ambit capital report

7/28/2019 Ambit Capital Report

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June 07, 2013

Strategy

THEMATIC

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.

Analyst contacts

Saurabh Mukherjea, CFATel: +91 99877 [email protected]

Gaurav Mehta

Tel.: +91 22 3043 [email protected]

Consultant: Anirudha Dutta

Tel: +91 98201 [email protected]

The most prominent fallen angelsName Period*

Hero MotoCorp 2004,09

TVS Motor 2004,09

Ranbaxy Labs. 2005,10

Tata Motors 2006,11

Tata Steel 2007,12

Bharti Airtel 2007,12

Indian Hotels 2007,12

Bharat Forge 2007,12

Source: Ambit Capital research; Note: * 2004, 09

indicates that these companies, which were greatfirms in 2004, have been identified as fallenangels in 2009.

Sustaining leadership

Name Period*

Berger Paints 2003,08

Asian Paints 2004,09

Larsen & Toubro 2004,09

Dabur India 2005,10

CRISIL 2005,10

Nestle India 2006,11

Balkrishna Inds 2007,12

TCS 2007,12

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

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

The systematic slide to mediocrity

We find that the average probability of a sector leader remaining a sectorleader five years later is only 15%, implying that 85% of BSE500 companiesslide towards mediocrity. In fact, the average probability of a great companybecoming a sector laggard five years later is 25%. Even the Nifty churns byaround 50% or so every decade (as compared to around 25% for developedmarkets and around 30-40% in other major emerging markets). The tendencyfor large, successful companies to slide down the market-cap spectrum is notconfined to the Nifty.

Why do successful firms slide with such regularity?

Promoters, in their own explanations for underperformance, tend to citeexogenous factors (such as business cycle, Government interference, rising

competitive intensity or the macro environment). However, such explanationsare not always convincing because within the same sector (and hence subjectto the same regulatory and competitive forces), whilst some firms are sliding,others are rising. Contrast, for example, the performance over the past fiveyears of Infosys vs HCL Tech or Bajaj Auto vs TVS Motors. In our view, the slideis primarily due to poor strategic decision making.

Our framework and forthcoming research on this subject

In the first of a series of strategy notes, we present our framework to analyseand evaluate why companies slide in performance. The framework is primarilybased on the works of Jim Collins and William Thorndike. The framework andthe case studies will help you understand how certain companies achievedgreat success, how they stumbled and how some of them recovered. The pastis relevant because it gives a peek into the future and is potentially adeterminant whether a company comes out of the rut to regain greatness. Thisfirst note has a preponderance of discussions on Tata group companies(owing to its virtue of being the largest and most diverse corporate group inIndia), an imbalance which subsequent notes will correct.

Investment implications

Our analysis shows that Tata Steel, Tata Motors, Titan and TTK Prestige are atan inflection point today. A cyclical turnaround in the domestic market couldpropel a turnaround at Tata Motors. Tata Steel, however, has largerchallenges 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. Wehave no firm answers, but we prefer Tata Motors over Tata Steel. TTK Prestigeremains on our BUY list (we do not cover Titan at present but like TTK Prestige,Titan is also on our ten-baggers list).


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Strategy

Ambit Capital Pvt Ltd 2

CONTENTS

Executive summary 3

Introduction.. 18

The greatness framework20

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 notes62


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Strategy


Executive summaryMore than 80% of great Indian companies slide to mediocrity in a brief span oftime. Super successful companies usually become victims of their own successbecause after a while, hubris and arrogance sets in and the promoter and/ormanagement make ill-judged strategic decisions. More than anything to do withthe business cycle or with regulation or competition, this point emerges forcefully

from our observations of corporate India over the past decade. Such faultystrategic decisions usually result in poor capital allocation which destroys RoCEand creates financial stress. Therefore, the importance of evaluating and trackingstrategic decisions to achieve long-term outperformance cannot be over-emphasised although it is an area that is often overlooked. Through a series ofnotes, we will analyse the management strategy of select companies, which willhelp you to understand not only the past but hopefully set a framework foranalysing the future as well.

Exhibit 1: Factors used for quantifying greatness (as used in the 2012 model)

Head Criteria

1 Investments a. Above median gross block increase (FY10-12 over FY07-09)*

b. Above median gross block increase to standard deviation

2 Conversion to sales a. Improvement in asset turnover (FY10-12 over FY07-09)*

b. Positive improvement in asset turnover adjusted for standard deviation

c. Above median sales increase (FY10-12 over FY07-09)*

d. Above median sales increase to standard deviation

3 Pricing discipline a. Above median PBIT margin increase (FY10-12 over FY07-09)*

b. Above median PBIT margin increase to standard deviation

4 Balance sheet discipline a. Below median debt-equity decline (FY10-12 over FY07-09)*

b. Below median debt-equity decline to standard deviation

c. Above median cash ratio increase (FY10-12 over FY07-09)*

d. Above median cash ratio increase to standard deviation

5Cash generation and EPSimprovement

a. Above median CFO increase (FY10-12 over FY07-09)*

b. Above median CFO increase to standard deviation

c. Above median EPS increase (FY10-12 over FY07-09)*

d. Above median EPS increase to standard deviation

6 Return ratio improvement a. Improvement in RoE (FY10-12 over FY07-09)*

b. Positive improvement in RoE adjusted for standard deviation

c. Improvement in RoCE (FY10-12 over FY07-09)*

d. 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 toaverage the data out over FY07-09 and compare that to the averaged data from FY10-12. This gives a more consistent picture of performance (asopposed to simply comparing FY07 to FY12).

80% of companies slide intomediocrity

thanks to managementhubris and arrogance


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Strategy


The systematic slide to mediocrity

We find that the average probability of a sector leader remaining a sector leaderfive years later is only15%, implying that 85% of BSE500 companies slide towardsmediocrity. In fact, the average probability of a great company becoming a sectorlaggard five years later is 25%. Even the Nifty churns by around 50% or so everydecade (as compared to around 25% for developed markets and around 30-40%

in other major emerging markets). The tendency for large, successful companies toslide down the market-cap spectrum is not confined to the Nifty.

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

Exhibit 2: The 'greatness' framework

Source: Ambit Capital research

Exhibit 3: Distribution of firms on the greatness score has been calculated byusing data over FY07-12 (total population: 381 firms)

0

10

20

30

40

50

60

0%-10% 10%-20% 20%-30% 30%-40% 40%-50% 50%-60% 60%-70% 70%-80% 80%-90% 90%-100%

No.offirms

Greatness Score

Zone of mediocrityGood,

not Great Zone of greatness

211 firmsscore < 50%

93 firms(between 50%

and 67%)

Only 77 firmsscore > 67%


Over five years, there is only a15% probability that a sectorleader retains its leadershipposition

and 25% probability that theybecome sector laggards

b. Conversion ofinvestment to sales(asset turnover, sales)

c. Pricing discipline(PBIT margin)

d. Balance sheetdiscipline (D/E, cashratio)

a. Investment (grossblock)

e. Cash generation(CFO)


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Strategy


Exhibit 4: Probability of self-destruction

2003,08 2004,09 2005,10 2006,11 2007,12 average

Probability that sector leaders in Year-0 stay sector leaders in Year-5? 12% 20% 19% 10% 17% 15%

Probability that sector leaders in Year-0 become sector laggards in Year-5?

23% 20% 30% 23% 31% 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 greatness2003,08 2004,09 2005,10 2006,11 2007,12 average

Probability that sector laggards in Year-0 stay sector laggards in Year-5?

20% 17% 13% 21% 19% 18%

Probability that sector laggards in Year-0 become sector leaders inYear-5?

37% 23% 42% 39% 28% 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 angelsUsing our greatness framework, we can identify the fallen angels i.e. the once-loved companies that were considered to be undisputed market leaders, say, for5-7 years, but then they faded away. More practically speaking, we use our modelto grade firms into leaders (scores above the 75 th percentile) and laggards (scoresbelow the 25th percentile). Then we define fallen angels as those firms that slidefrom being a leader to a laggard over a five-year period. Our quantitative analysissuggests that RoEs and RoCEs are the most sensitive measurables in a companysfall from grace.

