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IT is the (hidden) jewel in the crown - Views on News from Equitymaster
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  • Jan 15, 2000

    IT is the (hidden) jewel in the crown

    To most investors, Mahindra & Mahindra's stock price seems overvalued compared to its peers in the automobile sector - Punjab Tractors, Hero Honda and TVS Suzuki. The most common grouse is why should there be a premium for a plain automobile play? What investors don't realise is that the premium is not on its auto business, but its infotech operations.

    Mahindra & Mahindra (M&M) is one of India's leading lights in the Indian automobile sector. It embarked on its journey in corporate India with a foray in the utility vehicles (UV) and tractor segments. Not satisfied with the growth potential of these sectors, over the years the company has diversified in several areas, mostly unrelated - light commercial vehicles (LCVs), telecom, real estate, software and trading. To make matters more complicated for M&M, it also had investments in companies like Otis (India), which was just as unrelated as some of its other businesses.

    Needless to say, there was too much on M&M's plate and the conglomerate found it difficult to handle all its businesses under one roof. The only rational path was a restructuring, and M&M adopted it with an eye on the future. Eighteen subsidiaries of the M&M group were restructured under three business clusters - M&M, M&M Holding and Finance Ltd. (MHFL) and M&M Information Technology Services Ltd (MISTL). While M&M retained the auto-related businesses, the software business was transferred to MISTL and other businesses comprising realty and consultancy were pushed to MHFL. Even the Otis (India) investment issue was sorted out as the former bought out M&M's 24 percent equity stake.

    Like in most restructuring cases, the effects will be reflected over a period of time, but will still not deny the company some of its inherent advantages. In tractors lies the company's biggest strength, and has seen the company emerge as one of the top four players in the world in terms of volumes. The company has consolidated market share on a sustained and is just below 30 percent at present. It has identified acquisitions as a mode of enhancing market share and with this intent it bought a 51 percent equity stake in the state-owned Gujarat Tractors. This acquisition will put even more distance between the company and its competitors - Punjab Tractors, Eicher Motors and HMT.

    Utility vehicles have been an equal partner in M&M's growth process. Its range of vehicles (Commander, Armada) have been instrumental in the company grabbing more than 60 percent market share. Competitors like Tata Engineering (TELCO) have struggled to match M&M's vehicle range and marketing reach in rural areas.

    (Rs m) 2QFY2000 2QFY1999 Change
    Net Sales 8,307.0 8,053.0 3.0%
    Other Income 344.0 328.0 5.0%
    Expenditure 7,228.0 7,154.0 1.0%
    Interest 355.0 368.0 -4.0%
    Depreciation 302.0 285.0 6.0%
    Profit before Tax 766.0 573.0 34.0%
    Tax 163.0 95.0 72.0%
    Profit after Tax 604.0 478.0 26.0%
    Net profit margin 7.3% 5.9%  

    Three years ago the company entered into a joint venture with Ford Motors, USA for manufacturing passenger cars. This move was seen by analysts as an attempt on the company's part to spread risks. If that was the case, then the company's foray was not too successful and the Ford Escort' floundered against established players like Maruti. However, the venture has struck back with its latest offering - Ford Ikon, which has stolen the limelight from Maruti Esteem and Hyundai Accent.

    M&M has exposure to some other diverse businesses like ash handling for thermal power stations, for which it has tied-up with Boral Material of USA. It also deals in steel trading and realty.

    However, the biggest boost for the company in future will come from its software venture with British Telecom - Mahindra BT. The company has 60 percent equity stake in this venture and plans to list it soon. Given the rousing welcome that some of the fresh software offerings have received, this venture will unlock tremendous value for M&M.

    But, there are some concerns voiced by analysts, mainly about the US$ 232 million capital expenditure, which will depress profitability in the short term. Stagnant UV sales is another area which investors find disturbing and competition is not decreasing.

    But to M&M's credit it is taking remedial measures to correct the situation. In a smart move, the company converted its outstanding foreign currency convertible bonds (FCCB) amounting to US$ 52 million to global depository receipts (GDRs) to curtail interest costs and pare down foreign exchange outflow. Another factor that has gone in the company's favour is its innovative streak that has seen it launch models (in tractors and UVs) to pre-empt competition.

    But clearly, what will drive growth is not the auto business, but the IT business. Given the enormous IT potential and the BT brand name, the software venture of the company looks a like a winner in the making.



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