Piramal health care case study

Piramal Enterprises is the flagship company of the Piramal Group and is a world leader in its various business verticals. It has a global footprint of over 100 countries, manufacturing bases in USA, Great Britain, Sri Lanka, China and Canada and a diversified workforce representing the Piramal Groups diversified global portfolio. Recently, the UN Conference on Trade and Developments World Investment Report 2011 ranked Piramal Enterprisess CMO (contract manufacturing) business vertical as number five in the top 10 pharmaceutical contract manufacturers worldwide; and was awarded the number one position amongst all Indian CMOs. Drug discovery and research is an important part of the business. Piramal Enterprises aspires to be the first Indian company to discover, develop and launch its own NCE drug in the global market and has made steady progress towards that goal. The company has more than 115 issued patents and 395 pending patent applications in several countries. The patents and pending applications cover a wide variety of areas across multiple discovery and development programmes including compositions of matter (NCEs and natural products), methods of treatment, biomarkers, diagnostics, pharmaceutical compositions, drug delivery systems, etc. Healthcare Information Management: In May 2012, Piramal Enterprises Ltd acquired Decision Resources Group (DRG), a US based company, which is an independent provider of decision support tools, analytics and research for the global healthcare industry. Considered to offer the "Gold Standard" in analysis according to many of its clients, DRG provides web-enabled insights and predictive analytics via a variety of high value reports, databases, tools and advisory services to the global bio-pharmaceutical, managed care and med-tech industries. DRG is focused on three main market segments: (1) the Biopharma business unit provides reports, databases and advisory services on drug utilization trends and forecasting in a variety of therapeutic areas; (2) the Market Access business provides database and analytical services that healthcare companies use to assess the current and future opportunity of their products acceptance into a market; and (3) the Medical Technology business provides actionable insights and data on the medical device markets. Headquartered outside of Boston, DRG has a global presence with offices in Belgium, Canada, England and Japan.

Indiareit is the real estate equity funding arm. It the largest Reit fund by AUM (assets under management) in India i.e. Rs 3800 crore by June, 2011. It has domestic and offshore funds, and has recently raised funds from UK, Singapore and Dubai. PHL Finance Pvt Ltd. is the non-banking financial company (NBFC) that has recently formed to look into funding of real estate and infrastructure projects. How should one play breakouts? Well, heres one case study that attempts to answer the question. The two most important things one should look for before playing breakout 1. Formation of well defined resistance 2. Decisive Breakout from a well defined resistance In case of Piramal Healthcare: both the above happened. There was a formation of well defined resistance 1. at 200 dma and 2. at 410. AND the stock later broke out above both of them. Just see the chart below

Source: Chartalert.com

Trigger for Trading Plan: Breakout from well defined resistance Breakout above 200 dma: As you can see in the chart above: Piramal Healthcare formed a stiff resistance at 200 dma in 2011. The stock rallied multiple times to 200 dma but failed every single time. It was only in Dec 2011: Piramal Healthcare broke out above 200 dma decisively. Breakout above 410: In 2011- when stock was trying to take out 200 dma: it formed a base around 410 to launch an attack on resistance of 200 dma. But later in May 2011: the stock broke down even below 410 and became more weak technically. It was only in late Nov 2011: when stock made a big momentum move and broke past 200 dma: it also broke past 410. The momentum move that happened post breakout was very strong and stock rallied all the way to 480-490. It was a decisive breakout. How one could have played it? There are two ways one could have played trading moves: 1. Near Term Breakout; and 2. Breakout Buy on Pullback

