GMR Infrastructure Annual Report analysis 2015-16

GMR Infrastructure is the poster child of what ails infrastructure in India, and why equity investors often get the short end of the stick despite a well intentioned management. With a family trust resolving succession issues, reputed board members and iconic projects some even being the subject of case studies such as Delhi Airport/Kishangadh highway etc, GMR Infrastructure does command valuation premiums even basis reported numbers, while it trades at a P/BV of 1.6(negative PE multiple). However, it has been mired in regulatory issues(delays in gas linkages to power plants, court ordered delays in hydel plants, Maldives airport nationalization, Kishangadh highway bid cancellation due to 'force majure', CAG audit report claiming undue benefit to DIAL operator and power tariff regulators delayed acceptance of force majure to permit fuel price hike pass through), Some of these have reflected in the audit report with the management refusing to write down asset balances which are clearly doubtful,

The below table indicates that if the audit adjustments were given effect to, the company's reported loss would increase by 74%-172%, while the reported networth will erode by 53%-96%. This shows the importance of perusing the audit report and not just going by reported numbers

Little wonder then, that whenever there are regulatory announcement, the stock price oscillates like crazy. And with a F&O lot size >10,000, it is quite risky for speculators without insider information

Now, GMR is by no means alone as these links indicate. However, it is one of the most detailed and complex cases, therefore prompting me to write a blog post.
http://www.capitalmarket.com/CmEdit/story11-43.asp?SNo=869509
http://www.business-standard.com/article/pti-stories/sebi-exchanges-ask-75-firms-to-restate-a-c-on-audit-red-flags-115070500259_1.html

Key takeaways from Reliance Industries Annual Report for 2015-16

It is not everyone's favourite pastime to open a 400+pg annual report, but I could not resist the urge to read the RIL annual report once it was released. Here goes my takeaways(in no particular order). Those interested can download it from http://www.ril.com/getattachment/56a9a0bd-d1e1-4735-9e8f-ece1e7e71e87/AnnualReport_2015-16.aspx

• As versus prescribed CSR spend of ~56 crores, they have spent ~67 crores. Interestingly, nearly 90% of this is via Reliance Foundation and not directly.
• They have a CFO and a Joint CFO, who earn Rs 14crs and 11crs respectively. The division of work between them is not too clear
• Pg 13 and Pg 53 highlight Reliance's products in everyday life, and the product cycle chemistry. This is a must read for everyone
• Mukesh Ambani has accepted remuneration of ~40% of his approved limit, in an effort to set a personal example for moderation in managerial remuneration. 
• Jio's strategy seems similar to Wechat, in my view, considering the wish to integrate payments, communication and ecommerce. Would be interesting if they succeed.
• On reading the ambitious plan for Jio which would account for ~20% of group capital employed, I decided to hunt for reviews of the pilot launch. This link(http://techpp.com/2016/05/26/reliance-jio-apps/) is not very complimentary of the user interface, and therefore apps like Magzter, Netflix could rest easy for some time
• Under Prabir Jha, Reliance had switched to employee friendly initiatives like a 5 day week, RALP etc. But now, there is hardly any mention of HR in the report. While Reliance has a good employee brand (maybe not among IIM graduates but overall), the report could have focused more on building this
• The company is VERY science  and technology focused  as evident from the space devoted to the discussion. 
• Reliance achieved a 7yr high GRM/barrel of $10.8, which it attributes to  The ability to operate at high utilisation levels and switch product slate to suit market conditions enabled RIL to capture margin optimisation opportunities in the market.
• Under an innovation program GenNexHub, the company encourages startup via incubatio as follows: During the four-month-long programme, GenNext Hub conducts workshops and mentoring sessions for start-ups in the areas of customer development, market traction, operations, product roadmap, fund raising and pitching. It also provides expertise in IP, legal, financial compliance, HR and specific sectorial expertise. GenNext Hub is uniquely positioned as a global programme that helps start-ups think big and grow fast. This seems inspired by Rocket Internet, since the areas are not too relevant to Reliance. 
• The financials were not too insightful but that is only to be expected from a company audited by the Big4. 

Each DishTV subscriber worth Rs 8000-irrational exuberance?

A picture speaks a thousand words, as in the above case. I had blogged earlier about the seemingly long breakeven point for Dish TV DTH subscribers(http://financeandcapitalmarkets.blogspot.com/2011/12/20months-cash-cost-breakeven-dangers-of.html), and then I decided to analyze whether the equity markets shared my views or not. Taking a short term view does not work in market valuations, so I decided to analyze the trend for the past 5yrs(Mar07 till date), using data released by the company and the market cap data from BSE. Some interesting points

1. The company hypes up gross subscriber base, but also reports a net subscriber base. The difference between the two presumably(because I could not find any company definition) is the dormant subscriber base who have a Set Top Box, but who do not subscribe from Dish TV. Since investors may still assign a value to gross subscriber base in hope of returning customers, I decided to calculate the EV metric separately for both
2. After the slide in Mar09(in EV/subscriber terms), it dramatically rose till Mar11, perhaps driven by the explosive growth in subscriber base. However, that was not accompanied by a commensurate rise in ARPU/decline in subscriber acquisition costs. Hence, the market punished the stock with a stagnant share price since then despite the continuing subscriber addition, and the Digitization Bill 2011. 

