Where The Rich Are Investing

Enlightening experiments

Chaitanya Dalmia’s investment journey has been asset-class agnostic and the accompanying intellectual and material rewards have been more than gratifying

It is not unusual for full-time investors to read through multiple books at a given point of time. For private investor and voracious reader Chaitanya Dalmia, though, one particular book has consumed a good part of his reading time for the past two years. Vedanta Treatise by Swami Parthasarathy first caught Chaitanya’s attention — you guessed it — when he was reading another book, Success vs. Joy by Geet Sethi.

 Considering Parthasarathy’s book is only about 340 pages thick, why has Chaitanya taken so long to finish reading it? Hear it from Chaitanya himself, “The beauty of the book is that it makes you contemplate. That is why after every 15 to 20 pages, you tend to reflect and relate it to life, read it again and then try to make sense of the subtle point being driven home.” 

For those who have known the 38-year-old for long, that answer also contains the secret to his investment success. Despite handling a multitude of asset classes with his elder brother Abhishek, Chaitanya has never been the type to rush into an investment and is obsessed with not losing capital. He elaborates, “Our investing philosophy is to be opportunistic yet safeguard capital. If there is no opportunity, we will stay in a liquid fund and do nothing, for years if it comes to that. That has happened for six to 12 months, sometimes 18 but not longer.”

He also likes to keep a low profile and has an unassuming air about him. Rahul Saraogi, managing director, Atyant Capital Advisors, has known Chaitanya for about 10 years now and says being low-key is classic Chaitanya. They met through Amitabh Singhi, another common friend and investor, and the friendship has grown since then. Saraogi recalls, “Amitabh told me that he has this friend, who belongs to the Dalmia group. We decided to meet for lunch and, having known some of the other Dalmias, I was expecting someone who was a bit of a high-flier. Chaitanya arrived in a beat-up Honda City. Over the next couple of hours, he spent most of his time listening and laughing and spoke only occasionally.”

This stance of not attracting attention to oneself also spills over to the investing side. Veteran investor and founder of Fortuna Capital, Sanjoy Bhattacharyya, first met Chaitanya when he was the chief investment officer of HDFC Mutual Fund. At that point, Chaitanya was looking to invest in his fund and during the conversation, Bhattacharyya realised that both were quite interested in some PSU banks. He recalls, “Very shortly thereafter, I found out that they [the Dalmias] owned 1% of Indian Overseas Bank. They would never throw their weight around, while with half that stake, we used to visit the bank’s headquarters and have long chats.”

Saraogi, too, remembers those investments, as, at that time, Chaitanya was the odd investor professing his love for PSU banks. “Chaitanya bought a portfolio of PSU banks such as Oriental Bank of Commerce, Bank of Baroda, PNB, Union Bank and IOB, and since he was the earliest guy in the trade then, he made a lot of money. I remember the Union Bank IPO at ₹16, and nobody even wanted to go its roadshow.” Union Bank went on to trade as high as ₹400 and now quotes at ₹118. 

Early approach

Given the value investing philosophy that he follows, others conditions (RoE, RoCE) being fulfilled, Chaitanya puts a lot of store in three basic metrics — price earnings, book value and dividend yield. He says most times he gets a few dumbfounded faces when he mentions these basic filtering criteria. “When I mention dividend yield, I have had people ask me, ‘You invest for dividends, are you crazy?’. But the fact is, value takes its own sweet time to unlock and I need to be paid well while I wait.” Not only have dividends contributed significantly to Chaitanya’s overall return, the other two basic filters also indicate how other investors perceive the business. 

There is another reason why Chaitanya mostly doesn’t invest in a company that does not pay dividend. He believes even the best managements are prone to error or wrong capital allocation decisions. “You may have a cash machine, but what is the point if you deploy the cash into a ridiculous business? Look at what ITC is doing. They are partly distributing earnings from a phenomenal RoE business but putting the rest into one earning a ludicrous RoE (hotels).” 

 That said, Chaitanya is not averse to investing in a relatively low-dividend paying company available at a cheap price if the earnings are being sensibly redeployed. A famous example is that of Tata Tea (now Tata Global Beverages), which Chaitanya bought in 2001 at around ₹20 and where he stills holds half the original quantity bought. During the time of the Tetley acquisition, Tata Tea yielded 3% and most investors were circumspect about the deal working out given the leverage used. “While not strictly FMCG, it was trading much cheaper and had a higher yield compared with other FMCG stocks. The acquisition worked out well and the stock has appreciated 7 to 8 times over the past 10 years.”