Exhibit 6: List of 'fallen angels'

FY03, 08 FY04, 09 FY05, 10 FY06, 11 FY07, 12

Monsanto India Hero MotoCorp Monsanto India Tata Motors Bharti Airtel

Hero MotoCorp Eicher Motors Tata Motors SKF India SKF India

Eicher Motors Tata Motors ABB Bharat Forge Bharat Forge

Atlas Copco (I) Ashok Leyland Siemens Siemens Alstom T&D India

Godrej Inds. TVS Motor Berger Paints Kirl. Brothers AIA Engg.

CarborundumUni.

Motherson Sumi Tata Chemicals Havells India Lakshmi Mach.Works

CMC Siemens Bharat Electron Lakshmi Mach.Works

Gateway Distr.

ContainerCorpn.

Atlas Copco (I) Lakshmi Mach.Works

Bharati Shipyard Sterlite Inds.

ONGC Kirl. Brothers Gateway Distr. Allcargo Logistics Hind. Zinc

BPCL Berger Paints Tata Steel Ent. Network SAIL

IOCL PTC India SAIL Hind. Zinc Natl. Aluminium

Dr Reddy's Labs BPCL Natl. Aluminium SAIL Tata Steel

Ranbaxy Labs. HPCL Hotel Leela Ven. Tata Steel Indian Hotels

Guj GasCompany

IOCL ONGC Natl. Aluminium Hotel Leela Ven.

Neyveli Lignite GAIL (India) BPCL Hotel Leela Ven. MRPL

Sanofi India IOCL Thomas Cook (I) GE Shipping CoRanbaxy Labs. GAIL (India) Biocon

Guj Gas Company Ranbaxy Labs.

Neyveli Lignite GE Shipping Co

Neyveli Lignite

Source: Ambit Capital research; Note: 2003,08 indicates that these companies, which were great firms in2003, have been identified as fallen angels in 2008.

RoEs and RoCEs are the bestmeasures to identify acompanys fall from grace


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Strategy


Why do successful firms slide with suchregularity?Promoters, in their own explanations for underperformance, tend to citeexogenous factors (such as business cycle, Government interference, risingcompetitive intensity or the macro environment). However, such explanations arenot always convincing because within the same sector (and hence subject to the

same regulatory and competitive forces), whilst some firms are sliding, others arerising. Contrast, for example, the performance over the past five years of Infosys vsHCL Tech or Bajaj Auto vs TVS Motors.

Exhibit 7: NOPAT margins Infosys losing momentum;HCL Tech catching up

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Infosys HCL Tech

Source: Company, Ambit Capital research

Exhibit 8: RoCE of Infosys and HCL Tech moving indifferent trajectories

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Infosys HCL Tech


Exhibit 9: PAT margin of Bajaj and TVS way apart!

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

Bajaj TVS


Exhibit 10: Bajajs RoCE in a different trajectory vs TVS

0%

50%

100%

150%

200%

250%

300%

350%

FY0

3

FY0

4

FY0

5

FY0

6

FY0

7

FY0

8

FY0

9

FY1

0

FY1

1

FY1

2

Bajaj TVS


Within the same sector, there iswide divergence inperformance, suggestinginternal factors are more

important than external factors


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Strategy


The five-stage framework

In this note, we use a modified version of Collins framework and Thorndikesapproach to analyse capital allocation to understand why great Indian companiesslide. The core stages in our framework are as follows:

Stage 1 - Hubris and arrogance: The company is on top of its game.Operating margins, RoCE, growth, valuation multiples, etc., are at all-timehighs. Captivated by the success in its core business, the management startsbelieving its own press. Success and adulation intoxicates the top brass.Arrogance sets in. The company loses sight of the factors which made itsuccessful in the first place.

Stage 2 Unbridled expansion: In search of more growth and moreadulation, the management begins an expansion drive which is ofteninorganic. The firm overreaches into new geographies and product lineswhere it has no real experience or expertise. Sub-par capital allocation begins.

Stage 3 Stuck in a rut: Often cost discipline and/or product excellenceerodes and prices are then raised. Profits, return multiples and valuationmultiples start sliding. Company politics thrives. The leader becomesincreasingly autocratic and announces 'recovery plans' that aren't based onaccumulated experience.

Stage 4 Grasping for solutions: The company thrashes around and looksfor a solution even as profits and financial strength continue to slide. Seniormanagement jobs are on the line. Often a new leader comes in andsometimes he tries to fire silver bullets (eg. a 'transformative' acquisition, ablockbuster product, a cultural revolution, etc). However, a new leader (ideally,someone from inside) who takes a long, hard look at the facts and then actscalmly to put in place a measured recovery strategy with sensible use of cashand capital at its centre, could be the saviour.

Stage 5a Capitulation: The firm is sold or fades into insignificance or, andthis happens rarely, shuts down.

Or Stage 5b Recovery: The firm turns the corner and begins the long, slowclimb 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 implicationsOur analysis shows that Tata Steel, Tata Motors, Titan and TTK Prestige are at aninflection point today. A cyclical turnaround in the domestic market will propel theoutperformance of Tata Motors. Tata Steel has larger challenges of sorting out theproblems at Corus. Titan and TTK have had a great run for a decade and the keyquestion 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 ourBUY list. Both Titan and TTK are on our 10-baggers list.

Exhibit 12: Tata Steel's journey through the five stages

Stage Remarks

Hubris and arrogance Superb financial performance through FY01-05

(FY01-05)Feted as the lowest-cost steel producer globally by World SteelDynamics

Won the Deming prize

Company started believing that it had insulated itself from steel pricecycles

Unbridled expansion Evaluates alternative businesses to enter into including telecom, BPO, etc

(FY06-08) Bids for Corus in 2006 and completes the acquisition in 2007, after abidding war with CSNCorus acquisition at a value of US$12bn when company net worth wasUS$2bnCorus did not measure up to the criteria that the company hadenunciated in its annual reports for growth/ acquisition

Stuck in a rut After initial strong performance, Corus goes into the red

(FY09 - present) Domestic expansion plans get delayed

Company saddled with huge debt

Downturn in global steel cycle exacerbates the situation

Grasping for solutions Restructuring at Corus by mothballing capacities and disposing assets

(FY09 - present) Debt refinancing and equity raising

Enhance raw material security

Change of leadership at Corus

Capitulation or Recovery?Write-down of goodwill - acknowledgement that the acquisition is notworking

(FY09 - present) Plans to sell off underperforming and inefficient assets of Corus

Accelerate expansion plans in India to improve the competitive structureof the entire company


Exhibit 13: Tata Motors' journey through the five stages

Stage Remarks

Hubris and arrogance Strong financial performance between FY03-07

(FY03-06)

In a short span of time, becomes one of the three largest passenger

vehicle companies in the country

Unbridled expansion Takes two big challenges: develop the Nano and takeover of JLR

(FY07-08) Launch of Nano is widely celebrated; acquisition of JLR is criticised

Stuck in a rut Nano fails to deliver the expected results after the initial euphoria

(FY09)JLR is hit severely by the downturn in global demand after the financialcrisis

Grasping for solutions Several leadership changes at JLR and India business

(FY10)A three-tier strategy to revive the fortunes of JLR; decides not to cutback on investment plans

Strengthen the domestic commercial vehicle portfolio

Capitulation or Recovery?JLR starts performing strongly, although will continue to needsubstantial investments towards product development

(FY11- present) Work on to revive the fortunes in the domestic passenger car market


The four companies in our firstof a series of notes are poisedat an interesting juncture


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Strategy


Exhibit 14: Titan's journey through the five stages

Stage Remarks

Hubris and arroganceLaunches 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 Makes a foray into the European watch market

(FY96-98) Enters into jewellery exports

Stuck in a rut European watch foray creates financial stress; crimps company's abilityto invest in domestic business

(FY1999-2002) Jewellery exports fails to take off

Grasping for solutions Pull back from the European markets

Launch jewellery in the Indian market

Capitulation or Recovery? 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


Exhibit 15: TTK Prestige's journey through the five stages

Stage Remarks

Hubris and arrogance Successful launch of its US business through 'Manttra'

(FY90-94) Strong growth of pressure cookers and pans in India (25%+ CAGR)

Unbridled expansion Expansion of its US business; funding it through IPO proceeds

(FY95-99) Ventured into new markets like Middle East, UK and Australia

Stuck in a rutLabour issues in Hosur and Bangalore plant could not be managed intime

(FY2000-02) International sales was decimated due to stiff competition

Planned new product launches either failed or could not be executed intime

Government increased excise and other taxes

Grasping for solutions Reallocated and restructured responsibilities within existing seniormanagement team

(FY03-04) Reduced focus on exports

Convinced the Government to reduce excise tax rates on pressurecookersGave VRS to a large part of the workforce, relocated manufacturingfacility and resolved union problems

Capitulation or Recovery?Launched Prestige Smart Kitchens to support distribution of newproduct launches

(FY05 - present)Decided to diversify Indian operations across geographies andproductsConsistent innovation pipeline for new products meant that 50-70% ofsales generated in any year related to products/SKUs introduced over

the past three yearsSource: Company, Ambit Capital research


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Strategy


TATA STEEL LTD. TATA MOTORS LTD.

