Cash is King but it also kills.
One of the companies hit the market with an IPO. Their Merchant banker advised them to raise more money than required. The issue was subscribed. Excess money they invested in unrelated business. That business could not succeed. The return on share capital could not match the market expectations. The share price reached below par. Since the share price was below par, later on when they needed money, they even could not raise the money. The profitable business suffered as they could not invest at the right time.
When we met than during that period, they were badly in need of the money and the MD of the company narrated us the above story.
This brings us to two things:
- The necessity of the financial acumen of the company owners.
- Excess Cash Can kill the business.
The same is true when the company borrows excess money than required. The payment of interest and the principal amount of excess borrowing could be a challenge when this money is not invested wisely or in an unrelated business.
Another company was a market leader in the ceramic tiles industry. The MD was very dynamic. Based on the success of the business, raising money for them was easier. The group ventured into Compact Disc (CD) business competing with the market leader then. They borrowed and invested heavily in the business. Ceramic Tiles and Compact Disc!! See diversification.
Compact Disc is a technologically sensitive industry where changes are fast and margins were quite low.
When I met them, they were planning to invest in another unrelated business and wanted to raise money.
In between, they entered the capital market with IPOs for both the ventures. They were again flush with funds.
Today the group is insolvent. Their share prices are below Rs.1/-. It is a matter of just 12 years. Many time too much diversifications affect management bandwidth and the businesses suffer.
Two more lessons:
- Ability to raise money by no way suggest you need to raise money
- Success in one business does not guarantee success in another
Many times, excess capital raised temps the promoters to raise matching debt to set up a larger plant. This could impact the viability of the project. When the viability is impacted breakeven point, IRR, everything is affected. Performing assets would have to bear the excess load of the infrastructure. Even the market might not be ready for excess production. This could make the project unviable and ultimately fail.
Two more lessons:
- Do not set up excess capacity just because you have money, viability should be the key consideration.
- Excess capacity and investment make a healthy unit, sick with the excess burden.
There are various reasons and case studies where excess cash has failed the business and business empire.
Excess Money and Mismanaged Money both could result in bankruptcy.
“If you don’t take care of your money your money won’t take care of you.”
Smart companies like Infosys buy back shares when they face excess cash issues or declare a higher dividend. They are aware if they do not have a safe and attractive investment opportunity it is better to return the money to the shareholders.
Be watchful when you invest bank or equity shareholders’ money. They are the market and markets are ruthless. Perform or perish. Failure of one business could have a contagious impact on the other successful business.
When the money is available easily, either because of your track record or the market is flush with funds, be very careful in inviting money to your business. Money needs return irrespective of the cyclical nature of your business or your incompetence to manage the money.
“We were not taught financial literacy in school. It takes a lot of work and time to change your thinking and to become financially literate.” Robert Kiyosaki