Source: Chartalert.com

Trading Plan 1: Near Term Breakout: One could have just gone long on breakout past 200 dma OR gone long post breakout above 410 as seen in the chart above with 480 as the target. Remember, 480 was a chart high made while stock was negotiating 200 dma. Near term breakouts are risky as lots of times breakouts are traps but the reward also is outstanding if one is right as large move happens quite immediately Trading Plan 2: Buy on Pullback: It is one of the safe trading strategy and gives more stable low risk returns. Piramal Healthcare after clearly establishing the breakout above 200 dma/410 pulled back to 200 dma/410 by middle of May 2012. It offered excellent opportunity to all investors/traders who missed the previous move and stock made a huge surge of 25% in just less than two months post pullback. The objective of writing this article is to look at the trading opportunities stock offered in the past and how one could have played it. The idea is to learn. I hope the article is useful. Do give me your feedback. The cultural change here has been the key - there has been a great buy-in from the team. Working with picme has enabled to look at issues on a more structured and logical way. Often this has meant re-learning the way people do things and, while not always easy at first, the benefits are there for all to see. Piramal is a world-leading custom manufacturing organisation. The Morpeth site, which was previously a part of Pfizer Inc, is an integrated API & Formulations site with scale-up and commercial manufacturing capabilities. It routinely supplies over 300 finished dosage forms SKUs (stock keeping units) to more than 100 markets worldwide. The company initially approached us with a primary aim of bringing about efficiency gains. Response Russell Page and Jason Barclay of picme spent 15 days at the plant. They initially focused on workflow analysis, looking at how tasks were handled on a day to day basis and ways in which inefficiencies and wastage could be eradicated. The work we did here was about value stream mapping certain tasks and identifying waste. Engineers, operators and maintenance technicians worked with the picme team to analyse tasks and look at ways we could take a more structured, scientific approach to bring about efficiency gains Michael Devenport, Engineering Manager - Piramal

Engineers and technicians undertook training with us in 1st and 2nd level analysis and this training has now been embedded into the day to day activities at the plant, with the most significant breakdown of any working week now regularly examined in depth using scientific techniques. Finally, the team on Failure Mode and Effects Analysis (FMEA) which offers a structured approach to the prediction of potential failures. Solutions to the potential failures are then prioritised so that the most significant ones are dealt with first. For Michael Devenport and his team, the experience has proved invaluable, offering both immediate benefits as well as long term gains as learning and new ways of working are embedded into the team. The cultural change here has been the key - there has been a great buy-in from the team. Working with picme has enabled us to look at issues in a more structured and logical way. Often this has meant re-learning the way people do things and, while not always easy at first, the benefits are there for all to see. The picme guys have been really patient and understanding with us, putting their messages across in a way that is interesting and stimulating Michael Devenport, Engineering Manager - Piramal Result Cost savings of around 100,000 per year Hundreds of maintenance man hours eliminated General feel-good factor that comes with the successful application of any change-programme No matter how good you are, to substantially improve plant reliability and to continue to improve it into the future requires a structured approach and the discipline to follow that approach. This is what the Piramal team have implemented with their root cause analysis procedures Piramal Healthcare is probably one of the biggest names in the Indian pharmaceutical and a company that holds IT in high stead. This week Biztech2.com takes it readers

through the pharma giants journey with SAP Advanced Planning &Optimization component (SAP APO), which helped boost its supply chain. Beginning of the SAP Journey Piramal Healthcares relationship with SAP began a decade ago. With a distribution network in multiple geographies and 12 manufacturing facilities in India, Piramal needed a solution that could support its complex supply chain processes and continued growth while keeping costs down as well. "Piramal Healthcare has been one of the earliest adopters of IT solutions in India. Amongst the pharma companies, we are at the leading edge with using IT to drive our business. We deployed Saps first solution in 2000 and from then weve been adapting and using different modules as we have continued to grow as a company," says Nadini Piramal, Executive Director, Piramal Healthcare. Roadblocks: Legacy Systems and Manual Processes As with most established enterprises, Piramal Healthcare had the herculean task of eliminating legacy systems and manual processes. But these seemed to be not the only on the list of challenges. "We had legacy IT systems and people were used to working with them in a certain way. When you are used to using spreadsheets, you know what you can get, which is a limited amount of analysis. We had the huge task of getting people change their mindset and use SAP APO to its optimum so that they could benefit from the results could be got from it," explains Nandini. According to A Balaji, VP-IT, Piramal Healthcare, before SAP APO came into the picture, update master and transaction data took an awful lot of time. From the IT standpoint, the company faced numerous process challenges. "We, as a company are growing both organically and inorganically and have made quite a few acquisitions as well. With so much happening constantly, we have realised that it is better to relook from the business and IT solutions standpoint for smooth functioning of the business and overcoming challenges." Implementation SAP Advanced Planning &Optimization component took six months to be completed with a core team of 15 members. What was unique about this implementation was a large