Despite the slide in valuations, paying even Rs 6650-8133 per subscriber(on gross/net basis respectively) seems too rich for the following reasons.

1. given that the Dish TV's own Freedom card(at just Rs 750) permits even other operator's Set Top Boxes to be compatible with Dish TV. If other operators can copy that technology, then they can cannibalize each other's base without incurring the customer acquisition cost of around Rs 2200+ which they incur currently. In fact, the minor dealer's commission will be offset by the cost of the card viz Rs 750.
2. As Dish TV is competing against Airtel with 7.1 active subscribers and counting, it would soon be  a war of attrition, as smaller operators try to cannibalize the installed base on price basis. Of course, MNP and low voice tariffs fizzled out, but even if that happens for DTH, the adjustments period may take 1-2yrs which would drain cash. 
3. Reliance is the dark horse in this, as its 4G ambitions would impact the DTH market in some way, and given their historic cost competitiveness strategy, other operators would do well to heed the threat and scramble to reengineer their costs. And cost cutting does not seem the strength of the Essel Group, more so Dish TV.

Point (1) could be an upside IF Dish TV manages to acquire customers cheaply using its Freedom Card. But without further information, one cannot factor this into the valuation.
Conclusion:-AVOID the stock. If LEAPs were available, they would have been perfect to short the stock, but in the short 3 month horizons available, that is too narrow to use options.

Zynga and Google-more simillar than different?

Many of you would heard of Farmville/Cityville. The company which produced those games('Zynga') recently had an IPO at a $10bn valuation, riding the dotcom bubble. To be fair, the company has been making profits though. At first blush, nothing seems to link Zynga and Google except that Google was a pre IPO investor in Zynga, and has been linked to takeover attempts/bids. But on a closer reading of the Zynga prospectus(http://sec.gov/Archives/edgar/data/1439404/000119312511341923/d198836ds1a.htm), quite a few similarities pop out. The small text is a direct quote from the Zynga prospectus, and the text in normal font is my remarks.

1. Free:-All of our games are free to play, and we generate revenue through the in-game sale of virtual goods and advertising. Even Google does the same, with only enterprise applications being priced, and that too selectively.
2. Network Effects:-Because the opportunity for social interactions increases as the number of players increases, we believe that maintaining and growing our overall number of players, including the number of players who may not purchase virtual goods, is important to the success of our business. Google search results are 'intelligent' and improve from each search. Also for applications like Gmail, the network externalities are good. 
3. Data driven:-gather daily, metrics-based player feedback that enables us to continually enhance our games by adding new content and features.We continually analyze game data to optimize our games. We believe that combining data analytics with creative game design enables us to create a superior player experience. Google is also a famous analytics fan, which it uses to inform decisions.
4. Dual Class voting shares:-Zynga has a triple class voting share, which gives the founder around 36% voting power post IPO(1 share of his Class C shares=70 votes of Class A shares). This structure was held by Google as well.
5. Cloud Computing Dependence:-Zynga uses Amazon Web Services, while Google is all about cloud computing especially for Google Docs
6. Hiring through acquisitions: We have historically hired a number of key personnel through acquisitions, and as competition with several other game companies increases, we may incur significant expenses in continuing this practice. It is a lesser known fact that many popular Google applications like Orkut, Picasa and the like were acquired through early M&As. 
7. Letter from founder in IPO document:- Actually this is more like what Amazon did! But since Google tomtoms its principle especially 'Do No Evil', I thought there was a similarity there.

Still, one should not stretch the analogy too far. Google has survived multiple crisises and competitors, which Zynga brokeven only in FY10, and has yet to survive  extreme competition. But one must admire the essential freemium similarity in the business model. 

Karuturi Global Africa agriculture foray-goldmine or landmine?

