Symphony Ltd.

Company background and history:

 Symphony Ltd. is the global leader in residential, commercial and industrial air cooling. Starting in 1988
in Ahmedabad, India (its current headquarters), it underwent dramatic growth in its initial decade of
operations (through its IPO in 1994) post which, unsuccessful diversification led it through a process of
bankruptcy reorganization.
 Consequently, it abandoned all other product lines and focused exclusively on air coolers. In 2008, it
acquired IMPCO, a pioneer and global leader in industrial air cooling based out of Mexico. In 2015 it
acquired MKE, a Chinese company in the industrial and commercial air cooling segment (subsequently
renamed GSK). Both companies were acquired as a part of distress sales enabling Symphony to gain
significant capabilities in complementary segments and geographies in its industry, more importantly
at a bargain price. While it has been able to turn around IMPCO operations completely, the GSK
turnaround is still work in progress with a complete turnaround expected in 4-5 years.
 An extremely frugal and rational management focused on the long term with sufficient skin in the game
(promoter holding is 75%), has enabled Symphony to exhibit moat like characteristics in a seemingly
simple “low tech” business like air coolers. Continuous R&D, investment in its brand and a firm pulse
on the market has ensured a robust pipeline of relevant products to meet market needs and maintain
market leadership.
 Symphony is debt free with a current market cap of Rs. 12,000 cr.

Introduction:

The best way to value a stock is to value the company like a businessman who has been presented with
an opportunity by Mr. Market to buy the business. The question to answer, then, is – Would I want to buy
Symphony Ltd. for Rs. 12,000 cr. today?

As someone with a background in equity research who runs his own small business (for almost a decade
now), I couldn’t agree more with what Buffett famously said “I am a better investor because I am a
businessman and I am a better businessman because I am an investor”.

From a business perspective, it would be virtually impossible to find a business model better than
Symphony’s. Solid brand name and technical know how translating into strong topline (35% 10-year CAGR)
and bottom line (55% 10-year CAGR) growth, market leadership (50% share, 3.5x its nearest competitor)
in an industry with a long runway (10% product penetration, 10-15% industry growth, affordable product,
move towards organized market), high profitability (50% plus gross margins and 30% plus pretax margins),
phenomenal capital return ratios in excess of 200% (primarily due to a 100% outsourced production model
and unique working capital management), and finally, the ability to grow with very little capex. One can
think of very few product companies in the world with these characteristics – its usually only tech companies
like the Facebooks and Googles of the world which can do this. As a businessman, I cannot ask for anything
better. So, how do they do this? Why haven’t competitors been able to replicate their execution? Let’s look
at some of the answers in the detailed analysis ahead.

Air cooling - an industry with a long runway:

India being a hot country with low per-capita purchasing power provides the perfect environment for air
coolers which are relatively inexpensive (70% lower capital costs and 90% lower running costs vs. air
conditioners). The Indian air cooler market is estimated to be Rs. 3,500 cr. (growing at 15% p.a.) with
organized players accounting for 30% of the size. Less than 5% of the roughly 25 cr. households own air
conditioners and 10% own air coolers. These factors indicate a long runway ahead with the recent
phenomenon of premiumization (air coolers priced at over Rs. 10,000 now account for 15% of the organized
market share) providing the icing on the cake.

Focus, growth and the secret sauce

Focus (born out of a transformative near-death experience) and a unique business model:

They say that necessity is the mother of invention and it couldn’t apply more than in Symphony’s case.
When Symphony was recovering from its bankruptcy, they realized that while they had burnt their fingers
in other product lines (washing machines, water heaters), their brand name in air coolers was still extremely
strong. They decided to amputate all the “cancerous” limbs and focused only on that one segment which
was still alive – akin to what Steve Jobs did when he returned to Apple in the late ‘90s and reduced the
product line from over 20 products to just 4. While competition (Usha, Blue Star, Voltas, Bajaj) is present in
various product lines, Symphony has very sensibly stuck to focusing only on air coolers (domestic and
industrial).

Growth:

This focus has enabled Symphony to exhibit strong revenue growth (35% 10-year CAGR to Rs. 768 cr. as
of FY17) and PAT growth (55% 10-year CAGR to Rs. 165 cr. as of FY17) without debt addition or equity
dilution. Revenue growth has primarily been due to strong domestic demand, although 10% of sales are
now from exports. Gross margins continue to be in excess of 50% (a combination of price increase in line
with inflation and premiumization of product portfolio). Pre-tax margins are upwards of 30% (excluding other
non-operating income). Pre-tax return on capital employed in the core business is upwards of 200%. While
growth across all parameters of the P&L statement has been strong, as Buffett said, even a savings account
will give you a higher year on year return if you continue to put money in it. Hence, the key criteria to look
at would be the amount of capital that was required to post this kind of growth and the incremental return
on that capital.

