Our increase in consolidated net worth at the end of FY19 was '103 million whichincreased the per share book value by 7.0%. Over the last seventeen years (that is sincethe present owners took over) per share book value has grown from '151 to '525 ('602after ignoring the effect of goodwill writeoffs) which after factoring in dividend paidduring this period works out to a rate of 8.9% (9.9%) compounded annually.
It has been an eventful year at Revathi. A year marked by some new initiatives thatwould impact the balance sheet and both sides of the profit and loss account.
Balance sheet first. Shortly after we acquired the company I had taken a view thatusing internal accruals in the business leads to inefficiencies in working capitalmanagement. As such I decided to build a treasury with the surplus cash and startedmanaging it actively. It was invested in a variety of asset classes including publicmarket equities power assets including wind and a group captive gas-powered project ajoint development real estate project and minority as well as majority stakes in operatingbusinesses.
Excluding the capital employed for acquiring majority stakes in operating businessesabout which I have been sharing my thoughts over the years our average capital employedin Treasury operations has been about '28 crores (currently at '17 crores invested in thereal estate project). On this we earned pre-tax profits of approximately '2 croresannually. This excludes the unrealized gains on the real estate investment. If we includethat the figure would more than double to about '4.5 crores. This works out to an averagereturn of c.16% annualized.
The real estate market in general and specifically the real estate market in Mumbai hasbeen unusually tough for unusually long. Over the years I have been updating you aboutthe challenges we have faced in liquidating this investment. The latest challenge arisesout of the drying up of liquidity for developers from lenders of last resort i.e. NBFCs.Our partner acquired several joint development projects but is being able to work on onlyabout twenty per cent of these. The rest are in a state of limbo due to tight liquidity inthe market.
Our attempt to sell our stake in this project was very near conclusion last year butunfortunately fell through as the acquirer could not arrange the finances to acquire it.Now that Revathi's balance sheet is debt free the pressure to sell the project has eased.We are no longer in a hurry to exit this project. Having said that we continue to besellers and if we find an interested buyer at a fair price we will seriously consider anexit.
I had shared in my letter for FY16 how an event led to the acquisition of Semac. Italso led to significant build-up of debt which almost trebled from the pre-acquisitionlevel of '30 crores. As soon as that deal fell through in FY10 we knew it would be anuphill task to clean up the balance sheet. Due to losses in the Construction Equipmentbusiness debt stayed at an uncomfortably high level for eight long years. It startedwinding down meaningfully only in FY17 and I am happy to report that by the end of FY19we were debt free again.
The lesson in all of this is only one - avoid debt or at the very least have veryconservative levels of debt. The external environment has plenty of uncertainties whichcontribute to the risks a business faces. Why add a new and potentially lethal source ofrisk by way of debtRs. Having debt also crimps on the ability to invest in the corebusiness to strengthen it. Thankfully the bad dream is finally over!
Now turning to the Income statement. The Drilling Solutions business has had fairlystable Revenues. While that means there has not been much growth it has also meant thatthere has not been much volatility in the Revenues. In this sort of a business keepingcosts under control becomes an important lever to maintain profitability. Due toinflation keeping costs under check requires a cost control mindset. When a business isconsistently profitable as the Drilling Solutions business has been the cost controlculture is not automatic. Over the years we have had periods when the costs raged out ofcontrol (FY11 to FY14) and there have been years we pulled things back. Our totaloverheads peaked at '22 crores at EBIT level (FY17) and at '27 crores at pre-tax level(FY13). In FY13 we had almost '10 crores of costs relating to interest (that four-letterword again - debt) and warranty costs on a poorly structured annual maintenance contractwith a large customer. Taking those extraordinary costs out our normalized overheads havebeen in the '17-18 crore range. Over the past two years we have scaled the overheads downfrom '25 crores in FY17 to the '18-19 crore range at present. Until we find a sustainableway to grow the business we will continue to stay mindful of our cost structure.
The Income statement also has well the Income side. Early this year we split thebusiness into three verticals to bring greater focus on each. These are Equipment Spares& Service and Exports. Each vertical is headed by a seasoned hand. By doing this weintend to have greater focus on each segment including demonstrating greater intent ongrowing our exports. In the past we have exported equipment to several parts of the worldincluding some of the biggest mining markets such as the US Australia Indonesia andBrazil. We have also exported to markets closer home like Jordan Tunisia SerbiaZimbabwe etc. All these export efforts were sporadic. As a result we got limitedsuccess.
By making this organizational change we intend to invest consistently in building ourexports business such as visiting potential customers in target markets participating inexhibitions building distribution channels and perhaps even enter into joint ventureswith local partners. We are exploring all these options and we hope that over the next fewyears we will have a meaningful and repeat exports business.
