Raamdeo Agrawal, joint managing director of Motilal Oswal Financial Services Ltd., poses for photograph in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

Raamdeo Agrawal On Value Migration As An Effective Investment Process   

American consultant and author Adrian Slywotzky gave the world the concept of value migration. He defined it as the flow of economic and shareholder value away from obsolete business models to new. Aimed at managers, it also proved an effective tool for investment.

Every business has a life cycle where value flows out after peaking if it fails to adapt to new designs, veteran investor Raamdeo Agrawal said, explaining the three stages of value—inflow, stability and outflow.

Citing the example of Century Textiles Industry Ltd., he said it was the largest company in India by market capitalisation in the 1990s. In comparison, HDFC Bank Ltd. was “a kid with Rs 1,000-crore market cap”, Agrawal said. But with time as their values migrated, HDFC Bank now has a market value of more than Rs 5 lakh crore, he pointed out. “Value of the same company keeps shifting from one bucket to the other,” said Agrawal, chairman of Motilal Oswal Asset Management Company Ltd.

Investors are happy that value has grown from ‘X’ to ‘10X’ or ‘100X’, he said. What they don’t realise is that it will again come back to ‘10X’, according to Agrawal. “So the impretive question here is: how to capture the value of a company when it’s rising?”

The veteran investor, in an interaction with BloombergQuint’s Niraj Shah, answers investor queries on how he uses the concept to pick winners.

Watch the interview here.

Here are edited excerpts of Raamdeo’s answers to viewer queries.

Is the book Value Migration byAdrian Slywotzky where you have got the idea from? How have you used it ininvesting?

This is a management book and he is a consultantand a Harvard Professor. You can even listen to him on YouTube. He has givenexamples of Google and Amazon. Any concept is good when it is good in everypoint of time. He must have written it in the 1990s which was good. So, it isnot that this concept was good in the 90s and now it is not relevant. It is evenmore relevant.

I was wondering in the 90s when I was just about to invest, and I heard about price and value. I had heard that price is what we pay, and value is what we get. Then I was questioning myself that price is changing, then is value also changing? Is value permanent? One of my directors said he has seen one presentation by a professor where he talks about value shifting but he couldn’t give the concept. Next day I received this book as a gift. I read it and realised that value migration is a very powerful shift in the business design. It is a management concept for building businesses, changing businesses and building new strategies in businesses, but in investing also this concept can be very powerfully used. One has to understand what value migration is and how it can be used.

Value of the company is its enterprise value. Slywotzky has kept it very simple. He said it’s the market capitalisation plus debt. This is also flawed-based but is the best possible market measure. If the company is worth $100 billion or $1 billion then that’s the value. So, if a company has created that kind of value, say TCS has created Rs 7 lakh crore, so that’s a value. There is no point in finding what is the market value that has been created. That is the market value.

Does the market value shift? We know the winners and losers. In 1990s, Century was the largest company in India by market cap. Then came Reliance, then HUL, ONGC, and now TCS. So, for the last five years the largest company is TCS. HDFC Bank was a kid in 1996 with Rs 1,000 crore market cap and now it is a Rs 5-lakh-crore company. Banks are rising very rapidly. So, value keeps shifting in same business from one bucket to another. So, as an investor you are happy that the value has grown from X to 10X or 100X. What they don’t realise is that it will again come down to 10X or 15X. Like a lifecycle of a person, there is a lifecycle of a company, particularly in value migration. You take birth, 15-25 years you study and then the value starts accruing. We are still in the accrual phase and then at some point it topples off and then you start going down. Same thing happenes in every business. There is a small lifecycle of the companies. Very few companies at 40s and 50s are still at the top. Thousands of companies came and went. The biggest luxury of a minority investor is that he can choose to buy any company at any point of time of any quantity and sell in the same way. When value is rising, I must buy it at the right time. I would like to buy it at day zero. And I should sell it at day minus one when it peaks out. But buying at the lowest and selling at the highest is not possible. But we should attempt to buy as close as possible. So, value migration is one of the very powerful concept to buy this kind of things.

Then there is global value migration and local value migration. There are very large ones and small ones.

Can you explain more about the three stages of value migration as defined in the book? You said you get in at the point of value inflow and get out before the outflow. Would you explain it?

Every company has its own phase of value accretion,stabilisation and outflow. These are three simple stages. Companies are also driven by what happens in the business. HDFC Bank is a part of the private sector banking. So, actual value migration is happening at a much bigger pace from public sector to private sector. Public sector banks are making Rs 50,000 crore profit. Now, the private sector will expand the banking space and make Rs 2 lakh crore. But public sector banks will make zero profit. In 1995-97, all the profit was with them. And now 120-130 percent of profit this year has gone to private sector banks because net-net public sector lenders, all put together, have made losses.