buy-in of the stakeholders. Piramal Healthcare had a cross-functional team working on this project and it took around six months to deploy it in all its plants. Explains Nandini, "We have been very successful with this implementation in our Baddi plant, which is a formulations plant that services the domestic market. SAP APO takes a little more time to be implemented in a plant where you can manufacture multiple products and multiple lines because. This is so because this solution functions in such a way that the system thinks that you can do only one product or a number of products in just one line. We still have to work our way and see how we can adapt to that." "We have named this project, Project Alignment because here the alignment had to be made with both the business and IT. We have multiple businesses and we wanted them to be seamlessly integrated. We had approximately 15 core team members from Piramal and around seven members from Bristlecone, our implementation partner involved in this project." One of the best practices that team followed in this project was to involve the stakeholders in the whole process. Benefits Having been of the earliest adopters of SAPs solutions among Indian pharma companies, Piramal was sure that SAP Advanced Planning &Optimization component would yield the benefits that they had hoped for. Well, they were right as it did give them the whole gamut of financial, strategic and operational benefits. With SAP APO, the net demand generation, advance planning system, detailed distribution system have started functioning more efficiently with a faster response time. Adds Nandini, "We have a very large portfolio of products, some of them with very small runs but very high contribution and SAP APO has helped in better scheduling this. With better scheduling our products are manufactured faster and resulting in a higher contribution." SAP APO has also lessened the time for change-over and stock-outs, as well as lessened the inventory base. Piramal Healthcare has now moved from push-distribution to pulldistribution and thats critical for the business. Concludes Nandini, "The main benefit has been the lessening of stock-outs because we have varied products and therefore the

demand across all regions is varied, especially since we supply across India and SAP APO has helped streamline the demand and supply."

Even if you put zero value on Ajay Piramal, as the stock market is doing right now, youd have to agree that hes beaten the hell out of that insanely crazy market. Since 1988, when he took charge over what is now called Piramal Healthcare, and may soon be called by another name Ajay Piramal has made his long-term investors not just rich. Hes made them fabulously rich.

AJAY PIRAMALS TRACK RECORD SPEAKS FOR ITSELF

Consider this: Over the last 23 years, investors in Ajay Piramals flagship company have compounded their money at an average annual rate of 28%. In contrast, Sensex compounded at only 17% a year. The difference between compounding money at 17% a year and at 28% a year becomes truly staggering over time. While Rs 100 became Rs 3,700 with Mr. Sensex in 23 years, they became Rs 29,230 with Mr. Piramal instead. Ajay Piramals track record becomes even more impressive if one considers that the 28% a year return delivered by him was computed by using the currently undervalued stock price of Piramal Healthcare. As I write this, the company has 20.9 crore shares outstanding selling at Rs 479.owever, the company would have bought back and extinguished 4.2 crore shares (20% of the total) at Rs 600 each. An indication of the price at which the remaining 16.7 crore shares may be valued by the market after the buyback, one can look at the April 2011 futures price now quoting at Rs 450 per share. In effect, post buyback, the stock market is valuing Piramal Healthcare at about Rs 7,500 cr. When Ajay Piramal bought Nicholas Laboratories from its foreign parent in 1988, the companys market value was only Rs 6 cr. This launch pad into the drug space enabled him to ride on the wave of huge subsequent growth of the Indian pharma industry. After several brilliant acquisitions, mergers, spinoffs, and other corporate restructuring transactions orchestrated by him over the next 23 years, the company morphed into what became known as Piramal Healthcare.

Then, in May 2010, he stunned the business world by announcing that he has sold part of Piramal Healthcares business, constituting about half the companys revenues, for a staggering $3.8 billion, or about Rs 17,140 crores, to Abbott Labs of USA. Two months later, he sold the companys diagnostic business to Super Religare for Rs 600 crores. These two deals, having an aggregate value of Rs 17,740 crores delivered an upfront cash of about Rs 10,200 crores to the company. The balance Rs 7,540 crores almost all of it due from Abbott would be received over the next 42 months. Having an insignificant credit risk, these future receipts, which are not conditional upon the achievement of any milestones, have an estimated present value of Rs 6,300 crores, assuming a discount rate of 10% a year.

