Growth And Disruption Are Gaining Undue Investor Importance, Says Aswath Damodaran

Disruptors such as Reliance Jio Infocomm Ltd. or Paytm must be able to use their large subscriber bases to generate cash flows and profit for investors to find value in them, according to valuation guru Aswath Damodaran.

Investors and valuers will have to think through the business model of subscription-based companies to understand how they make money, Damodaran, professor of finance at the Stern School of Business at New York University, told BloombergQuint in an interaction. A lot of startups aren’t thinking about how to get value from users, unlike Facebook Inc. and Amazon.com Inc. that are successfully monetising their user base, he said.

Companies like Reliance Jio or an Ola can only create value for investors if they have a long-term plan to monetise their users like Amazon or Facebook, he said. Otherwise:

“Disruption is easy. Making money on disruption is really difficult.”

Similarly, growth is another buzzword like disruption that’s gaining undue importance among investors, he said, adding that companies aren’t meant to grow forever.

Damodaran explained: “If you’re a cigarette company, your growth days are behind you. I hope they are behind you,” he said. “But as an investor, I might still buy them. I don’t buy growth, I buy cash flows.”

“With a declining company, I don’t get growth, but I get huge cash flows,” he said. “There’s a subset of investors who want big dividends and big cash flows, and shrinking companies can deliver that.”

The tobacco-to-luxury hotels conglomerate ITC Ltd., he said, might be more valuable to its shareholders if it remains a shrinking cigarette company instead of dabbling with various other businesses that don’t fetch the best return on invested capital. Yet, he appreciated Indian IT companies for returning cash to shareholders, saying they recognised the return on invested capital wouldn’t be “that great”.

The valuation guru said mature-stage companies buying back stocks aren’t investing money, but was against mature-stage companies like Procter & Gamble Co. in the U.S. investing shareholder money. Ageing companies must accept that they’re ageing, and give back capital, he said.

When such companies buy back stock or return cash through dividends, investors use that money to buy (stocks of) modern-age companies, he said. Investors who would get money from the mature companies would buy into the Pinterests, Ubers and Olas of the world and maybe that’s where the money should be going, he said. “If you make existing companies hold on to the capital, you make them reinvest the capital, often in bad businesses, and there’s a price you’re paying.”

For the same reason, Damodaran is averse to taxing share buybacks or dividends, which according to him, is driven by the ideology that investing is good and returning cash is bad. Politicians around the world have this view, he said.

For automakers, he said the valuations would slowly converge with that of their global peers. Global automakers, according to Damodaran, are d on the basis of the risk from disruption. It’s only a matter of time before it happens to Indian peers, he said.

Disruption, he said, won’t happen because of the incumbents as history has shown. It almost seems as if change is happening in every sector, but it’s not accompanied by a change in the methodology of valuation, he said.

Watch the full interview here:

Here are the edited excepts from the interview:

I attended a session that you had addressed days back. There were a few excerpts I thought I’ll ask you about. You started off, in the first five or 10 minutes of that session you made a point about this very pertinent question as to ‘Who are we?’, ‘Who is anybody to pass a judgement’, ‘What is investment and what is speculation’? You can dive into five different paths of this statement but I want to dive into two. First, how do you think an investor, or what do you think an investor would be doing right now, when he is trying to invest in the markets, in India or otherwise? There is a lot of moving paths out there, Donald Trump being the principle one. Trade wars, slowdown, their interest rates, etc. are some other factors. So, when an investor is buying something he thinks is valuable, is it an investment or speculation? Because the future is very hazy.

Let’s start with the motives. You’re an investor, your ultimate motive is that you want to make money. The way you make money is, of course, you try to find the of a stock and then you look for stocks that are traded in less than that . You buy the stock and hope the price moves to that. A speculator/trader buys it at a low price and sells it at a high price. Basically, they don’t care about the .

