Achal Bakeri, Learning Machine

This is a Teaching Note and Not a Stock Recommendation

Teaching Note on Symphony

In early September 2013, I wrote a mail to a colleague requesting him to take a look at Symphony
— the world’s largest air cooler company.

At the time, the company’s stock price was Rs 295 per share.

I had seen a pattern which attracted me to the business and its stock, and the pattern that I saw, I
listed in my mail.

1. Branded player in the cooler market

2. Debt-free balance sheet
3. Market cap of EV of Rs Rs 1,032 cr. (stock price of Rs 295) compared for FY13 PBT of Rs 92 cr.
4. Pretax ROE of 44% (PBT for FY13 as compared to average net worth for FY12 and FY13)
5. Stock has corrected from a high of Rs 419 in October 2012 to Rs 295 now.
6. A high margin business. EBITDA margins of more than 25%
7. Company is also into exports
8. Rs 1,000 cr. odd valuation looks quite low to me given the potential size of the market this company can address.

I had put together some information on the company — annual reports, conference call
transcripts, some sell-side research reports and a report by CRISIL, an independent research outfit —
in a dropbox folder which I shared with my colleague.

My mail ended with two requests.

Let me know what you think about the business and the management. For the moment, let’s park the valuation
part of the thesis.

“Let’s park the valuation part of the thesis.” This was important. For two reasons. One, I was
gradually transitioning from being a classic Graham-and-Dodd style investor who invested in statistical
bargains to an investor who would invest into better quality businesses and paying up for quality was
an essential ingredient of that process. Indeed, that process involved thinking deeply about hard-to-
measure qualitative factors about the business before thinking about valuation. I was moving away from
“valuation first” mode to a “business first, management next, and valuation last” mode style of
investing.

And two, I didn’t want to be influenced by the views of others about Symphony’s market
valuation. In particular, I wanted to disregard this pessimistic view in the CRISIL report.1

Our fair value estimate, calculated using the DCF methodology, has increased from Rs 206 per share to Rs 220
driven by decline in cost of equity from 17.3% to 16.5%, on account of better stock liquidity that the company has
seen over the past six months. Our fair value implies P/E multiples of 11x and 10x FY13 and FY14 EPS estimates.
The stock is currently trading at Rs 337 which implies P/E multiples of 18x and 16x FY13 and FY14 EPS
estimates. At the current market price, the valuation grade is 1/5.

I didn’t have any idea about how better stock liquidity affects cost of equity capital. I still don’t.

I was more intrigued, however, by the valuation grade of 1/5 given by the analyst to the stock.
According to CRISIL, this meant that the stock had a strong downside from it’s prevailing level.

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The analyst also gave a rating of 3/5 to Symphony’s fundamentals. On a scale of 1 (poor
fundamentals) to 5 (excellent fundamentals), that rating of 3/5 meant that the business merely had
“good fundamentals.”

Over the course of next few weeks we spent a lot of time reading up everything we could about
Symphony and about Achal Bakeri. We never sought a meeting with the management. Indeed, till
date, I have never met Achal Bakeri. We didn’t feel the need because his company’s annual reports,
and conference call transcripts and other material available on the net was thought by us to be
sufficient. His candor about mistakes and lessons learnt were a very very important factor for me to
help me decide to pay up. It’s very rare to find candor in annual reports. The usual tendency when
things are going wrong is to blame someone else. Achal didn’t do that. He took the blame. He also
made amends. And he never looked back again. Isn’t that an amazing lesson?

By the time we concluded that this business enjoyed excellent fundamentals, it was early
November of 2013. We made the first purchase at Rs 403 on 26 November 2013 and the last one at
Rs 706 on April 16, 2014. The average acquisition price was Rs 425 per share. The current stock
price is about 2,100.

So, based on our highest purchase price, we paid about 39 times post tax reported earnings for
FY13 (Symphony closes its books on 30 June every year).

Were we out of our minds?

Perhaps not, as subsequent events tell. Check this out by comparing what we paid to what the
company now earns from its FY15 annual report and from the latest quarterly results.

Here is an extract of an internal note I wrote just before making the initial investment.

1. Symphony Limited, is one of the world’s largest manufacturer and retailer of air coolers. Air
coolers are perceived as aspirational products for people who are prosperous enough to be
able to afford them (and already own fans) but not prosperous enough to be able to afford air
conditioners. The chief demand drivers for people buying air coolers instead of air
conditioners are the difference between the capital costs of ACs and Air Coolers with the
latter being significantly cheaper and the difference between the running costs as well. Air
coolers cost as little as one-tenth to run as compared to ACs.
2. In India, Symphony controls 50% of the organized market. However, since the organized
market constitutes only 20% of the total market, Symphony has been growing faster than the

