Tuesday, 9 October 2012

Mr.Ajay Piramal - Businessman Stepping In Shoe of A Value Investor

Let me make a confession at the beginning, I am a convert, hence my views are bound to be biased! Yes, over last few months,  I have witnessed a slow but steady transformation in my feeling towards Mr.Piramal from curiosity to respect to awe. As I watch Mr.Piramal conducting the business of now re-named Piramal Enterprise, it leaves me with a feeling of deep satisfaction that i have made a right choice of making "side car investment" with Mr. Piramal. As an avid student of value investing, it is fascinating to watch some one taking the teachings of this highly intuitive and yet effective philosophy out of investment paradigm and start putting it into practice in making business decisions. In order to demonstrate how deeply value investing principles are ingrained in Mr.Piramal's business philosophy, let me analyze some of the decisions made by Mr.Piramal and how they relate to core principles of value investing. 


1) Mr.Piramal's decision to sell domestic formulation business to Abbott:  



Building business from scratch is like growing a baby. It takes continuous effort, unwavering commitment and complete dedication while end result is deep sense of satisfaction. One gets completely engrossed in the process and becomes deeply attached to the business. Hence, it is very difficult for one to let go of this attachment and sell the business, especially a successful one. Consider PHL in 2010, domestic formulations division was the bread & butter for PHL and Mr.Piramal had worked hard to bring it into top-3 in Indian pharma industry. In FY 10, healthcare and diagnostic business constituted roughly 60-65% of revenue for PHL. Moreover, the business had grown topline and bottomline at 17% and 34% CAGR respectively in last 8 years. (pg.11, AR FY11). In short, every thing was hunky-dowry! So what prompted Mr.Piramal to take decision of selling largest chunk of his business to Abbott? Here is an answer in his own words from interview given to HT in June 2012



"I have an obligation to my shareholders, to create maximum value for whatever they have invested and that’s what my job is and that’s what I am here to deliver. I don’t carry an egoistic or emotional attachment to the businesses. We did a calculation to justify the value that Abbott paid — I would have had to grow the business for 15 years at 20% CAGR with an operating margin in excess of 35%. Now that’s not possible and therefore, the choice was should I leave aside my ego that it is my business and I created it, or should I do what is in the best interest of shareholders. If you look at like that, that’s what a leader ought to do, in my view. Job of a leader is to act like a trustee."


Now this will  surely sound like music to ears of Philip Fisher or Warren Buffet who puts concept of "management as trustee of shareholder wealth" on top of the list in making investment decision.


 Also note similarity with Ben Graham's advice given in his seminal book Intelligent Investors. He tells that some times Mr.Market is brimming with enthusiasm and  offers ridiculously high price to buy out the your interest in the business. At that time, as prudent investor or sensible business man, you shall oblige and sell the business and take advantage of the deal offered by Mr.Market. Here in this case it was Abbott in place of Mr.Market and as Mr.Piramal describes, he happily sold his interest as in his own sense, price offered far exceeded intrinsic value of business.



PHL decided to buy-back shares instead of declaring special dividend: 


PHL decided to reward shareholders by offering buy-back of 20% of shares at 20% premium to market price. Now market did not like this move at all! Market was more interested in special dividend as it meant "cash in hand" of the shareholders even at the expense of getting less value! In spite of anticipating this unpopularity, management decided to act in manner which was in the best interest of the shareholders. Please refer to slide 7 & 8 for analyst presentation for Q3 FY11
As it is illustrated in the slide, for the same amount of money spent by the company, cash in hand of shareholder is much higher in "buy-back" option as compared to paying dividend due to tax efficiency of buy back. Moreover, it also is beneficial to continuing shareholders as number of outstanding shares go down by 20% (thus decreasing equity base) and help in enhancing EPS/ROE.  As Graham puts it in intelligent investor,


"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."



and now read what Mr.Buffet thinks on share buy back. Let's go to 1984 news letter where he penned down his elaborate thoughts on share repurchase and its virtues 


"While we enjoy a low tax charge on these proportionate redemptions, and have participated in several of them, we view such repurchases as at least equally favorable for shareholders who do not sell.  When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.".

