"A Very happy Dipawali and Subh Samvat 2074”
Firstly, I wish you and your family a “Very happy Dipawali and Subh Samvat 2074”
As some of you might be aware that our chairman Mr. Raamdeo Agrawal mentioning about Value Migration in most of his presentation on equities and recommend investors to read the book called Value Migration author by Mr. Adrian Slywotzky.
On this auspicious occasion, instead of sharing any stock idea, I thought of sharing my book review on “Value migration” which mostly ignored by most of the investors.
Book Review: Value Migration
The Customer priorities keep changing and evolving. Businesses that identify this and take timely or pre-emptive action end up on the right side of the customer equation. Those that fail to do so stand on the wrong side of value migration equation.
The term, value migration was introduced by Adrian Slywotzky. He defines value migration as a flow of economic and shareholder value away from obsolete business models to new, more effective designs that are better able to satisfy customers’ most important priorities. Value migration occurs when there is disconnect between customer priorities and existing business designs.
Measuring Value Migration:
· In his book, Value Migration, Adrian Slywotzky points out that value flows into and out of business designs. A key approach to measure that flow of value, he suggests, is price-to-sales ratio (market cap/trailing 12 months’ revenue). A ratio greater than two suggests value inflow phase, a ratio between one and two suggests stability phase, and a ratio lower than one indicates value outflow stage.
· Past instances of value migration suggests that value migration in terms of market capitalization is the earliest to show, followed by sales and then by profits. The market recognizes the potential beneficiaries of value migration much before reflection in financials. When value migrated from public sector banks to private sector banks, the rate at which the market capitalization of private sector banks expanded was much higher than the rate of growth in their profits in the earlier years.
The three stages of value migration model
· Value inflow stage: Value is absorbed from other companies or industries. In my view, Indian Jewelry industry is in the value inflow phase, where value is migrating from the unorganized sector to brands. Example : Tanishq
· Value stability stage: Competitive equilibrium with stable market shares and stable profit margins. What I believe is that Indian IT industry is in stability phase now – incremental value migration will be a function of pace of innovation and new value propositions.
· Value outflow stage: Companies lose value to other parts of the industry - reduced profit margins - loss of market share - outflow of talent and other resources. In last the 10 years, we have observed this happening in power sector where there is value outflow from conventional energy to renewables.
Slywotzky notices that the three stages of a company’s value migration describe its relative value-creation power, based on its ability to satisfy customer priorities better than competitors do and thus to earn superior returns”. The specific framing of migration puts emphasis on the ability of a company to meet customers’ needs better than its competitors, to generate return on invested capital, and, in consequence, to change the value of the capital belonging to the company’s shareholders. The starting point of the three stages of value migration model is the curve presenting the profit generated by a business design in relation to time.
Lets look at few examples of Value Migrations in India.
· Earlier, Industries that have seen value migration from the public to the private sector in India are Telecom and Aviation, This has spanned across sectors and created several winners in various industries. Typically, the drivers for such migration have been quality of service, technology, and/or lack of innovation by the public sector.
In the recent past there is a clear cut indication of Value migration from public to the private sector which has been a ubiquitous theme in India. For instance, If you remember, The doors of value migration for the banking industry opened in 1995, and since then, it has been a one-way journey in favor of private sector banks. Focus on customer convenience, technology, and new product introductions, and top management continuity facilitated the migration. The biggest beneficiary is HDFC which has emerged as 2 largest stocks in terms of market cap.
· Focus on profitable growth helped PBs to get significantly higher share in the profit pool. Share of PBs (Top-6) in overall profit pool in the system has increased to 42% in FY15 (75%+ in FY16 due to losses of PSBs) from 16% in FY05, as per reported data. Aggregate MCAP of PBs is at USD127b as against USD46b for PSBs. As at the end of FY05, aggregate MCAP of PBs was USD13.7b as against USD26.3b for PSBs.
· The catalyst for driving value migration has been rapidly changing technology, increasing customer education (the government is making efforts to increase digital penetration post demonetization), regulators’ favorable view on competition, and improving service.
Detecting Value Migration:
Some of the factors which can help investors in earlier detection of value migration are:
· Market share movements provide a very strong signal of value migration. Consistent share gain trends are usually a harbinger of bigger trends at work. E.g. Indigo’s consistent market share expansion in Airlines, Private Bank’s share gain in savings deposits or Eicher’s rising equities in premium two wheeler space all underscore a distinct value migration shift in the underlying businesses.
· Innovation leadership is another metric to identify potential beneficiaries of value migration. Players that drive innovation and create new categories/subcategories enjoy tremendous first mover advantages and trigger value migration. In Decorative Paints, Asian Paints is well- entrenched as an industry leader, with 55- 56% market share. However, it is innovation leadership that has cemented its position as industry leader and ensured continued share gains over the years (gained 1,500bp market share in ~15 years). It has been a pioneer in introducing several new practices in the industry – tinting machines, home solutions, color ideas etc.
· Customer satisfaction scores, while subjective, can act as a good starting point to understand whether customers are happy. Declining satisfaction scores should alert investors about impending value migration.
Why Understanding Value Migration is Important for investing?
Various investment frameworks have proven handy and successful in identifying stock ideas. Some of the successful frameworks include Economic Moats, GARP (Growth at Reasonable price), QARP (Quality at Reasonable Price). One of the frameworks that has delivered consistently and helped in creating investment value is the framework of Value Migration.
Value migration is typically less understood and not given enough credit in identifying investment opportunities. In a country like India where things are changing rapidly, value migration can occur in an industry, no industry can challenge the changing priorities and tastes of consumers and it has become essential that companies understand and adapt to such changes in order to keep its value intact.
For more details pls click on these below links (videos)
Thanking you
You’re faithfully,
Vikas Agrawal,
Vice President
Motilal Oswal Asset Management Company.