Mr. H.M. Nerurkar, MD, Tata Steel

Karl Slym, MD, Tata Dr Ralf Speth, CEOMotors Jaguar Land Rover

Tata Steels RoCE (%) through the different stages

0

10

20

30

40

50

60

70

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

Year

RoCE(%)

RoCE (%) through the five stages

Hubris&

Arrogance

Unbridled

expansion

Stuckinarut/Grasping for

solutions/Capitulation or

Recovery?

Tata Motors RoCE (%) through the different stages

-20

0

20

40

60

80

100

120

140

FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13

Year

RoCE(%)


Hubris&

Arrogance

Unbridled

expansion

Stuckin

arut

Grasping

for

solutions

Capitulation

orRecovery?

Tata Steels share price performance through thedifferent stages

Share Price chart-Tata Steel vs Sensex

0.0

200.0

400.0

600.0

800.0

1000.0

1200.0

1400.0

1600.0

Apr-00 Apr-02 Apr-04 Apr-06 Apr-08 Apr-10 Apr-12

Tata Steel S en sex

Hubris&Arrogance

5yrCAGRrelative

performanceof33%

Unbridledexpansion

3yrCAGRrelative

performanceof9%

Stuckinarut/Graspingfor

solutions/CapitulationorRecovery?

TilldateCAGRrelativeperformanceof

19%

Tata Motors share price performance through the

different stages

Share Price chart-Tata Motors vs Sensex

0.0

200.0

400.0

600.0

800.0

1000.0

1200.0

1400.0

1600.0

Apr-02 Apr-04 Apr-06 Apr-08 Apr-10 Apr-12

T at a Motors S en sex

Hubris&

Arrogance

4yrCAGRrelative

performanceof

31%

Unbridledexpansion

2yrCAGRrelative

performanceof 36%

Stuckinarut

1yr CAGR

relative

performance

of32%

Graspingfor

solutions

1yrCAGR

relative

performance

of240%

Capitulation orRecovery?

Tilldate CAGRrelative

performanceof49%


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Strategy


TITAN INDUSTRIES LTD. TTK PRESTIGE LTD.

Mr. Bhaskar Bhat, MD, Titan Mr. T.T. Jagannathan, Chairman, TTK Prestige

Titans RoCE (%) through the different stages

0

10

20

30

40

50

60

FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

Year

RoCE(%)


Unbridled

expansion

Stuckinarut

Hubris&

Arrogance?

Growth

TTKs RoCE (%) through the different stages

-10

0

10

20

30

40

50

60

FY90 FY92 FY94 FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12

Year

RoCE(%)


Hubris&

Arrogance

Unbridled

expansion

Stuckina

rut

Grasping

for

solutions

Capitulation

or

Recovery?

Titans share price performance through the differentstages

Share Price chart-Titan vs Sensex

0.0

500.0

1000.0

1500.0

2000.0

2500.0

3000.0

3500.0

4000.0

4500.0

5000.0

Apr-95 Apr-97 Apr-99 Apr-01 Apr-03 Apr-05 Apr-07 Apr-09 Apr-11 Apr-13

Titan Sensex

Unbridled

expansion

3yrCAGR

relative

performance

of32%

Stuckinarut

4yrCAGRinline

withSensex

Hubris&Arrogance?

TilldateCAGRrelative

performanceof36%

TTKs share price performance through the differentstages

Share Price chart-TTK vs Sensex

0.0

500.0

1000.0

1500.0

2000.0

2500.0

3000.0

3500.0

Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12

T TK P res ti ge S en sex

Unbridled

expansion

Dec94Mar99

CAGRrelative

performance

of 20%

Stuckinarut

3yrCAGRrelative

performanceof

29%

Graspingforsolutions

2yrCAGRrelative

performanceof31%

Capitulationor

Recovery?

TilldateCAGRrelative

performanceof69%

Note:TTKgotlistedinDec94,henceshareprice

performanceduringthefirststageisnotapplicable


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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 thefollowing issue:

1. Amongst todays 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 orslide 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 asector 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 sustaingreatness over long periods of time (eg. Asian Paints, HDFC Bank, ITC) have incommon with each other? How have these firms immunised themselves fromhubris and arrogance and the poor capital allocation decisions that follow?

3. Amongst the laggards and fallen angels of today, which are the greatfirms of tomorrow?

We return to our greatness model and now combine it with the tenets ofdisciplined capital allocation to identify the titans of tomorrow who are currentlyregarded as second- or third-rate players. So we will attempt to figure out whetherfirms like BHEL, Infosys, Wipro, and Indian Hotels, can mount a turnaround.

The list of laggards that can either continue to exhibit mediocrity or alternativelyshow enough mettle to revive and turnaround has been provided in exhibit 18 onpage 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 SectorMcap

($ mn)

6 mnthADV

($ mn)

3-yr shareprice CAGR

(%)

Next 2-yrEPS

CAGR (%)

Next 2-yrBVPS

CAGR (%)

3-yr averageRoE (%)

(FY10-FY12)

3-yr averageRoCE (%)

(FY10-FY12)

Eicher Motors Auto 1,642 1.3 63 31 25 15 31

Exide Inds. Auto Anc 2,112 3.7 5 22 18 26 40

Balkrishna Inds Auto Anc 446 0.3 34 12 21 30 25

Elgi Equipment Capital Goods 220 0.2 13 48 19 26 39

Cummins India Capital Goods 2,262 2.3 5 4 13 31 43

Whirlpool India Consumer Durable 467 0.4 -5 30 DNA 38 53

TTK Prestige Consumer Durable 690 3.1 77 24 33 49 69

Bayer Crop Sci. Fertilizers 970 0.4 24 DNA 25 24 32

Nestle India FMCG 8,982 3.0 24 15 24 110 141

Asian Paints FMCG 7,796 7.8 29 18 21 45 61

ITC FMCG 46,557 40.8 32 19 15 32 47

GlaxoSmith CHL FMCG 4,187 3.2 52 18 19 31 48

Carborundum Uni. Industrials 426 0.2 10 34 10 22 24Supreme Inds. Industrials 791 0.4 52 24 26 40 36

Sadbhav Engg. Infrastructure 279 0.3 -4 60 5 12 12

Redington India IT 539 0.5 -1 14 20 20 18

Persistent Sys IT 371 0.6 11 15 18 20 23

Jagran Prakashan Media 519 0.2 -10 9 14 28 32

CRISIL Miscellaneous 1,440 0.6 28 17 14 43 57

Kajaria Ceramics Miscellaneous 326 0.3 60 28 30 28 26

Cadila Health. Pharma 2,774 1.7 8 31 22 34 27

Ipca Labs. Pharma 1,333 1.7 30 22 25 26 25

Lupin Pharma 5,933 10.6 27 23 26 29 26

Torrent Pharma. Pharma 1,214 0.6 14 18 22 30 27

Mahindra Life. Realty 281 0.2 -2 22 12 9 11

Oberoi Realty Realty 1,276 0.5 NA 44 19 20 23

Titan Inds. Retail 4,330 12.4 35 22 30 46 61

Bata India Retail 1,004 3.5 51 26 23 25 38

Shoppers St. Retail 535 0.8 19 DNA 5 10 11

Torrent Power Utilities 1,089 0.8 -26 16 6 24 21

Source: Ambit Capital research, Bloomberg


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Exhibit 17: Sectoral leaders of today

Stock SectorMcap

($ mn)

6 mnthADV

($ mn)

3-yr shareprice CAGR

(%)

Next 2-yrEPS

CAGR (%)

Next 2-yrBVPS

CAGR (%)

