andhra
Pradesh Paper Mills
Limited, Travel Corporation
(India) Limited, India
Infradebt Limited
Dr. S. Sivaram holds M.Sc. from Indian Institute of
Technology, Kanpur, Ph.D Purdue University, W. Lafayete,
USA and Research Associate from The Institute of Polymer
Science - Akron, USA. He has over 30 years of experience
in research on polymer-synthesis, high performance
polymers and surface chemistry of polymers. He was
bestowed with the “Padma Shri” award by the President of
India in January 2006. He is the Hon. Secretary of Society
of Polymer Science, India.
He holds a Bachelors Degree in Physics from Delhi
University, a B.E. degree in Electronics and
Telecommunications from the Institute of Science,
Bangalore and also a Master’s degree in Computer Science
from UCLA, (USA). He was awarded the Padma Bhushan by
the President of India. He was awarded the Commander of
the Order of the British Empire by Her Majesty Queen
Elizabeth II. He is also an advisor to the Prime Minister in
the Prime Minister’s National Skill Development Council.
He holds a Bachelor’s Degree in Arts and Bachelors of Law
Degree from Canning College University of Lucknow. He
has also completed Post Graduate Diploma in Personnel
Management from Department of Business Management,
University of Delhi and Diploma in Labour Laws from
Indian Law Institute, Delhi. Mr. M.K. Sharma began his
career with DCM Limited and subsequently joined HUL.
Source: Company filings
Ambit Capital Pvt Ltd
22
Strategy
Titan
“This year we should cross $2 billion and our goal for 2014-15 is $3 billion. But
more than just numbers, there is a vision — the dream is to serve the Indian public
with extremely good quality, well-styled products in the lifestyle space and bring an
Indian pride to consumers. The point is that if one excels, then money will
follow... We are looking at categories that have potential but are under-represented
and under-served... Going forward we are looking at several categories where the
consumer can afford better quality. We believe in better quality, greater
professionalism, transparency and good access through retailing, where the
customer gets well-designed products at a reasonable price and at conveniently
placed locations. The values of Titan have to come alive in every new product and
store, which means quality, styling, store experience and integrity — all at a
reasonable price.”-Bhaskar Bhat
Titan is India's leading manufacturer-retailer of watches and jewellery and
dominates the organised sector in these two segments with a market share of 65%
and 20% respectively. The company has some of the most well-regarded consumer
brands in its portfolio (Sonata, Titan, Tanishq and Fastrack) across these product
categories. Over the last five years, Fastrack has recorded a revenue CAGR of over
40% to emerge as the leading youth brand with a turnover of nearly Rs10bn. The
company has launched prescription eyewear stores as it attempts to consolidate
the market.
Over the last 15 years, the company's revenues have increased to Rs101.2bn, at a
CAGR of 23.9% and net profits have increased to Rs7.3bn, at a CAGR of 29.7%. In
these 15 years, the company's market cap has recorded a CAGR of 35% as against
the Sensex return of 11%. Currently, the stock is trading at 29.4x FY14E
(Bloomberg consensus). Out of 35 analysts covering the stock, 20 analysts have a
BUY rating, 10 have a HOLD rating and 5 have a SELL rating on the stock. We do
not cover the stock but it features in our annually published ten-baggers list.
Exhibit 23: 20-year stock price chart along with Sensex performance
12,000
10,000
8,000
6,000
4,000
2,000
Titan
cZ
Apr-13
Apr-11
Apr-09
Apr-07
Apr-05
Apr-03
Apr-01
Apr-99
Apr-97
Apr-95
Apr-93
-
Sensex
Source: Company, Ambit Capital research
Ambit Capital Pvt Ltd
23
Strategy
Exhibit 24: Trailing P/E for Titan
Exhibit 25: Trailing P/B for Titan
(x)
50.0
(x)
20.0
40.0
16.0
30.0
12.0
20.0
8.0
10.0
4.0
-
Source: Company, Ambit Capital Research; Note: In fiscal 2002, the
company gave its consolidated financial for the first time. Hence,
standalone data is used for analysing the period prior to FY02.
FY13
FY11
FY09
FY07
FY05
FY03
FY01
FY99
FY97
FY95
FY93
FY13
FY11
FY09
FY07
FY05
FY03
FY01
FY99
FY97
FY95
FY93
-
Source: Company, Ambit Capital Research, Note: In fiscal 2002, the
company gave its consolidated financial for the first time. Hence,
standalone data is used for analysing the period prior to FY02.
Exhibit 26: Titan’s market cap expanded rapidly in two phases i.e. from October 2004 to November 2007 and
from April 2009 to December 2012
(Rs bn)
300
250
200
150
100
50
0
Apr-93
Apr-95
Apr-97
Apr-99
Apr-01
Apr-03
Apr-05
Apr-07
Apr-09
Apr-11
Apr-13
Source: Company, Ambit Capital research
Exhibit 27: Titan’s sales and sales growth (YoY)
(Rs mn)
120,000
50%
100,000
40%
80,000
30%
60,000
20%
40,000
10%
-
0%
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
20,000
Sales (LHS)
Sales growth (YoY) (RHS)
Source: Company, Ambit Capital research; Note: In fiscal 2002, the company gave its consolidated
financials for the first time. Hence, standalone data is used for analysing the period prior to FY02.
Ambit Capital Pvt Ltd
24
Strategy
Exhibit 28: Titan’s EBITDA and EBITDA growth (YoY)
(Rs mn)
12,000
10,000
8,000
6,000
4,000
EBITDA (LHS)
FY13
FY11
FY12
FY09
FY10
FY07
FY08
FY05
FY06
FY02
FY03
FY04
FY00
FY01
FY98
FY99
FY96
FY97
FY94
FY95
-
FY93
2,000
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
EBITDA growth (YoY) (RHS)
Source: Company, Ambit Capital research; Note: In fiscal 2002, the company gave its consolidated
financials for the first time. Hence, standalone data is used for analysing the period prior to FY02.
Exhibit 29: Titan’s PAT and PAT growth (YoY)
PAT (LHS)
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
FY05
-
FY04
0%
FY03
1,500
FY02
100%
FY01
3,000
FY00
200%
FY99
4,500
FY98
300%
FY97
6,000
FY96
400%
FY95
7,500
FY94
500%
FY93
(Rs mn)
9,000
-100%
PAT growth (YoY) (RHS)
Source: Company, Ambit Capital research; Note: In fiscal 2002, the company gave its consolidated
financials for the first time. Hence, standalone data is used for analysing the period prior to FY02.
Hubris and arrogance: Titan has had an outstanding run over the last ten years
under the stewardship of its managing director, Bhaskar Bhat. Bhaskar Bhat is an
old hand at Titan and took over the reins from Xerxes Desai. Inside the company,
Bhaskar Bhat is seen as a very approachable CEO and everyone addresses him by
his first name, a rarity in Indian companies. To the analyst and investor
community, Titan's success has made Bhaskar Bhat and the Titan management
more open to the investment community. In recent years, the company has been a
regular at select investor conferences and has improved its disclosures to investors.
None of the arrogance that usually comes with success and awards is visible in the
management of Titan, although they have justifiably been winning many awards
and accolades.
Shift in strategy: The company has largely stuck to its core jewellery and watches
business over the last decade. However, it has, over a period of time, articulated
its intention to morph into a lifestyle company - that is it wants to add other
product categories and brands to become a consumer lifestyle company. Whilst it
looks for diversification opportunities, the company has clearly articulated the
criteria for entering into new product categories. The categories that it would look
to enter are ones which have a large market size and are not consolidated, where
Titan can act as the consolidator, and the trust that the Titan and/ or Tata brand
evokes will be an advantage. There is no discernible shift in strategy visible yet.
On 25 July 2013, Titan amended its memorandum of association by way of a
special resolution through postal ballot to include the following clauses:
Ambit Capital Pvt Ltd
25
Strategy
Exhibit 30: Amendments to Memorandum of Association passed by Titan on 25 July 2013 – Part 1
Design, manufacture, sell, market, retail and deal as distributor and wholesaler, of all types of:
(Note: Elsewhere they have used the words "deal as distributor, wholesaler and retailer" but haven't used that here.)