INDIAS LARGEST CASH BARGAIN

The value of cash already received (Rs 10,200 crores) plus the present value of receivables (Rs 6,300 crores) comes to Rs 16,500 crores. From this, if we deduct taxes paid amounting to Rs 3,700 crores on the huge profits made on these disposals, Rs 2,500 crores utilized for the buyback, debt of Rs 793 crores, and two minor items relating to the payment of a non-compete fee and charity, we are left with net cash and cash equivalents of about Rs 8,700 crores as of now. On a per share basis (post buyback), this comes to Rs 517.This is the number I want you to focus on because it exceeds the stock price of Rs 450 per share. If Piramal Healthcare were to be liquidated today for just the cash and its equivalents, with no value received from the sale of its three operating businesses which Ajay Piramal decided not to sell, the stockholders would get about Rs 517 per share. The stock market, it its own wisdom, is valuing the whole company at Rs 450 per share. In other words, if you were to believe the stock market, this company is worth more dead than alive. For long-term investors, however, this is a great opportunity to partner with one of Indias great wealth creators on very favorable terms. Given that the current market value of the company is less than cash assets alone, the stock market is putting no value at all on the three operating businesses which appear on its balance sheet. Then, of course, there is Ajay Piramal, who does not appear on the companys balance sheet but, nevertheless, is its most important asset. He comes free too.

How often do you get a combination of: (1) a company with a large market capitalization; (2) cash in excess of its market value; (3) other assets having substantial future value; and (4) a brilliant and ethical owner-manager who has a demonstrated track record of enormous wealth creation for his long-term partners? Not very often, in fact, its very rare. Ajay Piramal is a rare occurrence and his story is worth telling you about. But the real story of the man is not just about how remarkably he sold the formulations business to Abbott. Nor is it only about the numerous smart acquisitions he has done although that has grabbed most of the medias attention over the years. Ajay Piramals story is also about a man who has a contrarian bend of mind, who ceaselessly explores multiple ways of creating value, and who has a very long-term orientation about wealth creation.

A WEALTH CREATION MACHINE

Take a look at the following table, taken from a presentation available from the companys website.

A Snapshot of Long Term Operating Performance The stunning growth depicted in the table is the result of both organic and inorganic growth. Thats another very rare combination. Being successful in M&A transactions is rare enough (about 70% of acquisitions fail to create value). Being successful in M&A and in operating several businesses in multiple countries is very rare indeed.

One test of long-term managerial performance I use, and which is favored by Warren Buffett, is an earnings-retention test. The test measures how every rupee earned, and not paid out as dividends, by a company gets reflected in incremental market value over a fiveyear rolling period basis. For companies that destroy value, every rupee of earnings retained is, over the long run, expected to translate into less than one rupee of incremental market value. For value creators, the equation is opposite. Every rupee retained should become much more than one rupee of incremental market value. Going back to 1990, I applied this test to Ajay Piramals flagship company. Even if we ignore that the companys stock is undervalued (which severely penalizes the results of this test), here is the report card: From 1990 to date: 5.8 times (that is, every Rupee 1 retained became Rs 5.80 in incremental market value); From 1995 to date: 5.5 times; From 2000 to date: 5.1 times; and From 2005 to date: 4.7 times. Any way you look at it, Piramal Healthcare has been a consistent wealth creating machine, one which has been only partially recognized by the stock market. Had the market given full value to the cash, the three operating businesses, and Ajay Piramal at the companys helm, the above results would look even more impressive. Even with one hand tied behind his back, Ajay Piramal has been a champion jockey. Why, then, is the market treating him like an also-ran?

A CONTRARIAN MIND
In deal after deal, it emerged that Ajay Piramal is a contrarian. Over and over again, he seems to watch what the crowd is doing, and then he goes and does the exact opposite. Back in 1990s, when MNC pharma were participating in a kind of a Quit India Movement, Ajay Piramal bought them out one by one at distressed prices. Now, when MNC pharma is desperate to be a part of the Indian pharma growth story, he has sold out to Abbott. His vision to expand the formulations business which focused on India, while other Indian pharma companies were focusing on exporting generics to the west, was another superb contrarian decision. Ajay Piramal enjoys taking the road less travelled by. And it certainly has made all the difference.