Their point is just timing; get in at the right price, get out at the right price. They want to make money as well. They both want to make money. So, why is it that we treat investors as this noble species and traders and speculators like mosquitoes. You want to get rid of them. The reality is, we need each other and I’ll explain why. If I lived in a world where everybody was an investor, investors by their very nature don’t trade very often, right? They buy and they hold. There will be very little liquidity. If there is very little liquidity, we would all face substantially more transactions cost. The reality is, those speculators/traders are the ones who provide the liquidity to allow me to benefit from having lower transactions cost and also allow me to make money in the first place. So, I am trying to make money from these speculators/traders and the traders are trying to make money from me. We need each other. So whenever I hear the talk of speculation, it makes me leery because I know what is coming next. You want to stamp out speculation. How do you do that? You want to drive speculators out of the market. You want to make the market safe for investors and in the process, you’re actually making it more difficult for investors to survive. So, I think we need each other, so stop calling each other names. And let’s accept that we have to co-exist.

Having said that, another point that you made in the same vein is that people now are unable to things correctly because the nature of businesses is changing, the rules of valuation are changing and people might still be stuck with the old principles and the old rules. Would you want to define that because across geographies a lot of things are moving around that people are not able to comprehend

I think we are creatures of habit. Human beings do things the way they’ve always done it. It makes them comfortable. So, this is not a bad thing, it’s the way we’ve always operated. We’ve always had trouble with transitions. I am sure that when the industrial revolution happened, when the world was primarily agrarian, there was a tremendous amount of adjustment that went with it. When the automobile first showed up 100 years ago and people had to move away from horse carriages, I am sure it was horrifically difficult to deal with, you know the noise and the roads and the dust. I mean, this is a part of a long-term process, change is difficult and we’re going through a period.

But I am not even sure that change is that much greater but it is happening in every dimension. Usually, it is one or two sectors that change. But now, almost everything is under assault. If you look at the automobile business, change is coming, consumer products change is coming, brand name companies are worried about brand names going away. And I think it’s a reflection of the fact that the last 20 years have seen the rise of the Indian chain. You’ve brought in two billion consumers into the game. What made you think that the two billion consumers worship by the same brand name altars that existed in the last century. So, some of this is predictable as the market has expanded and changed.

Some of it reflects the fact that the technology is here and now for us to disrupt our businesses with relatively little capital. I mean, take the example of Uber. If I wanted to start a car service company 30 years ago, it would cost a lot of money. I’d have to buy the cars, put them on the road. The fact that you have smartphones and you can connect cars to customers, allowed Uber to develop. Lots of companies are Uber-like, like Airbnb. I mean, in essence, you can think of this as a shared economy company.

So, I think that disruption has come, but many people continue to do things the way they did. I’ll give you an example. In valuation, one of the ways we typically companies is by projecting the cash flows for a certain period, we stop and we assume that the company will go on. In the sense, forever after that. And it’s a practice we’ve developed in the last century. It was developed to the companies of the last century—the GEs of the world. In essence, the coming demise of GE (it’s only a matter of time) brings home why we got away with it. GE lasted a hundred and five and plus years. So, when we assumed that it would go on for a long time, we were on fairly solid ground.

I give the contrast of Yahoo. A company that was founded in ‘92, became a hundred-billion-dollar company in seven years. They did it in seven years. What would’ve taken Ford or GM fifty, sixty, eighty years to do. They peaked for about three years and then Google came along, they went into a very steep decline, by 2015, Yahoo had gone away. Twenty-five years, from start to finish.

So, when you do valuation now, you get to ten, you’re no longer talking about going on forever, you’re talking about going out for another 10 years. But there are still people who put a 3 percent growth rate on these companies forever, acting as if it’s still the 20th century. I don’t blame them because you are creatures of habit. So, today when I talked about it, I said, you know when you get to your year ten, you’ll know what’s going to happen beyond that.

If you have a technology company, leave open the possibility that after you’re a ten, instead of having a 3 percent growth, you’re going to have a -5 percent growth. You may think that what does it even mean? It means that your company is going to peak into a ten and then eventually disappear because that reflects the reality that we face. The same thing can be said about everything from capital budgeting to how we set hurdle rates to how much we borrow, everything is driven by recognising that the life cycles for companies are getting shorter and if you don’t adjust to it and if you keep doing the things that you used to do, it is going to get you into trouble. This
applies to everybody from companies and investors to analysts.