3-yr averageRoE (%)

(FY10-FY12)


(FY10-FY12)

Eicher Motors Auto 1,642 1.3 63 31 25 15 31

Bajaj Auto Auto 8,854 15.8 17 15 24 68 72

Exide Inds. Auto Anc 2,112 3.7 5 22 18 26 40

Balkrishna Inds Auto Anc 446 0.3 34 12 21 30 25

IndusInd Bank BFSI 4,662 12.9 40 23 15 19 NA

HDFC Bank BFSI 28,586 35.2 22 25 19 17 NA

HDFC BFSI 23,141 37.8 16 16 13 21 NA

MM&FS BFSI 2,414 5.7 41 24 20 22 NA

Cummins India Capital Goods 2,262 2.3 5 4 13 31 43

Elgi Equipment Capital Goods 220 0.2 13 48 19 26 39

UltraTech Cem. Cement 8,871 7.3 25 14 18 21 22

Shree Cement Cement 2,881 1.4 32 16 26 27 20

TTK Prestige Consumer Durable 690 3.1 77 24 33 49 69Asian Paints FMCG 7,796 7.8 29 18 21 45 61

GlaxoSmith CHL FMCG 4,187 3.2 52 18 19 31 48

ITC FMCG 46,557 40.8 32 19 15 32 47

Supreme Inds. Industrials 791 0.4 52 24 26 40 36

Sadbhav Engg. Infrastructure 279 0.3 -4 60 5 12 12

TCS IT 50,479 37.9 25 13 24 40 50

Persistent Sys IT 371 0.6 11 15 18 20 23

D B Corp Media 807 0.3 3 21 13 33 34

Jagran Prakashan Media 519 0.2 -10 9 14 28 32

Cadila Health. Pharma 2,774 1.7 8 31 22 34 27

Lupin Pharma 5,933 10.6 27 23 26 29 26

Torrent Pharma. Pharma 1,214 0.6 14 18 22 30 27

Oberoi Realty Realty 1,276 0.5 NA 44 19 20 23

Mahindra Life. Realty 281 0.2 -2 22 12 9 11

Titan Inds. Retail 4,330 12.4 35 22 30 46 61

Bata India Retail 1,004 3.5 51 26 23 25 38

Jubilant Food. Retail 1,251 9.4 57 31 38 46 51

Idea Cellular Telecom 7,777 8.6 36 48 13 7 8

Bharti Airtel Telecom 19,697 28.7 4 59 9 16 16

Torrent Power Utilities 1,089 0.8 -26 16 6 24 21

Source: Company, Bloomberg, Ambit Capital research


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Exhibit 18: Overall laggards of today

Stock SectorMcap

($ mn)

6 mnthADV

($ mn)

3-yr shareprice

CAGR (%)

Next 2-yrEPS

CAGR (%)

Next 2-yrBVPS

CAGR (%)

3-yr averageRoE (%)

(FY10-FY12)


(FY10-FY12)

Bharat Forge Auto Anc 963 1.7 -3 25 10 11 12

BEML Ltd Capital Goods 125 0.8 -44 DNA DNA 7 9

Suzlon Energy Capital Goods 403 12.1 -41 54 -44 -12 5

India Cements Cement 366 1.9 -16 10 4 6 8

Century Textiles Conglomerate 478 4.8 -13 145 4 12 11

Simplex Infra Engineering & Construction 87 0.0 -41 12 6 11 13

Punj Lloyd Engineering & Construction 259 4.6 -27 DNA 1 -3 8

Natl.Fertilizer Fertilizers 383 0.1 -24 DNA DNA 9 11

Monsanto India Fertilizers 222 0.1 -3 DNA 3 15 17

G N F C Fertilizers 215 0.1 -10 DNA DNA 10 12

AIA Engg. Industrials 568 0.2 -7 19 15 18 25

Lak. Mach.Works

Industrials 396 0.3 4 DNA DNA 15 23

Firstsour.Solu. IT 123 0.2 -25 19 DNA 7 6

3i Infotech IT 50 0.2 -58 DNA DNA 9 9

Tata Elxsi IT 100 0.2 -12 65 16 22 24

Uttam Galva Metals 168 0.9 -14 DNA DNA 9 12

S A I L Metals 4,149 5.5 -33 8 6 15 17

Natl. Aluminium Metals 1,474 0.3 -32 DNA DNA 8 13

Tata Steel Metals 5,046 30.8 -14 99 -1 5 10

Thomas Cook (I) Miscellaneous 247 0.1 -3 30 13 11 14

Indian Hotels Miscellaneous 729 0.7 -19 66 2 -1 5

Hotel Leela Ven. Miscellaneous 134 0.1 -26 9 -33 2 3AstrazenecaPhar

Pharma 347 2.2 -5 DNA DNA 32 44

Natco Pharma Pharma 235 0.6 38 16 14 16 17

Omaxe Realty 428 0.6 15 75 16 6 7

Anant Raj Inds. Realty 323 2.3 -15 11 4 5 6

Ansal Properties Realty 60 0.2 -35 46 4 4 6

Mercator Shipping 51 0.2 -35 51 DNA 2 6

S C I Shipping 288 0.3 -40 DNA -8 0 3

M T N L Telecom 210 0.7 -30 8 DNA -49 -25



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Exhibit 19: Sectoral laggards of today

Stock SectorMcap

($ mn)

6 mnthADV

($ mn)

3-yr shareprice

CAGR (%)

Next 2-yrEPS

CAGR (%)

Next 2-yrBVPS

CAGR (%)

3-yr averageRoE (%)

(FY10-FY12)


(FY10-FY12)

Ashok Leyland Auto 1,114 2.5 -9 19 0 14 13

Sundram Fasten. Auto Anc 125 0.1 -10 DNA 15 16 14

Bharat Forge Auto Anc 963 1.7 -3 25 10 11 12

BEML Ltd Capital Goods 125 0.8 -44 DNA DNA 7 9

Suzlon Energy Capital Goods 403 12.1 -41 54 -44 -12 5

Birla Corpn. Cement 338 0.1 -12 15 3 20 22

India Cements Cement 366 1.9 -16 10 4 6 8

Guj Fluorochem Chemicals 522 0.8 18 DNA DNA 23 22

Guj Alkalies Chemicals 234 0.5 16 6 15 11 11

Simplex Infra Engineering & Construction 87 0.0 -41 12 6 11 13

Punj Lloyd Engineering & Construction 259 4.6 -27 DNA 1 -3 8

Jyothy Lab. FMCG 567 0.4 22 45 10 13 16

Tata Global FMCG 1,628 7.8 12 17 8 8 12Lak. Mach. Works Industrials 396 0.3 4 DNA DNA 15 23

Rel. Indl. Infra Infrastructure 99 3.8 -21 DNA DNA 11 13

GTL Infrastructure 44 0.2 -66 DNA DNA -2 10

3i Infotech IT 50 0.2 -58 DNA DNA 9 9

Tata Elxsi IT 100 0.2 -12 65 16 22 24

Container Corpn. Logistics 2,631 2.0 -1 7 11 18 23

Sh.Ashtavinayak Media 14 0.1 -57 DNA DNA 3 5

Natl. Aluminium Metals 1,474 0.3 -32 14 4 8 13

Tata Steel Metals 5,046 30.8 -14 99 -1 5 10

Indian Hotels Miscellaneous 729 0.7 -19 66 2 -1 5

Hotel Leela Ven. Miscellaneous 134 0.1 -26 9 -33 2 3

Astrazeneca Phar Pharma 347 2.2 -5 DNA DNA 32 44

Natco Pharma Pharma 235 0.6 38 16 14 16 17

Anant Raj Inds. Realty 323 2.3 -15 11 4 5 6

Ansal Properties Realty 60 0.2 -35 46 4 4 6

Rajesh Exports Retail 648 0.5 15 DNA DNA 19 13

Shree Gan.Jew. Retail 114 0.4 -7 DNA DNA 34 31

Mercator Shipping 51 0.2 -35 51 DNA 2 6

S C I Shipping 288 0.3 -40 DNA -8 0 3

M T N L Telecom 210 0.7 -30 8 DNA -49 -25

Bombay Rayon Textiles 530 0.5 -3 DNA DNA 8 8

Lanco Infratech Utilities 364 3.0 -48 55 -6 8 10



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1. IntroductionAlice: 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 Carrolls Alices Adventures in Wonderland

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 ayear, 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 (shareprice of`269; dilution of 40%), respectively. As the strategy of the two companiesunfolded, could this have been foreseen? Titan and TTK Prestige over the lastdecade have delivered shareholder returns of 58% CAGR and 82% CAGR,respectively. What will be the trajectory of these companies over the next fiveyears? We seek to answer these questions by tracking the journeys and evaluatingthe decision making of these companies.

