By Taponeel Mukherjee
Real per capita GDP, stock market indices and consumption trends in India are currently interesting. Even as real GDP at an aggregate and per capita basis have broadly trended higher, equity market valuations have fluctuated. Amidst the noise of market data, it is often easy to forget that some of the best investment opportunities arise when market valuations arent quite at their peak.
The single most significant takeaway is that as real GDP has trended upwards, the equity market, in real terms (inflation adjusted), has moved higher with considerable volatility. What many view as market downturns are opportunities to build and scale value-creating businesses.
Market downturns in public markets (equity markets) invariably compress valuations in private markets as well. One way to generate returns from the growing GDP per capita over the next two decades is through creating a valuable platform company to aggregate assets. Such a strategy is especially relevant when high-quality assets can be acquired in a market downturn.
At a fundamental level, a platform company would be one that uses acquisitions to build a business. Capital allocation is the principal function of any company, and in the case of a platform structure, the capacity to inorganically grow the business through meaningful acquisitions is the core objective.
Two fundamental factors determine the success of the platform. Firstly, the pricing environment needs to be one that is in some way a “buyer’s market”, i.e. valuations provide for attractive acquisitions. Market downturns are usually such an environment that is conducive to attractive pricing for deals. The ability of the platform structure to make attractive acquisitions is vital.
It is important to note that the platform company making purchases provides sellers with liquidity in a market downturn, thereby creating liquidity in relatively volatile market conditions. Even in situations without a market downturn, attractive deals are available through sourcing in the private markets or acquiring assets from companies with impaired capital structures.
The second most important factor for a platform structure is to get access to relatively low-cost capital for a longer duration. A healthy balance sheet for the parent business and focus on cash-flow rich businesses is critical in this regard.
A platform business in India has the advantage of one of the fastest-growing economies in the world. To leverage the growth in the economy it will be critical to choose products or services where the product or service meets two main criteria. One, extremely low-risk of substitution; and, two, low technology risk in the product.
Low-risk of substitution is that the need for the product will not disappear in the near term. For example, pharmaceutical products to manage chronic diseases will be a requirement for the foreseeable future. While technology as a backbone will be crucial to scaling the business, low-technology risk implies that the product by its very inherent nature isn’t at risk of technological obsolescence. An example would be the demand for baby foods in the FMCG space.
Using successful templates from other economies, the products and services offered for a platform structure can be for both B2C and B2B businesses. Such platforms usually work better in relatively fragmented markets. The ability to acquire relatively smaller firms from both private and public markets provides an opportunity to scale a business to command a higher valuation multiple relative to a smaller company.
Besides operational efficiency, the strategy that a platform company adopts in India will be dependent on factors such as whether the acquisitions are for regional expansion or a broadening of the product and service suite offered by the platform company. The critical determinant being: How the sum of the parts adds up to create more value than the individual components.
For instance, a successful consumer credit company in one region can create a platform for growth in other regions utilising the existing successful business model. Alternatively, a company selling baby food can generate greater value by acquiring companies that sell products related to baby care.
At a fundamental level, capital allocation through mergers and acquisitions is the cornerstone of creating a successful platform structure. In the Indian context, public market valuation volatility that compresses valuations provides long-term investors with entry points to develop platform companies to leverage the India growth story.
(Taponeel Mukherjee heads Development Tracks, an infrastructure advisory firm. Views expressed are personal. He can be contacted at [email protected] or @Taponeel on Twitter)