Earlier this year, I blogged about Karuturi Global's foray into Africa and its professed noble goals of meeting African food security etc (http://financeandcapitalmarkets.blogspot.com/2011/03/meeting-food-security-in-africanot-from.html). Since then, many things have changed which I thought should be highlighted in this post, for readers to take a balanced view

1. Water Wars:-The 5 upstream nations sharing Nile waters, entered into a treaty to improve their share of Nile waters, contrary to the historical preferential rights of Egypt and Sudan. While Egypt and Ethiopia are trying to resolve this(http://www.upi.com/Business_News/Energy-Resources/2011/09/23/Egypt-Ethiopia-mull-Nile-dams-dispute/UPI-28691316789638/), there is bound to be disputes and lack of clarity, which would hit investor sentiments
2. Land grab accusations grabbing momentum:-Karuturi's deal is held up as the perfect example of a sweetheart deal by activists, who overlook the capex it has to incur. But in case the Arab spring reaches Ethiopia resulting in a regime change, then I would not be too optimistic about the fate of Karuturi. Even its MIGA guarantees will not compensate much for loss of profits. 
3. Investors shunning risk:-With the turmoil in USA/EU, Karuturi would be hardpressed to find financing for expanding in the way it wished. Ditto for getting JV partners for food processing and storage. The way things are going, its completed sowing may be the peakk output
4. Climate risk:-Karuturi lost its first corn crops when around 12000 acres were flooded this year. The loss of $15MM was around 1/5th of the company's market cap at that time(http://www.ethiopianreview.com/content/34462) . Given the rising risk of climate change, such shocks may only increase in the years to come. 

Of the 4 risks, I would rate expropriation and climate risk as the main two factors, and it would be interested to see how the company deals with these risks. 

20months cash cost breakeven-the dangers of DishTVs strategy

Now, none of us would like to be classed as 'average', and I'm the first one to admit that there are quite a few pitfalls in that. Still, for the purpose of analyzing aggregate data, that would serve fine. To further appreciate the rest of the this post, read the DishTV presentation(http://www.dishtv.in/Library/Images/DishTVInvestorPresentationOct.2011.pdf) and my brief primer that follows

• As one knows, DTH companies spend heavily to get the customer to buy their set top box
• DishTV defines subscriber acquisition cost as, set top box subsidy+commission to dealer who sells/installs it + 80% of marketing spend! Now, one may argue that 80% of marketing spend is nothing but arbitary overheads allocation. Even if that maybe, the fact is the spend would be taken with that outcome in mind, so if the company expects 80% to earn sales, so be it. SAC is between Rs 2100-2300 at present.
• ARPU(average revenue per user) is internally split by DTV into amount attributable to service charges+FTA channels(presently Rs 100) and the balance for pay channels. ARPU around Rs 150 levels, expected to touch Rs 160 due to more HDTV etc. 

Now, all busineses have marketing costs and I daresay if FMCG/ITES sector calculated their Customer Acquisition Cost as conservatively as imputing 80% of marketing spend, then those figures would seem high as well. But going with what we have, the trend I noticed is even at improved ARPUs, the breakeven period at gross ARPUs of Rs 152(net Rs 114 after content costs) will be 20months to recover the subscriber costs of Rs 2232.

 

Of course, DishTV expects their ARPUs to grow exponentially due to HDTV revenues. But this graph(should not be much different for other plays) shows that DishTV is playing a numbers game to retain their 30% market share.  

But the danger in that, is DishTV themselves introduced a device card to make any STB of other operators, compatible to receive signals from DishTV. While DishTV packages this as Dish Freedom(http://www.dishtv.in/dish-freedom.aspx), this equivalent of mobile number portability for STBs may unleash an industry war, with players deciding to compete on content. After all, if DishTV can attack the installed base of other players, so can they. But like how MNP failed for mobile phones, DIshTV can only hope that subscribers will stick to the incumbent. But if the competitor comes and offers this device for free to hook DishTV subscribers, then it is a whole different ball game.

So what does the market think about this? Dish TV has gained 42% in the past one year, spurred no doubt by growing ARPUs and dominance. And its market cap of nearly 6500 crores(versus debt of just 1200 crores odd) for a 13million STB base, speaks of an implied valuation of Rs 5000 per STB, which is nearly twice the acquisition cost! Can this eyeballs game continue for ever? As CAs, MBAs and other professionals maybe we should think about the prudence of this approach for our clients.

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.

Asian Electronics fraud on investors by repricing stock options

When I opened the FY11 annual report of Asian Electronics(http://www.aelgroup.com/AEL_Annual_Report_2010-11.pdf), I got a shock by looking at the options repricing resolution. Stripped of all the legal jargon, they want the shareholders to lower the exercise price of options from Rs 28 to Rs 12.6 viz Rs 17.4 reduction. These options were granted hardly a year ago(viz 31st March 2010), and now they are seeking post facto approval because. In view of such depressed level of market price of shares, exercise of stock options at an exercise price of Rs. 28/-per share became unviable for all the grantees... revised the exercise price from Rs. 28/- per share to Rs. 12.60/- per share, to bring the exercise price in consonance with the prevailing market price of the shares of the Company

This logic is flawed. Options are not meant to be at the prevailing market price UNLESS the holders intend to exercise it  immediately, in which case they could have got it from the open market. They obviously intend to hold it till Mar-15, and exercise it when the price jumps over Rs 13.

Now, these options were exercisable within 5 yrs viz Mar-2015. But evidently, the directors and employees are in a hurry to cash out. Poetic justice perhaps further reduced the share price to Rs 8 as of today, so will they pass another resolution to reduce the exercise  

So how much are they profiting from this?

