Ambit Capital Report | Revenue | Investing

June 07, 2013

Strategy
THEMATIC

Why do great Indian companies self-destruct?
Over 80% of ‘great’ Indian companies slide to mediocrity in a short span of time led by poor strategic decision-making fuelled by ’hubris and arrogance‘. Such faulty strategic decisions usually result in poor capital allocation which destroys RoCE and creates financial stress. Thus, the importance of evaluating and tracking strategic decisions to achieve long-term outperformance cannot be over-emphasised although it is an area that is often overlooked. Through a series of notes, we will analyse management strategies of select companies. Our aim is not only to understand the past better but also to set a framework for analysing the future.

Analyst contacts
Saurabh Mukherjea, CFA
Tel: +91 99877 85848 saurabhmukherjea@ambitcapital.com

Gaurav Mehta
Tel.: +91 22 3043 3255 gauravmehta@ambitcapital.com

Consultant: Anirudha Dutta
Tel: +91 98201 34825 anirudha0765.dutta@gmail.com

The systematic slide to mediocrity
We find that the average probability of a sector leader remaining a sector leader five years later is only 15%, implying that 85% of BSE500 companies slide towards mediocrity. In fact, the average probability of a ‘great’ company becoming a sector laggard five years later is 25%. Even the Nifty ‘churns’ by around 50% or so every decade (as compared to around 25% for developed markets and around 30-40% in other major emerging markets). The tendency for large, successful companies to slide down the market-cap spectrum is not confined to the Nifty.

The most prominent ‘fallen angels’
Name Hero MotoCorp TVS Motor Ranbaxy Labs. Tata Motors Tata Steel Bharti Airtel Indian Hotels Bharat Forge Period* 2004,09 2004,09 2005,10 2006,11 2007,12 2007,12 2007,12 2007,12

Why do successful firms slide with such regularity?
Promoters, in their own explanations for underperformance, tend to cite exogenous factors (such as business cycle, Government interference, rising competitive intensity or the macro environment). However, such explanations are not always convincing because within the same sector (and hence subject to the same regulatory and competitive forces), whilst some firms are sliding, others are rising. Contrast, for example, the performance over the past five years of Infosys vs HCL Tech or Bajaj Auto vs TVS Motors. In our view, the slide is primarily due to poor strategic decision making.

Source: Ambit Capital research; Note: * 2004, 09 indicates that these companies, which were ‘great firms’ in 2004, have been identified as ‘fallen angels’ in 2009.

Sustaining leadership
Name Berger Paints Asian Paints Larsen & Toubro Dabur India CRISIL Nestle India Balkrishna Inds TCS Period* 2003,08 2004,09 2004,09 2005,10 2005,10 2006,11 2007,12 2007,12

Our framework and forthcoming research on this subject
In the first of a series of strategy notes, we present our framework to analyse and evaluate why companies slide in performance. The framework is primarily based on the works of Jim Collins and William Thorndike. The framework and the case studies will help you understand how certain companies achieved great success, how they stumbled and how some of them recovered. The past is relevant because it gives a peek into the future and is potentially a determinant whether a company comes out of the rut to regain greatness. This first note has a preponderance of discussions on Tata group companies (owing to its virtue of being the largest and most diverse corporate group in India), an imbalance which subsequent notes will correct.

Investment implications
Our analysis shows that Tata Steel, Tata Motors, Titan and TTK Prestige are at an inflection point today. A cyclical turnaround in the domestic market could propel a turnaround at Tata Motors. Tata Steel, however, has larger challenges of sorting out the problems at Corus, even if the domestic demand were to see an upswing. Titan and TTK Prestige have had a great run for a decade and the key question is will growth stall over the next five years. We have no firm answers, but we prefer Tata Motors over Tata Steel. TTK Prestige remains on our BUY list (we do not cover Titan at present but like TTK Prestige, Titan is also on our ten-baggers list).

Source: Ambit Capital research; Note: * 2003, 08 indicates that these companies have been identified as sector leaders in 2003 as well as in 2008.

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to disclaimer section on the last page for further important disclaimer.

Strategy

CONTENTS
Executive summary………………………………………………………………… 3 Introduction……………………………………………………………………….. 18 The ‘greatness’ framework………………………………………………………20 Self-destruction quantified……………………………………………………… 22 Identifying ‘fallen angels’………………………………………………………. 24 How and why do great companies fall?.................................................. 27 Case study: Titan………………………………………………………………….41 Case study: TTK Prestige………………………………………………………… 50 What we will cover in our forthcoming notes…………………………………62

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Strategy

Executive summary
80% of companies slide into More than 80% of ‘great’ Indian companies slide to mediocrity in a brief span of mediocrity… time. Super successful companies usually become victims of their own success because after a while, ’hubris and arrogance‘ sets in and the promoter and/or management make ill-judged strategic decisions. More than anything to do with the business cycle or with regulation or competition, this point emerges forcefully from our observations of corporate India over the past decade. Such faulty strategic decisions usually result in poor capital allocation which destroys RoCE and creates financial stress. Therefore, the importance of evaluating and tracking strategic decisions to achieve long-term outperformance cannot be overemphasised although it is an area that is often overlooked. Through a series of notes, we will analyse the management strategy of select companies, which will …thanks to management help you to understand not only the past but hopefully set a framework for analysing the future as well. hubris and arrogance
Exhibit 1: Factors used for quantifying greatness (as used in the 2012 model)
Head 1 Investments Criteria a. b. 2 Conversion to sales a. b. c. d. 3 Pricing discipline a. b. 4 Balance sheet discipline a. b. c. d. Cash generation and EPS 5 improvement a. b. c. d. 6 Return ratio improvement a. b. c. d. Above median gross block increase (FY10-12 over FY07-09)* Above median gross block increase to standard deviation Improvement in asset turnover (FY10-12 over FY07-09)* Positive improvement in asset turnover adjusted for standard deviation Above median sales increase (FY10-12 over FY07-09)* Above median sales increase to standard deviation Above median PBIT margin increase (FY10-12 over FY07-09)* Above median PBIT margin increase to standard deviation Below median debt-equity decline (FY10-12 over FY07-09)* Below median debt-equity decline to standard deviation Above median cash ratio increase (FY10-12 over FY07-09)* Above median cash ratio increase to standard deviation Above median CFO increase (FY10-12 over FY07-09)* Above median CFO increase to standard deviation Above median EPS increase (FY10-12 over FY07-09)* Above median EPS increase to standard deviation Improvement in RoE (FY10-12 over FY07-09)* Positive improvement in RoE adjusted for standard deviation Improvement in RoCE (FY10-12 over FY07-09)* Positive improvement in RoCE adjusted for standard deviation

Source: Ambit Capital research. Note: * Rather than comparing one annual endpoint to another annual endpoint (say, FY07 to FY12), we prefer to average the data out over FY07-09 and compare that to the averaged data from FY10-12. This gives a more consistent picture of performance (as opposed to simply comparing FY07 to FY12).

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Strategy

The systematic slide to mediocrity
Over five years, there is only a 15% probability that a sector leader retains its leadership position… We find that the average probability of a sector leader remaining a sector leader five years later is only 15%, implying that 85% of BSE500 companies slide towards mediocrity. In fact, the average probability of a ‘great’ company becoming a sector laggard five years later is 25%. Even the Nifty ‘churns’ by around 50% or so every decade (as compared to around 25% for developed markets and around 30-40% in other major emerging markets). The tendency for large, successful companies to slide down the market-cap spectrum is not confined to the Nifty. We use our ‘greatness’ model to assess the probability that sector leaders (defined as firms with a ‘greatness’ score in excess of 75th percentile of the sector) from five years ago are now amongst the sector laggards (defined as firms with a ‘greatness’ score of less than 25th percentile of the sector), i.e. what is the probability of self-destruction? We contrast this against the probability of sustaining leadership i.e. what is the probability that sector leaders are still sector leaders five years hence. We check this historically starting from 2003—for example, we assess the chances that a sector leader in 2003 was still amongst the sector leaders in 2008 and contrast this against the chances of it becoming a sector laggard by 2008 and so on.
Exhibit 2: The 'greatness' framework

…and 25% probability that they become sector laggards

a. Investment (gross block)

b. Conversion of investment to sales (asset turnover, sales)

c. Pricing discipline (PBIT margin)

e. Cash generation (CFO)
Source: Ambit Capital research

d. Balance sheet discipline (D/E, cash ratio)

Exhibit 3: Distribution of firms on the ‘greatness’ score has been calculated by using data over FY07-12 (total population: 381 firms)
Zone of mediocrity 60 50 No. of firms 40 30 20 10 0 0%-10% 10%-20% 20%-30% 30%-40% 40%-50% 50%-60% 60%-70% 70%-80% 80%-90% 90%-100% 211 firms score < 50% Good, not Great 93 firms (between 50% and 67%) Zone of greatness Only 77 firms score > 67%

Greatness Score

Source: Ambit Capital research

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Strategy Exhibit 4: Probability of self-destruction
2003,08 Probability that sector leaders in Year-0 stay sector leaders in Year-5? Probability that sector leaders in Year-0 become sector laggards in Year5? 12% 23% 2004,09 20% 20% 2005,10 19% 30% 2006,11 10% 23% 2007,12 average 17% 31% 15% 25%

Source: Ambit Capital research, Note: 2003,08 indicates the probability in Year-5 (2008) for a sector leader in Year-0 (2003)

Exhibit 5: Probability of rising to ‘greatness’
2003,08 Probability that sector laggards in Year-0 stay sector laggards in Year5? Probability that sector laggards in Year-0 become sector leaders in Year-5? 20% 37% 2004,09 17% 23% 2005,10 13% 42% 2006,11 21% 39% 2007,12 average 19% 28% 18% 34%

Source: Ambit Capital research, Note: 2003,08 indicates the probability in Year-5 (2008) for a sector laggard in Year-0 (2003)

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Strategy

Identifying fallen angels
RoEs and RoCEs are the best measures to identify a company’s fall from grace Using our greatness framework, we can identify the ’fallen angels‘ i.e. the onceloved companies that were considered to be undisputed market leaders, say, for 5-7 years, but then they faded away. More practically speaking, we use our model to grade firms into leaders (scores above the 75th percentile) and laggards (scores below the 25th percentile). Then we define ’fallen angels‘ as those firms that slide from being a leader to a laggard over a five-year period. Our quantitative analysis suggests that RoEs and RoCEs are the most sensitive measurables in a company’s fall from grace.
Exhibit 6: List of 'fallen angels'
FY03, 08 Monsanto India Hero MotoCorp Eicher Motors Atlas Copco (I) Godrej Inds. Carborundum Uni. CMC Container Corpn. ONGC BPCL IOCL Dr Reddy's Labs Ranbaxy Labs. Guj Gas Company Neyveli Lignite FY04, 09 Hero MotoCorp Eicher Motors Tata Motors Ashok Leyland TVS Motor Motherson Sumi Siemens Atlas Copco (I) Kirl. Brothers Berger Paints PTC India BPCL HPCL IOCL GAIL (India) Sanofi India Ranbaxy Labs. Guj Gas Company Neyveli Lignite FY05, 10 Monsanto India Tata Motors ABB Siemens Berger Paints Tata Chemicals Bharat Electron Lakshmi Mach. Works Gateway Distr. Tata Steel SAIL Natl. Aluminium Hotel Leela Ven. ONGC BPCL IOCL GAIL (India) Ranbaxy Labs. GE Shipping Co Neyveli Lignite Source: Ambit Capital research; Note: 2003,08 indicates that these companies, which were ‘great firms’ in 2003, have been identified as ‘fallen angels’ in 2008. FY06, 11 Tata Motors SKF India Bharat Forge Siemens Kirl. Brothers Havells India Lakshmi Mach. Works Bharati Shipyard Allcargo Logistics Ent. Network Hind. Zinc SAIL Tata Steel Natl. Aluminium Hotel Leela Ven. Thomas Cook (I) Biocon FY07, 12 Bharti Airtel SKF India Bharat Forge Alstom T&D India AIA Engg. Lakshmi Mach. Works Gateway Distr. Sterlite Inds. Hind. Zinc SAIL Natl. Aluminium Tata Steel Indian Hotels Hotel Leela Ven. MRPL GE Shipping Co

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Strategy

Why do successful regularity?
Within the same sector, there is wide divergence in performance, suggesting internal factors are more important than external factors

firms

slide

with

such

Promoters, in their own explanations for underperformance, tend to cite exogenous factors (such as business cycle, Government interference, rising competitive intensity or the macro environment). However, such explanations are not always convincing because within the same sector (and hence subject to the same regulatory and competitive forces), whilst some firms are sliding, others are rising. Contrast, for example, the performance over the past five years of Infosys vs HCL Tech or Bajaj Auto vs TVS Motors.
Exhibit 8: RoCE of Infosys and HCL Tech – moving in different trajectories
35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
FY11

Exhibit 7: NOPAT margins – Infosys losing momentum; HCL Tech catching up
30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Infosys
Source: Company, Ambit Capital research

HCL Tech

Infosys
Source: Company, Ambit Capital research

HCL Tech

Exhibit 9: PAT margin of Bajaj and TVS – way apart!
18% 16% 14% 12% 10% 8% 6% 4% 2% 0% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

Exhibit 10: Bajaj’s RoCE in a different trajectory vs TVS
350% 300% 250% 200% 150% 100% 50% 0% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY12
7

Bajaj

TVS

Bajaj

TVS

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

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FY13

Strategy

The five-stage framework
In this note, we use a modified version of Collins’ framework and Thorndike’s approach to analyse capital allocation to understand why great Indian companies slide. The core stages in our framework are as follows: The five-stage framework

Stage 1 - Hubris and arrogance: The company is on top of its game. Operating margins, RoCE, growth, valuation multiples, etc., are at all-time highs. Captivated by the success in its core business, the management starts believing its own press. Success and adulation intoxicates the top brass. Arrogance sets in. The company loses sight of the factors which made it successful in the first place. Stage 2 – Unbridled expansion: In search of more growth and more adulation, the management begins an expansion drive which is often inorganic. The firm ’overreaches‘ into new geographies and product lines where it has no real experience or expertise. Sub-par capital allocation begins. Stage 3 – Stuck in a rut: Often cost discipline and/or product excellence erodes and prices are then raised. Profits, return multiples and valuation multiples start sliding. Company politics thrives. The leader becomes increasingly autocratic and announces 'recovery plans' that aren't based on accumulated experience. Stage 4 – Grasping for solutions: The company thrashes around and looks for a solution even as profits and financial strength continue to slide. Senior management jobs are on the line. Often a new leader comes in and sometimes he tries to fire silver bullets (eg. a 'transformative' acquisition, a blockbuster product, a cultural revolution, etc). However, a new leader (ideally, someone from inside) who takes a long, hard look at the facts and then acts calmly to put in place a measured recovery strategy with sensible use of cash and capital at its centre, could be the saviour. Stage 5a – Capitulation: The firm is sold or fades into insignificance or, and this happens rarely, shuts down. Or Stage 5b – Recovery: The firm turns the corner and begins the long, slow climb to recovery.

 

Exhibit 11: The five-stage framework

Source: Ambit Capital research, From the book ’How The Mighty Fall’

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Strategy

Investment implications
The four companies in our first of a series of notes are poised at an interesting juncture Our analysis shows that Tata Steel, Tata Motors, Titan and TTK Prestige are at an inflection point today. A cyclical turnaround in the domestic market will propel the outperformance of Tata Motors. Tata Steel has larger challenges of sorting out the problems at Corus. Titan and TTK have had a great run for a decade and the key question is will growth stall over the next five years. We have no firm answers, but over the next five years, we prefer Tata Motors over Tata Steel. TTK remains on our BUY list. Both Titan and TTK are on our 10-baggers list.
Exhibit 12: Tata Steel's journey through the five stages
Stage Hubris and arrogance (FY01-05) Remarks Superb financial performance through FY01-05 Feted as the lowest-cost steel producer globally by World Steel Dynamics Won the Deming prize Company started believing that it had insulated itself from steel price cycles Unbridled expansion (FY06-08) Evaluates alternative businesses to enter into including telecom, BPO, etc Bids for Corus in 2006 and completes the acquisition in 2007, after a bidding war with CSN Corus acquisition at a value of US$12bn when company net worth was US$2bn Corus did not measure up to the criteria that the company had enunciated in its annual reports for growth/ acquisition After initial strong performance, Corus goes into the red Domestic expansion plans get delayed Company saddled with huge debt Downturn in global steel cycle exacerbates the situation Grasping for solutions (FY09 - present) Restructuring at Corus by mothballing capacities and disposing assets Debt refinancing and equity raising Enhance raw material security Change of leadership at Corus Capitulation or Recovery? (FY09 - present) Write-down of goodwill - acknowledgement that the acquisition is not working Plans to sell off underperforming and inefficient assets of Corus Accelerate expansion plans in India to improve the competitive structure of the entire company Source: Company, Ambit Capital research

Stuck in a rut (FY09 - present)

Exhibit 13: Tata Motors' journey through the five stages
Stage Hubris and arrogance (FY03-06) Unbridled expansion (FY07-08) Stuck in a rut (FY09) Grasping for solutions (FY10) Remarks Strong financial performance between FY03-07 In a short span of time, becomes one of the three largest passenger vehicle companies in the country Takes two big challenges: develop the Nano and takeover of JLR Launch of Nano is widely celebrated; acquisition of JLR is criticised Nano fails to deliver the expected results after the initial euphoria JLR is hit severely by the downturn in global demand after the financial crisis Several leadership changes at JLR and India business A three-tier strategy to revive the fortunes of JLR; decides not to cut back on investment plans Strengthen the domestic commercial vehicle portfolio Capitulation or Recovery? (FY11- present) JLR starts performing strongly, although will continue to need substantial investments towards product development Work on to revive the fortunes in the domestic passenger car market

Source: Company, Ambit Capital research

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Strategy Exhibit 14: Titan's journey through the five stages
Stage Hubris and arrogance Remarks Launches quartz watches in the Indian market and is widely successful; five-year goals achieved in two Enters the Middle East and is successful Unbridled expansion (FY96-98) Stuck in a rut (FY1999-2002) Grasping for solutions Capitulation or Recovery? Makes a foray into the European watch market Enters into jewellery exports European watch foray creates financial stress; crimps company's ability to invest in domestic business Jewellery exports fails to take off Pull back from the European markets Launch jewellery in the Indian market Relaunch the domestic jewellery SBU with 22ct jewellery Tanishq becomes a huge success Rejuvenate the domestic watch portfolio Expand the Fast Track brand into other product categories Launch prescription eyewear business Source: Company, Ambit Capital research

Exhibit 15: TTK Prestige's journey through the five stages
Stage Hubris and arrogance (FY90-94) Unbridled expansion (FY95-99) Stuck in a rut (FY2000-02) Remarks Successful launch of its US business through 'Manttra' Strong growth of pressure cookers and pans in India (25%+ CAGR) Expansion of its US business; funding it through IPO proceeds Ventured into new markets like Middle East, UK and Australia Labour issues in Hosur and Bangalore plant could not be managed in time International sales was decimated due to stiff competition Planned new product launches either failed or could not be executed in time Government increased excise and other taxes Grasping for solutions (FY03-04) Reallocated and restructured responsibilities within existing senior management team Reduced focus on exports Convinced the Government to reduce excise tax rates on pressure cookers Gave VRS to a large part of the workforce, relocated manufacturing facility and resolved union problems Launched Prestige Smart Kitchens to support distribution of new product launches Decided to diversify Indian operations across geographies and products Consistent innovation pipeline for new products meant that 50-70% of sales generated in any year related to products/SKUs introduced over the past three years

Capitulation or Recovery? (FY05 - present)

Source: Company, Ambit Capital research

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Strategy

TATA STEEL LTD.

