Conglomerate Crisis: Why Tatas, Birlas & Ambanis Must Become Warren Buffetts

http://swarajyamag.com/business/conglomerate-crisis-why-tatas-birlas-and-ambanis-must-become-warren-buffetts

R Jagannathan, March 21, 2016

Some lessons for Indian Conglomerates from the debt debacles of India Inc. 

Cronyism is not a sustainable way to build a business. What you gain on the political and economic swings you lose on the roundabouts. 

Businessmen who don’t have the resources to put in adequate equity to balance the debt should not be getting into projects that are too big for them. 

Diversification worked in the pre-1991 era when obtaining a licence was the key to profitability. Not today. 

In this age of competition, all businesses should downsize and focus on their core strengths. 

Having too many companies under one roof means capital allocations can go wrong so Conglomerates should aim to become capital allocating businesses, rather than operating ones. 

India’s big business has to shift its area of competence from running a company to judging the efficiency of their capital allocations.

After more than a decade of irresponsible growth, undigested acquisitions and unrelated diversification, India Inc clearly has to downsize. Groups as big as the Tatas and Birlas are feeling the weight of debt, and they will surely be better off selling entire businesses and becoming less of conglomerates. Focus, in the post-debt world, is going to be more important to success than size and diversity.

The big groups have to redefine their core business as the allocation of capital, and not running the various businesses themselves. In short, the Tatas and Birlas have to become Warren Buffetts, and not remain primary entrepreneurs. 

While the Tatas are probably big enough to hold on to most of their behemoths and still pay off their debts, one statistic is worth noting: of the total group market valuation of around $110 billion (Rs 7,47,000 crore), two-thirds comes from just one company (Tata Consultancy Services). They should ask themselves: are we better off growing our best businesses or feeding the slackers? Should we be leaner and more profitable, or larger and less effective in what we do?

For both the Tatas and Birlas, their current problems relate to two big overseas acquisitions they made in 2007, of Corus Steel and Novelis (aluminium products) respectively. While the Birlas bought Novelis for around $6 billion, the Tatas paid nearly $11 billion for Corus, before running smack into the global financial crisis that made it impossible to generate enough profits to pay back the debt incurred for the acquisitions. Now, the Tatas are busy hiving off portions of Corus to pare down debt. 

The Birlas are on a more even keel, but they too are stretched on debt. The Hindalco share today quotes at less than half the value it had around the time of the Novelis acquisition nine years ago. 

In the case of the Tatas, just two companies (Tata Steel and Tata Power) account for more than half the group’s overall debt of Rs 2,07,000 crore; for the Birlas, Hindalco accounted for more than half the group’s overall debt of Rs 1,25,000 crore. Clearly, one difficult acquisition each has damaged the growth prospects of the Tatas and Birlas.

If this is the case with the big boys, the midi groups are faring worse. The Economic Times today (21 March) notes that the Ruias are planning to sell their refinery in Gujarat – the second biggest in the country after Reliance’s – in order to prevent debt from killing off the entire group. The group has Rs 85,000 crore of debt, and selling off a three-quarters stake in the refinery and the connected Vadinar port will reduce 40 percent of the group’s debt.

Another ET magazine report (20 March) says the default-rated debts of five groups, is as high as 65 percent for Jaypee (the Jaiprakash group), 38 percent for Lanco, 37 percent for GMR, 36 percent for Essar and 5 percent for GVK.

And so the story goes on as one descends down the pecking order of Indian businesses grouped by size. 

The interesting thing about debt-driven downsizing is this: all these groups are selling not their worst businesses, but their best. Look at the irony. Greed in good times encouraged these businessmen to overload themselves with debt, but on the downside they are not even getting to keep their best businesses.

This is true across the board.

Vijay Mallya has been forced to sell his profitable United Spirits business and may now have to exit the beer joint venture with Heineken too. All for getting into the high-profile and lowest margin business of aviation. Its like indulging the trophy spouse who eats up your wealth while ditching the one who gave her all and made you a success.

Manoj Gaur of Jaypee is selling off his best cement businesses to keep the group afloat, and ET magazine quotes him as saying ruefully that “in tough times only good things go. That pain of selling some of our best assets will be there for life.”

There are several observations to be made on the debt debacles of India Inc.

First, cronyism is not sustainable way to build a business. What you gain on the political and economic swings you lose on the roundabouts when it is time to pay back the lenders who poured money like water into your ventures.

Second, debt is not the way to grow a difficult and risky business. Businessmen who don’t have the resources to put in adequate equity to balance the debt should not be getting into projects that are too big for them. When even the Tatas and Birlas are struggling to digest a Corus or a Novelis, what business did the GMR group have to get into airports and the Ruias into steel, oil, and telecom from their core shipping business? While telecom paid off in spades as Vodafone paid Essar a prince’s ransom to enter India, the fact is they got out just in time. A couple of years down the line, they would have been struggling with high spectrum costs. 

Third, diversification was the mantra of Indian business in the licence-permit era, when obtaining a licence was the key to profitability. So cronyism helped. But after the 1991 liberalisation, when competition increased, all businesses had to downsize and focus on their core strengths. And this is exactly what they did, but they forgot the lesson in less than a decade. In the post-2002 expansionary global economy, the old habits of unrelated diversification resurfaced, and groups that were earlier in cash-generating businesses like construction went into areas they knew nothing about. GMR and GVK went into airports (both are trying to exit now), Mallya into aviation, Unitech (a real estate company) into telecom, Anil Ambani into entertainment, and ITC into FMCG. Of all these unrelated diversifications, only ITC’s made some sense, for it was trying to get out of the tobacco trap, given growing global concerns about cancer risks from smoking.

Fourth, conglomerates (groups with multiple businesses that are unrelated to one another), and diversified companies (like Reliance, which has oil, refining, retail, telecom and media under one basic company) have to become capital allocating businesses, rather than operating ones. This is the only way they can run unrelated businesses under one banner. Having too many companies under one roof, or even several nominally separate roofs, means capital allocations can go wrong, for it is difficult for one promoter to be so good at deciding where to invest and where to disinvest. 

The primary job of Warren Buffett, whose Berkshire Hathaway is a holding company for diverse businesses, is to identify companies to acquire and companies to sell. He is not trying to run any company himself. But in the case of the Tatas or Birlas or even the Ambanis, promoters have a large say in how their companies are run. This is not a good way to run conglomerates, since no promoter, howsoever intelligent or hardworking, can be good at knowing how to run companies in different industries, with different competitive scenarios and different rates of technological change. 

India’s big business has to shift its area of competence from running a company to judging the efficiency of their capital allocations.

Those groups which do not have enough much capital to allocate should focus on their core strengths and businesses and not fritter away their energies in trying to grow big in multiple areas. Even cronyism cannot guarantee success in a super-competitive environment. Ask GMR and GVK. And the hordes of companies which got into telecom.