1. The 4 non executive directors are having 1 million ESOPs reprices=>a benefit of Rs 17.4 million.
2. Other key employees are having 3,51,550 ESOPs repriced=> a benefit of Rs 6.2 million.

One can justify the need to retain employees by repricing their stock options, but repricing for non executive directors? It smacks of a Faustian Bargain 'You scratch my back I scratch your back'. One would have thought that the self described eminent professionals with experience in over all management, finance and law, who bring a wide range of skills and experience to the Board would be above doing something like this, but evidently Rs 17.4 million is the price of their conscience.

Granted that this is subject to confirmation by shareholders but I wonder how did

• The compensation committee(all the said Non Executive directors) vote itself options repricing)?
• The nominee institution directors agree to this?(maybe because this saves an monetary outflow)?
• They ever think of seeking 'post facto' approval and seeking fait accompli. 

No wonder then, that Asian Electronics's reputation on the bourses is trash. 

What I like about CRISIL IER Reports

Concerned by the lack of analyst coverage on most stocks, NSE(National Stock Exchange) decided to commission CRISIL to cover selected stocks on an ongoing basis. Unlike conventional equity research reports, these reports do not give an explicit 'BUY'/'SELL' recomendation. Then what use is it you may ask? Well, the merits of this approach versus conventional equity research reports are

• Transparency:-It is an open secret that the lesser known brokerage houses(and indeed some of the bigger ones) seek a quid pro quo from the companies in return for covering then. CRISIL does IER either by commissioned by the exchange(NSE/BSE) or if commissioned by the company. The latter approach is non mandatory and may lead to conflict of interest as in credit rating model, but atleast the payer is explicitly disclosed upfront
• Differentiates between fundamentals and valuations:-CRISIL analyzes the companies on two parts-quality of fundamentals and valuation upside(viz Fair Value v/s Market Price). That is better than mixing the two up.
• Good environment analysis-competition etc:-This section is amazingly done in general.
• Corporate governance/risks:-CRISIL IER reports pull no punches when it comes to the corporate governance, contingent liabilities and risk management section.
• Track Record:- The reports give the history of the past reports mentioning their fundamental grade(and then calculated fair value) along with valuation grade(and the then CMP[current market price]). Hence, an investor can eyeball that track record and see how the fair value as calculated by CRISIL, has moved with the market price. 
• Freely downloadable:- Unlike other equity reports which are first shown to certain customers first, CRISIL releases all reports at the same time to all investors, which are freely downloadable.
• Response to queries:-Retail investors rarely have access to the analysts. But in this case, the CRISIL analysts are available on email(I did not try to call them though!) and do respond to queries promptly.

I've read reports from quite a few brokerage houses, and can say that the quality of these reports is certainly up there with the best. You may not get earth shaking insights, but certainly these reports cut investor risk substantially for stocks less tracked. While most of this may be already available in the detailed credit report, these are often not publicly available. 

Why Mercator Lines is a BUY thanks to coal play.

In June-11, the CEO claimed that the expected valuation of Mercator's coal mining assets would be $150MM for 20% or an implied equity valuation of $750MM for all the assets( http://www.moneycontrol.com/news/ipo-upcoming-issues/mercator-lines-to-launch-ipocoal-division-by-year-end_561459.html). But surprisingly, the global coal prices have only risen till then, but the company's share price has fallen around 40% and the total mcap is just $140MM. Instead of screaming 'BUY' from the rooftops, I thought I'll explore the possible reasons for that, and invite reader comment on the same. For those who have not heard of the company, it is a shipping company which has ventured into dredging, coal mining and oil & gas. It essentially aims to replicate Adani. Read about the company here(http://www.mercator.in/investors/mllinvestorppt.pdf) and download its FY11 annual report here(http://www.mercator.in//investors/AnnualReport/Mercator%20Annual%20Report%202010-11.pdf). The possible explanations for it-other than calling it a case of the bi polar Mr Market of Graham fame-are