TATA MOTORS LTD.

Mr. H.M. Nerurkar, MD, Tata Steel
Tata Steel’s RoCE (%) through the different stages
70 60 50 R o C E (% ) 40 30 20 10 0 FY01 FY02 FY03 FY04 FY05 FY06 Year FY07 FY08 FY09 FY10 FY11 FY12

Karl Slym, MD, Tata Motors

Dr Ralf Speth, CEO Jaguar Land Rover

Tata Motors’ RoCE (%) through the different stages
140 120

Hubris &  Arrogance

Unbridled  expansion

Ro CE (% )

Stuck in a rut/Grasping for  solutions/Capitulation or  Recovery?

100 80 60 40 20 0 -20 FY03

Hubris &  Arrogance

Unbridled  expansion

Stuck in  Grasping  for  a rut solutions

Capitulation  or Recovery?

FY04

FY05

FY06

FY07

FY08 Year

FY09

FY10

FY11

FY12

FY13

RoCE (%) through the five stages

RoCE (%) through the five stages

Tata Steel’s share price performance through the different stages
1600.0 1400.0 1200.0 1000.0 800.0 600.0 400.0 200.0 0.0 Apr-00 Apr-02 Apr-04 Apr-06 Tata Steel Apr-08 Sensex Apr-10 Apr-12

Tata Motors’ share price performance through the different stages
Share Price chart-Tata Motors vs Sensex
1600.0 1400.0 1200.0 1000.0 800.0 600.0 400.0 200.0 0.0 Apr-02 Apr-04 Apr-06 Apr-08 Tata Motors Sensex Apr-10 Apr-12

Share Price chart-Tata Steel vs Sensex Unbridled expansion  Stuck in a rut/Grasping for  Hubris & Arrogance   3 yr CAGR relative  solutions/Capitulation or Recovery?  5 yr CAGR relative  performanceof  ‐ 9% Till date CAGR relative performance of  performance of 33% ‐19%

Unbridled expansion   Hubris &   2 yr CAGR relative  Arrogance  4 yr CAGR relative  performance  of  ‐36% performance  of  31%

Stuck in a rut  1 yr  CAGR  relative  performance  of ‐32%

Grasping for  solutions  1 yr CAGR  relative  performance  of 240%

Capitulation or Recovery ? Till date  CAGR relative  performance  of 49%

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Strategy

TITAN INDUSTRIES LTD.

TTK PRESTIGE LTD.

Mr. Bhaskar Bhat, MD, Titan
Titan’s RoCE (%) through the different stages

Mr. T.T. Jagannathan, Chairman, TTK Prestige
TTK’s RoCE (%) through the different stages
60 50

60 50 40 RoCE (%)

40 RoCE (%) 30 20 10 0
FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 Year FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

30 20 10 0

Unbridled  expansion

Stuck in a rut Growth

Hubris &   Arrogance?

Hubris &  Arrogance

Unbridled  expansion

Stuck in a  rut

Grasping  Capitulation  for  or  solutions Recovery?

FY90 -10

FY92

FY94

FY96

FY98

FY00

FY02 Year

FY04

FY06

FY08

FY10

FY12

RoCE (%) through the five stages

RoCE (%) through the five stages

Titan’s share price performance through the different stages
Share Price chart-Titan vs Sensex
5000.0 4500.0 4000.0 3500.0 3000.0 2500.0 2000.0 1500.0 1000.0 500.0 0.0 Apr-95 Apr-97 Apr-99 Apr-01 Apr-03 Titan Apr-05 Sensex Apr-07 Apr-09 Apr-11 Apr-13

TTK’s share price performance through the different stages
Share Price chart-TTK vs Sensex
3500.0 3000.0 2500.0 2000.0 1500.0 1000.0 500.0 0.0 Dec-94 Dec-96 Dec-98 Dec-00 Note:  TTK got  listed  in Dec 94,  hence  share  price   performance  during the first  stage  is not  applicable Dec-02 Dec-04 Dec-06 Sensex Dec-08 Dec-10 Dec-12

Unbridled  expansion 3 yr CAGR  relative   performance   of ‐32%

Stuck in a rut 4 yr CAGR in line  with Sensex

Hubris & Arrogance? Till date CAGR relative   performance  of 36%

Unbridled  expansion Dec94‐Mar99  CAGR relative   performance   of  ‐20% 

Stuck in a rut Grasping for solutions 3 yr CAGR relative   2 yr CAGR relative   performance  of ‐ performance of ‐31% 29%

Capitulation or  Recovery? Till date  CAGR relative   performance  of 69% 

TTK Prestige

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Strategy

Who are the big winners and losers of tomorrow?
In our forthcoming notes, we will be using our ’greatness‘ model to address the following issue: 1. Amongst today’s ‘great’ firms which are the laggards of tomorrow? Using our ’greatness‘ model, we will attempt to identify the 80% of ’great‘ Indian companies of today that are most prone to sliding to mediocrity in the near future. The list of leading Indian companies that can either sustain good performance or slide to mediocrity in the near future has been provided in exhibit 16 on page 14 (in the entire BSE500 universe, ex-financials) and exhibit 17 on page 15 (on a sector by sector basis). 2. What do great companies who stay great have in common? What do the remaining 15% of the great companies who manage to sustain greatness over long periods of time (eg. Asian Paints, HDFC Bank, ITC) have in common with each other? How have these firms immunised themselves from ‘hubris and arrogance’ and the poor capital allocation decisions that follow? 3. Amongst the laggards and fallen angels of today, which are the great firms of tomorrow? We return to our ’greatness‘ model and now combine it with the tenets of ’disciplined capital allocation‘ to identify the titans of tomorrow who are currently regarded as second- or third-rate players. So we will attempt to figure out whether firms like BHEL, Infosys, Wipro, and Indian Hotels, can mount a turnaround. The list of laggards that can either continue to exhibit mediocrity or alternatively show enough mettle to revive and turnaround has been provided in exhibit 18 on page 16 (in the entire BSE500 universe, ex-financials) and exhibit 19 on page 17 (on a sector by sector basis).

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Strategy Exhibit 16: Overall leaders of today
Stock Eicher Motors Exide Inds. Balkrishna Inds Elgi Equipment Cummins India Whirlpool India TTK Prestige Bayer Crop Sci. Nestle India Asian Paints ITC GlaxoSmith CHL Sector Auto Auto Anc Auto Anc Capital Goods Capital Goods Consumer Durable Consumer Durable Fertilizers FMCG FMCG FMCG FMCG Mcap ($ mn) 1,642 2,112 446 220 2,262 467 690 970 8,982 7,796 46,557 4,187 426 791 279 539 371 519 1,440 326 2,774 1,333 5,933 1,214 281 1,276 4,330 1,004 535 1,089 6 mnth ADV ($ mn) 1.3 3.7 0.3 0.2 2.3 0.4 3.1 0.4 3.0 7.8 40.8 3.2 0.2 0.4 0.3 0.5 0.6 0.2 0.6 0.3 1.7 1.7 10.6 0.6 0.2 0.5 12.4 3.5 0.8 0.8 3-yr share price CAGR (%) 63 5 34 13 5 -5 77 24 24 29 32 52 10 52 -4 -1 11 -10 28 60 8 30 27 14 -2 NA 35 51 19 -26 Next 2-yr EPS CAGR (%) 31 22 12 48 4 30 24 DNA 15 18 19 18 34 24 60 14 15 9 17 28 31 22 23 18 22 44 22 26 DNA 16 Next 2-yr BVPS CAGR (%) 25 18 21 19 13 DNA 33 25 24 21 15 19 10 26 5 20 18 14 14 30 22 25 26 22 12 19 30 23 5 6 3-yr average RoE (%) (FY10-FY12) 15 26 30 26 31 38 49 24 110 45 32 31 22 40 12 20 20 28 43 28 34 26 29 30 9 20 46 25 10 24 3-yr average RoCE (%) (FY10-FY12) 31 40 25 39 43 53 69 32 141 61 47 48 24 36 12 18 23 32 57 26 27 25 26 27 11 23 61 38 11 21

Carborundum Uni. Industrials Supreme Inds. Sadbhav Engg. Redington India Persistent Sys Jagran Prakashan CRISIL Kajaria Ceramics Cadila Health. Ipca Labs. Lupin Torrent Pharma. Mahindra Life. Oberoi Realty Titan Inds. Bata India Shoppers St. Torrent Power Industrials Infrastructure IT IT Media Miscellaneous Miscellaneous Pharma Pharma Pharma Pharma Realty Realty Retail Retail Retail Utilities

Source: Ambit Capital research, Bloomberg

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Strategy Exhibit 17: Sectoral leaders of today
Stock Eicher Motors Bajaj Auto Exide Inds. Balkrishna Inds IndusInd Bank HDFC Bank HDFC MM&FS Cummins India Elgi Equipment UltraTech Cem. Shree Cement TTK Prestige Asian Paints GlaxoSmith CHL ITC Supreme Inds. Sadbhav Engg. TCS Persistent Sys D B Corp Sector Auto Auto Auto Anc Auto Anc BFSI BFSI BFSI BFSI Capital Goods Capital Goods Cement Cement Consumer Durable FMCG FMCG FMCG Industrials Infrastructure IT IT Media Mcap ($ mn) 1,642 8,854 2,112 446 4,662 28,586 23,141 2,414 2,262 220 8,871 2,881 690 7,796 4,187 46,557 791 279 50,479 371 807 519 2,774 5,933 1,214 1,276 281 4,330 1,004 1,251 7,777 19,697 1,089 6 mnth 3-yr share ADV price CAGR ($ mn) (%) 1.3 15.8 3.7 0.3 12.9 35.2 37.8 5.7 2.3 0.2 7.3 1.4 3.1 7.8 3.2 40.8 0.4 0.3 37.9 0.6 0.3 0.2 1.7 10.6 0.6 0.5 0.2 12.4 3.5 9.4 8.6 28.7 0.8 63 17 5 34 40 22 16 41 5 13 25 32 77 29 52 32 52 -4 25 11 3 -10 8 27 14 NA -2 35 51 57 36 4 -26 Next 2-yr EPS CAGR (%) 31 15 22 12 23 25 16 24 4 48 14 16 24 18 18 19 24 60 13 15 21 9 31 23 18 44 22 22 26 31 48 59 16 Next 2-yr 3-yr average BVPS RoE (%) CAGR (%) (FY10-FY12) 25 24 18 21 15 19 13 20 13 19 18 26 33 21 19 15 26 5 24 18 13 14 22 26 22 19 12 30 23 38 13 9 6 15 68 26 30 19 17 21 22 31 26 21 27 49 45 31 32 40 12 40 20 33 28 34 29 30 20 9 46 25 46 7 16 24 3-yr average RoCE (%) (FY10-FY12) 31 72 40 25 NA NA NA NA 43 39 22 20 69 61 48 47 36 12 50 23 34 32 27 26 27 23 11 61 38 51 8 16 21

Jagran Prakashan Media Cadila Health. Lupin Torrent Pharma. Oberoi Realty Mahindra Life. Titan Inds. Bata India Jubilant Food. Idea Cellular Bharti Airtel Torrent Power Pharma Pharma Pharma Realty Realty Retail Retail Retail Telecom Telecom Utilities

Source: Company, Bloomberg, Ambit Capital research

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Strategy Exhibit 18: Overall laggards of today
Stock Sector Mcap ($ mn) 6 mnth ADV ($ mn) 3-yr share price CAGR (%) Next 2-yr EPS CAGR (%) Next 2-yr 3-yr average 3-yr average BVPS RoE (%) RoCE (%) CAGR (%) (FY10-FY12) (FY10-FY12)

Bharat Forge BEML Ltd Suzlon Energy India Cements

Auto Anc Capital Goods Capital Goods Cement

963 125 403 366 478 87 259 383 222 215 568 396 123 50 100 168 4,149 1,474 5,046 247 729 134 347 235 428 323 60 51 288 210

1.7 0.8 12.1 1.9 4.8 0.0 4.6 0.1 0.1 0.1 0.2 0.3 0.2 0.2 0.2 0.9 5.5 0.3 30.8 0.1 0.7 0.1 2.2 0.6 0.6 2.3 0.2 0.2 0.3 0.7

-3 -44 -41 -16 -13 -41 -27 -24 -3 -10 -7 4 -25 -58 -12 -14 -33 -32 -14 -3 -19 -26 -5 38 15 -15 -35 -35 -40 -30

25 DNA 54 10 145 12 DNA DNA DNA DNA 19 DNA 19 DNA 65 DNA 8 DNA 99 30 66 9 DNA 16 75 11 46 51 DNA 8

10 DNA -44 4 4 6 1 DNA 3 DNA 15 DNA DNA DNA 16 DNA 6 DNA -1 13 2 -33 DNA 14 16 4 4 DNA -8 DNA

11 7 -12 6 12 11 -3 9 15 10 18 15 7 9 22 9 15 8 5 11 -1 2 32 16 6 5 4 2 0 -49

12 9 5 8 11 13 8 11 17 12 25 23 6 9 24 12 17 13 10 14 5 3 44 17 7 6 6 6 3 -25

Century Textiles Conglomerate Simplex Infra Punj Lloyd Natl.Fertilizer Engineering & Construction Engineering & Construction Fertilizers

Monsanto India Fertilizers GNFC AIA Engg. Lak. Mach. Works Firstsour.Solu. 3i Infotech Tata Elxsi Uttam Galva SAIL Fertilizers Industrials Industrials IT IT IT Metals Metals

Natl. Aluminium Metals Tata Steel Metals

Thomas Cook (I) Miscellaneous Indian Hotels Astrazeneca Phar Natco Pharma Omaxe Anant Raj Inds. Miscellaneous

Hotel Leela Ven. Miscellaneous Pharma Pharma Realty Realty

Ansal Properties Realty Mercator SCI MTNL Shipping Shipping Telecom

Source: Ambit Capital research, Bloomberg

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Strategy Exhibit 19: Sectoral laggards of today
Stock Ashok Leyland Sector Auto Mcap ($ mn) 1,114 125 963 125 403 338 366 522 234 87 259 567 1,628 396 99 44 50 100 2,631 14 1,474 5,046 729 134 347 235 323 60 648 114 51 288 210 530 364 6 mnth ADV ($ mn) 2.5 0.1 1.7 0.8 12.1 0.1 1.9 0.8 0.5 0.0 4.6 0.4 7.8 0.3 3.8 0.2 0.2 0.2 2.0 0.1 0.3 30.8 0.7 0.1 2.2 0.6 2.3 0.2 0.5 0.4 0.2 0.3 0.7 0.5 3.0 3-yr share price CAGR (%) -9 -10 -3 -44 -41 -12 -16 18 16 -41 -27 22 12 4 -21 -66 -58 -12 -1 -57 -32 -14 -19 -26 -5 38 -15 -35 15 -7 -35 -40 -30 -3 -48 Next 2-yr EPS CAGR (%) 19 DNA 25 DNA 54 15 10 DNA 6 12 DNA 45 17 DNA DNA DNA DNA 65 7 DNA 14 99 66 9 DNA 16 11 46 DNA DNA 51 DNA 8 DNA 55 Next 2-yr 3-yr average 3-yr average BVPS RoE (%) RoCE (%) CAGR (%) (FY10-FY12) (FY10-FY12) 0 15 10 DNA -44 3 4 DNA 15 6 1 10 8 DNA DNA DNA DNA 16 11 DNA 4 -1 2 -33 DNA 14 4 4 DNA DNA DNA -8 DNA DNA -6 14 16 11 7 -12 20 6 23 11 11 -3 13 8 15 11 -2 9 22 18 3 8 5 -1 2 32 16 5 4 19 34 2 0 -49 8 8 13 14 12 9 5 22 8 22 11 13 8 16 12 23 13 10 9 24 23 5 13 10 5 3 44 17 6 6 13 31 6 3 -25 8 10

Sundram Fasten. Auto Anc Bharat Forge BEML Ltd Suzlon Energy Birla Corpn. India Cements Guj Fluorochem Guj Alkalies Simplex Infra Punj Lloyd Jyothy Lab. Tata Global Auto Anc Capital Goods Capital Goods Cement Cement Chemicals Chemicals Engineering & Construction Engineering & Construction FMCG FMCG

Lak. Mach. Works Industrials Rel. Indl. Infra GTL 3i Infotech Tata Elxsi Infrastructure Infrastructure IT IT

Container Corpn. Logistics Sh.Ashtavinayak Media

Natl. Aluminium Metals Tata Steel Indian Hotels Metals Miscellaneous

Hotel Leela Ven. Miscellaneous Astrazeneca Phar Pharma Natco Pharma Anant Raj Inds. Ansal Properties Rajesh Exports Shree Gan.Jew. Mercator SCI MTNL Bombay Rayon Lanco Infratech Pharma Realty Realty Retail Retail Shipping Shipping Telecom Textiles Utilities

Source: Ambit Capital research, Bloomberg

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1. Introduction
“Alice: Would you tell me, please, which way I ought to go from here? The Cheshire Cat: That depends a good deal on where you want to get to. Alice: I don't much care where. The Cheshire Cat: Then it doesn't much matter which way you go. Alice: …so long as I get somewhere. The Cheshire Cat: Oh, you're sure to do that, if only you walk long enough.”

— From: Lewis Carroll’s Alice’s Adventures in Wonderland
Titan and TTK Prestige have delivered returns of 58% CAGR and 82% CAGR over the last ten years On 31 March 2007, Tata Steel had a market cap of `261bn (share price of `397) and Tata Motors had a market cap of `280bn (share price of `141). Then within a year, the two companies made acquisitions which made global media headlines. Five years later, as on 31 March 2013, Tata Steel and Tata Motors have a market cap of `303bn (share price of `313; equity dilution of 32%) and `858bn (share price of `269; dilution of 40%), respectively. As the strategy of the two companies unfolded, could this have been foreseen? Titan and TTK Prestige over the last decade have delivered shareholder returns of 58% CAGR and 82% CAGR, respectively. What will be the trajectory of these companies over the next five years? We seek to answer these questions by tracking the journeys and evaluating the decision making of these companies. Over the last two years, we have developed a framework called the ’greatness model‘ to identify ten baggers; basically we look for companies which over a sixyear period show that they can consistently invest in their business and generate profits and cash flows (see Section 2 for more details). Also, we use the greatness framework for other purposes:

Our greatness model identifies ten-baggers

The framework can be used to identify the propensity of leading Indian companies to fade away to mediocrity and vice versa (of second- or third-rung franchises to rise to greatness). This is discussed in Section 3 of this note. We can also use the framework to identify ’fallen angels‘ i.e. the once-loved companies that were seen as undisputed market leaders, say, for 5-7 years but then they faded away. Section 4 of this note identifies such companies in the context of the Indian market and discusses Tata Motors and Tata Steel.