In 1997-98, HDFC Bank was the only bank where I had applied in six names in public issue. I never apply in public issue. Because I have read the book and I was very clear about it that it is just going to flow one way through. The pace even today is 20-25 percent. It’s still in the value accretion phase. Then there will be a phase, five to seven years later, when this entire migration will be over and then everything will be private sector or professionally managed. At that point of time, further growth will be very difficult, may be 5-7 percent or sometime even low. Then there may be a completely new business model such as IP or internet-based. So, value would migrate to a new business model. If HDFC is not able to harness that new opportunity, then obviously there will be value outflow.

Is technology a bigger enabler of value disruptions or value migration as opposed to just pure play business design? Or do you believe technology is embedded in business design of the company?

It is. Technology has always been a disruptor. Now, you call technology as a computer or internet. But technology in its own form has always been there. Like car came from horse carts. So, that is also technology. Till 1905-1910, it was a car-driven person mobility. From there you came to a completely motorised thing. So, that is one of the largest value migrations. This is a technology-related value migration. But Slywotzky is talking about the business design.

Let’s take aviation. Every business has gone through value migration, but this one is far-reaching from full service airline to discounted service airline. What is the business design? What is the business model? As a business man how would I serve my customer? The first thing is who are my customers, what is my value proposition and how do I want to make money while serving them? So, I will buy an office, have a telephone, have five customers, give them advice and offer broking service. Say, I will make Rs 10,000. My total cost will be Rs 8,000. So, I will make a 20 percent profit. It is the business design. A businessman has to think of it ahead of time.

We are doing broking and are new generation brokers. In 1985, when I started my career there were all traditional brokerage houses—very high on ethics but with no computers, very slow, 1.5-2 hours of office, paper pushing or paper-based trading. It was extremely inefficient at that point of time. The information flow was very bad. While trading, you couldn’t get stock prices. You could get 30-40 stocks through radio. Economic Times used to come to many places after two days. After seeing price, then people used to call a broker. If he is good enough he will buy it for you and again you have to wait for two days.

People wanted research, quick and honest execution. I could impart only professionalism and honesty, quick and precise response. But for the paper-based system, I couldn’t have done anything. Later when technology came the settlement became computerised. Initially, the brokerages were family-run and had a few supporting staff. In 20-25 years, it was a completely different ball game. The business models change. In this process, businesses have exploded. We are talking about Rs 200-crore trade a day in Harshad Mehta’s time (boom time). And today, we do trades worth nearly Rs 20 lakh crore. Cost of doing trade has come down from 150 basis points to 5-7 basis points. Volumes and markets have expanded.

How is it that investors can detect value migration?

One is you look at existing players. How well they are doing and is the value flowing in or out. Look at private sector banks, in aggregate are their market caps going up or down. Banking need is same—deposit money,save, buy products and transfer money. Who should provide you the service is who is most efficient. You don’t care who owns the bank, but the business design.So, there is a certain way of doing business which evolved in 60s and 70s and they stayed with it. Technology was adopted much later. Their competitors in the private sector was top on technology. They came out with far more efficient models.

You have to see that in the same industry are new players coming and are their business models different. In broking, Kotak has launched a zero-brokerage platform. But we are not into zero brokerage. From our full-service brokerage house when we were charging 1-1.5 percent it came to discount brokerage when paper-based trading went away. We did this commercial broking for 17 years. Now it is giving way to zero-brokerage. The notice being given is that there is threat. We can do business, make money and not charge customers. The value migration model is already in place. Whether it will be successful or not, that time will tell. If making money in stock market is only executing trade, then life would have been much easier. Blockchain could do the entire stock marketing from one to another person. But there is research, advice and hand holding. You have to do a lot of things in broking. That’s where we think we are differentiating. We want to help clients to make money and rather than just trade.

Do you believe that there are live examples in Indian context or on the global context wherein innovation and leadership or customer satisfaction score is the factor which has made you identify the stage of value of inflow?

Yes. Both are there. In 1989-90, Gujrat Ambuja’s Mr Sekhsaria had innovated transportation from Veraval to Mumbai. It was Rs 2,000-3,000 per tonne transportation charge, which was unviable. What he did was formed hisown ships, bought the clinker here, made cement and sold it here. They bashed every single guy. He was the lowest cost producer at Veraval but the highest priced seller in Mumbai because of the transportation cost. The moment he bashed that transportation cost, he became the most competitive producer. He has a brand new cement plant, fantastic branding, quality was perfect, cost was lowest and price was highest. His payback period was 1.5 years. So, a small innovation in transportation lead to Gujarat Ambuja Cements. It was half a million company in 1989. It ended up buying then the giant, ACC, in 2003-04. So, one innovation leads to creation of a giant.

Kshitij Verma: How does one determine if value migration has matured and what are the triggers?

You are blessed because the economy is growing at 7-8 percent. So, the stabalisation phase is much more prolonged in most of the business. It is a straightforward concept. If the value is flowing in, the top line, bottom line, return on equity and free cash are growing. Nominal GDP is growing at 12 percent or GDP is growing at 8 percent and you are growing at 5-7 percent, your Ebitda is 20 percent. Still it is in the stabilisation phase and it is not bad, but it is less than 20 and it is not going to 21. Then total profit is same as Rs 500 crore, then Rs 520 crore and then Rs 490 crore. You are struggling and then finally it topples.