Bhattacharyya remarks, “If there is one thing that stands out in my mind about Chaitanya, it is how thorough and meticulous he is as an investor. Many of us, once we have a bright idea, are desperately keen to somehow confirm all the notions that we have, so that we can get on with buying the stock.” 

He cites an instance to demonstrate Chaitanya’s meticulousness. The two have several common investments and on one occasion, were contemplating investing in a tile company. In the tiles business, there is low-end competition from China and high-end imports from Italy and Spain. The Indian tile company had made its mark competing in the low- and middle-end segments and was now aspiring to move higher up the design and style chain. Chaitanya’s call was that the Indian company would have higher realisations per square metre once it broke free of the price competition at the low end. 

Since Chaitanya tends to use Bhattacharyya as a sounding board, he had discussed with him the investment drivers for the tile company and the kind of spends the company would need to incur to make that transition. “After going through Chaitanya’s analysis, I met the founder-chairman of the company and told him, ‘Saab, aapko itne paise lagenge, agle do dhai saal mein.’ Astonished, he asked, ‘Aap mere CFO se baat kar chuke hain kya?’ It shows how close Chaitanya was in getting it right,” adds Bhattacharyya. 

Saraogi and Chaitanya have also done some common investments. “We invested in NBCC after it fell post its IPO. Chaitanya is very disciplined about price and bought it at ₹95-100. At ₹160 or ₹170, he said there isn’t too much stuff on the table, and we sold it.” NBCC now trades at ₹120. 

Metrics trail

Saraogi says this precision is an outcome of the Dalmia brothers dabbling in multiple asset classes. He adds, “Abhishek and Chaitanya’s depth of understanding flows from their operating entrepreneur background and the private equity deals that they have done. Chaitanya has used a lot of that knowledge in his public investing.”

While that may be true, juggling multiple asset classes is an art in itself. Besides equities, the Dalmia brothers also deploy capital in private equity, private lending, money markets and real estate. While the purpose surely is to earn a higher return, the approach to each of them has been finely defined. 

 In terms of risk, private lending tops the charts, real estate is the most illiquid and money markets has the lowest risk and is most liquid. The purpose of the last is to serve as insurance in case all the markets are hit together. Chaitanya details his approach for the most illiquid as well as the riskiest piece. “We buy real estate with an investing mindset. If we like something, we stay put; we don’t develop or trade. We buy land rather than apartments to flip. In private lending, documentation is a point of haggling and we walk away from the deal if we can’t safeguard ourselves. Given our very stringent conditions of lending for less than a year, four times cover, collateral and personal guarantee, conversion agreement and 20% coupon, many borrowers also run away.”

As for private equity, after the Gesco bid, which put the Dalmias in the spotlight, the deals have kept coming. During that bid, they came in touch with several boutique merchant bankers, who continue to feed them proposals according to their size and philosophy. Here, too, there has been much learning.

The brothers’ first PE deal was Revathi Equipment and since then they have invested in four more companies. The infusion is either for debt repayment or growth capital. “Cash flow is a key objective. That is available in all asset classes that we delve into except real estate and PE (minority). Clearly, we couldn’t sit on five PE (minority) deals with no cash flow for five years. We, therefore, graduated to doing buyouts so that we control cash-flows. But, of course, buyouts come at a higher price and value. So, we had to significantly increase the outlay from ₹10-25 crore for a PE deal to ₹50-100 crore for a buyout,” says Chaitanya, explaining the rationale for selective PE investments.

And how do they decide where to invest and how much to pay? “We need visibility on if the earnings can double in 3-4 years. If so, we are comfortable paying 7-8 times current year’s earnings. The lower the number of founder partners the better, as it is easier to convince one partner. There has to be a track record of a decade as that gives you a reasonable idea of whether accounts are fudged. You can’t fudge beyond two to three years and the 10-year numbers tell you whether all the money is coming into the company.” 

As he dabbles with multiple asset classes, about 20% of Chaitanya’s time is spent attending to compliance and tax planning issues. Left to himself, he would gladly redirect that time to investing. Does that opportunity cost bother him? He says he has made his peace. “If I haven’t been able to understand a business that has become a multi-bagger, I don’t mind that. Having done my homework, if that idea goes, it is disheartening, but there will always be errors of omission and that is part of the game.” 