And you, of course, made that point that it might not be a bad thing. You used the example of ITC, I want you to dwell on that a bit.

But the moot question is, I remember you saying that a company shrinking is not necessarily a bad thing because it will be d more. Now please, if you can explain that or two, how would a model like that or how would an event like that draw investors? Because investors largely want to be associated with the growing company, of course, which is growing profitably. but of course, a growing company. If we strip off a company with a lot of its businesses which are not earning better than ROIC and they might be earning more cash but it is shrinking and is eventually going to die. How do investors associate with such a thing? How do you such a thing?

I think we attach too much respect for growth. I’ll give you an example, two words that have struck terror in my heart. Corporate sustainability.

It’s a big deal in business schools, right? We are going to teach companies how to sustain themselves. And when I hear the words corporate sustainability, here’s what I think of. I think of mummies. You know these Egyptian pharaohs the way they wrapped themselves saying I want to live forever.

So here’s what I am going to do. I am going to wrap myself in bandages, I am going to put myself in this great looking tomb, but guess what? They still die. You can sustain a company as a mummy. You can preserve it. But what’s the point of it? The corporation is a legal entity. If the reason for its existence is gone, why hold on to keep it alive? If you are a cigarette company, your growth days are behind you. They have to be behind you, I hope they are behind you. You are going to shrink over time but as an investor, here’s why I might still buy them. I don’t buy growth, I buy cash flows. With a growth company, I hope the cash flows happen in the future that. With a declining company you know how this works, I get no growth but I get huge cash flows. Is it right for every investor? Not necessarily but let’s face it. There’s a sub-set of investors who want to get big dividends and big cash flows and the shrinking companies can deliver them. The problem though is, no one wants to be the CEO of a shrinking company.

This morning in class, I asked a question. I said, “When was the last time you saw a movie about a CEO who made his company smaller?” I said we saw the movie of Steve Jobs, why did he become a legend? Because he took this $10-billion company and made it a $600-billion company. We love empire builders. We being Harvard Business School professors, strategy people, everybody wants to talk about growth as a good thing. But growth isn’t explicit. Growth is a good thing in terms of increasing revenues and earnings.

But what you have to do to deliver that growth is a cost. So, if we have to do huge acquisitions and capex to deliver that growth, the net effect would be negative. I get the good stuff of growth but I am doing three times more in getting that growth. So one of the graphs I like to show in my class is that I actually to take every publicly traded company in the face of the earth at the start of the year and I compute, whether how did these companies earn more than their cost of capital? It’s buzz but basically, you need to earn your cost of capital just to break even. Last year, out of 43,000 companies, 60 percent earned less than their cost of capital. So you’re going to grow and you’re going to earn 3 percent less than your cost of capital, you might be able to thump your chest and say, look I’ve grown 6 percent! But as an investor, I’d say, but you spent so much to get that 6 percent, you were 10 percent less than you were last year. I don’t invest for growth, I invest for . So, if your best days are behind you, you prefer that you act your age.

I use this concept of a corporate life cycle that companies have to act their age. The reality is, if you are an ageing company, the way to act with an ageing company is to start to prune down. To get smaller.

To shrink. I mean, I point to Europe, I don’t want to point them out as zombie companies but walking dead companies. Basically, these are the companies whose best days are behind them because they are preserved, they are well-preserved and they keep going.

It’s not good for the economy because they take capital that would have otherwise have gone to the young. So, when people point to the U.S. and say, look at those U.S. companies, they are buying back hundreds of billions.

That’s a terrible thing. So even in the U.S., in fact, it’s become a political issue now, we’ve got to cut back on these buybacks, it’s terrible. I think people are missing the point. It’s true that the companies are buying back stock and not investing the money. But I don’t want the Proctor and Gambles of the world to be investing my money in the first place. But when they buy back their stock, it doesn’t disappear in a black hole.

It goes in the investor’s pockets and guess what? They buy their Pinterests and their Ubers and the Ola’s of the world and maybe that is where the money should be going. If you keep existing companies holding on to capital, you may make them re-invest that capital often in bad businesses, then there is a price you are paying. That capital cannot go to the businesses of the future. I’d much rather that capital allocated right. For that to happen, ageing companies have to accept the fact that they’re ageing and give back the money.

