An Indian five hundred rupee banknote is arranged for a photograph. (Photographer: Dhiraj Singh/Bloomberg)

CFO Leaders: Capital Allocation - By M&M and L&T CFOs

A Boston Consulting Group report on capital allocation, among the top priorities of a CFO, says companies that exercise superior capital budgeting discipline do three things well:

  1. They invest in businesses rather than projects.
  2. They translate portfolio roles into capital allocation guidelines.
  3. They strive for balanced investment portfolios.

For all the fancy consulting theories around capital allocation—the basic goal of every chief financial officer is common—that the returns must exceed the cost of capital.

Easier said than done.

The group chief financial officer of Mahindra & Mahindra Ltd. applies a five-parameter test when determining which business or project to invest in. He should know, the automotive major is invested in 21 industries.

“You don’t only look at financial metrics,” says VS Parthasarathy as he lists the five boxes every investment must tick.

  • Will it lead to a leadership position in the market?
  • Is it globally competitive? (That doesn’t mean it has to expand to another country. But if global competition comes to the country will the business be able to compete against them, he asks.)
  • Is it customer centric?
  • The potential financial returns?
  • Is the arbitrage of the company based on labour or innovation?
In India it’s very easy to get labour arbitrage...but two years down the line it will go away. Therefore, show me innovation arbitrage. Can I make a car at one-tenth the price of a the global measure? Because my volumes are lesser.
VS Parthasarathy, Group CFO & CIO, M&M

Pricing Capital Right

The investment case may be compelling but another important step to ensure superior returns on capital is to price that capital correctly.

Engineering giant Larsen & Toubro Ltd.’s Chief Financial Officer, R Shankar Raman, details one big change in capital allocation strategies over recent years. Earlier capital was allocated on an even cost basis. But the returns were inconsistent. So, we have this whole concept in the company, he says, can we risk adjust the returns and hence price the cost of capital differently?

This applies not just to the over dozen verticals in L&T but also its investments in financial services and technology.

If it’s a business which gives predictable returns, annuity cash flows, you can afford to give it a lower cost of capital because the risk that you take is low. If there’s a business which will be volatile and cyclical, then the capital you allocate has a greater degree of risk and hence you need to price that risk and allocate capital at higher cost. So, the thresholds that we have for the services business, for manufacturing businesses, for project businesses, are varied.
R Shankar Raman, CFO & Director, L&T

Shankar Raman elaborates with an illustration of how this works even for a project bid.

“When we bid for a project, let’s say we work with an 18 percent ROCE (return on capital employed) on the project. It has segments. It has a construction phase, engineering phase, equipment manufacturing phase... So, the allocation to capital goes in three different directions. While the blended return could be 18 percent, we try to tweak the individual return, so that the pricing of that particular segment is appropriate for the risks which we carry. Overall ultimately, we need to be competitive. At the end of the day, we need to be L1 (top bidder) to get the projects. But having said that, when we allocate capital within that framework, we just want owners to that capital to realise that there is certain commitment that they have given to the organisation. So, we have robust pre-bid process where these segments are given weighted capital and there is commitment by each of these segments—they say this is what they will deliver within this time. The sum total of all this is what I take to the board...”

The Right Returns

Parthasarathy applies a 50-25-0 theory for return on capital employed (ROCE) across the group’s various businesses.

Fifty percent ROCE for companies which have gone through a particular cycle return enough cash to invest in others, he points out. The tractor business at M&M or the group’s IT services company Tech Mahindra Ltd. are examples of high ROCE, he says. Twenty five percent is the benchmark that relatively new investments/businesses should earn over a 5-7-year period, for instance a business like Mahindra Holidays. And the zero is for new investments that are currently getting no return.

But sometimes, returns take a backseat.

In 2010, M&M acquired a controlling stake in Reva Electric Car Co. While it was India’s largest electric car manufacturer, the acquisition was by no means large-sized. After all, those were very early days in the electric car revolution.

What do you think the IRR (internal rate of return) would have been, he asks. The bet on technology is one of the “real options” CFOs have to consider, he emphasises.

If you train a person and he leaves then it’s difficult. But if you don’t train a person and he stays, it is worse. So, if you don’t take this bet and the world changes then where will I be?
VS Parthasarathy, Group CFO & CIO, M&M


Watch VS Parthasarathy and R Shankar Raman discuss capital allocation strategies.

The Dilemma Every CFO Faces

To invest in a struggling/new business or return cash to shareholders? The two CFOs narrate contrasting experiences.

Pulling The Plug...Or Not

In 2018, L&T sold the Kattupalli Port to Adani Ports and Special Economic Zone Ltd.

R Shankar Raman: “We had invested in a shipyard which had a port attached to it that came as an adjunct. We realised after building the port and trying to run it for about two years that the business is a completely different business. The kind of connect you need to have to make ships call on your port in preference to nearby ports, and the mechanisation that you need to achieve, and the volume you need to achieve is a completely different ball game. It is not connected with what we generally do.