1) Apparels
5) Perfumes
9) Musical instruments
2) Garments
6) Writing Instruments
10) Entertaining apparatus
3) Sarees
7) Mobile Phones and related services
11) Sound equipments
4) Fragrances
8) Personal convenience articles, devices
12) Lifestyle accessories
and render after sale services and service incidental thereto
Source: Company, Ambit Capital research
Exhibit 31: Amendments to Memorandum of Association passed Titan on 25 July 2013 – Part 2
Design, develop and render content through educational workshops, conferences, theatre and entertainment shows through any
media including via the internet, design, manufacture, market, sell, retail and deal as distributor, wholesaler and retailer of:
1) Gadgets
4) Do it yourself kits
6) Sports products
2) Entertainment products
5) Activity books
7) Food and beverages
3) Toys
and further engage in any segment of value addition either forward or backward in development, distribution and retail of such content.
Source: Company, Ambit Capital research
Exhibit 32: Amendments to Memorandum of Association passed Titan on 25 July 2013 – Part 3
Design, manufacture, sell, market, retail and deal as distributor, wholesaler, retailer of products used in kitchen including:
1) Appliances
3) Kitchen utensils
5) Hobs
2) Storage shelves
4) Chimneys
6) Furniture and cabinets
and render after sale services and services incidental thereto.
Source: Company, Ambit Capital research
Exhibit 33: Amendments to Memorandum of Association passed Titan on 25 July 2013 – Part 4
Design, manufacture, sell, market, retail and deal as distributor, wholesaler, retailer of products powered by solar energy
including:
1) Solar panels
7) Solar lantern chargers
12) Solar water heaters
2) Solar powered home lighting systems
8) Solar mobile
13) Solar signs
3) Solar batteries
9) Solar cookers
14) Solar inverters
4) Solar fans
10) Solar garden
15) Solar powered UPS
5) Solar torches
11) Solar cooler caps
16) Solar generators
6) Solar lights
and render after sale services and services incidental thereto.
Source: Company, Ambit Capital research
Exhibit 34: Amendments to Memorandum of Association passed Titan on 25 July 2013 – Part 5
Carry on the designing, engineering, manufacturing, producing, assembling, fabricating, altering, repairing, marketing, buying,
selling, trading acquiring, representing manufacturers, storing, packing, transporting, forwarding, distributing, importing,
exporting and disposing of:
Product, components, sub-assemblies and assemblies catering to a wide variety of industry applications including but not limited to aerospace,
solar, power, alternative energy, automotive, engineering, medical devices, oil & gas, electrical for both civilian as well as defence use.
Services related to process & product design, engineering design, CNC programming, CAD & CAM, testing inspection, calibration, nondestructive testing, supply chain, vendor management, quality management system, productive maintenance, plant layout & infrastructure
planning, machine maintenance, machine servicing, spares management, aircraft maintenance repair and overhaul, ground handling.
Design, manufacture and commissioning of automations solutions as well as machine building for a wide variety of industry applications
including but not limited to aerospace, solar, power, alternative energy, automotive, engineering, medical devices, oil & gas, electrical for both
civilian as well as defence use.
Design, manufacture and commissioning of tooling, jigs, fixtures, moulds, press tools, die sets for a wide variety of industry applications
including but not limited to aerospace, solar, power, alternative energy, automotive, engineering, medical devices, oil & gas, electrical for both
civilian as well as defence use.
Source: Company, Ambit Capital research
Ambit Capital Pvt Ltd
26
Strategy
Inter-generational shift or tension within promoters or change in
management: There is no change in promoters, and therefore, there is unlikely
to be any tension that family-run companies usually face. The professional
management is likely to continue without any major upheavals. In 2012, there
were news reports that Bhaskar Bhat may move to another Tata company but the
rumours seemed to have died down. However, within the Tata Group, there has
been a change at the very top - Cyrus Mistry has assumed charge from Ratan Tata.
Will Cyrus Mistry look to consolidate the various retail businesses within the Tata
Group? The Tata Group has a presence in different formats and categories of
retailing through group companies, Trent Limited and Infiniti Retail. Any
consolidation will result in tensions that could rock Titan's performance.
Capital allocation: In capital allocation, Titan faces the biggest challenge of the
future. Over the last ten years, Titan has invested its capital to expand the watch
and jewellery business. Based on the reported segmental capital employed, 58%
of incremental capital over FY04-13 has been invested in the jewellery business.
Our discussions indicate that Fastrack has required limited capital allocation since
most of the growth has been franchisee-driven.
The watches business faces the challenge of being a tired brand. It is no longer as
exciting a brand as it used to be. How will the company move up the price points
in watches and rejuvenate the brand? The road map it chooses will determine its
capital allocation to the watches business, which will likely be primarily in
marketing and brand building.
Due to recent regulatory changes (see the table below), which while temporary
may last a few years, growth may be muted, margins will come under pressure
and working capital requirements will increase in the gold and jewellery business.
However, the management has already indicated that the expansion in jewellery
stores will slow down. We believe that after a brief lull, the growth in the jewellery
business will resume, as the smaller jewellers will be worse affected by the
regulatory changes. Further, governance concerns are impacting some of the other
large jewellery chains.
Exhibit 35: Recent regulatory changes and their impact
RBI's announced changes
Customs duty increases on gold from 2% in January 2012 to 8%
in June 2013
Gold shall be made available in any form for domestic use only
to entities engaged in jewellery business/bullion dealers
supplying gold to jewellers
At least 20% of gold imports by each nominated bank/agency
should be made available for exports
Entities/units in the SEZ and EoUs, Premier and Star trading
houses are permitted to import gold exclusively for the purpose
of exports only
Impact on the sector
1. Given 2-4x asset turns for organised jewelers, this cost
inflation was passed on to the customers through a 1.0-1.5%
increase in gold prices.
2. Jewellery demand in India is inelastic for a 1-2% increase in
the price of gold.
1. Bullion sales, which accounted for ~400 tonnes of gold
imports in FY13 will be stopped officially.
2. Smuggling of gold for the purposes of bullion consumption
could accelerate.
1. Industry sources suggest that ~500-600 tonnes of gold were
imported for jewellery consumption and ~70 tonnes was
imported for exports purposes in FY13.
2. Assuming similar levels of exports in the future, the official
domestic jewellery consumption in India will fall by ~50% over
the next 12 months given the 20% restriction related to exports.
3. There exists uncertainty around: (a) the exact nature of
implementation of this change for a particular jeweler; and (b)
ability of the RBI/Government to monitor the implementation of
this change.
Since it is unlikely that exports by these entities will substantially
increase, this will possibly lead to a reduction in imports by
these entities.
Source: Company, Ambit Capital research
Therefore, the challenge for Titan lies in the deployment of the free cash flows.
Will it aggressively expand the prescription eyewear business? Will it add new
product categories to its portfolio? An indication of the same was when Titan
Ambit Capital Pvt Ltd
27
Strategy
amended its Articles of Association to include multiple categories including sarees,
perfumes etc. The five-year strategy will likely be rolled out in 2H2013. Based on
the categories that Titan wants to enter into, investors will have to evaluate the
investment opportunity.
Exhibit 36: Titan's capital allocation over FY04-13
FY04-13
Debt repayment,
13%
Increase in cash
and cash
equivalents, 36%
Dividend paid,
17%
Purchase of
Investments Subsidiaries &
Others, 2%
Net Capex in
Others incl.
precision engg.,
4%
Interest paid,
11%
Net Capex in
Jewellery, 7%
Net Capex in
Watches, 9%
Source: Company, Ambit Capital research; Note: Size of the pie which represents total capital available for
deployment is Rs 31.3bn. Of this, net proceeds from issuance of equity/preference shares accounts for 1%,
interest income received accounts for 9% and the balance 90% is cash generated from operating activities.