We take our analysis beyond number crunching and take a deep look into strategic decision making

In Section 5, we take our analysis beyond number crunching and delve into the reasons why a number of great companies fade away whilst a few fall from grace but then pick themselves up and make a comeback. Since most companies make important strategic decisions that determine their future trajectory, we explore whether analysis can help to identify the strengths and flaws of such strategic decisions. As we begin this series of notes on India Inc’s strategic decisions, we also understand that luck and/or timing, as in all else in life, plays a big role in corporate success. Seemingly similar decisions have diametrically opposite results. And that is what makes corporate history interesting, exciting and relevant. For example, both Tata Steel and Tata Motors made large acquisitions at around the same time, acquisitions that were multiple times their balance sheet size then. One acquisition now seems hugely unsuccessful whilst the other is an albatross around the neck and the first major challenge for the new chairman of the group. At the time of the acquisitions, experts had expected exactly the opposite outcome.

Seemingly similar decisions have diametrically opposite outcomes

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Some fallen angels revive and become great again

The main purpose of this series of notes is to give investors a toolkit (both in terms of analytical tools and in terms of questions to ask managements) which will enable them to analyse strategic decisions that are made by corporates as they happen. Furthermore, since some great companies can recover after falling, we intend to arm investors with tools that can help them track and time the ‘turnaround trade’ i.e. when the ill-effects of poor strategic decisions have peaked out. Investors need to have a toolkit to analyse strategic decisions as they happen because of the huge impact such decisions have on capital allocation and thus on RoCE, which we find to be the single best metric to assess a company’s rise and its subsequent fall. For example, two companies from Ambit’s ten-baggers list—Titan Industries (Section 6) and TTK Prestige (Section 7)—went through a crisis and then emerged from it to have a strong run over the last ten years. How did they get into trouble? How did they come out of it? Have they proofed themselves from future disasters? What should investors watch out for? We seek answers to these questions in this note.

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2. The ‘greatness’ framework
‘’Greatness is not in where we stand, but in what direction we are moving….’’
The ’greatness‘ framework The framework uses publicly available historical data to assess which firms, over a sustained period of time (FY07-12), have been able to relentlessly and consistently: (1) Invest capital; (2) Turn investment into sales; (3) Turn sales into profit; (4) Turn profit into Balance Sheet strength; (5) Turn all of that into free cash flow; and (6) Invest free cash flows again. Clearly, this approach will have limited value if there is a structural break in the sector or in the company, which makes past performance a meaningless guide to future performance. However, to the extent that such structural breaks tend to be the exception than the rule, the ‘greatness’ model helps in creating a shortlist of stocks that investors can then analyse in greater detail.

— Oliver Wendell Holmes This quote appropriately captures the driving philosophy behind our ’greatness‘ framework that lies at the core of our process of identifying potential ten baggers. We had unveiled this framework on 19 January 2012 with the first iteration of the ’Tomorrow’s ten baggers‘ note. This framework studies a firm’s structural strengths by focusing not on absolutes but rather on improvements over a period of time and the consistency of those improvements. A basic sketch of the underlying process behind the making of a great firm has been recaptured in Exhibit 20 below.
Exhibit 20: The ’greatness‘ framework

a. Investment (gross block)

b. Conversion of investment to sales (asset turnover, sales)

c. Pricing discipline (PBIT margin)

e. Cash generation (CFO)
Source: Ambit Capital research

d. Balance sheet discipline (D/E, cash ratio)

We rank the BSE500 universe of firms (excluding Financial Services firms and excluding firms with insufficient data) on our ’greatness‘ score, which consists of six equally weighted headings—investments, conversion to sales, pricing discipline, balance sheet discipline, cash generation and EPS improvement, and return ratio improvement. Under each of these six headings, we further look at two kinds of improvements:

 

Percentage improvements in performance over FY10-12 versus FY07-09; and Consistency in performance over FY07-12 i.e. improvements adjusted for standard deviations.

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The various metrics used to quantify greatness can be seen in the following exhibit:
Exhibit 21: Factors used for quantifying greatness (as used in the 2012 model)
Head 1 Investments Criteria a. b. 2 Conversion to sales a. b. c. d. 3 Pricing discipline a. b. 4 Balance sheet discipline a. b. c. d. 5 Cash generation and EPS improvement a. b. c. d. 6 Return ratio improvement a. b. c. d. Above median gross block increase (FY10-12 over FY07-09)* Above median gross block increase to standard deviation Improvement in asset turnover (FY10-12 over FY07-09)* Positive improvement in asset turnover adjusted for standard deviation Above median sales increase (FY10-12 over FY07-09)* Above median sales increase to standard deviation Above median PBIT margin increase (FY10-12 over FY07-09)* Above median PBIT margin increase to standard deviation Below median debt-equity decline (FY10-12 over FY07-09)* Below median debt-equity decline to standard deviation Above median cash ratio increase (FY10-12 over FY07-09)* Above median cash ratio increase to standard deviation Above median CFO increase (FY10-12 over FY07-09)* Above median CFO increase to standard deviation Above median EPS increase (FY10-12 over FY07-09)* Above median EPS increase to standard deviation Improvement in RoE (FY10-12 over FY07-09)* Positive improvement in RoE adjusted for standard deviation Improvement in RoCE (FY10-12 over FY07-09)* Positive improvement in RoCE adjusted for standard deviation

Source: Ambit Capital research. Note: * Rather than comparing one annual endpoint to another annual endpoint (say, FY07 to FY12), we prefer to average the data out over FY07-09 and compare that to the averaged data from FY10-12. This gives a more consistent picture of performance (as opposed to simply comparing FY07 to FY12).

Exhibit 22: Distribution of firms on the ‘greatness’ score has been calculated by using data over FY07-12 (total population: 381 firms)
Zone of mediocrity 60 50 No. of firms 40 30 20 10 0 0%-10% 10%-20% 20%-30% 30%-40% 40%-50% 50%-60% 60%-70% 70%-80% 80%-90% 90%-100% 211 firms score < 50% Good, not Great 93 firms (between 50% and 67%) Zone of greatness Only 77 firms score > 67%

Greatness Score

Source: Ambit Capital research

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3. Self-destruction quantified
"We're so great we can do anything!" — How the mighty fall, Jim Collins 80% of listed companies’ returns are less than inflation Over the last 20 years, around 80% of listed companies have failed to deliver shareholder returns in excess of inflation (assuming an annual inflation rate of 7.9%). Given that nominal GDP growth over this period has been around 15% per annum, such paucity of shareholder returns is surprising. Even more worryingly for those who prefer investing in large caps:

The top-100 companies (in terms of their market cap as of March 1993) have delivered an average return of only 7% per annum in the subsequent 20 years; and The Nifty has ’churned‘ by around 50% or so every decade (as compared to around 25% for developed markets and around 30-40% in other major emerging markets).

Sustaining leadership
Through our ‘greatness’ model, we seek to contrast the probability of sector leaders remaining sector leaders over long periods versus them turning sector laggards.

Methodology
We use our ‘greatness’ model to assess the probability that sector leaders (defined as firms with a ‘greatness’ score in excess of 75th percentile of the sector) from five years ago are now amongst the sector laggards (defined as firms with a ‘greatness’ score of less than 25th percentile of the sector), i.e. what is the probability of self-destruction? We contrast this against the probability of sustaining leadership i.e. what is the probability that sector leaders are still sector leaders five years hence. We check this historically starting from 2003—for example, we assess the chances that a sector leader in 2003 was still amongst the sector leaders in 2008 and contrast this against the chances of it becoming a sector laggard by 2008 and so on.

Results
Whilst the average probability of a sector leader remaining a sector leader five years later is only 15% (see the table below), the average probability of it becoming a sector laggard is 25%. Thus, the chances of a sector leader becoming a sector laggard are significantly higher than its chances of sustaining leadership, i.e. the probability of self-destruction is relatively high.
Exhibit 23: Probability of self-destruction
2003,08 Probability that sector leaders in Year-0 stay sector leaders in Year5? Probability that sector leaders in Year-0 become sector laggards in Year-5? 12% 23% 2004,09 20% 20% 2005,10 19% 30% 2006,11 10% 23% 2007,12 17% 31% average 15% 25%

Source: Ambit Capital research, Note: 2003,08 indicates the probability in Year-5 (2008) for a sector leader in Year-0 (2003)

Laggards become leaders with Conversely, when we look at sector laggards, we find that it is much more likely that they will become sector leaders five years later (34% probability) as opposed unerring regularity to staying laggards (18% probability).

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Strategy Exhibit 24: Probability of rising to ‘greatness’
2003,08 Probability that sector laggards in Year-0 stay sector laggards in Year-5? Probability that sector laggards in Year-0 become sector leaders in Year-5? 20% 37% 2004,09 17% 23% 2005,10 13% 42% 2006,11 21% 39% 2007,12 19% 28% average 18% 34%

Source: Ambit Capital research, Note: 2003,08 indicates the probability in Year-5 (2008) for a sector laggard in Year-0 (2003)

The two preceding tables show that mean reversion in corporate fundamentals is the norm in India. Very few leaders remain leaders (only 15% probability) and very few laggards remain laggards (only 18% probability). This implies that the fundamentals of more than 80% of Indian companies revert to the mean – the mighty go into decline and the puny begin to rise.

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4. Identifying ’fallen angels’
"The bigger they are, the harder they fall." - Joe Walcott We identify fallen angels Using our greatness framework, we can identify the ’fallen angels‘ i.e. the onceloved companies that were considered to be undisputed market leaders, say, for 5-7 years, but then they faded away. More practically speaking, we use our model to grade firms into leaders (scores above the 75th percentile) and laggards (scores below the 25th percentile). Then we define ’fallen angels‘ as those firms that slide from being a leader to a laggard over a five-year period. Our quantitative analysis suggests that RoEs and RoCEs are the most sensitive measurables in a stock’s fall from grace. More specifically, we use the following steps to quantify the sensitivity of a fundamental parameter (such as sales growth, asset turnover, profit margins, RoE, and RoCE) as firms decline from being leaders to laggards: (1) Using the difference between the value of the parameter in years t & t-5, and dividing it by the average for the period (t-5 to t), to arrive at value x; (2) Using the difference between the value of that parameter in years t+5 & t, and dividing it by the average for the period (t to t+5), to arrive at value y; and (3) Using the difference (y-x) to measure the sensitivity of that parameter. RoE and RoCE best reflect a firm’s fall from grace Based on this, RoE and RoCE are the most sensitive factors that best reflect a firm’s fall from grace. Exhibit 28 on page 26 provides a list of fallen angels. As seen in this exhibit, some of the once-loved companies that have been identified as ’fallen angels‘ based on our ‘greatness’ framework include companies such as Hero MotoCorp, Ranbaxy Labs, Tata Motors, TVS Motor, Tata Steel, Bharat Forge, Indian Hotels and Bharti Airtel. Bharti is a good example of a fallen angel Bharti is the numero uno in the telecom space and for many years it seemed that the company could do no wrong as it went from strength to strength. However, Bharti appears on our list of fallen angels in FY12, as for some time now, it seems that the company and its management can do nothing right. For one, growth in the domestic market slowed down as tariffs were driven down by high competitive intensity. The industry bid astronomical amounts for the 3G/BWA spectrum in FY11 auctions, resulting in the Government garnering `677bn. It whet the Government’s appetite as spectrum reserve prices have been set much higher than industry expectations in auctions since. Moreover, regulatory challenges increased especially in the aftermath of the 2G scam. Whilst Bharti has not been accused of anything in the scam related to the 2008 licence handouts, no one is quite sure of who may try to implicate whom in the murky world of Indian politics-business. Possibly stung by the 2G scam, the Government and the regulator have become more punitive, introducing what may deemed to be ‘anti-industry’ regulations such as one-time excess spectrum fee on retrospective basis, reduction in termination rates and possible abolishment of roaming. These are all external challenges that impact the entire industry. What added to Bharti’s woes was its decision to make a big bet on the African market. It acquired Zain at an enterprise value of `503bn (US$10.7bn; 51% of its then market cap of US$20.9bn). Bharti was trading at 6.1x FY11 EV/EBITDA when it acquired Zain and instead of issuing stock, it paid in cash. Three years down the line, with the

Decision to acquire Zain - a game changer

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Strategy

benefit of hindsight, the acquisition seems ill-timed and expensive. Whilst the Africa market is potentially large (total population of 495mn in 17 countries), the larger markets are moderately penetrated (~51% average), have significant competition and present varying regulatory challenges. The acquisition was completed just after the highly expensive 3G auctions and at a time when the management’s attention was possibly needed in the domestic business. The company has undergone multiple management changes including swapping roles, whilst the well-oiled machine appeared to be stumbling. The company’s market cap tumbled from US$38.0bn in August 2011 at its peak to a low of US$16.5bn in August 2012. Since then it has partially recovered.
Exhibit 25: Bharti's subscriber growth in India has tapered off recently
200 190 180 170 160 150 140 130 120 110 100
mn

Exhibit 26: Snapshot of African countries in Bharti’s portfolio
Percentage of Mobile Population Bharti's FY12 penetration (mn) Africa Revenue (%) Nigeria Zambia Congo DRC Gabon Tanzania Congo Brazzaville Ghana 34.3% 9.6% 9.4% 7.3% 6.0% 4.5% 4.3% 4.0% 20.6% 100% 162.5 13.5 67.8 1.5 46.2 4.1 25.0 16.1 158.3 495.0 59% 61% 23% 120% 56% 95% 85% 27% 47% 51%

May-10

May-11

May-12

Jan-10

Sep-10

Jan-11

Sep-11

Jan-12

Sep-12

Jan-13

Niger Others Total

Source: COAI, Ambit Capital research

Source: COAI, Ambit Capital research

Similarly, no one would have doubted the leadership position of Indian Hotels five years ago. Indian Hotels also does well on our ‘greatness’ framework for 2007. In fact, its ‘greatness’ score was 71% in 2007, which implies that it was consistently investing capital, converting that into revenues, converting revenues into profits, maintaining high return ratios, generating operating cash flows, and investing these cash flows again. Indian Hotels’ five-year average net sales growth (FY03-07) was 26% and its EBIT margins were close to ~21%. Even its RoEs and RoCEs were pretty decent, unusual for an Indian hotel chain. The five-year (FY03-07) average RoE was ~10% and RoCE was ~11%. Much of this was also reflected in its stock price performance— Indian Hotels outperformed the Sensex by 13% CAGR over December 2002December 2007).
Exhibit 27: Indian Hotels - breakup of revenue growth
(in ` mn unless otherwise mentioned) Standalone revenues Room revenues Average Room Rate (` per day) Room occupancy (No. of rooms) FY02 5,380 2,530 4,418 1,569 FY07 16,184 8,451 9,234 2,507 5-year CAGR (%) 25 27 16 10

Source: Company, Ambit Capital research; Note: standalone entity

As can be seen in the above exhibit, according to the disclosures made by the company in the Management Discussion & Analysis section, it appears that whilst the AR` increased at a CAGR of ~16% over FY02-07, the remaining 10% of the growth in room revenues was on account of an increase in the number of rooms.

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However, over the next five years, Indian Hotel’s leadership position faded away. The five-year average net sales growth (FY08-12) declined to 7% (from 26% in the previous block of five years). This was accompanied by a corresponding decline in its EBIT margin to ~15% average over this period. Even its FY08-12 average RoEs and RoCEs declined to ~3% and ~8% respectively. Not only did Indian Hotels underperform the Sensex by 16% (the five-year CAGR over December 2007December 2012 of Indian Hotels’ stock price was -17% as against -1% for the Sensex), even its ‘greatness’ score declined to a mere 8% (in FY12). The reasons for the fall from grace are usually multiple and can be a result of external (usually not controllable) or internal factors (usually addressable by the management). A sharp decline in the price of a global commodity coupled with reduction in import tariffs can hit an entire sector very hard. These are external factors and the Indian steel industry was adversely affected by these factors in the 1990s. In the 1990s, Tata Steel undertook restructuring when others chose a debt-fuelled expansion binge Usually, internal factors are also involved. For example, in the steel industry, whilst the new entrants in the 1990s went on a high-cost debt-fuelled investment binge, Tata Steel went on a restructuring and modernisation programme. The results were there for all to see over the next decade. Research has shown that when companies fall from grace, over 80% of the factors are within management control or internal and less than 20% are external. Hence, it is important to scrutinise and understand corporate and management strategy for strong investment returns and to avoid minefields. And last but not the least, is the role of lady luck. We will discuss these in greater details in the next section.
Exhibit 28: List of 'fallen angels' i.e. companies which in the space of five years went from being top quartile to bottom quartile on our ‘greatness’ scores
FY03, 08 Monsanto India Hero MotoCorp Eicher Motors Atlas Copco (I) Godrej Inds. Carborundum Uni. CMC Container Corpn. ONGC BPCL IOCL Dr Reddy's Labs Ranbaxy Labs. Guj Gas Company Neyveli Lignite FY04, 09 Hero MotoCorp Eicher Motors Tata Motors Ashok Leyland TVS Motor Motherson Sumi Siemens Atlas Copco (I) Kirl. Brothers Berger Paints PTC India BPCL HPCL IOCL GAIL (India) Sanofi India Ranbaxy Labs. Guj Gas Company Neyveli Lignite FY05, 10 Monsanto India Tata Motors ABB Siemens Berger Paints Tata Chemicals Bharat Electron Lakshmi Mach. Works Gateway Distr. Tata Steel SAIL Natl. Aluminium Hotel Leela Ven. ONGC BPCL IOCL GAIL (India) Ranbaxy Labs. GE Shipping Co Neyveli Lignite Source: Ambit Capital research; Note: 2003,08 indicates that these companies, which were ‘great firms’ in 2003, have been identified as ‘fallen angels’ in the year 2008. FY06, 11 Tata Motors SKF India Bharat Forge Siemens Kirl. Brothers Havells India Lakshmi Mach. Works Bharati Shipyard Allcargo Logistics Ent. Network Hind. Zinc SAIL Tata Steel Natl. Aluminium Hotel Leela Ven. Thomas Cook (I) Biocon FY07, 12 Bharti Airtel SKF India Bharat Forge Alstom T&D India AIA Engg. Lakshmi Mach. Works Gateway Distr. Sterlite Inds. Hind. Zinc SAIL Natl. Aluminium Tata Steel Indian Hotels Hotel Leela Ven. MRPL GE Shipping Co

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5. How and why do great companies fall?
“I change my mind when the facts change. What do you do?” - John Maynard Keynes As highlighted in the preceding sections, more often than not great firms regress to mediocrity in India. Why does this happen? CEOs and promoters in their own explanations for underperformance tend to cite the business cycle or Government interference and regulations (eg. the telecom sector or the infrastructure sector). Occasionally, they point to rising competitive intensity in a sector (eg. in twowheelers). However, such explanations on closer inspection are not particularly compelling because within the same sector (and hence subject to the same regulatory and competitive forces), we find some firms which are sliding and others which are rising. Infosys’s performance lagged behind peers has For example, over the past five years, as Infosys’s NOPAT margin has slid from 25.1% (in FY09) to 19% (in FY13) and its RoCE has fallen from 30.4% (in FY09) to 20.2% in FY13, HCL Tech has displayed a very different trajectory. HCL Tech’s NOPAT margins have remained relatively flat over FY09-12 (15% in FY13 vs 15.5% in FY09) and its RoCE has risen from 21.1% in FY09 to 27.2% in FY13. (We have used a 12-month period ending March for HCL Tech.) Unsurprisingly, therefore over this period, Infosys has underperformed the Nifty by 20 percentage points whilst HCL Tech has outperformed the Nifty by 540 percentage points.
Exhibit 30: RoCE – moving in different trajectories
35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Exhibit 29: NOPAT margins – HCL Tech catching up
30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0%

Infosys
Source: Company, Ambit Capital research

HCL Tech

Infosys
Source: Company, Ambit Capital research

HCL Tech

Bajaj Auto has outperformed TVS Motors

Another example is Bajaj Auto and TVS Motors. Over the past ten years, TVS Motors’ PAT margin has slid from 4.7% (in FY03) to 3.5% in FY12 and its RoCE has fallen from 26.2% (in FY03) to 23.0% in FY12. Over the same period, Bajaj Auto’s PAT margins have risen from 10.6% (in FY03) to 15.8% in FY12 and its RoCE has risen from 30% (in FY03) to 200% in FY12. Unsurprisingly, whilst TVS Motor’s share price has risen by a CAGR of 6% over the last ten years, Bajaj Auto’s share price has returned to a CAGR of 40% over the last five years (Bajaj Auto was listed in 2008 after the demerger).