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industry because it’s taking market share from the unorganized players.
3. Symphony is a highly growth oriented company and does not perceive itself as an Indian
company. In 2008, Symphony acquired Impco Air Coolers of Mexico— a company which
was founded by the inventor of evaporative air coolers. Impco is a supplier of air coolers to
US retailers like Wal-Mart and Costco. The acquisition was done at a bargain price and there
are huge synergy benefits being realized by Symphony. Since Impco acquisition gives access to
Industrial cooler technology to Symphony, a new vertical for the company has opened up in
India, which, I believe has huge growth prospects.
4. Revenues have grown from Rs 24 cr. in FY05 to Rs 308 cr. in FY13. Pre-tax earnings have
grown from a loss of Rs 3.9 cr. to a profit of Rs 92 cr.
5. Operating cash flow grew from Rs 3 cr. in FY05 to Rs 85 cr. in FY 2012.
6. As of June 2013, the company’s net worth was Rs 187 cr. There is no debt. Instead, there was
excess cash of about Rs 100 cr. So, the net operating assets were only about Rs 87 cr. On that
base, the company delivered pre-tax earnings of about Rs 87 cr. in FY13, which means that
the core ROE is 100%, which is fantastic.
7. The company announced its results yesterday and they were excellent. Revenues for Sept
2013 have trebled and net earnings have jumped by 7 times. Please see attachment.
8. We expect the earnings of this company to grow at a rapid pace for the next decade but even
if we don’t count future growth, at its current market value of Rs 1,200 cr., we are paying
only Rs 1,100 cr. (after netting off excess cash) for this superb business which earns Rs 87 cr.
of pre-tax earnings. [BASED ON WHAT WE HAVE DISCUSSED IN THE CLASS, HOW
MUCH WAS I PAYING FOR FUTURE GROWTH? IN OTHER WORDS, WHAT WAS
THE IMPLIED GROWTH RATE IN THE MARKET PRICE OF THE STOCK AT THE
TIME?]

TO DO LIST FOR YOU

1. Relate the above note to my lecture “The Mathematics of Investing” as well as Buffett’s essay
on “The Good, The Bad, and The Gruesome.” How would you classify this business? Why?
2. Using the annual report for FY09 and FY15 estimate incremental capital needed by the
business (excluding surplus cash) and compare with average annual operating cash flow (after
working capital changes). What do you conclude from this?
3. Monitor how average working capital (inventories + receivables - current liabilities) in relation
to revenues has changed over time. What does that change signify?
4. If I recall correctly, Symphony bought IMPCO for less than Rs 5 cr. (It was a very small
amount). What did they get back in return? Evaluate this by studying what company has
written about IMPCO in annual reports post acquisition.
5. Think about the value proposition the company offers to its customers? Why do they want to
buy its products in the first place?
6. Think about threat from substitute products? Which products, if any, can threaten air coolers?
7. Go to the company’s website and see the variety of coolers it offers.
8. From the annual reports, read about the culture of innovation that exists at Symphony where
making mistakes is not frowned upon. Indeed it’s encouraged. Reminds me of two of my
favorite Jeff Bezos quotes:
⁃ If you only do things where you know the answer in advance, your company goes away.
⁃ It’s not an experiment if you know it’s going to work
9. Read the company’s conference call transcripts. You can get them from here.
10. Watch the advertisements of the company’s products. For example this, this and this. What do

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you think about the company’s marketing strategy? How much money does it spend on
advertising and marketing? Is that money spent more in the nature of an expense or an
investment which expands the moat of the business?
11. Think about the industry structure of the business and how it contributes to Symphony’s
ability to grow faster than the industry. Refer to the company’s presentation “Symphony 25
years 1988 - 2013” sent to you in a separate mail.
12. Read the following extracts about Mr. Bakeri from my “Seven Intelligent Fanatics” talk.

Extract on Achal Bakeri from Seven Intelligent Fanatics Talk.

These guys understand the power of focus, and the power of extreme specialization. They agree
with Charlie and they agree with Warren.

What Charlie and Warren say on the subject makes a lot of sense. Defining your circle of
competence and stating within that circle is a very very good idea. It’s an idea which was also
expressed by an Indian philosopher much before Charlie and Warren.

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The power is extreme focus is best illustrated by studying our #4 intelligent fanatic.
Achal Bakeri runs the world’s largest air cooler company called Symphony. But in 2004,
Symphony was in bankruptcy. Why? Lots of reasons. He was leveraged. He was into asset heavy
manufacturing.

But another key reason what that he wasn’t focused. He was making air coolers, air conditioners,
water heaters, water purifiers, and washing machines.

Today’s his focus is on air coolers. He got out of manufacturing and instead focused on product
design, R&D, branding, marketing and distribution. He has eight vendors who make coolers for him.
He bought Impco in a fire sale. That’s the company in Mexico that invented industrial cooling. He is
now exporting air coolers to more than 60 countries including the United States. His market is not just

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India — it’s wherever in the world is heat, low humidity and a middle class which finds air
conditioning too expensive. That’s quite a big part of the world.

His has his task laid out: To become the dominant air cooler company in every market.

Symphony is one of India’s most profitable companies. It has a debt-free balance sheet. It earns a
pre-tax ROE of 90%. And the growth has been very rapid.

************
Charlie Munger says:

“In nature and in business, specialization is key. Just as in an ecosystem, people who narrowly specialize can get
terribly good at occupying some little niche. Just as animals flourish in niches, similarly, people who specialize in the
business world - and get very good because they specialize - frequently find good economics that they wouldn’t get any
other way.”

What Charlie said applies to each of these guys. They are very very good at what they do because
they are focused.

And they understand the important of scale. Every one of them. Achal Bakeri sells coolers to
India’s middle class. Less than 10% of Indian households have coolers. And he also exports to more
than 60 countries. Symphony may be the world’s largest air cooler company; it is still a tiny company
with annual revenues last accounting year of only $89 million.