Conclusion: Titan's strategic decisions over the next 3-6 months will determine
whether the company repeats the performance of the last decade or slides away to
mediocrity. Fresh decisions to allocate capital to new product categories will have
to be evaluated against what has been the company's stated policy so far and also
the timeframe within which the new product categories can be expected to
contribute meaningfully to growth and returns. It is well worth remembering that
the jewellery business took more than ten years after its launch to attract investor
attention. Moreover, as mentioned in our first note, scarred by some of its failures
in the 1990s, Titan is no longer willing to take bold decisions. Will this be its
Achilles’ heel over the next decade?
Questions to ask the Titan management
1.
2.
3.
4.
5.
6.
7.
8.
Ambit Capital Pvt Ltd
What are your plans to invest in the jewellery business? What returns have
you seen in your very large format Tanishq stores and what is the proportion
of such stores in your jewellery floor space?
Has Eye Plus turned the corner? What is the investment plan for this business
and what is Titan's USP?
Most eyewear chains in India continue to incur losses or they make marginal
profits. What return targets do you have and over what period of time?
Could eyewear or Fastrack have grown faster? Over the last ten years, if you
could go back and do things differently, then what would you like to do
differently?
The Titan brand seems to have lost its sheen to some extent. It is no longer
seen as unique. Consumer preferences have also changed a lot over the last
20 years. What steps do you see being taken to rejuvenate the brand?
You have changed your AoA to include various other product categories.
What criteria will be pursued to decide which categories you would like to
enter into and what is the timeframe for the same?
By what timeframe do you see any of the new category launches and when
do you see them of a size where they make a meaningful impact to the
company's performance?
Tata group: What is the plan for the different retailing and consumer-facing
businesses within the group? How are the synergies being exploited?
28
Strategy
Exhibit 37: Background of Board of Directors of Titan
Name
Designation
Age
(yrs)
50
No. of
years
on
board
0.75
Present
in no. of
other
boards
14
Non exhaustive list of
companies in which
Directorships/
chairmanship is held
Mahindra
World
City
Developers Ltd, Tamilnadu
Petroproducts Ltd.
Mr. Hans Raj
Verma (IAS)
Chairman,
NonExecutive and
NonIndependent
director
Mr. Bhaskar
Bhat (B.Tech.
in Mechanical
Engg from IIT
Madras,
PGDM from
IIM
Ahmedabad)
MD,
Executive and
NonIndependent
director
59
11
5
Tata Ceramics Ltd, Trent Ltd,
Bosch Ltd, Virgin Mobile India
Limited, Incube Ventures Pvt
Ltd
Mr. N.N. Tata
(B.A
(Economics)
from
University of
Sussex, IEP,
INSEAD,
France)
Mr. Ishaat
Hussain (BA
and FCA,
England &
Wales,
Advanced
Management
Program from
Harvard
Business
School)
Non
Executive and
NonIndependent
director
57
10
9
NonExecutive and
NonIndependent
director
66
24
14
Mr. N.S.
Palaniappan
(IAS)
NonExecutive and
NonIndependent
director
54
0.5
14
Mr. T.K. Balaji
(B.E. from
Madras
University,
PGDM from
IIM
Ahmedabad)
NonExecutive and
Independent
director
65
27
9
Trent
Ltd,
Voltas
Ltd,
Landmark Ltd, Trent Brands
Ltd,
Tata
Investment
Corporation
Ltd,
Trent
Hypermarket
Ltd,
Kansai
Nerolac Paints Ltd, Tata
International Ltd, Drive India
Enterprose Solutions Ltd
Tata Sons Ltd, Tata Steel Ltd,
Voltas Ltd, Tata Inc., Tata
Teleservices Ltd, Tata AIG
General Insurance Co Ltd,
Tata AIA Life Insurance Co
Ltd, Tata Consultancy Services
Ltd, Tata Sky Ltd, The Bombay
Dyeing
&
Manufacturing
Company Ltd, Tata Capital
Ltd, Viom Networks Ltd, Go
Airlines (India) Ltd, Tata
Capital Financial Services Ltd
Tamil
Nadu
Industrial
Development Corporation Ltd,
Tamil
Nadu
Energy
Development Agency, Tamil
Nadu Newsprint and Papers
Ltd, Tamilnadu Petroproducts
Ltd.,
Neyveli
Lignite
Corporation Ltd., Chennai
Metro Rail Limited, Tamilnadu
Generation and Distribution
Corporation Board, Tamilnadu
Transmission Corporation Ltd,
Tamilnadu Maritime Board,
Tamilnadu Electricity Board
Ltd,
Tamilnadu
Sugar
Corporation
Limited,
Nilakottai Food Park Ltd,
Tamilnadu Minerals Ltd, Tamil
Nadu
Salt
Corporation
Limited, TIDEL Park Limited
Lucas TVS Ltd, India Nippon
Electricals
Ltd,
Sundaram
Clayton Ltd, Delphi-TVS Diesel
Systems Ltd, Lucas Indian
Service Ltd, T V Sundaram
Iyengar & Sons Ltd, Apollo
Hospitals Enterpise Ltd, TVS
Automotive Systems Ltd, TVS
Investments Ltd, TVS Credit
Services Ltd
Ambit Capital Pvt Ltd
Experience
Mr. Hans Raj Verma, IAS, serves as the
Chairman, Managing Director and Principal
Secretary of Tamil Nadu Industrial Development
Corporation Ltd (TIDCO). He has been a Nonexecutive Director of Tamil Nadu Petroproducts
Ltd. since Nov 1, 2012 and Titan Industries Ltd
since Oct 31, 2012.
Mr. Bhaskar Bhat has been the MD at Titan
Industries Ltd, since April 1, 2002 and serves as
its CEO. Since 1983, Mr. Bhat has been
associated at the Tata Watch project that later
became Titan Watches and is now Titan
Industries. He started as a management trainee
at Godrej & Boyce Manufacturing in 1978. After
spending five years at Godrej, he joined the Tata
Watch Project initiated by Tata Press.
Mr. Noel Naval Tata serves as Group Chief
Executive Officer at Tata International Singapore
Limited and has been its Managing Director since
August 12, 2010. Mr. Tata serves as the
Managing Director of Tata International Limited
since August 12, 2010. He has extensive
experience in various fields including marketing,
administration, and investments.
Mr. Ishaat Hussain has been Finance Director of
Tata Sons Limited (Alternate Name: Tata Group)
since July 28, 2000 and serves as its Member of
Group Executive Officers and Member of Group
Corporate Centre. Mr. Hussain served as a
Senior Vice President and Executive Director of
Finance of Tata Iron & Steel Co. Ltd. for almost
ten years. He is Expert in Financial Management
& overall Management and Operational Control
and having vast experience in the areas of
finance, banking, accounts, audit, taxation and
general management.
Mr. Palaniappan has been the Chairman and MD
at Tamil Nadu Newsprint and Papers Limited
since Dec 13, 2012. He serves as Principal
Secretary
of
Industries
Department
at
Government of Tamil Nadu. He has held various
positions in the Tamil Nadu Government. He
serves as Principal Secretary to Government at
Rural Development & Panchayat Raj Department.
He is also Member of the Governing Council of
IIT (Madras), Chennai Metropolitan Development
Authority,
Entrepreneurship
Development
Institute and Mono Rail Empowered Committee.
Mr. Balaji serves as MD of Lucas-TVS Ltd and
served as its CEO. Mr. Balaji has been the MD of
Delphi-TVS Diesel Systems Ltd since April 1,
2002. He served as the President of Automotive
Component Manufacturers Association of India
(ACMA). He is an Industrialist with rich business
experience. He is a Member of CII National
Council. He is a member of Development Council
for Automobiles & Allied Industries, GoI. He was
conferred a Special Award by the FIE Foundation
of Maharashtra in March 1995 in recognition of
his contribution to the development of
automotive component industry
29
Strategy
Name
Designation
Age
(yrs)
72
No. of
years
on
board
11
Present
in no. of
other
boards
6
Non exhaustive list of
companies in which
Directorships/ chairmanship is
being held
Brahmos
Aerospace
Thiruvananthapuram Ltd, Global
Vectra Helicorp Ltd, Karnataka
Hybrid Micro-Devices Ltd, Tata
Advanced Materials Ltd, Titan
TimeProducts Ltd
Dr. C.G.
