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Monday, October 17, 2011

Why auditing is increasingly resembling TQM

During my B.Com days,  I had multiple chapters on TQM, and then felt it to be totally irrelevant to what a chartered accountant would do in practice. But after studying for CA Final, some insights which I've got are shared below, which would bring out the essential similarity between the two
  • Tone from the top:-This is the basic premise of TQM and is increasingly being adopted for audits. Read any audit report and they state that keeping effective internal controls is the job of management. So management turns around and informs the employees that risk is everyone's job
  • Build in quality rather than inspect:-TQM prefers to build quality rather than reject defective products. Similarly, due to the quantum and volume of work, auditors now rely extensively on process integrity. Even Computer Assisted Audit Techniques(CAAT) can only do so much, and are quite difficult and expensive to apply.
  • Controls are everyone's concern:-This is applied in most organizations nowadays, with all employees being told to handle risk
  • Process over product:-Rather than a tick box mentality, the focus in auditing(TQM, financial, internal) is to fix the process rather than routinely complain about the defects.
There are other points as well, but these salient points caught my attention

Wednesday, October 5, 2011

Is Geodisic Ltd another Satyam, or merely very undervalued?

Heard of Geodesic? Unless you are an IT sector fan, you probably would not. But if you have ever read Chandamama, used the stock screen chart on moneycontrol.com, downloaded the Mundu app on Apple Store/Nokia Ovi etc, you have used their products/brands. And that is the beauty of the company, its business is focussed on growth areas like security, anti piracy and mobile VAS. The promoters are all engineers with ample industry experience, and have big dreams. Another Onmobile in the making you would say. But the market does not think so. And there are good reasons for that. 

When I first hit upon this stock in the Edelweiss stock screen, it seemed too good to be true. P/E around 1.5, P/BV of 0.44 yet positive cash flows, growing business etc. But still, it has tanked by 30%  in this financial year. Despite a net cash position of around 600 crores(Rs 1282 crore cash as per balance sheet LESS $113.5MM FCCB @ Rs 50/$), the share trades at just Rs 480 crores. When I first looked at the stock in Mar-11, the valuations at Rs 700 crore, were even higher than what they are now. But the market does not believe in it. I found later that
  1. The management did not care about investor relations/conference calls, prompting a group of activist investors to cover the issue on their blog here(http://geoinvestors.blogspot.com/). Only after repeated persistence did the company resume the conference calls from Aug-11.  
  2. One of the promoters was a co-founder of Aftek, not known for its good accounting practices. 
  3. The accounting is error prone(though they DID correct it in time) as exposed by an analyst Nishith Shah from IDFC,  during their Aug-11 conference call(http://geodesic.com/files/investor/financial/reports/quarterly/transcript/Geodesic-Earnings-edited_Aug30-2011.pdf). To their credit, the company boldly fended his queries. But the fact remains that neither the accounts department nor the auditors had detected that error in time.
  4. The company despite its huge cash pile has not declared sizeable dividends, nor has invested much in buybacks or M&As. This behaviour has raised issues as to the whether the cash pile is genuine or cooked up like Satyam.
  5. They did not utilize segment reporting to its fullest extent. That is why despite the management bromide in the MD&A about growth, analysts and investors could only guess at the actual revenues/profits due to each activity. And when there is uncertainty, especially in this environment, people tend to assume the worst about the company.
  6. Surprisingly, while quite a few equity research analysts cover the stock, there are no publicly available equity research reports on the net. On the geoinvestors blog mentioned earlier, it is alleged that brokerage houses demand quid pro quo for publishing research reports on stocks, which this company was unwilling/unable to pay. Because of the lack of research coverage, it would deter even the brave retail investors from buying in.
 The annual report for FY11 throws up some interesting highlights(http://geodesic.com/files/investor/financial/reports/annual/geodesic-ar-fy2010_111.pdf). An important thing is that the auditors have not audited assets worth Rs 1918 crores, relating to the Hong Kong and Mauritious subsidiaries. And tucked away in a note to Schedules 11 & 23, is the disclosure that Rs 1100 crores cash(out of total balance of Rs 1282 crores) is tucked away in non scheduled banks in foreign subsidiaries. One would have thought that to assuage investor interest, the company will atleast name those banks, or give some additional assurance to investors. But that has not been done.
Given the earlier accounting errors as exposed in the Aug-11 conference call, the investors have naturally not put much faith on the cash balances tucked away abroad. Maybe they are waiting for the Rs 565Cr odd FCCB debt to be repaid, before they believe that the stock has any value.
Update:- Post the FY11 AGM held on Sept 30,2011; the company has declared the breakup of its cash balances on this link(http://www.geodesic.com/investors/shareholders_2010-11). That accounts for $247MM. So now, the valuation concerns should hopefully reduce.