************
They are low profile, frugal and conservative. Five of them have no debt and the remaining three
have extremely strong balance sheets. They run their businesses for profitable growth as the numbers I
showed you proved. They understand the idea of per-share intrinsic business value. They don’t over
bid for assets in acquisition deals. Nor do they dilute equity on unfavourable terms. In fact, most of
them have delivered growth with zero dilution.

Moreover, they understand the concept of moat and spend all their time trying to expand theirs.
Charlie’s observation that “almost all good businesses engage in ‘pain today, gain tomorrow’
activities” applies very well to the businesses managed by these seven guys. They invest in their
businesses while thinking in terms of decades and not the next quarter.

They are also what Charlie calls “learning machines.” Recall, the case of Achal Bakeri — the
cooler guy. He made many mistakes, but he learnt and he never repeated them. In fact, he was candid
about his mistakes. He listed them in his letters. And he said I am never going to borrow money again,
I am going to focus on becoming the best cooler company in the world and I am going to out source
manufacturing so I can focus on product design and branding and marketing.

Disclosure and warning:

This is a teaching note and not a recommendation. While I am long the stock, I am NOT
recommending it to anyone.

Sanjay Bakshi
November 14, 2015

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This is a Teaching Note and Not a Stock Recommendation

Teaching Note on Averaging Up

One of the most counter-intuitive ideas in value investing in high-quality businesses is the power
of averaging up. Very few value investors appreciate this power. If you’ve picked the right kind of
business which will be worth several times current market valuation in a few years time, then you must
not hesitate in buying its shares simply because they are selling at an all-time high market valuation.
Your focus should always be on potential future value a decade or so from now and how much money
is there to be made between now and then.

There is a kind of pleasure that many value investors get from seeing the prices of their stocks fall
from their cost because they can then buy more shares at an even lower price. To be sure, this practice
— called averaging down — has its merits provided one has picked the right business to invest into.

I don’t have any particular issue about averaging down. What I do find surprising is many that
value investors avoid investing in businesses simply because their stock prices are selling at an all time
high. Moreover — and this is even more inexcusable in my view — they refuse to buy more shares at
prices higher than their cost even though management has executed even better than what was
originally estimated by the investors. In a sense, the investors fall for “anchoring bias” where they
anchor to their cost price and keep hoping the stock price will fall below that price so they can buy
more shares.

The reality is that in high quality businesses — and Symphony is just one of them — there will be
multiple times to buy more shares and one must never focus on cost price of existing shares or the fact
they happen to be selling at all-time high price and much higher than one’s own initial purchase price.

Equity investing has asymmetric payoffs. You can’t lose more than 100% of your money provided
you have not borrowed money to fund the purchase. But you can makes tens of thousands of
percentage points over your cost if you pick the right kind of businesses. (In June 2009, Symphony’s
market cap was $8 million. Today it’s $1.1 billion with no new shares outstanding).

If the thesis is playing out far better than you expected, then you must revise your estimate of
potential future value. Value is not a static number. While the stock price may have gone up, it may not
have gone up enough. That creates an opportunity to buy more shares. In case of Symphony that’s
what happened…

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The Wisdom of Ian Cassel

My friend Ian Cassel, who runs MicroCap Club in the US knows the power of averaging up
better than most value investors known to me. Here are some of his tweets on the subject.

Successful money manager and author, Peter Lynch agrees with Ian. In his book, One Up on Wall
Street, he writes about The Twelve Silliest (and Most Dangerous) Things People Say About Stock
Prices. #3 on the list is called

IF IT’S GONE THIS HIGH ALREADY, HOW CAN IT POSSIBLY GO HIGHER?”

Right you are, unless of course you are talking about a Philip Morris or a Subaru. That Philip Morris is
one of the greatest stocks of all time is obvious from the chart on . I’ve already mentioned how Subaru
could have made us all millionaires, if we’d bought the stock instead of the car.

If you bought Philip Morris in the 1950s for the equivalent of 75 cents a share, then you might have
been tempted to sell it for $2.50 a share in 1961, on the theory that this stock couldn’t go much higher.
Eleven years later, with the stock selling at seven times the 1961 price and 23 times the 1950s price, you
might once again have concluded that Philip Morris couldn’t go higher. But if you sold it then, you
would have missed the next seven-bagger on top of the last 23-bagger.

Whoever managed to ride Philip Morris all the way would have seen their 75-cent shares blossom into
$124.50 shares, and a $1,000 investment end up as a $166,000 result. And that doesn’t even include the
$23,000 in dividends you picked up along the way.

If I’d bothered to ask myself, “How can this stock possibly go higher,” I would never have bought
Subaru after it already had gone up twentyfold. But I checked the fundamentals, realized that Subaru
was still cheap, bought the stock, and made sevenfold after that.

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The point is, there’s no arbitrary limit to how high a stock can go, and if the story is still good, the
earnings continue to improve, and the fundamentals haven’t changed, “can’t go much higher” is a
terrible reason to snub a stock. Shame on all those experts who advise clients to sell automatically after
they double their money. You’ll never get a ten-bagger doing that.

Stocks such as Philip Morris, Shoney’s, Masco, McDonald’s, and Stop & Shop have broken the “can’t
go much higher” barriers year after year.

