A minute for your Feedback please

Wednesday, July 27, 2011

Evaluating Indian listed companies promoters competence and investor friendliness-some pointers

Open any investing treatise, especially on fundamental investing, and one of the golden tips you get is to assess management quality/competence. Now, this may sound irrelevant, given that the listed company which you are wanting to purchase is alive, listed and functioning. Also, chances are that the company would post a profit(atleast in nominal terms, or in proforma terms!). So should not the results speak for themselves? In this case no. Despite that famous adage that 'past results are not indicative of future performance', promoters are merely people(like us) and likely to behave in the same way. So this analysis serves purposes of 'Forewarned is forearmed'. Some points to note are
  1. Performance of group companies:- In IPO prospectuses, this information is easily available. Otherwise, one would need to extract the list of associate companies from the annual report, and then Google them to see what crops up. This does reflect on competence. 
  2. Performance/Investor Communication in bear markets:- Nobody is perfect, but one would expect management to 'tell it as it is'. If a promoter has survived a bear market cycle and retained investor confidence, then chances are he will do well in any market. Ajay Piramal is a classic example, so it is surprising why investors are valuing his cash stack(from sale of pharma business) at less than the cash value itself. 
  3. Treatment of past investors/lenders:- Certain Indian industrial groups like Essar would delist at rock bottom prices, make losses in listed companies(but rarely in unlisted group companies), repeatedly go for restructuring of bank debt without proper risk management, not rewarding shareholders adequately etc. Grizzled veterans of Indian stock markets would probably be the best ones to share war stories, but otherwise Google(extensively) would help a bit
  4. Can Board check generational decline? :-When otherwise well governed companies like HCL, Wipro, Asian Paints, Glenmark catapult family members to top positions where not justified by age/track records/achievements, then one should worry about future performance. If there are independent directors who have good track records in business/service, and not dependent on the company for substantial portions of their incomes, then one may rest a bit
  5. Mergers of associate companies into listed companies:- These valuations often favour the promoters, who would own nearly 100% in the associate company. While reputed firms perform the valuations, even they know what side their bread is buttered, and would err at the higher side of the valuation for the selling company-while avoiding too perverse a valuation. 
  6. Related party transactions:- This note is one of the densest and foggiest notes, along with pension/derivatives notes. But it is a must read, because even blatant ethical issues can be camouflaged there. For instance, Reliance had substantially funded Mukesh Ambani's gas pipeline project with debt, but now pays him thousands of crores in carriage fees. 
  7. Non compete agreements/promoter entities in related businesses:-Without non compete agreements, the chances of promoter firms taking lucrative investment opportunities, is quite high. In infrastructure companies, this is an especially high risk
  8. Odd compensation structures:- In a leading Indian infrastructure conglomerate(which gave blockbuster returns in FY11), the CFO has been voted a compensation of 2Cr+/annum plus a commission upto 2% net profits. At its maximum, the commission could be 50Cr+. For a company with a promoter CEO/MD, this raises questions of whether this is a payoff for something else.
  9. Repeated issue of preferential warrants:- Promoters love preferential warrants. For a premium of just 25%, they get a 18month call option on the stock, AND the premium is adjustable against the strike price if eventually converted. Of course, the obvious solution would then be to issue warrants at strike price=133% of current market price. Then it would make sense to convert as the premium becomes a sunk cost. While promoters argue that rights issue would take too much time/costs, no other investors get these sweet heart deals. While this tactic has backfired in the bear markets of today, this tactic is investor unfriendly. 
  10. Rights Issues at around market price;- This is a clear indication that management wants to boost its stake without paying extra for preferential allotment. So the easier solution is to issue rights at around market price, no investor will pick it up, then promoters can subscribe to the unused portion. 
This is all I can think of for now.more later!

No comments: