Famous words of Mr. R Subramaniam (Subhiksha, Subiksha fame)

The problem is that Indian retail was doing too much, too soon. The kind of investments and expansion that Indian retail was attempting was unprecedented. We ourselves added 1,500-plus stores in under 24 months — even for a small store format, this would surely be a global record. Big players like Reliance and Birla were investing as if there was no tomorrow — the mirage of retail being the next telecom in respect of market capitalisation opportunity was so alluring that no investment was too large, and no loss was too big to take in the quest for size and scale. And most organised retailers had nothing but consultant reports to work on since none of them had any exposure to retail — and consultants could not figure what the issues peculiar to Indian retail were.

This is not a story on retail. Nor on R Subramanian or Subhiksha..but on ‘the mirage…market capitalisation’ . LOL. If businessmen ran their businesses because people should be impressed with their net worth, there has to be something wrong. Completely wrong. Market capitalisation in the long run is a function of EPS * Price Earning Ratio.

EPS is a function of profit after tax/ share capital and Price Earning Ratio is a function of how much the market likes you. So if you think you can increase your market capitalisation without EPS (cash flow) but just on hype there is something wrong with you. Completely wrong.

Look at the ADA group – there is no new creation of this group which has generated cash in the recent past -( telecom was created by MDA). There is no sensible profitability in the mutual fund, life insurance, general insurance, power businesses, but market cap is high. So high that he is called the 3rd richest man in India.

The Kumar Mangalam Group is generating cash from Aluminium, Copper (but poor margins), Cement, etc. but burning very fast on Telecom, Financial services, Retail, – and not generating cash flow! Hopefully it will generate market capitalisation!

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  1. I agree with article on the whole. The basic premise is a very valid point – managing businesses for market capital. As rightly pointed out, market capital is a function of profit. And profit is a function of business efficiency and strategy.

    However, I disagree that ADAG Mutual Fund business is not generating cash. Reliance MF is probably top 2 (#1 ?) in Amount of money being managed – with a good mix of equity & debt funds. Money management, world over, is a highly profitable business, once a scale is obtained. Fixed Costs remain fairly fixed, despite (big) increase in funds being managed. HDFC Chairman Deepak Parekh as said recently that HDFC AMC (2nd largest?) is a highly profitable, cash generating business for him. I don’t see why Reliance may not be one..

    Reliance manages INR 100000+ Crores. Even accounting for a middling 1.5% expenses (avg of equity+debt funds cost per year) , the Reliance MF generates 1500 Crores cash. I did not include expenses, but in any case, this should be good cash generator.

  2. I think in case of Subhiksha, it is the ICICI Venture which has to blamed. In its greed to profit from market capitalization, ICICI Venture forced Subramaniam to change his strategy as a cost effective retailer to expand rapidly all around the country, without regard to profitability. I have observed many such cases where in P/E funds putting pressure of the promoters to expand rapidly so that they can exit qat a profit through IPO/sell out. Another case of such nature is of MTR Foods. MTR Foods was known for ‘quality ready to eat’ south indian food. When JP Morgan took a equity stake in the company, and brought its own professional money managers in to the company, who took a dubious step of entering in to north indian food, which was not the forte of MTR Foods. And it was a disaster. Company soon started losing money. Luckily for the promoter of MTR Food, JP Morgan sold its stake along with that of promoter – at a huge premium- to an Italian Company. But for this, MTR too would have faced lot of financial difficulties, after burning so much cash on unrelated line of business….at the behest of P/E investor.

  3. I agree with Subra and Mr. R Acharya! If you are a small or a low profile entrepreneur your VC can take you for a ride. A VC is normally a highly qualified bachha very good in ppt and very poor in business sense. So taking a company like MTR for a ride is nothing new. Most VCs are merchant bankers in a new clothing and looking for fees – and as quick an exit as possible. They will not support you during the downtimes and will actually push you over, if you are not careful. Reliance profits are true – the amc must be making money, but profitability would be a joke as of now at least. With zero entry load a big subsidy is also lost…so making money (sensible money if you have invested Rs. 500 crores) should mean about Rs. 120 crores PAT. This looks difficult, that is all.

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