So, Mr.Buffet clearly indicates that share repurchase program gives an opportunity to existing shareholders to redeem some of their capital with low tax liability without adversely impacting interests of continuing shareholders. Mr.Buffet puts in necessary conditions for initiating share repurchase (As highlighted) which were met in case of PHL.

PHL's Investment in Vodafone India: PHL bought 11% stake from Essar in Vodafone India at roughly 5800 crores. Mr.Piramal made it very clear that this invsetment was only financial investment and company had no plans to enter into this sector. It was indeed a smart strategy to park huge surplus cash in a way that maximizes return while giving time to PHL to find out good specific opportunities in its area of operations. However what is more remarkable is the deal Mr.Piramal extracted from Vodafone. As he emphasizes that "trust" and "respect" that PHL has created over a period of time that helps him get a better deal than rest of the people.  So here is the deal, 

PHL buys out 11% stake from Essar in Vodafone India in two tranches of similar proportions. PHL has an option to sell its stake in IPO if Vodafone India decides to go public in 24 months from the date of investment. However, if Vodafone decides not to go for IPO, Vodafone will buy back 11% from PHL in the range of 7000- 8300 crores (Vodafone AR, page 59). Now in the worst case, company is getting 10% annualized return at floor price of 7000 crores while PHL will earn 20% return at 8300 crores. So minimum return PHL will earn is 10% CAGR which is still better than money put in fixed deposit. 

Now, if Vodafone decides to come up with IPO by 2014, which is not an unlikely event, considering their plan for expansion and their intent of going public, Vodafone India can at least command valuation similar to that of Bharti (as it is comparable in size with Bharti)  even if one doesn't consider premium for MNC. So, going by FY 12 numbers, Vodafone India clocked EBIDTA of 1.2 billion pound i.e. roughly 10,000 crores. Considering today's situation of  extremely negative sentiments about telecom sector, Bharti is still trading at Market cap of 1,00,000 crores i.e. 10 times last year's EBIDTA (10,300 crores).Hence, it is not unreasonable to assume Vodafone India also getting similar valuation of roughly 1,00,000 crore market cap. This will value PHL's 11% stake at 11,000 crores, cool 80% return in 2 years i.e. 38% CAGR! Reminds you of something? yes,  Heads I don't lose, tails I win big! Low risk- high return game...

PHL's Acquisition of DRG : PHL completed acquisition of DRG in June 2012 at 3400 crores paying 4 times expected revenue for FY 2012. As indicated by PHL management, publicly listed companies engaged in similar business trade at valuation of 3-5 times topline  Hence, DRG was not that cheap by these standards. PHL decided to pay fair price. Now read this sentences from Mr.Buffet 

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”  

                                      and 

“A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital.”

As many of you may be knowing, DRG is in the business of  healthcare information management where they collect "vertical specific" data, organize it into usable information and sell information to customers where information arbitrage is important. Now look at the analyst presentation on DRG put up by PHL. PHL describes reason for acquiring DRG; here are the key points

  • Recurring revenue flow  which is tied into budgeting cycle (predictable business
  • Data gets embedded into client's system ( one of the moat of "high switching cost" mentioned by Pat Dorsey in his extremely useful book "Little book that builds wealth")
  • High value of insights; the risk far outweighs the price (of subscription); reputation of source (hence authenticity) matters ( very high switching cost due to potential negative impact)
  • Quality, accessibility and frequency of data and sources is more important than price (pricing power a key attribute that quantifies moat)
  • High barriers to entry with, 290 analyst with deep industry knowledge and relationship; data collection process with irreplaceable longitudinal data and  network of 125000 advisers and data providers ( again Pat Dorsey's one of the moats, Network effect; difficult to replicate) 
  • strong operating leverage ( as company scales up, higher percentage of top-line flows to bottom-line)
  • Strong free cash flow ( another key attribute (along with pricing power) of great business) 

As can be seen from the above analysis, DRG demonstrates all the attributes of a great business (having sustainable moat). Hence, DRG is a perfect example of buying a company with sustainable moat (in Pat Dorsey's words strong moat) at fair price. 

