Softlogic borrows for aggressive growth – Chairman Ashok Pathirage

The listed conglomerate reported fivefold revenue growth in five years, borrowing heavily to invest in businesses in retail, healthcare, financial services and leisure. Margins may be low but Pathirage believes the debt strategy allows the group to quickly seize opportunities in a transitioning economy aiming to be the top listed revenue maker a few years from now

Listed conglomerate Softlogic Holdings’ revenue has grown five-fold since it went public in 2011 to Rs56 billion for the financial year ending March 2016 and profits doubled to Rs2.2 billion. “Not many have been able to achieve what we have,” Founder Chairman and Chief Executive Ashok Pathirage says, forecasting another good year with revenue expected to reach Rs70 billion.

Softlogic has borrowed heavily since the 2011 IPO to invest in businesses in retail, healthcare, leisure and financial services. Borrowings doubled to Rs44.7 billion during this period. Some market analysts are jittery about Softlogic’s strategy. Fitch Ratings Lanka downgraded the company’s credit rating in stages from A- in 2012 to one notch above speculative grade BBB- by 2014 over high borrowings.

High borrowings to fund investment in these businesses propel strong revenue growth but impacts profitability. This is reflected in Softlogic Holdings’ net profit margin of around 5% and share price which has gained by only Rs2 over five years to Rs13.2 as at end March 2016.

For Pathirage, who controls the group with a 70% stake, growth is more important at this stage to make of opportunities that may no longer exist a few years from now. “We can be a lot more conservative, relaxed and still enjoy high profits but we will not have enough growth,” he says.

According CAL Research, a unit of Capital Alliance Securities, the debt strategy is paying off for Softlogic Holdings. Group profit growth is forecast at 34% from 2015 to 2018 with retail, healthcare, ICT and financial services revenue growing 36%, 22%, 42% and 15% respectively.

Softlogic Holdings is a futuristic company. We are aligned with the economic journey of the country. Our per capita is growing and this is why we invested in sectors that have potential to grow like retail, healthcare, financial services and leisure

Softlogic is the holding company for listed high street fashion retail chain Odel, listed hospitals group Asiri, insurer Asian Alliance, a finance company and stockbrokerage under the Softlogic brand, and hotels Centara Ceysands – in the South – and Mövenpick, in Colombo.  Softlogic is also the largest distributor of Samsung devices in Sri Lanka. The company has a vehicle dealership which is losing money.

Pathirage is now focusing on consolidating the group’s strong fashion and electronic retail segments investing Rs7 billion on a 600,000sq ft mall. He believes this will propel group revenue closer towards the large listed companies like conglomerate John Keells Holdings which reported a Rs93 billion turnover last year.

According to Pathirage, who founded Softlogic as a software company 25 years ago, the group is asset rich and the foundations are set for higher growth. He says he can sell off some of the businesses to bring down group debt to zero and still make enough money, but this is not what he wants.

“Look at some of the other conglomerates. They are static and their top lines are not growing as fast. Last year, our top line grew 43%. We are getting to where we want to be, despite what some say about our debt position,” he contends.

aBorrowing for growth

There is so much opportunity in Sri Lanka and we don’t want to dilute ourselves at this point in time but if we are to grow, I reckon we will have to do it at the right time.

If you look at our group, turnover was Rs56 billion last year and we expect it to grow to Rs70 billion this year, slower growth but at a reasonable rate given the economic challenges at the moment. At this rate, in three to four years, Soflogic will beat the biggest conglomerate in Sri Lanka in terms of top line, if everything goes well.”

Softlogic Holdings turns 25 this year. We started off as a software company with Rs1 million and nine employees. Last year we made a Rs2 billion profit with over 9,000 employees. Not many have been able to achieve what we have.

Look at some of the other conglomerates. They are static and their top lines are not growing as fast as ours. Last year, our top line grew 43%. We are getting to where we want to be, despite what some say about our debt position.

The foundation has been solidly set. Some of the investments are yet to commence operations and show results, like the Mövenpick Hotel, our first five star city hotel, which is opening this December. We have invested almost Rs7 billion and next year it will start contributing to the top line although we don’t expect it to generate profits in the first year.

Softlogic Holdings is a futuristic company. We are aligned with the economic journey of the country. Our per capita is growing and this is why we invested in sectors that have potential to grow like retail, healthcare, financial services and leisure.