1. Coal Mines not as promised:-The coal mines are in Mozambique(85% stake in 1BN tonnes estimated reserves) and in Indonesia(230MM tonnes). The present coal profits-around 20 crores/quarter-are derived from the Indonesian mines. Now, the CIA World Fact book shows that Mozambique is a debt laden poor company with crumbling and inadequate infrastructure. Mercator's 30yr license was to commence from last year(2010) but it is still looking for a partner to operate the mine. The fact that they have not yet found a partner  in the M&A crazy world of coal acquisitions, that too in the next big continent('Africa') speaks volumes for the asset quality-because the global majors are not that slow....
2. Shipping business value destroying? Holding companies are valued at even less than the cash on their books(like Piraral Holdings) because investors are worried that good assets will go to stem the cash drain from bad assets/ill advised actions. But this rationale does not really hold, because the company WAS profitable till the crisis, and is still recognized as an efficient operator. 
3. Market has priced in political risks of expropriation?:-If we content that the Indonesian export tax on coal will make exports uneconomic, then the entire coal IPO valuations stems on Mozambique. Given that the royalty is just $1/ton(sounds too low right?), Mozambique may be tempted to do an Indonesia and hike the royalty. It may even go further to nationalize the mines-but given the diplomatic relations etc involved, that seems a tad bit unlikely. 
4. Market still views it as a shipping company:-Despite the company's efforts to change its name, market itself as a coal company etc, it is still viewed, monitored and valued as a shipping company. But whatever the value is, would it be negative?
5. Consolidated v/s Standalone numbers:-The Jun-11 quarterly consolidated EPS is Rs 0.6 but the standalone(only shipping) is a loss of Rs 1.61. Investors who do not read beyond the fineprint and panicked at thestandalone loss, may have dumped it.
6. Unsure IPO prospects:- Where the global markets may have frozen, investors may be sceptical about the prospects of the IPO happening. But at any EV, it is a no brainer!
7. No clarity on holding structure:- The group organizational chart is not given, and it is difficult to ascertain the vital element of which company holds the coal mines(i.e which SPV). Mercator claims it to be housed in Singapore and ultimately Mozambique, but little clarity on that.
8. Why have other investors not caught on yet? Maybe this stock is off their screens, and in the flight to safety this may have been ignored...

None of these reasons(except 1 and 3) hold much water. And for the huge margin of safety, I think this is a classic Graham stock, which is hurt by the distressed shipping sector valuations.  Other non financial advantages are

• Qualified and stable management team since inception-promoter CEO is from IIT Roorkee, aptly complemented by a Chartered Accountant, the Jt MD. 
• Loyal independent directors:-Unlike some other companies, it has not seen an exodus of independent directors in the wake of Satyam. But then, it did have a clean image. 
• Trading at historically low multiples:- P/BV is around 0.6. 

Recomendation:BUY @ CMP Rs 25. It seems a no brainer and multi bagger.

When the going gets tough, the smart guys cook the books-examples of Jet,Kingfisher and others

Warren Buffet famously said that an investor should have shot down the first aircraft that the Orwells flew, so that future investors would not have seen value destruction. In India, the same story of value destruction has emerged, but to compound the industry woes of economy dependence, LCC price wars, ATF etc; some companies are not above cooking the books. Following are some examples from the FY11 press releases/annual reports, for the financial reporting period ending Mar-11. The facts speak for themselves, and bring out why accounting risk is quite high in this sector, and for some business houses in particular.

1. Cherry picking accounting rules which allow favorable treatment-even before their final adoption: Kingfisher airlines readily adopted a draft accounting standard, to reduce its losses by Rs 37 crores. This may seem good practice(early adoption) but the company does not show such enthusiasm for other proposed rules(like IFRS itself!). And going by the management judgement on deferred tax assets, one must wonder the wisdom of this choice-despite the 'independent expert' view. If the expert was confident of its view, it should have allowed itself to be named. The note reads 'The Company has adopted the Exposure Draft on Accounting Standard - 10 (Revised) Tangible Fixed Assets which allows costs on major repairs and  maintenance incurred to be amortized over the incremental life of the asset..Had the Company not adopted this method of accounting, the loss before tax for the year and the loss after tax for the year would have been higher by Rs.3,726.83 Lacs  and Rs. 2,517.66 Lacs respectively..This revised accounting policy has been confirmed by an independent expert and in the opinion of the management, this accounting treatment has resulted in a fair depiction of the working results and the state of the affairs of the Company.'
2. Accounting for brought forward tax losses despite track record of losses:- Kingfisher Airlines in their Mar-11 press release announced that, Deferred Tax Asset is recognized on account of unabsorbed depreciation and business losses for the year ended March 31, 2011 aggregating to Rs. 49,341.80 Lacs. The management is of the opinion that there is a virtual certainty supported by convincing evidence against which such deferred tax will be realized. I do not know of any other Indian company, with comparable loss record/industry prospects, that has boldly felt that it will make enough  taxable profits in reasonable time to offset these losses.
3. Shifting depreciation method from WDV to SLM:- This typically results in lower depreciation expense and higher profits, atleast for the initial years. So Jet Airways discloses that . In order to reflect a more appropriate preparation/presentation of financial statements, the Company has changed the method of Depreciation on all owned tangible assets (including Simulators) other than Aircraft from Written Down Value Method to Straight Line Method w.e.f. I st April, 2010 and the surplus arising from retrospective computation has been accounted and disclosed under Exceptional Items for the Year ended 31 st March, 2011. This bottomline boost amounted to Rs 135 crores, as compared to PAT of 48crores loss.
4. Recording LCC investments at book value despite heavy equity erosion. This is not unique to airlines, but even where they are not market leaders(Jet Lite has just 7% market share), they are very optimistic. For instance, Jet invested nearly Rs 3200 crores in Jet Lite, yet is not accounting for the value erosion. Note that the valuer is unnamed, also that mere expectation of turnaround without a stated timeframe, is used to defer loss recognition.  The justification reads as follows The Company has equity and preference investments aggregating to Rs. 164,500 lac in Jet Lite (India) Limited, a wholly owned subsidiary, and has advanced an interest free loan amounting to Rs. 1,52,951 lac as on 31 st March, 2011. A reputed valuer has valued the equity interest in the subsidiary as on 31 st March, 2011 based on its business plans, which supports the carrying value of such investment The Company continues to provide financial support to the subsidiary's operations to further such business plans and expects it to turnaround. Accordingly, the subsidary's financial statements have been prepared on a "Going Concern" basis and no provision is considered necessary at this stage in respect of the Company's investments and loans outstanding from the said subsidiary
5. Extending the financial year erratically:-When you expect to report a bad year, what do you do? Delay the release of annual report(R-ADAG companies), or extend the accounting year. In May-11, Mafatlal Industries initially had extended their accounting year from May-11 to August-11, but buoyed by the sale of land, they preponed it to June-11! This travesty is documented in their May-11 quarterly results press release. The Company in its Board Meeting held on 9th  May, 2011, had extended the Financial Year 2010-11 of the Company by three months from ending on 31st May, 2011 to ending on 3I st  August, 2011. The Board of Directors of the Company have now passed a resolution on 27th  June, 2011, for change of Financial Year 2010-2011 to end on 30th  June, 2011 instead of 31st  August, 2011. In view of this, the Financial Year of the Company would be for 13 months period i.e. from 1st  June, 2010 to 30"' June,2011 in modification of the Resolution passed on 9th  May, 2011..