Krishnadas
Nair (B.E.
(Metallurgy)
from IIT
Madras, M.Sc.
Engineering
and Ph.D
Engineering
from
University of
Sask Canada)
NonExecutive and
Independent
director
Ms. Vinita Bali
(B.A.
Economics,
Master's
Degree from
Michigan
State
University,
M.B.A from
JBIMS,
Mumbai)
NonExecutive and
Independent
director
58
7
5
Britannia Industries Ltd, Piramal
Glass Ltd, The Bombay Dyeing &
Manufacturing Co. Ltd, Bombay
Burmah Trading Corpn Ltd
Ms. Hema
Ravichandar
(B.A. from
Madras
University,
PGDM from
IIM
Ahmedabad)
NonExecutive and
Independent
director
52
4
1
Marico Limited
Prof. Das
Narayandas
(B.Tech from
IIT, PGDM
from IIM,
Ph.D in
Management
from Purdue
University,
USA)
NonExecutive and
Independent
director
53
2
0
Mr. T.K. Arun
(Bachelor in
Commerce,
Associate CS)
NonExecutive and
NonIndependent
director
53
1
12
Ms. Ireena
Vittal
(B.Sc from
Osmania
University,
PGDBM from
IIM Calcutta)
NonExecutive and
Independent
director
45
0.5
2
-
Cheslind Textiles Ltd, Manali
Petrochemicals Ltd., DLF Info Park
(Chennai) Ltd., Ascends IT Park
(Chennai)
Ltd.,
Tamil
Nadu
Petroproducts Ltd., Tranflor Infra
Structure Park Ltd., Sree Maruthi
Marine Industries Ltd., Asian
Bearings Ltd., Great Sea Traweler
Building Yard Mandapam Limited
and
Southern
Petrochemical
Industries Corporation Ltd.
Axis Bank Ltd, Godrej Consumer
Products Ltd
Experience
Dr. Nair served as the CEO and the Chairman
of Hindustan Aeronautical Ltd. He has rich
experience covering academia, R&D and
industry. He serves as an Independent Director
of Global Vectra HeliCorp Ltd. He is a Member
of following Committees holding honorary
assignments, Scientific Advisory Committee to
the Cabinet of India, Scientific Advisory
Committee to the Cabinet of India, Enterprise
Reform Committee to the Government of
Kerala - Chairman of Society of Defence
Technologist, President of Society of Indian
Aerospace Technologies.
Ms. Bali has been the CEO of Britannia
Industries Ltd., since 2005 and as its MD since
May 31, 2006. She served as a Managing
Principal Officer of Zyman Group, USA. She
has spent over 16 years overseas in a variety
of marketing, sales and general management
positions with eminent multinationals. She has
a rich and diverse experience in packaged
foods and beverages gained from working
with Cadbury Schweppes and The Coca-Cola
Company in several continents in a variety of
marketing, sales and general management
positions.
Ms. Ravichandar serves as an Advisor of
Gridstone Research Inc. She served as Senior
Vice
President
of
Human
Resources
Development at Infosys Technologies Ltd. from
1998 to July 2005. She has more than 27
years of experience in the field of Human
Resources across different industries especially
in Information Technology. Her experience
spans
across
Change
Management,
Leadership Development and Human Resource
Development. She provides Strategic HR
Advisory to organizations. She holds several
key industry positions and served as the
Chairperson for The Conference Board USA 's
HR Council of India.
Prof. Das Narayandas is a Member of the
Advisory Team at Satmetrix Systems, Inc. He
serves as Associate Professor of Business
Administration of the Harvard Business School,
advises WhisperWire on market penetration
and expansion strategies. His background
includes management experience in sales and
marketing for various multinational firms that
involved field sales and sales force
management, new product development,
alliance
formation
and
marketing
communications.
Mr. Arun serves as General Manager and
Secretary of TIDCO, Chennai. His expertise
includes
structuring
of
Public
Private
Partnerships (PPPs) for Infrastructure Projects
including Water, Ports and Roads, PPP
documentation viz., Concession Agreements
and related Contracts, Bid Process Structuring,
Bid Process Management; Contract drafting /
negotiation, Contract Management and
Arbitration.
Ms. Ireena Vittal serves as Senior Advisor of
Blufin Advisors Private Limited. Ms. Vittal
worked at McKinsey & Company. Ms. Vittal is
an independent strategic advisor, with
significant knowledge in agriculture and urban
development in India and emerging markets.
She co-authored several studies relating to
agriculture and urbanisation.
Source: Company, Ambit Capital research
Ambit Capital Pvt Ltd
30
Strategy
Sun Pharma
Sun Pharma is India's third-largest pharma company and amongst the fastestgrowing Indian generic company in the US (41% CAGR over FY10-13). Over the
last 15 years, the company's revenues have increased to Rs113bn, at a CAGR of
30% and net profits have increased to Rs36.2bn, at a CAGR of 32%. In these 15
years, the company's stock price has recorded a CAGR of 43% as against the
Sensex return of 11%. Currently, the stock is trading at 29.0x FY14E (based on
Bloomberg consensus). Of the 47 analysts covering the stock, 28 have a BUY
rating, 17 have a HOLD rating and 2 have a SELL rating on the stock. We have a
BUY rating on the stock.
Exhibit 38: 20-year stock price chart along with Sensex performance
28,000
24,000
20,000
16,000
12,000
8,000
4,000
Sun Pharma
Dec-12
Dec-11
Dec-10
Dec-09
Dec-08
Dec-07
Dec-06
Dec-05
Dec-04
Dec-03
Dec-02
Dec-01
Dec-00
Dec-99
Dec-98
Dec-97
Dec-96
Dec-95
Dec-94
-
Sensex
Source: Bloomberg, Ambit Capital research
Exhibit 39: Trailing P/E for Sun Pharma
Exhibit 40: Trailing P/B for Sun Pharma
Trailing P/E (x)
5-yr avg
Source: Bloomberg, Ambit Capital research
Ambit Capital Pvt Ltd
10-yr avg
Trailing P/B (x)
5-yr avg
FY13
FY11
FY13
FY11
FY09
FY07
FY05
FY03
FY01
FY99
FY97
FY95
-
FY09
5.0
FY07
10.0
FY05
15.0
FY03
20.0
FY01
25.0
FY99
30.0
FY97
35.0
FY95
11.0
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
-
40.0
10-yr avg
Source: Bloomberg, Ambit Capital research
31
Strategy
Exhibit 41: Sun Pharma’s market cap
1,200
1,000
800
600
400
200
Dec-12
Dec-11
Dec-10
Dec-09
Dec-08
Dec-07
Dec-06
Dec-05
Dec-04
Dec-03
Dec-02
Dec-01
Dec-00
Dec-99
Dec-98
Dec-97
Dec-96
Dec-95
Dec-94
-
Market Cap (Rs bn)
Source: Bloomberg, Ambit Capital research
Exhibit 42: Sales and sales growth (YoY) for Sun Pharma
%
120,000
60.0
50.0
100,000
40.0
80,000
30.0
60,000
20.0
40,000
10.0
20,000
-
Revenue (Rs mn)
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
FY05
FY04
FY03
FY02
FY01
FY00
FY99
FY98
FY97
(10.0)
FY96
-
Revenue growth (RHS)
Source: Company, Ambit Capital research
Exhibit 43: EBITDA and EBITDA growth (YoY) for Sun Pharma
FY12
FY11
FY10
FY09
FY08
FY07
FY06
FY05
FY04
FY03
FY02
FY01
FY00
FY99
FY98
FY97
FY96
EBITDA (Rs mn)
140.0
120.0
100.0
80.0
60.0
40.0
20.0
(20.0)
(40.0)
FY13
%
45,000
40,000
35,000
30,000
25,000
20,000
15,000
10,000
5,000
-
EBITDA growth (RHS)
Source: Company, Ambit Capital research
Ambit Capital Pvt Ltd
32
Strategy
Exhibit 44: PAT and PAT growth (YoY) for Sun Pharma
%
40,000
110.0
35,000
90.0
30,000
70.0
25,000
50.0
20,000
30.0
15,000
PAT (Rs mn)
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
FY05
FY04
FY03
FY02
FY01
(30.0)
FY00
FY99
(10.0)
FY98
5,000
FY97
10.0
FY96
10,000
PAT growth (RHS)
Source: Company, Ambit Capital research
Hubris and arrogance: We have not detected any signs of hubris or arrogance
from the management. The promoter families of Dilip Shanghvi and Sudhir Valia
have always maintained a low profile. People close to the company say that Dilip
Shanghvi is almost obsessive about his privacy and in his attempts to avoid
publicity. Of late in spite of Mr Valia’s prolific deal making in his personal capacity
in Uninor (now Telewings Communications), Fortune Financial Services and, most
recently, Antique, the promoters have largely stayed away from the limelight. Dilip
Shanghvi's investments in the power sector are also managed at an arm's length
from Sun Pharma.
