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Monday, September 12, 2016

How to gauge management quality and integrity in India

There is a lot of articles on this but mostly in the western context. I thought to write a brief note on what I do to evaluate Indian companies
  1. What they say about themselves
    1. MD&A: There will obviously be puffery and exaggeration but do they take a balanced view and try to highlight risks/issues? Or do they just take credit in the good years and blame external factors in the bad years 
    2. AGM Q&A: Do they address all questions including critical questions?
    3. Conference Calls: How is the behaviour and confidence on the con-calls?
    4. Investor Presentations: Is the presentation balanced?
  2. What others say about them
    1. Scuttlebutt What do competitions,employees, channel partners, suppliers and regulators say about them? Are there serious quality or safety concerns? 
    2. Media(Incl interviews): What does the media say? Does this seem paid media/hagiography or an objective look?
  3. Public records
    1. Are they listed as defaulters or have criminal cases been filed? Have they/related entities defaulted on debt to banks, or has case been filed against them in personal capacity(eg murder-this is a real case against the MD of a listed infra co in maharashtra)
  4. How did they behave during adverse times
    1. Did they convert preferential issue warrants at above market prices? Or did they allow it to lapse: Before SEBI made it mandatory for preferential allotment to require a minimum 25% upfront non refundable advance, promoters used the warrants as a free 18month call option! While 25% is low, it is still enough of a deterrent for opportunistic investors. When the regulations were lax, did the promoters allow the warrant to lapse
    2. Did the company cease all non mandatory investor relations activity: Some companies in 'bad times'(when they make losses/stock price collapses) stop updating IR presentations or maintaining the site. If possible, ask a veteran investor in the stock if the company did like this. 
  5. Ownership/Shareholding pattern
    1. How much is purchased vs acquired via mergers into listed company, ESOPs etc: Have the ownership stake increased via merger of unlisted entities into the listed companies at valuations blessed by a pet merchant banker, in the era before this required majority votes from non interested shareholders
    2. How much is insider trading-and is this buy/sell? Do the promoters trade frequently in their sales? How much pledged and do they usually buy or sell>  
  6. How are their incentives aligned with yours
    1. Management compensation linkage with company profit: Do the promoters primarily link remuneration to profit or clearly defined KPIs
    2. Do the management take a pay cut/NIL pay when company starts defaulting/making losses?
    3. Related party transactions- red flags: Is a high extent of expense/sales from related parties? 
    4. Other related entities/business group: If having outside business interests or part of vertically integrated group, how aligned are the interests of the listed and non listed entities
    5. Minority shareholders Squeezeout: Have they squeezed out minority shareholders ever earlier(supposedly this was done by Godrej also one).
  7. Professional Management
    1. How much are the KMPs paid? Are the KMPs paid at the maximum possible limit? How reasonable is the compensation given industry salary levels?
    2. How much is the compensation growth of promoters vs others? Do promoters take a hike when everyone else is flat
    3. Are the 2nd generation promoters catapulted into high levels at remunerations greater than market levels? Is the 'usually foreign educated' son/daughter made a VP/AVP at levels greater than IIM/HBS alumni? This indicates undue favouritism. 

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