Take a look at the table below –

(Rs. Cr) Consolidated 2008 2017 Change Times (x)

Net income 12.1 165.6 153.5 13.7

Net fixed assets 6.2 77.1

Working capital 7.5 284.2

Less Excess Cash 3.2 282.8

Total Capital Employed 10.5 78.5 68.0 7.5

Cumulative 9 year earnings (2009 - 2017) 750.3

Incremental Capital Invested 68.0

Reinvestment rate 9%
ROIC 126%
Over the last 9 years, Symphony grew its profits 14x while capital invested grew only 7.5x. In other
words, over almost a decade, Symphony generated cumulative net profits of Rs. 750 cr. and retained less
than 10% of those.

Incremental return on capital employed was an astonishing 125%.

These numbers are consolidated and so include (currently) loss making acquisitions like the Chinese one.
The “core” standalone business paints a better picture of the true economics of Symphony’s business-

(Rs. Cr) Standalone 2008 2017 Change Times (x)

Net income 12.1 173.2 161.1 14.3

Net fixed assets 6.2 67.6

Working capital 7.4 271.7

Less Excess Cash 3.2 282.2

Total Capital Invested 10.4 57.1 46.6 5.5

Cumulative 9 year earnings (2009 - 2017) 749.6

Incremental Capital Invested 46.6

Reinvestment rate 6%
ROIC 246%

Over the last 9 years, Symphony grew its profits 14x while capital invested grew only about 5.5x. In
other words, over almost a decade, Symphony generated cumulative net profits of Rs. 750 cr. and retained
just 6% of those.

Incremental return on capital employed was an even more astonishing ~ 250%.

So, what’s the secret sauce? How is Symphony able to grow its business with such little incremental capital
(both in terms of fixed assets and working capital)? The answer is twofold -

1. Outsourced production obviates the need for large capex:

While demand for air coolers continued to grow through 2003-2008, Symphony didn’t have
sufficient internal funds to expand manufacturing capacity and so they chose to outsource
production instead of taking on debt to expand its own manufacturing capacity – a strategy deemed
extremely risky at that time but a masterstroke in hindsight. Consequently, almost 100% of
Symphony’s products are manufactured by 10 vendors with Symphony choosing to focus only on
quality control, R&D, brand building and capital allocation. A topline of over Rs. 750 cr is generated
by an employee strength of less than 500.
 2. Negative total capital employed makes working capital a source of float:

Dealers provide advances for Symphony products 9 months prior to actual sales. These funds act
as a float and enable the company to generate treasury income and more importantly, have a
negative total capital employed, not just negative working capital, since these advances > net
fixed assets plus working capital (excluding excess cash and investments)

Why would dealers do this when Symphony’s other competitors have to provide discounts and an extended
credit period to these dealers? Again, the answer lies in strong product demand due to Symphony’s brand.
This is the way it works - Symphony provides a pricing incentive to dealers beginning July (typically the
beginning of the sluggish sales season for coolers) with as much as 40% of it’s annual sales commitment
coming in the form of such advances. While dealers get better pricing and an assurance on price, Symphony
gets assured sales and not insignificantly, a float that generates treasury income. Despite the cash
advances, Symphony dealers generate an ROI in the range of 30% due to strong product pull making it a
win-win for both sides.

(Management is the) Moat:

In a seemingly simple industry like air coolers, where a traditional Porter’s 5 forces competitive advantage
analysis using would not lead one to believe that a company can possess a moat, how has Symphony
created a moat? The answer - a management that has adapted (learned from the past near-death
experience) and continued to be extremely rational and focused on the long term. Hence, it would be futile
to talk about management and moat separately.

The promoter Mr. Achal Bakeri, is also the CMD and has sufficient skin in the game (75% promoter stake)
to be adequately incentivized to take decisions which will enhance shareholder value in the long term.

Rational and long term oriented:

Management frequently urges investors to look at the medium to long term results and ignore short term (a
few quarters, a single year) results. In practice as well, management has always shunned short term
opportunistic gains in favor of bigger long term goals. This is evidenced as recently as the last financial
year (FY17) when management introduced a new product at low introductory prices. When actual demand
turned out to be 2.5x of projected demand, they decided to fulfill that demand at the low introductory price
and take a hit on their bottom line instead of increasing prices midway and taking undue advantage of its
dealers and customers. One way to look at the ‘bottomline hit’ might be to recharacterize this is as a long
term investment in the brand instead of a revenue expense.

Management has also exhibited a rational perspective for both internal and external capital allocation
opportunities -

Their M&A criteria is extremely conservative wherein they have selectively acquired companies in trouble
for a bargain (often close to zero – the China acquisition was for Rs. 1.55 cr), applied best practices from
India (essentially a capital light structure) to turn them around and then capitalized on two-way knowledge
transfer. Both their acquisitions so far have been strategic fits in terms of entering -

1. New segments within its industry – Their acquisition of IMPCO in Mexico enabled them to enter the
industrial cooling segment and helped them get know-how in addition to marquee customers like
Walmart - this learning would have otherwise taken years. Their execution was as per plan –
 quickly outsource production, pay down debt, make the core company profitable and apply
industrial cooling know-how in India. For ex. Symphony’s industrial cooling solutions now cool
Patanjali’s Haridwar plant.

2. New geographies – The Chinese acquisition helped Symphony enter into a new market and also
acquire key patents in industrial air cooling in addition to a manufacturing base in China. It is likely
to apply its turnaround formula (asset light operations) and enable knowledge transfer to its Indian
entity thereby further strengthening its global leadership position.