Shift in strategy? This marker is flashing ’amber‘: Sun’s growth and Dilip
Shanghvi’s reputation have been built on successfully acquiring and profitably
integrating ten firms over the past decade or so. However, with the exception of
the latest acquisition, DUSA, Sun has hitherto focused on acquiring small
businesses which are in trouble and then turning around their performance. Our
concern is that Sun’s acquisition strategy now seems to be changing as the firm
becomes more confident of its own abilities.
Exhibit 45: Major M&A deals in the US for Sun Pharma
Deal Value
Comments
(US$ mn)
Year
Deals
1997
Caraco
2005
Formulation plant in Bryan
NA
2005
Assets of Able Labs
NA
2008
Chatten Chemicals
52
2009
Caraco acquired some
products of Forest’s
Inwood business
NA
Increased generic product offerings
2010
Taro
NA
Dermatology and topical product
manufacturing plant in Israel and Canada
50
Privatisation
2011
2012
2013
100% ownership of
Caraco
Acquired DUSA Pharma
Acquired URL Pharma's
generic business*
8
230
100-120
Dosage form plant
Dosage form plant in Ohio
Dosage form plant in New Jersey and
Intellectual property for the products
Import registration with Drug Enforcement
Administration (DEA); API plant approved
by DEA in Tennessee, US
Entry into dermatological treatment devices
Adds 107 products to the US portfolio
Source: Company, Industry, Ambit Capital research. Note: * indicates Ambit estimate
“We are still a very small player in the U.S.,” billionaire Shanghvi said. “We will
have to look at a slightly bigger acquisition rather than to look at very small
acquisitions that we have done in the past.” - Dilip Shanghvi quoted in Bloomberg
on 24 January 2011.
Ambit Capital Pvt Ltd
33
Strategy
Will this self-confessed bottom-hunting approach to acquisitions change?
Shanghvi hints it might. "At one point I liked to buy assets that were, let's say,
stressed; today we are open to look at assets where we can add value even if they
are not under stress," says Shanghvi as quoted in Business Standard (1 November
2011). "And with our capability and experience we realise it is possible for
us to develop synergies and justify the investment."
This is one marker which is clearly flashing ‘amber’ for investors. Unlike many
successful companies which diversify into unrelated areas, Sun has remained
focussed on the pharma sector itself. However, what has changed is the appetite
for larger M&As. Over the past few years, Sun has articulated a more aggressive
M&A strategy towards expansion of branded generics business both in the US as
well as in other developed and emerging markets. News reports related to multibillion-dollar acquisition by Sun Pharma also makes us nervous.
“Sun Pharmaceutical Industries Ltd. (SUNP), India’s largest drugmaker by market
value, is looking for acquisitions in Europe including a possible takeover of German
generic-drug maker Stada Arzneimittel AG (SAZ), people familiar with the matter
said…Sun has sought to raise about $1 billion for a European deal, said one person
familiar with the matter, who asked not to be identified as the process is private.
Company executives recently toured Europe to meet with potential targets, another
person said.” – Bloomberg News, 8 February 2012
“Drug major Sun Pharmaceutical Industries is said to be in talks to buy Sweden's
pharma firm Meda AB in a deal worth up to $5 billion, according to media reports.
Sun Pharma has been in talks with several banks to raise funds to buy out Meda for
as much as $5 billion as part of its expansion plans, Wall Street Journal has
reported. A spokesperson of Sun Pharma refused to comment on the reports, while
e-mailed queries to Meda remained unanswered. The Mumbai-based firm had,
however, last week termed the reports of a possible deal as "speculation".” –
Economic Times, 3June 2013
In a interview to Business Standard on 17 February 2011, Shanghvi said, "We
would like to create centres of excellence in technology in different research sites
that we have in India as well as now in Israel and Canada, and leverage these
capabilities to produce innovative and differentiated products and sell them not only
in India and the US, but also in regulated and semi-regulated markets as a brand
company."
A seasoned strategic advisor to the Pharma sector states that “After the Protonix atrisk penalty, there is a high probability that Sun Pharma will pursue a big acquisition
to show that the US$550mn payment is not a significant setback. The only question
is whether it will be a sub-US$1bn acquisition or a multi-billion-dollar affair. If it is
the latter, I would be worried as I don’t see Sun having the management bandwidth
to integrate a large European or American acquisition…In a way, the unsuccessful
bid for Bausch & Lomb is a sign of things to come.”
Our view is that Sun has a two-pronged strategy:

to deepen its market access into the US as well as other developed and
emerging markets; and

to develop a basket of proprietary products which enables the company to
develop a ‘moat’ around its business.
This strategy, however, is not an abrupt development. Sun has been moving the
pieces around the chess board starting with the hiring of Kal Sundaram in 2009,
tying up with Merck for Emerging Markets in April 2011, anointing Israel Makov
(ex-CEO Teva) as Chairman in May 2012 and acquiring Dusa Inc in December
2012. Sun had also got a shareholder resolution approved in October 2012 for
capital raising of Rs80bn. What has raised the tempo now is the overall step-up in
M&A in the generic space and a feeling of being ‘left out’ amongst companies with
Ambit Capital Pvt Ltd
34
Strategy
larger aspirations. The reported bids made for Meda and Stada is also seen in the
above light.
To be fair to Sun Pharma, the management in the past has clearly highlighted that
they would not be forced into an acquisition and would bide their time. This is
highlighted by the fact that Sun articulated an M&A strategy years ago but it is yet
to commit to any significantly sized acquisition. There has, however, been no
comment from the management on the recent reported bids made, particularly,
the US$8bn bid for Bausch & Lomb, an opthalmology firm with no evident
synergies with Sun.
Inter-generational shifts or tensions amongst promoters/management: We
have not detected any signs of differences amongst the promoter families.
Moreover, from all accounts, it appears that Dilip Shanghvi has been focussed
over the past few years on strengthening the management bandwidth at Sun
Pharma.
Shanghvi is almost alone among first-generation entrepreneurs in his decision to
hand over the chairmanship to an outside professional. “What I plan to do
[working] with Shanghvi is not only look for opportunities, but build management
capacity that will support globalisation, something which many organisations
overlook,” - Israel Makov in Forbes magazine, November 2012.
The hiring of Kal Sundaram earlier as the CEO, who is now heading Sun’s US
business including Taro as well as the appointment of Israel Makov as the
Chairman are the first of what we believe to be continuous process of building
great management bandwidth in Sun Pharma. Moreover, over the past few years,
Sun has gradually introduced a number of senior management executives to the
wider world including Abhay Gandhi - head of domestic formulations - as well as
a number of senior scientists at Sun Pharma Advanced Research Company
(SPARC).
Despite this apparent deepening of management bandwidth, industry participants
highlight that Dilip Shanghvi remains utterly central to decision making on almost
every issue of significance within the Group. “Dilip Shanghvi takes every single
intellectual property decision Sun has to make, he determines capital allocation and
he decides which markets the firm should enter. Everything in Sun hinges around the
promoter…that might be why Sun ended up paying for Protonix. Sun had a strong
case for Protonix and yet the ended up having to pay…Can Sun Pharma really
become a global player with this sort of dependence on the promoter?” asks the
recently retired CEO of a rival pharma company.
