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Michael Porter is well known for his five forces framework, which remains one of the best ways to assess an industry's underlying structure.

Industry Analysis

An individual company can achieve superior profitability compared to the industry average by defending against competitive forces and shaping them to its advantage.


However one of the forces that is threat of new entrants or barriers to entry is the most important force within Michael Porter's framework of competitive analysis.


Focusing your attention on this particular force can help you make an actionable point for competitive advantage or strategies available to the company to remain superior.


Before we talk about Michael Porter's threat of new entrance or barrier to entry, let's look at the other four forces:


Supplier power is the degree of leverage a supplier has with its customers in areas such as price, quality, and service.


Suppliers may have power if:

-       there are very few suppliers of a particular product.

-       there are no substitutes.

-       switching to a competitive product is very costly.

-       the product is extremely important to buyers.

-       the supplying industry has a higher profitability than the buying industry.


Buyer power is the bargaining strength of the buyers of a product or service.


Buyers may have power if:

-       there are a small number of buyers.

-       the company purchases large volumes.

-       switching to a competitive product is simple.

-       the product is not extremely important to buyers.

-       customers are price-sensitive.


Substitution threat addresses the existence of substitute products or services, as well as the likelihood that a potential buyer will switch to a substitute product.


Competitive Rivalry describes the intensity of competition between existing firms in an industry.


Threat of new entrance or barriers to entry 

This is one of the most important forces that a company has to deal with. An industry structure where barriers to entry are low will be crowded by many players. These industries may require less capital, have low scale and will often show a low return on investment.


The first area to look at is supply. These are usually cost advantages that allow a company to produce and deliver its products or services more cheaply than its competitor. These advantages could be related to proprietary technology or experience or maybe a combination of both.


The second area to look at is the demand. Some companies have access to market demand that their competitors cannot match. This is often linked with customer lock-in, out of habit, switching costs or simply not being able to find a substitute.


For example, if Nestle decides to increase Maggie’s price by ₹1, chances are that its demand will not be impacted. Similarly, we know that Tanishq charges a premium for its jewellery but still there is customer loyalty, may be driven by the brand power.


The third lever is the economies of scale. If the company has a high fixed cost in comparison with its total cost, as the demand increases it enjoys economies of scale because the cost per unit will decline.


There could be government protection. However, research indicates that any protection in the form of government licenses or patents is limited.


A sustainable competitive advantage would often be extremely simple but very difficult to replicate. At any point in time, any of the licenses can be a competitive advantage but licenses also come with their own expiry date.


One of the aspects of understanding competitive advantage is to figure out how sustainable are those advantages.


Look for local leaders either by geography or by sub-industry. The structure would often be only limited players (1-2), have high ROIC, limited debt and would often display pricing power.

India's financialization has just started. CAMS stands to gain from that growth. As the young population continues to find meaningful employment.

India's Financialization has just started

Computer Age Management Services Limited is a technology-driven financial infrastructure and services provider to mutual funds and other financial institutions with over two decades of experience. With the initiative of creating an end-to-end value chain of services, the company has grown its service offerings and currently provide a comprehensive portfolio of technology based services, such as transaction origination interface, transaction execution, payment, settlement and reconciliation, dividend processing, investor interface, record keeping, report generation, intermediary empanelment and brokerage computation and compliance related services, through its pan-India network to its mutual fund clients, distributors and investors. It also provides certain services to alternative investment funds, insurance companies, banks and non-banking finance companies. The nature of company’s services to mutual funds spans multiple facets of their relationship with their investors, distributors and regulators. By providing a range of services, it plays an important role in developing and maintaining its clients’ market perception.

Market Share – 69%

Industry Structure – Oligopoly

Investor/Promoter – FII (47%) DII (23%)

Category – Mid Cap

MD Compensation – 4.12 Crores (March 2023) Reasonable 1.45% of Net Profit

Net Profit – Rs 285 Crores (March 2023)

Services to AMC – 90% revenue

Auditor – Not BIG5

CAMS enjoys competitive advantage related to Customer Lock-ins. There is no contract per se, but if an AMC or insurance company signs up, it is very hard for the company to change their backend provider due to massive operational dependency.

