Stopping the Blow

Stopping the Blow

Abhay Baijal, Consultant, Ex-CFO, Chambal Fertilisers and Chemicals Limited, 0

Imagine you are in medieval India, 500 years ago and you are a Rajput General of a kingdom in Rajasthan – Mughals are in ascendance; they have captured many territories and eye your kingdom.

Your spies have given you some information. A large contingent of foot soldiers about 5000, cannons – some 20 in number, and cavalry some 200 in number have moved out. It is early May, and the beginning of the dry season.

You are now sitting in your garrison. Your kingdom is the last few in the area which has held out. You are blessed with a water source – a river that runs through two out of four seasons – the bed dries only by late April. You have a kingdom of some 30,000 people, and an army of about 3,000 with 2,000 reservists. You can mobilize for about 100 days of war. You have no cavalry, but can borrow elephants some 10 in number from the neighboring kingdom with whose General you have cordial terms. Both see the Mughals as a common enemy.

There are three possibilities in so far a battlefield is concerned – A valley about 2.5 km bound on three sides by hills about 150 meters high – and is the easiest land based approach to the Garrison. The river sweeps three quadrants of the Garrison and is a natural barrier running two sides and back.

Obviously, the enemy has only one possibility in flood season – that is the land based approach through the valley. In the dry season it is anybody’s guess.

What are the thoughts in the Generals mind?

Cut to the present, you are also the CFO of a company – your problems can be similar, not military but strategically similar.

You have, let’s say a cozy business with a running EBTDA margin of some 18 percent. The product that you manufacture is a B2B – you are into a compressor of a Refrigerator. Your claim to a USP is that the compressor is low noise, has two percent better efficiency and uses the latest environment friendly Freon. Your competitors are a large Indian industrial group with several lines of business – of which this one – their claim to fame is their aggressive tactics, strong cash flow from other businesses, and a brand. Their own product is inferior on efficiencies as compared to yours – but they discount and sell, your product is preferred over theirs for more conscious customers – they ask for your compressors. So many brands use your compressor for the higher end Refrigerators. They mostly use your competitors equipment for the mid market brand.

There is another smaller competitor in the mid market segment he is about 20 percent of the size of the bigger conglomerate competitor.

As of now the volumes are in favor of the mid market brand in the ratio 1.75:1, and these take up to 90 percent of the market. The balance of the 10 percent is by way of direct imports which come mainly from China. The 10 percent is in the very highest price range – and in the very large refrigerator size.

There was a news item you saw while reading Stock Exchange notices today – the Board of the conglomerate had set up a Blue Sky Strategy Committee to analyze acquisitions.

What should the CFO do?
Obviously your first thought is – Is my company the target? Or could it be the smaller company in the same mid market segment? You look at your market Cap, around 1,035 Cr – Your EBITDA per share is about 30/- basis 18 percent EBITDA on 1,000 Cr sales and 6.0 Cr Shares outstanding of face value 10/-. But somehow you have a share price of Rs 175 that is 5.90X. You have been growing around three to four percent in volume terms, and about 11 percent in nominal terms - without much effort – and the feeling is that if the B2B outreach is better the growth could easily turn to six percent volume terms. There would be a move to more conscious customers wanting a better product and the final manufacturers would place more orders for their lines, which could shift from the mid market segment. In other words, a nominal growth of 13-14 percent. Basis the current product cut and B2B outreach you could increase your turnover EBITDA and Market Cap. The Promoter Family owns 38 percent, DIIs and FIs own 17 percent, and the rest is floating stock. The real attraction in the company is also the cash in books – you are more or less debt free if you take the 300 crore of cash in the books. The land on which the factory stands somewhere on an important national highway some 4.5 Acres is easily worth 250 crore. Looking to all this you have the conviction that your story is not well told and the market doesn’t appreciate your worth.

anticipation is a skill that can be learnt – but it is a discipline – the grooves in the mind about the approaches have to be cut – and the pathways oiled for the wheels to run in without clogging

But the Promoters do not seem to care – the family has been announcing ever higher dividends, it has reached almost 55 percent pay out ratio. Last three years average PAT was about 105 Cr, and he was averaging Rs.9 per share as dividends. He thought that was also a pretty good Dividend Yield.

One way to make it difficult for the conglomerate was obviously:

(1)Increase Market Cap or
(2)Find long term Institutional Investors who wouldn’t off load – reduce floating stock
(3)Go for a Share Buyback!
(4)Go for the acquisition of the 20 percent competitor of the Conglomerate --- reduce cash in the books, add value and threaten the conglomerate’s compressor division by higher market cap and squeezing him from both ends of the product spectrum.

There could be many more –it is a good case study obviously, but the important point regardless of the merits of the options is the mind set of anticipation.

Stopping the Blow is about anticipation, which is an attitude of the mind. Both the Rajput General and the CFO who could be threatened by an acquisition are facing a similar problem. The problem is a possibility that they could be flattened by a stronger adversary, the organization’s constituents could feel threatened, their culture and values could be roughshod.

There are a hundred of other situations of risks – visible and invisible – known and unknown. But to the wakeful and watchful belongs the night.

There are opportunities, risks, strength and weakness in every situation. How they can be best utilized is the job at hand.

There is obviously a disciplined approach to all of this – anticipation is a skill that can be learnt – but it is a discipline – the grooves in the mind about the approaches have to be cut – and the pathways oiled for the wheels to run in without clogging. That shall be the subject of my next.