So Indian IT started doing that very actively over the last 18 months. Now there has been a taxation issue, creeping up on the buyback as well. Were you happy that the Indian IT did that?

I don’t like the dividend tax and the buyback tax. Because implicit in that tax is a view, right? It’s a view that when you give money back, it’s a bad thing. When you invest the money, it’s a good thing. My point is, that’s is not a great attitude to take. I don’t want a company to be forced to invest in bad projects because the tax that you attach in the buyback is so punitive that they don’t want to buy back the shares. So, I think that it’s ill-advised. I think that it’s ill-advised because it’s driven by the view that investing is good and returning cash is bad. And it goes back to what I said about politicians around the world are making the mistake of saying that when cash is returned, it’s somehow being wasted. It just gets recycled. It goes to a different company that needs capital and can use it better. So I don’t like anything that gets in the way of companies being able to return the cash. Don’t make it more difficult, make it easier.

Maybe there’s a message there. I wanted to link a couple of things that you’ve written on your blog, on your website. There is a point somewhere down where it says that ‘the meatless meat products have made the deepest inroads in urban and affluent populations and allured the greatest form of meat-eaters other than life-long vegetarians. The plus is that this market has a significant buying power but the minus is that the urban, well-to-do millennials can only eat so much’.

Now, I want to try to link this in a strange sort of way, in auto space. The government’s intentions are clear, the electric vehicles are out, they have not made their in-roads yet. If anything, the lowest strata would not be able to buy it, the cost might be prohibitive as of now, and space is under disruption for a variety of reasons. Have you ever had a chance of Indian autos because you mentioned autos in your earlier answer?

I have looked at the established orders. I haven’t looked in the startups yet.

That is fine, but the established autos, what is your point of view there?

I think that the automobile business around the world is at a crossroad. It is at
a crossroad because the business is hitting a stagnation point. There is still growth in the pockets, right? There is growth in India, there is growth in China because you are getting more people in the middle class so I am not saying people are going to stop buying autos. But just like cigarettes, you can see the end coming. I was in Mumbai, you know travelling all over the place on a Wednesday. I was in a car and to be quite honest I would have got faster to wherever I was going if I got out of the car and walked. So, here is the problem, at some point you are going to keep selling cars but if you are in a perpetual traffic jam, your car just becomes a vehicle you sit in for a day rather move from point A to point B. So. the first is, without roads, what’s the point of having the cars?

I do think that there is an environmental issue. I mean, you’ve noticed that Delhi is already one of the most polluted cities in the world and I think there is the reality whether you like it or not, that automobiles have to shift their way from producing toxic fumes to perhaps being electric. It is not going to be easy partly because of inertia because you always use a gas car and you always stop at a gas station because it is easier for you. Change is coming surprisingly quickly you know; you start at the affluent areas because that’s where you notice it. I live in California and I see that one in three cars in San Diego are now hybrids or electrics. There used to be lanes earlier that were designated just for electric cars. But now we have so many of these cars, that there is no point in doing it.

That happened over a period of ten years and the electric cars used to be much more expensive than the gas cars, but the prices have started to come down...the electric car business is evolving. The technology is changing. The batteries, in fact, the most expensive and the technology there with electronics we know, its Moore’s Law. It is kind of kicking in. I would not be surprised if three years from now, you saw electric cars at roughly the same price as gas cars and when that happens, it’s not an affordability issue anymore.

It is a question of how quickly would people shift? So, I think change is coming and automobile companies know it. You know, Volvo has already shifted entirely. I think by 20-20, they said that every Volvo car will either be a hybrid or an electric car. They see the writing on the wall. It is going to come later to the emerging market auto companies because you still have this buffer of people who don’t have cars, who are buying cars you don’t have to worry about when will people switch their ways.

You would have the most affluent part of the market. The top 10 percent of luxury cars are the ones that deliver 90 percent of your profits. So, if your luxury customers start switching away, even though it might be relatively few cars, you are going to start to know the effect on your bottom line very quickly. So, I think collectively, automobile change is coming.