Over the last two years, we have developed a framework called the greatnessmodel to identify ten baggers; basically we look for companies which over a six-year period show that they can consistently invest in their business and generateprofits and cash flows (see Section 2 for more details). Also, we use the greatnessframework for other purposes:

The framework can be used to identify the propensity of leading Indiancompanies to fade away to mediocrity and vice versa (of second- or third-rungfranchises 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-lovedcompanies that were seen as undisputed market leaders, say, for 5-7 years butthen they faded away. Section 4 of this note identifies such companies in thecontext of the Indian market and discusses Tata Motors and Tata Steel.

In Section 5, we take our analysis beyond number crunching and delve into thereasons why a number of great companies fade away whilst a few fall from gracebut then pick themselves up and make a comeback. Since most companies make

important strategic decisions that determine their future trajectory, we explorewhether analysis can help to identify the strengths and flaws of such strategicdecisions.

As we begin this series of notes on India Incs strategic decisions, we alsounderstand that luck and/or timing, as in all else in life, plays a big role incorporate success. Seemingly similar decisions have diametrically opposite results.And that is what makes corporate history interesting, exciting and relevant. Forexample, both Tata Steel and Tata Motors made large acquisitions at around thesame time, acquisitions that were multiple times their balance sheet size then.One acquisition now seems hugely unsuccessful whilst the other is an albatrossaround 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.

Titan and TTK Prestige havedelivered returns of 58% CAGRand 82% CAGR over the lastten years

Our greatness model identifiesten-baggers

We take our analysis beyondnumber crunching and take adeep look into strategic

decision making

Seemingly similar decisionshave diametrically oppositeoutcomes


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The main purpose of this series of notes is to give investors a toolkit (both in termsof analytical tools and in terms of questions to ask managements) which willenable them to analyse strategic decisions that are made by corporates as theyhappen. Furthermore, since some great companies can recover after falling, weintend to arm investors with tools that can help them track and time theturnaround trade i.e. when the ill-effects of poor strategic decisions have peakedout. 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 onRoCE, which we find to be the single best metric to assess a companys rise and itssubsequent fall.

For example, two companies from Ambits ten-baggers listTitan Industries(Section 6) and TTK Prestige (Section 7)went through a crisis and then emergedfrom 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 thisnote.

Some fallen angels revive andbecome great again


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2. The greatness frameworkGreatness is not in where we stand, but in what direction we aremoving.

Oliver Wendell Holmes

This quote appropriately captures the driving philosophy behind our greatnessframework 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 theTomorrows ten baggers note. This framework studies a firms structural strengthsby focusing not on absolutes but rather on improvements over a period of timeand the consistency of those improvements. A basic sketch of the underlyingprocess behind the making of a great firm has been recaptured in Exhibit 20below.

Exhibit 20: The greatness framework


We rank the BSE500 universe of firms (excluding Financial Services firms andexcluding firms with insufficient data) on our greatness score, which consists of sixequally weighted headingsinvestments, conversion to sales, pricing discipline,balance sheet discipline, cash generation and EPS improvement, and return ratioimprovement.

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 forstandard deviations.

b. Conversion ofinvestment to sales(asset turnover, sales)

c. Pricing discipline(PBIT margin)

d. Balance sheetdiscipline (D/E, cash

ratio)

a. Investment (grossblock)

e. Cash generation

(CFO)

The greatness

framework

The framework uses publiclyavailable historical data toassess which firms, over asustained period of time(FY07-12), have been ableto relentlessly andconsistently:(1) Invest capital;(2) Turn investment intosales;(3) Turn sales into profit;(4) Turn profit into

Balance Sheet strength;(5) Turn all of that intofree cash flow; and(6) Invest free cash flowsagain.

Clearly, this approach willhave limited value if there isa structural break in thesector or in the company,

which makes pastperformance a meaninglessguide to future performance.

However, to the extent thatsuch structural breaks tendto be the exception than therule, the greatness modelhelps in creating a shortlistof stocks that investors canthen analyse in greaterdetail.


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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 Criteria

1 Investments a. Above median gross block increase (FY10-12 over FY07-09)*

b. Above median gross block increase to standard deviation

2 Conversion to sales a. Improvement in asset turnover (FY10-12 over FY07-09)*

b. Positive improvement in asset turnover adjusted for standard deviation

c. Above median sales increase (FY10-12 over FY07-09)*

d. Above median sales increase to standard deviation

3 Pricing discipline a. Above median PBIT margin increase (FY10-12 over FY07-09)*

b. Above median PBIT margin increase to standard deviation

4 Balance sheet discipline a. Below median debt-equity decline (FY10-12 over FY07-09)*

b. Below median debt-equity decline to standard deviation

c. Above median cash ratio increase (FY10-12 over FY07-09)*

d. Above median cash ratio increase to standard deviation

5Cash generation and EPSimprovement

a. Above median CFO increase (FY10-12 over FY07-09)*

b. Above median CFO increase to standard deviation

c. Above median EPS increase (FY10-12 over FY07-09)*

d. Above median EPS increase to standard deviation

6 Return ratio improvement a. Improvement in RoE (FY10-12 over FY07-09)*

b. Positive improvement in RoE adjusted for standard deviation

c. Improvement in RoCE (FY10-12 over FY07-09)*

d. 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 toaverage the data out over FY07-09 and compare that to the averaged data from FY10-12. This gives a more consistent picture of performance (asopposed to simply comparing FY07 to FY12).

Exhibit 22: Distribution of firms on the greatness score has been calculated byusing data over FY07-12 (total population: 381 firms)

0

10

20

30

40

50

60

0%-10% 10%-20% 20%-30% 30%-40% 40%-50% 50%-60% 60%-70% 70%-80% 80%-90% 90%-100%

No.offirm

s

Greatness Score

Zone of mediocrityGood,

not Great Zone of greatness

211 firms

score < 50%

93 firms

(between 50%

and 67%)

Only 77 firms

score > 67%



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3. Self-destruction quantified

"We're so great we can do anything!"

How the mighty fall, Jim Collins

Over the last 20 years, around 80% of listed companies have failed to delivershareholder returns in excess of inflation (assuming an annual inflation rate of7.9%). Given that nominal GDP growth over this period has been around 15% perannum, 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) havedelivered 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 toaround 25% for developed markets and around 30-40% in other majoremerging markets).

Sustaining leadership

Through our greatness model, we seek to contrast the probability of sectorleaders remaining sector leaders over long periods versus them turning sectorlaggards.

Methodology

We use our greatness model to assess the probability that sector leaders (definedas 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 agreatness score of less than 25th percentile of the sector), i.e. what is theprobability of self-destruction? We contrast this against the probability ofsustaining leadership i.e. what is the probability that sector leaders are still sectorleaders five years hence. We check this historically starting from 2003forexample, we assess the chances that a sector leader in 2003 was still amongst thesector leaders in 2008 and contrast this against the chances of it becoming asector 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 itbecoming a sector laggard is 25%. Thus, the chances of a sector leader becominga 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 2004,09 2005,10 2006,11 2007,12 average

Probability that sector leaders in Year-0 stay sector leaders in Year-5?

12% 20% 19% 10% 17% 15%

Probability that sector leaders in Year-0 become sector laggards inYear-5?

23% 20% 30% 23% 31% 25%

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

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 opposedto staying laggards (18% probability).

80% of listed companiesreturns are less than inflation

Laggards become leaders withunerring regularity


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Exhibit 24: Probability of rising to greatness

2003,08 2004,09 2005,10 2006,11 2007,12 average

Probability that sector laggards in Year-0 stay sector laggards inYear-5?

20% 17% 13% 21% 19% 18%

Probability that sector laggards in Year-0 become sector leaders inYear-5?

