Fourteen years after the company went nearly bankrupt, last financial year (when the rupee was much stronger), Ahmedabad-headquartered Arvind Mills’ sales touched the magical billion-dollar-mark briefly, and it stuck out as the world’s largest denim maker after European players shut capacities due to a weak economic situation. Those were two landmarks chairman Sanjay Lalbhai had set for himself to achieve in three years when he, with help from consultancy McKinsey & Co., first unveiled his audacious plans for Arvind in 1993 (the rupee traded at 31 to a dollar then). Before globalisation became a much-used word, Lalbhai was the first entrepreneur to think of building significant global capacity in his business of choice—denim—and not be satisfied with a nominal presence. Yet, his narrative took a dangerous turn, and in boardrooms across India, became a cautionary tale of overreach, and globalisation gone wrong. Chastised, personally humiliated, and anxious that he had put his legacy at risk (he comes from a family of pioneering industrialists), Lalbhai laboured to save Arvind. He reduced debt, streamlined operations, and remade the company.

Since 2007, beating the drab economic sentiment after the Lehman crisis, Arvind has bucked the trend and consistently grown sales and profits. Arvind has three large divisions—denim (28% of sales in FY13), other premium cotton textiles (43%), and brands and retail (25%). If fate dealt Lalbhai a bitter blow a decade and a half ago, now it’s ready to make amends, presenting him with a once-in-a-lifetime opportunity. Actually, make that two.

The markets have sensed something’s stirring: In the six months between May and November, the stock has climbed nearly 60% on the Bombay Stock Exchange—even doubled on some days—while the Sensex has risen just over a percent. Jayesh Shah, Arvind’s chief financial officer and Lalbhai’s longtime confidant, says that in the last six quarters, Arvind has outperformed the analyst consensus. Trading in Arvind has increased: On average, over 2 million shares were traded every day in October, and towards the end of November, delivery declined to 17% from 26%, indicating higher speculative activity. Foreign institutional investors had already increased their stake from 2.5% to 15.7% in the last four years—and there’s a buzz that they are looking for more, which may explain the speculation.

In 2003, when Western countries decided to dismantle the quota regime that mandated how much each country could export, India seemed a natural beneficiary. It had raw material (cotton) and a fairly well-developed textile and garment industry, and was closely trailing its biggest competitor, China. However, after the World Trade Organisation finally dismantled quotas in January 2005, China raced ahead. A weak currency, superior infrastructure, cheap labour, favourable terms of finance, and a thrust on exports converted China into a world beater, accounting for nearly a third of the world’s trade in cotton textiles. Currently, it does trade worth $240 billion (Rs 15 lakh crore), compared with India’s $35 billion.

THE BROTHERS LALBHAI: Punit (left) and Kulin have been each given a business to prove their competence.
THE BROTHERS LALBHAI: Punit (left) and Kulin have been each given a business to prove their competence.

But, as Lalbhai sees it, a strengthening renminbi, rising wages (nearly three times that of Indian textile workers), higher cotton procurement prices (till recently 30% more than the global average), and a focus on the domestic market has blunted China’s edge. In recent quarters, he says, China’s exports have been growing at 2%, compared with the earlier 25%. Meanwhile, the rupee around 60 to the dollar has made Indian exports very competitive. Arvind is betting on this realignment and that any fall in China’s share will benefit India. A 4% dip could even double India’s business. There are other cotton-producing countries, notably Pakistan, that will also gain, but given the size of players and the availability of a trained workforce, “the real benefit will come to India”, says Lalbhai. “This is the big story.”

Then there’s the Rs 1.9 lakh crore domestic market for readymades, which is growing at 20% annually on the back of a younger population, urbanisation, and growing per capita income. This could boost brands and retail. (When they say ‘brands’, Arvind managers are referring to the many garment labels such as U.S. Polo Assn., Tommy Hilfiger, GANT, and Flying Machine that they sell; some of these are licensed, others they own.) Lalbhai is betting on these two “coming inflexion points” and argues that whoever gets it right will be in a position to create unprecedented shareholder value. Amar Chaudhary, Arvind’s strategy head, says the next 10 years will be momentous for the firm.