Just one question though, I will follow up on that. How do you believe people could in the automobile companies? Hits are two because India has been a growth market. They have been given premium evaluations because of the growth. This year, we might actually see negative growth. Do you reckon that over the course of the next few years, the way people auto-mobile companies may change and get lowered dramatically?

It will converge on global automotive companies. You know the Volkswagens, the Toyotas, the Volvos, the BMWs, the Daimlers, all are being d on the assumption that disruption is going to put their models at risk and it’s only a matter of time before that it comes to Indian companies that why can’t they start produce? I will come to the Clayton Christensen that ‘Disruption almost never seems to come with the status quo, when it does, it doesn’t seem to work’. So, I wouldn’t hold my breath saying that the Chevy Volt is going to take over the world because you know, history works against you.

Okay true. So, let’s talk about the new age businesses. You see a lot of them in your part of the world. Out here, companies are coming up. My question though is in India we do not have many of those listed players of that click variety. They are largely in the private space. Except the Jio, which is an outlier. How do you think the Indian markets could these? What do you reckon India will do to these companies like the Ubers and the Lyfts are d in the West. How do you think that process will happen in India?

I think it’ll be priced. Uber and Lyft got priced. Do you know how they got priced? They got priced on the basis of what we see a spade in the last run. Guess what? Ola and Flipkart, if they had gone public, they would’ve been priced. I am perfectly comfortable that Indian investors would have found a way to price them because the pricing game is very simple. You price them based on some metric. So, I am convinced that in any market you can get young companies priced. But very few people in the U.S. these companies. And their reason for not valuing them, which I think, is too much uncertainty. I have never bought into that argument. When there is a lot of uncertainty, it is not I can’t make estimates, my estimates have a bigger range on them but that doesn’t mean I can’t the companies. I am just going to be wrong on a larger scale with these companies because there are so many larger companies that I don’t control. So, I am perhaps the minority on this one because most people in the U.S. believe there is no point in Uber. There is no point in valuing Pinterest. This is a pricing game, you buy it at a low price, you sell it at a high price. So, right now there might be no rhyme or reason to pricing other than that I can sell it to somebody at a higher price. But you know what? That is the way all young businesses start. It is a pricing game. Dotcom companies, priced based on website visitors and eyeballs early on, have over time evolved. There will be an evolution. There will be what I call a Bar mitzvah moment where these companies will be, as when will you figure out, how to make money? When will that happen?

I don’t know and these companies don’t know either. But if they are not ready, they are going to be in trouble. So, they will take a while, they will take an adjustment phase before they get there but I don’t think even in the markets like the U.S. people see the prices. Somebody must have d the company. It’s just a demand and supply. That’s why on an opening day, you saw all kinds of gyrations. I was at CNBC that morning and every expert was convinced that the stock would do it, come out at 45 and go up to 60 because that’s what the bankers have been told, that’s what the institution investor has been told. But the reality opened at 45 and dropped at 38 which tells you how little the pricing game is under the control of even the biggest players. It is just demand-supply, psychology, behavioral factors that drive pricing.

I am trying to understand this because you are probably going to write about it. There is no concrete way or a ‘correct’ way to these number of user base companies right now. It is a factor of demand and supply purely?

There is a way to price them but to them, you have to start to ask fundamental questions. You’ve got to ask questions like, hey, Uber has 90 million riders that are impressive, but how much is a rider worth to Uber? Or let me put it more simply, Netflix has over 230 million subscribers or whatever their updates are, or a hundred and seventy million. How much is a subscriber worth to Netflix? And actually, it is not a difficult question to answer, right? A Netflix subscriber pays, in the U.S., about 14 dollars a month so I can figure out how much they collect as revenues. So there are some expenses associated with servicing these users so I can estimate that.
And I can estimate how long the user stays on with Netflix and given that I have a Netflix history, I have a sense of you know, they stay for around eight years, ten years. So, if you gave me a Netflix subscriber I can say, a Netflix subscriber is worth about 450 dollars to Netflix. If you say, how does that help me? I can say if you know how many subscribers, you have to multiply it by four and have a for Netflix. That gives you one slice of the . If you say what other slices that could there be? Netflix is not done. They are adding new subscribers. I could a new subscriber by looking at how much it costs to acquire the new subscriber and that gives me a second layer of the . And then to complete the process, I say what does it cost for Netflix to operate, the reality is, Netflix’s biggest expense is what they spend on content and subtract other costs and get the for the company.

