In this past week, two major corporate news events in India escaped sufficient scrutiny and analysis.
First, Tata Steel announced that it had been forced to pull back from its decision to partner with German steel giant Thyssenkrupp after the European Commission raised the red flag on the proposed merger.
Second, in Kolkata, ITC stalwart YC Deveshwar’s sudden passing away prompted its board to quickly announce the elevation of Sanjiv Puri as the new chairman and managing director in a matter of three days.
These momentous events impacting two iconic companies—ITC and Tata Steel—aren’t linked in any way. But seen together, they represent big corporate governance risks that we invariably underestimate in this country and tend to brush under the carpet. They also bring into question how decision-making is done at the highest levels in some of our biggest companies, whether boards are able to function independently and also whether sufficient care is taken to de-risk operations.
The weakened steel fibre
Two years ago, Tata Steel bet on a bold plan to save its underperforming European steel business. The much celebrated acquisition of Corus in Europe in 2007 had ended up as a millstone around Tata Steel’s neck. Through sporadic attempts and a misguided light-touch integration plan, the Indian management team at Tata Steel had struggled to turn around the underperforming business in the UK, and servicing the debt used to buy an asset more than four times bigger than Tata Steel had been onerous. Soon after he took over in December 2012, the then Tata group chairman Cyrus Mistry tried his best to understand the situation. But the continued lackadaisical performance prompted him to announce that Corus’ UK assets in Port Talbot would be put on the block, putting more than 15,000 jobs at risk. It prompted Sajid Javid, the UK’s Business Secretary, under intense pressure from the unions to fly down to Mumbai to meet Mistry.
Even though Mistry’s intent was clear, in hindsight, he and the rest of the Tata Steel top team including its managing director and chief executive TV Narendran, executive director and CFO Koushik Chatterjee, and Tata Steel UK's former CEO Bimlendra Jha made one crucial mistake: they forgot to keep Ratan Tata informed and seek his sign-off. On September 24, 2016, Mistry was unceremoniously shown the door by Ratan Tata and the rest of the Tata Sons in a dramatic coup. While no one knows the real reasons behind the purge, the decision to sell Port Talbot did figure on the list of possible reasons for this abrupt dismissal. Insiders say that even today that option remains off the table.
The plan to merge with Thyssenkrupp AG was formally announced in September 2017. It seemed a smart idea to drive consolidation, improve pricing power and allow Tata Steel to focus on its growing India business. But even at that early stage, it was obvious that there were inherent risks involved. In October 2017, I had flagged off those same risks in some detail in this instalment of my Strategic Intent column.
The merger would create a formidable European steel giant. But for a variety of reasons, getting it cleared past the stringent EU system was always likely to be tough. The strong automotive lobby in Europe wouldn’t want the merger, because consolidation in the steel industry would reduce their bargaining power. Plus, there was significant overlap of assets between Tata Steel Europe and Thyssenkrupp across the steel value chain in tin plates packaging capacity and electric steel, which would spark concerns of undue market dominance. After the MoU was formally signed in March 2018, the European Commission did flag off these concerns. And it was left to the two companies to come up with a credible plan.
Right at the start, the union representatives and their experts had raised concerns about the merger and why it would be tricky to get a plan past the commission without making major concessions. However, the Tata Steel management said they had ways to circumvent that, given that tin packaging had plenty of substitutes like card board packaging, etc. It didn’t seem like a credible plan back then.
So when the European Commission raised its concerns, the two companies had to scramble to put together what is known as a ‘remedy’. As it turned out, much of the cuts in the capacity had to be made by Tata Steel Europe’s UK operation and also in Belgium, which was part of the Dutch facility. And apart from a relatively redundant plant in Spain, the German partner was unwilling to yield to any cuts in capacity. That led the European works council, consisting of the UK and Dutch unions, to raise a hue and cry, maintaining that it seemed more like a takeover, rather than a merger of equals. Roy Rickhuss, the general secretary of the Community union, flew down to Mumbai to meet Tata Sons chairman N Chandrasekaran. By April 2019, it was clear that the plan wouldn’t have the support of the unions.
The next meeting of the European works council was scheduled in Amsterdam. When the unions reached the city, they were told that European Commission had met the two firms as scheduled in Brussels. And the Commission wasn’t ready to give its approval to the merger. Even before the unions could meet Narendran and Kaushik Chatterjee, Thyssenkrupp had issued a statement calling off the merger. Tata Steel followed with its own statement shortly afterwards. And Narendran and Chatterjee joined the conference with the unions via Skype from Brussels to announce the inevitable and maintained that it would be business as usual.
Here’s the moot point: did the Tata Steel board evaluate the inherent risks sufficiently, especially in case of a no-show? Even if they did, their efforts to sell a credible plan didn’t look serious enough. Unlike in India, where the Competition Commission lacks teeth, the EC tends to scrutinise plans thoroughly. And the folks in charge at Tata Steel Europe ended up putting all its eggs in one basket. The merger seemed like a last throw of the dice, and that too, without a viable Plan B.
The debt overhang—a humungous $13 billion at the group level and $2.5 billion in the European operations alone—remains a huge worry, especially since the cash flows from the European operations are hardly enough to service the debt. This is despite the relatively high contribution from Tata Steel’s IJumuiden operations in the Netherlands. In an interview to Bloomberg, CEO TV Narendran also suggested they would scout for potential partners from outside the European region to make another attempt to find a sustainable overseas operation. He also spoke about making the operations cash positive—something that has been in the works for well over a decade now, without much success. The unions, meanwhile, are pressing Tata Steel for answers. But there are more questions than answers at this stage, said Rickhuss, in a statement to the media. The inability to turnaround the European steel business for over a decade now doesn’t reflect well on the reputation of Tata Steel and the larger Indian steel industry, says a steel industry veteran, on conditions of anonymity.