For instance, industry experts believe that decisions like the at-risk launch of
Protonix cannot and will not be taken by professional managers, with the final call
to be made only by the owner-management. Similarly, Dilip Shanghvi is almost
legendary of walking in alone to negotiate M&A deals when the other side is
represented by a battery of professionals. Given the rising importance of markets
like the US, the company is likely to face more such decisions where the
promoter’s inputs are final. Potential tensions could arise as the senior
professionals are not obsessive about guarding their privacy as the promoters are.
Capital allocation: Sun has consistently generated higher-than-sector RoEs and
RoCEs over the past ten years. The focus on the then niche chronic therapeutic
segments in India back in the nineties has largely paid off given the rather staid
growth in the acute segment. This has enabled the company to steadily increase
market share to 4.9% in FY13 (vs 3.2% in FY07), making it amongst the largest
branded formulations players in India. The international business growth has also
helped sustain the high RoEs given its presence in high-margin areas like
injectables and dermatology (through Taro).
Going ahead, the challenges for Sun Pharma are multiple. The first is to diversify
away from India and the US, which are at present its key markets. Secondly, Sun
would like to extend its branded franchise into other markets to help sustain its
Ambit Capital Pvt Ltd
35
Strategy
competitive advantage. It is in light of these challenges that the company wants to
pursue acquisitions aggressively. The third, and in our view, the hardest challenge
for Sun Pharma, is to deepen the management bench so that the firm does not
revolve around the genius of one man.
If Sun is able to get these steps right, it should be able to maintain its historical
higher-than-sector return ratios even as it diversifies away from its traditional
markets. Thus, scalability of its successful business model in India and the US to
other newer markets is the key question asked of future capital allocation.
Conclusion: Given Sun Pharma’s extremely strong track record, investors have
largely shrugged away concerns arising from the large acquisitions that Sun may
commit to. However, the decisions arising from these future capital allocation
questions do raise flags regarding strategy going forward and investors should
quiz the management as to what is the threshold beyond which the management
would be uncomfortable raising debt for any large M&As.
Questions for management:
1. Who is being groomed as the successor to Dilip Shanghvi?
2. As the second generation works its way through the company rank, how would
the responsibilities and authority be split?
3. Other than the two promoters and Israel Makov, who are the five most-senior
executives in Sun Pharma and what are the domains of authority?
4. How do the compensation packages of Sun Pharma’s senior executives
compare with what executives earn at other leading Indian pharma companies
like Dr.Reddy’s, Cipla, Lupin and Ranbaxy?
5. Why did Sun Pharma bid for Bausch & Lomb, an opthalmology firm? What
made it so attractive to Sun?
6. Why is it that Sun’s promoters are so confident of making a mark in developed
markets through a proprietary branded portfolio? A peek into their thought
process in this regard is critical to understand Sun’s future development.
7. What is the threshold beyond which the company will not leverage itself
further?
8. How does Sun Pharma plan to fully integrate Taro to access its copious cash
generation now that the Taro turnaround has been achieved?
9. Sun Pharma recently split its domestic operations into a separate subsidiary.
Why was this done and what are Sun’s plans for its domestic business?
Ambit Capital Pvt Ltd
36
Strategy
Exhibit 46: Background of Board of Directors of Sun Pharma
Age
(yrs)
Name
Designation
Mr. Dilip S.
Shanghvi
Promoter,
Managing
Director
57
Mr. Israel
Makov
Chairman
73
Mr. Sudhir
V. Valia
Whole-time
director
Mr. Sailesh T. Whole-time
Desai
director
Mr. S.
Mohanchan
d Dadha
Nonexecutive
independe
nt director
Non-executive
Mr. Hasmukh
independent
S. Shah
director
Mr. Keki
Mistry
Nonexecutive
independe
nt director
Non-executive
Mr. Ashwin S.
independent
Dani
director
56
58
76
79
59
71
No. of
years on Other directorships
Experience
board
Chairman and MD at
Sun Pharma Advanced
Founder and MD of Sun Pharma since 1982. He has wide
Research Centre,
18
extensive industrial experience in the Pharmaceutical industry. He
(SPARC), Taro
holds directorships in various Sun Pharma subsidiaries.
pharmaceutical
industries
Mr. Israel Makov serves as an Advisor of Teva Pharmaceutical
Industries Ltd. Prior to joining Sun Pharma, he served as the
Bio light Israeli Life
President and CEO of Teva Pharmaceutical Finance LLC since April
1
Sciences, Given
2002. He founded INNI (Israel National Nanotechnology
Imaging Inc,
Initiative). He currently also serves as the Chairman of Bio Light
Israeli Life Sciences Invts Ltd. and Given Imaging Inc.
18
Non Executive & Non
Mr. Sudhir V. Valia, a CA by profession, is responsible for
Independent Director
finance, commercial, operations, projects and quality control at
of Sun Pharma
Sun Pharma. Mr. Valia has been a Director of Caraco
Advanced Research
Pharmaceutical Laboratories Ltd., since 1997 and Taro
Pharmaceutical Industries Ltd. since 20 September 2010.
Centre, (SPARC),
Taro
Pharmaceuticals,
Mr. Desai is a entrepreneur with 30 years of wide industrial
experience including 20 years in the pharmaceutical industry itself.
14
None
He holds directorships in various subsidiaries of Sun Pharma and
has also served as a director of SPARC until 2007.
15
Wardex
Mr. S. Mohanchand Dadha served as the Promoter and MD of
Pharmaceuticals Ltd,
the erstwhile Tamil Nadu Dadha Pharmaceuticals Ltd (acquired
Kerala Chemists and
by Sun Pharma in 1997). Mr. Dadha is a successful entrepreneur
Distributors Alliance
with more than five decades of wide experience in the pharma
Ltd., SPARC
Industry. He has experience in financial and accounting areas.
He is also a trustee of many charitable trusts.
Mr. Hasmukh Shantilal Shah, BA (Hons) Economics, M.A.
Sociology earlier served as the MD of Indian Petrochemicals Corp.
Micro Inks Ltd.,
Ltd. (IPCL). Mr. Shah served in senior positions with the
Feedback First Urban
Government of India as Joint Secretary to the Prime Minister of
Infrastructure Fund Ltd,
11
India and Secretary of Post and Telegraph Board. He served as an
Oswal Multimedia KID
Advisor to General Electric Company. He has made significant
Ltd., Supreme
contribution in social, cultural and rural development activities like
Petrochem Ltd, Atul Ltd
leprosy eradication, water management, conservation and
management of man-made and other natural heritage.
Currently, the MD of HDFC. He has worked as a consultant for
10
HDFC, Gruh Finance,
the Mauritius Housing Co and for the Asian Development Bank.
IL&FS, GE Shipping,
He was Deputed on consultancy assignments to the
Torrent Power, HDFC
Commonwealth Development Corporation in Thailand,
Asset Management
Mauritius, the Caribbean Islands and Jamaica to review and
Co, HCL
evaluate the operations of mortgage financial institutions in
Technologies, HDFC
these countries. He serves as a Director of The Bombay Chamber
Standard Life
of Commerce and Industry and Association of Leasing &
Insurance Co Ltd
Financial Services Companies. He has been a Director at BSE
Ltd., since 22 June 2010. He served as a Director of Credit
Information Bureau (India) Ltd until November 2005.
Mr. Ashwin Dani has been an Advisor of Hitech Plast Ltd. since 30
May 2009 and is the co-founder of the Colour Group of India. He
was the MD and Executive Vice Chairman of Asian Paints until
Resins and Plastics Ltd,
2009, post which he is the non-executive vice chairman and
Hitech Plast Ltd, Gujarat
director of the company. He is the President of the Board of
Organics Ltd, Asian
9
Governors of the U.D.C.T. Alumni Association, Mumbai and is the
Paints, Wockhardt
President of the Indian Paint Association (IPA), the premier paint
Hospitals, ACC
association in India. He is a member of the Executive Committee
of the Federation of Indian Chambers of Commerce and Industry
(FICCI), New Delhi.