I reiterate, both acquisitions were at bargain basement prices.

Management continues to be extremely conservative even with its internal criteria for growth capex (for
instance when deciding to setup 2 export facilities in SEZs.) – their thumb rule is that the payback period
for any capex should be less than 1 year – as a businessman, I love this conservatism.

(Extremely) frugal:

Till about 5 years back (when Symphony moved into its own corporate headquarters), Symphony used to
occupy rented space at offices owned by Mr. Bakeri’s family’s real estate business (an interesting nugget
– the total rent they paid across all their offices was just under Rs. 1 lakh /month – this for a company which
had sales of over Rs. 300 cr. at that point – frugality at its best)

Focused (on strengthening the moat):

Management has been extremely focused on strengthening every aspect of its business and thus, widening
the moat.

 Management continues to invest in brand building – in fact, Symphony spent Rs. 41 cr. on
advertising in FY17, as much as its total revenue just a decade back.
 Focus, focus and focus on improving every small aspect of the business – from using apps to
capture real time sales data for better analytics leading to better inventory replenishment at their
retail outlets to continuous product innovation like introducing air purifier, touch and talk functions
in their coolers, management is intensely focused on improving every aspect of their product,
supply and delivery chain.

A company which has emerged from bankruptcy with the same top management is going to have an
extremely low probability of being flippant with money, providing a margin of safety.

Risks:

 While one cannot rule out competitive intensity impacting profitability and return ratios in the future
(after all no moat is permanent and no brand immortal), the primary risk for Symphony, currently is
more in terms of capital allocation. Symphony is currently sitting on an estimated Rs. 500 cr in excess
cash and generates Rs. 80-90 cr of free cash flow annually.

 When you’re looking at businesses that can grow without requiring too much capital, rational allocation
of the free cash flow becomes critical. After all, the only reason for paying a premium for a company
which generates substantial growth with very little incremental capex requirements is that the investor
would (ideally) get meaningful amounts of profits returned to him since the reinvestment requirements
/ opportunities would be minimal. In this context, while dividend payout has been around 40% of profits
 over the last 4 years on an average, dividend actually dipped sharply in FY17 (even after excluding the
impact of a special one-time dividend in FY16). Of course, investors should not have a problem as long
as management is able to meaningfully grow the reinvested capital. Buffett used the free cash flow
from companies like See’s (which grew with only a sliver of incremental capital) to buy other great
businesses. In the case of Symphony, this is still an open question.

 Management has often talked about considering buybacks (in quarterly conference calls as well as the
annual report). At such high valuations, however, a buyback would almost certainly not be value
accretive.

Valuation – the fly in the (otherwise perfect) ointment:

The difference between a great company and a great stock is price. And this is where the cookie crumbles.
A purchase at the current price with a 5-8 year holding period would almost certainly be devoid of any of
margin of safety. Let’s see how –

Total returns for a shareholder come from 2 sources –

1. Growth in enterprise value (combination of earnings growth and/or multiple expansion)

At 67x TTM earnings, or over 50x 1 year forward earnings (even assuming a 25% growth), the scope
for multiple expansion seems extremely limited. In fact, unless Symphony can continue to demonstrate
at the end of the 5-8 period that it can continue growing at high rates (20-25%), there is actually a
chance of multiple contraction. Even in the most optimistic case that the multiple continues to hold,
Symphony would have to grow earnings at 18 - 20% without any missteps, an aggressive requirement
in and of itself. Looking at it another way, there is no margin of safety in a stock where everything
needs to end well just to get a 18-20% return.

The scope for the first, then, seems limited. How about the second?

2. Dividends and buybacks (capital allocation decisions by the management)

While dividend payout has been around 40% of profits over the last 4 years on an average, dividend
dipped sharply in FY17. Even at the higher (40% range) dividend, the dividend yield at current prices
would still not be meaningful to compensate for the potentially mediocre growth in enterprise value.

All in all, it is better to be roughly right than precisely wrong (Buffett quoting John Maynard Keynes) and
while I have not done a precise valuation of Symphony, it suffices to say that an investment at the current
price would most certainly lead to a mediocre return over time. The market often gets ahead of itself and
this seems to be the case for Symphony, where a large part of the future growth seems to be priced in.

This stock, to my mind, should be somewhere at the top of the list of stocks to buy when (and if) Mr. Market
gets depressive and offers a compelling opportunity.
Conclusion:

“Leaving the question of price aside, the best business to own is one that over an extended period can
employ large amounts of incremental capital at very high rates of return.” – Warren Buffett (Berkshire
Hathaway 1992 annual report)

However, there are the rare businesses which can be categorized as “better than the best” –

“It’s far better to have an ever-increasing stream of earnings with virtually no major capital requirements.
Ask Microsoft or Google.” – Warren Buffett (Berkshire Hathaway 2007 annual report)

And then finally, you have the absolutely rare businesses – product businesses that can provide an ever
increasing stream of earnings with virtually no major capital requirements – Symphony! A great company
but certainly not a great stock.

Note: I do not own the stock