In the retail segment, we are doing a lot with the fashion retail store chain, Odel. We have improved Odel’s profitability over the last one-and-a-half years since the acquisition, contained unnecessary expenses and at the same time improved the look and feel of the department store. We have done away with factory rejects. You will never find factory rejects in any of our Odel stores anymore. You will only find branded articles or our own private labels. So, that was the first step.

We will invest Rs7 billion on a 600,000sq.ft mall on Odel property at Alexandra Place, Colombo 7. There is another property in Battaramulla and we will decide whether or not to sell it to fund the mall.

We want to create value in anything we do. Fashion retail is projected to make a turnover of Rs20 billion in five years. This year it will have a turnover of about Rs9 billion.

We can surely bring in other investors to share the risk and reduce some of our debt and will still achieve our growth objectives but we don’t believe in this. Why should we be quick to share in the value that we are creating here?

In healthcare, we started off with a five percent stake in Asiri Hospitals ten years ago. Today we are the controlling shareholder of the largest hospitals group with a market cap of over Rs30 billion. In terms of multiples of how you value a company, Asiri’s multiples are 50% less than most healthcare companies in the region. So, if you value Asiri Hospitals based on these multiples then the value of the company should be almost double. We are investing Rs5 billion in a hospital in Kandy which will open in the next 22 months and we know it has the potential to be a winner.

The point is this: we are engaged in solid businesses. When we acquired Asian Alliance for Rs4 billion many people said it was overpriced. Recently, we sold the general insurance business alone for Rs1.5 billion, which is the smaller part of the business. We are left with the life insurance business valued at over Rs10 billion. When we bought Asiri Hospitals ten years ago its valuation would not have been even Rs3 billion. Today it’s ten times that. Soflogic Finance Company, which we acquired for Rs265 million today, has a loan book of over Rs15 billion.

If we sell Asiri or Odel we can demand a much higher valuation and pay off all the debt in the group. But why should I do that when we have big plans for the group? We are on a value creation journey in the next four to five years.

We had a partner for Asiri Hospitals called Actis who bought a 28% stake three years ago for $28 million. They sold their stake to TPG Growth for $60 million; they are probably aiming to double their investment in three to four years. So you can see where the valuations are heading and this is just one sector in the group.

If you take retail, we are the largest fashion retailer and once the mall comes up we will be able to drive more growth. When we bought Odel at net asset value, we didn’t pay anything for the business. We bought Odel for the land value alone. After one-and-a-half years, the land values have appreciated 70-100% so we are already up on the deal. What about the business, after all we are not a real estate company? We acquired the business because we knew that if we get it right it can deliver strong results; so, for me the business is the biggest asset and not the real estate gain.

Many of the large listed companies are reporting static topline growth rates between -1 to 2%. I am not saying our goal is to beat the biggest company in Sri Lanka on turnover. The point I am trying to make is that we are focused on growth sectors and the goal is to create value.

We are growing in ICT. We are one of the largest mobile phone distributors in the country with over Rs1.5 billion sales each month; we expect revenue from this segment alone will be around Rs18 billion.

We ventured into the leisure sector with a property in Bentota and it is doing well.  We will open Mövenpick at the end of this year and we think it is a great product. The rooms will be the biggest in the city I believe though I am not too sure of Shangri-La’s specs. We will have exclusive specialty restaurants, a nightclub, a rooftop bar, it will be a great hotel and people can look forward to a fantastic experience. These two hotels alone cost nearly Rs12 billon. I have no doubt that they will create value going forward.

Debt sense

Expansion and acquisitions have been financed mostly through debt. Given the high EBITDA the businesses generate we are not worried about the debt scenario. We can easily sell off either the retail or healthcare business and settle our debts and still, comfortably, make enough money. The point is, if you look at all these pieces – retail, healthcare, financial services or leisure – we are so much more valuable and I don’t see the debt position we’ve taken as a risk because we make good EBITDA for the sound business models we are in and, to boot,  have so much value in our assets.

a2Our businesses offer great value and great products. We’ve never taken shortcuts to window dress something for sale. Whatever we take on we do as we believe in the business – we are passionate about it. If we are not passionate then we will move away. We have a firm business plan and moving forward all these segments will add great value to the business and shareholders.

We are not in the mood to sell any of our companies because we believe the next three to five years is the best period for Sri Lanka in terms of growth. It has been five years since the end of a 25-year war and you cannot expect significant improvements in the economy to happen in five years. Of course, there are challenges. Everybody knows, even at this point, there are challenges, but these are minor setbacks. I think the country is set for a takeoff unless some unlikely catastrophe hits us. But I am positive. In that journey, Softlogic is well set and we will go after our objectives.