I am feeling convinced that given enviable track record of value investing principles of generating above-average returns for a long period of time, journey with Mr.Piramal will turn out to be a one big joyride for PHL investors!

21 comments:

  1. Hi Dhwanil,

    Awesome post. What I like most is the great application of acquired wisdoms from the investing gurus.

    Let us pool ourselves out of the comfort of being in the side car with Mr. Piramal and get started with the bear case.

    Why would someone be willing to sell this great opportunity to a fellow investor ? Would love to have some views from you on this regard.

    ReplyDelete
    Replies
    1. Hi Rudra,

      Yes, I think we need to be devil's advocate to understand the downside and risks. Let me answer your question specifically.

      - Even today, Piramal's business is surrounded with lots of uncertainty. Say when Vodafone investment matures and receivables from Abbott flows, what will happen to 8000-10000 crores money flowing into the company? where will he invest? may be he will partly retire debt. With rest of the money, Will he make a new acquisition or he will simply make another opportunistic investment? will money spent on R&D be productive and result into cashflow in future?

      - Secondly, if one starts evaluating PHL business as any one evaluates other businesses i.e. EPS/Cash flow/P/E parameters, will anyone invest? How about quarterly losses reported for last two quarters? Most of the people who do not go to the depth of the story and have faith in Mr.Piramal and his abilities will think, it is not worth remaining invested.

      - Analyst love DCF! and how do you value PHL on DCF basis when even Mr.Piramal doesn't know where the cash flow is going to come from (becoz he doesn't know where he is going to invest huge surplus cash!)

      Delete
  2. Hi Dhwanil,

    Nice Post. What fascinates me about Mr. Piramal is that he constantly displays behavioral traits requried for a successful investor. I have written a post on the same at: http://goo.gl/n7iIp

    Would appreciate your views on the same.

    regards,

    ReplyDelete
    Replies
    1. Hi Saurabh,

      Great post from your side as well. I completely agree with behavioral traits that Mr.Piramal has displayed till now surely give lot of comfort to shareholders that their money are highly unlikely to be deployed in suboptimal manner.

      Best Regards
      Dhwanil Desai

      Delete
  3. Another great post Dhwanil

    I believe stocks like Piramal Healthcare provides opportunity to benefit from positive swans while protecting the downside. Looking another way, it provides around 4% dividend yield and assuming the worst case of 4% growth growing forward and no-rerating, stock will still give 8% return. I was very much convinced by the arguments put by Prof Sanjay bakshi on his blog and bought it immediately.

    ReplyDelete
    Replies
    1. Thanks Anil. I also got introduced to PHL and Mr.Piramal through Prof.Bakshi's blog and after digging on my own, felt even more convinced. I am sure as Prof. Bakshi says, serendipity will come into play sooner or later!

      Best Regards
      Dhwanil Desai

      Delete
  4. thanx a lot such a valuable info.

    ReplyDelete
  5. But still my apprehension towards investing my money based on One person is preventing me to invest into Piramal It might turn out to be a blunder like if someone said same thing of Buffet in early 80s and stayed away.

    But i would like to know more about the next level of management and their capabilities which should increase once conviction that its not just about Ajay but the process of the group

    ReplyDelete
  6. Fine post Dhawnil,

    The sentence " Yes, over last few months, I have witnessed a slow but steady transformation in my feeling towards Mr.Piramal from curiosity to respect to awe." sums up quite well what i have experienced too. Good thing is, it's still available at a very reasonable valuation for people who might be making up their mind late. It's my top holding, invested regularly from 450 odd levels till 260 odd levels (via Piramal Life Science).

    Regards

    ReplyDelete
  7. Dear Dhawnil,

    I am a regular follower of your blog.
    Want to share a minor point.
    Bharti has 118 million users where as Vodafone as 52 million users. Therefore I think it would be a better idea to take Vodafones market cap at arnd 60000 Crs and not 1 lac cr.
    Wat re your thghts on the same??