Chaudhary, a thirtysomething former consultant who was scalped from Boston Consulting Group early this year, has been tasked with creating and building Arvind’s strategic planning cell. His induction into the top team shows how differently Lalbhai is thinking this time. He wants more people to ask hard questions. Bakul Dholakia, former director of the Indian Institute of Management, Ahmedabad, who sits on Arvind’s board, says their board meetings last long, at least two and a half hours, and the directors discuss strategy as well as subjects like forex hedging in detail. The need for a strategy head, which led to Chaudhary’s recruitment, was discussed at the board.

Last time, early successes blinded Arvind. “When you have a huge advantage on cotton and cost, and the world is your market, you don’t think of demand. Demand is not to be considered a factor of risk,” says Lalbhai. (It was Arvind’s inability to foresee falling demand in denim that plunged it into chaos.) “You start believing that you know everything and that you can’t go wrong,” he says, adding that there was a “lack of knowledge. We were all new and didn’t know how to react to liberalisation. There was never an understanding of risk.”

Jayesh Shah, CFO, Arvind Mills
Jayesh Shah, CFO, Arvind Mills

TEXTILES AND apparel are inherently susceptible to an array of bogeys—weather, cotton cultivation, global commodity prices, currency, stockpiles, and fashion. Though value addition does diminish exposure to risk, it doesn’t eliminate it completely. Lalbhai says, with a smile, that he knows “risk and reward go hand in hand”. All that he’s trying to do, he argues, is build a business that’s sensitive to risk.

For example, given that China has built a huge cotton stockpile and may unwind some of that any day, Arvind doesn’t keep more than 10 days of cotton inventory. Then the issues of global versus local, textiles versus garments, multiple brands across different customer segments (a portfolio approach)—they are all examples of risk mitigation. As Lalbhai argues, his model has to be built on factors (currency, cotton prices, and demand) changing dramatically, “and your capacity still making sense”.

There are caps on how much money Arvind’s managers can burn. Lalbhai says that regardless of the opportunity, he doesn’t want to increase long-term debt. “Call that a constraint,” he says emphatically, adding: “If my profits fall, I will grow slowly.” As an aside he says these days many customers have been asking him to increase production, “but I don’t want to grow beyond this”.

Though in FY13, Arvind’s long-term debt at Rs 947 crore was higher than its Ebitda of Rs 680 crore, by FY14 it should largely stay flat. (A workers’ strike in the first quarter of FY13 affected earnings.) Lalbhai says he’s comfortable at such levels.

Equally, he is mindful of shareholder wealth. Notwithstanding its recent buoyancy, Arvind’s stock is nowhere near what it once was—a favourite of fund managers, and part of the Sensex from 1996 to 1998. He says he doesn’t want to disproportionately put resources into ideas that don’t create value, no matter what the opportunity may be. Of the total capital employed—Rs 5,376 crore as of September this year—Rs 3,070 crore was in textiles and Rs 955 crore in brands and retail (the remainder went to other businesses such as real estate and telecom).

This mix, with a bias towards manufacturing, isn’t working very well. On an expected
Rs 1,000 crore Ebitda in FY14, Arvind’s valuation is Rs 3,000 crore, or a multiple of three. Compare that with Page Industries, the maker of Jockey undergarments, which has a multiple of 33 or a market capitalisation of Rs 5,800 crore on an Ebitda of Rs 176 crore.

Some of this has to do with Arvind’s past. Lalbhai says the financial community still keeps asking him about debt. This, despite the fact that the company’s leverage is now down to 1.1 from a high of 6 in 2001. Equally, he builds a case for building the brands and retail business further: “Why invest in spinning and weaving? We will invest in processing and garmenting, which add value. We need to create a capital-light model for the business to be revalued.” In the coming years, brands will soak up 40% to 50% of the capital that Arvind deploys, and retail (Megamart, Next, Debenhams) 20%. The brands and retail business is built on a 7% to 8% GDP growth assumption. What if that falls to, say, 4% to 5%? Lalbhai says while he may tweak or recalibrate the capital allocation, the focus on brands will continue.

