Its been long break for me from blogging but with new year am back in action. Its normal tendency to ensure that you fulfil your New Year resolution atleast in first month of the year and thats what this blog signifies. 2010 has certainly been the year I would like to forget except for change of job and role at fag end of the year which has been positive event in my life. I think its enough update about me and I don’t think it’s interesting enough to discuss and the waste space on my blogs.
The title can mislead the people who have not been following the markets. So let get it clear for such people that I am not sharing any story about bank nor land but its buzz word of 2010. Its story which has got my grey cells thinking for quite some time. Story that once again exhibits conflict between my theoretical understanding and empirical evidence. So I thought to write about it and get the views of others to clear my doubts.
Valuation has always been tricky subject to handle and assumptions for the same vary from analyst to analyst. So there is not point on arguing assumptions at any point in time when it comes to valuation. But very few times I have seen disagreement on the methods of valuation or on fundamental concepts. One of such concepts is that valuation is typically done on going concern basis with few exceptions. Exceptions are cases where companies is believed to liquidate or similar cases. But is this being reflected in the market is my question? One can easily check the stocks in market and you will find really high valuations for certain companies which are even loss making. The price commanded by them in the market is high as 100 times its EPS. So I undertook its analysis and found one common buzz word associated with them was “Land Bank” and I realized the difference is because I was doing simple DCF on going concern assumption whereas market price was factoring in the price of its assets. So is this right method since the market suggests so? Is it temporary factor and market will correct in future? But price pattern doesn’t suggest so.
To understand the issue let’s take case of Bombay Dyeing which is most simple one. The company has debt-equity ratio of 9.23, EPS growth of -109.46% but currently commands PE of 115, way above the industry average. The reason is huge land bank available with the company in prime areas of Mumbai. The company PE has been in this range for quite some time due to the speculation of company’s plan to develop real estate. So market valuation has factored in current market price of the land or future cash flows it would generate with the real estate. I would have been comfortable if it was second reason since it follows with going concern assumption. But then would you factor such high valuation for the company who is entering real estate for the first time in life and whose expertise is in textile. Also the risk associated with such project is way high to command this PE. Further if company commands this PE based on the market value of its land then in the downturn why was the stock not punished for low market value of its so called land bank since the news of them developing real estate goes way back to 2008. Why market valued it as textile player then? Should we analyze these companies with two business units and do DCF for both of them? Or should we do DCF for its textile business and add market value of land? If this is market practice why don’t we follow it for all similar stocks? Further this concept inherently is accepting the concepts of mark to market for all the asset class which has been issue of contention for quite some time. The land is illiquid asset and to which level can its market value be factored in our assumptions. Would the investors in this stock continue to be the investor if one time unlocking of value for its land bank is done? Who would be buyers at that point in time? Further company being textile company can still use its proceeds to decrease it debt and use remaining for the future capex in which case investors looking for one time gain would not receive any additional payout. So in this case also it is going to be company capability in textile business that one needs to analyze from long term perspective. All this doesn’t justify to me this high PE for the company given that they have not done well in textiles recently. This is just one of the examples; similar cases exist for Bayer Cropscience, Century textiles, golden tobacco etc. These are questions I am pondering for quite some time. I understand analyst once believes that asset value is realizable and then he factors the same in price so this rule cannot be generic. But then once value is realized the question still exists is where the proceeds would be utilized? Would it be utilized in development of real estate or textile business? Also till the value is realized its only notional value and this concept is used when we value investment companies who might have equities which are of high market value of its book. Otherwise small investment companies like Pioneer investment must command much higher price since it has securities worth more than its market cap at current price and further they are much more liquid. Same is true with other such investment companies.
So what was my intention of the blog? It was not to highlight case of Bombay Dyeing but rather at concept level I wanted to discuss such scenarios. Especially my view is land value at current market price cannot be factored in fully in calculation since it’s not realizable. Further the company’s plan of using the proceeds is very important factor along with the company strategic goals. If its land bank which is attractive, I would rather invest in comparable real estate company than such companies or at least compare it with peers in real estate before coming to this decision. Currently I believe analyst have been more speculative and have gone overboard when factoring the value of ‘landbank’ and have not been consistent with the concept or mark to market in all such cases. I might be proven wrong and cases like Bombay Dyeing might prove them correct but valuation like this makes me rethink my basics. Maybe Bombay Dyeing might not have been right example to discuss this given its long history and brand name but cases like it are in plenty and I would certainly like to understand the investors story in such cases that can prove my view incorrect.