Geodesic-the next multibagger like Onmobile?

What drew me towards this company is NOT any stock screen/analyst report(very few of them actually!) but its quarterly financial results press release(available here). While other companies use this as a statutory compliance tool, Geodesic uses it as a marketing tool to state two entire pages of achievements during the quarter. This does reflect the company's innovative and upbeat approach, and that prompted me to look further. And a perusal of their annual reports/other documents only stoked my interest further. Consider this

1.  NOT a geographic information systems company:- The name certainly evokes that sentiment in me(and I suspect I'm not alone). They are into the following businesses 
1. Communication/collaboration:- like Cisco
2. Mobile VAS:- under the Mundu brand
3. Electronic computing platform:- They have developed Linux based handheld device GeoAmida, which is used in several E-governance projects. The UID scheme may boost these sales, as may the increasing IT usage in both State/Central projects
4. Financial products/services:- Like most other IT Cos
5. Content:- Chandamama brand but also they serve as content aggregators.
2. Attrition rate well under 5% for the past 6 years-a commendable feat in any industry specially IT.
3. Berkshire Hathway approach to managing subsidiaries- operate as an aggregation of separately-managed small and medium- sized businesses, most of whose decision-making occurs at the operating
   level. They would rather suffer visible costs maybe of a few bad decisions than incur invisible costs that come from decisions made too slowly – or not at all.
4. Infosys style conservativeness with cash;- They prefer security to high returns on cash/investments.
5. Transparent tax planning:-The company discloses(Pg 29 FY10 AR) that Geodesic Holdings Limited (GHL), Mauritius  primarily acts as the Holding Company for all subsidiaries of the Company outside of India.This is to streamline the processing and operations of outside subsidiaries!! 
6. Owners of iconic brand Chandamama:- This mythological based magazine is expected to break even in FY11, and has good content library value
7. Marquee client list:- They have vastly successful client relationships(Apple/HDFC etc) and their Ipad app Mundu TV is the No1app on Apple India store.

But every rose has its thorns. The negatives:-

1.  Their tax exemption expired in Mar-11(like for all other IT companies in EOUs), but given the export dependence(98%+ sales) , their effective tax rate may still be lower.
2. Non transparent segment reporting:- Despite the plethora of business activity description and their 'hands off' approach to operating subsidiaries, they have not chosen to disclose any breakup. This is counter productive in terms of valuations because they do not get the rich valuations that Onmobile gets. This incidentally, is the biggest hurdle to fairly valuing this company.
3.  Investor Relations seems a bit weak
1. Have stopped posting the conference call transcripts after 4Q'10. I do not know whether they even hold it an analyst conference call or not.
2.  The analyst research reports(downloadable on the investor relations homepage) are quite old, indicating that possibly the coverage on this stock has ceased.
3. They had to send a corrigenda to the FY-10 Annual Report(albeit minor detail) which does not reflect favorably on the financial reporting process. 