So, one of the things I am working on is developing a framework and using it to a Uber rider, a Netflix subscriber, an Amazon prime member. And the reason I want to do that is because I find a lot of laziness and sloppiness with user-based companies and what I mean by that is venture capitalists who look at a company with lots of users, therefore you must be worth a lot of money. I can’t make that leap. I mean, I tell people this is a MoviePass company. For those who are not familiar with MoviePass, MoviePass was this company in the U.S. which offered a subscription-based service for $10 a month. You could see as many movies as you want over the course of the month. An absurd business proposition because they actually picked up the price of your ticket when you went to the movie. The average cost of a movie ticket in the U.S. is $9.25. If I go for a movie in San Diego it would cost me $18. All I have to do is, go for a movie in San Diego and MoviePass is in it. It made no sense in the beginning, but you know, venture capitalists poured money into the company.

Why? Because it got lots of subscribers. Because they were giving away. That’s like Starbucks saying do you want to make a $10 subscription, you can drink as many coffees as you want in a month. They are going to get millions of subscribers. And venture capitalists actually threw money at this company because of lots of subscribers and my response was, what’s wrong with you? Did none of you ever stop and ask the question, how are you ever going to make money? The answer was no. They were just dazzled by the numbers of users and subscribers and they threw money at the company.

I am not trying to compare, I am just using some Indian examples so that people might understand this, I am not trying to compare Indian businesses to MoviePass, but this, a high number of subscribers and how do you. Such as Paytm, fabulous number of subscribers. Jio? A fabulous number of subscribers, how would you go about valuing those businesses?

I’d have to think through the rest of the story, right? Getting subscribers was the easy part but now you have to figure out the business model that these companies have in mind to convert those subscribers into earnings and cash flows and revenues. I mean, I’ve told people that disruption is easy. Making money on disruption is really difficult. I mean, I actually find this odd that, we attach so much respect to the word disruption. I mean, when I went to school, do you know what happened to that disruptive kid in your class? Nothing good happened to him, right? He ended up in the Principal’s office or got expelled from school. Disruption is throwing a bomb. And now you’ve got to re-build and my problem with Silicon Valley and disruptive companies are that they think it’s all about the disruption. They are so dazzled by, ‘hey I’ve disrupted the status-quo’ that they forgot to tell me what they want to replace it with. With these companies, I think they’ve got one half of the equation done and I am looking for clues from them that I know that they are working on the second half. I give them time, I know that this is going to take time, but I want to see tangible evidence that you’re actually trying to figure out a pathway to making money. That’s what I look from earnings reports. I don’t care that you can report higher users, but I want you to show me what you’re doing to convert this big user count into profits and cash flows and . And you’d be surprised about how many startups haven’t thought through that. They are so caught up in ‘let’s go for users’ they haven’t thought through that. But what separates good user-based companies from bad ones is that the good ones constantly think of two channels. One channel is that they want to deliver more users because they know that, that dazzles people. But the other channel is that they are working on getting from the users. And to me, the best example, there are two best examples that they work on the second channel while working on the first one: One is Facebook. One thing that has always impressed me about Facebook is while it has the most dazzling user numbers of any company (2.3 billion, no one’s ever going to get close), it has always been a company focused on how do we create ? When they paid $19 billion for Whatsapp, it was never just for the users, there was a long-term plan. Hey, this is how we create the ecosystem, and this is where the gets drawn. The other company is Amazon, with Amazon Prime.

This is I think a window in how patient Amazon is building these models. Amazon Prime, was created in 2004. For five years, it was just stagnated with around one million members maybe, two million.