A short commentary on the financial results now follows. Ever since the old management(which we inherited with the business) retired in FY10 we have had only two good years(FY16 and FY17) in comparison with our history up until FY10. Our average pre-tax marginin the second period (FY11 onwards) has been half the average margins we used to make inthe period leading upto FY10. The good news is we got back to those historical levels inFY19 after adjusting for a couple of big write-offs that do not pertain to actions takenin the current year. We wrote-off unusable inventory worth '1.5 crores and bad debts worthalmost '2 crores during the year. Without these write-offs our margins climbed fiftypercent over the average margins during the second period. To be sure some of thesewrite-offs are unavoidable and will happen in the future also. But not of this magnitudeand not in a single year.
Another metric to focus on is the return on capital employed. In the
Drilling Solutions business in three of the last four years our return on capital hasranged in the early to mid-twenties. This is in line with the historical average of theperiod upto FY10.
The underperformance of Semac relative to the '90 crores of capital deployed has beena drag our overall performance.
A quick recap of our journey with Semac so far is in order. Management transitionsespecially of founders who have built the business over several decades in aservice-oriented business (as opposed to manufacturing) are disruptive. At the time ofpurchase of the two businesses we had put in suitable covenants to align their intereststo ours as well as some non-compete covenants. Unfortunately neither of those covenantsled to a smooth transition from the old leadership to new leadership.
We delayed the inevitable buying time to prepare for the eventual disruption. Theupside of this was that we had only one loss year in the eight years post acquisitiondespite the Lehman blow up which led to a serious disruption in the global (and Indian)economy for several years right after our acquisition and despite the prolonged slowdownin the Indian economy which led to a significant slowdown in industrial capex whichcontinues to this day. The profits were not outstanding (in relation to the investmentmade) but fairly consistent at c. '8 crores pre-tax. The downside was these Principalsran the business on such a hands-on basis that it was very tough to build the next line ofleadership under them. As a result we were able to postpone the inevitable but not avoidit altogether.
That inevitable finally hit us in FY17 which was the first year post the exit ofPrincipals. While we had been developing new leadership at some of our offices we werenot able to groom anyone for taking on the role of a CEO. This forced us to hire two CEOsin quick succession neither of whom was able to fill the large shoes of the Founders.
After two years of trying out hired guns at the end of the first quarter of FY19 Idid what I should have done sooner - promoting people from within to take up the role. Bythat time our order pipeline had significantly depleted as the new CEOs failed to bringin enough work to replenish our order book. Inheriting a weak order book means at least afew quarters of pain since the sales cycles in this business is three to six months. Thisis when the economy and capex cycle are normal. When the capex cycle is slow as it hasbeen the pain gets prolonged. To make up for lost time we bid for projects worth about'10000 crores in a short span of three quarters. However we saw decision making for newcapex get delayed even at bellweather companies like Tata Consultancy Services. Given ourfocused strategy the quality of clients we are working with and the kind of competitorswe are winning against I am quite hopeful that these dark days will end sooner thanlater.
There is of course a silver lining to our underperformance in the Design business. Thatis the Design Build business which has gone from a startup with no team and no Revenuesat the beginning of FY16 to '80 crores in Revenues this year. This business hasconsistently earned low teens pre-tax margins with very little capital employed. So farthe business model seems to be holding up and therefore we should be able to continue togrow the business with similar financial characteristics.
In the FY14 letter I had written about a company that was wholly owned by Revathi -Renaissance Construction Technologies. That company was into the business of providingproject management services. Post our exit it also got into construction of projects asdistinct from Design Build described above. At the time the business was quite new andthere were a lot of risks involved in the business including the liability of torts.Besides Revathi's balance sheet was under a lot of stress due to underperformance in theConstruction Equipment business soft Drill business and a leveraged balance sheet.Keeping the overall circumstances in mind the Board decided that being a startup in anon-core business it was adding extra risk to Revathi which was not advisable. HenceRevathi sold the business to Revathi's promoters in FY14.
Semac's performance in recent years has been quite soft. As a result banks wereuncomfortable in extending non-fund based facilities to the Design Build business. Giventhe success of the business we were getting more business than Semac could handle due tothe limitation imposed by banks. Therefore we decided to take on the spillover work inSemac Construction Technologies (SCTIL) (erstwhile Renaissance Construction Technologies).FY19 was the first year in which SCTIL took on its one and only Design Build project.
Now that the business is stable and proven and given that Revathi's balance sheet isnow healthy it makes sense to grow this business under the direct ownership of Revathiso that there are no conflicts of interest between Semac and SCTIL going forward. Giventhis would be a related party transaction shareholders will be asked to vote on thisproposed corporate action.
I would like to thank each and every member of Revathi and Semac and their families forbatting for the company during tough times. It takes belief in the management when thereare no results to show for all the talk. I want to express gratitude to everyone forstanding behind me like a rock and working twice as hard to row our boat away from thestormy seas towards calmer waters. I am quite confident that there is pot of gold at theend of the rainbow.
I would also like to thank our shareholders for being patient in these difficult times.All of you have suffered due to my mistakes and I am committed to come good and make yourjourney with us worthwhile.