marico acquisitions - boost or boast

The growth strategy

The path for Marico has been clear: growth through acquisitions. Since 2005, it has made 10-12 acquisitions covering India, Bangladesh, Egypt, South Africa, Malaysia, Singapore and Vietnam. 

In a highly competitive market categories that the firm operates, one of the two strategies should pay: Increase volumes or increase prices, or may be a fair combination of the two. Since there is a limit to increasing prices and volumes of the current products, what better way than increasing the product portfolio? So does the management think and hence, these acquisitions. 

Acquisitions are good if price paid for these is fair in comparison to the future cash flows. Although, there are some exceptions, one of the parties to the transaction would have an edge over the other. This means, the value gained by that party would be at the cost of the other. That is how mergers and acquisitions function in the corporate world. Of course, most of them fail to create any value.

The historical performance

In this respect Marico has not done badly so far. Over the last decade its revenue has grown at an impressive annual rate of 20%; its operating and net margins have remained steady; but, return on capital and return on equity have reduced from high levels to reasonable levels.

The primary reasons for lower return ratios are the acquisitions. Its first major acquisitions took place in 2011 which included:

1) Singapore based skin care solutions business Derma-Rx for Rs.1.44 b; 

2) The Ingwe brand (mainly Caivil and Black Chic brands in hair care) from South Africa based Guideline Trading Company. Surprisingly, no information about the consideration and fair value of assets acquired is disclosed in the annual report. 

3) The 85% equity in International Consumer Products Corporation (ICP), a Vietnamese FMCG company having brands such as X-Men, L’Ovite, Thuan Phat in cosmetics segment. Here too, no information about the consideration and fair value of assets acquired is disclosed in the annual report. Instead, the resulting goodwill (which is the excess of consideration over the fair value of net assets acquired) of Rs.2.21 b is disclosed.

If we have a look at the fixed assets note and the statement of cash flows it appears that Marico's total cost of acquisition in 2011 was about Rs.4.62 b.

The stock performance in the past:

Clearly, shareholders have been happy.

The restructuring in 2013

Marico has undergone significant restructuring:

1) The divestment of Kaya Skincare business into a new (being listed) entity, Marico Kaya Enterprises Limited. As a consideration, the shareholders of Marico have been issued 1 share of Marico Kaya each (face value Rs.10) for every 50 shares of Marico (face value Rs.1), fully paid up. Because of this, Kaya skincare, including the 2011 acquisition of Derma-Rx, will be out of Marico's operations. 

2) In May 2012, Marico acquired the (Halite) personal care business of Paras Pharmaceuticals Limited from Reckitt Benckiser for a consideration of Rs.7.45 b. This is effectively for Set Wet, Livon, Zatak, Eclipse, Recova and Dr Lips brands.

The investments and free cash flows

Marico has made net investments of about Rs.26.28 b including working capital in the last decade. A large portion of this, about Rs.15.32 b, has come in the last 3 years. Consequently, revenues and margins will undergo some change in the coming years as the new acquisitions start flowing into the business. 

These investments have been funded by both equity and debt. If fresh issues of shares is used to fund acquisitions, there will be potential problems: It results in dilution of earnings for the existing shareholders; especially when the price paid for acquisition is not a bargain, it results in lower value for the business.

For the first time in many years, Marico issued new shares (apart from its annual employee stock options) in May 2012. It issued 29,411,764 equity shares on a preferential allotment basis at Rs.170 per share to two foreign investors - Indivest Pte.Ltd., an affiliate of Government of Singapore Investment Corporation (GIC) and Baring India Private Equity Fund III Listed Investments Limited.

The acquisitions on a regular basis have made sure that the firm has never had any meaningful free cash flows in the last decade. Its poor payout ratio reflects this.

The future performance
Marico owns brands such as Parachute, Nihar, Saffola, Hair & Care, Revive, Mediker, Livon and Set-wet (in India) and Fiancée, HairCode, Camelia, Aromatic, Caivil, Hercules, Black Chic, Ingwe, Code 10, X-men, L’Ovite and Thuan Phat (international).

Whether Rs.7.45 b for Set Wet, Livon, Zatak, Eclipse, Recova and Dr Lips brands is a fair price, time will tell us. However, considering their collective current revenue of about Rs.1.50 b, it will take significant growth in revenue and operating margins, and a high return on capital to justify this acquisition. 

After these acquisitions, Marico's book capital has increased significantly because of which there will be pressure on return on capital in the coming years unless higher operating margins are sustained.

As per its latest quarter's report the company has a target revenue growth of 15-20% and operating margin of 14-15%. Well, if I take their word for it and estimate the value of equity of the firm on a going concern basis it falls short of its current market value. 

Nevertheless, we have a precedent of two foreign investors buying shares at a price of Rs.170 per share in May 2012. The stock has run up 18% since then. 

You can bet on Harsh Mariwala and the CEO if you wish to; after all, the past is some indicator of the future, if not the best one. But then, it is your call on revenues, margins, cash flows and the risk.