No Change in Pricing Strategy Please!!!
After long break I am back to blogging. It has been one full year now after my graduation and I must confess that graph of my intellectual curiosity is exponentially dipping with time. Unlike academic life, Professional life doesn’t give that luxury to experiment, learn & grow. The daily mundane task eats most of the time. But I have somehow continued my habit of reading universities blogs, business magazines etc which have been helpful to stay somewhat abreast with latest studies/researches, news etc.
Few days back I came across very interesting article in recent edition of HBR. Though I hadn’t been the big fan of HBR during MBA days but these days I do glance through the same. As always I found most of the articles uninteresting except one which caught my eyes. I had experienced the same in past one year. I can’t recollect its exact title but it was something like “Why are business leaders not ready to innovate pricing”. During MBA everyone is taught different methods of pricing (cost based, market based, value based etc.). Phew!! One year away from academics really makes it difficult to recollect all the jargons and methodology (Signs of becoming unemployable :( ).But just try your luck to implement one of them in real world and you will face the resistance. The same experience is narrated by the author.
I have read n number of articles and research in recent times on pricing in the recession etc (of course sources includes mother of all gas content Mckinsey & peers) but my success of implementing those or convincing people to do the same in my company is questionable. So why is this resistance? The fact is no one wants to take hard decision. No one wants to lose competitive edge and innovation can never come without risk of failure. Consider for instance IT outsourcing industry which went through the troubled times during recent crisis. Every CEO, CFO in their quarterly results were cautious and have made statements like we are experiencing pricing pressure and it has affected our margins by x basis points. But none of the analysts have asked them what they are doing to counter the same. Every company fears any change in their methodology might cause them to lose customer. But can’t there be win-win situation? There are such methods but companies are just not trying them. Why? Simply because they can get away easily and isn’t the matter of their survival.
Consider other industry where the case is not same-Telecom industry. Tata Teleservices came up with pay per second pricing. Was it good for the industry as such? Perhaps not. Was it good for the company? Questionable. Was it good for the customer? Certainly yes. So what was it that made Tata Teleservices to risk a change in pricing which IT outsourcing industry isn’t ready for? It was question of its existence in competitive market. In absence of any differentiation among players price is final weapon which they had and they used it. I am not here to justify their action or strategy but am providing only the situation when company looks for innovation in pricing.
Other situation when company is ready to experiment with pricing is when there is huge gap with demand and supply and its sellers market. Example of this can be realty pricing in Mumbai wherein developers started charging for built-up and super built up area and then it became norm. But such cases are not going to be more in future given nature of competition that exist today & our integration with global economies.
So what am I trying to suggest by these random examples. Put theory aside. In real world 99% of the company would resist any change in implementation of new pricing methodology until it becomes matter of its survival. This is hard truth. But given such situation arises in your industry would your company be able to suddenly come up with new pricing strategy or just wait for competitor to act and then copy if successful. Which one is good strategy? Latter can also lead to case where no one in industry is ready to risk itself causing industry wide slump (Airline industry). So isn’t it advisable to at least have alternate pricing strategies ready and tested so that it can be implemented any time. Isn’t it good idea to have dedicated team to look at innovative pricing models & be ready with its go to market strategy. I believe some more part of the R&D expense should be spent here. There is enough scope to learn from one industry and replicate in other. Why stick to well defined methodologies learnt in B-school or follow the market leader? Innovation in pricing is need of the hour along with product/service innovation. Corporate world please wake up!!!!
Few days back I came across very interesting article in recent edition of HBR. Though I hadn’t been the big fan of HBR during MBA days but these days I do glance through the same. As always I found most of the articles uninteresting except one which caught my eyes. I had experienced the same in past one year. I can’t recollect its exact title but it was something like “Why are business leaders not ready to innovate pricing”. During MBA everyone is taught different methods of pricing (cost based, market based, value based etc.). Phew!! One year away from academics really makes it difficult to recollect all the jargons and methodology (Signs of becoming unemployable :( ).But just try your luck to implement one of them in real world and you will face the resistance. The same experience is narrated by the author.