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Exhibit 31: PAT margin of Bajaj and TVS – way apart!
18% 16% 14% 12% 10% 8% 6% 4% 2% 0% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

Exhibit 32: Bajaj’s RoCE in a different trajectory vs TVS
350% 300% 250% 200% 150% 100% 50% 0% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
28

Bajaj

TVS

Bajaj

TVS

Source: Company, Ambit Capital research

Source: Company, Ambit Capital research

In this section, we use a modified version of Collins’ framework and Thorndike’s approach to analyse capital allocation to understand why great Indian companies slide. The core stages in our framework are as follows: The five-stage framework

Stage 1 - Hubris and arrogance: The company is on top of its game. Operating margins, RoCE, growth, valuation multiples, etc., are at all-time highs. Captivated by the success in its core business, the management starts believing its own press. Success and adulation intoxicates the top brass. Arrogance sets in. The company loses sight of the factors which made it successful in the first place. Stage 2 – Unbridled expansion: In search of more growth and more adulation, the management begins an expansion drive which is often inorganic. The firm ’overreaches‘ into new geographies and product lines where it has no real experience or expertise. Sub-par capital allocation begins. Stage 3 – Stuck in a rut: Often cost discipline and/or product excellence erodes and prices are then raised. Profits, return multiples and valuation multiples start sliding. Company politics thrives. The leader becomes increasingly autocratic and announces 'recovery plans' that aren't based on accumulated experience. Stage 4 – Grasping for solutions: The company thrashes around and looks for a solution even as profits and financial strength continue to slide. Senior management jobs are on the line. Often a new leader comes in and sometimes he tries to fire silver bullets (eg. a 'transformative' acquisition, a blockbuster product, a cultural revolution, etc). However, a new leader (ideally, someone from inside) who takes a long, hard look at the facts and then acts calmly to put in place a measured recovery strategy with sensible use of cash and capital at its centre, could be the saviour. Stage 5a – Capitulation: The firm is sold or fades into insignificance or, and this happens rarely, shuts down. Or Stage 5b – Recovery: The firm turns the corner and begins the long, slow climb to recovery.

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Strategy Exhibit 33: The five-stage framework

Source: Ambit Capital research, From the book ’How The Mighty Fall’

Tata Steel and Tata Motors – two companies from the same group and such different trajectories over the last 3-5 years

We first apply the framework to two of the largest and well-regarded companies in India—Tata Steel and Tata Motors. We chose these two companies not only because both of them appear on our fallen angels list, but being part of the same industrial group, they present a good chance to compare and contrast their respective strategies over the last decade. Both the companies, at the peak of their performance in the last decade, made big acquisitions that made headlines globally. How and why did they make these decisions and could the results of the same have been foreseen or at least forecasted with certain probability assigned to them? In the next two sections, our case studies on Titan and TTK (two mid-cap stocks that we like) takes you through the history of these two companies as they grow, stumble, take big bets and then enjoy a decade of strong growth. Stage 1: Hubris and arrogance In stage 1, when a company experiences great success, it starts generating considerable free cash flow (as, almost by definition, high profits and high RoCE over the span of multiple years translate into considerable free cash flow). This often leads to hubris and arrogance, which finally drives poor capital and resource allocation decisions.

After FY02 - an era of strong performance

In the successful years spanning FY01-05, Tata Steel generated more cumulative EBITDA (`135bn) than it had generated in totality over the previous 15 years. Tata Steel’s RoCE rose from 10% in FY2000 to 61% in FY05. Tata Steel’s performance during this period was a result of: (1) a strong upturn in the global steel cycle due to strong economic growth worldwide in general and specifically in China; and (2) Tata Steel’s restructuring and modernisation efforts of the previous decade and a half, which bore fruits.

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Strategy Exhibit 34: Tata Steel - standalone CFO and RoCE

70 60 50 40 30 20 10 0 FY98 FY99 FY00 FY01 FY02 FY03

Standalone
CFO and Ro CEs multiply o ver FY2000 to FY05

120,000
Visibility o ver stro ng cashflo ws in the co ming years gives co nfidence to expand geo graphically with a large acquisitio n

100,000 80,000 60,000 40,000 20,000

Capacity gro ws fro m 3.3mt to 5mt

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

CFO (RHS)
Source: Capitaline, Ambit Capital research

RoCE (%)

For Tata Motors, in the four successful years spanning FY05-08, the firm generated a cumulative EBITDA of `136bn. In the ten years prior to FY04, the same firm had generated a cumulative EBITDA of only `70bn. Pre-tax RoCE for Tata Motors rose from 4.5% in FY98 to 33% in FY06. Tata Motors’ performance was driven primarily by the upturn in the domestic market. Alongside this generation of capital, comes fame, adulation, awards and press attention. In a country, which has liberalised only in the last couple of decades, such public attention combined with the financial fruits of success can prove to be a heady cocktail for many CEOs. As a result, just as they have to make the most capital allocation decisions in their companies’ history, managements find that their egos are being stroked by the press, the sell-side and investment bankers. Stage 2 then follows and overexpansion – organic or inorganic – begins. A major part of the performance was thanks to the market growth To be fair, both Tata Motors and Tata Steel at the early part of the last decade had the humility to acknowledge the role of the general upswing in the economy to their strong performance. To quote Ratan Tata, the then Chairman of Tata Motors, from the FY03 annual report: “It is important also to recognise that a major component of the company’s performance has been due to the growth in market size…” Both the companies were coming out of a difficult period and reflected the orientation of the managements of the two companies. Tata Steel had spent much of its life since inception in a highly controlled and protected environment. Once economic liberalisations started, Tata Steel spent the years restructuring and modernising to meet the challenges of an extremely difficult operating environment in India and globally. Further, with liberalisation, Tata Steel had become exposed to global cycles of the steel industry. Tata Motors has a history of taking on BHAGs and coming out tops Tata Motors, on the other hand, had been used to taking big, hairy, audacious goals (BHAGs1) and was used to operating in an environment where business cycles were notorious and vicious. First, the company took on the Japanese JVs in the LCV market in the 1980s. In the late 1990s, Tata Motors embarked on indigenously developing a passenger car (Indica), the launch of which coincided with the economic slowdown and the downturn in the CV industry. In the first decade of the 21st century, Tata Motors would endeavour to build the cheapest car in the world and take over two iconic luxury car brands that BMW and Ford had struggled with.

1

 A term borrowed from the book ‘Built to Last’ by James Collins and Jerry Poras 

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Well-deserved recognition and accolades often sow the seeds of hubris and arrogance

Strong turnaround performance brought recognition in its wake. Once again we would like to stress that the recognition and awards are well deserved but its consequences often are the seeds of future downfall. In 2000, Tata Steel became the first firm in the Tata Group to qualify for the JRD-Quality Value Award, an award created by the Group in 1995 in memory of JRD Tata and with the aim of recognising business excellence. When, in July 2000, Dr JJ Irani, the then MD of Tata Steel, received the award from Ratan Tata at Mumbai’s elegant National Centre for Performing Arts (NCPA), the ovation that ensued never seemed to cease. (Source: Tata Log, by Harish Bhat, Penguin Books, 2012.) In 2004, Tata Steel, now under the leadership of its new MD, B. Muthuraman, received a special ’Leadership in Excellence‘ plaque to mark the company’s progress up the ’Quality Value‘ ladder. At this stage, Tata Steel was regularly being feted by World Steel Dynamics as one of the most-efficient and low-cost global steel companies. In October 2008, Tata Steel won the Deming Prize, the manufacturing equivalent of the Nobel Prize. In November 2008, at a special ceremony in Tokyo, Muthuraman, who would eventually be bestowed the Padma Bhushan by the President of India, received the Deming Prize. Says Harish Bhat, a veteran of the Tata empire, “The Indian national flag was prominent on the dais that day, which made many people at Tata Steel very proud – some even wept with joy.” (Source: Tata Log, by Harish Bhat, Penguin Books, 2012.) When Tata Motors launched the Indica, the very first India-made car, in the January 1998 Auto Expo, the public gave it a euphoric welcome. The then minister of commerce and industry, the late Murasoli Maran, called the car “The Kohinoor of India”. Three years later, when the ’Indica V2‘ was launched, “it became the fastest-selling automobile in Indian history when it completed sales of 100,000 cars in less than 18 months. The [car’s] market share zoomed to over 20% during the year 2000-02.” (Source: Tata Log, by Harish Bhat, Penguin Books, 2012.) With the Indica’s commercial success came other accolades. JD Power, a car review publication, called the Indica V2 diesel the best in the ‘operating costs’ category, ahead of the legendary Maruti 800. BBC Wheels declared the Indica V2 the ‘best car in the `3 lakhs to `5 lakhs category’. For Tata Motors, the heady success of the Indica in the 1990s (the first contemporary car designed by an Indian firm) was compounded by the sensational debut of the LCV 'Ace' in the mid-2000s. These two runaway successes combined with the boom in the Indian economy over FY04-08 boosted the management’s confidence. Stage 2: Unbridled expansion

Lack of management bandwidth and relatively small domestic market are constraints for Indian companies

By itself, expansion is not a bad thing. However, in the Indian context, there are two limiting factors which make expansion a perilous affair—lack of promoter (or key management) bandwidth and the relatively small size of the domestic market. The modest size of the domestic market means that market leaders relatively early in the Nifty lifecycle find that they have to venture abroad or into new sectors to sustain growth. Unfortunately, Indian companies, for all their claims to be reliant on ’professional management‘, are still overwhelmingly dominated by and run by promoter families. These families are only human and once they find that they have to expand beyond the core business and the core territory that they know so well, they struggle. Expansion into new countries or new sectors by Indian companies are rarely successful as the finite nature of the promoter’s skill set puts a natural cap therefore on how far an Indian company can go. Rapid expansion into new markets or products usually results in poor capital allocation which dilutes both operating margins and RoCEs. Thus, the slide in the company’s financial strength and share price begins. Tata Steel and Tata Motors are classic examples of these problems.

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We continue with the examples given in the preceding sub-section. In August 2004, Tata Steel announced the acquisition of NatSteel, a South Asian steel maker with ~2mt of steel capacity for ~SG$260mn. Whilst NatSteel was a pure converter with low margins, Tata Steel believed the acquisition would give it entry in South Asian markets and eventually drive significant synergy benefits. Then, in December 2005, Tata Steel acquired Millennium Steel, Thailand, which has a 1.2mt steelmaking capacity and 1.7mt long products rolling capacity. In April 2007, Tata Steel completed the acquisition of Corus After this came the mega acquisition - in 2006, Tata Steel bid for Corus. Tata Steel’s first bid for Corus in October 2006 was at 455pence/share. A counter bid by CSN Brazil made Tata Steel raise its offer twice, and Corus was finally acquired by Tata Steel at 608pence, 34% above the original bid value. The total acquisition cost for Tata Steel was US$12.04bn, which was funded through a combination of debt and equity. To put this acquisition into perspective, Tata Steel’s FY06 shareholders’ equity was just over US$2bn. To date, this acquisition remains the largest by an Indian firm.

Corus did not fit with Tata Steel’s publicly stated strategy…

Tata Steel’s global foray should not have been surprising given that the company had consistently articulated its strategy in its communication to shareholders. As early as 2003-04, the chairman Ratan Tata wrote to shareholders: “It (Tata Steel) must explore ways of enhancing its capacity domestically as also establishing finishing facilities in strategic location internationally, leveraging its low-cost Indian base and the availability of domestic iron ore.” The same year in its MDA, the company stated: “It is the Company’s vision to be a 15 million tonne company by year 2010. This would be achieved through organic growth and through acquisition of steel capacities, both within and outside the country”. What was surprising in the acquisition of Corus was that Corus did not have raw material security and would not be able to leverage on the low-cost production base in India. The Corus acquisition was not consistent with the company’s stated vision. Read these excerpts from the MDA in its FY05 annual report: "In the near term, the industry cost structure is likely to remain high due to shortage of coking coal and iron ore. These structural deficiencies in the steel value chain are unlikely to be resolved in the near future... the company believes that the maximum value can be created by making semi-finished products (slabs/ billets) at locations where raw materials are available (or can be competitively assembled), and by finishing them at locations where customers/ markets currently exists or will grow in future." Corus certainly did not fit into the above criteria. What did Tata Steel see in this acquisition then? The acquisition could have partly been driven by the then prevalent wisdom in the steel sector about consolidation, with Mittal Steel (LNM Group) showing the path. But LNM was consistently following the strategy of having primary manufacturing in countries which had cheap energy or availability of raw materials or both. The other reason, and the less flattering one, could be that Tata Steel was driven by hubris into making a large acquisition to match the chairman’s vision of taking the group global. In Corus, Tata Steel saw the chance to become one of the largest steel producers in the world. In its FY07 annual report, Chairman Ratan Tata wrote to shareholders: "Undoubtedly the most notable event during the year was the company's public offer to acquire 100% of the shares of Corus group plc... the acquisition of Corus has transformed Tata Steel from a domestic producer to an international steel company with global scale." One can only speculate if the outcome would have been different, if instead of a marketing person (B Muthuraman), an operations person (Dr JJ Irani) had been at the helm of the company at that point of time. Was the acquisition driven by the group chairman's vision to take the group global and caution was thrown to the winds?

…so why did Tata Steel acquire Corus?

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To be fair, Tata Steel’s move was welcomed by most analysts and industry watchers

To be fair, Tata Steel’s decision was hailed by most industry observers as being one which was synergistic and sensible. Steel Business Briefing stated that there were lot of synergies and Tata Steel was acquiring "extremely good management" and "extremely good distribution". Initial results were encouraging given that steel prices were buoyant and the deal was hailed as a success over the next few quarters. Such was the hubris that Muthuraman, the then MD, gave a target of the combined EBITDA margin to improve from 13% to 25% in five years. In contrast, in 2001 and 2002, the company would be hesitant to forecast steel prices beyond one quarter. Unfortunately for Tata Steel, in FY12 and FY13, the combined EBITDA margin achieved was 9.3% and 9.2% respectively. Leaving aside the acquisition price for Corus and leaving aside the recession that the world economy entered after September 2008, Tata Steel simply did not have the management bandwidth to run an ailing European steel manufacturer. We quote from the April 2013 issue of Forbes: “It was a bad start” says Leahy (Secretary of British Trade Union community). And he blames Kirby Adams. (Adams, once MD of BlueScope Steel, was chosen by B Muthuraman, then MD of Tata Steel, to replace Philippe Varin, who was exiting Corus after seeing off the acquisition.) “We had a fraught relationship with Adams,” says Leahy. “He didn’t understand how to deal with unions. It was an unmitigated disaster.” Not surprisingly, Adams left in 2010. Even as all of this was happening, a slowdown started to loom and job cuts were rising. Köhler, the third managing director in two years, shifted gears in the restructuring process that Adams had initiated in Europe. He centralised functions across verticals and regions. His aim was to integrate key functions like operations, sales, marketing and the supply chain. Whilst the intentions were noble, the organisation was completely unprepared. Instead of improving communication channels with the leadership team across units, insiders said Köhler surrounded himself with ‘yes men’. An executive from Tata Steel Europe, who declined to be named, said Köhler surrounded himself with former colleagues from ThyssenKrupp: “There is no British executive in the top management.”

“It was a bad start”

Exhibit 35: Management changes at Tata Steel
Philippe Varin stepped down from his position on April 6, 2009, within two years of the acquisition. He was to be replaced by Kirby Adams, formerly chief executive of BlueScope Steel, headquartered in Australia In June 2010 Kirby Adams stepped down from his executive roles Mr Kolher's term gets over by October 2013 News reports mention that Tata Steel is looking out for a new CEO for the European business

May 2003 - April 09

Philippe Varin, CEO Kirby Adams, CEO (was made MD & CEO from September 09) Mr. Karl-Ulrich Köhler, MD & CEO

April 09 - October 10

October 2010 present

Source: Company, Ambit Capital research

An integration team was put in place right from Day 1, but company insiders speak about how the integration proved to be a big challenge. Even when a seasoned Tata veteran, Dr T Mukherjee, was based out of London, he could make limited headway and apparently there were too many differences between the Dutch and the English managers. Further, Dr Mukherjee was close to retirement and probably did not have the appetite to drive the tough integration process. Raw material security proved to

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be elusive, without which having production facilities in high-cost locations did not make sense. Also, this was the first really large deal for a company; its earlier biggest challenge was operational in nature and internally focused – restructuring and modernisation. To top everything, the global financial crisis came soon after and demand in Europe is yet to recover to its pre-crisis levels. In Tata Motors’ case whilst the Indica and the Indigo had been relatively successful, the firm was not able to attack Maruti’s market share in a meaningful manner. Meanwhile, Ratan Tata had the dream and vision of building an affordable family car to migrate two-wheeler users to fourwheelers. Tata Motors took up the challenge and began serious work on the development of the low-cost car (Nano) in the mid-2000s (total project cost of around US$1bn, according to unofficial sources). The product was showcased in the Auto Expo in January 2008 and then the Nano was launched in the summer of CY10 amidst much fanfare. Tata Motors strategy was clear and it is a company that is used to executing BHAGs Tata Motors’ strategy was very clearly enunciated in the chairman's statement in its FY02 annual report, "In the commercial vehicles segment, the new vehicles being developed today will totally upgrade the company's product range... a greater commitment to build an international presence for the Company's brands and products in selected international markets." On passenger cars: "...the necessary investments to continue to develop and renew a range of products would be uneconomical, given the limited size of the Indian market. Therefore, the challenge will be to explore a creative and meaningful relationship which would synergise our company's advantages with the market size and access of an international associate." The takeover of Daewoo's CV business and tie-ups with MG Rover and Fiat were consistent with the company’s stated strategy.
Exhibit 36: Tata Motors - standalone exports
(` mn) Total revenues Export revenues % of standalone revenues FY05 2,03,769 14,527 7.1% FY06 2,38,721 21,967 9.2% FY07 3,16,112 26,873 8.5% FY08 3,28,850 27,541 8.4% FY09 2,82,615 22,064 7.8% FY10 3,81,448 19,215 5.0% FY11 5,16,070 33,390 6.5% FY12 5,97,950 35,980 6.0%

Source: Company, Ambit Capital research

But the acquisition of JLR was still a surprise

At around the same time, after months of negotiation, Tata Motors acquired JLR for US$2.3bn in March 2008. To put this acquisition price of US$2.3bn into perspective, Tata Motors’ shareholders’ equity was US$2bn at the end of FY08. Prior to that, the company had acquired the commercial vehicle unit of Daewoo in South Korea, and used the technology available to develop world-class CVs for the Indian market. Paradoxically, for Tata Motors, whilst the JLR acquisition turned out to be a success, the fact that the Nano failed to find buyers and then the Commercial Vehicles market turned south in India left Tata Motors without cash or management bandwidth to build a new small car for the Indian market. As a result, Tata Motors lost market share heavily (from 17.1% in FY06 to 11.7% in FY13) in the Indian passenger vehicle market.