Errors of commission

While Chaitanya is resigned to errors of omission, he can’t suppress a hearty laugh when recalling his errors of commission. A distinct aspect of Chaitanya’s approach when dealing with public equities is to stay away from meeting managements of the firms. He says, “I don’t meet managements any longer because they only have good things to talk about their prospects and what they want to hide, they will never reveal in any case. I know many promoters but majority of them don’t know the value of their own stock.”

One of the earlier times (in 2002) when he actually met the management, he ended up making the worst investment decision of his life. SSI was one of the poster children of the tech boom and its stock went all the way to ₹7,000 before correcting to ₹300. That is when Chaitanya got in, lured by the cash the promoter had raised by way of an ADR when the stock was trading above ₹4,000.

SSI had negligible debt and since Chaitanya’s calculation showed net cash per share of more than ₹300, he bought in thinking that the core business was free. He was, clearly, unprepared for what came next. The cash was swindled and the stock went into free-fall, dropping as low as ₹30. The takeaway, “We could have lost 100% of our capital but were lucky to escape with a loss of ₹2 crore (about 20%). Even though the percentage was low, the rupee loss was significant. Since then, we decided to stay away from crooked managements despite how cheap any stock may seem.” 

His latest misadventure is an evergreen value trap called MTNL. Here, the signs were flashing red from the start — a dying business, geographically restricted and horribly managed — but Chaitanya’s thesis was that despite falling profits, it was still an asset-rich profitable company sitting on cash and prime land. It was paying dividends and there was an additional kicker in income tax refunds and receivables from DoT, each running into several hundred crore.

Where he got blindsided was the debt that the inept management kept on steadily piling in spite of getting the 3G spectrum at concessional terms, a year prior to the private players. “When I bought in at ₹120, it was priced slightly more than the cash in the books. Like the boiling frog, I didn’t anticipate the scale of the damage. I did sell part of my holding between ₹160 and 180 but what is left has caused considerable damage. If an asset sale happens or alternatively, if the government gives further concessions, it may show some life. In the worst case, it will go to zero. Selling at the current price is inconsequential. The learning was that I need to be more nimble in extrapolating a change taking place outside my original thesis.”

This and his earlier mistakes have made Chaitanya acutely aware that in the market, one cannot know everything about everything. Hence, his first line of defence is diversification across asset classes. Then, even in the equities portfolio, the number of stocks varies from 15 to 25. He explains, “25 is the ceiling and 15 the floor, because there are so many extraneous factors that, even if you wish, you can do nothing about. For insurance against imperfect information, you need to diversify.” 

This prudence also means holding a high level of cash. Depending on the market conditions, it varies from 5% to 25%. “We sit on cash until its value goes up significantly. When the markets are craving liquidity and opportunities abound, the cash you are holding comes in handy,” says Chaitanya. One such opportunity was the 2008 credit crisis. Saraogi says, “In late 2008, we were fully invested and impacted by the market going down. Chaitanya had lots of cash around and that helped him. But even then, it is not that he just took the cash and bought everything.”

That was 2008. How about now — where does Chaitanya see opportunity? “I am looking at exceptions in the hated space. Most companies in the infra space are beaten out of shape, but some with a sustainable niche and clean balance sheet are priced for bankruptcy. There is opportunity in engineering, capital goods and textiles.”

Worth one's while

Having been in the market for close to 15 years now and after paying Mr Market’s fees, Chaitanya’s approach has evolved to one of passionate detachment. His passion ensures that he is thorough with his checklist and a sense of detachment is necessary because it can take much longer than anticipated for the price-value gap to converge. The outcome is a mix of equanimity as well as intellectual humility.

Bhattacharyya says Chaitanya can envision how a business can grow in the long term — not in the next six or 12 months, but where it can be in the next three or five years — in a realistic way. “Most of us either get carried away or we fail to understand how things will be like three years from now. Chaitanya has that wonderful balance.” And given his mentor status, has Bhattacharyya’s passion for bridge rubbed off on Chaitanya? “No, it hasn’t,” Bhattacharyya says with a chuckle. “I did say it’s worth a shot and his response was, ‘Let me think about it’.” Did he not stress the spillover benefits of bridge onto investing and don’t people try to imbibe the qualities of one they look up to? “He has a very strong identity of his own. While he tries to assimilate the best that he sees in other people and build that into his way of thinking, at another level, he is very much Chaitanya Dalmia,” sums up Bhattacharyya.