I have read n number of articles and research in recent times on pricing in the recession etc (of course sources includes mother of all gas content Mckinsey & peers) but my success of implementing those or convincing people to do the same in my company is questionable. So why is this resistance? The fact is no one wants to take hard decision. No one wants to lose competitive edge and innovation can never come without risk of failure. Consider for instance IT outsourcing industry which went through the troubled times during recent crisis. Every CEO, CFO in their quarterly results were cautious and have made statements like we are experiencing pricing pressure and it has affected our margins by x basis points. But none of the analysts have asked them what they are doing to counter the same. Every company fears any change in their methodology might cause them to lose customer. But can’t there be win-win situation? There are such methods but companies are just not trying them. Why? Simply because they can get away easily and isn’t the matter of their survival.
Consider other industry where the case is not same-Telecom industry. Tata Teleservices came up with pay per second pricing. Was it good for the industry as such? Perhaps not. Was it good for the company? Questionable. Was it good for the customer? Certainly yes. So what was it that made Tata Teleservices to risk a change in pricing which IT outsourcing industry isn’t ready for? It was question of its existence in competitive market. In absence of any differentiation among players price is final weapon which they had and they used it. I am not here to justify their action or strategy but am providing only the situation when company looks for innovation in pricing.
Other situation when company is ready to experiment with pricing is when there is huge gap with demand and supply and its sellers market. Example of this can be realty pricing in Mumbai wherein developers started charging for built-up and super built up area and then it became norm. But such cases are not going to be more in future given nature of competition that exist today & our integration with global economies.
So what am I trying to suggest by these random examples. Put theory aside. In real world 99% of the company would resist any change in implementation of new pricing methodology until it becomes matter of its survival. This is hard truth. But given such situation arises in your industry would your company be able to suddenly come up with new pricing strategy or just wait for competitor to act and then copy if successful. Which one is good strategy? Latter can also lead to case where no one in industry is ready to risk itself causing industry wide slump (Airline industry). So isn’t it advisable to at least have alternate pricing strategies ready and tested so that it can be implemented any time. Isn’t it good idea to have dedicated team to look at innovative pricing models & be ready with its go to market strategy. I believe some more part of the R&D expense should be spent here. There is enough scope to learn from one industry and replicate in other. Why stick to well defined methodologies learnt in B-school or follow the market leader? Innovation in pricing is need of the hour along with product/service innovation. Corporate world please wake up!!!!
Finance in IT industry
This post is for all the finance graduates who are wondering about opportunities that are present for them in Indian IT industry. There is very less awareness about the roles for finance graduate in IT. It is common perception that only role available is that of business analyst who acts as domain expert for financial sector and plays key link between business and software engineers. This business analyst is expected to work from requirement gathering to testing. But this is just operational role from IT organization perspective. Of course then there are also roles which are present in any company irrespective of the industry like one of financial planning and budgeting etc. But other than these there are other exciting and upcoming areas which I guess should interest most of the finance guys and which are present in most of the companies which have attained certain IT maturity.I intend to just highlight this broad area in my post.
Assuming a finance graduate joins an investment bank/fund house; his success would depend on his ability to manage his portfolio of assets such that he provides higher returns to his clients. This requires skill-set that enables him to perform valuation of different available assets and which I believe is the one of the most difficult part of his job. So is there any opportunity for the such person in IT industry ? Is there anything which could be as challenging as this? And my answer is yes. In fact gravity of problem increases than in financial sector. There the aim is to do valuation of asset and manage portfolio of assets which are mostly tangible and quantifiable but in case of IT one must do valuation of services and manage portfolio of applications. This is certainly more difficult since its intangible. If asked to draw parallel with equity then imagine yourself trying to value equity offered by newly formed company in some very new industry with no existing comparables. Imagine if someone was asked to value google as company in say 1980’s. Yes now I guess one would understand the gravity of problem trying to value intangible service. So why is it required in IT to do valuation of services? Its answer is very simple: - for its existence. It is very common problem which many CFO and CEO face today. They unable to understand where does the money for IT go? And moreover what tangible benefits does IT provide to the company. If you put in more MBA terms how does IT help in increasing shareholders value? You may like stakeholder instead of shareholder then I am fine with it too!! The problem is more aggravated when IT is horizontal servicing different business units. No business units are able to determine financial gains from IT services and economic downturn like this certainly makes them prune their IT budgets. So it is required to determine value of the IT services. Now the next question is how. This is most difficult since there has not been any Damodaran born in the industry to help them. Though there are certain guidance provided by different governing body but literature and research is much sparse compared to one available with financial sector. So I think this is one of most challenging areas for finance guys with bit of IT knowledge and strong business fundamentals to look forward for in IT industry.
