Tata vs Mistry: Will it get uglier before it gets better?

There’s an old saying about the world of business, “Shirtsleeves to shirtsleeves in three generations”, which means that the wealth created by the first generation of a family is squandered by the third generation.

Recent statistics also back this. For instance, according to an article in the Harvard Business Review, just 30% of family businesses make it through the second generation, 10-15% through the third and 3-5% through the fourth.

In India, however, blood seems to run thicker than water. According to estimates by financial services firm Credit Suisse, Asia is home to 76% of all family-owned businesses worth more than $1billion, many of which have been around for decades.

Tata Group, the $100-billion-dollar family-owned conglomerate, is an example of a family-owned business that has survived for close to 150 years and has established a presence across industries and countries. And even though the group is now embroiled in a controversy over the removal of Cyrus Mistry as the chairman of Tata Sons, the group’s holding company, on October 24, history shows that the group is likely to weather the storm.

Different strokes

Family-owned businesses are fundamentally different from those run by professionals (such as a Hindustan Unilever, Nestle, and Procter and Gamble) in that they have a long-term plan and hence look beyond the profit motive while investing in capital. So, while professionally run companies would quail at the prospect of losses involved in a new product, a family-owned business would employ huge amounts of capital to pursue a vision.

Take, for example, Reliance Industries' foray into telecom in the early 2000s and more recently, with Reliance Jio in September. Both involved investing in massive amounts of capital for a business fundamentally different from the conglomerate's core strengths of petrochemicals and refining.

Similarly, Tata Motors also moved away from their core strength of truck manufacturing by investing in the car business with Tata Indica in the 1990s and Nano in the 2000s.

Beyond the profit motive, family-owned businesses also put a lot of focus in building trust and their reputation through community service and social objectives. For instance Tatas, Birlas and Bajajs have all built a reputation for philanthropy.

A question of returns

Capital allocation is how businesses deploy their financial resources and capital to generate returns. Family-owned businesses tend to use large amounts of capital to chase promoter ambitions and dreams – but some of these decisions might not always work out in the long run. For instance, Tata Steel acquired the Anglo-Dutch firm Corus in 2007, but the acquisition ran into trouble after steel prices slumped and the group is now seeking to divest the Europe arm of its business. In comparison, Tata Motors’ acquisition of Jaguar Land Rover in 2008 has fared much better.

Overall, however, the picture is gloomy for the Tata Group. As the Economist observed, “seven of the nine-largest listed Tata entities in terms of capital employed have negative economic value added, meaning that their earnings before interest and tax translate into a return below their overall cost of capital.”

This seemingly poor allocation of capital lies at the heart of the controversy over Mistry’s dismissal from Tata Sons, which the Irish-Indian businessman had called “wrongful”. In his letter to Tata Sons after his ouster – which was leaked to the media – Mistry raised many issues regarding allocation of capital Tata Group companies. He said:

Tata Power aggressively bid for the Mundra project based on low-priced Indonesian coal. As regulations changed, the losses in 2013-14 alone amounted to Rs 1,500 crores. Given that Mundra constitutes Rs 18,000 crores of capital employed (40% of the overall company's capital employed), this substantially depresses the return on capital for Tata Power as well as carries the risk of considerable future impairment.

A familiar story

Tata Sons has two major shareholders –Tata Trusts and the Mistry family’s Shapoorji Pallonji. Cyrus Mistry, appointed as Tata Sons’ head in 2012, was the only chairman in its 148-year history who was not related to the founding family.

Clearly, this experiment did not end well.

But even feuds within the family are not new to India Inc. India’s biggest corporate battles have involved brothers (Mukesh and Anil Ambani, Rajiv and Sanjiv Bajaj, their father Rahul Bajaj and his brothers and the Birla family); and fathers and sons or sons-in-law (Bhai Mohan Singh of Ranbaxy versus his son Dr Parvinder Singh and Raunaq Singh of Apollo Tyres versus son Onkar Singh Kanwar and TPG Nambiar of electronics group BPL versus Rajeev Chandrashekhar).

Solution on the horizon?

No one expected the Tata Group to join this unenviable list of feuds in family-owned businesses. Both the Mistrys as well as the Tatas maintain a low profile and are publicity-shy.

History, however, tells us two things. First, such tussles tend to get ugly before they get better – the dispute between the Ambani brothers, for instance, had made headlines before a reconciliation of sorts after close to a decade.

Second, a settlement will be found simply because there is too much at stake. A prolonged battle benefits neither the Tatas nor the Mistrys since their charities and wealth are tied to the future of the Tata Group. Hence, interim chairman Ratan Tata and his team will, eventually, find a suitable successor for Tata Sons and the Mistry family will either reconcile to this or sell out their stake.

Anupam Gupta is a chartered accountant and has worked in equity research since 1999, first as an analyst and now as a consultant. His Twitter handle is @b50.