But Amazon did not abandon it. It let it grow. Until about last year, a typical prime member was paying less than one third of what the shipping subsidies because with Prime, you get free shipping and people said, ‘Are they crazy? Why would they do it?” They’re finally turning the corner because what they did is, taken those prime members and what a typical prime member does is, he spends about three times more on Amazon than a non-prime member. You take those profits and you add them on the 99. That’s just the tip of the iceberg for Amazon. In fact, I call Amazon a disruption platform.

It is basically is a disruption platform. It can go after businesses and now, it has an army that it can use called Amazon Prime. And that should scare every company out of its wits. Right? If you’re JPMorgan, Amazon Bank comes and starts, it is going to send that hundred and twenty, hundred and thirty-million-dollar prime army after you. So, I think, it took a long time to play out so there is a long-term plan of converting those numbers into s. So, whether it is Jio, whether its Ola, whether its Paytm, that’s what I am thinking for. Show me that you have that second platform so some of these companies can become immensely valuable companies, but it will require work because scaling up is easy but building business platforms is hard work. And that’s I think is the X-factor here, building that business platform.

Okay, last two or three questions professor.

Somebody that we spoke to very recently said in a consumption or staples company, the correction in valuation or otherwise doesn’t happen because of the price dropping but because of the time correction. These stay stagnant, they don’t grow but they don’t de-grow as well and that space in India and getting disrupted. Because smaller companies, regional companies coming out and eating out the market share of some of these. Have you had a chance to look at because you looked at ITC so closely? How do you think markets will these? The reason I am asking this is, this is that one layer of companies in addition to certain banks which are still d at the topmost valuation multiples that India is enjoying right now.

I’ll make a general statement about the brand name, consumer products because a lot of these companies that you are talking about also have built brand names over time and have essentially stable, predictable cash flows. Around the world, brand names are under assault. They’re under assault partly because it is like, somebody is 25 and has a different opinion on Britannia biscuits and somebody who is 65 who would say, how would I live without my Britannia biscuits? I think that, when I d Kraft -Heinz last year, this was the point which I would make. People thought Kraft -Heinz, they were not going to go away they were the most powerful brand names in the world. Now Heinz with its 57 kinds of ketchup and Kraft, with its you know, melted, disgusting cheese you know whatever. It is but people said that they were not going to go away and what you’ve learned since the Warren Buffett 3G acquisition is that both, and these are very savvy and highly regarded investors and both over-estimated this staying power of brand names. And if Warren Buffett and 3G can get blindsided by how quickly brand names can fail, I wouldn’t be surprised if the average investor is overestimating the staying power for many of these consumer staple companies because I think brand names are coming under assault for lots of different reasons. Part of the reason is, the way we get information is different. We no longer watch TV so maybe one of these brand names where much of the recognition came from, hey, they were on TV. Now, I might be getting it on my phone, it’s very different.

How people get information, what creates brand names. You are going to see it play out. It is not that I am not going to sell short over these companies, but I’d be wary about paying premium prices just because they produce something I view as a consumer staple and it has a brand name that is recognised. You have a brand name; you have a consumer staple so it is going to last forever. Nothing lasts for a long time. It has lasted for a long time but here, you’ve got to see change coming and that change is going to mean a lot of adjustment in, not just the investor part on the company’s part too in terms of how much money they’ve used to keep these brand names afloat.

Indian Banks?

There are some horror stories but one thing I would do is not over-react. It’s not the end of the world yet, there is a lot of cleaning up to do. And the reason that it is going to take a while because it doesn’t happen overnight. This is something which has happened over decades and it reflects in India. In India where people borrow and lend money on personalities and networks rather than corporates and cash flows. So, I am not saying these were bad people but it was just the way things were done. You lend to a person, not to a company even if that person was a promoter of the company. It is a person you are lending to. And what we are discussing that because of that process of lending, there are no assets or cash flows to back it up. And the promise is that when you make big mistakes as a bank, you often try to take the mistakes back and put them away. It’s human nature. If I park it there, maybe one of these days the company would pay me back and I could take it. So, I think there is collective guilt to go around, which is, the banks have made mistakes, the companies have borrowed money probably overreached, the government was looking away, the regulators should’ve done a lot. So, if we exercise in blaming people, I think we will go down the wrong way.

