A rejuvenation in progress

After a recent meeting in Mumbai with the top management of an Indian conglomerate group, we came back with a clear message — the group's commitment to its purpose does not mean that it will continue to operate loss-making businesses. This strengthened our conviction in the changing culture and capital allocation of the group.

We have always held the group in high regard for the benchmarks of corporate governance standards they have set in India. Over the years, we have been shareholders of many group companies, including a real estate business and an automotive parts business (both still held in the portfolio today), as well as an IT services business and a financial services business in the past. However, we have observed a weakness in the group’s capital allocation discipline over the last decade. The group had set up or acquired a range of businesses from an automobile manufacturer in South Korea to two-wheelers in India, which increased the business complexity and caused the group to struggle with losses. At the same time, we found that businesses with significant potential, such as the real estate business, were not being held to account for their consistently weak performance. We have not been shareholders of the conglomerate group in recent years.

Our engagement with the senior management of the group culminated in a letter in February 2020 to the chairman, where we highlighted our concerns:

As we look back at the group’s history, however, one aspect has been bothering us, which is the capital allocation of the Company. When you took over in 1997, the standalone profit of the group was USD 58m. The 14 subsidiaries of the Company produced a further USD 5m of profit. But in 2019, whilst the standalone profit was USD 730m, the remaining c.200 subsidiaries, JVs and associates detracted about USD 50m from this sum. This is not a one-off occurrence. In fact, the group’s subsidiaries in aggregate have been lossmaking for 5 of the last 7 years.

Source: Excerpt from FSSA’s engagement letter to the group in February 2020

 

 

In his reply, the chairman acknowledged these issues and pointed towards the initiatives being taken to improve the group’s returns. He also introduced us to the recently appointed CEO-designate and in our first discussion with him, he came with a copy of our letter. He had created a framework to categorise businesses based on their potential to achieve a return-on-equity (ROE) threshold of 18%. Those that could not achieve this goal within a stipulated time-frame would be exited. The company’s recent 2021 Annual Report admitted to the mistakes made and the poor shareholder returns, and publicly stated the intention to introduce strict controls in the capital allocation process.

We also noted that there was an ongoing generational change in the group’s board and management team. As longstanding directors and key senior executives retired, younger board members and managers took charge. High-quality independent directors such as an executive chairperson of Godrej Consumer Products and a senior leader at the Murugappa group joined the board. A new Group CFO who had led a strong performance at the group’s tractor business was appointed, and the farm and automotive businesses were consolidated under his management. Management at several subsidiaries also changed. A new CEO was appointed at the real estate business, with a mandate to accelerate the company’s growth. Following these changes closely, we gained confidence in the CEO’s plans to improve capital allocation and performance. We initiated a holding in the group.

We have been encouraged by the management’s decision to “walk the talk” by stopping incremental investments and exiting several poorly performing businesses. This includes the Korean automotive manufacturer which had bled losses since its acquisition in 2013, an aircraft manufacturing business in Australia, an electric two-wheeler manufacturing business in the US, a metal fabrication business in Turkey and an automotive service business in India. Our discussions have indicated that there will be more exits from larger operations if they fail to meet ROE targets. The group has increased its focus on growing its core businesses — automotive, farm, financial services and IT services. These businesses have long track records of profitable operations and the opportunity to scale-up significantly in the coming years. At the real estate business, we have seen a marked shift in the company’s growth aspirations under its new CEO.

Scanning the radar for signs of management and ownership changes is a critical part of our investment process. Be it generational change at an automotive company, a transformation of the culture at a bank, the improvement in capital allocation across the group companies of another conglomerate under the new group chairman, or the change in ownership at a brewery, we have repeatedly observed that these events can lead to substantial shareholder returns in subsequent periods. We believe we are at the early stages of such a rejuvenation at the aforementioned Indian conglomerate group. Based on this conviction, it is now among the strategy’s largest holdings.

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* Company data retrieved from company annual reports or other such investor reports. Financial metrics and valuations are from FactSet and Bloomberg. As at 30 April 2022 or otherwise noted.

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