Garments use capital more efficiently. Ashish Kumar, head of Arvind Exports, says that if in fabric, a Rs 100 crore investment generates sales of
Rs 100 crore annually, in garments, it will “generate a turnover of Rs 600 crore”. Although this business is still in investment mode and gobbling cash, the return on capital at 12.5% is nearly the same as the return on capital of the much more mature textiles business (12%). The drawback: The brands business is operationally more complex. So, if in textiles six machines require one operator, in garments, one machine requires two.

The ultimate objective: to split Arvind into two—textiles, and brands and retail. In the past, whenever there’s been talk of this, the stock has risen. In his conversation with Fortune India, Lalbhai laid down the road map for the split: It should happen around 2018, by when he expects the brands and retail business to be independent. Internally, the estimate is that in three years, the brands and retail business will be cash positive and not depend on the textiles business.

While this may seem a nifty bit of forward integration, the real beauty of it is that brands and retail has few linkages with textiles. Of the 20 million individual garments sold last year, Arvind didn’t stitch a single piece: They were all outsourced. Again, barely half of all those garments were made from Arvind’s textiles. What that means is, operationally, one business doesn’t depend on the other and is therefore de-risked. The value here is not created in the manufacturing, but in the design. Lalbhai’s younger son Kulin points to U.S. Polo Assn., a brand they have licensed and built into Rs 500 crore in sales in five years: It employs 100 designers who are making the difference, he says.

Creating two large, independent businesses also sounds like a masterstroke in succession planning, with one each going to Kulin and his elder brother Punit. But Lalbhai says, “We don’t know that.” He adds though that discussions around succession planning have already begun. “Always better to get it done earlier because it is one kind of uncertainty. But you can’t push it.”

For the moment, Punit, who did his masters in ecology from Yale and wanted to be an ornithologist, has been given the mandate to create a business around technical textiles, a specialised area which encompasses everything from clothing that can be worn inside furnaces to making industrial filters and tyre cord. Kulin, a Harvard MBA, is building brand Arvind. Shortly, Kulin will unveil an e-commerce model where customers can customise their clothes and order over the Internet. Currently, each business is in the early phase of growth, clocking revenues of Rs 100 crore each. In five years, that should rise to Rs 1,000 crore each. Lalbhai says his sons need to prove they can run a business well, before they can “preach”.

WITH HIS SHOCK of snow white hair, sitting in his cavernous office in the company’s oldest factory complex in Naroda, near Ahmedabad, with deliberately unpainted, concrete walls, overlooking a lush green garden, Lalbhai looks more a Zen Master thinking deeply—about strategy, risk, capital allocation, shareholder wealth, and the role of his sons—than the high-energy fortysomething who once tore around the globe, building a global business. He says he’s seen more highs and lows than anyone else, and hence the highs don’t matter anymore. “There is no need for too much excitement. I am happy to just enjoy the process.”

When Lalbhai first talked of globalisation, he was much ahead of his time. A weak capital market, inflexible currency rules and a non-existent India story weighed against him. Today he isn’t talking conquest, but rather a measured growing of the businesses “at a natural pace”. Yet, there is a certain element of disruption, of different models competing against each other, inherent in what Arvind is trying today. Though Lalbhai doesn’t explicitly say so, you get the sense that he is trying to build an adaptive company that can think quickly on its feet.

Consider that if Kulin’s efforts at building Arvind as the go-to destination for made-to-measure wildly succeeds, it’ll take away from the brands business. Kulin himself adds that sometime in the future, they may have to choose between Megamart and the Arvind stores. “But that’s the idea of a portfolio. Have many brands that jostle.”

Again, if in the domestic garments business, Arvind is betting on outsourced manufacturing, in the non-denim fabric business (woven cotton shirting and khakis), where competitors like Madura Garments buys its fabric for its Louis Philippe and Van Heusen shirts, it is looking at ramping up garmenting capacity for exports. Most big textile companies, such as Hong Kong-based Esquel and LuThai have downstream garmenting capacity to extract more value addition on the fabric they produce. Esquel makes 150 million metres of fabric and has a capacity to make 125 million shirts. Arvind makes 120 million metres of woven cotton fabric but has negligible garmenting capacity. Says Lalbhai: “Garmenting will make our business proposition sticky as customers increasingly want end-to-end services under one roof.”

