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When companies bite more than they can chew... - Views on News from Equitymaster
 
 
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  • Jun 13, 2013

    When companies bite more than they can chew...

    Companies usually pursue an array of growth strategies. One of them could be taking up risky and challenging projects. However the fact that they are taking the risk of making a commitment beyond their resources and competence is often ignored. This then becomes a case of 'biting more than one can chew'. While there is nothing wrong in being ambitious, companies need to ascertain the risks vs returns from growth carefully. Without that even some of the strongest companies have lost their edge and destroyed shareholder wealth.

    Voltas - a victim of mis-evaluation of risks vs. returns

    Take Voltas' struggle to execute its Middle East project for instance. The company, once a heavyweight in the capital goods sector, fell into the trap of going overboard with its expansion plans despite having limited resources.

    Here we discuss a significant event that catapulted into big challenge for the company. Voltas's bidding for Sidra Medical Research Centre project proved to be quite troublesome. It won the prestigious project, Sidra Medical Research Centre, Qatar in 2008. Sidra is expected to be one of the most ultramodern and all-digital academic medical center. Voltas believed the project will open the doors for it to Qatar's Mechanical, Engineering and Plumbing (MEP) market.

    Also, despite knowing it will have minuscule margins on the project, the company perceived the project as a stepping stone and reference point to win large orders for 2022 FIFA World Cup; which will be held in Qatar.

    What went wrong with the project?

    To its dismay, the project faced several hurdles. There was delay in execution due to numerous changes in project's designs and specifications. This shot up the total cost of the project from initial Rs 10 bn to Rs 15-16bn.

    Since Voltas was handling such a large project for the first time, it became difficult for it to coordinate with multiple agencies and intermediaries to get the work done. Also due to the project cost shooting up; Voltas had to take the cost overrun hit twice on its books for Rs 2.8 bn and Rs 2.6 bn.

    Voltas is still optimistic on recovering at least 90% of the total cost overrun amount. It can claim the amount at the final settlement; when the project gets completed by December 2013. However, we fear that the company may not recover the whole amount as approval of claims is always a difficult task in project business. In addition, payment issues in the Middle East due to poor economy have been rising every year.

    Strict labor policies came in way of project execution

    Another challenge for Voltas was execution of the project in Qatar; a country known for its strict labor laws. There has been enormous delay in execution due to non-availability of visas to Indian workmen in Qatar. Visas are a critical issue in Qatar as nationals from Syria, Jordanian, Egypt, India, Bangladesh and Pakistan are restricted. A project as large and meticulous as Sidra required highly skilled workers; which was a challenge for Voltas.

    We believe this issue is prevalent in few other Middle East regions also such as Bahrain. This significantly increases cost and execution time of the project as the contractor first has to train the labor before embarking on the project. Therefore, strict labor policies in Middle East may impact Voltas' execution of its other projects as well.

    To conclude...

    Voltas is a case in point that blue chip companies are not immune to failure if they lack foresight to gauge possible threats to their growth plans. While it remains to be seen whether the Sidra project actually opens the door for Voltas to bigger projects, the company's margins and shareholder returns have been compromised in the meanwhile. Voltas may continue to struggle to recover its cost overrun claims for a while. We infer that Voltas did pay a price for underestimating the risks to growth, probably, underplaying the tough economic scenario prevalent at that time.

     

     

    Equitymaster requests your view! Post a comment on "When companies bite more than they can chew...". Click here!

    1 Responses to "When companies bite more than they can chew..."

    TMJ. Jayan

    Jun 19, 2013

    I am a Life Member of Wealth alliance & ValuePro subscriber.
    Thanx for this article & on 19.06 also. You have advised "Buy" on Voltas & CG in Hidden treasure & "Buy" on Voltas on ValuePro. But Ranbaxy according to u is may be worth for long term only as Voltas also. Management of Ranbaxy is Good according to the history; I would call Ranbaxy also is a good one for Long Term as is Voltas, although they were found out by US corporate governance rules of Pharma sectors. But U r not. What is the underlying fact according to EM for not encouraging Ranbaxy? Pls. revert.

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