One, however, needs to keep a careful watch during the transition phase. For instance, Infosys, which had a massive value inflow, is now in the value-stabilisation phase or maybe it is struggling with current profits and growth. Since the world is getting digital, services will be required. Customers’ requirements are changing. Whether they will or not, I am not someone to judge but when the numbers came I can say that they are in the value inflow mode.

How will you identify whether the IT sector is at the cusp from where it will fall off the cliff into value outflow or will it have the next leg of value outflow after this stability? What triggers will you watch out for?

I am a data driven guy. The way I know broking, I don’t know other’s business. Businesses are capital input and output model. At the end of the day, it comes down to profit and loss and balance sheet. We keep watching in the quarterly results, discussions and interviews. So, when the results come, that tells me whether there is inflow, outflow or stabilisation. From the numbers, I go back to the boardroom. Then we do our research, open the balance sheets, read the research reports, talk to the company, their competitors, ex-employees, current employees and see what is really happening. Since I don’t run an IT company, I don’t really know what’s happening. I would hence not be able to give specifics of what is happening in any business but once I look at numbers then I can say whether something crazy happening there or not.

Do the numbers from the PSU and private banking space tell you that value has already migrated and are PSU banks at a point of no return?

The banking sector is very large. There is a retail loan segment, within which there are secured and unsecured loans. Then there are housing loans, vehicle loans...a whole variety of them. Then you have business loans for small, medium enterprises, large corporates and the government itself. So, there is whole plethora of customers for them. It is a business model of somebody on where they want to fund. Lot of banks say that they don’t do only term loans, and only do working capital loans because they can’t judge the companies’ projects, etc. That is the business design. As far as the public sector is concerned, the word is out that the current model is not right, if there is any doubt about that, then I am helpless. I was very clear about this after reading the book. The issue is that the people who are responsible, owners of the banks, must make changes. I am not the person to suggest changes, it is for the players, managers, consultants and MDs who are successful bankers, have to redesign the design.

The business design has to redesigned..whatever are the deficiencies, in terms of ownership, incentive scheme, HR policy, current compensation scheme, freedom to move, surveillance...all of this has to be looked into. If a serious effort is not made, the value migration which is already happening from public sector banks to private banks, will gather momentum. It is anyway continuing at a rapid pace. NBFCs are also like private sector banks.

Can there be some migration out of private banks into smarter non-banking finance companies?

Sure, NBFCs are doing the same thing as a private sector bank. I would say that private sector banks are NBFCs and NBFCs are private sector banks. In fact, NBFCs are a lot freer from regulatory constraints of the Reserve Bank of India than their private counterparts. It is evident that value can outflow from private sector banks to well-managed NBFCs and vice versa.

Like in the case of housing finance, it is a domain of specialized NBFCs. What stops a bank to give a run for their money in housing finance because the cost of liability is much lower here. Nobody has demonstrated that, but it is possible. Bajaj Finance, in their consumer loans segment, is showing that they can give banks a run for their money and grow very rapidly. In India, licensing is not for specialized line of NBFCs but all of them will come as the economy expands and as regulators become more innovative and open minded. They will all come.

Do you believe that in India, we are in a bit of value inflow stage for the lending business? A lot of people compare India’s household debt to GDP to a lot of other emerging markets and say that we have a long way to go. We are probably at the emergence of the lending super cycle in this country. Do you believe that it is true? While the NBFCs have grown in size meaningfully, we may still not be in the stability phase but in the inflow phase.

As a concept, I would still club NBFCs with private sector banks as a box. And then individually you have to see which NBFC is good and whether you could have a portfolio of only NBFCs. For me, it is not that different conceptually. Another thing I was reading about was, the lindy effect. I was reading a book called ‘Skin The Game’ where he talks about the lindy effect...he says that the shows which go from 100 to 200 days are the shows that have done 100 days and the shows which go from 200 to 300 days are the ones that have done 200 days. So, by seeing a show successful for 25 days, you cannot say that it will last for 400 days. It has to cross those hurdles.

The companies which are very successful, keep winning. And the winners are for five-ten years, which will surprise you on the upside. Because the economy per se is blasting off at 7-7.5 percent. If it keeps growing at 7-7.5 percent in the next 10 years, and the broad model does not change, the migration does not happen from private sector banking to some public sector. Say, government gives out crazy rules that all goes to private sector from public sector. At that time, this kind of model will see stabilisation and outflow. But otherwise my sense is that successful companies in India will become more successful overtime.

This is the power of value migration. You don’t have to preempt. Don’t come in front of speeding truck. When value is inflowing, don’t come in front of it. Why do you have to hypothesise and think about when it is going to stabilise or pick out? Let it pick out. There will always be a phase when it will go up and then down. So, during that phase you have to take the call...that I have made enough of it and let me get out and buy something else.

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