IN NOVEMBER 2013, Nita Ambani, the wife of India’s richest man, Mukesh Ambani, joined a glittering party with Bollywood stars to inaugurate British retailer Marks & Spencer’s (M&S) biggest India store in Bandra, Mumbai’s tony suburb. Ambani’s company Reliance has a joint venture with M&S, and they are planning to increase the number of stores in India from 36 to 80 by 2016. On the other hand, three years after setting up its maiden store in Palladium, an upscale mall in central Mumbai, Spanish clothing brand Zara’s India revenue is estimated to be Rs 500 crore; the picky retailer has grown to a dozen stores and will add another 18 stores in the next three years. Zara has a joint venture with the Tata Group. Last year, Kumar Mangalam Birla bought out Kishore Biyani’s Pantaloon to expand his clothing business. Then, the government approved another popular Swedish retailer, the $17 billion H&M Hennes & Mauritz (H&M) to invest Rs 720 crore to start retailing operations here.

While in the apparel trade, labels like H&M or Zara are seen as ‘retail concepts’ (they need a certain kind of display and location) and not comparable with the majority of Arvind’s labels, these are semantics. From a customer’s viewpoint, they are competing choices. And Arvind is up against companies, which are way bigger.

The folks at Arvind concede that point. But they also say they’ve been in this longer than anyone else. Arvind CFO Shah says they were “first movers”. “We’ve been preparing for this for nearly 20 years.”

Lalbhai began early when there was no concept of ready-to-wear in the India. Even before he began making denim, he bought the Flying Machine brand that made jeans popular in India from startup entrepreneur Rajiv Badlani. It was quickly followed up with licensing the shirting brand Arrow, as well as Lee, and Wrangler (VF Corp) in 1992. Today, the business consists of 13 licensed brands such as U.S. Polo Assn., GANT, Nautica, Hanes, Wonderbra, a joint venture with Tommy Hilfiger, and 11 owned brands like Flying Machine, Colt, and Excalibur. (The licensing deal with VF converted into a joint venture in 2006, which was dissolved in 2011.) Then it has five retail brands—Debenhams, Next, Club America, and its own Megamart and Arvind Store. Says Kulin: “The concept of licensing a number of brands is an emerging market phenomenon because it is not possible to build these in a short time.”

What that also means is that Arvind has learnt from its mistakes. J. Suresh, managing director, Arvind Lifestyle Brands and Arvind Retail, is witness to that. A former Hindustan Unilever exec, Suresh has been with Arvind for eight years. When Lalbhai brought him in, he wanted Suresh to salvage the brands and the retail business. In 2006, after Lalbhai had set up a JV with VF Corp and the Tommy Hilfiger management was separated from Arvind, the residual garment business comprised Arrow (Rs 80 crore), Megamart (Rs 70 crore, and it sold surpluses), Ruf n Tuf (Rs 70 crore) and brands such as Newport and Excalibur. The business circa 2006 was clocking sales of around Rs 220 crore, with an operating loss of nearly Rs 20 crore.

There were many things going wrong—Flying Machine had been neglected, Ruf n Tuf was sold at a loss to Big Bazaar, and Arrow wasn’t seen as a happening brand for the youth. But the most telling fact was that in the previous eight years, nearly a dozen CEOs had come and gone. Yet, Lalbhai continued to believe in brands.

Early on, Suresh and other senior Arvind managers divided India into three parts to determine what to target: India 1, with 20% of the population and accounting for 35% of spends, going up to 40% if luxury goods were included; India 2 (middle class), 38% of the population and 35% of spends; and India 3 (bottom), accounting for the rest. Back then, Lalbhai had a lot of aspirations for the last category. Ruf n Tuf, for instance, was squarely targeted at this segment.