Life after the exit of a tall leader
[Graphic by NS Ramnath]
On the other hand, while the ITC board was prompt in stepping up to announce a successor in a matter of just three days, it chose not to disclose the unfortunate news about Deveshwar’s cancer to investors. The board perhaps knew about Deveshwar's health from early 2014 when he abruptly fell absent from the Annual Plan meetings. They would also have approved his medical expenses in India and abroad. Deveshwar would suppress all disclosures about his cancer; in fact not even call it by that name perhaps since he represented a cigarette company. The cancer progressively got worse. But instead of advancing the timing of his much delayed succession, the board chose instead to extend his tenure, not once, but thrice. (Take a look at the accompanying graphic to understand the chronology of events.)
And then early morning on May 11, the world woke to the sudden news that Deveshwar had died in harness.
It was a shocker for most people. After all, Deveshwar had been a towering figure, an extremely capable and highly respected leader, in the same mould of transformational leaders in ITC like AN Haksar and Jagdish Sapru. In fact, he was also the only remaining link with that generation that helped build the foundations at ITC.
Now, while Sanjiv Puri is well-regarded, he is widely viewed as lacking the experience and stature that Deveshwar commanded. That’s perfectly understandable, given the big shoes he has to fill. The key question: is he ready to lead a complex conglomerate with diverse businesses? There are many existential questions about ITC’s culture, its business portfolio, and leadership pipeline, which are part of the legacy that Puri inherits from Deveshwar.
Deveshwar’s plan to use the huge free cash flow to diversify into new businesses may have been strategically sound. But the profitability of these non-cigarette businesses are yet to be clearly established. ITC has recently announced that it is selling John Players apparel brand to Reliance Retail, as a signal that its lifestyle retailing business needs a complete shake-up. The hotels business has been expanded at breakneck speed, but the occupancy levels haven’t quite kept pace, putting margins under huge pressure. The foods business has scaled well, except that Aashirvaad atta commands very thin margins. The personal care portfolio, including premium shampoos, body washes and soaps, have been expanded every year, but market shares have been slow to take off. And therefore, it has taken a long time to establish beachheads. So much so that the capital employed in the FMCG and hotels business account for nearly 42% of capital employed, and that too, without generating returns for some years now. On the other hand, paperboards and agribusiness have given 15-18% return on capital. The much-talked about e-chaupal foray has been gradually scaled back, ever since the rural retailing initiatives (Chaupal Sagar) bombed and the private procurement strategy for wheat and soya met with regulatory obstacles.
Puri also has a challenge on his hands in managing the complex three-tiered leadership structure, at the board, the corporate management committee and the divisional management structure. Towards the end, Deveshwar had begun to take all key decisions from his command centre at Virginia House in Kolkata, perhaps to push things along. At one of his last senior leadership conferences, Deveshwar apparently addressed the spouses in the audience and implored them to nudge their partners, especially those who weren’t pulling their weight! It was merely one small sign that generating sustainable profitable growth was becoming a challenge, even for a stalwart like Deveshwar. And Puri’s ability to tackle some pretty serious management challenges remains untested.
The impact of this over-centralisation on leadership development has been immense, say insiders. ITC’s famed entrepreneurial culture has developed cracks. Many divisional leaders are now inclined to kick every key decision upward. There’s another source of disquiet. For a while, the company’s employee stock ownership plan (ESOP), started by Deveshwar, helped provide potential huge wealth for employees. Last year, with ESOP schemes under water, the scheme was withdrawn.
While as non-executive chairman Deveshwar had committed to grooming Puri all the way till 2022, the board ought to have reassessed the situation independently. Especially since till the very end, given the power distance between the two, insiders say that even as non-executive chairman, Deveshwar was still very much in charge and Puri simply followed his orders. And that wasn't surprising since Deveshwar had spent almost two decades as executive chairman.
At Virginia House, ITC’s HQ in Kolkata, insiders (and even former employees outside) talk about this in hushed voices. Curiously, even when Puri was elevated as CEO & MD in 2017, he didn’t find a place in most board committees, except for investor relations.
The ITC board ought to have seen this coming. In fact, the signs were apparent a long while ago. I had raised them in a cover story titled The King’s Gambit in Forbes India, back in 2010. It now looks like the chickens are coming home to roost.
The ITC board repeatedly failed to have its say on CEO succession, awarding Deveshwar an unprecedented 23-year tenure at the helm. Now, why is that a worry? The fact is that regular leadership transitions create opportunities for fresh introspection, review, and also much-needed spring-cleaning. But when leaders get unduly long tenures, the consequences on culture and leadership talent can be particularly damaging. Especially, the spectre of over-centralisation and not giving other leaders the space to grow. It remains to be seen whether Puri can step up to the challenge.
Instead of splitting the roles with a non-executive chairman and CEO, the ITC board has decided to combine the two roles. As executive chairman and CEO, Puri has a term only till April 1, 2020. That’s because the Securities and Exchange Board of India (SEBI) makes it mandatory to split the office of the chairman by that date. So what happens on April 1? Will Puri step down as CEO & MD and become non-executive chairman and hand over the reins to B Sumant, who is widely seen as next in line? That would indeed be a piquant outcome, given that Puri was ostensibly being groomed to run ITC. Or will ITC then look for a new non-executive chairman at that time? Either way, the ITC board now faces its acid test.