A VALUE INVESTOR
Another pattern that emerges is that like any good value investor, he simply does not overpay for assets and he often finds value where there is a distressed seller. Ajay Piramal about his acquisition strategy, he listed his three acquisition principles. One, there has to be a strategic fit and you have to be honest when you evaluate that. I have seen that there are many investment bankers and consultants who want the deal to happen and so they convince you that there is a strategic fit. Two, M&A is a very heady thing to do for a CEO. At least for the first few weeks, everybody puts your photo in the newspapers and talk about you and so there is this tendency to over pay. And, as you know, 70% of M&A deals dont create value. So whatever the value you have set out, you should not exceed that. We dont believe that you can get value out of overpayment.

Three, never look for a perfect asset. If you are going to acquire a perfect asset then the whole world is going to bid for it and its a very easy calculation to understand value and then you have to keep outbidding the next bidder. So there has to be some chink.That asymmetry which you can recognize that is there today an inefficiency perhaps, or something wrong which you can correct that is where the value is created. In every acquisition of ours there was something that other bidders found wrong and thats why they didnt do it.Take the classic case of Nicholas Laboratories in 1988. That company was a small multinational and for two or three years they was struggling and they wanted to exit. Another multinational had the offered to buy them out, they had gone through with it in terms of value. Everything was agreed because it was another UK company. But the reason they did not do it, and this is what one of their directors later told me, is because they realized there was some contingent liability relating to some excise duty matter. And you know in many corporations nobody is willing to take the final decision. You need clearance from accounts, you need clearance from legal and so on. If you asked a legal person if there is a risk? Yes there is a risk. But you have to evaluate the risk.Is it really going to materialize and if it does what could be the consequences. In multinationals nobody is willing to take the chance. Instead, they always say, we cant do it. And thats how we entered the pharma industry. Or take a look at the Roche and Rhone Poulenc deals. In both these transactions, there was something which was wrong and thats why I tell people when they do M&A deals

within our group that if you find everything right, then please understand you have to pay top dollar plus. In the case of Rhone Poulenc, when we acquired it, we realized there was a manufacturing plant in Mumbai. A plant in Mumbai that does manufacturing is a cost. It is a value destroyer because the costs are high. And there are issues of union etc. To most people, thats a negative. For us, that was a positive because we knew that we can deal with unions and that we can realize value from that asset by developing it. One metric commonly used in the pharma M&A deals is price-to-revenue. The highest Ajay Piramal ever paid was 3 times revenues for ipill, the popular oral contraceptive brand he bought from Cipla in March 2010). More typically, he paid less than one times revenue for most of his acquisitions. When it came to the sale of formulations business to Abbott, however, he was able to obtain a stunningly rich price of 9 times revenues. In contrast, Ranbaxy sold out to Daiichi in June 2008 for 5 times revenues. Indeed, the sale of the formulations business to Abbott, is one of the most richly-priced pharma deals ever.

SEAMLESS WEB OF DESERVED TRUST

A big part of the reason why he got such a rich price, is to do with a seamless web of deserved trust Piramal has created with big pharma over the years. After all, Ajay Piramal is a Buffett and Munger fan and often goes to attend Berkshire Hathaway meetings in Omaha. Charlie Munger attributes Berkshire Hathaways enormous success to this idea.When you get a seamless web of deserved trust, he once said, you get enormous efficiencies. Its what the Japanese did to beat our brains out in manufacturing: suppliers, employers, the purchasing company, management all created a seamless web of deserved trust. Its the same with good football teams. We are trying to live in a seamless web of deserved trust. It has worked for us, and it is the ideal way to live. How can Berkshire Hathaway work with only 15 people at headquarters? Nobody can operate this way. But we do. Now that we were warming up, Piramal wanted to tell me more about the creation of his own seamless web of deserved trust over 23 years. This web of trust extends to our dealings with everyone including those from whom we have bought businesses and those to whom we have sold. In almost every acquisition that we have done, there was somebody who was willing to pay higher from Nicholas Laboratories, Roche, Rhone Poulenc, to ICI there were higher bidders but we ended