The JLR acquisition was widely criticised

Unlike Corus, the JLR acquisition was criticised by industry observers and analysts. To quote from a few news reports at that point of time:

"But many investors and automotive analysts question whether a bid by India's Tata Motors - maker of workhorse trucks and low-end mass market cars - for the two luxury brands would make much business sense." (Source: nbcnews.com) "But while Corus acquisition was widely seen as a good match - and since appears to be paying off - experts don't see similar synergies in a Tata Motors takeover of Jaguar and Land Rover." (Source: nbcnews.com)

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The above goes to show how difficult it is to get capital allocation decisions right, especially where M&As are concerned and how decisions look smart or foolish with the benefit of hindsight. In the same article, various experts made comments such as "makes no sense at all" and "value destructive given lack of synergies" on the JLR acquisition. The concerns of the automotive industry veterans were that Ford had underinvested in R&D which Tata Motors would have to make up for and did not have the resources for. Stage 3: Stuck in a rut As the company tries to the cope with its larger scale (with its competitive advantages diluted in new markets/products and with its management talent ’maxed out’), operating performance gets stuck in rut. Profit margins and RoCEs stagnate at low levels. As the share price continues to slide, pressure builds up on the management and organisational politics takes hold. The pressure and the politics make it that hard for the company to break out of the cycle of underperformance. Deterioration in the macro environment can further hurt the performance. Tata Steel’s consolidated RoCE slid from 22% in FY08 to 4% in FY10 and 8% in FY12. The firm’s consolidated RoE declined from 32% in FY08 to -17% on FY10 and 7% in FY12.
Exhibit 37: Tata Steel - Net debt:equity rises to 1.9x in FY09 and FCF negative for last two years due to India capex
3.00 2.50 2.00 1.50 1.00 0.50 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12
Net debt : Equity rises due to Corus acquisiti on Curreny devaluatio n and actuarial loss negatively impacts equity Stronger PAT and Equity raising of Rs45bn increases net worth

80,000 60,000 40,000 20,000 (20,000) (40,000) Rs mn

FCF (RHS)

Net Debt to equity (x)

Source: Company, Ambit Capital research

The global financial started the slide

crisis

The end of the liquidity-fuelled global growth cycle was especially harsh for European steel makers. Capacity utilisation in Europe fell from nearly 90% to less than 70%. Subdued steel prices coupled with rising raw material costs led to Tata Steel Europe reporting an EBITDA loss in FY10. Since then, the company’s European operations have been making losses at the PAT level as interest costs cannot be recovered by the wafer-thin EBITDA margins. Senior management at Tata Steel Europe has seen multiple changes, with the MD being changed thrice within a span of two years. Senior executives from Tata Steel India who were deputed to Europe also returned to India within a short span as differences of opinion within the firm rose. What compounded the confusion was that in search of solutions, Tata Steel Europe spent US$80m on management consultants, but, in the words of a former executive, “The consultants left when it was time to deliver”. The parent company also went for multiple rounds of equity dilution between 2007 and 2011. (For a comprehensive account of just how much infighting Tata Steel saw in Europe, refer to the comprehensive story in Forbes’s April 2013 issue: http://forbesindia.com/article/boardroom/putting-the-shine-back-into-tatasteel/35049/1 .)

“The consultants left when it was time to deliver”

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As early as 2008, Tata Steel was considering asset disposal in Europe?

The first sign that all was not well was evident in the FY08 annual report itself, within a year of the acquisition. Muthuraman wrote, "The integration with Corus is proceeding smoothly and is yielding better than predicted results." Ratan Tata wrote, "The Tata Steel and Corus operations are being run as one virtual company..." However, Koushik Chatterjee, CFO, wrote: "The group will pursue the optimisation of its European assets, dispose and restructure assets that are of low profitability..." This clearly indicates that within a year of the acquisition Tata Steel was considering disposal of assets in Corus, but it never moved fast enough.

Both Nano and JLR did not Tata Motors also hit an air pocket immediately after the JLR acquisition. The Nano perform well after the initial missed the October 2008 roll-out deadline due to the now infamous land issues at euphoria Singur in West Bengal. Nano deliveries commenced in July 2009 and these coincided with a recovery in the domestic automobile market. However, the Nano was unable to see a significant uptick, with volumes averaging a mere 3,372 units/month in FY10. Overseas, JLR volumes plunged post acquisition as the world economy melted post-Lehman. JLR’s volumes declined 32% YoY in FY09 and volumes continued to slide in 1HFY10 (declining 6% YoY). Tata Motors’ consolidated RoCE before tax deteriorated from 23% in FY08 to negative 2% in FY09 before recovering to 12.5% in FY10.
Exhibit 38: Tata Motors - Net debt:equity ratio has declined after the FY09 shock
5.5 4.5 3.5 2.5 1.5 0.5 (0.5) FY98 FY99 FY00 FY01 FY02
A fter witnessing weak vo lumes at the beginning o f the decade, M HCV vo lumes gro w at 34% CA GR o ver FY03-05, resulting in debt-equity ratio easing JLR witnesses reco very fro m 2HFY1 0. Do mestic M HCV sales,to o , make a stro ng co meback resulting in stro ng FCF generatio n & bringing do wn the debtequity ratio A cquistio n debt fo r JLR, do emstic and glo bal slo wdo wn severly impacts earnings. Debt equity ratio blo ats

50 25 (25) (50) (75) (100)

Nano pro ject co st and expansio n o f M HCV facilities results in uplift in debt-equity ratio

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FCF
Source: Company, Ambit Capital research

Net debt-equity

The timing was poor in Without a doubt, the timing of the two deals was poor. But that is known only with hindsight, but rich valuations the benefit of hindsight. The global financial crisis hit both the companies hard. To quote Ratan Tata from an interview to Hindustan Times first published on 11 May were always rich.., 2009: “If one had known there was going to be a financial meltdown then yes (Tata went too far) but nobody knew… Both the acquisitions were made, I would say, at an inopportune time in the sense that they were near the top of the market in terms of price.” Valuation was also an issue. Tata Steel paid 12.0x the peak EBITDA of ,..Tata Steel paid 12.0x Corus’s Corus, a commodity business, when Tata Steel was trading at 4.75x trailing EBITDA whilst it was trading at EBITDA. only 4.75x trailing EBITDA Stage 4: Grasping for solutions By now the situation is desperate due to the weak financial position of the company (a combination of sustained losses and/or high debt taken on to finance acquisitions). Desperate times call for desperate solutions and one frequently sees the old management team shunted out at this stage. How the new management team reacts holds the key to which of the two stage 5s – capitulation or recovery – the company heads towards. If the new management aims for dramatic ’silver bullets‘ such as a ‘transformational’ acquisition or drastic cultural change or investment in a blockbuster product, then it is more likely that stage 5a comes into play. On the other hand, if the new management calmly takes stock of the situation, assesses

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the operating metrics in detail and gradually puts in place a strategy which focuses on generating cash and conserving capital then stage 5b becomes more likely. Tata Steel’s corrective action seems to have come a bit late

Continuing with the examples given in the previous sub-sections. Tata Steel undertook several measures to re-structure its European operations: (1) Cut production in Europe from 20mt in FY08 to 14mt in FY12 by idling blast furnaces at three sites; and (2) Sale of its stake in TeeSide Cast Products in FY11. Simultaneously, Tata Steel went ahead with expansion plans in India to increase capacity from 5mt to 16mt. Over FY08-12, capacity at Jamshedpur increased from 5mt to 10mt. Furthermore, the company is continuing with a 6mt greenfield expansion at Kalinganagar (which seems to be well behind schedule and has overshot its original budget by US$2bn). Net debt levels for the company have remained elevated at ~`500bn since FY08 (implying consolidated debt:equity of 1.6x at the end of FY13). This is despite the consolidated business generating healthy cash flow from operations of ~`560bn over FY08-12. We highlight that Tata Steel's consolidated capex over FY08-12 was ~`445bn, which largely pertains to the Indian expansion. Therefore, had Tata Steel delayed the Indian expansion, it would have largely repaid the outstanding debt by FY12. However, Tata Steel's approach of going ahead with the expansions at both Jamshedpur and Kalinganagar have kept debt levels elevated and invited significant balance sheet stress. Tata Steel has posted a net loss of `70bn in FY13, largely due to goodwill write-down of `83bn during the year. According to the April 2013 cover story in Forbes, Tata Steel is looking for a new European head, as the current leader has failed to deliver on time. The pressure to turn Tata Steel around is clearly rising and it looks likely that the company will have a new CEO in the coming months. In parallel, Tata Steel will have a new MD when the current MD, HM Nerurkar, steps down in September. The current Group CFO, Koushik Chatterjee, is tipped to get the job. After two years of strong growth, Tata Motors’ MHCV sales in India moderated in FY12 and severely slowed down in FY13 (down 25% YoY). The company continues to lose market share in the domestic passenger vehicle in India: its market share fell from 14% in FY11 to 11.7% in FY13. Unsurprisingly, the Tata Motors’ passenger vehicle business in India saw several senior management exits even as the Nano failed to make a significant dent and 20% of the plant capacity in the Sanand factory was actually used. Moreover, at a time when demand for diesel cars in India skyrocketed, the sales of Indica and Indigo fell (by 34% in FY13). A former senior official at Tata Motors is quoted in the May 2013 issue of Forbes as saying: “…this is the result of lack of focus, poor allocation of resources and narrow vision for the car business…In the last five years, there were just too many things vying for attention. First, there was making the Nano itself. Then Singur and taking the plant to Sanand. Then fires in the Nano. Then Jaguar Land Rover.” “All of this meant that everything that had been planned for the car business was getting postponed. And we never had enough money to invest in building a pipeline for our existing brands,” he says. But the underinvestment in the domestic passenger car business was likely a part of the strategy. To quote from the annual report of the company: "Its strategy would be to maximise the variety of passenger car offerings on a single platform." Clearly for the company it did not make sense to invest in the development of new platforms only for the domestic market. Between May 2010 and September 2012, Tata Motors went through a repeated and rapid churn of its Indian management team. Finally, Karl Slym

Key part of the strategy is to  ramp up domestic capacity as fast as possible

Tata Motors’ domestic business  is going through a downturn, but it also missed the surge in SUV demand

“This is a result of a lack of  focus and poor allocation of resources”

Deliberate underinvestment in the domestic car business?

Rapid churn of management in  the domestic business

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(former GM executive) was appointed as MD of Tata Motors’ domestic business in September 2012. Now i.e. in May-June 2013, Slym is changing the top organisational structure in Tata Motors and several new appointments have been made. It appears that there will be drastic changes to products (over the medium term) and a portfolio revision over the long term. This will be critical in dealing with Tata Motors’ core problem in the Indian car market—outdated and uncompetitive products. In December 2012, Slym rolled out his ‘One Team, One Vision’ plan with the intention of apparently focusing on the customer.
Exhibit 39: Management changes at Tata Motors' domestic business
May 2010 May 2010 May 2010 December 2010 December 2010 March 2011 March 2011 September 2011 June 2012 June 2012 August 2012 September 2012 September 2012 Rajiv Dube R Ramakrishnan (VP- Sales & marketing, CV) Girish Wagh Nitin Seth Neeraj Srivastava (Regional Manager - West, CV) S. G. Saxena Rajesh Nair (Head - Used car business) Carl Peter Forster Prakash Telang Neeraj Srivastava Karl Slym Ranjit Yadav Neeraj Garg President Passenger Car Division Vice President (Commercial), Passenger Car Division Vice President (Operations), Passenger Car Division Head - Car Product Group Head - Car Product Group Head - Utility Vehicles Head - Utility Vehicles Group CEO Managing Director Head - Car Product Group Managing Director President Passenger Car Division Vice President (Commercial), Passenger Car Division

Source: Company, Ambit Capital research, Note: Pink shaded rows denote exit and Grey shaded rows denote entry

JLR saved the day for Tata Motors

However, even as Tata Motors’ Indian business was sliding, JLR saw a strong recovery and boosted Tata Motors' consolidated earnings. In FY12, JLR generated profit after tax of GBP1.4bn as compared to GBP1bn in FY11. The company’s revenue increased from GBP9.8 billion in FY11 to GBP13.5 billion in FY12. In FY12, the company sold 314K vehicles, a 29% YoY increase. In FY13, almost 80% of Tata Motors’ consolidated EBITDA and nearly 70% of its consolidated turnover came from JLR. Whilst to experts the JLR acquisition appeared to be ill fated, the company seems to have done a thorough due diligence before going ahead with the acquisition. In the summer of 2007, Ratan Tata and Ravi Kant travelled across the US and UK, meeting JLR dealers to ascertain whether the brands still evoked passion. The company had ascertained that the two marquee brands retained their allure. Ford had significantly invested in product development and therefore, there was a strong product pipeline and the company had strong R&D capabilities. It also ensured that JLR retained its premium positioning. Further a predominantly single-country manufacturing base (in this case, the UK) helped, unlike in Corus which was spread across countries. A few quotes below are illustrative: “There are no first reactions. We have been in the midst of the deal for so long that there was just a sense of achievement.” (Source: Ravi Kant’s interview to Economic Times; 28th March 2008) "We have enormous respect for the two brands and will endeavour to preserve and build on their heritage and competitiveness, keeping their identities intact. We aim to support their growth…” (Source: Tata Motors press release; 26th March 2008) "We have seen the proposed plans for the next five years and we have bought into those business plans... we believe in those plans." (Source: Ravi Kant's, MD, interview to Economic Times; 28th March 2008) “A three-tier model was developed… First, a short-term goal to manage liquidity with the assistance of KPMG was put in place. Then came a mid-term target to

JLR seems to have been a wellthought-out acquisition and not a chest-thumping one

 

 

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contain costs at various levels…. Finally, a long-term goal that runs until 2014 was drawn up, focusing on new models and refreshing the existing ones.” (Source: Mint article in November 2010)

"Crucially, Tata Motors was able to keep product development plans going, which paid off with the global economy reviving and customers returning to JLR showrooms."(Source:http://www.livemint.com/Companies/UhROXPttBWa40lV OgtS6wL/How-Tata-Motors-turned-JLR-around.html)

Exhibit 40: Management changes at Jaguar Land Rover

The current JLR CEO has been in the saddle since February 2010

January 2010 February 2010 March 2010 August 2010 August 2010 March 2011 November 2012 November 2012 December 2012 December 2012

David Smith Ralph Speth Tim Davis Simon Warr Frank Klaas Mike O’Driscoll Frank Klaas Fiona Pargeter Des Thurlby Simon Lenton

Chief Executive Officer Chief Executive Officer Director - Quality Director - Communications Director - Communications Managing Director - Jaguar Director - Communications Director - Communications Director - HRD Director - HRD

Source: Company, Ambit Capital research, Note: Pink shaded rows denote exit and Grey shaded rows denote entry

Stage 5a: Capitulation When the new management’s silver bullet misfires, then capitulation becomes inevitable. In the Indian context this usually means that the company slides into mediocrity. The other two options – hostile takeover and bankruptcy – are rare in the Indian context due to institutional factors. Hostile takeovers are very difficult to execute given how the Indian takeover code works and bankruptcy is rarely enforced by Indian creditors (who are usually the banks). Stage 5b: Recovery As the new management cuts costs, sells non-core assets and focuses on generating cash flow from the core business, the company begins the long, slow path to recovery. Tata Steel: Write-offs and equity raises loom Corus, part of the problem, but not the only issue Given the economic conditions in Europe, freeing up the Indian operations’ strong cash flows for debt repayments has been pretty much the only realistic solution for Tata Steel to cure the ills of the unfortunate acquisition. However, frequent rounds of capacity expansions have diverted the healthy cash streams. We estimate that Tata Steel’s debt levels would have fallen by nearly 70% from present levels, assuming that 75% of cash flow generation over FY08-13 was available for deleveraging. The management is taking a bet that the low-cost Indian operations will become more significant in the overall scheme of things and the company will expand its way out of trouble. Given the escalation in the overall project cost at Kalinganagar, capex levels are likely to increase, with spending of ~US$2.5bn in both FY14 and FY15. The cash flows from the enhanced capacity in India (from 6.8mt to 9.7mt) would generate most of the cash required for capex (FY13 saw cash flow generation of ~`90bn on 6mt throughput). However, given the high spending intensity, Tata Steel may also need to tap the equity markets in the coming quarters. Beyond 2014, Tata Steel should be see cash flow streams of at least `120bn p.a. even in a steel downcycle, which can be used for debt repayments. Tough Corus decisions needed at The European question will also need a cure. Tata Steel’s recent write-off of US$1.6bn of goodwill related to Corus is the start to a more comprehensive overhaul of operations in the geography. Whilst it may be early days as regards details, we believe this would entail considerable restructuring of the British operations (~11mt of capacity) including asset sales, whilst the more modern Netherland operations (~7mt) are likely to be largely retained. Through these

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measures, Tata Steel would effectively retain only a smaller stub of the original acquired Corus business (~21mt steel-making capacity). The European restructuring could involve further goodwill write-offs as well as some cash charges. Tata Motors: Tough road to recovery in passenger car but JLR and MHCV should help the overall business Karl Slym has his strategy in place, but will JLR be able to support the company given its own capex needs? For Tata Motors, Karl Slym’s six-point agenda to turnaround the domestic passenger car business (as detailed in the May 2013 issue of Forbes) is to streamline the supply chain, create a new vertical for product planning and management, create a new quality function, create a new strategy team for both passenger cars & CVs, implement the ’one team, one vision‘ plan focusing on the customer, and improve the customer experience. Tata Motors’ standalone debt:equity ratio was at 0.9x as at March 2013. The company has guided for an average annual capex of `30bn for the standalone business (mostly towards product development) for the next 3-4 years. Whilst we expect JLR to generate significant cash flow from operations of GBP7.2 bn over the next three years, JLR has its own ambitious capex plans (over US$2bn annually for the next 4-5 years) which we believe will more or less consume the cash generated from operations. We also expect the domestic MHCV volumes to ultimately recover and generate cash in the standalone books which can take care of the standalone capex requirements to a significant extent. We also believe given the current debt:equity ratio of 0.9x, there is headroom to raise leverage if required. As a result, funding does not appear to be a challenge in turning around the domestic car business. However, we believe the real challenges facing the turnaround of domestic car business are: a) Time required to develop the right products - Karl Slym admits it himself in the Forbes article mentioned above that it takes many years to develop a new car. b) The competitive intensity in the domestic passenger car industry continues to rise with several international players lining up a number of products for launches. c) The diesel segment which has been Tata Motors’ forte has been recently losing its sheen given the reducing gap between gasoline and diesel prices and the significantly high premium price of diesel cars.

d) Most importantly, it will take not less than a great product to undo the significant brand erosion that Tata Motors’ cars have seen over the years. Tata Motors does not have a single strong leader today On a balanced consideration of the above factors, we believe the odds are heavily stacked against the company in preventing further market share erosion as well as reinstating the market share that it used to enjoy in the mid-2000s in the domestic passenger car segment. A key risk is that whilst Ravi Kant was earlier running both the Indian and global operations, now the India and JLR businesses have two separate CEOs, who may not always see eye to eye. However, given that JLR continues to perform well and the domestic MHCV segment is not facing any structural issues, we remain positive on the stock.