Source: Company filings. Note: (a) Mr. Israel Makov was appointed as Chairman wef 29 May 2012; (b) Mr. S. Mohanchand Dadha was an Executive
Director until 21 March 2001 and wef 22 March 2001 he was appointed as a non-executive director; (c) Mr. Keki Mistry appointed wef 28 August
2002; (d) Mr. Ashwin S. Dani appointed wef 28 January 2004; (e) Mr. Hasmukh S. Shah appointed wef 22 March 2001
Ambit Capital Pvt Ltd
37
Strategy
Issues raised about our 7 June note
by investors
Issue 1: A 15- or 20-year period is too short a period in the history of a
company
In our view this is a very valid issue, especially if the study is limited to a 15-year
or less history of any company. And this is a limitation of any study of Indian
corporates since 1991 heralded such a complete break from the past that the
performance pre-1991 in most cases cannot be compared to what happened after
that. Ideally, a company's greatness and/ or longevity can only be evaluated if one
analyses the performance in few economic cycles and under different leaders. Very
rarely do we find companies that in 15 or 20 years have seen multiple economic
cycles as well as a change in leadership.
Whilst the longer the time period of analysis, the more robust the conclusions (Jim
Collins in his book ’Good to Great‘ looked at companies that have survived for
over 100 years), studies covering 15 or 20 years are useful given that we have
seen four economic cycles since the Indian economy was liberalised in 1991
(1991-96; 1997-2002; 2003-07; 2008-2013) and most companies have seen 2-3
shifts in management post 1991, barring some promoter-controlled families (like
Reliance Industries) and some professionally managed companies like HDFC,
HDFC Bank and Larsen & Toubro. Some of the changes have been highlighted in
the previous section.
Hence, whilst ideally a study of a 50 year or more period will be more relevant
and make the study and framework suggested more robust, a 20-year-old period
is justifiable, in our opinion, especially given the number of economic and
investment cycles that India has been through (see the exhibits below).
Exhibit 47: In the last 20 years, there have been multiple GDP growth and
investment growth cycles in India…
Phase 2: 1997‐2002
Phase 1: 1991‐1996
25%
Phase 3: 2003‐2007
Phase 4: 2008 onwards
10%
8%
15%
6%
10%
5%
4%
-10%
FY11
FY09
FY07
FY05
FY03
FY01
FY99
FY97
FY95
FY93
-5%
FY91
0%
GDP Growth (YoY, in %)
Investment Growth (YoY, in %)
20%
2%
0%
Investment Growth (YoY, in %)
GDP Growth (YoY, in %)
Source: CEIC, Ambit Capital research
Ambit Capital Pvt Ltd
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Strategy
Exhibit 48: …as have been cycles in profit margins and return ratios for Nifty
firms
24%
35%
Phase 1: 1991‐1996
Phase 2: 1997‐2002
Phase 3: 2003‐2007
Phase 4: 2008 onwards
22%
RoE (in %)
20%
25%
18%
16%
20%
14%
15%
PBITM (as a % of Sales)
30%
12%
RoE (in %)
FY11
FY09
FY07
FY05
FY03
FY01
FY99
FY97
FY95
FY93
10%
FY91
10%
PBITM (as a % of sales)
Source: Capitaline, Ambit Capital research, Note: RoE and PBITM captures median RoE and PBITM for Nifty
firms. For Phase 1, we have used the RoE and PBIT margins of the initial Nifty constituents.
Issue 2: Macroeconomic factors and policy drive performance
Macroeconomic outlook and policy measures clearly have a bearing on corporate
performance. However, over a cross-cycle period, corporate decision-making has
a greater impact on performance than the macro cycle. In fact, global research has
shown that over 80% of corporate performance can be attributed to internal
decision making rather than external factors. We would like to highlight one such
study by a 2008 HBR paper titled ’When Growth Stalls‘ (see Exhibit below):
“It happens even to exemplary companies: after years of neck-snapping acceleration
in revenue, growth suddenly stalls. And no one saw it coming. Worse, if executives
don’t diagnose the cause of a stall and turn things around fast, a company stands
little chance of ever returning to healthy top-line growth.
It’s tempting to blame stalls on external forces (economic meltdowns, government
rulings) and conclude that management is helpless. But…the most common causes
of growth stalls are knowable and preventable:
 A premium market position backfires
 Innovation management breaks down
 A core business is abandoned prematurely
 The company lacks a strong talent bench.”
Exhibit 49: The root causes of revenue stalls
Within Management's Control 87%
STRATEGIC FACTORS 70%
Premium Position Capacity 23%
Innovation management breakdown 13%
Premature core abandonment 10%
Failed acquisition 7%
Key customer dependency 6%
Strategic difusion orconglomeration 5%
Adjacency failures 4%
Voluntary growth slowdown 2%
ORGANIZATIONAL FACTORS 17%
Talent bench shortfall 9%
Board inaction 4%
Organizational design 2%
Incorrect performance metrics 2%
Outside Management's Control 13%
EXTERNAL FACTORS 13%
Regulatory actions 7%
Economic Downturn 4%
Geopolitical changes 1%
National labor market inflexibility 1%
Source: From the article “When Growth Stalls” by Matthew S. Olson, Derek Van Bever and Seth Verry of Harvard Business Review
(http://hbr.org/2008/03/when-growth-stalls/ar/1
Ambit Capital Pvt Ltd
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Strategy
It was in this context as we had argued in our first note that even if the Chinese
SUV market had seen strong growth recovery after the financial crisis, Tata Motors
would not have been able to benefit from the same if JLR did not have a strong
product pipeline, something the Tata Motors’ management had repeatedly
commented upon after the JLR acquisition.
The same Tata Motors did not benefit from the growth in the domestic passenger
car or SUV market growth, as it did not invest in product development or the
development of a new platform, something which was originally part of their
strategy. Of course, if there was no strong growth in the Chinese or western SUV
market, then the JLR acquisition would have looked very untimely and put the
entire company under severe financial stress.
In many of our discussions, investors were still willing to give Tata Steel the benefit
of the doubt on its acquisition of Corus because of the following:
 The global economic downturn affected the company adversely. But for this,
things would have been fine for the company.
 The company had plans to supply pellets/ sintered ore/ pig iron from India to
its European operations.
 The company had plans to simultaneously augment its raw material security by
acquiring mines or tying up raw material supplies overseas.
Let's look at each of these arguments. Immediately after acquisition, Corus
generated its peak EBITDA of US$2.3bn in the year to 2008. Assuming the good
times had continued, and assuming nothing else changed, the payback period for
Tata Steel would have been at least 6 years, not exactly a prudent investment.
The company had never articulated any investment plans in India to produce
sinter/ pellets in quantities required to feed its European operations and Tata Steel
surely knew that after its European acquisition, the company did not have the
wherewithal to invest large sums in India to set up pig iron facilities and it would
have been aware of the odds to get all the requisite approvals to open new mines
in India. Further, by the time Tata steel acquired Corus there was a fairly vocal
group in the domestic market which was lobbying against the export of iron ore,
and getting all the requisite approvals for mines had become extremely difficult.
Moreover, any such project on a scale to make a material difference to its
European operations would have taken over a decade to set up, a luxury that Tata
Steel did not have. Lastly, by the company's own admission, going by what it said
in its FY05 annual report, raw material shortages are likely to keep the cost
structure for the steel industry high and hence semi-finished products should be
manufactured where raw materials are available. The company has tried to
augment its raw material security but with limited success so far.
Ambit Capital Pvt Ltd
40
Strategy
Exhibit 50: Tata Steel - Commentary on raw material integration pre-FY08
Annual
report
for
FY04
Commentary
"Sustained availability and stability of raw material prices are pre-requisites for smooth operations and stable output prices, for a
capital-intensive industry like steel."
FY05
FY06
FY07
"On the raw material front, the Company’s entire present requirement of iron ore and a large part of coking coal are met from
captive sources. However, with the expansion of capacity, this may not be possible. The Company is, therefore, actively engaged
in identifying new iron ore and coal mines."
"Security of raw material supply has become a new priority with various global steel manufacturers seeking captive capacities or
long-term commitments for iron ore."
"Your Company is also working towards ownership and development of additional raw material sources in India and overseas
for its enhanced operations."