up acquiring these businesses. Why did this happen? The only reason why it happened every time is because of the trust we have. Why did we get this valuation from Abbott? It is because of this trust. Seeing what other transactions in the environment before us (he is talking about RanbaxyDaiichi deal), they could have gotten another asset at much lower price. So why did they come to us? Because there was this level of trust and understanding. Having a web of trust is our philosophy. I am comfortable with it. We dont have a single legal case. Why? Why did we not go into patent challenges? Because you cant have a relationship where you keep fighting. Ajay Piramal wants you to know that by refraining from fighting big MNC pharma companies on theirturf (as many Indian pharma companies have done), he was able to get a much better value for the formulations business from them on his turf. Can this advantage be replicated? I think so. How could it be otherwise? Take for example the CRAMS business about which he is optimistic and has a long term vision. This is a small business at present but Piramal expects it to grow. Pfizer (the worlds largest drug company) is a customer of Piramal Healthcare in its customs manufacturing business.The act of letting someone else handle your intellectual property by big innovative pharma companies, requires a very high degree of trust in the manufacturing partner. By leveraging his web of trust, Piramal expects to become a partner of choice for big pharma companies. Of course this requires a very long term vision, which is another element of the pattern that emerges by studying his track record.

LONG TERM VISION

He tells I dont take much cognizance of the stock market which focuses on the short term. I will do whats right for the business and the shareholders.Frankly, I dont owe my job to an analyst. So, therefore, I can afford to take a long term view. For instance, he decided to go into drug discovery business very early. This business requires very long term thinking, ability to take risks, and to be prepared for failures, for the success rate is very low. Moreover, there is hardly any earnings visibility something that most analysts abhor. But if you get lucky, then the sky is the limit. If you step back a bit and see what is happening to the big pharma companies in USA and Europe, you will see that there is this big wave coming. Its a wave of shift of innovation from west to the east. Its a small wave right now. But Ajay Piramal can see it becoming a tidal wave in a few years.

Through Piramal Life (the unit was spun off from Piramal healthcare in 2007), Ajay Piramal has positioned himself just ahead of this approaching tidal wave. Shakespeare, who wrote There is a tide in the affairs of men, which taken at the flood, leads on to fortune, would have approved.

GRAND STRATEGY # 1: DRUG DISCOVERY

A big part of Ajay Piramals grand strategy is to retain Piramal Life. But why did he spin it off in the first place and what will he do with it now? He tells that Piramal Life was spun off from Piramal Healthcare in 2007 because it had a very different risk profile. By its very nature, the drug discovery business is a highly speculative business. Mixing it with the formulations business did not make sense, hence the spin off. To many, Piramal Lifes spin off may have appeared as an attempt to correct a past mistake of going into the drug discovery business in the first place. After all, spin offs are often used to get rid of troublesome businesses created by overoptimistic and overconfident men. This, most definitely, was not the case here. Both Ajay Piramal, as well as his highly qualified and accomplished spouse, Swati Piramal, who runs the company, are very optimistic about the longterm potential for the drug discovery business in India. In many ways, their contrarian traits can be seen from the way Piramal Life has been managed. For example, if you run a drug discovery company, one way to de-risk the business is to out-license your molecules to a big, and more prosperous pharma company who will then put its financial, technical, and political strength behind its development and approval by regulators such as the FDA. Of course, they would do that in return for a big part of the upside. This is how drug discovery model has worked for decades. Well, thats not how contrarians Swati and Ajay would like to make it work forthem. Piramal Life has 14 molecules under development, and has no intention, (at least, as of now) to outlicense any of those molecules. The reason is simple: They dont want to give away the upside. If they decide to out-license now, I wont be surprised that they would be able to negotiate and obtain upfront, and subsequent payments several times the current market value of the company (current market cap at Rs 108 per share is Rs 274 crores). But that is not how they think. They think in terms of not years, but decades. They think in terms of not maximizing near term reported earnings, but maximizing eventual net worth.

Both of them share a dream of leading the first Indian company which goes from discovery of a molecule to the global launch of a drug. Can they do it? Let me ask you the question another way. Given the resources technical, human, financial, and their excellent relationships with big pharma they now have, is there anyone else in India who can do it? And if they do it, can you imagine the financial consequences? Sometimes in life, exposure to lowprobabilityhighpositiveimpact situations (positive black swans) can massively improve the financial results of that lifetime if you get lucky, for you only have to get lucky once in a big way to make it worth your while. And the best way to get lucky is to organize for good luck to come to you. Louis Pasteur was right when he wrote: Luck favors the prepared mind. The minds of Swati and Ajay Piramal are prepared and they have positioned Piramal Life to have a chance for the best shot at the goal in the drug discovery business. There are two more interesting aspects about Piramal Life worth noting here. One, the company has negligible revenues, is highly leveraged (at least when measured against debt service ratios), and has large accumulated losses. Typically, this implies a large bankruptcy risk. However, the way I see it, the day Piramal Healthcare sold the formulations business to Abbott, the bankruptcy risk in Piramal Life disappeared because a very rich, committed, and longterm oriented parent now stood behind it. Two, the large accumulated losses in Piramal Life alone would be quite useful to highly profitable and tax paying Piramal Healthcare. Thats because in a merger, they could be used as a tax shield. Back-of-the-envelope calculations show that these accumulated losses alone, are worth about Rs 60 per Piramal Life share, to Piramal Healthcare. For these strategic and financial reasons, it makes imminent sense for Piramal Life to return to its very rich parent although there is no certainty by which this would happen.

