The most powerful value creation vehicles are businesses that provide products and services. The product has a value that is greater than the cost of putting it together. This value is generated because the product/service is able to satisfy
- A pain/problem (medical services, food products, utility, housing…)
- A pleasure (cakes, candy, gambling…)
- Or provide prevention (insurance)
For example a great educational book can provide future value greater than the cost of printing and paper. This excess value is called profit
These vehicles co-exist in an evolutionary environment called capitalism. The worst are culled through bankruptcy and the best prosper and pro-create. For a business to remain competitive it has to further 2 fundamental qualities
- Productivity: increasing the efficiency of its processes (link)
- Uniqueness: this is also called the economic moat (reference Oracle of Omaha). It is a unique selling proposition that gives the business an edge over its competition. It could arise from patents, branding, scalability etc…
There are 2 broad kinds of business assets that we will come across
Good Assets (profit making)
- Has a great product. Usually the source of its economic moat. Can be seen in consistent historical growth in market share, EPS
- Has demonstrated consistent increase in productivity. . Can be seen in consistent historical growth in EPS
- Great management. People make a business great not machinery/processes. Can be evidenced in historical ROE, ROCE , Book value increase
Usually if you can find this business at price lower than its intrinsic value (FCFE model) it is a great opportunity to own a value creating vehicle. This is a great tool for passive investing.
Bad Assets (loss making)
- Has lost customer focus and is concentrating on the wrong product segment. This is a case of squandering away the economic moat and being attacked by other vehicles in this evolutionary environment. Can be evidenced in losing market share
- Has sacrificed productivity and cannot deliver value at right price. Can be evidenced in increasing cost base
- Bad management
These are typical targets for a turnaround. The most generic steps involved are
- How to restore uniqueness? A new product plan has to be chalked out with customer focus. This usually requires a capex outlay
- Productivity has to be brought on par with industry. This usually requires destroying over capacity and downsizing the fixed cost base. This usually requires a cash outlay for redundancies
- People , this is the most crucial part. The right managers are required on the frontlines who can give you feedback. This usually requires a cash outlay for redundancies.
The most important consideration is to ensure that this business still has a fighting chance to restore uniqueness and productivity and the CASH to ride out the capex and redundancies