Inside a Dalal Street darling and its 'multiverse of madness'

In a recent story , we delved into renowned market guru Raamdeo Agrawal's QGLP investing framework. This investment style assesses companies based on their quality, growth, longevity and price or QGLP. Among companies that made it through this checklist, Innovana Thinklabs caught our eye. And why would it not. The small-cap touts solid operating metrics and has consistently delivered an annual ROCE of over 25 per cent since FY17. The stock has been a market darling, multiplying investor wealth by a staggering 11 times in the last four years (as of May 18, 2024).

Naturally, we decided to look into what Innovana does. But our research left us scratching our heads. It reminded us of the Oscar-winning Hollywood sci-fi flick 'Everything Everywhere All at Once,' a name quite fitting for the company, too. What do they have in common?

The absurdism. Wikipedia describes the film as an absurdist comedy-drama. Innovana evokes a similar imagery. Like the movie's protagonist, whose many parallel selves exist in multiple universes unaware of each other's existence, Innovana Thinklabs is a web of unrelated businesses, divorced of any synergies. In its first avatar, the company began operations as a software developer in 2015. Its product portfolio included applications like file openers, privacy protectors, ad-blockers, etc. This business remained its primary breadwinner until FY19. But the following year, it ventured into uncharted territories. It opened fitness gyms and began constructing residential properties. Absurd much? But wait, there's more. Come FY21, it began providing online astrology, tarot card readings, and started developing gaming studios. Another step into FY22, and it was selling banking products by forming a fintech platform!

Small-cap companies, known for having fewer resources, tend to keep a bull's eye on their core business. However, Innovana's muddled capital allocation decisions show an absence of clarity on the management's part. Even if the company manages to find some success in its many ventures, it will still, at best, be handy at many things, proficient at none. Or, as we call it in investing parlance, a serious case of 'diworsification'.

''It's Messy, and Glorious'' , read a New York Times review of the film whose ''science-fiction mumbo-jumbo is a big part of the fun''. At first glance, Innovana is glorious, too. It flaunts solid financials, thanks to its core software business. The profit after tax has grown 29 per cent per annum over the last five years. The net profit margin for 12-months ending December 2023 was an impressive 42 per cent! But a closer look reveals the other messy half. It takes the company unusually longer to pay back its creditors. For instance, at payable days of 1,215 in FY21, it took over three years to clear its dues, which is rare for a small-cap player. The extremely high payable days also make its cash conversion cycle negative.

A mind-bending trip is how some reviewers on movie database site IMDb describe the film. Others call it 'bizarre' for the crazy, chaotic visuals set against cosmic multiverse travelling. Innovana has been jumping universes, too. And quite bizarrely at that. How else will you explain dropping your money-making business midway? Its software development arm, Innovana Techlabs, has remained the company's most profitable segment. Instead of increasing focus on this business to grow it further, the company diverted its resources towards the gym vertical, Innovana Fitness labs, which has been making losses since its inception in FY20. The residential construction division, Innovana Infrastructure, used 20 per cent of the company's assets while contributing a meagre 6 per cent to the net profit in FY23. Mind-bending, isn't it? There's more. The company has been aggressively disbursing loans to its subsidiaries over many years. Loans given to subsidiaries as a percentage of equity capital were 33, 42 and 32 per cent in FY23, FY22, and FY21, respectively.

Our take

Purely based on its headline numbers, the company appears fundamentally strong. However, its complexity of operations can give a sci-fi mystery thriller a run for its money. Before investing, you should have answers to some primary questions:

1. Is the management simply confused?
   
2. Does it believe the core profitable software segment has no more room for growth?
   
3. Does it need to aggressively look for new opportunities in this segment?
   
4. How does it arrive at its capital allocation structure?
   
5. Does it have a concrete plan to grow the secondary businesses?

Remember that a booming market lifts all sorts of companies. Hence, we leave you with some wisdom from investing sage Warren Buffett, who once said, " only when the tide goes out do you discover who's been swimming naked. "

Also read: This company's revenue skyrocketed 10x in two years: Is it a smart investment or a risky bet?