India’s Kings of Capital – Part II: Deepak Parekh

In part I of this series, we looked at how Uday Kotak has successfully steered the Kotak group over the past 35 years (read Part – I here). In this piece we try and delve deeper into the illustrious career of another successful Gujarati banker – Deepak Parekh. We explore the two vital facets of institution building that Deepak Parekh has mastered: (i) allocating financial capital; and (ii) allocating human capital. Under his leadership, the HDFC group has become India’s most successful financial services conglomerate by dominating virtually every segment that it has ventured into since its inception in 1977.

“Humble, unassuming, and often frugal, these “outsiders” shied away from the hottest new management trends. Instead, they share specific traits that put them and the companies they lead on winning trajectories: a laser-sharp focus on per share value as opposed to earnings or sales growth; an exceptional talent for allocating capital and human resources; and the belief that cash flow, not reported earnings, determines a company’s long-term value” – William Thorndike in ‘The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success’, (2012).

Not only were Kotak and HDFC founded a few years apart, they have, by and large, followed a similar strategy of starting out as non-bank lenders, and over time establishing businesses across banking, broking, investment banking, general insurance, life insurance, and asset management. The sheer dominance of the HDFC group is underscored by the fact that India’s largest mortgage lender, private bank, asset management company, and private life insurer are all HDFC group companies. Having been at the helm of affairs of India’s leading financial services conglomerate for over 30 years, Deepak Parekh is a personification of a consistent compounder.

Deepak Parekh: The Insider Outsider

Banking runs deep in Deepak Parekh’s blood – his grandfather was the first employee of Central Bank of India; his father was the deputy managing director of Central Bank and his uncle, the legendary Hasmukhbhai Parekh, fondly known as HTP was the Chairman of ICICI before he founded HDFC Limited in 1977 with an initial share capital of Rs. 100 million. While HT Parekh was toying with the idea of forming a housing finance company after retiring from ICICI as at the age of 65, a young Deepak Parekh was working at Chase Manhattan as its assistant representative for South Asia. It took some convincing, but HT Parekh managed to persuade his nephew Deepak to join HDFC Ltd at a 50% lower salary. Thus, Deepak Parekh joined HDFC Ltd. as a Deputy General Manager in 1978, a year after HDFC Ltd. was formed.

Housing finance was an alien concept for Indians in the 1970s; lending directly to middle class Indian households was looked upon with great scepticism. As a result, far from having a competitor, in the initial years HDFC Ltd. did not even have a regulator. Eventually, in 1988, HDFC Ltd. itself incorporated India’s next three housing finance companies – Gujarat Rural Housing Finance Corporation (Gruh Finance), Housing Promotion and Finance Corporation (promoted with SBI and what is now SBI Home Finance) and Can Fin Homes (promoted with UTI and Canara Bank). The scepticism around HDFC Ltd. was such that when Deepak Parekh went to meet the Chairman of UTI to seek an investment in HDFC Ltd’s IPO, his request was turned down on the grounds that retail lending was too risky a business and that UTI, which was then the only equity mutual fund in India, would therefore not be able to invest in the IPO. As a result, when HDFC Ltd. went public in its first year of its incorporation, its IPO flopped, and the stock traded at a 20% discount to its issue price on the day it got listed. Ironically, 5 years later, looking at HDFC’s success in mortgage lending, UTI became the company’s largest shareholder.

By the late 1980s, HDFC Ltd. had firmly established its credibility not only in India but also globally, it was successfully raising long term funding from the International Finance Corporation (IFC), World Bank and the United States Agency for International Development (USAID). By 1985, Deepak Parekh had risen to the post of Managing Director and he became the executive Chairman of HDFC Ltd. in 1993. As HDFC Ltd’s core mortgage business was flourishing with little competition, Deepak Parekh shifted his focus towards capitalising on the HDFC brand name by assuming a more strategic role with a focus on: (i) allocating financial capital; and (ii) allocating human capital across the HDFC Group. As we will see in the coming section, it is in this role that he has created maximum value for HDFC group shareholders.

Allocating financial capital to build the HDFC empire:

Diversifying across the Financial Services landscape: HDFC Ltd. used its experience of pioneering the mortgage finance business and the credibility of the HDFC brand to establish businesses across India’s Financial Services landscape as soon as regulators allowed private players to participate in each sector. This has ensured that the HDFC group has been well placed to make the most of out of every chapter of India’s financialization story. For example, the mortgage business has become extremely competitive over the years resulting in the sector earning a lower return on equity than what possible earlier but because HDFC Ltd. was astute enough to create market leading franchises across banking, life insurance and asset management, it has been able to consistently generate shareholder returns through these businesses.

• Banking: In 1993, banking was opened to the private sector with a capital requirement of Rs. 100 crores. At that time HDFC’s net-worth was Rs. 300 crores but Deepak Parekh was convinced that the time was right for HDFC to move away from being a single product company. However, he faced a setback when the Board of HDFC Ltd. rejected his idea. The Board’s argument was that HDFC Ltd. had no experience in banking and there was no need to venture into banking when the core business was doing so well. It was after a lot of convincing that the Board relented. Eventually it was agreed that external talent had to be hired if the group does get a banking license. Therefore, in some ways HDFC Bank owes its existence to Deepak Parekh’s conviction and vision.

