OO1 to OO3: Understanding India’s Family-Owned Businesses

Posted on by fundooprofessor

I wrote a note ten days ago for a highly-respected US-based institutional investor and thought of sharing a slightly modified version of it with my students in class and over here.

Link

Thanks,

SB

Published by fundooprofessor

I am Distinguished Adjunct Professor at Flame University, Pune. Previosuly, I was Adjunct Professor at MDI, Gurgaon, where I taught MBA students two popular courses titled “Behavioral Finance & Business Valuation"(BFBV) and Forensic Accounting and Corporate Governance (FACG) for many years. I am also Managing Partner at ValueQuest Capital LLP— an investment advisory boutique which helps its clients invest their capital in good quality businesses.

30 thoughts on “OO1 to OO3: Understanding India’s Family-Owned Businesses”

  1. Thanks again Prof.

    I recently sold a strongly performing battery manufacturer *solely* because I felt he fell into what you classify as the OO3 bucket. In short time since, it has gone up again leaving me thinking if I was wrong. Your article gives me confidence I was probably right (and I don’t feel like I missed out on the gains).

    As I read your points under ‘Capital stewardship’, I recalled reading parts of “The Outsider – 8 Unconventional CEOs”. Have you read the book?

    – Prem

      1. Nice pointer Prem, being in the same boat and sold the battery manufacturer too. The initial position was taken on the premise of a strong foreign entity being their partner will restore some control on the capital stewardship and management compensation, however as Prof. highlights, political clout laden promoters sometimes think too big of themselves. Better to avoid returns from such counters.

  3. How would you classify entrepreneurs who milk a legacy that they have been left behind without any ambition/vision to scale it up ? For eg., a second generation of a business – which is still a good business but has slowed down considerably. In the ultra long run, it might destroy value but what about the medium term – 3-5 years

  4. Dear Prof.Bakshi, thanks for sharing this, it helps be sober and keep perspective when investing. I personally experienced a type 003 promoter, a well known brand that was incredibly successful in one area over 2 decades. But the business became commoditized, although it generated huge cash flow. This promoter and his son were incredibly ambitious, and started diversifying into multiple areas to become famous. They used the cash flow from the existing business, and also borrowed big time for expansion into areas that they were not competent at, but were currently trendy. Within 4 years, only a skeleton of the original business remains, and the stock is now 1/100th of its peak value. Shareholders were destroyed, many careers of employees were destroyed….

  5. Rajaram, Warren Buffett related a story in his 1995 letter on similar lines. He wrote:

    “I can’t resist repeating a tale told me last year by a corporate executive. The business he grew up in was a fine one, with a long-time record of leadership in its industry. Its main product, however, was distressingly glamorless. So several decades ago, the company hired a management consultant who – naturally – advised diversification, the then-current fad. (“Focus” was not yet in style.) Before long, the company acquired a number of businesses, each after the consulting firm had gone through a long – and expensive – acquisition study. And the outcome? Said the executive sadly, “When we started, we were getting 100% of our earnings from the original business. After ten years, we were getting 150%.”

    🙂

  6. Thanks Prof

    Fully Agree that OO3 type should be strictly avoided for straight equity. What’s your view in case of special situations investment in companies run by OO3 type promoters, where the time period is only 3-6 months.

    1. A one-night stand with the wrong kind of partner can still get you into trouble. Promoters with wrong intentions have announced buybacks without intentions of carrying them out. De-listings have taken place at surprisingly low prices because there were some dealings “behind the scene.”

      I recall an instance of a distressed company being acquired by a then prosperous company through a preferential allotment of shares. The allotment triggered an open offer for the target company and the offer was made. As part of the deal as explained in the public announcement, the preference shares of the distressed company were to be concerted into its equity shares at a specified swap ratio. The preferred was selling at a deep discount to the equity. The spread was so lucrative that it offered a 52% flat return over 6 months.

      About 21 months later, the deal was cancelled. By then the financial situation of the acquirer was worse than it was before the acquisition, and that of the target was terrible.

      Having said that, if you are sure that you have a solid contract, with SEBI’s protection and a deadline that won’t be missed beyond a reasonable time, go for it.