    Karun Sandha

    ReplyDelete
    Replies
    1. Hi Karun,

      According to latest numbers in August 2012, Airtel has 186 million customers while Vodafone has 152 million customers in India. Frankly, It is difficult to do a elaborate comparison of Bharti and Vodafone as Vodafone India details are scarce. However, I feel considering little differential in customer base in terms of scale (as we are talking about 15-20% differential), similar range of EBIDTA and international group credentials will help vodafone India command valuation equal to Airtel. Also one should keep in mind that current valuations are based on uncertain policy environment in the sector and subdued market condition. So, though, I do not have elaborate quantitative framework to back my numbers, just rough calculations with some very primary and basic understanding of the market/valuation, my gut feel is (which very well may be wrong) Vodafone can command valuation similar to that of Airtel.

      Best Regards
      Dhwanil Desai

      Delete
    2. Hi Dhwanil,

      My mistake, missed out 1 in 152 if the number is 152 million in comparison to 180 million of Airtel then ur calulations are 110% correct.

      Dhwanil wat are your thghts about future of airtel.

      Secondly, do some blogging on digitalisation of Cable TV. I am personally bit bullish on all media houses as their subscription revenues are bound to inc.

      Delete
  8. hi Dhawnil,

    Good post and have been following Piramal closely after Prof. Bakshi did post detailed analysis on his blog. Yes, the stock is cheap given the limited downside but there are few things which I don't get and little bit sceptical.

    1. Salaries to the family is itself very high given they have majority of shareholding. Not so high though compared to likes of Jindal's.
    2. Entry into Financial services - they paid 225 crores for a business of 28 crores and 9 crores of profit. I think it's steep valuation. Although, I don't understand that business, I am sure there is reasoning behind it.
    3. Only route to get into business would be acquisition and as you know 90% of acquisitions are a failure although Mr. Piramal has higher degree of success in the past. This however doesn't guarantee future success as well.

    I have small holding but still skeptical on few of the things like the above points. Need to see wider Moat for the company to put large bet on it. Let me know your thoughts!

    thanks,
    Ignatius

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    Replies
    1. interesting thoughts... I agree with you on a wider moat.But at the price at which the scrip is available, not a lot of things need to go right for it to realize value.
      There is a lot of upside potential but to get good returns not everyone of them needs to be right!!!

      Delete
  9. Hi Dhawnil,
    Recently came acorss your blogs. Excellent work. Quickly gone through most of your last 2 yrs blogs.
    Have prepared fact sheet about stock ideas discussed here. Want to share with you. Would you mind sharing your emaild with me? Or you can ping me at valueinvest30@gmail.com

    ReplyDelete
    Replies
    1. Hi valueinvest30,
      my e-mail id is desaidhwanil@hotmail.com

      Best Regards
      Dhwanil Desai

      Delete
  10. I have been a value investor for a long time. Value investing is all about buying a stock for 10 dollars when the real value of the stock is 20 dollars.

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  11. Buying a stock when it trades at a deep discount to its actual value is the best way to reduce your risk when investing in stocks.

    ReplyDelete
  12. This comment has been removed by the author.

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  13. Saurav Jalan said...
    Hi Dhwanil,
    Nice post indeed. I also own shares of Piramal Enterprises and like you I am also satisfied by the outcome post Abbott deal. Given the limited downside risk, I was never worried as I felt that cash in the hands of a rational and honest person carry less risk as compared to others.
    Also,there are many businesses where people are more important than anything else. Investment management being one such example.People who invest with a good portfolio manager do not know where their money would be deployed. What they do know is as and when opportunity comes the funds would be deployed rationally and intelligently.
    Low-risk with uncertainty can produce phenomenal outcomes.Google and Microsoft are few examples as the downside financial risk in their starting up days was very limited and upside we all are aware ! Who knows Piramal Enterprises can expose its investors to positive black swans!
    It requires character to stay detached from external noise and simply meditate on maximizing shareholder's value/wealth.Very smart people lack such traits but at the same time people like Warren Buffett, Charlie Munger, Ajay Piramal, Ajit Jain(BRK Reinsurance), Dilip Sanghavi(Sun Pharma) and many more are living practitioners of that.

    ReplyDelete
  14. Hi Dhwanil,

    Do you know any reasons why this is in continous down swing lately? Anything which happened with business or just markets mood swings?

    Thanks again for your valuable posts!

    ReplyDelete