The key to successful valuation migration is a conducive policy environment, according to renowned stock picker Raamdeo Agrawal.
“Opportunities to create value will emerge but you need to grab it at the right time,” the veteran investor said. “While India grabbed some opportunities, we did miss out on some.”
Citing the example of the software services industry, Agrawal said the country put its best foot forward when the Y2K problem hit the industry in the 1990s. “The government introduced its best tax structure. A trillion-dollar value migration opportunity was created.” In contrast, India failed to capitalise on the burgeoning steel demand in the 2000s. “During the steel boom, we had got an opportunity to set up huge steel plants in Odisha. But we couldn’t clear any of the projects.”
Agrawal, however, said India has the potential to create value over the next 15 years. Aviation is one sector where he sees opportunities for value migration despite ‘temporary blips’ like volatility in crude prices, as people prefer air travel over railways. “The migration was happening even with crude at $110 a barrel. We just need the right kind of competitive structure for making money,” he said.
Agrawal was speaking to BloombergQuint on the second episode of the special two-part series, explaining how to invest using ‘value migration’, a concept introduced by American consultant and author Adrian Slywotzky.
Slywotzky 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.
Watch the full interview here:
Here are edited excerpts of the interview with Raamdeo Agrawal
Value migration across all businesses would be movement from obsolete designs to newer and more effective designs. This could also be cross-country, it could also be cross industry and it could be cross company as well.
It can be cross regions to. Climatic conditions are good for making something. Say, sugar is being cultivated in UP and then some other states decides to take on sugar consumption as there could be lot of water. So,sugar cultivation can go from UP to Maharashtra, Karnataka. In Maharashtra,they did encourage in 60s, 70s and a lot of these states started becoming sugar producing.
In automotive manufacture, earlier it could be manufactured in north and now Gujarat is becoming a big hub because state government decided to build the auto hub. There was no auto hub there but now Maruti, Telco, Ford, Hero Honda has come, Honda itself is coming. So, now it is becoming large automotive hub. It became auto hub in front of us. So, it all depends on policies. It can migrate. It must be a better business model and that is why people come. In India, it is lead by incentive structure of what the state government is offering. In Haridwar, to produce motorcycle, where you go for a pilgrimage, why do you do it ? So, this kind of migrations can happen.
You must see why people are doing it. It must be done for some incentives. There was zero sales tax, zero excise. The payback period was less than two years for the plant.
One form of value migration is high income to low income, something that IT did as well. How do you see that evolving over the years? Does that model of value migration still exist and can be made use of for investing ?
One of things is a country level migration. Wealth actually migrates. It is a trickle down and you can’t stop it. Global wealth in aggregate is growing and it is trickling down. US is the major hub of wealth creation right now. There is always leader at one point of time. Some point of time, it was Europe and UK and now it is the U.S. So, from the U.S., everybody is working for the U.S.
At some point of time, textile was major source of value migration. So, it went to Japan. So, Japan made all kinds of textile, shoes, all kinds of consumer goods,electronic gadgets and they supplied. So, then Japan became as rich or probably more rich than America. After that 70s and 80s scorching growth and from 325-400 yen to a dollar, it became 80 yen to a dollar. So that was a migration and your per capital GDP from $3-5000 went to $40,000-50,000. That was one of the largest value migration. In that America didn’t suffer, but Japan went up.
After that HongKong, Korea and then China. We have seen this in last 15 years. It has happened in front of us. Till 2002, we didn’t know where China is and today China is everywhere. So, it is for the country to play the game very well. You have to create a conducive condition for migration of global values into your country.
In Orissa, we got opportunity in the steel boom. We got opportunity to set up huge steel plants. But when they came we couldn’t just clear any of the projects. So, value couldn’t migrate from Chinese steel companies to Indian steel companies. The world will through opportunity at you. In Software, we were very good. When the opportunity came in 90s, the Y2K problem came, we put our best foot forward. Government gave the best possible taxation structure. No tax for 10-15 years. There were no restrictions. It was a terrific example of how you create value migration in country. There was trillion-dollar value migration. In 2000, we were doing $5 billion of exports and today we are doing $120 billion exports and it is still growing. So, that’s the level of migration we create if the country, government are aligned and agile. They have to decide where is my strength and where I have to create my migration.
