Source: Octahedron Capital
Mohnish Pabrai on Rain Industries
Rain Industries is headquartered in Hyderabad, India. However, the bulk of its operations (and revenues) are in the United States and Europe.
When Pabrai Funds first invested in Rain in mid2015, the market cap was $175 million. This was a business that had revenues of $1.9 billion in 2013 and 2014. I thought the odds were pretty high that it would generate over $175 million in after-tax earnings in a single year in the not too distant future – and in the 12 months ended 9/30/18, Rain reported over $165 million in after-tax earnings. That number includes over $70 million in depreciation and amortization. Free Cash flow (before capex) exceeded $235 million.
Indian securities laws do not allow any single Foreign Portfolio Investor (FPI) to own more than 10% of any listed business. Thus, all we could invest in Rain Industries was a bit less than $20 million. We own 9.8% of Rain Industries. If these ownership limits did not exist and we could find willing sellers, I would have been happy to have Pabrai Funds put $60 million into Rain and own about 30% of the business.
A business generating $165 million in after-tax earnings, it is not going to change hands at $175 million. And that indeed turned out to be true. On January 8, 2018, Rain’s market cap was over $2.35 billion. A nice home run! We had more than a 12x return in less than three years.
So, why didn’t we sell? What stopped me from selling is that I got to know the business and its amazing leader, Jagan Reddy, a lot better over the last few years.
In the last 3+ years that we have owned Rain, I have seen Jagan Reddy (Rain’s Managing Director and 40+% shareholder) make one smart decision after another. In fact, I have never seen Jagan make even one dumb decision.He has made very large capital allocation calls over the last 12+ years and they have been flawless. It is a remarkable record. He is a dream manager.
In 2006, Rain was a sleepy Indian cement company with a small pet coke calcining operation based in India with revenues of under $115 million. Seven years later, revenues were $1.9 billion and net income exceeded $115 million. Jagan achieved all this without issuing a single share of stock.
He took on a lot of debt, but it was shrewdly arranged where the only recourse was to the assets he was purchasing.In 2007 and 2013, he purchased two remarkable assets for $1.5 billion with no money down, high-yield debt and no recourse beyond the assets acquired! In fact, the 2nd asset, Rutgers, was bought with all the recourse being limited to the 1st asset he purchased (CII Carbon).
After each acquisition, Jagan rolled up his sleeves to take costs out and make both operations the lowest cost operators in the entire industry. At industry low points, Rain’s competitors have mothballed plants and lost money, but Rain has always been in the black. Through internal accruals, Rain has thus far paid back $600 million of the $1.5 billion it borrowed. It refinanced the debt with perfect timing in early 2018 – extending maturities and cutting the interest rate substantially.
To give you an example of how Jagan thinks, the company has embarked on two growth capex projects in 2018 that will collectively cost $140 million. It would surprise me if these projects do not increase after-tax earnings by at least $30 million when completed in 2019. Intrinsic value will go up by around $300 million. He is not done yet. Every year Rain is going to hand Jagan $100-$250 million in cash. It will get intelligently redeployed. And each time he’ll probably increase market value by 2x or more of the capex spend.
It would be very dumb to say goodbye to such a gifted leader and capital allocator.
Rain is being valued these days at $560 million. A bad year for the company would mean floor earnings of perhaps $100 million. A good year may produce more than $250 million in after-tax profit. Perhaps average earnings will be $150 million. However, we have to add to that Jagan’smagic with reinvesting earnings at a high ROE. In that scenario, “floor earnings” may very well be $200 million in a few years. Rain is cheap based on estimated future cash flows if intrinsic value does not increase. It is insanely cheap if earnings are redeployed at a 30+% after tax annual return.
Jagan’s hands were tied behind his back with the heavy debt load and lack of capital for most of his career. He is finally getting to flex his muscles. For the first time, he’s likely to be handed $100-250 million every year. I’d like to stick around to see what Rain looks like in 5-10 years.
Last year Rain started an “Advanced Materials” business unit and brought in a senior executive from BASF to run it. Advanced Materials may be Jagan’s next home run.
In hindsight, it was likely a mistake for at least PIF3 not to lighten up when the stock went over Rs. 400/share. We did sell some of PIF3’s Rain position at around Rs. 375, but the stock wasn’t there for very long and as Rain’s stock price declined, our selling ended. I will continue to carefully monitor Rain and lighten up our holdings if such a move is warranted
-From 2018 Memo to Investors