Equity or debt?

We can surely bring in other investors to share the risk and reduce some of our debt and will still achieve our growth objectives. But we don’t believe in this. Why should we be quick to share in the value that we are creating here? Equity can sometimes be more expensive than debt; there are instances where we have issued equity and purchased them back. If I believe one day that it would add value to the company to buy out the minority shareholders of Asiri Hospitals, I would do so – if I had the capacity. We can consolidate more profits to the holding company if we buy them out now rather than diluting it further. We can even consider going for a rights issue.

We have no problem with the balance sheets of our retail, healthcare, financial services or leisure companies in the group. Their balance sheets are solid. What we’ve done is taken out debt at holding company level and invested in these segments. We are thinking of capitalizing the holding company. Going forward we will not borrow significantly to fund these segments. The investment for the mall will come from the retail company and the Kandy hospital will be financed by Asiri which has a strong balance sheet. Mövenpick will probably be the last investment where the holding company borrows to fund it, at least for a while.

We closely hold 70% of Softlogic; the rest is with the public. So, if we want to capitalize the holding company further we don’t mind going for a rights issue. If we believe the companies in the group can support the holding company in the short- to medium-term we may not even do that. At this moment we don’t want to sell.

Taking risks

It is the passion to succeed that subdues those elements of risk. It is not the hunger for money that keeps me motivated. I am passionate about success. If it’s money then you can sell everything, settle all the debts and just focus on Asiri Hospitals for example. I can relax, play more golf and easily generate Rs5 billion in profits each year. But this is not what I want. I want to build a great organization with great people. There are challenges and this makes it exciting.

What for most people is risky is I must say, not risk from a broader perspective. Sadly, I think Sri Lanka does not embrace the entrepreneurial spirit. Most companies are run by executives who play it safe, planning comfortable retirements. So, why would they want to take such risks? There are companies that sit on so much funds that only generate interest incomes. Are they running a financial business or a good business? It is the same thing with some of our banks. They want to play it safe but all businesses have their own share of risk which cannot be avoided.

Weak links

Our loss making automobiles segment needs to be evaluated. Let’s see where we can go. We may divest the smaller businesses if they don’t make sense to us. ICT is difficult to evaluate and we may couple it with retail. It’s all about the brand and things can change. Look at what has happened to Nokia. Today, Samsung sales amount to Rs1 billion a month. We will enhance its scope, but it is difficult to know where the ICT sector will be five years from now. This is why we want to remain focused on retail, healthcare and financial services – these are our brands and we have full control over them. We have no control where Samsung will be five years from now but whatever the changes we will offer our customers the best available devices at that time.

I am passionate about success. If it’s money then you can sell everything, settle all the debts and just focus on Asiri Hospitals for example. I can relax, play more golf and easily generate Rs5 billion in profits each year. But this is not what I want

We can undertake easier businesses, be a lot more conservative, relaxed and still enjoy high profits. I don’t need to do any of this. I can easily sell off some of our businesses and bring down the debt to zero and run a company without much worry. But we will not have enough growth. We see great opportunities that will not last for more than 20 to 25 years from now so we need to work hard to make things happen. From almost nothing we’ve built a company that will reach a revenue target of Rs70 billion this year. If we were not aggressive where would we be today?

Those moments

Getting into healthcare was a coincidence, it was not a result of planning and strategic execution. A friend piqued my interest and I invested in a 5% stake in Asiri Hospitals with no intention of taking it further. The investment got me a seat at the board but I never attended any meetings. Before long I realized there was huge opportunity here. At that time most private hospitals were family-owned with no big vision. I bought more and more into Asiri and eventually took control. Then I began what some people told me were very risky acquisitions. I bought over Asha Central hospitals for Rs1.8 billion when borrowing costs were around 25%. If I did not buy it then we would not have been the largest healthcare provider today. We built the Asha Central Hospital and later sold a plot of land at Horton Place which belonged to Asha Central for Rs2.8 billion, a billion more than the entire investment I put into that company.

I knew the risks but I gave the project leadership. Now the focus is on retail and I don’t visit the hospital anymore, it runs on autopilot mode because I have built a good team there. I spend a lot of time on retail and it is my baby for now. I see the growth prospects and I will work hard to get there.

Even the Odel acquisition was not something I had planned for. The former owners approached me. We already had international retail brands with us and they thought I was the best person to take it forward. It was a great opportunity for Softlogic to dominate the sector.