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6. Case study: Titan
“Luck is the residue of design.” — Branch Rickey Since 1991, Titan’s stock has returned CAGR of 23% Titan Industries in its short history of just over 25 years tasted dizzying success to begin with and then plunged to the depths as its big new bets went awry. It took nearly a decade to come out of trouble but it did. The company took big, hairy, audacious goals (BHAG) very early on in its existence. Possibly scarred by some of the near death experience, Titan has been remarkably quiet and measured in its approach over the last decade. "Scars of the failure still hang over the head of the current leadership," according to a former senior employee of Titan. Since 1991, Titan’s stock has returned 23% CAGR, of which 100% of the returns have been in the last ten years i.e. FY04-13 (59% return CAGR over FY03-13).
Exhibit 41: Titan’s share price return vs Consumer Durables Index vs Sensex
14,000 12,000 10,000 8,000 6,000 4,000 2,000 Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13

Base of 100 as on April 1, 2003

TTAN IN Equity
Source: Bloomberg, Ambit Capital research

BSETCD Index

SENSEX Index

A large chunk of the super returns can be attributed to the growth in the jewellery business

A large part of the return can be attributed to the strong top-line growth in the jewellery business, which increased from `3.2bn in FY03 (43% of company revenues) to `81.1bn in FY13 (80%). Segmental profits increased from `0.1bn (20% of total) to `8.9bn (84%). What is remarkable is not just growth, but the fact that this was achieved with only `8.3bn of additional capital employed. As a result, pre-tax RoCE of the jewellery SBU improved from 11% to 111%. Of the total shareholder returns (TSR) over FY03-13, 97% is due to earnings growth and 3% due to P/E rerating.
Exhibit 42: Titan - transformation from watchmakers to jewellers…
100% 80% 60% 40% 20% 0% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 Revenue contribution (LHS)
Source: Company, Ambit Capital research
43% 47% 49% 54% 62% 68% 72% 77% 75% 80% 80%

70% 60% 50% 40% 30% 20% 10% 0% Revenue growth (RHS)

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Strategy Exhibit 43: Jewellery business - contribution to Titan's PBIT
100% 80% 60% 40% 20%
20% 20% 51 % 24% 34% 52% 62% 73% 76% 84% 79%

100% 80% 60% 40% 20% 0% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 PBIT contribution (LHS) PBIT growth (RHS)

0%

Source: Company, Ambit Capital research

Exhibit 44: Titan - Jewellery - 84% of PBIT but only 49% of capital employed
60% 50% 40% 30% 20% 10% 0%
1 1 % 1 7% 20% 1 3% 39% 24% 21 % 29% 32% 34% 39% 54% 45% 52% 67% 46% 69% 61 % 72% 1 1 0% 1 22% 1 1 1 %

140% 120% 100% 80% 60% 40% 20% 0%

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 CE as % of total CE (LHS) Jewellery RoCE (RHS) Titan RoCE (RHS)

Source: Company, Ambit Capital research; Note: RoCE is before considering tax

Exhibit 45: Earnings growth is the main driver of Titan's share price
700% 500% 300% 100% -100% -300% -500% Share price return EPS Growth P/E multiple Growth FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Source: Company, Bloomberg, Ambit Capital research

Tanishq’s birth in the domestic Like many important and successful decisions, Tanishq, Titan's jewellery business, market was a bit of an accident started accidentally. And in the face of tremendous challenges, when the group wanted to pull the plug, it survived because of another accident at birth. But we are getting ahead of our story. Titan was born because Xerxes Desai was looking for new opportunities and challenges and Tata Press was seen to have limited opportunities. Mr Desai zeroed in on watches, a market that was dominated by the public sector behemoth, HMT, and smuggled watches. HMT was into mechanical watches and did not have a quartz offering. As often happens with a company that has a dominant market share, the company was not in a hurry to offer a quartz range of watches, although it had considered doing the same and had tied up for technology. The customers seemed happy and were not asking for quartz and why give something to the consumer if they did not want or

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need it and cannibalise its own offering? This author remembers getting his first wrist watch in 1981, when he passed his Class X exams. It was an HMT naturally, and a model named Rohit. But such was the demand in the market that there was a waiting period for the black dial and only the gold dial was available off the shelf, and a 15-year old in a hurry did not wait. HMT’s overconfidence Titan’s opportunity was The market thus was ripe for a newcomer. Titan stepped in. Desai decided that Titan will enter the market with a quartz offering and challenge HMT. It was his strategic decision, according to people in the know. This is important because in future, given the success of the watch business, it would be difficult to challenge Desai’s decisions. For talented and trained manpower, Desai did not have to look far. HMT had a tie-up with Seiko and had evaluated the quartz opportunity. It had a bunch of trained engineers who were frustrated with the company's decision to not go ahead with a quartz offering. They moved en masse to Titan, and Titan was in business.

Titan’s dream debt meant that Titan had a dream debut. It achieved its five-year projections in two years. Then, Desai would have no one to the company thought about taking its offering overseas. The Middle East was the challenge his decisions later on first port of call and thanks to the South Asian diaspora, Titan performed well. The seeds of the next disaster were planted, as it so often happens, in the heady success of the early years. The management believed it had the Midas touch. In 2000, a software executive was brought back to India from the US to head the international watch business. Europe was the next challenge or rather the next stop in the international journey of the watch business. A protégé of Xerxes Desai, the first MD of Titan, handpicked his man to head the European foray. Titan had evaluated granite This was also a time when it was not easy to get foreign exchange for imports. A and IT exports as two new net foreign exchange earner had quite a few benefits and as a result many business opportunities companies used to export anything from pulses to toothpastes (when they were in the business of manufacturing petchem, textiles or steel); many also resorted to false declarations. Titan considered exporting granite slabs and IT exports, but finally zeroed in on jewellery exports. IT was not a bizarre choice given that six different Tata group companies were engaged in IT services at that point of time. Why did Titan enter into the Jewellery after all had two things going for it - firstly, India had a traditional expertise in jewellery manufacturing and India was a large player in diamonds and jewellery business? gemstones; secondly, jewellery and watches were retailed by the same chains overseas, and so Titan would have a synergy. Thus, the company had two BHAGs simultaneously—a foray into watches in Europe and jewellery exports. The forex earning from jewellery was to support the watch business. This was when Titan's standalone net worth was `1.6bn (in FY96) only and brand building in Europe would need investments of around US$5mn-10mn annually over many years. Arrogance and hubris, as Titan enters the European watch market According to people who were involved in the decisions at that point of time, there was a belief of invincibility within the company. Also, there was external validation that added to the hubris. Business schools were inviting the senior management to speak on Titan's foray into Europe even before it happened, and Philip Kotler, the marketing guru, in his maiden visit to India mentioned how Titan would be one of the Indian brands that will soon be a force to reckon with in Europe or words to that effect. To top it all, there were few who could question Desai, who has a larger-than-life personality within the company especially after the success of quartz watches in India. But the European foray into watches backfired. By year two, the company decided to go for broke and went on an advertising spree. But the distribution was not in place and building brands at a global level meant many years of sustained investments in the brand, a capability that Titan did not have at that point of time. As one executive then involved with the business stated, "We tried to repeat a successful formula from the domestic market into Europe and it didn't work...we were not used to being told what to do and the MBOs in Europe were dictating terms to us...We didn't have the distribution to justify the spend. Brand building is a

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cash losing proposition and we needed stock turns of 10-20x to justify the spend, whereas the best brands were doing 2-3x." “Difficulty of the market was Another former executive said, "Difficulty of the market was underestimated. Plus underestimated” other things went wrong - the hiring was bad, we assumed that if we advertise, people will come and we underestimated the amount of spend necessary (about US$5mn-10m per year for five years at least)." Jewellery exports also failed, but the European watch business financially stressed the company In jewellery exports, Titan met failure for the second time. It started dealing with large jewellery chains but soon lost eight of its key customers, as it failed to meet the exact requirements and was also seen as uncompetitive. On top of this, India's poor infrastructure played a role. Customers simply could not believe that the company could not give a definite date of when products will reach them after the goods had left Titan's premises. But the goods were at the mercy of the customs and airport authorities, something overseas buyers could not appreciate and were also not willing to live with, naturally.

Titan tries to change the Indian So the company had a modern jewellery factory, but no market. It was then that consumer’s jewellery buying Desai turned his attention to the domestic market. Like watches, he wanted to habits… change the behaviour of customers in the jewellery market. There were two specific challenges—first, there was a strong bond with the family jeweller which spanned many generations; and second, the company wanted to sell 18ct gold jewellery. The Indian market was for 22ct gold jewellery as against the 18ct gold jewellery globally and Desai wanted to change the Indian consumer. Who could argue with the man who had brought quartz watches into the Indian market? A senior member of the team even pleaded with Desai, saying his wife would never buy 18ct jewellery but it was to no avail. …but fails The result was another disaster. In 1998, the jewellery division ran up a loss of `250m on a turnover of `250m. Accumulated losses in the international watch division by March 2002 were also large at GBP9 million (`623mn) and largely hidden in a web or maze of subsidiary and associate companies, all perfectly legal by the letter of the law but something that hid the true health of the company for years. As of 31 March 2001, US$38.5m was employed in the European operations, primarily in brand building and stocks. When we quizzed former executives about these financial structures, everyone shied away from discussing these "Enron-like structures". Part of it was led by India's regulations wherein goods exported, which remained unsold, could not be brought back into the country! The former executives we met declined to talk about the structures. For FY97-98, losses at international subsidiaries were almost half of Titan’s standalone profits. Perhaps in subsequent years i.e. fiscal 2001 onwards, these losses might be more than what was actually stated, as its direct subsidiary (which used to amortise TITAN trademarks) sold ‘TITAN trademarks’ for NLG18.3mn (`422mn, 22% of Titan’s FY01 standalone net worth) to its step-down subsidiary which had a policy of not amortising trademarks. The annual report for fiscal 2001 states, ”The value of the trademarks has not been amortised as amortisation of trademarks is not compulsory under the existing Netherlands Antilles regulations, and the management is of the view that the book value of the trademarks represents the current fair value.”
Exhibit 46: International business dragging down Titan’s profitability
FY96 Currency Loss at international Subsidiaries (mn) Average Exchange Rate (INR/NLG) Loss at international Subsidiaries (` mn) Titan's standalone profits (` mn) Intl. Loss as a % of Titan's standalone profit NLG (1.0) 20.86 (20) 276 -7% FY97 NLG (3.6) 20.42 (73) 242 -30% FY98 NLG (3.6) 18.58 (67) 146 -46% FY99 NLG (6.0) 21.66 (130) 170 -76% FY2000 NLG (1.3) 22.92 (29) 193 -15% FY01 NLG (3.5) 24.13 (85) 235 -36% FY02 Euro (1.9) 42.10 (81) 131 -62% FY03 Euro (2.5) 48.00 (122) 62.1 -196%

Source: Company, Ambit Capital research; Note: * Degree of loss is reflected in the historical price chart of Titan. Refer to the same time period chart of the exhibit - ‘Chronology of major events and share price vs event correlation’

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Titan Industries Ltd
100% 1 Titan Watch Company Ltd 87.5% 12.5% 100% Before Mar '04 Titan International (Middle East) FZE 100% Before 100% Titan International Holding BV 19% Titan International Investment BV 19% 100% After Mar '04 3 41% 40% Rockbourne Holding BV 1. 2. 3. 4. Sold trademarks having Gross block of NLG 20.7mn and Netblock of NLG 16.5mn for NLG 18.3mn Sold above trademark for $13.75mn to Rockboune Titan International Investment BV sold shares of 100% subsidiary, Titan International (Middle East) to Rockboune Titan International Holding sold shares of 100% subsidiary, Titan Watches & Jewellery Intl. (Asia Pacific) to Rockboune 4 41% 40%

Outside Titan group
Tata International AG Tata Enterprises (Overseas) AG

Titan Brand Holding NV

Titan Watches & Jewellery International (Asia Pacific) Pte. Ltd 2

100% After Mar '04

Source: Company, Ambit Capital research

Exhibit 48: Titan - chronological events to hide the losses
Year FY95 FY98 FY99 FY200 0-04 FY01 Particulars of Events Titan International Holding BV (TIHBV) started capitalising the trademark of ’Titan‘ to market outside India Until FY98, TIHBV capitalised `427mn (22% of FY98 standalone net worth) TIHBV sold the above trademarks to Titan Brand Holding NV (unconsolidating the sister concern) for `410mn (net book value `370mn) Titan Brand Holding NV did not amortise trademarks as there was no mandatory requirement like for TIHBV Incorporated Rockbourne Holding BV (Titan Industries had 3.61% interest and Tata group companies outside the Titan group had 96.39%) Made surplus of `191mn by transferring the above trademark to Rockbourne Holding BV. Titan International Investment BV and Titan International Holding BV sold their 100% holding in Titan International (Middle East) FZE (TIME) and Titan Watches & Jewellery International (Asia Pacific) Pte. Ltd (TAPL) to Rockbourne Holding BV (This were the first couple of transactions for the company since incorporation). Albeit there were no negative reserves standing in the books of these two companies viz TIME and TAPL, their holding company had reserves. Sale of these investments helped to turn their negative reserves and surplus to positive. We believe that these two companies made a loss of `61.5mn if profit from sale of investment is stripped out. This will result in a surplus of `209mn. Total surplus arising on account of restructuring is `400mn, according to the annual report of FY04 Divested the stake in overseas subsidiary by selling stake in Titan International Holding BV and Titan Brand Holding NV

FY04

FY08

Source: Company, Ambit Capital research

Publicly there was denial and But there was denial within the company of the mounting problems. A Times of no acknowledgement of the India interview at that time quotes Xerxes Desai: “In recent years, our primary focus failure has been on expansion into Europe and the Tanishq jewellery business. Now that both are on track, we can turn our attention to other things.” In a similar vein, in the FY01 annual report, the Director’s Report states: “The Titan brand has now been firmly established in Spain, Portugal, Greece and Austria.”

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Management commentary in Fiscal 2004 Annual Report
“Shareholders are aware that TIML has made losses aggregating to about GBP9 million and that the funds employed in the European operations aggregate to about US$39.50 million at the year-end. During the year, as planned, the overseas operations have been restructured in order to obtain the maximum possible benefit from the various assets created abroad, and in the process, ownership of the overseas trademark rights to the Titan brand and our other brands as well as the shareholding in TIME and TAPL are being transferred to a new overseas company, Rockbourne Holding BV (RHBV). This restructuring has resulted in a net aggregate surplus of about `40 crores which is duly reflected in the consolidated accounts, and which has correspondingly reduced the accumulated losses. As mentioned earlier, as a matter of abundant caution, and in order to make up the balance of the accumulated losses in the European Operations, the Company has made additional provisions aggregating to `25 crores in the accounts for the year ended 31 March 2004 towards diminution in investments and doubtful loans and advances. As a result of the sale of its shareholding in TAPL, Titan International Holdings BV (TIHBV) the Company's wholly owned subsidiary in the Netherlands, ended the year with a profit of EUR1.28 million wiping out its earlier carried forward losses.” An accident at birth saved the jewellery business As the losses mounted, there were concerns at the group level to pull the plug on the jewellery business. Ishaat Hussain, the group finance whiz and member of the board, was in favour of pulling the plug, something that he gracefully acknowledged at the 25th anniversary celebrations of Titan Industries. Opposing him was Xerxes Desai. A new team was brought in to turnaround the business— first Vasant Nangia, who had spent three years in the international watch business and then Jacob Kurien, when Nangia left to start Oyzterbay. An accident at birth now saved the jewellery business. When the Tatas decided to venture into watches, they could not get a licence since consumer goods were not a priority area. As a result, they entered into a JV with the Tamil Nadu government (TIDCO) and therefore, there would always be a government representative on the board, who would frequently be changed, depending upon who was in power. During the important discussions, the then government representative suddenly piped up and said that the Chennai Tanishq store was very good and his wife really liked it. That was it as nobody wanted to upset the government representative; the jewellery business got a breather. Whilst as business and research analysts we agonise over strategy, we have to accept with all humility the role that luck often plays in success or failure. The European foray may have panned out differently if Titan could have acquired a European brand. Such an opportunity did arise very early on and for a sum of money that Titan could afford. But the proposal was shot down at Bombay House, the group headquarters. This was a time when Indian companies were not known for overseas acquisitions and TV channels did not run ads of Indian businessmen buying marquee global brands. It all changed in the 2000s, and within the Tata group, Tata Tea, Tata Steel, Tata Motors and Indian Hotels made major acquisitions. A time came when ’every month, Bombay House was asking the Titan management about their global plans.’ Finally, the jewellery business Titan finally moved to 22ct gold jewellery and thus, overturned one of its key USPs discovers its USP when it entered the business. Successful companies and leaders are willing to change and take the mid-course correction. To break the bond with the family jeweller, the company put Karatmeters in every store and asked women to test their jewellery for purity. Further, in another campaign, the company promised to replace the impure jewellery with pure jewellery and pay the difference between 19ct and 22ct. Many women realised that they were being cheated by their family

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jeweller for a very long time. Said a former executive, "90% of the jewellery tested was below 22cts and we knew we were on the right track." The above two decisions were largely responsible for the turnaround. But it was also backed by superb advertising and brand building support, execution at the store level, with staff recruitment and training, to ensure a great retail experience and clever financing. One of the early and memorable ad campaigns ran with the tag line "Is there a thief in your family?" Later on as the brand became successful, there was a regular association with Hindi films (especially to promote its range of traditional jewellery, an area of perceived weakness) and Hindi film stars. Every company goes through a crisis, and Titan's management was capable of correcting the course. If we look at our framework in the previous section, it seems that Titan has been able to step out of danger at the Stage 2 or Stage 3 level, never going beyond that. Is Titan now too cautious to take BHAGs? Is this history important? How is it relevant for the future? Given that investments are often based on the near-term performance of the company, it is often easy to forget the genes of the company as well as when things could go right or terribly wrong. Under Desai and the band of very capable executives he assembled (including Bhaskar Bhat, the present MD), Titan took a number of bold decisions and was not afraid of failure. It was willing to take BHAGs and at the same time undertake mid-course correction. Over the last ten years, whilst Titan's execution machine has functioned brilliantly, it has not taken BHAGs. Xylus, Titan Eye Plus, Gold Plus and the US foray into jewellery with two stores - all were done in a calibrated manner with limited risks. Titan has changed. The scars of the failures are still fresh. The credo now is not to touch anything that is working well and there is a fear of making mistakes, according to a former executive in the know. Different challenges confront Titan now. For many youngsters, Titan is "my father's brand". The brand is getting old and may not have any connect with gen next. Fast Track is an excellent brand, but may risk being not aspirational enough by playing the volume game. Plus over time, the company has built up overheads that may hurt in a downturn. For Titan to repeat the growth of the next decade, it will have to rejuvenate the brands or find new revenue streams.
Exhibit 49: Titan - fixed costs can be a drag on margins
60% 50% 40% 30% 20% 10% 0% FY04 FY05 FY06 FY07 FY08 FY09 YoY increase in FC (LHS)
Source: Company, Ambit Capital research

Challenges ahead for Titan

11% 9%

10%

12% 9% 7% 7% 6% 10% 8% 5% 5% 37% 13% 19% 9% FY10 20% FY11 FY12 6% 4% 2% 0%

48% 32% 19%

39%

FC as % of total revenues (RHS)

As we are writing this, an email pops into our inbox. It’s from one of the former executives we have met. He writes, "I am at a Tanishq store and there is standing room only! So how does it matter who did or said what! Old ladies, young women, men, girls - can never figure why Indians have this fascination!" Who did and said what matters and precisely for that reason the stores are full even today. When we visited the flagship Dickenson Road outlet of Titan one weekday morning, the store was very busy. This when other chains that have tried to replicate Titan's jeweller success have failed. May be it is too early to start worrying about the next growth impetus for Titan.