Frankly, I’ve never been able to predict which stocks will go up tenfold, or which will go up fivefold. I try
to stick with them as long as the story’s intact, hoping to be pleasantly surprised. The success of a
company isn’t the surprise, but what the shares bring often is. I remember buying Stop & Shop as a
conservative, dividend-paying stock, and then the fundamentals kept improving and I realized I had a
fast grower on my hands

************

Remember the lesson: The stock does not know what you paid for it. Sunk costs and historical
purchase prices, 52 weeks highs, or all time high prices are mere anchors. Do not be influenced by
wrong anchors. Instead keep your eyes on potential future value a decade from now and be willing to
adjust that number (up or down) based on new information that warrants a change in that number.
(Recall the lesson in Bayesian thinking in my lecture “Worldly Wisdom in an Equation.”)

As Buffett, who often averages up, says

In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the
scoreboard.

Disclosure and warning:

This is a teaching note on the concept of averaging up and not a recommendation. While I am
long the stock, I am NOT recommending it to anyone.

Sanjay Bakshi
November 15, 2015

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This is a Teaching Note and Not a Stock Recommendation

Teaching Note on Symphony’s Capital Efficiency

Symphony is one of the most efficient capital allocators that I know of.

I have uploaded an excel file in which I have done some analytical work on Symphony. You can
get it from here. From that excel file, I will display some extracts here and will try to demonstrate just
how good Symphony is when it comes to capital efficiency. But first I have to tell you about

Scott-Fetzer

Recall that in “The Mathematics of Investing” lecture, I had displayed a slide on Scott-Fetzer —
an extraordinary business acquired by Berkshire Hathaway. Here is that slide.

Warren Buffett bought this business in 1986 when it had a book value of $172.6 million. Soon
after he bought it, however, he withdrew the surplus, non-operating cash in the acquired company’s
balance sheet. This cash withdrawal of $125 million meant that the ending book value for 1986 (after
adjusting for earnings of $40.3 million for the year) turned out to be $87.9 million. Then, over the
next 7 years, earnings grew from $48.6 million to $79.3 million but the book value of assets rose by
just $6.1million — from $87.9 million to $94 million.

This type of outcome is very rare. Raving about it to his shareholders, Buffett wrote in his letter:

As you can see, Scott Fetzer’s earnings have increased steadily since we bought it, but book value has not grown
commensurately. Consequently, return on equity, which was exceptional at the time of our purchase, has now
become truly extraordinary. Just how extraordinary is illustrated by comparing Scott Fetzer’s performance to that
of the Fortune 500, a group it would qualify for if it were a stand-alone company.

Had Scott Fetzer been on the 1993 500 list — the latest available for inspection — the company’s return on equity
would have ranked 4th. But that is far from the whole story. The top three companies in return on equity were
Insilco, LTV and Gaylord Container, each of which emerged from bankruptcy in 1993 and none of which
achieved meaningful earnings that year except for those they realized when they were accorded debt forgiveness in
bankruptcy proceedings. Leaving aside such non-operating windfalls, Scott Fetzer’s return on equity would have
ranked it first on the Fortune 500, well ahead of number two. Indeed, Scott Fetzer’s return on equity was double
that of the company ranking tenth.

You might expect that Scott Fetzer’s success could only be explained by a cyclical peak in earnings, a monopolistic
position, or leverage. But no such circumstances apply. Rather, the company’s success comes from the managerial
expertise of CEO Ralph Schey…

… The reasons for Ralph’s success are not complicated. Ben Graham taught me 45 years ago that in investing it is
not necessary to do extraordinary things to get extraordinary results. In later life, I have been surprised to find that
this statement holds true in business management as well. What a manager must do is handle the basics well and
not get diverted. That’s precisely Ralph’s formula. He establishes the right goals and never forgets what he set out

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to do. On the personal side, Ralph is a joy to work with. He’s forthright about problems and is self-confident
without being self-important.

Track Record of Symphony/Achal is Better Than That of Scott-Fetzer/Ralph

If you look at the balance sheet of Symphony over the last few years you’ll notice that it has
significant treasury assets. These are classified as current and non current investments and we should
treat them as surplus to the needs of the business. In other words, in order to evaluate the economics
of the operating business, we should only look at operating assets employed in the business and count
non-operating assets — in this case, surplus treasury assets — separately. I have done this breakup in
the exhibit below be treat cash and bank balance as an operating asset and money parked in mutual
funds under Current and Non current investments as non non operating assets.

This segregation will help us evaluate how well the operating business has performed over the
years.

Now take a look at the next exhibit where I display total operating assets employed in the business
(net fixed assets, inventories, receivables, operating cash and other current assets). That is, I removed
surplus treasury assets from the picture because we will think about that separately. Now, we have just
the operating assets required to run the business. I also list revenues as well as operating cash flow
generated by the business after working capital changes. Notice, the operating cash flow numbers do
not include treasury income which is the correct treatment, because we need to compare operating
assets with operating cash flow. And on that score, Symphony has done outstandingly well.

Pay particular attention to the performance from FY11 till FY15. While revenues over that period
increased from Rs 291 cr. To Rs 579 cr., total operating assets required to produce that incremental
revenue did not change at all! It remained at Rs 201 cr. This is absolutely stunning performance.

The growth in the operating cash flow numbers are even more stunning. In FY11 they were Rs 25
cr. By FY15, they had grown to Rs 167 cr., without requiring any additional investment in operating assets.

Now, take a look at the improvement in this picture over the last 4 years.

Wow!

Recall, this Buffett quote which I had shared with you in an earlier lecture. It applies beautifully to
Symphony.

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A business is wonderful if it gives you more and more money every year without putting
up anything – or by putting up very little. And we have some businesses like that. A business is
also wonderful if it takes money, but where the rate at which you re-invest the money is very satisfactory.

