India Inc's Debt-Wish Is Coming True: They Now Have To Downsize And Focus

How corporates in India are finally waking up to the reality of excessive debt and what is the way out

One of the good things to happen because of the growth slowdown in India is that corporates are learning to see the downside of excessive debt and the upside of focus.

Monday’s Economic Times(28 December) says the Jaypee Group is trying to find buyers for its cement plants in a bid to pare down debt. The group has a humongous debt overload of around Rs 75,000 crore. Selling all its cement units at an enterprise value of around Rs 19,000 crore (which means, minus debt, the group will get much less in hand) will not do much to really shrink the overall size of the group’s debt. But it will help it survive. More important, getting rid of cement will help it focus on fewer businesses, which include power, roads and infrastructure, hopefully will better results in future.

GMR Infrastructure, which too went into all these businesses and airports as well (without the cash for it, one must add) is now trying to sell a 30 percent stake in its airports business. It runs the Delhi and Hyderabad airports and the overall group has run up a debt of Rs 43,439 crore. Selling a large chunk of the airports business will help it recover from the default status many of the group’s entities have gotten into.

GVK, GMR’s Andhra rival in infrastructure, committed the same follies and is now stuck with Rs 24,000 crore of debt. It too is trying to pare down debt by selling a stake of upto 49 percent in the two airports its runs – Mumbai and Bengaluru.

Anil Ambani’s Reliance Group, which has over Rs 76,000 crore in debt between telecom and infrastructure, is trying to keep its head above water by selling the tower assets of the telecom group and some real estate assets, among other things.

The point of mentioning these examples is to illustrate two points: that India’s big corporations have been short on focus and long on hope in the way they managed their businesses. A focused group with one or two businesses to run will know what is the appropriate level of leverage it can hope to sustain in each business through good times and bad. A diversified conglomerate operating in several businesses with different capital needs is sure to make the mistake of over-leveraging.

The other point is that Indian businessmen have been too greedy for their own good. Having been brought up in the scarcity environs of the licence-permit raj, they have looked on the opportunities thrown up by delicensing and deregulation as an all-you-can-eat buffet-for-Rs 299. People often overeat in fixed-price buffets; you tend to stuff your face with whatever you can lay your hands just because the total bill is fixed. Eating more is seen as value for money spent, and not just eating right. It’s the same with groups that try to run too many businesses that are unrelated to one another.

When you enter too many businesses with too little cash, it is akin to a debt-wish (pun intended)

In the past, Indian businessmen did not fear debt for the simple reason that they either expected a sure profit from a licence-controlled business or did not expect to repay at all, since the business were built wholly or substantially with loans from public sector banks. Most of them could be written off once the money was siphoned off in profitable private businesses. It was the banks that were left holding the baby. If you don’t intend to repay debt, you don’t have to think how much risk you can handle or who gets hurt in the process.

The 2008 global financial crisis and the collapse of the Indian growth story after 2012 has changed things forever. With the Narendra Modi government and the Reserve Bank of India (RBI) making it clear that they will get tough on defaulters, businessmen know that the game has changed. They have to repay what they can, and salvage what businesses they can.

It’s a good thing, for Indian businessmen have been wading too deep into the water with nothing on, and now that the tide is out, we know they’re naked – to use Warren Buffett’s evocative imagery. Naked means low equity and too much debt in capital-hungry businesses.

There are only three ways forward: sell businesses, focus on the good ones, and raise more equity. The days of pure debt-financed expansion, courtesy a corrupt political system that uses public sector bank resources to dole out favours, are coming to an end.

Even the big conglomerates have to rethink their business models as debt is killing them slowly.

The Tatas, for example, are struggling to keep their costly Corus Steel acquisition from ruining their entire steel business.

The Birlas still have spent years trying to manage the debts needed to finance their Novelis purchase.

Anil Ambani is in sell mode to do the same.

Even his brother, Mukesh Ambani, who is undertaking his most ambitious and difficult expansion into telecom – Reliance Jio – from early next year, will have to rethink the conglomerate model. Reliance Industries, the flagship, was a near zero-debt company some time ago, but in the quarter to September 2015, its outstanding debt stood at Rs 1,72,765 crore, against cash reserves at half that level (around Rs 85,000 crore). There is no cash or equity problem here, but that is assuming Jio does well.

The debt spike is probably due to the high cash needs of Reliance Jio in its launch phase, where the company will have to reach a minimum subscriber base of 100 million in two or three years just to be a No 5 in the telecom game.

It is clear where the group’s money is coming from: the old petroleum and petrochem businesses. The profits from here are bankrolling the group’s expansion beyond the group’s traditional commodity areas to retailing and telecom. Reliance is entering high-risk consumer facing businesses where capital needs are high and returns may be low in the initial years.

The logical thing for the group to do is to float each business into a separate venture, so that overall risks can be contained and capital allocations more rational.

The same can be said with ITC, which is using its cash-spewing tobacco business to fund cash-guzzling branded businesses in the FMCG sector. The entry cost in FMGC is high, but ITC has used its cash generously to build it as it fears tobacco may be in long-term decline, given growing consciousness about smoking hazards. Even so, ITC shareholders would probably have been better off if the FMGC business had been in a separate venture, as tobacco as a standalone business would have generated much better shareholder wealth.

Conglomerates are not easy to run once they become so big and so diverse. Focus becomes more important than just size as focus builds efficiency and consciousness about high capital costs. Indian conglomerates have to downsize and refocus to deliver on shareholder returns.