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The Surface To Air Company

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Years after Anand Mahindra had convinced the board of India's largest tractor maker Mahindra & Mahindra (M&M) to bet Rs 600 crore — its largest investment ever — in developing what was eventually called the Scorpio, a senior board member confided in him. "Anand, you didn't know, but your job was on the line. If the Scorpio hadn't succeeded, we might have come back to you and said you need to find something else to do," Anand recalls.

It sounds preposterous that such a message should be conveyed to the scion of M&M's founding family. But with stalwarts like former ICICI chairman N. Vaghul, former Hindustan Lever chairman Ashok Ganguly, HDFC chairman Deepak Parekh, Godrej Industries MD Nadir Godrej and Murugappa group vice-chairman M.M. Murugappan in the Keshub Mahindra-led board, it may well have had a Plan B.

Anand does not know if that message holds true today, but he is going ahead with the biggest portfolio expansion in the history of the 63-year-old company. Over the past 18 months, the tractors and utility vehicles (UVs) company has extended its presence across the entire spectrum of the automotive value chain with two-wheelers at one end and small turbo prop aircraft at the other. The middle is being populated with electric vehicles and trucks. A small entry into powerboats makes it appear an ambitious foray into land, sea and air — all at the same time (M&M is undergoing a global brand overhaul, which will be unveiled by Anand on 17 January).

"I don't think my job has ever been on the line since then," says Anand. "If you are successful, the board gives you a longer rope." Investors, analysts and financial institutions, too, will be watching the 55-year-old to see where he takes the conservative firm. M&M is the only automotive company in the world with such a range of products (see ‘Mahindra: The Transporter'). Honda comes close, but it doesn't have tractors, three-wheelers and trucks, for instance.

At the core of this expansion lies a blunt reality: the world's largest tractor manufacturer and India's largest UV producer needs higher  scale to be competitive globally. It is the world's 17th largest UV company. With the recent Ssangyong acquisition, it will be No.13. The largest — Toyota Motor — would be eight times M&M's size in global UV sales with volumes of over 2.5 million per annum.

So the Rs 32,052-crore ($7.1-billion) M&M had to gain heft in procurement, manufacturing and research to take on the financial muscle of  Toyota's $243.55 billion, Volkswagen's $155.63 billion, Renault-Nissan's ¤96.34 billion ($127.11 billion) or Honda's $109.84 billion. Smaller scale also limits its ability to absorb tectonic shocks. The horizontal expansion is to gain muscle.

Consultants told Anand to stick to tractors because no Indian company would survive in automobiles. He paid no heed to them. "Core competence theory is narrow. It says stick to one thing and do it well. I believed in the Porter theory, which says it is not about the one thing you do; it is about the number of things you do in a pattern that becomes difficult to replicate," he says.

Even though India's nascent economy is throwing up enormous business opportunities, few traditional family groups are testing their limits as M&M is. The next few years will prove if its management had the bandwidth to handle the new forays and whether the group's finances had the resilience to fund a wide portfolio of 11 businesses and 110 subsidiaries.

Riding The Triad
In December 2009, M&M acquired 75 per cent each in Australian firms Aerostaff Australia and Gippsland Aeronautics for Rs 175 crore. Aerostaff is an aircraft component maker. Gippsland makes small turbo prop aircraft. At the same time, M&M entered the powerboats business through Mahindra Odyssea. In May 2010, it acquired 55 per cent of Bangalore-based Reva Electric to add two cars. In April 2010, it bought out Renault in Mahindra Renault, the joint venture (JV) that produced the Logan.

In October, it entered the motorcycles market with the 125-cc Stallio and the 300-cc Mojo (in July 2008, it had bought Kinetic Motors to launch scooters) that pits it against Hero Honda, Bajaj Auto and others. The same month it entered the heavy commercial vehicles segment in a JV with the 175-year-old firm Navistar to compete with Tata Motors and Ashok Leyland. It launched 25-tonne and 31-tonne trucks.

Besides, over the past few years, Hemant Luthra, who heads Mahindra Systech, has spent $300 million to build a $900-million global auto components business from scratch through a dozen acquisitions, mostly in Europe.
In non-automotive, there are IT firms Tech Mahindra and Mahindra Satyam, Mahindra Holiday, SEZ Mahindra World City and Mahindra Finance, which is seeking a bank licence. Mahindra Partners, which acts as an internal private equity firm, has entered retail in a small way with ‘Mom & Me' stores focusing on children, and is foraying into solar power and logistics. And few remember that M&M was one of the bidders for Jaguar Land Rover. What if…?