Now let’s calculate return on operating assets for Symphony over the years. I do this by comparing
pre-tax operating cash flow generated by the business for a year with average operating assets
employed during the year. See the exhibit below.

Take a look at the the last row which shows pre-tax return on assets. It’s a beautiful Symphony!

And then it gets even better. Notice we just measured return on assets. But, as investors we should
be more interested in return on equity. So, let’s take a look at that.

We start by looking at how the operating assets have been financed. We already know that
Symphony is a debt-free company. So the operating assets must have been financed by current
liabilities and equity. In the exhibit below, I show this picture where I take the total operating assets
from which I deduct current liabilities to arrive at funding provided by equity investors. For FY15, that
number was Rs 93 cr. Notice this number has been falling. It was Rs 153 cr. In FY11.

Next, I compare pre-tax operating cash flow for each year with average funding for that year
provided by equity investors to arrive at what I call as Pre-tax Core ROE. And the Symphony
becomes even more beautiful as the last row of the exhibit below shows.

The core engine of Symphony’s business is compounding capital at an astonishing rate. To be

sure, there are many businesses which do that. But then they don’t have the kind of revenue and
operating cash flow growth that Symphony has delivered. Take Castrol. That business has very high
pre-tax core ROE but has been experiencing volume decline. Earnings in Castrol have grown only
because the company increases prices. In contrast, in the case of Symphony, we get volume growth
plus a very high pre-tax core ROE. It’s not surprising that Symphony’s stock has massively
outperformed that of Castrol.

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The Narrative behind Symphony’s Success

I just cited some numbers which tell us just how extraordinarily profitable Symphony’s operating
business is. But those numbers are the result of a narrative. And just like in the case of Scott-fetzer, the
there is a central character in that narrative. In case of Symphony, it’s Achal Bakeri. Indeed, if I was
to re-state Buffett’s words, I would do that in the following manner.

You might expect that Symphony’s success could only be explained by a cyclical peak in earnings, a monopolistic
position, or leverage. But no such circumstances apply. Rather, the company’s success comes from the managerial
expertise of CEO Achal Bakeri.

The reasons for Achal’s success are not complicated. Warren Buffett taught me 21 years ago that in investing it is
not necessary to do extraordinary things to get extraordinary results. In later life, I have been surprised to find that
this statement holds true in business management as well. What a manager must do is handle the basics well and
not get diverted. That’s precisely Achal’s formula. He establishes the right goals and never forgets what he set out
to do. He’s forthright about problems and is self-confident without being self-important.

Sanjay Bakshi
November 15, 2015

************

Subsequent Development

I sent the above Teaching Note to Mr. Bakeri and here is what he wrote back.

The analysis is deeply penetrating. For me personally, the note is also humbling. Thank you very much
for your words and for sharing.

If I may add something –

1. We have been segregating ‘Operating Assets and ‘Non-Operating Assets’ in our quarterly and
annual financials by terming them as ‘Home Appliances Business’ and ‘Corporate Funds’ respectively.
We also provide ratios accordingly.

2. The sharp jump in Operating Assets in 2011-12 is due to the consolidation of the Mexican
subsidiary Impco. Impco has a fully vertically integrated manufacturing facility with a large gross block.
It also has significant current assets. High inventory (compared with Symphony) due to its business
model and high receivables (compared with Symphony) since it extends credit to its customers. If one
were to look at Symphony’s stand-alone ratios, for both fixed and current assets, they get better.

3. The numbers quoted in the note are understandably from the annual report and for end of the

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year as on June 30. At that point in time, Impco’s current assets are at their peak since it is the peak of
its season. Symphony on a stand-alone basis too has its highest current assets between March to June.
From July till December, Symphony actually operates on negative working capital because it sits on
advances from the trade. The correct picture would emerge if one were to take an average of monthly
or quarterly current assets rather than at end of the year.

4. Similarly, the ‘non-operating assets’ at the end of the year are at their lowest. They are at their
peak between July and September. So, the correct level of ‘non-operating assets’ would be the monthly
or quarterly average of the year. This would be considerably higher than as on June 30.

5. There is also a significant increase in fixed assets between 2014 and 2015. This is largely on
account of investment in a new office for Symphony – in other words in real estate. If this were to be
excluded, ‘operating fixed assets’ have by and large remained constant on a stand-alone basis over the
last several years. We have not needed to invest more than few crores every year to add new models or
to upgrade existing models. This addition in gross block is more or less offset by reduction due to
depreciation.

6. We have informed the stock exchange and also mentioned in the annual report that we are
transforming Impco’s business model into something like Symphony’s – asset light and variable cost.
We have begun the process of out-sourcing manufacturing at Impco and of monetizing its fixed assets –
primarily real estate and its machinery. With this, we will reduce the fixed assets and the ratios even at
the consolidated level will get better still. This will reduce Impco’s depreciation and overheads and
consequently of Symphony’s at the consolidated level. Also, with the funds realized, Impco will be able
to repay its internal debt to Symphony, which in turn will reduce its interest cost. Once the debt is paid
off, Impco will be insulated from ForEx fluctuations which has been hurting its profitability.

I hope this clarification is useful.

Disclosure and warning:

This is a teaching note and not a recommendation. While I am long the stock, I am NOT
recommending it to anyone.