One has to accept the fact that this is the problem, we need to fix it, we cannot fix it overnight. If we do it, the shocks that get created will be greater than whatever problem you’re trying to fix. I would suggest some process which has a ramp which is little smoother where you try to fix the proms, give it time, you don’t try to overreach but I do think that we’ve got to start.

At the minimum, we’ve got to start doing it. You can’t make the problem bigger but at least we can start solving the solvable part but it requires patience, and I think it requires a subtle touch.

Do you think that certain companies, the BFSI companies are tech-enabled, maybe follow a certain algorithm etc. so that they are not person connected but system connected, average profiles in place are getting fabulous valuations from the market currently. I don’t know if you have looked at these companies but Bajaj Finance for example, getting fabulous valuations. Do you think those valuations might stay?

There is also a little bit of a zero-sum game here. There are some banks that are now paralyzed because of their problems, they cannot lend money, this is a big market. You have not made some players, who are big players which have made it to the sidelines. There is at least this space now where if you are not one of those trouble-bags, you have a zone of opportunity. Does it justify the pricing? It depends on how long the zone of opportunity stays open. The problem with international services is getting new startups. Starting new banks is so incredibly difficult that until those banks come back of the sideline, you’ve left the space open for the Bajaj Finances in the world to grow and go and make lots. So are they overd? I am not sure because it depends on how long the pain lasts and how long banks stay on the sidelines. At least I think I understand the rationale that is driving money where it’s going and it’s the nature of the process. Sectors, people often need to pick the three best of the five best companies. But the fewer of the quality companies you pick, the more the pricing will be for those companies because it’s about demand chasing supply.

One final question professor, I believe you have some views on the sovereign bond issue that has caught the imagination of every policymaker and finance person in India.

I tell people, don’t create solutions to problems that don’t exist. So, I want to know what is the motivation to issue a sovereign bond? I’ll tell you why Latin America is the epicenter of sovereign bonds. Every Latin American company has dollar-denominated in bonds. You know why, because in the ’80s and ’90s when the currency had become so untrustworthy. Brazil issued dollar-denominated bonds not because they wanted to but because they couldn’t do anything else. There is a mismatching problem, right? If you borrow money in a currency, if you are a corporation and do a rupee-based project, you might borrow in dollars to make rupee-based projects. You are creating a mismatch. You are creating a mismatch that you don’t have, you are creating a risk you don’t have. Brazil had no choice they had to issue dollar-denominated bonds. I am not a macroeconomist but if India says, look I want to issue foreign-denominated bonds, I would say why? Do you want to borrow money? Are you unable to borrow money in rupees? Are you tapping foreign investors? Is that your motivation? Do you believe they will give you a lower rate because they didn’t buy into the Indian growth story?

Maybe there is a rationale there and the rationale has to be not that you are borrowing in dollars but in some inflation adjusted rate. The rate you borrow in dollars is lower than the rate you borrow in rupees. You are going to borrow a lower rate in dollars. That’s false cheapness. My worry is that when countries issue in sovereign bonds is that, it looks cheaper. Turkey borrowing in dollars thinks it’s borrowing in a lower rate in a lira but it’s fake because it’s to the extent that inflation rates are different in the two currencies. Borrowing money in dollars at 5 percent Is actually more expensive to India than borrowing money in rupees at 6.5 percent. I would assume that people doing this would be sophisticated enough to recognize the difference, but I worry about the on the face of cheapness. So let’s say you open the sovereign bond door and you issue sovereign bonds.

So, first time people would be careful and do the right things but at some point in the process, on the next borrowing you might say, look it cost me only 4 percent in dollars, 6 percent when I issue in rupees it is cheaper to borrow in dollars, let’s keep borrowing in dollars and that’s a dangerous reason to borrow in dollars. So, there are good issues in borrowing sovereign bonds but I don’t know what the motivation is here.
What’s the problem you’re trying to fix, what do you hope to gain by issuing sovereign bonds? I am not going to take the position that this is good and this is bad I can see a rationale and I can say I get it but I can also see a rationale and say, that makes no sense to me.