      1. Thanks a lot Sir, off late my thinking was leaning towards avoiding OO3 managment even cases of special situations, except for very few cases of open offers.

        In one of your post you talked about return per unit of risk. In a very short period of my experience with special situations investment with pathetic managements is that return per unit of risk declines when ever I invest with such management. Thanks again.

  7. Why do the private equity guys still go and invest in several of the OO3 businesses? They should rather groom OO1 raw material when they see it.

    Why do our banks lend to OO3 types?

    How to influence some OO2 guys to become OO1 or become even better stewards of capital?

  8. Caution on OO1: Wanting to create something great, being long term oriented, being ethical, etc do not automatically guarantee that an OO1 will have the “intellectual capacity” to take his/her business to commanding heights.

    Many entrepreneurs who scale to $100M may not scale to $1B and those who scale to $1B may not scale to $10B. Thus, they may underperform.

    We are seeing this over the past decade as Infy failed to become a true peer of global consultancies like IBM or Accenture. The leadership simply does not have what it takes, even though it is OO1.

  9. Thank you Prof for the very interesting article!
    For all investing purposes can we club OO2 with OO1 category? In your experience what differences have you seen in outcomes of investing with these two different types of promoters?

    With your example of Unitech vs Hawkins, the difference between OO1 and OO3 is very clear to me. Thank you for the great example!

    1. For investment purposes, we should club OO1 and OO2 because there are so few OO1’s out there. The reason why this is important is because I hear a lot of criticism about how well the promoters of some family-owned businesses in India are paid. Typically, the criticism mentions total remuneration paid to promoters as a percentage of revenues. There is very little, if any, discussion about how much wealth these promoters have created for minority stockholders over the last decade or so, where that wealth was created through the growth in the underlying value of a high-quality business recognized by the stock market.

      Sure, other things remaining unchanged, we all would prefer to partner with an OO1. That’s what Mr. Buffett does in his most of his acquisitions. A typical BRK acquisition involves the acquisition of an outstanding business created and run over decades by an OO1.

      But there aren’t very many OO1’s out there (or perhaps, I haven’t found many) so a refusal to invest with OO2’s carries large opportunity costs.

      One last point, which has little to do with your question but I thought of mentioning it here. The chief difference between an OO2 and OO3 is that the former makes money with investors, while the latter usually makes money off investors (both equity and debt) and the state. So, for long-term investors, its very important to be able to identify an OO3, and watch him from a safe distance.

  10. Thank you Prof for the great lecture, one of many.

    I wish I could have joined your class, but unfortunately I live quite far away from the U.S.

    I have a practical question though, maybe even technical in nature:
    How can a small individual investor, like me, invest in a specific company in the stock exchanges in India? I understand that the markets in India aren’t exactly open for foreigners.

    Kind regards,

    Michael

  13. Dear Prof, Interesting article and thought provoking. Is there a shift possible between O2 to O3 and viceversa?

    Regards,

    Nikhil

      1. hello sir,
        that alternate link is also not working . for tcil ppt those links are not working

  16. OO1 example:

    ‘My purpose is larger than me, when you make your purpose larger than you, you show up every day on time, every single time. My purpose is to make people happy as a result of what I do. When I make a cycle, I make it for that girl who will receive it as a reward for having done well in school. I make it for that man who makes his way to work every day on two wheels. I make it for the youngster who races on it and finds pleasure on his bike getaways. I imagine the looks on their faces when they first see their bicycles. They will own it; they will become friends with it for years to follow. I am building a bicycle that will live up to that friendship. I come here every day, unfailingly, to ensure that my product does not fail that friendship.’

    ‘When we built Hero cycles, when I went city to city selling cycles and dealerships, I did not do it so that one day I would not have to do it again. I did not build this family so that one day I could leave it. I did not give up my teenage fun so that I could make up for it when I grew old. I built Hero Cycles because I wanted to live for something – I wanted to live for the people. I live because there is something to go and work for every day. I come back because I have built something to come back to every day. Hero Cycles is my home. Where else will I go?

    — From the Book, The Inspiring Journey of a Hero. Learning from the life of O.P.Munjal.

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