Sanjay Bakshi
November 15, 2015

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This is a Teaching Note and Not a Stock Recommendation

Teaching Note on Symphony’s Pro Social Business Model

One of the things I love about Symphony is it’s pro-social business model. In previous lectures, I
have spoken to you about

1. business models with pyramid schemes embedded in them,

2. business models which sell products or services which may be legal but are a net negative for
civilization — tobacco is a prime example where true costs are socialised but benefits are
privatised, and
3. business models which promote use of leverage, gambling or predatory lending.

Over the years, I have become averse to investing in such businesses, regardless of what others
think about the wisdom or otherwise of such an approach. (Recall my mail on the need for an inner
scorecard vs an outer scorecard).

Indeed, one the first questions I ask myself before I contemplate investing in a business is:

Is this business a net positive for humanity?

If, in my view, the answer is overwhelmingly no, then I will not invest in such a business. While
everyone is entitled to one’s own worldview, my own view is that, averaged out, anti-social business
models have shorter life spans than pro-social ones. But, even if a few, highly profitable anti-social
models may last long time, I am uncomfortable owning them because I have to look at myself in the
mirror every time I shave in the morning…

What is Symphony’s value proposition to its customers? To provide them with a comfortable
environment at a reasonable price. It does not cause harm to civilization. When people feel
comfortable, they are happier, they fight much less, and they are more productive. They sleep well at
night. Isn’t that far better than predatory lending at interest rates of 45% a year leading to debt-traps
for borrowers often causing them to commit suicide as happened in Andhra Pradesh a few years ago?

In the industrial cooling segment, Symphony provides its customers productivity enhancement,
and higher morale — something that the company’s presentation also points out.

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Symphony is not like the pharmaceutical company (about which I have written to you
extensively), which did this to its customers.

and is now paying the price for that. Such practices don’t promote longevity, even though they
may promote near term profitability and what matters in the long run is both profitability and longevity.

Profits in Ethics

One of the best books on the subject of investing in pro-social businesses I have read is “100 to 1
in the Stock Market” by Thomas Phelps. It has a chapter titled “Profit in Ethics” which contain some
lessons which I think are worthy of your attention. While you should read the entire chapter which I
have reproduced at the end of this note, my favorite quotes from it are:

Earlier, I said there were two approaches to investing, one, the psychological one and, two, the
statistical. Actually there are three. And in the long run the third is the most important. It is what might
be called the ethical or even spiritual approach... Beware of cynics in high places. Avoid the fast buck
artists, the something-for-nothing shysters. Remember that a man who will steal for you will steal from
you. Ask yourself whether the company in which you contemplate investing is contributing to making
this a better world. If the answer is no, avoid it like the plague.

and

To make the biggest gains, don’t buy companies whose sole goal is to make money… Bet on men and
organizations fired by zeal to meet human wants and needs, imbued with enthusiasm over solving
mankind’s problems. Good intentions are not enough, but when combined with energy and intelligence
the results make it unnecessary to seek profits. The come as a serendipity dividend on a well-managed
quest for a better world.

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Disclosure and warning:

This is a teaching note on the concept of averaging up and not a recommendation. While I am
long the stock, I am NOT recommending it to anyone.

Sanjay Bakshi, November 15, 2015

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This is a Teaching Note and Not a Stock Recommendation

Voice Share

In the latest annual report of Symphony, Achal Bakeri writes:

Our Share of Voice was a staggering 81% in 2014-15 (as measured by an external agency), virtually
crowding out the rest of our sector.

Our sustained advertising will continue to reinforce our Share of Voice that translates into higher
revenue.

Relate Mr. Bakeri’s comments with those of Warren Buffett relating to “Share of Mind”
below with respect to:

1. Role of advertising in captivating consumers’ minds;

2. Role of advertising in creating an entry barrier; and
3. The nature of successful advertising as an investment instead of an expense and the
consequences of such a treatment in both evaluating the fundamental economics of
the business as well as its valuation.

Buffett on “Share of Mind”

Source: Address to MBA Students at Florida University 1998.

On Kodak

30 years ago, Eastman Kodak’s moat was just as wide as Coca-Cola’s moat. I mean if you
were going to take a picture of your six-month old baby and you want to look at that picture
20 years from now or 50 years from now. And you are never going to get a chance—you are
not a professional photographer—so you can evaluate what is going to look good 20 or 50
years ago. What is in your mind about that photography company (Share of Mind) is what
counts. Because they are promising you that the picture you take today is going to be terrific
20 to 50 years from now about something that is very important to you. Well, Kodak had that
in spades 30 years ago, they owned that. They had what I call share of mind. Forget about
share of market, share of mind. They had something—that little yellow box—that said
Kodak is the best. That is priceless. They have lost some of that. They haven’t lost it all.

************

On See’s Candy

It is a tough thing to decide but I don’t want to buy into any business I am not terribly
sure of. So if I am terribly sure of it, it probably won’t offer incredible returns. Why should
something that is essentially a cinch to do well, offer you 40% a year? We don’t have huge
returns in mind, but we do have in mind not losing anything. We bought See’s Candy in 1972,

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See’s Candy was then selling 16 m. pounds of candy at a $1.95 a pound and it was making 2
bits a pound or $4 million pre-tax. We paid $25 million for it—6.25 x pretax or about 10x
after tax. It took no capital to speak of. When we looked at that business—basically, my
partner, Charlie, and I—we needed to decide if there was some untapped pricing power
there. Where that $1.95 box of candy could sell for $2 to $2.25. If it could sell for $2.25 or
another $0.30 per pound that was $4.8 on 16 million pounds. Which on a $25 million
purchase price was fine. We never hired a consultant in our lives; our idea of consulting was
to go out and buy a box of candy and eat it.