Who do the next 15 years belong to then ?
India has a terrific chance.
And what within India then?
The way I see is there is so exciting in India. We will emerge. Whether some other countries will emerge faster than us, but I don’t see any large country at this juncture of this magnitude. The pace at which China could do it, but we have the opportunity to do it faster than China. But we got to really manage it well. There is very high probability that it will happen. Because now the enterprises are not in the hands of government, but they are at the hands of newer business and private sector. So,they will happen like Infosys, Wipro. And not at the mercy of government. Of course, they have provided the conducive environment. And now, this government is talking about ease of doing business. They are much more business-like.
My sense is that at some point of time or it is already happening that migration of lot of business could happen at very rapid pace into India. The per capita GDP growth which is 7-7.5 percent. If it even this pace, it is massive. Once you gain size from 2 trillion to 5-7 trillion, the world will listen to you. You have to buy 500 planes, 300 planes every year. Who else is absorbing this number of planes. You are the biggest defense buyer in the world. So, it all changes as you have money in the pocket. Once you create the growth and money in the pocket, everybody rallies around.
Let’s talk about some of those examples if you will. One obvious value migration to my mind at least has been the migration from railways to roads plus air.However, it’s a space which is bogged down by one variable which is crude. But do you believe that there is a stage of value inflow into the Indian aviation sector currently?
Yes, it’s a perfect example. Crude is just a temporary blip. The migration was happening even at $110. It will happen because it is far more superior design. When I couldn’t afford to buy a ticket of railway, I was very happy coming at a speed of 40 km and 24 hours to travel 1000-1200 kms. Now I can afford to buy an air ticket. I came from Raipur and from there it takes 20 hours. The train which brought me to Mumbai still takes same time with same coaches. Tickets are more. That time there where two flights in a week. Today there are 7 direct flights and they are all full. That’s the level of migration. Yet, we are flying 100 million passengers in a year in a country of 1300 million. Out of that unique passenger must not be more than 10 millon or 20 million. 20 million out of 1300 million are yet to fly. If you are travelling by train you could have travelled twice in a year. Now, the moment this facility is there at reasonable price, you can go anytime you want. So, at a higher price you travel many more times. So, the market expands big time. So, this is happening. But how do you make money ?
Now come to analyzing the money making opportunity. For that you need a right kind of competitive structure. If there is one vada pav guy on a street, he can be useless follow, but yet he can make money because there is no competition. If you want eat it, then better give 25 bucks and take it. In theatre, they sell popcorns at 250 bucks and also in stadium for a match they cost you 500 bucks. So, you are captive customer. But economies are not like that. They can be captive for an hour or two but not for the whole year. So, you have to figure out what is the competitive structure in aviation. There you see is there any dominant player, is he best, are consumers happy, is it giving value, what is the business design. In that segment, all the full-service airline has given, again there is second level of value migration within value migration. One value migration is in transportation stage where it is big level, from railway it is coming to aviation. There is one source of growth of aviation. Now, within aviation the value is migrating from full service to discount airlines. Now, within that who is the best, who is gaining market share, how fragile is the business model and how fragile is the businessman. When you have anti-fragile businessman and anti-fragile business model, then you get an anti-fragile company and a multi-bagger.
In this book, they have cited an example of IBM versus Microsoft. The value of the company will not necessarily be dependent on the size of revenue. At a value inflow stage, the market value could be way higher even if the revenue is not as high. What are your views ?
It is not about size and that’s why he is not going by sales. Sales of General Motors may be the highest today, but they don’t feature anywhere in market capitalisation. Fiat has some $100 odd billion turnover but the market capitalisation came at around $5-$6 billion. So, by value, he is referring to the Enterprise Value.
We are talking about India being able to export a lot to the outside world. What about the domestic space? In the case of Hindustan Unilever Ltd. for instance, for the longest time people thought that it is stable, stagnant but suddenly after long phase of value stability, it is looking like beginning of a phase of value inflow once again. There has not come a phase of value outflow. How does one disect all of these ?
With HUL, there has always been value inflow, then stabilization, then again inflow, then stabilization and then inflow. You will never find a value outflow kind of situation with HUL.