Conglomerate Versus Federation
Has M&M opened too many fronts? "We are a player in mobility," explains Anand. Bicycles? "Theek hai, woh bhi dekhenge (all right, we will look at that too). But in motorised mobility, the entry point is two-wheelers…aircraft is the ultimate halo." Isn't it stretching itself too thin?  "Each sector has a flagship. We have independent autonomous presidents," he says.

But are investors looking for such giant conglomerates? As roots of capitalism grow strong-er, investors prefer companies with one business over those with multiple businesses. M&M's span of activity attracts ‘conglomerate discounts' on the price-to-earning multiple. "Discount is 15-20 per cent on M&M," says Angel Broking's senior analyst Vaishali Jajoo. Anand, however, says M&M is not a conglomerate but a federation (see interview on page 40).

"Contrary to the oft repeated ‘conglomerate discount' in the western markets, recent research shows that evidence on this is mixed at best," says Krishna Palepu, professor of business administration, Harvard Business School (HBS). Adds Tarun Khanna, professor at HBS: "The advantage of a well-run business group can last for decades, since institutional change usually happens reasonably slowly."

Analysts, however, do not take kindly to conglomerates. "We continue to value the company on a sum-of-the-parts basis, given that it is a conglomerate," says a J.P. Morgan equity research report on M&M in October 2010.

"In US, companies were penalised with  ‘conglomerate discount' because the stockmarket and institutions are extremely well developed. Due to institutional voids (in India), CEOs like Anand Mahindra can add significant value," says Vijay Govindarajan, professor of international business, Tuck School of Business, US.

If there is one reason why investors and analysts are not yet hammering M&M, it is the cautious investments (under Rs 1,000 crore) in new areas, while core business capex is over Rs 4,000 crore. "Bulk of investment remains in core auto or related businesses, we do not believe this is a concern," says Priyamvada Balaji, senior director at Fitch Ratings. "It is a well thought out, optimally resourced entry (into new sectors)," says M.M. Murugappan, a board member of 12 years. "Two-wheelers is an exploding area and aeronautics is the future of mobility in India," adds director Ashok Ganguly.

Group CFO Bharat Doshi assures that M&M is not stretched financially. "We have Rs 2,800 crore of surplus and internal accruals are growing," says Doshi. In 2009-10, while M&M's sales grew 17.46 per cent, its PAT grew 85 per cent to Rs 2,871 crore. He credits the "50 per cent rule" mandated six years ago wherein even if demand falls by 50 per cent, profitability should remain. "You need room for business cycles, for global shocks, for passion. When volumes grow, you get a multiplier effect," says Doshi.

For the $464-million Ssangyong acquisition, which is expected to close by March this year, Doshi says M&M will provide largely from internal generation.

Trials And Tribulations
Financial prudence is one insurance. M&M, which earns over 60 per cent of its automotive revenues from rural and semi-urban areas, is vulnerable to macro-economic changes such as adverse crop and weather patterns. Also, unlike other auto makers who have petrol vehicles too, M&M's diesel line-up will be hit if the government decontrols. "Higher fuel prices may impact demand," says Fitch's Balaji.
Among its new businesses, it has garnered 10 per cent market share in scooters against leader Honda's 42 per cent, but its overall share in two-wheelers is just 1.44 per cent (leader Hero Honda is at 44.24 per cent) because until last October, it didn't have Stallio and Mojo in the motorcycles segment, which accounts for 76 per cent of two-wheeler sales. "In motorcycles, it will take them some time," says an auto analyst with a Mumbai-based equity research firm.

In cars, M&M's strategy is yet to evolve. It is not planning new vehicles to replace the Logan, which will be refurbished, rebranded and launched in a compact version that takes advantage of lower excise. It has two new Reva cars but the car market is a ruthless space that requires a suite of products and constant upgrades. "Competition is an issue in the car market," says Fitch Ratings' Balaji.

In the power boats business, however, M&M can paint its own canvas since current products in the Indian market are imported. "The market is disorganised. There is space for quality infrastructure delivery for a made-in- India product," says Zhooben Bhiwandiwala, the head of the boats business. But the pie is small. Mahindra Odyssea, which gets its boats contract manufactured in Goa, has products in the Rs 15-55 lakh range. In 2010, it sold 10 boats.