What we did know was that they had share of mind in California. There was something
special. Every person in Ca. has something in mind about See’s Candy and overwhelmingly it
was favorable. They had taken a box on Valentine’s Day to some girl and she had kissed him.
If she slapped him, we would have no business. As long as she kisses him, that is what we
want in their minds. See’s Candy means getting kissed. If we can get that in the minds of
people, we can raise prices. I bought it in 1972, and every year I have raised prices on Dec.
26th, the day after Christmas, because we sell a lot on Christmas. In fact, we will make $60
million this year. We will make $2 per pound on 30 million pounds. Same business, same
formulas, same everything—$60 million bucks and it still doesn’t take any capital.

And we make more money 10 years from now. But of that $60 million, we make $55
million in the three weeks before Christmas. And our company song is: “What a friend we
have in Jesus.” (Laughter). It is a good business. Think about it a little. Most people do not
buy boxed chocolate to consume themselves, they buy them as gifts— somebody’s birthday or
more likely it is a holiday. Valentine’s Day is the single biggest day of the year. Christmas is
the biggest season by far. Women buy for Christmas and they plan ahead and buy over a two
or three week period. Men buy on Valentine’s Day. They are driving home; we run ads on the
Radio. Guilt, guilt, guilt—guys are veering off the highway right and left. They won’t dare go
home without a box of Chocolates by the time we get through with them on our radio ads. So
that Valentine’s Day is the biggest day.

Can you imagine going home on Valentine’s Day—our See’s Candy is now $11 a pound
thanks to my brilliance. And let’s say there is candy available at $6 a pound. Do you really
want to walk in on Valentine’s Day and hand—she has all these positive images of See’s
Candy over the years—and say, “Honey, this year I took the low bid.” And hand her a box of
candy. It just isn’t going to work. So in a sense, there is untapped pricing power—it is not
price dependent.

On Disney

Think of Disney. Disney is selling Home Videos for $16.95 or $18.95 or whatever. All
over the world—people, and we will speak particularly about Mothers in this case, have
something in their mind about Disney. Everyone in this room, when you say Disney, has
something in their mind about Disney. When I say Universal Pictures, if I say 20th Century
Fox, you don’t have anything special in your mind. Now if I say Disney, you have something
special in your mind. That is true around the world.

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Now picture yourself with a couple of young kids, whom you want to put away for a
couple of hours every day and get some peace of mind. You know if you get one video, they
will watch it twenty times. So you go to the video store or wherever to buy the video. Are you
going to sit there and premier 10 different videos and watch them each for an hour and a half
to decide which one your kid should watch? No. Let’s say there is one there for $16.95 and
the Disney one for $17.95—you know if you take the Disney video that you are going to be
OK. So you buy it. You don’t have to make a quality decision on something you don’t want to
spend the time to do. So you can get a little bit more money if you are Disney and you will
sell a lot more videos. It makes it a wonderful business. It makes it very tough for the other
guy.

How would you try to create a brand—Dreamworks is trying—that competes with Disney
around the world and replaces the concept that people have in their minds about Disney with
something that says, Universal Pictures? So a mother is going to walk in and pick out a
Universal Pictures video in preference to a Disney. It is not going to happen.

On Coca-Cola

Coca-Cola is associated with people being happy around the world. Everyplace –
Disneyland, the World Cup, the Olympics—where people are happy. Happiness and Coke go
together. Now you give me—I don’t care how much money—and tell me that I am going to
do that with RC Cola around the world and have five billion people have a favorable image in
their mind about RC Cola. You can’t get it done. You can fool around, you can do what you
want to do. You can have price discounts on weekends. But you are not going to touch it.
That is what you want to have in a business. That is the moat. You want that moat to widen.

On See’s Candy

If you are See’s Candy, you want to do everything in the world to make sure that the
experience basically of giving that gift leads to a favorable reaction. It means what is in the
box, it means the person who sells it to you, because all of our business is done when we are
terribly busy. People come in during these weeks before Christmas, Valentine’s Day and there
are long lines. So at five o’clock in the afternoon some woman is selling someone the last box
candy and that person has been waiting in line for maybe 20 or 30 customers. And if the
salesperson smiles at that last customer, our moat has widened and if she snarls at ‘em, our
moat has narrowed. We can’t see it, but it is going on everyday. But it is the key to it. It is the
total part of the product delivery. It is having everything associated with it say, See’s Candy
and something pleasant happening. That is what business is all about.

And there aren’t very many businesses like that.

On Coca-Cola

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This (he holds up a can of Cherry Coke) – not the cherry version, but the regular version
– has a terrific moat around it. There’s a moat even in the container. There was some study
made as to what percentage of people could identify blindfolded what product they were
holding just by holding the container. And there aren’t many that could score like Coca-Cola
in that respect.

So here’s a product with a share of mind. There are six billion people in the world. And I
don’t know what percentage of them have something in their mind that’s favorable about
Coca-Cola, but it would be a huge number. The question is 10 years from now will that
number be even larger and will the impression be just a slight bit more favorable on average
for the billions of people that have it? And that’s what the business is all about. If it develops
in that manner, you’ve got a great business.