I hope I pointed to some new areas for most of you guys who are not well versed with this industry and an opportunity for 2010 graduates. I know it doesn’t look as sexy as working in investment bank but for someone like me who passed out in 2009 and was forced to join IT industry it looks really exciting. From the day I joined industry my aim was to leverage my finance knowledge and provide new perspective in IT and am atleast satisfied that in my 6-7 months I have been able to research and work on this area. This is how I have made my knowledge relevant to my company and “am trying to create value for shareholder/stakeholders and who knows I may be damodaran in making for this industry." :)
This post is also answer to lot of questions which my friends are trying to figure out like what am I doing in an IT company. In fact one of them was shocked to know that even after MBA Finance I have rejoined IT industry. He glanced at me with a look as if I was black sheep in finance community and must be stripped of my degree. For him it was demeaning of the esoteric financial knowledge by working in an IT company . I hope that this awareness will help me to salvage some pride in eyes of such guys.
Assuming a finance graduate joins an investment bank/fund house; his success would depend on his ability to manage his portfolio of assets such that he provides higher returns to his clients. This requires skill-set that enables him to perform valuation of different available assets and which I believe is the one of the most difficult part of his job. So is there any opportunity for the such person in IT industry ? Is there anything which could be as challenging as this? And my answer is yes. In fact gravity of problem increases than in financial sector. There the aim is to do valuation of asset and manage portfolio of assets which are mostly tangible and quantifiable but in case of IT one must do valuation of services and manage portfolio of applications. This is certainly more difficult since its intangible. If asked to draw parallel with equity then imagine yourself trying to value equity offered by newly formed company in some very new industry with no existing comparables. Imagine if someone was asked to value google as company in say 1980’s. Yes now I guess one would understand the gravity of problem trying to value intangible service. So why is it required in IT to do valuation of services? Its answer is very simple: - for its existence. It is very common problem which many CFO and CEO face today. They unable to understand where does the money for IT go? And moreover what tangible benefits does IT provide to the company. If you put in more MBA terms how does IT help in increasing shareholders value? You may like stakeholder instead of shareholder then I am fine with it too!! The problem is more aggravated when IT is horizontal servicing different business units. No business units are able to determine financial gains from IT services and economic downturn like this certainly makes them prune their IT budgets. So it is required to determine value of the IT services. Now the next question is how. This is most difficult since there has not been any Damodaran born in the industry to help them. Though there are certain guidance provided by different governing body but literature and research is much sparse compared to one available with financial sector. So I think this is one of most challenging areas for finance guys with bit of IT knowledge and strong business fundamentals to look forward for in IT industry.
I hope I pointed to some new areas for most of you guys who are not well versed with this industry and an opportunity for 2010 graduates. I know it doesn’t look as sexy as working in investment bank but for someone like me who passed out in 2009 and was forced to join IT industry it looks really exciting. From the day I joined industry my aim was to leverage my finance knowledge and provide new perspective in IT and am atleast satisfied that in my 6-7 months I have been able to research and work on this area. This is how I have made my knowledge relevant to my company and “am trying to create value for shareholder/stakeholders and who knows I may be damodaran in making for this industry." :)
This post is also answer to lot of questions which my friends are trying to figure out like what am I doing in an IT company. In fact one of them was shocked to know that even after MBA Finance I have rejoined IT industry. He glanced at me with a look as if I was black sheep in finance community and must be stripped of my degree. For him it was demeaning of the esoteric financial knowledge by working in an IT company . I hope that this awareness will help me to salvage some pride in eyes of such guys.