To my mind, the EV(Rs 590Cr Debt+Rs 730Cr Equity) of Rs 1380 crore does not do justice to the company's growth prospects, management and brand. The share is trading at just over book value(Rs 80/share) which is surprising-but maybe due to the non disclosure of segments. But why my comparison with Onmobile? Even Onmobile had a strong content base, good management and initial analyst apathy. Also, Geodesic's mobile apps foray(and apparent success) does make it comparable(though we do not know to what extent). Given the superior operating parameters of Geodesic(sales, margins) v/s Onmobile, the valuation gap looks to only narrow here on.


To my mind, upside triggers for this stock are:-

1.  Aadhar Project:- This may boost the demand for GeoAmida, as would other E-governance projects
2. Apple Store launches:- If they can continue the run of successful apps, market may reward them.
3. Improved reporting/visibility:- If the conference calls are held more often AND segment details published, valuations may improve.
4. Possible M&A-given the very high FII holding, the stock is ripe for a hostile acquisition. Of course, the high FII holding is also a chance to pick up the stock at fire sale prices if FIIs start exiting India en masse. The promoter holding of 20% is quite low....
   
   Ownership Pattern
   

The corporate governance discount-why Lok Housing's valuations are rock bottom.

A friend suggested that I look into Lok Housing And Constructions Limited(LOKHSG) where he has an investment. What further triggered my interest was the low enterprise value of the stock(market cap Rs 104Crores and around Rs 56 crore debt; total EV=160 crores). For a company with several interesting projects

1. After repeal of Maharashtra's land  ceiling control law ULCRA, land of approximately 3,29,704.64 sq. mtrs. at Ambernath in the suburbs of Mumbai, has become available for development
2. 49% stake in redeveloping  around 30 acres of land (362 buildings and over 8000 tenements in the prime location Kalbadevi in Mumbai's C ward, involving demolishing these old and dilapidated buildings and in their place constructing  high rise structure in the ear-marked plots. Approvals have come and construction would start soon. Pilot project of 30acres is expected to increase to 232 acres.
3. On-going projects such as Lok Mansarovar, Lok Prabhat and Lok Nirman.
4. As one of the schedules show, they have 86.17 lakh sq feet work in progress, work in progess valued at around Rs 390/sq foot. Given that developers usually get a profit of around Rs 2000+/sq feet(conservative), this amount can only rise. 

 Then WHY is the mcap stagnating at this low premium? I had a look at their FY10 annual report(download here) and some earlier ones. And this is what I noticed(also note the nonperformance v/s Sensex)

Index Comparison

1. Independent director Mr BC Jain(renowned Chartered Accountant) appointed in Mar-10, resigned in Nov-10 itself(see here). As a professional, he has a lot to lose by remaining on a board of a company with doubtful antecedents, and so his resignation should be viewed in that light
2. They have debt of 56Cr but operating cash flow of only about 3Cr/yr. Repayment is difficult, and in fact they have defaulted on the Rs 42Cr debt from SBI. In the post LIC Housing Finance era, it will be difficult for them to raise funds from banks, to complete their projects. Other channels like PE funds are expensive demanding an IRR of 18%-20%+
3. As my friend Miheer Desai pointed out, there are accounting irregularities. In 2008-09, they had to restate their debtors/inventories because they had accelerated revenue recognition on instalments which they were unable to collect. Though this was an industry wide phenomenon, it affected Lok the most relatively. On the socalled doctrine of 'relating back', they has the accounts revised
   for FY 06-07 and FY 07-08. This can be viewed favourably(honest enough to revise) but also draws doubts on the accounting/audit quality

Inspite of all this, the upside factors for the stock though can be

1. Bigger fool theory:-In May-10, Promoters were allotted 5 million shares @ Rs 40/share. They have an incentive to boost the share price to above that. 
2. Land bank valuations when monetized AND success of the redevelopment project. If they can sell off/partner with bigger builders, this can be beneficial.If we look at the stock price performance, it has tracked sales/profit(as it should) WITHOUT considering option valuation of landbank.
   
   Performance Chart
   
3. New political alignments. The Mumbai share bazaar gossip places Lok in the company of the Hindu right wing party-Shiv Sena-which controls the Mumbai municipal corporation but which has been out of power for the past 6yrs+ in the State. Given that lucrative projects need the co-operation of both State and local Govts, realignment with the Congress/NCP(parties in power at the State level) may boost the scrip
4. Clarity on debt repayment:- Once this is repaid atleast substantially, stock may go up.

 Only fools go where angels fear to thread. In a stock without any institutional presence, and with such serious issues, investing needs a leap of faith. But then, the returns can be exponential.

A look at the internal audit system at India's largest sugar producer

BHL(Bajaj Hindustan Ltd) is a Shishir Bajaj group company, and is the largest sugar producer in India with an overall share of more than 20% of the Uttar Pradesh production(As at Sep-2010). For an Indian company, the risk/audit disclosures are exceptionally lucid and detailed and deserve a mention. I detail below their internal audit measures with my comments in italics. It is sourced from 2009-10 Annual Report.