• Life insurance: The insurance sector was opened to private players much later in the early 2000s. HDFC Ltd. found a like-minded partner in Standard Life for its life insurance and asset management businesses. It was Deepak Parekh’s longstanding personal relationship with Gerry Grimstone, the Chairman of Standard Life, that led to not one but two joint ventures between the two companies. Despite being a large global life insurer, Standard Life’s investment in HDFC Life has been highly rewarding for the former’s shareholders – Standard Life’s stake in HDFC Life is currently valued at Rs. 120 bn, amounting to 27% of Standard Life Aberdeen’s market cap.

• General insurance: HDFC Ltd. had initially entered into a joint venture with Chubb, a large Property & Casualty insurer from the US, in 2002 but since Chubb believed India to be a high-risk country, it was too rigid with its underwriting. So, while other general insurers were growing at 30-40% in the nascent market, HDFC was not growing at all. Facing a JV failure for the first time, HDFC decided to buy out Chubb’s stake in 2007 which was then sold to Ergo, Munich Re’s insurance arm. HDFC Ergo is currently India’s 3^rd largest private general insurer.

• Asset management: Unlike other financial sectors where HDFC was among the first entrants when the sector opened up, it was a late entrant in the asset management space. The Asset Management Company (AMC) business opened up in 1993 but HDFC AMC was setup only in 2000. Even though it was a late entrant, it is currently India’s largest AMC in terms of AUM.

HDFC group’s in-house investment banker: Deepak Parekh had spent the initial years of his career as an investment banker, plying his trade across New York, Singapore and Hong Kong. It would be an understatement to say that he has put his early years of investment banking experience to good use for the HDFC group. Over the past 43 years with HDFC Ltd., he has taken 5 companies public and by our count, completed at least 7 M&A deals.

Unlike most listed companies where a large number of mergers, acquisitions, spin offs etc. destroy minority shareholder value, the HDFC group under Deepak Parekh’s leadership has consistently been able to create wealth for minority shareholders through these transactions – whether it be whilst acquiring companies or whilst selling them (as we saw in 2019 when HDFC Ltd sold its stake in Gruh Finance at 14 times price to book). The failure of HDFC Ltd.’s IPO early on in Deepak Parekh’s career taught him to be fair to retail shareholders. For instance, during HDFC Bank’s IPO in 1995 when bankers wanted to price the issue at a premium to its book value, Deepak Parekh said “leave some money on the table. Investors will reward you in the future for doing so”, as a result HDFC Bank shares were priced at par at Rs. 10 and the issue was subscribed 55 times.

Allocating human capital to run the HDFC empire effectively:

Even though the HDFC brand enjoyed credibility in the financial system as well as amongst retail depositors and investors, without capable leaders at the helm of each business, the HDFC group could not have replicated the success it enjoyed in the mortgage finance business. Whether it be convincing Aditya Puri to leave a plush Citibank job in Malaysia or handpicking Amitabh Chaudhary to head HDFC Life even though he had no prior experience in the insurance sector, Deepak Parekh’s knack of picking the right people for the right job has proven to be of immense value for HDFC group shareholders.

Drawing upon his vast network and experience, over the years Deepak Parekh has become a close confidante of other promoters who are looking to hire people for the top managerial posts. Deepak Parekh made a tough job sound easy when he was quoted as saying “I have suggested dozens of CEOs for several organisations at various points of time. It doesn’t take days and hours of interviews. For me, 10 minutes is enough to assess if the candidate is right for the job.”
Investment implications:

William Thorndike’s outstanding book on the art of capital allocation, ‘The Outsiders’, not only explains why the promoter’s main job is capital allocation, it also provides a simple framework to define a CEO’s success in the long run – “It’s the increase in a company’s per share value, not growth in sales or earnings or employees, that offers the ultimate barometer of a CEO’s greatness”. The increase in per share value of Kotak Mahindra Bank as on 15^th May, 2020 since its listing in 1995 has been 22% vs. an increase of 10% in the Nifty. Similarly, the increase in per share value of HDFC Ltd. since 1993 i.e. the year in which Deepak Parekh became Chairman has been 23% vs. an increase of 11% in the Nifty. This suggests that Deepak Parekh and Uday Kotak have been enormously successful CEOs.

Through their consistent compounding, Deepak Parekh and Uday Kotak have reinforced that the prerequisites of wealth creation in India are: (i) maintaining a high standard of corporate governance; (ii) prudently allocating capital; and (iii) finding, and retaining, outstanding leaders. Although these three tasks might intuitively seem to be simple, over 90% of India’s listed companies do not clear Marcellus’ proprietary accounting and capital allocation filters leaving us with a small universe of investable stocks. It is no surprise that the HDFC group companies and Kotak Mahindra Bank rate highly on our proprietary accounting and capital allocation models. As a result, the HDFC group companies and Kotak Mahindra Bank now cumulatively account for 15% of the market cap of India’s 50 largest companies (by market cap) and are likely to dominate India’s financial ecosystem for years to come.

Disclosure: HDFC Bank and Kotak Mahindra Bank are a part of most of Marcellus’ portfolios

Tej Shah is a portfolio counsellor at Marcellus Investment Managers