37% 23% 42% 39% 28% 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 isthe norm in India. Very few leaders remain leaders (only 15% probability) and veryfew laggards remain laggards (only 18% probability). This implies that thefundamentals of more than 80% of Indian companies revert to the mean themighty 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

Using our greatness framework, we can identify the fallen angels i.e. the once-loved companies that were considered to be undisputed market leaders, say, for5-7 years, but then they faded away. More practically speaking, we use our modelto grade firms into leaders (scores above the 75 th percentile) and laggards (scoresbelow the 25th percentile). Then we define fallen angels as those firms that slidefrom being a leader to a laggard over a five-year period.

Our quantitative analysis suggests that RoEs and RoCEs are the most sensitivemeasurables in a stocks fall from grace. More specifically, we use the followingsteps 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, anddividing 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, anddividing 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.

Based on this, RoE and RoCE are the most sensitive factors that best reflect a firmsfall 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 onour greatness framework include companies such as Hero MotoCorp, RanbaxyLabs, Tata Motors, TVS Motor, Tata Steel, Bharat Forge, Indian Hotels and BhartiAirtel.

Bharti is the numero uno in the telecom space and for many years it seemed thatthe 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 seemsthat the company and its management can do nothing right. For one, growth inthe domestic market slowed down as tariffs were driven down by high competitiveintensity. The industry bid astronomical amounts for the 3G/BWA spectrum in FY11auctions, resulting in the Government garnering `677bn. It whet theGovernments appetite as spectrum reserve prices have been set much higher thanindustry expectations in auctions since. Moreover, regulatory challenges increasedespecially in the aftermath of the 2G scam. Whilst Bharti has not been accused ofanything in the scam related to the 2008 licence handouts, no one is quite sure ofwho 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 becomemore punitive, introducing what may deemed to be anti-industry regulations suchas one-time excess spectrum fee on retrospective basis, reduction in terminationrates and possible abolishment of roaming.

These are all external challenges that impact the entire industry. What added toBhartis woes was its decision to make a big bet on the African market. It acquiredZain 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 Zainand instead of issuing stock, it paid in cash. Three years down the line, with the

We identify fallen angels

RoE and RoCE best reflect afirms fall from grace

Bharti is a good example of afallen angel

Decision to acquire Zain - agame changer


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benefit of hindsight, the acquisition seems ill-timed and expensive. Whilst theAfrica market is potentially large (total population of 495mn in 17 countries), thelarger markets are moderately penetrated (~51% average), have significantcompetition and present varying regulatory challenges. The acquisition wascompleted just after the highly expensive 3G auctions and at a time when themanagements attention was possibly needed in the domestic business. Thecompany has undergone multiple management changes including swapping roles,

whilst the well-oiled machine appeared to be stumbling. The companys marketcap tumbled from US$38.0bn in August 2011 at its peak to a low of US$16.5bn inAugust 2012. Since then it has partially recovered.

Exhibit 25: Bharti's subscriber growth in India hastapered off recently

100110120

130140

150160170

180190200

Jan-10

May-10

Sep-10

Jan-11

May-11

Sep-11

Jan-12

May-12

Sep-12

Jan-13

mn

Source: COAI, Ambit Capital research

Exhibit 26: Snapshot of African countries in Bhartisportfolio

Percentage ofBharti's FY12

Africa Revenue

Population(mn)

Mobilepenetration

(%)

Nigeria 34.3% 162.5 59%

Zambia 9.6% 13.5 61%

Congo DRC 9.4% 67.8 23%

Gabon 7.3% 1.5 120%

Tanzania 6.0% 46.2 56%

Congo Brazzaville 4.5% 4.1 95%

Ghana 4.3% 25.0 85%

Niger 4.0% 16.1 27%

Others 20.6% 158.3 47%

Total 100% 495.0 51%

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. Infact, its greatness score was 71% in 2007, which implies that it was consistentlyinvesting capital, converting that into revenues, converting revenues into profits,maintaining high return ratios, generating operating cash flows, and investingthese cash flows again.

Indian Hotels five-year average net sales growth (FY03-07) was 26% and its EBITmargins were close to ~21%. Even its RoEs and RoCEs were pretty decent, unusualfor an Indian hotel chain. The five-year (FY03-07) average RoE was ~10% andRoCE was ~11%. Much of this was also reflected in its stock price performanceIndian Hotels outperformed the Sensex by 13% CAGR over December 2002-December 2007).

Exhibit 27: Indian Hotels - breakup of revenue growth(in ` mn unless otherwise mentioned) FY02 FY07 5-year CAGR (%)Standalone revenues 5,380 16,184 25

Room revenues 2,530 8,451 27

Average Room Rate (`per day) 4,418 9,234 16

Room occupancy (No. of rooms) 1,569 2,507 10

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

As can be seen in the above exhibit, according to the disclosures made by thecompany 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 thegrowth 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 Hotels leadership position faded away.The five-year average net sales growth (FY08-12) declined to 7% (from 26% in theprevious block of five years). This was accompanied by a corresponding decline inits EBIT margin to ~15% average over this period. Even its FY08-12 average RoEsand RoCEs declined to ~3% and ~8% respectively. Not only did Indian Hotelsunderperform the Sensex by 16% (the five-year CAGR over December 2007-December 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 ofexternal (usually not controllable) or internal factors (usually addressable by themanagement). A sharp decline in the price of a global commodity coupled withreduction in import tariffs can hit an entire sector very hard. These are externalfactors and the Indian steel industry was adversely affected by these factors in the1990s.

Usually, internal factors are also involved. For example, in the steel industry, whilstthe new entrants in the 1990s went on a high-cost debt-fuelled investment binge,Tata Steel went on a restructuring and modernisation programme. The resultswere 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 controlor internal and less than 20% are external. Hence, it is important to scrutinise andunderstand corporate and management strategy for strong investment returns andto avoid minefields. And last but not the least, is the role of lady luck. We willdiscuss these in greater details in the next section.

Exhibit 28: List of 'fallen angels' i.e. companies which in the space of five years wentfrom being top quartile to bottom quartile on our greatness scores

FY03, 08 FY04, 09 FY05, 10 FY06, 11 FY07, 12

Monsanto India Hero MotoCorp Monsanto India Tata Motors Bharti Airtel

Hero MotoCorp Eicher Motors Tata Motors SKF India SKF India

Eicher Motors Tata Motors ABB Bharat Forge Bharat Forge

Atlas Copco (I) Ashok Leyland Siemens Siemens Alstom T&D India

Godrej Inds. TVS Motor Berger Paints Kirl. Brothers AIA Engg.

CarborundumUni.

Motherson Sumi Tata Chemicals Havells IndiaLakshmi Mach.

Works

CMC Siemens Bharat ElectronLakshmi Mach.

WorksGateway Distr.

ContainerCorpn.

Atlas Copco (I)Lakshmi Mach.

WorksBharati Shipyard Sterlite Inds.

ONGC Kirl. Brothers Gateway Distr. Allcargo Logistics Hind. Zinc

BPCL Berger Paints Tata Steel Ent. Network SAIL

IOCL PTC India SAIL Hind. Zinc Natl. Aluminium

Dr Reddy's Labs BPCL Natl. Aluminium SAIL Tata Steel

Ranbaxy Labs. HPCL Hotel Leela Ven. Tata Steel Indian Hotels

Guj GasCompany

IOCL ONGC Natl. Aluminium Hotel Leela Ven.

Neyveli Lignite GAIL (India) BPCL Hotel Leela Ven. MRPL

Sanofi India IOCL Thomas Cook (I) GE Shipping Co

Ranbaxy Labs. GAIL (India) Biocon

Guj GasCompany

Ranbaxy Labs.

Neyveli Lignite GE Shipping Co

Neyveli Lignite

Source: Ambit Capital research; Note: 2003,08 indicates that these companies, which were great firms in2003, have been identified as fallen angels in the year 2008.

In the 1990s, Tata Steelundertook restructuring whenothers chose a debt-fuelledexpansion binge


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5. How and why do great companiesfall?

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 regressto mediocrity in India. Why does this happen? CEOs and promoters in their ownexplanations for underperformance tend to cite the business cycle or Governmentinterference and regulations (eg. the telecom sector or the infrastructure sector).Occasionally, they point to rising competitive intensity in a sector (eg. in two-wheelers). However, such explanations on closer inspection are not particularlycompelling because within the same sector (and hence subject to the sameregulatory and competitive forces), we find some firms which are sliding andothers which are rising.