GRAND STRATEGY # 2: EXPANSION OF CRAMS, CRITICAL CARE, AND OTC

Another part of Ajay Piramals grand strategy is to expand the three businesses that he did not sell. These are Custom Research and Manufacturing (CRAMS), Critical Care, and Over-the-counter (OTC) business. These businesses are small right now, but should grow in size as well as profitability over the next few years. Keep in mind that the

growth-oriented Piramal is always on the lookout of cheap inorganic growth and it wouldnt surprise me if he made a few very smart acquisitions in these businesses over the next few years. The key thing, when you have cash, is to also have discipline. Famous fund manager Peter Lynch once wrote about the bladder theory of corporate finance, according to which the more the cash that builds up in the treasury, the more the pressure to piss it away. While this principle is largely followed by many companies and men who have suddenly come into cash, is it likely that Ajay Piramal is such a man? I doubt it very much. His track record of demonstrated discipline in acquisitions speaks for itself. And recently, when Paras Pharma was being auctioned, while he had an interest in acquiring the company, he walked away because the asking price was too high. He agrees with Warren Buffett, who once said that the smarter side to take in a bidding war is often the losing side. The key thing to remember here is that, given the current market value of the company, all of these businesses come free to the buyer of the stock at the current price. These include some of the most well recognized brands in the OTC business including ipill, Lacto Calamine, and Saridon. Do you remember the jingle, Sirf ek Saridon aur sardard se aaram. Na rahe pida na rahe dard. Bas ek, sirf ek, sirf ek Saridon?). Well, if you own the stock at the current price, then among many other OTC products, ipill, Lacto Calamine, and Saridon come free (the brands, not the pills or the lotion).

GRAND STRATEGY #3: DIVERSIFICATION

Since the sale to Abbott, the media has been chasing Ajay Piramal about his plans for the cash. In response, he has consistently said three things. One, he will reward shareholders. This is already done through the buyback. Two, he will expand the remaining three businesses he did not sell. And three, he will diversify into one or more new businesses. This last statement has spooked the markets. Anytime a company announces a plan to diversify into a new business, the markets tend to dislike it. Usually the market is correct in this assessment because companies do tend to waste cash through diversification. However, my view is that you cannot paint everyone with the same brush.

Just as the markets skepticism for Ajay Pirmals grand strategy of growth though acquisitions was wrong, its skepticism for his decision to diversify is also likely to be wrong. The market forgets that his original decision to move into the pharma business in 1988 was also a decision to diversify away from the textile business. Nevertheless, the investment community is skeptical about what he will do with the money. Will he go into real estate? (He has denied this.) How about insurance? Or Retail? My question about this is: Does it matter? Should one not focus on the mans track record of wealth creation instead of worrying about whether he will go into real estate? And if he does go into real estate business, so what? Of all the people in India, he has one of the best experiences in the business. He was behind Peninsula Land, he was behind India REIT, he was behind Indias first retail mall (Crossroads) and he is behind Sunteck Realty. Indeed, if Ajay Piramal were to announce that he will diversify into real estate, investors should rejoice for two reasons. One, the man has experience and track record of having done exceptionally well in that space. Two, the space is full of opportunities where he can create value by buying into distressed situations prevalent in the real estate space at present. Then there is talk about his acquiring Hindustan DorrOliver. So I asked him, not whether he would diversify into the real estate business in Piramal Healthcare, or whether he is going to buy Hindustan DorrOliver. Instead, I asked him, what are the things he seeks when he wants to buy into a new business. He simply repeated his three acquisition principles mentioned earlier. How consistent! He did, however, mention, that he would expand overseas in both related, as well as unrelated ares.

