Disruption at the door
A constant threat of becoming redundant is forcing companies to exit their commoditised businesses and look for growth opportunities
By Malini Bhupta | May 23, 2019
It takes a lot of courage to sell an existing business and walk away from it. And yet, many companies are doing precisely this because it is becoming hard to generate profits sustainably from commoditised businesses. By getting out of legacy businesses, these companies are freeing capital and management time to focus on innovation and new opportunities. Call it disruption, if you will, but companies are taking bold calls and morphing so that they remain relevant to their stakeholders. In time, this trend will become more pronounced and companies that fail to take these tough decisions will atrophy. This trend, which has been precipitated by large activist investors, has a profound message for others because businesses have to be viewed/evaluated differently.
Last December, ABB announced that it was selling its power-grid business, which was the least profitable anyway, to Hitachi at an enterprise value of $11 billion. Back in 2014, the global power and technologies major had announced its Next Level strategy, which sought a 'shift in centre of gravity driving profitable organic growth, strengthening competitiveness and lowering risk.' The company is now focused on new-age technologies like automation, robotics and IoT. Cash proceeds ($7.8 billion) from the sale of the power division will be returned to shareholders. Some of the largest investors in ABB have supported the move. The company will invest a part of the proceeds to cut costs and become more efficient. Another company to undertake such a transaction was Johnson Controls, the world's largest manufacturer of auto batteries. The company sold its batteries business to private-equity players in late 2018. The batteries business accounted for $8 billion in its global sales of $31.4 billion. When the world's largest manufacturer of auto batteries sells its entire business, it merits some inspection. Closer home, Barings Private Equity Asia announced in April that it was acquiring a 30 per cent stake in NIIT Technologies from the promoters. Sanjay Jalona, CEO of L&T Infotech, had told me back in 2017 that they were the right size to pivot into a digital-services company from a pure-play IT services company. Pivoting is not everybody's cup of tea and those who cannot are smart to sell.
These developments carry a rather profound message for investors because there's nothing usual about business anymore. In my view, investors don't always read the writing on the wall when dramatic shifts occur. Almost a decade ago, when IT behemoth Infosys started missing its own growth forecasts, most sell-side analysts came out with even higher targets after every quarterly miss. After several such mishaps, Nimish Joshi of CLSA wrote a stinging open letter in April 2012 to the then CEO of Infosys, D Shibulal, questioning the company's ability to forecast its own future. It took investors and analysts a fairly long time to figure out that cloud services, social media, mobile and digitisation were disrupting the traditional business model of Indian IT. It is my guess that similar things are playing out across other industries, too. Even as consumer behaviour and technologies are shifting rapidly, investors are willing to pay a premium for legacy and past performance. Take for instance, some consumer companies that command very rich valuations even though they are losing market share to challengers.
Launching a product today is relatively easier than it was in the brick-and-mortar days. Challengers today can disrupt a business sitting anywhere and that too in a very short span of time. For instance, Juul, an e-cigarette manufacturer, has smoked out the biggies from the electric-cigarette market in less than two years after it was launched in 2015. Juul has a cult following in the USA. It had a market share of 13.7 per cent in the USA, which went up to 75 per cent by 2018. Juul Labs had a valuation of $15 billion in 2018, after it was spun out from Pax Labs in 2015. In December 2018, Altria, one of the world's largest manufacturers of cigarettes bought a 35 per cent stake in Juul for $12.8 billion cash. The deal will give Juul the distribution and marketing muscle it needs to go global. After its tremendous success with the young folk in America, the company is already talking of launching in Asian countries like India.
Last year, Elara Capital came out with an extensive report on large consumer companies in India acquiring or investing in start-ups. Clearly the behemoths see the writing on the wall. Mint newspaper reported in August 2018 that eight of India's top 12 brands had ceded nearly 40 basis points to two percentage points of either volume or value market share to newer entrants in home care, packaged foods and beverages categories between 2012 and 2017. The data was compiled by Euromonitor but many companies challenged the data. It is a similar story in women's personal hygiene, too, with several new challenger brands chipping away the market shares of Whisper and Stayfree. In the face of such disruption, can behemoths continue to command a premium of 60-70 times their earnings?
If we consider consumer companies, automobiles as a sector is staring at some big shifts. Given that 10 out of the world's most polluted cities are in India and the oil import bill is $50 billion a year, it makes immense sense for India to march towards electrification. Among some strategists and investors, this conversation has already started. But it isn't mainstream yet. Goldman Sachs, for instance, believes that 2025 will be an inflection point for cars in India. This will be supported by a drop in prices of lithium batteries, government push, India specific product development, improved battery efficiency and new technology. The global investment bank said that electric two-wheelers would be viable by 2019 itself. These sharp shifts will have major implications for investors and businesses because disruption is at the door.
The author is the editor of Value Research Stock Advisor.
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