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Chronology of major events and share price vs event correlation
Exhibit 50: Titan - share price chart – FY93-98: Weak performance of jewellery exports and European operations
(Rs)
12 11 10 9 8 7 6 5 4 3 2 1 Apr-93 Oct-93 Apr-94 Sep-94 Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Proposes to set-up plant to manufacture table clocks JV with Timex formed in 1992 Domestic watches doing well. Started toying with idea of entering Jewellery business Launch of 'Tanishq' range of watches with 18 Karat gold in India

2005 was first year of flat YoY growth

Introduced Sonata watches and Tanishq's 22 Karat ethnic Jewellery

Consecutive years of decline in exports resulting from weak gobal macro conditions coupled with unfavourable move in currency rate and disruption in supply chain. 18 karat jewellery was not perceived well as customers were reluctant to move away from conventional 24 karat segment

—— TTAN's Share Price

Source: Company, Bloomberg, Ambit Capital research

Exhibit 51: Titan - FY98-03: Pulled back from Europe; Tanishq business accelerates in India
(Rs)
9

8

7

6

Introduction of Karatmeter in Tanishq stores which helped in brand creation and gaining customer loyalty

Increase in Excise duty to 16% from 8% for watches having MRP above Rs500 and making watches below Rs500 completely exempt Dismal performance in Europe affecting titan sales growth of intl. subsidiaries and net margins across Titan

5 Weak gobal macro conditions continues Jewellery business picking up

Gave VRS to certain employees

4

3

Launched Fastrack

2

1

Ending JV with Timex

Vasant Nangia, COO of Tanishq quits. Jacob Kurian takes his chair

Apr-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Sep-02 Mar-03

—— TTAN's Share Price

Source: Company, Bloomberg, Ambit Capital research

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Strategy Exhibit 52: Titan - FY03-08: Evolution of Jewellery (Tanishq) as the key growth driver for Titan
(Rs)
100 Launch of first Tanishq store in US 2008 market crash

90

80 Announcing third business under brand Titan Eye+ Jewellery business back on track. Tanishq becomes a success story Titan forms newly formed Precision Engineering SBU; Tanishq enters into Silverware Titan clocked average sales growth of 40% for FY06-08

70

60

50

40

30

Launched Flip collection, a dualfaced watch

Reintroduced Fast Track range

Management guiding for 40% growth in FY08 which was in line with consensus estimates

20

10

Apr-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08

—— TTAN's Share Price

Source: Company, Bloomberg, Ambit Capital research

Exhibit 53: Titan - FY08-13: Riding the wave of aspirational consumption in India through Tanishq
(Rs)
330 Signs agreement to acquire Swiss watch brand Favre Leuba for up to EUR 2 mn

300 Sales CAGR of 32% over FY09-12 whilst clocking 54% net profit CAGR for the same period. FY10 saw rebound in net profit margin which was on a downtrend since FY06. FY11-12 reaping benefits of massive store expansion exercise adding net 135 stores in FY09 (38% of FY08 end stores count)

270

240

210

180

150

120 Management comment on Q4FY12, expecting lukewarm sales growth, despite that confident of achieving FY12 guidance

90

60

30 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13

—— TTAN's Share Price

Source: Company, Bloomberg, Ambit Capital research

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7. Case study: TTK Prestige
“The harder you practise, the luckier you get.” — Gary Player TTK Prestige was incorporated as a private limited company in 1955, under the name ‘TT Private Limited’. Founded by Mr. TT Krishnamachari, the company started manufacturing pressure cookers in 1959 with technical support from the Prestige Group, UK, along with marketing rights extending to UAE, Sri Lanka and South Africa. As the current management proudly told us, “As a group we have been successful at identifying long-term consumption trends in India. We imported pressure cookers into India before cooking gas became readily available to consumers. We started selling ballpoint pens when they were prohibited from use by students in schools. We sold condoms when elders in the family used to give blessings for 16 children to the younger generation.”

Spreading its wings: 1994 to 1999
By 1994, TTK was a wellestablished player in India’s pressure cooker market In 1984, the company bought the brand ‘Prestige’ for sales and distribution in India. By 1994, TTK was a well-established player in India’s pressure cookers and pressure pans (launched in 1984) market and had recently (in 1992) expanded its footprint into the US though their own brand called ‘Manttra’. Revenue CAGR over FY90-94 was 25% whereas PAT CAGR for the same period was 34%. Following the success of its core business, TTK Prestige decided to expand its international operations and enter into new product segments in India. In September 1994, TTK Prestige raised `298mn through an IPO valuing the firm at `1.1bn, ~10.0x one-year forward P/E multiple. Of the total IPO proceeds, `230mn was intended to fulfil the needs for international expansion by fulfilling the corresponding working capital requirements, modernisation of existing manufacturing facilities and including establishment of overseas corporate body (Manttra). The balance was intended to be used for setting up a non-stick cookware plant following a tie-up with Dupont for the coating to be used on the surface of these products. As part of its IPO prospectus, TTK Prestige announced revenue forecast CAGR of 28% over FY94-99 and PAT CAGR of 35%. In order to achieve these growth targets, the company launched new products domestically and ventured into new markets like the Middle East, the UK and Australia. However, it significantly underperformed its own published expectations. Domestic sales CAGR over FY9498 was 10% vs 29% projected whilst export sales CAGR over FY94-98 was 12% vs 22% projected.
Exhibit 54: TTK - Comparing the company’s projections from its IPO prospectus with reported numbers (` mn)
FY95 Proj. Income PBT PAT Act. Diver. -5% 1% -3% Proj. 1,364 170 120 FY96 Act. 1,180 131 90 Diver. -13% -23% -25% Proj. 1,610 210 145 FY97 Act. 1,260 124 84 Diver. -22% -41% -42% Proj. 1,900 250 180 FY98 Act. 1,160 59 51 Diver. -39% -76% -72% Proj. FY99 Act. Diver. -36% -62% -56%

In 1994, `298mn was raised through an IPO to expand pressure cookers in international markets and nonstick cookware in India

1,060 1,006 125 88 126 85

2,250 1,450 300 210 114 93

Source: Company, Ambit Capital research; Note: Proj. – Projected; Act. – Actual; Diver. – Divergence

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Strategy Exhibit 55: TTK - Anecdotes from management commentary for FY95-98
Year Revenue Management commentary on performance growth 31% Management commentary on prospects

FY95

 Spread marketing of cookware geographically  Introduced ‘Kitchen-in-a-box’; accepted by public  Stainless steel range of PCs getting traction
India

 Silverstone
in FY96

range of non-stick cookware to be introduced

 Pursuing to increase export sales  New range of aluminium cookware planned in FY96  Tie-up with Braun of Germany to market their products in  Entering into kitchen tools projects; in the process
finalising necessary tie-ups

of

FY96

17%

 Increase in material cost could not be passed  Restructuring of export business  Recession in consumer durable industry and
calamities affected sales

 Expects exports to grow post restructuring
natural  Hopes FM’s budget will reverse recessionary trend

FY97

7%

FY98

-9%

 Introduces kitchen knifes and stainless steel cookware  Capex programme to expand/modernise plants  Industrial unrest affected operations significantly  Discontinued personal products trading line  Durable industry saw lower consumer off-take  Entered into the UK and Australian markets during
year

 Industrial

unrest in Bangalore and Hosur units which started in the end of 1QFY98. Expects it to be temporary

 Planning to upgrade and introduce new models to achieve
greater market share

 Plans to improve working capital management
the

 Absorbed  Reports

overheads

the

entire

manufacturing

and

marketing

of settlement with the labour union albeit settlement valid up to May 2001

Source: Company, Ambit Capital research; Note: PC – Pressure cooker; NS – Non Stick

In our meeting with Mr. T.T. Jagannathan, the Chairman commented on his experience of exports during the 1990s – “The large American retailers will fleece you until you are bankrupt. They are the worst counterparties to deal with if your business does not have the scale to help you negotiate better terms. It was a terrible experience. One retailer did not pay us for 300,000 pieces while another rejected a consignment of 400,000 pieces. Also, Wal-Mart wanted deliveries within 24 hours! It was unreasonable. Once the Indian market started doing well, we were not very keen on exports anymore.”

The perfect storm: 1999 to 2003
In 1999 TTK Prestige announced: (a) its intentions to increase its customer base in the US (retail chains) by 40%; and (b) an entry into East European markets FY99 appeared to be the start of a stabilisation period for the company, with revenue growth of 31% YoY (domestic sales growth of 26% and exports growth of 64%) and PAT growth of 84% YoY for the year. This growth was driven by a combination of: (a) successful launches of new models—Prestige Supreme and Prestige Armour cookers; and (b) 56% YoY growth in exports as its US outfit Manttra Inc commenced operations during the year. On the back of this strong performance, TTK Prestige announced: (a) its intentions to increase its customer base in the US (retail chains) by 40%; and (b) an entry into East European markets. The downfall: FY2000 (4% YoY decline in revenues and 61% YoY decline in PAT) saw a combination of the following headwinds:

FY2000 saw 4% YoY decline in revenues and 61% YoY decline in PAT due to a combination of several headwinds

 

Labour issues in its Hosur unit plant became major obstacles to regular operations. International sales declined by 48% YoY due to: (a) recessionary environment in the US market due to the IT slowdown; and (b) stiff competition from other countries’ manufacturers in the US. Budget 2000: In February 2000, the then Finance minister, Mr. Yashwant Sinha, announced an increase in excise duty on pressure cookers from 8% to 16%. This affected the growth prospects of the company as TTK’s products became expensive, and they lost market share to unorganised players.

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To add to this, the company also faced the following issues in the subsequent years (FY01-03):

‘Smart cookers’ bombed after launch – designs acceptable in the US do not necessarily work in India: In 2002, TTK had introduced the ‘Prestige Smart’ range of cookers but in the immediate next year they wrote off `88.3mn of inventories through securities premium. The management stated, “Whilst the design of this range was greatly accepted in the export market, it was launched ahead of its time in the domestic market.” Exports declined further: Exports for TTK Prestige suffered over FY01-03 due to a combination of: (a) a recessionary economic environment after the 9/11 attacks; (b) intense competition from global peers; and (c) not being able to cope with the changing product requirements of the US market, according to the management.

Exhibit 56: TTK - anecdotes from management commentary over FY2000-03
Year Revenue growth Management commentary on performance Management commentary on prospects

 Engaging  Industrial
FY00 -4% unrest affecting Hosur unit’s operations also resulting in product launch delays

external management consultants to bring organisational transformation

 US market underwent unexpected developments  Launched new range in flask, NS cookware and PCs

 Planning to introduce gas stoves, low-capacity PCs  Implementing VRS  Looking for value-adding opportunities involving
acquisitions, alliances and partnerships

 Divesting non-core assets  To outsource non-critical manufacturing  Redrafted its export strategy to build a stable customer
base

FY01

0%

product  Higher excise duty led to fall in operating profits  Planning to launch new range of domestic  US economic slowdown affected export sales appliances, gas stoves and pressure cookers  Outsourcing outfit affected due to Gujarat’s earthquake, causing delay in product launches

 Organising business in four strategic areas according to
electrical

 Invested
FY02 2%

heavily in branding of Smart Cookers and electrical appliances export market

 Steps

for reorganisation of distribution, tailoring production to avoid building up of inventory, etc. stainless steel and aluminium PCs resource substantial reduction in fixed cost, reduction in excise duty, productivity-linked long-term settlement with workers likely to change fortunes of the company

 Incurred development expenses on products for the  To develop product for export market. Intr. new range of  Continued  Domestic
recession in the consumer durables segment affected retail off-take

 Effecting  Expects

capacity correction and right-sizing human

FY03

-18%

sales fell due to high excise duty, nonavailability of products and re-organisation of capacity a standby

 First year of loss in the last four decades  Gave VRS and made Bangalore plant as
unit

 To launch six new products in FY04

Source: Company, Ambit Capital research; Note: PC – Pressure cooker; NS – Non Stick

TTK’s balance sheet weakened substantially after several writeoffs

Financial impact of ‘the perfect storm’: FY03 was the first year of loss in TTK’s history (`115mn of loss representing 14.8% of FY02 net worth). Whilst the impact on TTK Prestige’s P&L is shown in the table below, it is worth highlighting the balance-sheet write-offs that did NOT go through the P&L in FY03. TTK had written off `196.4mn against securities premium (part of reserves) on the balance sheet in FY03, which equates to 25.4% of FY02 net worth. These adjustments to reserves included `88.3mn on account of inventory write-offs, `23.7mn on account on diminution in the value of investments in TTK Tantex (textile and personal care business) and `84.4mn on account of voluntary retirement schemes. Had they routed these write-offs through the P&L instead, losses for FY03 would have increased by `130mn (~17% of FY02 net worth) and over FY04-07 (both years included), amortisation of VRS expenditure would had resulted in ~28% lower profits than that reported cumulatively during that period.

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Strategy Exhibit 57: TTK's deteriorating financials from FY2000 to FY03
(in ` mn) Revenues Revenue growth EBITDA EBITDA margin Net Profit Net Profit growth Net Profit margin Total Debt Capital Employed RoE RoCE Debt/Equity Source: Company, Ambit Capital research FY2000 1,303 -4% 100 8% 36 -61% 3% 339 1,141 5% 8% 0.42 FY01 1,242 0% 84 7% 16 -57% 1% 498 1,293 2% 6% 0.63 FY02 1,272 2% 96 8% 7 -55% 1% 666 1,439 1% 4% 0.86 FY03 1,048 -18% (59) -6% (115) -1737% -11% 809 1,266 -19% -4% 1.77

As K. Shankaran, CFO, puts it, “The biggest issue we faced was that although we had grown to a decent size, we were still running TTK Prestige as a small company. There was no segregation of responsibilities amongst senior managers and hence every senior manager was working like a jack of al tradesl. We had to change that.”

The recovery phase: FY02-04
Restructuring of managerial responsibilities was the biggest step towards recovery The seeds of TTK Prestige’s recovery phase were planted when R. Srinivasan, a professional management consultant, was appointed as a non-executive director on the Board of the company in October 2000. Srinivasan launched a ‘total transformation project’. Shankaran says, “The biggest change brought over by Mr. Srinivasan was around management restructuring. In 2002, a team of 23 senior managers of TTK Prestige went to a small economy hotel in Mysore to stay for a couple of days. There, the decision was taken to segregate responsibilities amongst members of the senior management team.” This included:

Mr. TT Jaganathan took charge of product innovation which in hindsight became the main factor of TTK’s success in the subsequent years. His designation changed from ‘Chairman and Managing Director’ to ‘Executive Chairman’. Mr. Ravichandran took over product launches and operational efficiency responsibilities with his designation changing from ‘Joint Managing Director’ to ‘Managing Director’. Mr. Shankaran, was made responsible for handling labour union problems, bureaucrats/politicians and investor relations in addition to his existing role of handling taxation, legal and secretarial matters. Mr. Shankaran says, “Given my strong public speaking skills, I was the obvious choice for this role.” Mr. Chandru Kalro was made head of the sales, marketing and operations department.

In the 18 months that followed the changes in the managerial structure highlighted above, TTK Prestige saw the following benefits to its operations: The excise duty increase on pressure cookers was reversed in 2002 Reduction in excise duty on pressure cookers and cookware: The February 2000 excise duty increase announcement led to the formation of ‘All India Pressure Cooker Manufacturing Association’ with Mr. Shankaran being made the President of this association. Mr. Shankaran says, “On behalf of members of this association, I wrote a speech to the Government citing the importance of pressure cookers for empowering women and its contribution to the progress of the Indian household. Surprisingly, within a couple of months, this letter gathered significant

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attention amongst political leaders in Delhi”. Thereafter, when Mr. Jaswant Singh became the Finance Minister of India, he decided to reduce excise duty on pressure cooker from 16% to back to 8%, and in addition to that, non-stick cookware was made completely exempt from excise duty, down from 16% duty applicable previously. “We were back to profitability”, says Mr. Shankaran. Labour union problems were Resolving labour union problems: Mr. Shankaran says, “The then union leader resolved in FY03 was playing a role in fuelling workers’ agitation against the company’s management both in Bangalore as well as in Hosur. Through regular interactions with the union and citing instances of salary cuts taken by the management I was able to win back the trust of the union”. Thereafter, many workers were also given voluntary redundancies (`9.8mn in FY01 and `78.5mn in FY03) and almost the entire production was shifted from the Bangalore manufacturing unit to Hosur, with Bangalore being classified as a ‘stand-by’ unit by the company from FY03 onwards.
Exhibit 58: TTK - salary cuts for T.T. Jaganathan in FY99 and FY01 (` mn)
FY97 T.T. Jagannathan Designation Remuneration S. Ravichandran Designation Remuneration Jt. MD 0.2 Jt. MD 1.7 Jt. MD 1.8 Jt. MD 2.2 Jt. MD 2.2 MD 2.1 MD 7.5 MD 6.3 MD 3.3 CMD 5.7 CMD 2.2 Exec. Chairman 2.2 FY98 FY99 FY2000 FY01 FY02

Source: Company, Ambit Capital research

PSK Network was set up in June 2003 to help sell new products including appliances

Setting up Prestige Smart Kitchens (PSK) retail network: As TTK Prestige was expanding the product range to include new categories, especially electrical appliances, the biggest hurdle faced by the company with respect to distribution was the refusal of multi-brand dealers to stock these bigger ticket products in their stores due to: (a) lack of enough shelf space available; (b) lack of willingness to invest in Prestige-branded kitchen electrical appliances; and (c) lack of an appropriate footfall into their store for these products. To resolve this issue, the company opened a franchise retail store in Coimbatore on 6 June 2003 to showcase TTK’s widened product offering to customers. Mr. Shankaran says, “I still remember the date because it was a big step forward for us and an auspicious date was chosen to open the first PSK”. Thereafter, PSKs helped boost sales of kitchen appliances and gas stoves along with other products by acting as competition to the traditional dealer in their vicinity. Few months after the successful launch of the PSK concept, demand for the widened product portfolio of TTK Prestige improved across the traditional dealer network in south India.
Exhibit 59: PSK’s success contributing directly and indirectly to TTK’s success
600 500 400 300 200 100 0 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E Total number of PSKs (LHS)
Source: Company, Ambit Capital research

20% 16% 12% 8% 4% 0% % of total sales from PSKs (RHS)

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The group structure consolidated into companies from ~25

was five

Shedding flab – consolidation within the group companies: In order to streamline its operations and focus on the core business, the TTK Group decided to reduce the number of companies in the group down from 20 in FY01 to 5 in FY02 – TTK Prestige, TTK Healthcare, TTK Textiles, TTK LIG and TTK Services. This, we believe, led to increased focus by the two promoters – Mr. TT Jagannathan (on TTK Prestige) and Mr. TT Raghunathan (on TTK Healthcare)– on the strongest areas of the group. In a press interview in January 2002, Mr. TT Jagannathan commented, “It is a constant process of re-inventing oneself. We have decided to focus on our core expertise and divest our interests in non-core activities. There were certain areas where we found that we were not performing well. So we decided to exit such activities.”