For example, over the past five years, as Infosyss NOPAT margin has slid from25.1% (in FY09) to 19% (in FY13) and its RoCE has fallen from 30.4% (in FY09) to20.2% in FY13, HCL Tech has displayed a very different trajectory. HCL TechsNOPAT margins have remained relatively flat over FY09-12 (15% in FY13 vs15.5% in FY09) and its RoCE has risen from 21.1% in FY09 to 27.2% in FY13. (Wehave used a 12-month period ending March for HCL Tech.) Unsurprisingly,therefore over this period, Infosys has underperformed the Nifty by 20 percentagepoints whilst HCL Tech has outperformed the Nifty by 540 percentage points.

Exhibit 29: NOPAT margins HCL Tech catching up

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Infosys HCL Tech


Exhibit 30: RoCE moving in different trajectories

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%30.0%

35.0%

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

Infosys HCL Tech


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

Infosyss performance haslagged behind peers

Bajaj Auto has outperformedTVS Motors


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Exhibit 31: PAT margin of Bajaj and TVS way apart!

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

Bajaj TVS


Exhibit 32: Bajajs RoCE in a different trajectory vs TVS

0%

50%

100%

150%

200%

250%

300%

350%

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

Bajaj TVS


In this section, we use a modified version of Collins framework and Thorndikesapproach to analyse capital allocation to understand why great Indian companiesslide. The core stages in our framework are as follows:

Stage 1 - Hubris and arrogance: The company is on top of its game.Operating margins, RoCE, growth, valuation multiples, etc., are at all-timehighs. Captivated by the success in its core business, the management startsbelieving its own press. Success and adulation intoxicates the top brass.Arrogance sets in. The company loses sight of the factors which made itsuccessful in the first place.

Stage 2 Unbridled expansion: In search of more growth and moreadulation, the management begins an expansion drive which is often

inorganic. The firm overreaches into new geographies and product lineswhere it has no real experience or expertise. Sub-par capital allocation begins.

Stage 3 Stuck in a rut: Often cost discipline and/or product excellenceerodes and prices are then raised. Profits, return multiples and valuationmultiples start sliding. Company politics thrives. The leader becomesincreasingly autocratic and announces 'recovery plans' that aren't based onaccumulated experience.

Stage 4 Grasping for solutions: The company thrashes around and looksfor a solution even as profits and financial strength continue to slide. Seniormanagement jobs are on the line. Often a new leader comes in andsometimes 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 actscalmly to put in place a measured recovery strategy with sensible use of cashand capital at its centre, could be the saviour.

Stage 5a Capitulation: The firm is sold or fades into insignificance or, andthis happens rarely, shuts down.

Or Stage 5b Recovery: The firm turns the corner and begins the long, slowclimb to recovery.



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Exhibit 33: The five-stage framework

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

We first apply the framework to two of the largest and well-regarded companies in

IndiaTata Steel and Tata Motors. We chose these two companies not onlybecause both of them appear on our fallen angels list, but being part of the sameindustrial group, they present a good chance to compare and contrast theirrespective strategies over the last decade. Both the companies, at the peak of theirperformance in the last decade, made big acquisitions that made headlinesglobally. How and why did they make these decisions and could the results of thesame have been foreseen or at least forecasted with certain probability assigned tothem?

In the next two sections, our case studies on Titan and TTK (two mid-cap stocksthat 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 arroganceIn stage 1, when a company experiences great success, it starts generatingconsiderable free cash flow (as, almost by definition, high profits and high RoCEover the span of multiple years translate into considerable free cash flow). Thisoften leads to hubris and arrogance, which finally drives poor capital and resourceallocation decisions.

In the successful years spanning FY01-05, Tata Steel generated more cumulativeEBITDA (`135bn) than it had generated in totality over the previous 15 years. TataSteels RoCE rose from 10% in FY2000 to 61% in FY05. Tata Steels performanceduring this period was a result of: (1) a strong upturn in the global steel cycle dueto strong economic growth worldwide in general and specifically in China; and (2)

Tata Steels restructuring and modernisation efforts of the previous decade and ahalf, which bore fruits.

Tata Steel and Tata Motors

two companies from the samegroup and such differenttrajectories over the last 3-5ears

fter FY02 - an era of strongperformance


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Exhibit 34: Tata Steel - standalone CFO and RoCE

0

10

20

30

40

50

60

70

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

-

20,000

40,000

60,000

80,000

100,000

120,000

CFO (RHS) RoCE (%)

Rs bn%

Capacity

grows

from3.3mt to

5mt

Visibility over strong

cashflows in the

coming years gives

confidence to

expand

geographically with alarge acquisition

CFO and RoCEs

multiply over

FY2000 to FY05

Standalone

Source: Capitaline, Ambit Capital research

For Tata Motors, in the four successful years spanning FY05-08, the firm generateda cumulative EBITDA of`136bn. In the ten years prior to FY04, the same firm hadgenerated a cumulative EBITDA of only`70bn. Pre-tax RoCE for Tata Motors rosefrom 4.5% in FY98 to 33% in FY06. Tata Motors performance was driven primarilyby the upturn in the domestic market.

Alongside this generation of capital, comes fame, adulation, awards and pressattention. 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 bea heady cocktail for many CEOs. As a result, just as they have to make the mostcapital allocation decisions in their companies history, managements find thattheir egos are being stroked by the press, the sell-side and investment bankers.Stage 2 then follows and overexpansion organic or inorganic begins.

To be fair, both Tata Motors and Tata Steel at the early part of the last decade hadthe humility to acknowledge the role of the general upswing in the economy totheir 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 majorcomponent of the companys performance has been due to the growth in marketsize

Both the companies were coming out of a difficult period and reflected theorientation of the managements of the two companies. Tata Steel had spent muchof its life since inception in a highly controlled and protected environment. Onceeconomic liberalisations started, Tata Steel spent the years restructuring andmodernising to meet the challenges of an extremely difficult operatingenvironment in India and globally. Further, with liberalisation, Tata Steel had

become exposed to global cycles of the steel industry.

Tata Motors, on the other hand, had been used to taking big, hairy, audaciousgoals (BHAGs1) and was used to operating in an environment where businesscycles were notorious and vicious. First, the company took on the Japanese JVs inthe LCV market in the 1980s. In the late 1990s, Tata Motors embarked onindigenously developing a passenger car (Indica), the launch of which coincidedwith the economic slowdown and the downturn in the CV industry. In the firstdecade of the 21st century, Tata Motors would endeavour to build the cheapest carin the world and take over two iconic luxury car brands that BMW and Ford hadstruggled with.

1AtermborrowedfromthebookBuilttoLastbyJamesCollinsandJerryPoras

major part of theperformance was thanks to themarket growth

Tata Motors has a history oftaking on BHAGs and comingout tops


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Strong turnaround performance brought recognition in its wake. Once again wewould like to stress that the recognition and awards are well deserved but itsconsequences often are the seeds of future downfall. In 2000, Tata Steel becamethe first firm in the Tata Group to qualify for the JRD-Quality Value Award, anaward created by the Group in 1995 in memory of JRD Tata and with the aim ofrecognising business excellence. When, in July 2000, Dr JJ Irani, the then MD ofTata Steel, received the award from Ratan Tata at Mumbais elegant National

Centre for Performing Arts (NCPA), the ovation that ensued never seemed tocease. (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 companysprogress up the Quality Value ladder. At this stage, Tata Steel was regularlybeing feted by World Steel Dynamics as one of the most-efficient and low-costglobal steel companies.

In October 2008, Tata Steel won the Deming Prize, the manufacturing equivalentof the Nobel Prize. In November 2008, at a special ceremony in Tokyo,Muthuraman, who would eventually be bestowed the Padma Bhushan by thePresident of India, received the Deming Prize. Says Harish Bhat, a veteran of theTata empire, The Indian national flag was prominent on the dais that day, whichmade 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 theJanuary 1998 Auto Expo, the public gave it a euphoric welcome. The then ministerof commerce and industry, the late Murasoli Maran, called the car The Kohinoorof India. Three years later, when the Indica V2 was launched, it became thefastest-selling automobile in Indian history when it completed sales of 100,000 carsin less than 18 months. The [cars] market share zoomed to over 20% during theyear 2000-02. (Source: Tata Log, by Harish Bhat, Penguin Books, 2012.)

