Capital Allocation, A Spin-off, & A Dividend Policy Tweak: An AltG Love Triangle

Poornima Vardhan loves jets.

The AltG principal has a special proclivity for mobility-related consumer businesses. That's why she persuaded Taponeel Mukherjee that AltG should work with a large-cap player with a dwindling share price that was short on ideas but high on potential.

While Taponeel Mukherjee and Poornima Vardhan speak to corporations, private equity funds, and hedge funds on a regular basis, they believe that there is significant value-unlocking opportunity in a set of businesses that significantly need to transform as tectonic shifts occur across the economic and macro environment.

Taponeel Mukherjee's first remarks when he sat across from the senior management team were, "There's potential, but we're gonna have to shake up things around here". AltG's Taponeel Mukherjee and Poornima Vardhan viewed the business as high quality and sticky but with three fundamental problems: 

1. Poor Capital Allocation: The business was missing structural industry shifts and allocating capital to low-growth businesses and paying dividends.  Essentially, Stop Paying Dividends, Invest In Growth! 
2. Buy, Don't Build: The company was looking to build operationally intensive businesses when being a patient capital allocator could create significantly more value.
3. Time for a Spin-off: The sum of parts for the company was greater than the whole. One of the company's subsidiaries was massively undervalued. 

The problems above weren't exclusive to this company, but a long list of ones that Taponeel Mukherjee and Poornima Vardhan speak to. Over the last decade, the sector has been through a complex business transition, with software increasingly capturing a substantial portion of the value chain rather than hardware. The company has continued to invest in low free cash flow (FCF) generating opportunities, resulting in a very low single-digit free cash flow return.

This was a classic "AltG Type" value-creation opportunity through their APEX Formula - A company with strong top-line growth, enviable market position and poor capital allocation. As Poornima Vardhan told top management, "If you're investing in projects with a FCF yield of 7% when Indian Gilts are trading roundabouts, you can't expect the market to value your share. You need to be investing in opportunities that are annually compounding at 15-20%. Essentially, you need to allocate capital to software". Taponeel Mukherjee chipped in, "You don't have to necessarily build, given your industry knowledge and adjacencies, you have got to be buying and investing into the high growth software space. Software businesses in your industry have twice the growth, higher margins and FCF yields that are more than twice of your existing business". Taponeel Mukherjee and Poornima Vardhan convinced management to significantly change their capital allocation strategy from hardware to software.     

Additionally, the company had the wrong capital allocation with respect to its dividend policy. Poornima Vardhan says, "We see a lot of companies that should be investing in the next phase of industry growth and not paying dividends. Of course, there are dividend-seeking investors who form a significant part of the capital base, and there are companies that should serve them”. Taponeel Mukherjee chips in, "You're in the fastest growing economy in the world - India. Your shareholders deserve the opportunity to participate in companies that can allocate capital to high-growth value-creating opportunities rather than returning cash to them".

Taponeel Mukherjee adds, "Most times, management misses the importance of capital allocation. Essentially, this business could have had thrice its market capitalization by investing in a basket of mobility-related software stocks over the last 6 years. While it's not the management's job to buy indices, it shows the magnitude of the missed opportunity. More importantly, it shows that for senior management, capital allocation is as important, if not more, than operational efficiency".

With the aforementioned capital allocation play, AltG's capacity to identify monetizable large-scale opportunities that ride structural trends throughout the Indian consumer markets stands out. Poornima Vardhan continues, "We observe businesses sticking to strategies that have worked in the past. By identifying, structuring, and capitalizing on the industry's tectonic shifts that frequently make or break enterprises, AltG delivers enormous value for our clients and partners”.

As AltG's team delved over the company's strategy, operations, capital structure and market positioning using AltG's proprietary APEX Formula, they were able to spot a significant value-unlocking opportunity through a spin-off of a highly undervalued division. The market and current investors were underpricing the subsidiary vis a vis its public peers significantly. Taponeel Mukherjee and Poornima Vardhan saw that the spin-off would value the subsidiary at about twice its current implied valuation, thereby realizing a few billion dollars of market capitalization. Through the use of its APEX formula, AltG understands the complexity of investor bases, investor preferences, focused investment, and capital-raising.

Taponeel Mukherjee adds, "Here was a high-growth business hidden inside a mature company. Separation of the businesses and a more efficient corporate structure was a no brainer". Poornima Vardhan adds, "As Indian capital markets mature, a lot of focus will come into not just the structure of a company's balance sheet but the balance sheet of the investors financing the company. A company's strategy is only as good as its capital structure".

As the India opportunity abounds, AltG's Poornima Vardhan and Taponeel Mukherjee are watching India's consumer markets. Whether it be Mobility, QSR, Healthcare, Housing, Footwear, Consumer Food, Sports & Entertainment or Beverages - If It's Happening, AltG Is Watching!