Acceleration phase: FY04 onwards
“Since 2004, it has been onwards and upwards for us.” Mr. Shankaran says, “Since 2004, it has been onwards and upwards for us.” The factors driving the success of TTK Prestige since FY04 include:

Consistent product innovation: TTK Prestige has consistently launched over 50 new product variants and SKUs every year and at least 1-2 new product categories every year. Consequently, 50-70% of the company’s total sales that year came from products launched by Prestige over the previous three years. This has helped TTK Prestige in maintaining over 50% market share in south India consistently. As the pressure cooker and cookware demand has shifted towards induction-friendly SKUs over the past 12 months, TTK Prestige has been pro-active in revamping its product portfolio accordingly. This has helped the group gain market share away from Hawkins at an exponential pace over the past 12 months given the latter’s sluggish response so far to the evolving demand. “With our tagline ‘Are you ready for a smarter kitchen’, we have always aimed at making the loudest noise in the kitchen appliances market” says Mr. Chandru Kalro, COO, TTK Prestige.

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Strategy Exhibit 60: New product launches from Prestige
Products FY04 New products launched during the year

FY05

FY06

 Over 50 new product variants and SKUs;  Deluxe range of pressure cookers in aluminium, hard anodised, stainless steel and duo metal;  Handi range of pressure cookers;  Omega Select range of non-stick cookware;  Newer models of stoves and kitchen electrical appliances  Over 50 new product variants and SKUs  Handi Pressure Cookers in aluminium, SS and anodised form for the domestic market  English curry pan for the UK market  54 new product variants and SKUs  High-end domestic kitchen appliances like chimneys, hobs, microwave ovens, kettles, etc  Inner-lid cookers in handi format with a choice of polished alum, anodised and colour finishes and with a patented
safety device under the brand name Prestige Nakshatra

FY07 FY08 FY09 FY10

FY11 FY12

 Non-stick coated pressure cookers in both Handi and Kadai shapes  Duplex gas tables  Deluxe mixer grinders  New range of metal-spoon friendly non-stick cookware  89 new product variants and SKUs in 7 categories  Selective modular kitchens  86 new product variants and SKUs  Opened two Prestige Kitchen Boutiques to promote sales of modular kitchens  New category of induction cooktops  Seven more Prestige Kitchen Boutiques opened  New range of induction cooktops  Induction compatible pressure cookers and cookware  Apple range of inner-lid pressure cookers  Microwave pressure cookers  67 new product variants and SKUs in 13 categories  Launched Microwave Pressure Cookers and Apple range of inner lid pressure cookers  60 new product variants and SKUs in 6 categories  Agreements with World Kitchen, USA to enter high-end Tableware/Cookware and Storeware segments  Agreement with Vestergaard Frandson Group, Switzerland to enter domestic water filter segment.  Agreements with Bialetti Industries Spa, Italy, whereby TTK bought their pressure cooker and cookware manufacturing

plants in Romania and Italy for installation in India. Also entered into outsourcing arrangements with their Indian subsidiary

Source: Company, Ambit Capital research

Focus on R&D: One of the biggest examples of focus on research and development has been TTK Prestige’s success in the induction cooktop segment despite competition from the stronger electrical appliances brands such as Bajaj, Phillips and Preethi. With all these players (including TTK Prestige) offering Chinese-manufactured induction cooktops since 2009, TTK was the only one to ‘Indianise’ the product by changing the presets to ‘Idli’, ‘Dosa’, ‘Curry’, etc and hence this helped the company become 2-3x larger than Bajaj/Phillips in terms of nationwide market share in this product category. Superior supply chain management: The group follows a hub-and-spoke supply chain model with 23 warehouses across India and a large number of wholesale distributors present across cities to cater to the demands for stock from all three distribution channels—retail supermarkets, traditional dealers and franchisee shops. This has been a strength of the company particularly against its largest competitor, Hawkins, over the past 3-4 years.

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Strategy Exhibit 61: TTK emerging as a leader in the organised space
(Rs mn) 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 (Rs mn) 1,600 1,200 800 400 0 -400

TTKPT (Total sales - LHS) TTKPT (PAT - RHS)
Source: Company, Ambit Capital research

HAWK (Total sales - LHS) HAWK (PAT - RHS)

Exhibit 62: TTK - Share of kitchen appliances significantly increased over the years
(Rs bn) 15.0 12.0 9.0 6.0 3.0 0.0 FY06 FY07 FY08 FY09 FY10 FY11 FY12 Pressure Cookers & Pans NonStick Cookware Kitchen Appliances
Source: Company, Ambit Capital research

FY13 Others

Exhibit 63: TTK - Over the past decade, contribution of pressure cookers and nonstick cookware in total domestic sales mix has been decreasing
90% 70% 50% 30% 10% -10% -30% FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 71% 73% 76% 74% 73% 69% 69% 67%

62%

59%

56%

53%

Dom. share of PC & NSC as % of Total Dom. Sales Pressure Cookers (PC) YoY sales growth Non stick Cookware YoY sales growth (NSC)

Source: Company, Ambit Capital research

Cautious approach towards exports in recent years

Cautious approach towards exports in recent years: Given the historical volatility in its exports franchise (see the exhibit below), the management currently is following a cautious approach of NOT focusing on an ‘owned’ brand in export markets but acting mainly as an outsourced manufacturer.

Ambit Capital Pvt Ltd

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Strategy Exhibit 64: TTK - exports have seen variable trends; however, in the past five years, it has seen a steady growth trajectory except for FY10
(Rs mn) 700 600 500 400 300 200 100 0 20% 15% 10% 5% 0%

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

Exports at FOB (LHS)
Source: Company, Ambit Capital research

Export as a % of total sales (RHS)

Management’s succession plan for the future
A well-thought management succession plan for the future TTK’s management team admits, “We have become over 10x our size over the past decade. We realise the need for an improved structuring of managerial roles to include specialists for each part of the business. Therefore, we have appointed Aon Hewitt, an HR consulting firm, to run a five-year project to incorporate an HR restructuring strategy”. This includes the following changes:

 

Progression towards a ‘professionally-run organisation’ with Mr. Jagannathan stepping down from his role of Executive Chairman after a few years. Promotion of Mr. Chandru Kalro from his current role as Chief Operating Officer to replace Mr. Ravichandran as the MD of TTK Prestige from 1 April 2015. Performance incentives of the senior management team to include shareholding in the TTK Family Trust which currently owns 63.2% in TTK Prestige’s total equity shares. Creating leadership roles for several verticals including different distribution channels, product categories, and geographies. For this, the performance of a group of 50 candidates is being monitored internally to assess the need for hiring external talent for these leadership roles over the next 3-4 years.

Where do we go from here?
TTK Prestige is on track towards evolving across geographies, product segments and distribution channels. Whilst this growth benefits from weak competition in the pressure cookers and non-stick cookware segments, the company faces tough competition from companies like Bajaj Electricals and Phillips in the kitchen electrical appliances segment. The following factors are likely to be the biggest drivers of TTK Prestige’s evolution into a strong pan-India diversified retailer in the years to come:

  

Product innovation across all product categories. Improvement in the after-sales service through the recently renewed focus towards expanding the network of after-sales service stores across the country. Concerted effort towards streamlining management responsibilities, not only at the senior management level but also at the level of each product, geography and retail network.

We reiterate our BUY stance on the stock.

Ambit Capital Pvt Ltd

FY13

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Strategy

Share price performance over the past two decades
Exhibit 65: TTK - a combination of both EPS growth and rerating in P/E multiple has contributed to shareholder returns over the past decade
7000% 6000% 5000% 4000% 3000% 2000% 1000% 0% -1000% FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 Cum. Share price return
Source: Company, Ambit Capital research

Base = April 1, 2005

Cum. EPS Growth

Cum. P/E multiple Growth

Chronology of major events and share price vs event correlation
Exhibit 66: TTK - FY94-98: Underperformance against previous expectations
(Rs)
130 120 110 100 90 80 70 60 50 40 30 20 10 Dec-94 Jun-95 Dec-95 Jun-96 Dec-96 Jun-97 Dec-97 —— TTKPT's share Price Launched new products in US, started operations in UK and Australia Sales growth slowing down from 17% in FY96 to -9% in FY98 and contraction in net profit margin from for 8% to 5% for like period, mainly attributable to bad Indian economic conditions and labour strikes. IPO listing Launch of Non Stick Cookware

Source: Company, Bloomberg, Ambit Capital research

Ambit Capital Pvt Ltd

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Strategy Exhibit 67: TTK – FY1998-2003: The perfect storm
(Rs)
90 Gave VRS to workers at Hosur plant

80

Slow down in US economy affecting TTK's export Government's budget announcing hike in excise duty from 8% to 16% and Sales Tax in some states

Organised players loosing market share to unorganised players Budget reducing excise duty on Pressure cookers from 16% to 8% with Nonstick cookware exempt from excise duty

70

60

50

Export's gaining strength forming almost 17% of turnover Surge in turnover witnessing 31% growth in FY99

Union trouble affecting operations Reported loss for first time in 4 decades

40

30

20 Industrial unrest in Hosur and Bangalore units

10

Entered into kitchen electical appliances

Apr-98 Oct-98 Apr-99 Oct-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Sep-02 Mar-03

—— TTKPT's share Price

Source: Company, Bloomberg, Ambit Capital research

Exhibit 68: TTK - FY03-08: Consolidation of existing business strengths
(Rs)
250 TTK announced that it will invest Rs 520mn in setting new manufacturing units and launching new products. Planned to spend heavily in brand and expanding PSKs to 150 in numbers 2008 Market crash

225

200

Management Interview; guiding 62% PAT growth in FY07

175

150

125

Launched Prestige Smart Kitchen and engaged in other brand extension exercise to transforn from single product company to multi product Recouped market share erstwhile lost to unorganised players. Rebuilding exports

100 Consolidating phase for TTK. Resolved union problems

75

Top line growth for FY06-08 averaged 21% whilst bottom line for same period averaged 73%

50 Surge in net profit by 437% coupled with consecutive years of healthy sales growth

25

Apr-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08

—— TTKPT's share Price

Source: Company, Bloomberg, Ambit Capital research

Ambit Capital Pvt Ltd

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Strategy Exhibit 69: TTK - FY09-13: Rapid market share gains through successful expansion across geographies, product categories and distribution channels
(Rs)
4,000 Long term settlement with Hosur workers

3,500 Management gives FY12 guidance of 50% topline growth above Analysts' estimates of 25%. Signing MoU with Gujarat Govt for setting manufacturing unit

3,000

2,500 Achieving sales growth of 60% and PAT growth of 50% in FY11 Management Interview; guiding revenue of Rs 5.0bn and PAT of Rs 0.55bn for FY10 TTK plans to purchase cookware plant in Italy and pressure cooker plant in Romania. Also in discussion with Chinese company for manufacturing tieup to meet growing demand

2,000

1,500

1,000

Calling EoGM to voluntarily delist TTK

500

PAT growth of 134% in FY10. Achieved sales guidance given earlier. Net margin increased from 6% to 10% making it a new normal margin for TTK

Apr-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13

—— TTKPT's share Price

Source: Company, Bloomberg, Ambit Capital research

Ambit Capital Pvt Ltd

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8. What we will forthcoming notes

cover

in

our

The framework developed in Section 5 of this note when combined with our ‘greatness’ model (as described in Section 2) gives us flexible and powerful tools. In our forthcoming strategy notes, we will use these tools to delve into several topics. Some of these topics are listed below. Topic 1: Amongst today’s ‘great’ firms which are the ones that appear to be gripped by ‘Stage 1: Hubris and arrogance’ and are about to enter ‘Stage 2: Unbridled expansion’? We will look for companies that have a track record of at least 5-10 years of unprecedented success for the firm in question AND have delivered operating margins, RoCEs and RoEs which are considerably higher than that of the peer group. The quantitative analysis will be backed by extensive qualitative analysis and research of existing literature to connect the dots to identify signs of hubris and arrogance. Topic 2: Amongst the great Indian firms of yesteryear, which are the ones which can pick themselves up from ‘Stage 4: Grasping for solutions’? Can Hero Motors, Infosys, BHEL, Tata Motors, Bharti Airtel, Indian Hotels and Tata Steel recover? We do not have the answers as yet but we will analyse the internal and external dynamics of the industry and management to arrive at some answers. Topic 3: The CEOs role - allocate capital and talent According to Thorndike, CEOs need to do two things well to be successful: run their operations efficiently and deploy the cash generated by those operations. Whilst a lot of attention is paid to operations in our analysis, very little attention is paid to resource allocation, both capital and human. If human resource allocation is done well, then operations will be taken care of. For allocation of capital, there are three choices of raising it - internal cash flows, equity or debt issuance - and six choices of deploying it - invest in existing business, diversification, acquisition, pay down debt, pay out dividends or buyback stock. We will use this framework to analyse what decisions the CEOs of the companies that we study have made when faced with these choices and what have been the results and learnings from the same. Topic 4: How should Indian CEOs assess acquisitions? We look at all transactions by BSE200 companies over the last ten years wherein they have acquired assets either in India or abroad. We measure the three-year share price performance of these stocks relative to the Sensex pre- and postacquisition as a proxy to assessing the success of these acquisitions. Whilst the three-year median share-price performance pre-announcement was 11% (relative to Sensex), the three-year median price performance post-announcement was -5% (relative to Sensex). Why do most M&As fail to deliver?

Ambit Capital Pvt Ltd

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Strategy Exhibit 70: Relative performance, pre- and post-announcement of acquisition

Pre-announcement

Pre-announcement

+11%

-5%

Post-announcement

Source: Bloomberg, Ambit Capital research; Note: performance is three-year median share price performance (CAGR) relative to Sensex.

Topic 5: Why do Indian firms return so little capital to their shareholders? From family managed to professionally-run companies, the Indian managements usually loathe to return capital to shareholders, unless the promoter or controlling group feels the need for funds. Whilst some of the reluctance is based on the logic of saving for a rainy day, their action tends to depress RoCEs and share price performance. What are the other reasons for this reluctance and is there something cultural about it? Topic 6: Amongst the laggards of today which are the great firms of tomorrow? We return to our ’greatness‘ model and now combine it with the tenets of ’disciplined capital allocation‘ to identify the titans of tomorrow. Topic 7: What do companies that sustain good performance have in common? What do the 15% of companies that have remained in the ’great‘ list over a sustained period of time (eg. ITC, Asian Paints, and HDFC Bank) have in common? How have these firms immunised themselves against ’hubris and arrogance‘ and the poor capital allocation decisions that stem from it?

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Strategy

Institutional Equities Team
Saurabh Mukherjea, CFA Head of Equities Research Analysts Aadesh Mehta Achint Bhagat Ankur Rudra, CFA Ashvin Shetty Bhargav Buddhadev Dayanand Mittal Gaurav Mehta Jatin Kotian Karan Khanna Krishnan ASV Nitin Bhasin Nitin Jain Pankaj Agarwal, CFA Pratik Singhania Parita Ashar Rakshit Ranjan, CFA Ravi Singh Ritika Mankar Mukherjee Ritu Modi Shariq Merchant Tanuj Mukhija Utsav Mehta Sales Name Deepak Sawhney Dharmen Shah Dipti Mehta Parees Purohit, CFA Pramod Gubbi, CFA Praveena Pattabiraman Sarojini Ramachandran Production Sajid Merchant Joel Pereira
E&C = Engineering & Construction

(022) 30433174

saurabhmukherjea@ambitcapital.com

Industry Sectors Banking / NBFCs Cement / Infrastructure Technology / Telecom / Media Automobile Power / Capital Goods Oil & Gas Strategy / Derivatives Research Metals & Mining / Healthcare Strategy Banking E&C / Infrastructure / Cement Technology NBFCs Real Estate / Retail Metals & Mining Consumer / Real Estate Banking / NBFCs Economy / Strategy Healthcare Consumer E&C / Infrastructure Telecom / Media Regions India / Asia India / Asia India / Europe / USA USA India / Asia India / Asia UK

Desk-Phone (022) 30433239 (022) 30433178 (022) 30433211 (022) 30433285 (022) 30433252 (022) 30433202 (022) 30433255 (022) 30433261 (022) 30433251 (022) 30433205 (022) 30433241 (022) 30433291 (022) 30433206 (022) 30433264 (022) 30433223 (022) 30433201 (022) 30433181 (022) 30433175 (022) 30433292 (022) 30433246 (022) 30433203 (022) 30433209 Desk-Phone (022) 30433295 (022) 30433289 (022) 30433053 (022) 30433169 (022) 30433228 (022) 30433268 +44 (0) 20 7614 8374

E-mail aadeshmehta@ambitcapital.com achintbhagat@ambitcapital.com ankurrudra@ambitcapital.com ashvinshetty@ambitcapital.com bhargavbuddhadev@ambitcapital.com dayanandmittal@ambitcapital.com gauravmehta@ambitcapital.com jatinkotian@ambitcapital.com karankhanna@ambitcapital.com vkrishnan@ambitcapital.com nitinbhasin@ambitcapital.com nitinjain@ambitcapital.com pankajagarwal@ambitcapital.com pratiksinghania@ambitcapital.com paritaashar@ambitcapital.com rakshitranjan@ambitcapital.com ravisingh@ambitcapital.com ritikamankar@ambitcapital.com ritumodi@ambitcapital.com shariqmerchant@ambitcapital.com tanujmukhija@ambitcapital.com utsavmehta@ambitcapital.com E-mail deepaksawhney@ambitcapital.com dharmenshah@ambitcapital.com diptimehta@ambitcapital.com pareespurohit@ambitcapital.com pramodgubbi@ambitcapital.com praveenapattabiraman@ambitcapital.com sarojini@panmure.com

Production Editor

(022) 30433247 (022) 30433284

sajidmerchant@ambitcapital.com joelpereira@ambitcapital.com

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Explanation of Investment Rating
Investment Rating Expected return (over 12-month period from date of initial rating) >5% <5%

Buy Sell
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