Corporate Governance Determines Value Creation

Value creation is hampered when companies enter the wrong territories without having enough expertise, says Andrew Holland, CEO, Investment Advisory, Ambit Capital, in an interview to Shailendra Lotlikar, while also sharing his views on the Indian corporate scenario and their value creation capacities.

• There have been many instances where companies have jumped into areas that they do not possess an expertise in. They have thus burnt their fingers. My point is to get into spaces that you are confident of.
• Retailing is going to be huge in India. If you look at companies like HUL, and Nestle, you will notice that they are doing what they have done best. They are just replicating the model that they have followed and succeeded in Europe.
• There are many stories that have created value, and Titan Industries is one of them. Also, Havells India is a fantastic story, as also there is TTK Prestige.

Andrew Holland,
CEO, Investment Advisory, Ambit Capital

How do you feel the Indian companies have been able to create value?

I think companies became increasingly over-confident in 2006-07. This is not the case with India alone, but with all the countries that I have studied. In that span, companies claimed of building on a piece of land that they were holding. My point is that if you do not have the experience of building then why you better sell the land than building something. Why are you trying to become a builder when you are not one? There are many instances like this where the companies have jumped into areas that they do not possess any expertise in. They have thus burnt their fingers and what we are seeing now is their existence in non-core areas. Everyone thought that the party would not end, not just in India but also across the globe. I think that is where the value creation story in India has paused; with the over confidence of the Indian corporates.

If you look at the older companies or groups, they have expanded in other areas. The Reliance Group is an example. Do you think this is a good thing to happen in the Indian corporate scene?

Just looking at Reliance will not suffice. You have to remember that at one point of time they had a huge cash flow. It is ok to use your cash flows to look at long-term industries like the retail business. We know that this may not be creating value now, but it is a long-term factor and will last for the next 30 years. They have, as a group, got involved in share buyback and tried to get back to investors, in the form of dividends too. It is a cause of worry when you are going into businesses without having an expertise in it. Also, if you are not using the existing cash flows and using your shareholders money.
[PAGE BREAK]

On a whole, do you think value creation has happened in India?

Well, if you look at the market capitalisation, there is certainly some value created by India Inc. There are very few companies that have created value for share holders year after year. The expansion that companies did overseas, they were just lucky to have it timed correctly along with the global meltdown. It started paying off in some time. Like in the case of Jaguar and Land Rover, they have indeed given decent returns. But on the flip side, the domestic business has not been a driver in the recent years. You should always be investing where you have an expertise. Also, there is Mahindra & Mahindra, from a nowhere it has become a leading player in the automobile industry. So there has been value creation.

There are many stories that have created value, and Titan Industries is one of them. Also, Havells India is a fantastic story, as also there is TTK Prestige.

Taking it up from that point, you have mentioned three to four names here and I believe that some of them are in the top 50 list. Let me take this opportunity to ask you what has made these companies create value while certain others have not?

The main reason behind this is that they were stuck to what they knew. In case of Pantaloons, they should not have ventured into insurance or other businesses. They lost focus here. While in case of ITC, you will see that they get 90 per cent of their earnings from cigarettes, but they have humungous amount of cash flows that they have used to diversify in several other businesses like hotels, paper, IT, etc.

Going forward, do you think that any particular sector in India is going to create value?

It all depends on the management and their corporate governance. I am bullish on the upcoming sectors like Healthcare and Education.

Are you bullish on the Retail sector?

Retailing is going to be huge. If you look at companies like HUL, and Nestle to name a few, you will notice that they are doing what they have done best. They are just replicating the model that they have followed and succeeded in Europe. We know that the population in India is young and it is going to rise.
[PAGE BREAK]

Coming to the management front, what are you more comfortable with, a family run business or an entrepreneurial run business?

Let me slightly change this while I am answering the question. When I was in South Korea, I have seen that the management has been holding more than 50 per cent of the holdings. But things are slightly different in India. I think that the economy distinguishes these things. The question you asked is a difficult one to answer. You will find that it is the family run business that is big in size. They are the people you want at the helm.

To answer your question, it is okay with me until and unless you have the correct people on board. It is important to have a person who can take things forward with a vision. Rio Tinto is an example of that. You will see that Infosys has encountered some problem in terms of transition. But on the other hand there is TCS that has been moving ahead without any change in the management. A similar problem has been faced by Wipro.

How do you see India Inc. climbing up the value chain five years, going forward?

I think that corporate governance has really started to chip into the board rooms in a big way. This is not right. In case of JP Morgan, they have come out of this big crisis. I don’t think that India is much behind. But it will take some time as businesses grow more complex, you may need more people in the board room who can create value. We know of companies where the top leaders are Indians, so there is no dearth of talent.

If you are to bet on three companies for the next three to five years time horizon, which would they be?

Talking of the big companies, I am bit confused between ITC and Reliance. They have huge cash flows which can be used for diversification. I am not too sure if this model holds true for the telecom companies. Reliance will begin tightening things going forward and so is the case with ITC. I think TCS, Wipro and Infosys will continue their march forward. But the company that we are looking forward to is Tech Mahindra. I think the Tata Group will see a reasonable change going forward across their businesses. There will be an alignment of businesses. The one that I am betting on in the group is Tata Global Beverages.