A tale of two deals
In the last one year, a couple of corporate transactions in the Valley are noteworthy. Two companies, which could not have been more different, sold equity to raise capital. So far, business in Kashmir have been only debt financed. Now with one company divesting its majority stake to a bigger player, and the other one brining in financial investors, equity makes an entry. Both these are regular corporate transactions that happen every day all over the world. But it is for the first time that these transactions were done in the Valley.
One of the companies is a diversified family-owned enterprise known for its pioneering forays since the mid-50s. The patriarch, with old school business acumen, ran a tight ship in the best of times. A home-grown legend, Kh Saif-ud-Din, who passed away in 2015, built the Saifco Group as one of the largest in the Valley. It is a diversified business group that includes investments in manufacturing, hospitality, construction, entertainment, and retail.
The other one, a new age company, about a decade old, is still in a startup mode. It is operating in the infra-services sector. The promoter, a first-generation entrepreneur, shuttles between Srinagar and West Virginia, USA to run the business online and offline. Khurram Mir puts himself in the line of fire every day to make QUL Fruits, a billion-dollar enterprise in 10 years. From curating new orchards to transforming old ones, grading, storing and selling apple, QUL is a tech-enabled integrated platform covering the entire horticultural value chain.
A couple of day back, this newspaper reported that the Saifco Group has sold majority stake, 60 per cent, in its cement subsidiary to JK Cements. The deal size, Rs 174 crores, is quite small by national standards but big by local record. The total equity of Saifco’s cement business has been valued at Rs 290 crores. The enterprise value, given the debt that the company has, would be in the range of Rs 170 to 175 crore.
This is perhaps the first corporate transaction between a large listed national corporate and a local privately held unlisted business. More such deals will take place. While private corporate investment is desperately required in Kashmir, it is equally important to attract the right kind of investment, in terms of the type as well as the sectors. This requires an enabling policy framework which is based on the requirements of the local economy and future trends in the global economy.
Saifco’s decision to bring in a senior partner is a strategic one. With a top-line of Rs 85 to 90 crore, it has got a valuation multiple of 3x, which is relatively low. The average top-line multiple for the Indian cement industry is currently around 7 to 8x. Not that Saifco has been shortchanged. It will have a positive impact on all their businesses as the group will get de-levered and have some growth capital as well. Also, in working with a listed entity, a culture of corporate governance will get introduced into the Group as also to the nascent Kashmir Inc.
The broader message that is coming through from the financial markets is that old economy, asset heavy, highly leveraged and above all polluting assets will be undervalued. This is not the future.
Around this time last year, it was reported that QUL Fruits had raised Rs 60 crore of private equity by divesting a minority stake in the company. On the basis of the capital raise, the equity value of the company was Rs 400 crore. With a leverage of around Rs 100 crore, the EV would be close to Rs 300 crore. The top-line multiple that QUL got was about 12x. It may not be the best in the sector which has multiples of 18x, but the message in the numbers is that such business is valued by the market. It is future centric operating in the sustainability space, hence value accretive.
While the two transactions are not at all comparable from a financial equity perspective, they are instructive for policy making, and as a signal for other private investors.
The underlying business model for enterprises like Saifco Cement is the local consumption demand of J&K. It is a resource-based import substitution business and hence margins are high. Operating in an oligopolistic market, the home market consumption can be a constraint in the long run. Now with a connectivity infrastructure upgrade of railways, low freight will be a big kicker in the margins.
QUL Fruits, on the other hand, is an enterprise based on the production in the Valley, not its consumption. It is export oriented linked to consumption outside of Kashmir and operating in a competitive but relatively unconstrained market. Besides, QUL, brick-and-mortar business has strong tech culture and digital presence.
The big takeaway from these two transactions in the private financial markets, is for investments to be made in the sphere of production. The norm in Kashmir is to invest in consumption sectors. The era of import substitution, the development strategy of the 1950s and 60s, is long dead. Besides inherent drawbacks like inefficiency, lack of competition, it has increased the inflation threshold of the Valley economy resulting in high prices for consumers and correspondingly reduced real incomes.
By following production-oriented investment strategy, investments that create and increase capacities rather than those utilising capacity, the income and employment generation in the economy will be much higher. This includes hospitality as a service product chain. More importantly, the resource endowments of the economy and the local stakeholder will be at the centre of the economic strategy. This has never been so all along, perhaps since the mid-sixties.
These transactions also prove that the tried-tested-failed strategy to bring corporate capital into Kashmir, by giving attractive incentives undercutting the neighbouring state, setting up industrial estates, is intrinsically flawed. It is far better to nurture local capital do greenfield investments and seek national and international investment at the brownfield and expansion stage.
The local entrepreneur is far more equipped to take the project risks. Where help is required is to ramp up the size. What this means is that institutional and corporate investments should provide the growth capital, not the seed capital. The market will then direct investments into Kashmir on the basis of higher profitability and better than benchmark returns, not government exhortations or support.
The way forward then is rather simple: investments must be made in the sphere of production with an export-oriented growth strategy. Value should be built in the business by leveraging technology and creating knowledge assets. At a size of around Rs 200-250 crore, look to raise growth capital or de-leverage the business or do both. Owning 100 per cent of your business doesn’t have any special value; 51 per cent is just as good. Encash some value in five years’ time and reinvest in technology of production. It will be a virtuous cycle of private sector growth independent of the government, be it the Union or the state.
The author is Contributing Editor Greater Kashmir