"In order to secure raw materials especially coal in the future, the Company has been evaluating options to acquire strategic
stake in coal companies in India and overseas. Pursuant to this, the Company has entered into an agreement with the AMCI
(CQ) Pty. Ltd., Australia to secure up to 20% of the coal produced by it."
"As in the case of others, raw material security is a significant imperative for the long-term sustainability of the Company’s
success. Focused efforts are therefore being made by the Company to achieve higher levels of raw material security to meet its
increased needs in line with its further growth aspirations. Tata Steel is actively exploring operations in resource-rich countries
for iron ore and coal, as also seeking fresh leases for iron ore and coal at various locations in India."
"As part of its long term strategy, the Company is focused on developing raw material sources for its global operations. In this
regard, the Company has formed a Global Minerals Group which is actively exploring various opportunities to secure access to
iron ore and coal in various geographies. This will enable the Company to continue its competitive cost position in the global
steel industry."
Source: Company, Ambit Capital research
Exhibit 51: Tata Steel - attempts to augment raw material security
Year of
acquisition
Jul-05
Mine
Initial Targets/Progress plans
Current status
Carborough
Downs Joint
Venture
The first raw coal production began in August
2006 and the mine was producing around
1mtpa in FY09. The second phase of
expansion was in progress in FY09, on
completion of which, it is likely to produce
3.7 mtpa of coking coal and PCI coal.
According to the annual report for FY08,
feasibility studies for the project are in
progress and completion is expected by
September 2008.
According to the FY10 annual report, on completion
of the second phase in FY11, it was likely to produce
around 2.5 million tonnes of coking and PCI coal
during
the
fiscal
year
2010-11.
The FY12 annual report mentions that it is operating
at 1.8mtpa capacity.
The first shipment from Mozambique was shipped
only in June 2012. Further, although Phase I is likely
to produce 1.5mt of coking coal and 0.9mt of thermal
coal, despatches of only 1mt of coking coal and
0.25mt of thermal coal are likely in 2013. Further,
Phase II has been delayed indefinitely.
Was put on hold in FY11 due to rising security
concern
in
the
Ivory
Coast.
Not discussed in any annual report after FY11.
According to the annual report for FY11, the
Environmental
Impact
Assessment
has
been
completed and the mining licence was awaited.
Not discussed in any annual report after FY11.
As of 4QFY13, only trial production has begun and a
1mt shipment is likely in FY14.
Nov-07
Coal project,
Mozambique *
Dec-07
Ivory Coast – Iron
Ore Deposits
Jan-08
Oman Limestone
Project
Sep-08
New Millennium
Capital Corp Iron
ore Project, DSO
Canada *
The company, Tata Steel Cote d’Ivoire has
been formed and the exploration and
feasibility studies were to commence.
An exploration licence for an area of 25
square kilometers has been granted to the
Joint Venture and the exploration and
feasibility studies were in progress in FY09.
According to the annual report for FY09,
production from the DSO project was
expected to commence in 2011.
Source: Company, Ambit Capital research; Note: * Key projects for Tata Steel
That said, there is no doubt that the macroeconomic outlook and policies drive
share price performance. Often capital allocation decisions are taken under a
specific set of assumptions and a dramatic shift in such assumptions can impact
how the decision is viewed over a period of time. That is why the corporate CEOs
job is so tough and that is why only a small minority of companies sustain excellent
performance over long periods of time.
It is also true that both Tata Steel's and Tata Motor's decision to go for large
acquisitions overseas looked risky. The attempt of our study (and to understand the
markers) is only to see if we can with some degree of probability say whether one
decision has a better chance of succeeding than the other. We did that for Tata
Steel and Tata Motors in our first note, but the real test is when we apply the
Ambit Capital Pvt Ltd
41
Strategy
markers to successful companies and use them as a predictive tool. If we are able
to do that, then we will consider it a job well done.
Issue 3: Ambit is retrofitting theories to events with the benefit of hindsight
A criticism made of our first note is that we are retrofitting theories to events with
the benefit of hindsight. There are no easy answers to this one because we had
the benefit of hindsight and it would be difficult to ignore the information we had
and what was available in the public domain. It is for this reason that we did not
laud or criticise a particular capital allocation or strategic decision with the benefit
of hindsight; all along our attempt has been to look at the information available
when the decisions were being taken and then logically analyse whether one
could make a judgmental call on the relative risk. How good our framework and
markers are will only be known a few years from now as we try to forecast which
companies are at risk of becoming fallen angels and which companies will rise
after a period of mediocre or poor performance.
Issue 4: Recoveries are unpredictable and hence, it is difficult to buy such
companies
Investors and investment houses have different styles and there is no one size that
fits all. Sell-side houses like ours trying to cater to a wide range of funds will
obviously face the challenge that whilst one approach may have an appeal with a
certain section of investors, the same approach may not find favour with another
set. This is the very nature of the brokerage business. Whilst many investors that
we met over the last one month wanted to first discuss the fallen angels and which
ones we think will rise back to glory, many others did not want to discuss the
same. The latter's take was simple - recoveries are unpredictable and a lot
depends on luck and therefore, they as custodians of small investors’ savings
cannot take undue risky bets in such potential turnaround stories.
Ambit Capital Pvt Ltd
42
Strategy
Institutional Equities Team
Saurabh Mukherjea, CFA CEO, Institutional Equities
(022) 30433174
saurabhmukherjea@ambitcapital.com
Research
Analysts
Industry Sectors
Desk-Phone
Aadesh Mehta
Banking / NBFCs
(022) 30433239
E-mail
aadeshmehta@ambitcapital.com
Achint Bhagat
Cement / Infrastructure
(022) 30433178
achintbhagat@ambitcapital.com
Ankur Rudra, CFA
Technology / Telecom / Media
(022) 30433211
ankurrudra@ambitcapital.com
Ashvin Shetty
Automobile
(022) 30433285
ashvinshetty@ambitcapital.com
Bhargav Buddhadev
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(022) 30433252
bhargavbuddhadev@ambitcapital.com
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Oil & Gas
(022) 30433202
dayanandmittal@ambitcapital.com
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Strategy / Derivatives Research
(022) 30433255
gauravmehta@ambitcapital.com
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Metals & Mining / Healthcare
(022) 30433261
jatinkotian@ambitcapital.com
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Strategy
(022) 30433251
karankhanna@ambitcapital.com
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Banking
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vkrishnan@ambitcapital.com
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nitinbhasin@ambitcapital.com
Nitin Jain
Technology
(022) 30433291
nitinjain@ambitcapital.com
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pankajagarwal@ambitcapital.com
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Real Estate / Retail
(022) 30433264
pratiksinghania@ambitcapital.com
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Ravi Singh
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ravisingh@ambitcapital.com
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(022) 30433175
ritikamankar@ambitcapital.com
Ritu Modi
Healthcare
(022) 30433292
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Shariq Merchant
Consumer
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shariqmerchant@ambitcapital.com
Tanuj Mukhija
E&C / Infrastructure
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tanujmukhija@ambitcapital.com
Utsav Mehta
Telecom / Media
(022) 30433209
utsavmehta@ambitcapital.com
Sales
Name
Regions
Desk-Phone
Deepak Sawhney
India / Asia
(022) 30433295
deepaksawhney@ambitcapital.com
Dharmen Shah
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dharmenshah@ambitcapital.com
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India / USA
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diptimehta@ambitcapital.com
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USA / Europe
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USA
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pareespurohit@ambitcapital.com
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India / Asia
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praveenapattabiraman@ambitcapital.com
Sarojini Ramachandran
UK
+44 (0) 20 7614 8374
E-mail
sarojini@panmure.com
Production
Sajid Merchant
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Joel Pereira
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(022) 30433284
joelpereira@ambitcapital.com
E&C = Engineering & Construction
Ambit Capital Pvt Ltd
43
Strategy
Explanation of Investment Rating
Investment Rating
Expected return
(over 12-month period from date of initial rating)
Buy
>5%
Sell
<5%
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Parel, Mumbai 400 013, India.
Phone: +91-22-3043 3000
44
Fax: +91-22-3043 3100