VALUATION OF PIRAMAL HEALTHCARE (OR WHY DCF SUCKS)

One of the paradoxes about Ajay Piramal is that while he has a disdain for elaborate excel models of DCF valuation taught at business schools, it is the very same DCF (or rather the absence of the possibility of using it) which is a key reason for the streets neglect for the stock. When I asked him about how does he, when he buys into less than perfect assets, go about valuing them, and whether he uses formal DCF models or a more simple back-ofthe-envelope calculations, this is what he told me:

Management students may not like this. I am also a management student and both my kids are but let me tell you that management schools are doing a disservice by (overusing) DCF. There is nobody in the world who can predict whats going to happen in 10 years. And I was a student, so I know how to create value you change the terminal value and instead of 0.5% you will make it 2% growth and suddenly the value increases. So I dont believe in this. I really do believe you have to get the back-of-theenvelope calculations right. Who can predict what the market growth is going to be. If you tell me anybody who had predicted that the markets will grow like they have in India today. I dont think so. If anybody could predict to me what is going to happen to the exchange rate which is another big variable? I dont think so. Nobody can predict what happened to interest rates. So everything is variable and yet on that basis we make a fixed 10 year projection and do the DCF? I dont believe in this and in my entire life I have never done it. So here is the paradox: Ajay Piramal has not made his money by relying on elaborate DCF modeling. On the other hand, sell-side analysts and many investment professionals make their living by DCF modeling. Pick virtually any research report on any stock and turn to the pages in the end and you will see what I mean. There will be projections about the future (many of which will turn out to be wrong), based on which there will projections of future cash flows, which would have been brought back to present value using more projections about cost of capital. This false precision is yet another form of physics envy, practiced by men (mostly) who forget that its better to be roughly right, than to be precisely wrong. The trouble with doing DCF on Piramal Healthcare is this: How do you make the projections about a company, which is largely sitting on cash, and has plans to deploy that cash in some new businesses but at this time, even the ownermanager does not know which businesses the company will enter into? So, the analyst is thinking: How can I even begin to apply DCF on Piramal Healthcare. To a man with a hammer, everything looks like a nail. The analyst, who only knows DCF, is like that man. He has just one tool DCF and he tries to use it on Piramal Healthcare and he fails, so he tries again by beseeching Ajay Piramal to tell him where will he put the companys money, just so that he can make a model, but Ajay Piramal says: I dont know yet. After several failures, the analyst gives up. My advice to the analyst is that he needs another tool, one which he will find if he reads the influential paper Investing in the Unknown and the Unknowable (http://www.hks.harvard.edu/fs/rzeckhau/unknown_unknowable_PUP.pdf), by Harvard

Professor and a, much admired by Charlie Munger, champion bridge player, Richard Zeckhauser.

THE WORLD OF UU INVESTING.

In his paper, Prof Zeckhauser states, Most investors whose training, if any, fits a world where states and probabilities are assumed known have little idea of how to deal with the unknowable. When they recognize its presence, they tend to steer clear However, unknowable situations have been and will be associated with remarkably powerful investment returns Indeed, I would speculate that the major fortunes in finance, have been made by people who are effective in dealing with the unknown and unknowable. This will probably be truer still in the future. When it comes to valuing Piramal Healthcare, yes there is uncertainty. There is no visibility. But is this uncertainty the same as risk? Risk, advices Warren Buffett, should be thought of as the probability of permanent loss of capital. While most uncertain situations are also risky (e.g. new startup ventures), this doesnt mean that every uncertain situation is also risky. I ask you to carefully think about this. Given what you now know about Ajay Piramal, given his past track record, and given the asking price for becoming his partner (free), how likely is it that if you do become his partner, and if you have a longterm view, you will suffer a permanent loss of capital? While the street steers clear from Piramal Healthcare, Indias largest cash bargain, because the outlook is uncertain and there is no clear visibility and that makes it too risky does that have to mean that you should steer clear too? Thats a question I will leave for you to answer. As for me, I have to tell you that I own shares in Piramal Healthcare, and I have to tell you that Ajay Piramal bought shares in the company in November 2010 at around Rs 460 per share, and that the company has just completed a buyback at Rs 600 per share. The stock is selling for 450. The cash per share is 517. Everything else is free.