I notice that they do not really have controls set in for the power plant. Maybe they will update their next year's annual report to take care of that. Another control not mentioned here is the check on raw material procurement price. After all, if mill procure at less than the State Advisory price, they may be legally liable for penalties. These instances do not seem captured but otherwise the controls do seem robust, and more than that, the company's confidence in disclosing that is to be commended.


General Measures
These are done by any decent internal audit firm and include

1. Checking of Accounts vouchers on test check basis
2.  Physical verification/analysis of inventory and of  Surplus, Discarded and Non moving stock
3.  Checking of Store Ledger with respect to timely accounting of Receipts and Issues of Material
4. Reporting on overdue debtors  of Sugar, Molasses, Press Mud & Organic Manure
5. Review  of  Statutory  dues and  timely  filing  of Returns
6. Checking of Excise and Service Tax Reconciliationsfor timely availing input credit in eligible cases. Umpteen companies are mired in this litigation for credit. They are taking preemptive measures.
7. Pre Audit of Purchase and Work orders issued from units & Post Audit at Corporate office Noida. It is good that they are following good capital budgeting practices of pre audits. 
8. Verification  of  system of  recording  all  incoming materials including freight incurred thereon
9. Review  and  reporting  on material  sent  to  outside parties for repair/ Jobwork
10. Review of Inter unit and Inter Company Material in Transit cases
11. Checking and reporting on Employee’s  Imprest debit balances.
12.  Checking and reporting on Excess Interest chargedby Bank on OD/ CC Accounts

Sugar Industry Specific measure

1. Reconciliation of Empty Sugar Bags-I guess this would be with the packaging material consumed
2. Checking of Tools & Tackles issued to Employees &Contractors.
3. Surprise checking of dispatch of Sugar, Molasses, Bagasse and Press Mud on Sample basis. Dispatch being Govt controlled, compliance with schedules are necessary
4.  Surprise check of Cane Centers, records maintained thereat and review of Cane control, checks & MIS reports. This guards against tendency to delay updation of records. 
5. Checking of Safety measures and civic conditions of Sugar Godowns at Units. This is not merely a quality/Production issue since it carried operational risk.

Lessons from Jain Irrigation proposed NBFC foray-Information overload, unsustainable value addition

When Jain Irrigation informed the stock exchanges on 28th Jan,2011 of its plans to set up a NBFC to "integrate rural financing and sale of Company's products to the farmers", the response was muted. This item, hidden in a host of other resolutions, was missed out by the financial press/markets. But when the realization sank in, panic selling crashed the price from Rs 225/share to less than Rs 175 on Feb 3rd, 2011. After 'experts' on a popular financial site(www.moneycontrol.com) opined that this strategy was 'synergistic' with  the current one, order returned and the share price has bounced back to 200+. This episode has quite a few lessons for investors

1. Learn from parallels across industries:-Educomp(India's premier education company) had an issue with mounting receivables from Government and other schools which had installed its 'Smart Class' infrastructure heavy solutions. These mounting debtors and capex heavy nature of business depressed the ROE/ROCE margins. Finally in 2009, Educomp decided to spinoff its receivables and infrastructure business to a SPV, which would pay Educomp upfront. What distinguishes this from Enron is that Educomp has negligible equity stake in that SPV and has persuaded banks/financial institutions to purchase the securitized debtors via the SPV route-without recourse. If we carefully notice, even Jain Irrigation had a problem of debtors, because the Govt would delay subsidy payments(Jain Irrigation's business model revolves around farmer's purchase being subsidized by Govt, which directly pays the manufacturer). So it now wants the farmer to take debt from its own NBFC(leaving the latter to bear the payment delay).
2. Information Overload:- In a low promoter held stock(and fairly liquid one at that), you would expect such vital information to disseminate quickly. But it took 2 working days for the impact to sink through. If this is the scenario with a 1 page press release, I shudder the imagine the consequences when IFRS comes to India with its voluminous disclosures. Like how Enron did, companies may get away with blatantly confessing sins in their financial filings, with analysts being non the wiser. 
3. Irrational response:- Then panic was unjustified because shareholders could have voted with their ballots instead of stampeding out of the stock-unlike a typical Indian company with 50%+ promoter holding, shareholder activism may actually work here.
4. Unsustainable plans:- Strategy 101 classes harp on entering a venture if there is a strategic moat. In this case, there is little evidence to suggest that Jain Irrigation has a retail distribution strength. And then the stringent RBI licensing norms for NBFCs could come in their way, unless they tie up with a bank/financial player. Which begs the question-why have a NBFC instead of an alliance?
5. Irrational valuation concerns:- A reason raised on some forums was that the company is entering a low margin NBFC business which detracts from the high margin 'Micro Irrigation Systems'. Fine- so use Sum of the Parts approach to value it-why punish the entire P/E ratio for that

I suspect this issue will fester longer and make the stock more volatile. Investors in this counter are advised to read up on this issue and take a long term view.