When you get into a project or investment which stretches you, I think you need to have the maturity as an organisation to say if it's something you cannot manage. There comes a point in time when people connected to that venture will be emotional about it and they will always say we will manage and find a solution. So, we (CFOs) need to have that step-back attitude to make the judgmental call and move away. At the end of the day, every organisation has a unique cash flow cycle and it has its own bandwidth to see how much of incubation it can do to a business. There comes a point where if it is not going to make financial sense or the ‘right to win’, then you need to pull the plug, because things change. We have been able to do it.”

Kattupalli Shipyard  
Kattupalli Shipyard  

In 2008, M&M acquired the assets of two-wheeler manufacturer Kinetic Motor Co. But in the ten years since, despite one reinvention and one restructuring effort, it failed to make a mark in that business. Despite running up several hundred crores in losses year after year M&M didn’t quit the two-wheeler business. Instead, last year it invested more to launch Jawa motorcycles, repositioning the business from mass market to premium.

VS Parthasarathy: “We are not financial investors. We don’t have 3-4 year time frame. We have a longer time frame. However, every time we have to ask this question, are we putting good money after bad money? This is very important question to ask. How do you ask it in a real situation?

So, I ask three questions and this has come through board leadership.

  1. Is the mega trend continuing?
  2. Is our right to win and right to play intact?
  3. And is it the right leadership?

If first two questions are asked, then the third question you have to ask rightly. You keep asking these questions.”

The three Jawa Motorcycles on stage at the launch with M&M Chairman Anand Mahindra (second from left). (Source: BloombergQuint)
The three Jawa Motorcycles on stage at the launch with M&M Chairman Anand Mahindra (second from left). (Source: BloombergQuint)

Sit On Cash Or Return It To Shareholders

In January, market regulator Securities and Exchange Board of India rejected L&T’s proposal to do a Rs 9,000 crore buyback—repurchasing shares from shareholders.

R Shankar Raman: “We changed track as a strategy from investing in infrastructure, in very asset heavy, long gestation projects, and we moved to asset-light, which is EPC oriented (projects). This (EPC) is only working capital. The cash to cash cycle is maybe 180 days. The EPC business is doing well, it generates cash. We are light geared in our balance sheet. So, consequently we have little debt to retire and the cash was not going to heavy investments. So, we approached the regulator for a buyback. It did not happen.

I don’t think we should be under pressure to deploy cash. The pressure of excess cash will make you do wrong things. It is important to stay slim when it comes to cash resources. One thing that we have done is the corporate has seized the cash from the businesses. We have not allowed the cash to lie in businesses which generated the cash. The businesses continue to run thin on cash budgets that they have.

As far as the corporate is concerned, we will have to take a portfolio approach. As a conglomerate which has presence in manufacturing, services, EPC business, in projects, we have a bouquet to look at. We have 15-16 verticals. And each vertical has a growth opportunity. Now that return to shareholders has not come through, we are examining as to which businesses deserve an expansion.

We have been a very organic company all this while. Today there is an opportunity, now, that we have cash, to look at inorganic opportunities. Had I not had cash and had I had to raise money for investing, I would have thought little more deeply as compared to the openness to look at opportunities. This doesn’t mean irresponsible investing, throwing around cash. But it is a great comfort that should an opportunity come by there is money in bank which can be invested.

I am looking at mega trends which are going to shape the next 5-7 years. If there are value chains missing in what we do. We are trying to see whether we could invest for competency. Very clearly, as a company we said we will not invest for scale. We don’t have to invest money to get an X contract or a set of people. We need to invest for competency.”

Earlier in April, soon after this interview, L&T made a Rs 10,700 crore bid for a controlling stake in IT services company Mindtree Ltd.. If it succeeds it may merge Mindtree with L&T Infotech Ltd. sometime in the future.


VS Parthasarathy: “We made life easy for everybody. When we invested in any business, we first told them that you have to go and list. Once they list then there is no question of capital allocation between each other. Now they have a board which is responsible to shareholders of their own company. Nine listed companies (in the group) and for capital allocation they have to look downstream. And if it makes sense for Tech Mahindra Ltd. to return the money to shareholders, they will return the money.

When you find yourself in a position where you don’t expect the (investment) return to be higher or you don’t have enough things to do with the money then you can certainly return (to shareholders).”

“There is never ‘more cash’ in balance sheet (than needed). The times are so volatile, to keep powder dry is doing business a great favor.”


Finance leaders discuss blind spots, venture funding, capital efficiency, doing business with government and green capital. Watch here....

CFO Leaders is a knowledge and experience sharing series to engage the best financial leaders, understand their approach to conventional challenges, such as capital allocation and risk control, and new challenges such as rapid tech changes and a narrowing world.


Also read the first story in this series - The Making Of Five Star CFOs and the next story in this series - Mapping And Pricing Risk

Watch the full CFO Leaders - Episode 1.