The business that has generated maximum curiosity is the entry into aircraft segment — M&M is only the second Indian private aircraft maker to do so after Taneja Aerospace. Gippsland has turbo props such as agricultural aircraft GA200C and the eight-seater GA8 Airvan. It is building an 18-seater turbo prop. Airvan has already gone through the FAR32 certification (a test of fly-worthiness for passengers) in 38 countries. M&M had already forayed into aviation with a $10-million investment in subsidiary Mahindra Aerospace, with a facility at Mallur, near Bangalore. Along with the National Aerospace Laboratories, it is developing a five-seater N5, which goes into production this year. In aircraft, M&M has stolen a march over the Tata group, which also aspires to enter the segment.

"There is a lot of investment worldwide by companies such as Honda and Embraer in VLJs (very light jets). The days of 50-70 seater jets are numbered; the jet trend is moving towards 100-seaters. In the regional space, smaller turbo props will dominate in the near term," says Kapil Kaul, CEO, Indian subcontinent & Middle East, Centre for Asia Pacific Aviation (Capa).

Mahindra Systech's Luthra reckons that of the 5,000 aircraft sold in the world, nearly 4,600 are turbo props. "If we can develop the N5 for $10 million, we can sell it for $0.5 million a piece," he says. "M&M has demonstrated it wants to be in aerospace. The question is whether they want to be of the scale and size (to compete)," says Kaul.

But M&M's even bigger aerospace bet is in  defence offsets through Aerostaff, which can produce large components such as structures, assemblies, wings and fuselage. (In defence offsets, any company with a defence import of over Rs 300 crore is liable to use more than 30 per cent domestic products or services). "We want to make money in a reliable manner in the offsets business. We have bought another facility from Boeing, which is going to be transferred. It is also for taking advantage of offset. The real opportunity for India is in parts," says Anand.

Making Synergies Work

To strengthen the back end, Anand is leaning on synergies. "We have to watch out that every synergy that has to come, does come," says M&M board member Nadir Godrej.

Hence, there are two divisions: tractors and UVs, where M&M is self-sufficient; and, newer businesses such as cars, trucks and two-wheelers, which will be leveraged for sourcing, manufacturing and technology but through JVs. "Our core competency is in tractorsn and MUVs; there we go alone. Where we don't have core competency but it is a part of the ecosystem, we said let us do JVs," says Pawan Goenka, president of the auto and farm equipment business.  

"If you take 200,000 tractors and 300,000  vehicles, you are a half-a-million volume company. You add Navistar and two-wheelers… (it is) a scale of procurement that is approaching a million," says Anand.

Mahindra Intertrade procures all the steel for the auto and farm equipment businesses and key vendors globally. It has also begun servicing Tata Motors and is negotiating with Nissan. There is at least 50 per cent overlap between the auto and farm equipment vendors.

When Mahindra Odyssea was launching the boats business, it took help from Mahindra Systech, which had experience of fibre glass fabrication. "The Scorpio buyer is potentially a buyer for our boats," says Bhiwandiwala. There are now boat dealers in four cities, two of whom are M&M's existing auto dealers. When Anoop Mathur was setting up the two-wheeler business, all 50 dealers chosen were either from among the auto or farm equipment dealers. He also has about 50 sizeable suppliers in common.

But the biggest demonstration of synergy is in two recent projects. One, the 250,000-units flexible manufacturing plant at Chakan, which will make products as diverse as the new global SUV, trucks (and the yet-to-be-launched construction equipment), commercial vehicle  Maximmo and, perhaps, two-wheelers. "Our capex per unit output will be lower. Our opex will be lower. Most importantly, if one segment has a higher demand, we can balance rather than have capex sit idle," says Pawan. In fact, it is a separate company where non-Mahindra  vehicles can also be assembled and manufactured for a fee.

The second project is a new R&D centre, Mahindra Research Valley, in Chennai, where M&M is colocating its entire R&D. Fully staffed, it will have over 2,000 engineers and will be capable of end-to-end vehicle development.

It will be a long while before the net effect — positive or negative — of M&M's bold moves are visible for scrutiny. For the moment, however, Anand is not engaging in any debate: "Nobody can say why are we biting more than we can chew. The bottomline is: we have done all these things and what is our debt:equity ratio? It is 0.20:1. I rest my case."


(This story was published in Businessworld Issue Dated 24-01-2011)