Expansion

I don’t need to enter new sectors. People call me every day asking me whether I am interested in investing in a new venture. We are not interested. We are focused on what we want to do with what we have now.

Real estate is something we may consider. We may not go further into ICT. We started as a software company and haven’t gone far with that. I now believe in brick-and-mortar businesses where value is tangible. Dot-coms, e-commerce, their valuations and how they operate are opaque to me. No one really makes money. We may reconsider in the future depending on the opportunity but I would rather invest in tangible stuff for now.

Shareholders and creditors

I have the controlling stake in the holding company but we have a good understanding with the minority shareholders who are with us because they appreciate what we are achieving. Our creditors also have faith in us. Otherwise it would not have been possible to raise the money we have today.

Margins and ROI

Five percent is a good place to be in terms of net profit margins but you need to look at the specific sectors we are in. Healthcare, for instance, has an EBITDA margin of 30% which is among the highest in the region. An ROI better than bank interest rates is what investors look for. Take a step back and look at look at the bigger picture. When we took over Asiri ten years ago it was valued at Rs3 billion and today it is Rs30 billion which means the return must have been 100% each year. Look at Odel: its valuation was Rs5.5 billion when we acquired it and four to five years from now the valuation will be three to four times that. So what is the return? That is what we are building. We are not looking for short-term gains or conservative returns.

People

We have strict KPIs monitored on a daily basis. I have all the numbers of the retail stores on a daily basis. We don’t sit at the end of the month by which time it’s too late. To clock this kind of growth you need to be at the wheel. People like to come here because of the challenge and dynamic culture. We have share options for some companies but not Softlogic because the share price is undervalued. Soflogic Finance has an employee share option scheme but I don’t know whether they’ve earned it because there are KPIs they need to achieve beforehand.

For me, I am always working until I fall asleep. I don’t switch off. I may be relaxing or watching television but I am still hands-on on the job thanks to mobile technology. Coming to office is as good as a holiday because I enjoy working so much.

Minimum float rule

This is a good thing to have but we are not a developed market for it to work. We don’t have enough retail investors to drive this market. Without more people coming into invest we may see more de-listings if we try to impose minimum float rules because no one wants to see their companies lose value for no reason. Our share market does not reflect the true value of most listed companies. Then the owners end up buying the shares back leaving the stock exchange.

Will Softlogic leave the stock exchange? I don’t know. I can’t give an answer. We may think of de-listing Softlogic Holdings because our shares are not getting a fair value but we may keep some of our companies listed. That’s a possibility.

When we took over Asiri ten years ago it was valued at Rs3 billion and today it is Rs30 billion which means the return must have been 100% each year. Look at Odel, its valuation was Rs5.5 billion when we acquired it and four to five years from now the valuation will be three to four times that

Rising interest rates

Cost of funding will increase and we can pass on some of it to our consumers but we don’t expect interest rates will move up significantly. Even if there is upward momentum, it will be temporary, and we can sustain it.

Centara Ceysands

The hotel is doing well. In July occupancy was at 80% and in August it was nearly 91%, so we will be full when the season arrives. The big players will have to get their act together. Especially, the city hotels, when the global brands enter with attractive value propositions. But there is no reason to worry because the economy is growing and more tourists will also visit the country but they will have to realign their hotels and products to meet the growing demand for more value.

Ratings

Credit ratings are important to raise money but sometimes we may not see eye to eye when it comes to valuations. Ratings agencies are crucial but they seem to work best with more conservative companies. It’s good to know the risks and where you stand, and we are working at getting a good credit rating. We have enough money, and cash flow is healthy. We have ventured into more cash driven business like hotels and retail.

Expect the worst, move on

Very rarely does anything keep me up at night. I work so hard I just fall asleep. There is little that troubles me. I don’t care about uncertainties in the policy environment. Haven’t we seen enough of those?

If we had governments that created an enabling environment for businesses no one would have ever heard of a guy called Ashok Pathirage. We have seen unpredictability all the time and we base our decisions on the predictability that governments will be unpredictable, let me tell you that much. You have got to work with that.

You may suddenly find the rupee falling or interest rates spiking. We look at the worst case scenario, plan accordingly and move on. This is why having the right people is so crucial. We’ve created a top team that works with me inside out. We can nurture the best. It’s all about having a dynamic team otherwise you cannot do any of this.

At the end of the day, there is a limit to what I can do. When we see opportunities we will go after them but I am not saying that we will be this aggressive over the next 25 years. One day someone else will take over from me and you may find a bigger, more conservative company with slower growth simply because no one is willing to take on calculated risks.