Suresh and his team convinced Lalbhai that Arvind should focus on India 1 and India 2, and give up on India 3, which required a different business model. The strategy for India 1 was via brands such as GANT and U.S. Polo Assn. and speciality retail. In menswear, Arvind launched garments around Arrow—those that would be positioned alongside it like U.S. Polo Assn. and those that would sit above—Nautica, GANT, Tommy Hilfiger, and Ed Hardy. Then they licensed Elle as a women’s wear brand to round off the portfolio. Most of these also have a line of kids’ wear. They also tied up with Next and Debenhams for speciality retail.

MADE TO MEASURE: Arvind aims to provide end-to-end services under one roof.
MADE TO MEASURE: Arvind aims to provide end-to-end services under one roof.

India 2 was targeted through Megamart and value brands. Arvind tied up three such value brands—Cherokee, Jeffrey Bean, and Moschimo—which it sells through Megamart. Cherokee, in the U.S., sells $800 million of merchandise to Target and another £600 million (Rs 6,135 crore) worth to Tesco.

Operationally, individual buying teams of each brand were collapsed into a central sourcing team. Apart from reducing teams within the organisation, the move has resulted in consolidation of vendors, giving them scale to handle large orders from Arvind. It also makes brand entry easier. Earlier, each team would develop its own new vendors. Now, they just have to plug into central sourcing which organise vendors at short notice. Says Suresh: “At a time of intense competition, our time-to-market has been reduced substantially, giving us a competitive advantage.”

He set three phases to track growth. The first was to make the business profitable in three years. Between 2006 and 2009, sales nearly doubled to Rs 400 crore and operating losses tapered to Rs 5 crore. Phase two stretched another two years: By March 31, 2011, sales had increased to Rs 1,170 crore. During this time, Arvind junked the discounting model because excise duty changes made it unattractive, and reinvented Megamart as a value brand. The third phase (currently under way) is to touch Rs 5,000 crore in sales by 2017, which will somewhat coincide with the brands and retail spinoff. The other target that was set: to become the No. 1 retailer of kids’ wear, premium men’s wear, and speciality retail.

Suresh expects that brands such as U.S. Polo Assn. will be valued at 20 times Ebitda eventually. By his estimates, currently the brands business may be valued at around Rs 2,000 crore overall (on an Ebitda of Rs 70 crore) but that would include several brands that are still in the investment stage. Meanwhile, there are reports that Arvind is talking to partner GAP, H&M, and Uniqlo. These discussions couldn’t be confirmed. But for all the progress that the brand business has made in the last five years, the strategy is still work in progress. Lalbhai says that sometimes analysts don’t get the portfolio approach. Kulin says that often they sit around the table discussing the optimum number of brands they should have.

One of the reasons that Arvind is building a portfolio, says Shah, is that for any premium brand to cross Rs 700 crore in turnover is a challenge. “There are only so many U.S. Polo Assn. shops you can have in a city or a mall.” What he leaves unsaid is that their positioning restricts the number of cities where they can be sold. Today, Tommy Hilfiger, U.S. Polo Assn., and Arrow are sized at around Rs 500 crore each (retail value) and considered power brands. Flying Machine is at about Rs 200 crore, and Shah expects that they will have a few more power brands which will eventually clock Rs 500 crore-plus in revenue. In other words, they’ll need to keep feeding new brands as growth from power brands plateau.

So, where does this leave denim, the business that Lalbhai is still commonly associated with? Though there is a surfeit of capacity in the country and Arvind is not the only super-sized player it used to be, at an average of $1.75 per metre, its realisations are at a 10% to 15% premium over others. Thanks to its in-house design centre in Naroda that dreams up special washes and products like khadi denim, it has international customers such as GAP and H&M on its rolls. GAP buys about 15 million metres and H&M buys 3.5 million metres annually. In the next five years, though the business is expected to grow, its share in the company’s overall revenue will fall to 17% as other businesses grow faster.

This by itself may not be a bad thing. Arvind Singhal, seasoned apparel industry analyst and the chairman of Delhi-based retail consultancy Technopak, says very few existing textile companies have been able to move successfully away from their core business. But of Arvind, he says, “They have lots of good cards to play.”

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