Well, I think it’s very likely to develop in that manner. But that’s my own judgement. I
think it is a huge moat at Coca-Cola, although I think it varies in different parts of the world
and all of that. Then on top of everything else, Coca-Cola has a terrific management.

************

On Coca-Cola

When you get into consumer products, you’re really interested in finding out, or thinking
about, what’s in the mind of how many people throughout the world about a product now –
and what’s likely to be in their minds five or ten or 20 years from now.

Virtually every person on the globe – well, let’s cut that down to 75% of the people on the
globe – has some notion in (his or her) mind about Coca-Cola. The word “Coca-Cola”
means something to them. By comparison, (the word) “RC Cola” doesn’t mean anything to
virtually anyone in the world. It does to the guy who owns RC and his bottler, of course. But
virtually everybody in the world has something in mind abut Coca-Cola.

And, overwhelmingly, it’s favorable. It’s associated with pleasant experiences. And part of
that is by design. The product is wherever you’re happy – at Disneyland. Disney world and
ballparks – every place you’re likely to have a smile on your face, (including the Berkshire
Hathaway meeting, I might add).

That position in the mind is pretty firmly established with people in close to 200 countries
around the world. And a year from now, it’ll be established in more minds and have a very,
very, very slightly different overall position. And 10 years from now, that positioning could
move just a little more. So it’s not share of market, but share of mind, that counts.

On Disney

Disney is the same way. “Disney” means something to billions of people. And if you’re a

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parent with a couple of young children and you’ve got 50 videos in front of you that you can
buy, you’re not going to sit down and preview an hour-and-a-half ode each of those videos
before deciding which one to stick in front of your kids.

You have something in your mind about Disney. And you don’t have it about the XYZ
Video Company. In fact, you don’t have it about Twentieth Century or Paramount….

So that name, to billions of people – including lots of people outside this country –has a
meaning. And, again, that meaning overwhelmingly is favorable. And it’s reinforced by the
other activities of the company.

Just think about how much somebody would pay if they could actually buy that share of
mind of billions of people around the world. You can’t do it. You can’t do it with a $1 billion
dollar advertising budget or a $3 billion advertising budget – or by hiring 20,000 super
salesmen. But Disney’s got that today.

The question then becomes what does that name stand for five or ten or 20 years from
now? Well, you know that there’ll be more people who’ve heard of Disney. And you know
that there’ll always be parents interested in having something for their kids to do. And you
know that kids will love the same sorts of things…

That’s what you’re trying to think about….

On American Express

American Express is an interesting case study…. We always think in terms of share of

mind versus share of market – because if the share of mind is there, the share of market will
follow.

Probably 75% of the people in the world have something in their mind about Coca-Cola
– and overwhelmingly, it’s favorable. Everybody in California has something in their mind
about See’s Candy – and overwhelmingly, it’s favorable.

The job is to have it in a few ore California minds – or world minds in the case of Coke –
over the years and have it get even a little bit more favorable as the years go by. If we have
that, then everything else will follow. And consumer product organizations understand that.

American Express had a very special positioning people’s minds about financial integrity
over the years – and ubiquity of acceptance. For example, when the banks closed in the early
‘30s, American Express Traveler’s Checks actually substituted to some extent for bank activity
during that period.

The worldwide acceptance of American Express’ name meant that when American
Express sold Traveler’s checks (they could add a surcharge). For many years, the two primary
competitors were what is now Citicorp (First National City) and Bank of America. So here

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were two other premier organizations – Citicorp and Bank of America (and actually Barclay’s
and Thomas Cook had one, too) – and American Express charged you 1% for your Traveler’s
checks, whereas the others didn’t.

Yet American Express still had two-thirds of the worldwide market after 60-70 years
despite charging more than these other well entrenched, well known competitors. And any
time you can charge more for a product and maintain or increase market share against well
entrenched, well known competitors, you know that you have something very special in
people’s minds.

And the same thing happened when their credit card came out. Originally, American
Express went into the credit card business because they thought that they were going to get
killed in Traveler’s checks. They thought the credit card was going to be a substitute – and
therefore they had to go into it. It was a defensive move.

It came about because a guy named Ralph Schneider and Al Bloomingdales and a couple
of other people came up with the Diner’s Club idea. And the Diner’s Club idea was sweeping
initially New York and then the country during the mid-‘50s. And American Express got very
worried. They were afraid that people would use these cards… instead of Traveler’s checks.
So American Express backed into the credit card business.

Meanwhile, Diner’s Club had the restaurants signed up already. And they already had the
high-rollers carrying around their card, whereas nobody had the American Express Card. But
despite the jump the Diner’s Club had in its business, American Express immediately went in
and started charging more than Diner’s Club for the card – and yet they kept taking market
share away.

Well, that’s a great position to have in people’s minds where, where faced with a choice,
they’re willing to go with a newer product at a higher price and leave behind an entrenched
product. Well, that just showed the power of American Express. American Express had a
special cachet that identified you as something special when you pulled out your American
Express Card – as opposed to the Diner’s Club Card and the Cate Blanche Card (which was
the third main competitor). Visa still didn’t exist.

So you could see this dominance prevail. It told you what was in people’s minds – which is
why I bought into the stock in 1964. We bought 5% of the company – which was a huge
investment for us at that time. I was only managing $20 million at the time. But you could see
that this share of mind – this consumer franchise – had not been lost.

1
CRISIL IER (Independent Equity Research) Report on Symphony dated October 25,
2012.

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