The company is not protected by any special rights, however customer relation that is asset management companies and insurance companies relationship with camps is there ultimate strength.

This advantage is reflective in high margins and ROIC.

Any growth impact has a positive contribution to the cash generation in the company. CAMS enjoys operating cushion, and this also create economies of scale advantage. The deployed capital can help service more AMC/Insurance and the cost of service may continue to decline due to low capital needs.

India's financialization has just started. CAMS stands to gain from that growth. As the young population continues to find meaningful employment.

And growing comfort with mutual funds, more people are expected to deploy there savings towards mutual funds.

CAMS must protect its market share of 68-69% and maybe grow it further. They have to continue to find opportunities within the related field of asset management whether it is working with financial advisors, portfolio management schemes, insurance companies, banks or AIFs.

Let’s look at the implied growth.

Average 5 years FCF ~210 crores, assuming a discount rate of 10% given that the company has predictable cash flow and is high ROIC and high margin company.

Implied growth using these assumptions is 20%, close to the recent past. Infact, different scenarios can be created by tweaking the assumptions.

Assuming a discount rate of 10%, terminal growth 5% but latest cash flow, expected growth is 14%, less than the historical average.

Irrespective, expected growth is closer to the historical average.

Analysis must also include arriving at the fair value of company. This includes discounting future cash flows and requires a bunch of assumptions. This is where analysis becomes ‘grey’ rather than give black or white solution. You must perform your own analysis and make your own judgement, continue to refine your analysis based on the new inputs.

Price is the most important piece of investing. A great company at a very high price is a bad investment. Similarly, an average company at cheap price can be a great investment.

How much margin of safety you want to keep depends upon the quality of company. A high quality will have low margin of safety (20% discount from fair value) whereas a lot quality will need a high margin of safety (50% discount from fair value).  

When a company goes public and sells shares to a wide range of investors, price discovery happens. The price of the shares is based on what investors think those shares are worth.

Flow of capital is everything
In any competitive economy capital invariably seeks the areas of highest expected return. – Pat Dorsey

Usually, a company is started by its founders. As the company grows its profitability, the set of founders and early investors may require liquidity and they exit a portion of their holdings. This process also enables the discovery of a ‘fair price’ for the company.


So in a way, there is a difference between prices quoted in private markets versus public markets. We often say that a private company is available at a discount to its closest publicly listed company, this discount is a liquidity discount.


When a company goes public and sells shares to a wide range of investors, price discovery happens. The price of the shares is based on what investors think those shares are worth.


Each investor decides what he or she thinks the value of the shares should be and decides based on whether the current price is above or below that estimate of the fair value.


Interestingly, private company valuation depends upon the performance of the company. It is based on the future cash flows of the company.


However, market liquidity can create an illusion of value. In 2020/21, interest rates were all-time low, the risk capital flow reached its peak and a lot of start-ups received funding. These start-ups and founders were celebrated across the media.


In the next 18 months, liquidity dried up and these start-ups reached an existential crisis. The movement of interest rates created liquidity, inflation peaked, interest rates increased, and liquidity reduced. It’s a textbook version of market play.  


This means, essentially, the private investors in 2020/21 were not paying for the performance of the investee company rather they were caught up in FOMO. 


Public markets are the worst. Any reasonable businessperson who is running a cash-rich business and is under no pressure from an outside capital contributor will choose to stay private. This way he/she can focus on the business.


However, public markets are filled with emotions. Even if the company does well but does not meet investor’s expectations, the investors would be disappointed.


What’s the point of doing fundamental analysis, then?


“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” ― Benjamin Graham


An astute investor will always be looking for opportunities where the market is depressed, often a short-term phenomenon. As the market gets euphoric, a smart investor is on the sidelines.


Not only does the share price drop when the market realizes that the company won’t be able to deliver but regaining credibility may take years.


Conversely, if the market’s expectations are too low and you have a low share price relative to the opportunities the company faces, a smart investor jumps in.  


In the short term, the movement of the market is driven by capital flows, however, in the long run, fundamentals must shine and share prices respond.


The collective wisdom of the market is too good.


Be a long-term equity investor.

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