Sunday, October 2, 2011

Anon Analytics-the new Wikileaks of Equity Research?

Sell Side equity research has been critiqued for its inherently conflicted business model, where issuer pays. Unlike credit rating agencies, there is no statutory mandate for equity research, nor is there a fair dealing provision for access to company. Therefore, any sell side analyst,even if objective, will think twice before giving a SELL rating/publishing bad news because that may cutoff access to the company, and 'disadvantage' him in relation to the other analysts. Whether more access to management is an advantage(better insight) or a demerit(familiarity bias) is a value judgement I leave to the reader. But despite the delinking of investment banking mandates to equity research compensation, the fact remains that 10years after the 2001 Spitzer settlement, things have not improved much. Research on herd mentality does state that crowds tend to go berserk, because each member of that crowd revels in anonymity, and thus allows the animal spirits/suppressed side to come out. Given that published equity reports are likely to err on the optimistic side, anything that encourages the negative side to be more extensively published/reported, is only a good thing. But don't short sellers anyway plant news articles, talk down the stock and 'manipulate prices'? What new can an anonymous equity research report accomplish? For one, the report mentioned here(http://anonanalytics.com/pdf/Chaoda.pdf) is 100% based on public information. They have creatively used a mosaic of reports, transcripts, primary research, public filings etc to weave together a damning indictment of that company. And in that sense, it is simillar to Wikileaks(in terms of audacity, novelty), but different in the sense that no confidential information is disclosed initially. Perhaps to prevent a Wikileaks type attack on their servers, they have warned that if their identities are ever compromised, they would release the (for now) non public information password on the internet, which would presumably raise even more furore. So why will this succeed? I'm sure that several equity research analysts have a conscience, which is hardly slaked by having to sugar coat reports to avoid seeing their bonus pools shrunk/relationships harmed. Given the facility to submit reports anonymously, with the editing/fact checking being done by that website, I can almost visualize a Wikipedia type crowdsourcing of work, culminating in a series of reports. Of course, it would be negatively biased, but we have enough positive stuff out there! Relying on 100% public(or verifiable) information may seem restrictive, but as websites like footnoted.org show, there is often gold hidden away in those filings which analysts miss due to information overload or just lack of interest/training. Hence, this scope should permit scalability(easier to verify/fact check reports) and make markets more efficient.

How to get elected as a small shareholders director of India

Below is a checklist for the same, reflecting my understanding after reading the relevant rules(http://www.mca.gov.in/Ministry/actsbills/rules/TCAotSSDR2001.pdf) and some analysis.
  1. Does this apply to the company? If the company has paid up share capital(excluding reserves & surplus but including preference shares) of 5 crore or more OR it has 1000 or more small shareholders. The first criteria(5 crores) can be seen from balance sheet but only the company will know about the 2nd criteria(1000 or more small shareholders) because the quarterly shareholding reports those with shareholding
  2. Are YOU a small shareholder? Check the face value of the share(say Rs 5). As you should not hold more than Rs 20,000 nominal value, that means that you should not own more than 4000 shares(viz Rs 20000/Rs 5). Even if the market price is Rs 1000 and your value of shares is Rs 40 lakh, then also you are termed as small shareholder! This is the vagaries of law.
  3. Are YOU eligible to be a small shareholder director:- If you are already a small shareholder director on Board of 2 companies, you cannot take this additional post. The routine disqualifications(insolvency, ceasing to hold ownership, court orders etc) apply.
  4. Get the support of 100 such shareholders - note that even 100 shareholders holding ONE share each can nominate one person as their small shareholder director. In practice, unless you are in an investor association OR investors are unhappy with dividend/share price return as in case of Geodesic, this will be difficult in practice.
  5. These 100 small shareholders should sign the notice to be sent to the company, nominating another 'small shareholder'. They should leave a notice of their intention with the company at least  14 days before the meeting under the signature of at least 100 small shareholders specifying name, address, shares held and folio number and particulars of share. The proposed nominee should file his consent with the company, to stand for election.
  6. The company sends postal ballot to investors(http://mca.gov.in/Ministry/notification/pdf/G.S.R_30may2011.pdf), To save the cost, it will well decide to appoint the director nominee in case nobody else is interested. As mentioned in the Section 252(1), 0nly small shareholders can vote on this matter, so the company would only need to send them the ballot
 PROS:- Way to get on the Board, and be informed of key decisions and push for transparency, creating this nuisance value. Also, not reelected each year, so continuous 3 year stint. For public sector banks, a similar rule applies and there are candidates who contest those elections well. So no reason why this should not happen here also.
CONS:-From the angle of the company, the nuisance value may go up for those who may try blackmailing the company to pay them off!
Disclaimer:- I do not know of any small shareholder director, despite the provision being around for 10yrs+> Maybe the investors do not care/are not aware. This post will help the latter, not former.