Problem of Plenty


By Sanjeev Pandiya


Saudi Arabia has set up a desalination project producing 800 cu km of water per day. This came at a cost of $3.4 billion, and its 28 desalination plants use the oil energy equivalent of 1.5 million bpd (barrels per day). Around 50 per cent of the cost of the water is actually the cost of energy, another 35 per cent would be the cost of capital.



By 2030, India will have a water deficit of 6,900 cu. km per day at current levels of usage growth. At current prices, water would find a market at about Rs 1-3 per litre in domestic and industrial markets, while the rest can be left for agriculture.



Going by the Saudi numbers, it would take about $30 billion to convert India's domestic and industrial water markets to desalination. Add piping and transportation, and we are looking at maximum $60-100 billion. The cost of energy and the cost of capital could be brought down by a company that decides to charge off this huge investment to revenue.



Such a company would sit at the heart of India's economic growth. If the company decides to invest in solar plants at Rs 13 crore per megawatt, it would need another $30 billion to reduce the cost of water by half. Put it all together and we are looking at a game plan of nearly $100 billion, with an impact on the Indian economy of about two-three times what telecom has done.



More than the investment capability, such a company would need to move government and get the regulator's support. The business would be domestic, would need high-quality project management skills, and the ability to manage complex logistics and financing. Only Reliance can do it. I can't think of anybody else in India who would even think of doing something so transformational. I wish Dhirubhai had lived longer; he had just the ability to pull off something so audacious.



The reality

Yet look at what it is actually doing. A late (re)-entrant into telecom, down $5 billion and trying to catch up with a pack of global telecom players already spread out over many countries, with far superior brands. If Reliance uses the regulator to try and bend the rules, the resultant PR backlash could prove suicidal for both the company and the government that it manipulates.



In retail, it was a good idea to buy the real estate (while competition was leasing it) and use its enormous cash pile to muscle its way into what looked like a big industry. At the moment, the jury is out on whether retailing is really a need in a country with high infrastructure costs and low spending power per person. If somebody is just sitting there with free real estate, waiting for retail spends to rise, he would garner an unassailable position in the business, should it ever take off. On the other hand, we are not yet sure that organised retail will ever take off in the manner that it has in the US and Europe.



Have money, will use/(lose) it. This is a simple encapsulation of one of the major laws of human behaviour. The clause in brackets is the automatic, 'normal' way to go after the first state of existence has been achieved. You make money because you do something right; and then you do something with the (resultant) money that has nothing to do with what you were doing right in the first place.



Reliance made its money from oil and petrochemical assets: its main forté being project management, financial engineering and managing the cost of capital, and of course, handling the government interface. Its weaknesses have been its HR and the ability to attract (and retain) talent, build brands and generally, deal with intangible assets. Quite simply, Reliance (like most big companies) fails at decentralised businesses that are light on assets and heavy on 'spend'.



A business like water or solar would need one-time project management skills, good financial engineering and the ability to manage the cost of capital. These businesses would operate from Reliance's strengths. If all these are in place, the resultant assets would sit at the heart of the economy, competing with other more expensive options (like coal-based thermal assets). If Reliance throws its weight behind these two 'big trends' it would be saved the following problems:



The sumo wrestler's problem. If you are too big, people don't like you anyway. For the same reason that Blue Line/DTC buses are disliked on Delhi's roads, Reliance's attempts to muscle into anybody else's domain will see a PR backlash. We have already seen this in retail, and (I think) we will see it in telecom.



The governance of Reliance. Water and solar are vacant areas, where Reliance's muscle power will be welcomed. Its ability to harness government policy will be seen as good for the country and it will be seen as a 'gentle giant' (like the Tatas). MDA has once said that the problems of India are the problems of Reliance; in fact, Reliance would be spearheading India's movement in Clean Tech, achieving parity with China's ambitious move into green energy. As the biggest user of green energy, the water sector would see the development of a water market, dominated and 'managed' by Reliance.



From a doing company to a platform company. With such huge size, it cannot retain flexibility, like the sumo wrestler. Therefore, it should harness markets and create infrastructure to do things, rather than try and make things or sell services to people. Telecom qualifies as a platform business, but the management of brands is a decentralised activity, at which Reliance is unlikely to be the best.



Underperformance. Some of the best money managers in the world are distinguished by a unique ability: to write cheques back to their investors when they can't find proper avenues for investing their vast hordes of cash. At Reliance, that does not mean dividend payouts, but certainly buybacks should be considered. That would be a very good way to consolidate control. At least, the stock price will not underperform. There is no precedent in history for a company that accounts for more than 4 per cent of GDP in a major economy actually outperforming that economy.



The alligator in the water. For any foray to make a difference to the giant's P&L and cash flows, Reliance would have to scale up to a significant size. The probability that it will do this too soon and too much is very high. That will destroy the fundamentals of any business that it gets into; but most of the damage will be to itself. The exception would be a concept business like solar, where the only risk is technological…and that can be passed off to the government.



Where to next?

It is most likely that Reliance will now underperform its past track record of creating wealth. Certainly, even if Reliance the company remains the largest private organisation for a long time to come, Reliance the stock will definitely underperform the markets, especially if it tries to reinvest its cash in new businesses, in trying to compound its earnings growth.



In a perverse way, the younger Ambani's now discredited strategy of spreading himself too thinly on the ground, with partial stakes in concept businesses and immature industries, could be the way to go, if RIL must hold onto its cash. Maybe then RIL should look at turning into a PE Fund, where it buys management teams and backs small companies in immature businesses. There is nothing about RIL that points to them being able to beat the markets, but this could be a last resort.



History has no precedent where a company of Reliance's size has chosen to shrink in size, so that it can manage itself better. Warren Buffet runs Berkshire Hathaway at $180 billion, but in the US economy. Besides, Berkshire has decentralised management, which will stand independently, even if Warren (and Berkshire's earlier holding structure) is no more. This cannot be said of Reliance.


source; Valueresearch