With the Indicas commercial success came other accolades. JD Power, a carreview publication, called the Indica V2 diesel the best in the operating costs

category, ahead of the legendary Maruti 800. BBC Wheels declared the Indica V2the best car in the `3 lakhs to `5 lakhs category.

For Tata Motors, the heady success of the Indica in the 1990s (the firstcontemporary car designed by an Indian firm) was compounded by the sensationaldebut of the LCV 'Ace' in the mid-2000s. These two runaway successes combinedwith the boom in the Indian economy over FY04-08 boosted the managementsconfidence.

Stage 2: Unbridled expansion

By itself, expansion is not a bad thing. However, in the Indian context, there aretwo limiting factors which make expansion a perilous affairlack 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 earlyin the Nifty lifecycle find that they have to venture abroad or into new sectors tosustain growth. Unfortunately, Indian companies, for all their claims to be relianton professional management, are still overwhelmingly dominated by and run bypromoter families. These families are only human and once they find that theyhave to expand beyond the core business and the core territory that they know sowell, they struggle.

Expansion into new countries or new sectors by Indian companies are rarelysuccessful as the finite nature of the promoters skill set puts a natural captherefore on how far an Indian company can go. Rapid expansion into newmarkets or products usually results in poor capital allocation which dilutes both

operating margins and RoCEs. Thus, the slide in the companys financial strengthand share price begins. Tata Steel and Tata Motors are classic examples of theseproblems.

Well-deserved recognition andaccolades often sow the seedsof hubris and arrogance

Lack of managementbandwidth and relatively small

domestic market areconstraints for Indiancompanies


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We continue with the examples given in the preceding sub-section. In August2004, Tata Steel announced the acquisition of NatSteel, a South Asian steel makerwith ~2mt of steel capacity for ~SG$260mn. Whilst NatSteel was a pure converterwith low margins, Tata Steel believed the acquisition would give it entry in SouthAsian markets and eventually drive significant synergy benefits. Then, in December2005, Tata Steel acquired Millennium Steel, Thailand, which has a 1.2mt steel-making capacity and 1.7mt long products rolling capacity.

After this came the mega acquisition - in 2006, Tata Steel bid for Corus. TataSteels first bid for Corus in October 2006 was at 455pence/share. A counter bidby CSN Brazil made Tata Steel raise its offer twice, and Corus was finally acquiredby Tata Steel at 608pence, 34% above the original bid value. The total acquisitioncost for Tata Steel was US$12.04bn, which was funded through a combination ofdebt and equity. To put this acquisition into perspective, Tata Steels FY06shareholders equity was just over US$2bn. To date, this acquisition remains thelargest by an Indian firm.

Tata Steels global foray should not have been surprising given that thecompany had consistently articulated its strategy in its communication toshareholders. As early as 2003-04, the chairman Ratan Tata wrote toshareholders:

It (Tata Steel) must explore ways of enhancing its capacitydomestically as also establishing finishing facilities in strategic locationinternationally, leveraging its low-cost Indian base and the availability ofdomestic iron ore. The same year in its MDA, the company stated: It is theCompanys vision to be a 15 million tonne company by year 2010. This wouldbe 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 haveraw material security and would not be able to leverage on the low-costproduction base in India. The Corus acquisition was not consistent with thecompanys stated vision. Read these excerpts from the MDA in its FY05 annualreport: "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 steelvalue chain are unlikely to be resolved in the near future... the companybelieves that the maximum value can be created by making semi-finishedproducts (slabs/ billets) at locations where raw materials are available (or canbe competitively assembled), and by finishing them at locations wherecustomers/ markets currently exists or will grow in future."

Corus certainly did not fit into the above criteria. What did Tata Steel see inthis acquisition then? The acquisition could have partly been driven by the thenprevalent wisdom in the steel sector about consolidation, with Mittal Steel(LNM Group) showing the path. But LNM was consistently following thestrategy of having primary manufacturing in countries which had cheap energyor 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 alarge acquisition to match the chairmans vision of taking the group global.

In Corus, Tata Steel saw the chance to become one of the largest steelproducers in the world. In its FY07 annual report, Chairman Ratan Tata wroteto shareholders: "Undoubtedly the most notable event during the year was thecompany's public offer to acquire 100% of the shares of Corus group plc... theacquisition of Corus has transformed Tata Steel from a domestic producer to aninternational steel company with global scale." One can only speculate if theoutcome would have been different, if instead of a marketing person (BMuthuraman), an operations person (Dr JJ Irani) had been at the helm of thecompany at that point of time. Was the acquisition driven by the groupchairman's vision to take the group global and caution was thrown to thewinds?

In April 2007, Tata Steelcompleted the acquisition ofCorus

Corus did not fit with TataSteels publicly statedstrategy

so why did Tata Steel acquireCorus?


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To be fair, Tata Steels decision was hailed by most industry observers as beingone which was synergistic and sensible. Steel Business Briefing stated thatthere were lot of synergies and Tata Steel was acquiring "extremely goodmanagement" and "extremely good distribution". Initial results wereencouraging given that steel prices were buoyant and the deal was hailed as asuccess over the next few quarters. Such was the hubris that Muthuraman, thethen 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 behesitant to forecast steel prices beyond one quarter. Unfortunately for TataSteel, in FY12 and FY13, the combined EBITDA margin achieved was 9.3% and9.2% respectively.

Leaving aside the acquisition price for Corus and leaving aside the recessionthat the world economy entered after September 2008, Tata Steel simply didnot have the management bandwidth to run an ailing European steelmanufacturer. 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, waschosen by B Muthuraman, then MD of Tata Steel, to replace Philippe Varin,

who was exiting Corus after seeing off the acquisition.) We had a fraughtrelationship with Adams, says Leahy. He didnt understand how to deal withunions. 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 cutswere rising.

Khler, the third managing director in two years, shifted gears in therestructuring process that Adams had initiated in Europe. He centralisedfunctions across verticals and regions. His aim was to integrate key functionslike 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 Khler surrounded himself with yes men. An executivefrom Tata Steel Europe, who declined to be named, said Khler surroundedhimself with former colleagues from ThyssenKrupp: There is no Britishexecutive in the top management.

Exhibit 35: Management changes at Tata Steel

May 2003 - April 09Philippe Varin,CEO

Philippe Varin stepped down from his positionon April 6, 2009, within two years of theacquisition.He was to be replaced by Kirby Adams,formerly chief executive of BlueScope Steel,headquartered in Australia

April 09 - October 10

Kirby Adams, CEO(was made MD &

CEO fromSeptember 09)

In June 2010 Kirby Adams stepped down from

his executive roles

October 2010 -present

Mr. Karl-UlrichKhler, MD & CEO

Mr Kolher's term gets over by October 2013News reports mention that Tata Steel islooking out for a new CEO for the Europeanbusiness


An integration team was put in place right from Day 1, but company insidersspeak about how the integration proved to be a big challenge. Even when aseasoned Tata veteran, Dr T Mukherjee, was based out of London, he couldmake limited headway and apparently there were too many differencesbetween the Dutch and the English managers.

Further, Dr Mukherjee was close to retirement and probably did not have theappetite to drive the tough integration process. Raw material security proved to

To be fair, Tata Steels movewas welcomed by most analystsand industry watchers

It was a bad start


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be elusive, without which having production facilities in high-cost locations didnot make sense. Also, this was the first really large deal for a company; itsearlier biggest challenge was operational in nature and internally focused restructuring and modernisation. To top everything, the global financial crisiscame 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 relativelysuccessful, the firm was not able to attack Marutis market share in a

meaningful manner. Meanwhile, Ratan Tata had the dream and vision ofbuilding an affordable family car to migrate two-wheeler users to four-wheelers. Tata Motors took up the challenge and began serious work on thedevelopment of the low-cost car (Nano) in the mid-2000s (total project cost ofaround US$1bn, according to unofficial sources). The product was showcasedin the Auto Expo in January 2008 and then the Nano was launched in thesummer of CY10 amidst much fanfare.

Tata Motors strategy was very clearly enunciated in the chairman's statement in itsFY02 annual report, "In the commercial vehicles segment, the new vehicles beingdeveloped today will totally upgrade the company's product range... a greatercommitment to build an international presence for the Company's brands andproducts in selected international markets."

On passenger cars: "...the necessary investments to

ambit capital report

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