Why so ?
Because all the products are day-to-day needs, there is no disruption there. Everybody is still using detergents for washing clothes, you don’t have a digital way of doing that. Except for cell phones and computers,what has changed for 40 years? They are part of the so-called old economy and consumer needs.
Nearly 85 percent people in 1985 were below poverty line. What has changed for them is that the market size of consumers has grown. So, people who were not using toothpastes and detergents then are now using it. That's due to the master marketeers. They exactly know whom to sell what, at what price and when. They are two-three steps ahead of the incoming trend. They positioned themselves in rural India way ahead. They invested and never got paid and probably now, the pay-off time is coming for them.
How it will affect the FMCG companies where distribution network was considered as a MOAT whereas new company with better product or similar product of lower price can use online to scale up? Can this happen that newer companies/vertical specialists not having the MOAT of distribution but can use online to disrupt the models of an HUL or some of the others ?
There is no importance of my view. Let him demonstrate.You don’t have to preempt anything. Why are you worried for something which is not happened. The entrepreneur is one guy who is such an artist, he will find million ways of making money, if he can make money. So, let somebody demonstrate that I will make money then I will examine his business model as how lasting it is. Why hypothesize something which is not there ?
Lets talk about retail. Now India is a curious case of two large online giants being there. But when we speak to the offline players, they say offline sales will not die. What would be your thoughts on this ?
We will leapfrog. Nothing is going to change that dramatically. Migration or this discussion is about winning and not just about selling. So, offline can keep selling but may not win. General Motors have 5 billion dollars turnover, but he incurred 5-billion-dollar loss. We don’t know in future what will happen.
Where would you place your bets now in retail, because as an investor, you are obviously looking at five years out or ten years out to try and figure our where you will make money. In retail what would you do ?
In retail it’s actually a very interesting scenario where industry is growing,whosoever it is catering to. Per capita income is growing rapidly so obviously the goods and service required there is growing. So, obviously goods and services required there is growing. Who are the guys who meet the demand and that too profitably? So, there is opportunity for everybody. There are guys who don’t have the address also of where to deliver by Amazon and that’s the very large population of the country. So, they don’t have credit card, payment mechanism, delivering address or even if there is address there is no person to receive it. I find it difficult to order it many times. I have not ordered successfully anything online so far except for movie tickets. So, offline has still life.
In a growing environment, you have to figure out how these offline guys will tackle it. Whenever you know the trouble, entrepreneurs in India are very smart to counter strategize the problem. The known problem will never become problem. The guy who is doing things offline is trying to do it in such a way that online will not threaten his life. There is so much on table. You are talking about economy which have gone from $2.5 trillion to $5 trillion in which 60 percent is retailing. So, you are talking about $3-4 trillion. In that organized is very little. So, let the organized become very large, whether it is offline or online. In that, online is very small and none of them are very profitable. The cost of logistics is higher than the cost of goods itself. Cost of goods offline is $1 per kg. Now, you do the logistics. So, there are lot of such issues for making a profitable model which is tough but will happen. The online will not leave as they have massive backing of global value created. Amazon’s market cap is helping fund Amazon India. Same way Flipkart with Walmart. So, all that money is flowing here, and they are forcing value migration from offline to online within India. So, these are all very complex model. You just have to watch the show and see who is making money. Is there a new guy in the segment making money? Then go and meet them and ask what the business model is.
Migration from being serviced by a large PSU to smarter models, do you think that model has kick started in meaningful way? The companies at large, everyone talks about expensive valuation but are they still in the value inflow stage ?
You leave aside valuation of stock market. But per-se when you look at the business, it is same repeat what has happened with banks is now happening with insurance. Look at life insurance. LIC has been reduced from 100 percent to about 50 percent. But it is not necessary that they will be marginalized. It is long relationship and customers and even I see lot of value in the value offered by LIC. Because LIC has a government sovereign guarantee. If I am insuring myself for $100 million out in for 30-40 years, I will rather take a LIC policy because I am guaranteed of payoff if my kith and kin need D-Day call, I am sure of getting the payouts. Because in insurance ultimately you got to be paid out. PSU has its own value proposition but how do you design and leverage on that value proposition and make a successful business model, that’s a challenge.
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