Financial reporting and taxation a zero sum game?

Reposting from another blog of mine http://apoliticallyincorrect.blogspot.in/2012/10/financial-reporting-and-taxation-zero.html  At the risk of repetition, views purely personal.

Fake or not, Gselevator has lots of useful career advice, quotes/insights.

For nearly a year now, the anonymous tweeter acccount(https://twitter.com/#!/GSElevator), claiming to give quotable quotes mentioned in Goldman Sachs, has been source of endless amusement among those associated with finance. While some people feel that this is not written by a Goldman Sachs person due to basic ignorance about the firm revealed in some tweets(http://www.ritholtz.com/blog/2012/02/why-gselevator-is-a-fake/), the tweets albeit caustic and revealing, can really give lots of insights. 

1. Against arm chair critics:-People who are in position to, or smart enough to solve the European debt crisis don't have the time to debate it on Facebook.
2. How upbringing affects our views:-Dude, don't blame chicks for their insecurities. Most fairy tales teach girls that only men can save them.
3. Importance of Excel in finance:-If you can't use Excel without a mouse, keep your résumé updated. 390 Greenwich is just down the street.
4. How retail investors are conned:-Retail investors should be circumspect of any offering they’re able to get their hands on. If you can get it, you don’t want it.”
5. Why bankers should be rich:-If people never trust a skinny chef, they shouldn't want their bankers to be poor.
6. About Euro:-The Euro is dead. They're just bickering over who pays for the funeral.
7. Financial literacy/Money:-The lottery is just a way of taxing poor people who don't know math. If life's a game, money is how you keep score.
8. How things never change:-Solar power has been the next big thing for forty years.

I did not update this post written way earlier, but the above is itself good food for thought

Why DISH TV is still a speculative bet-negative equity, cash burn..

Earlier, I blogged about the irrational exuberance in the valuations of Dish TV as reflected by high EV/subscriber, which even exceeded the replacement cost (http://financeandcapitalmarkets.blogspot.in/2012/02/each-dishtv-subscriber-worth-rs-8000.html). Given that nea

Some points to note from the Sep-12 earnings release(http://www.dishtv.in/Library/Images/EarningsReleasefortheQuarterEndedSeptember30,2012.pdf) are

1. They are STILL playing the subsidy game(not passing on cost increase due to rupee depreciation etc to the subscriber)-increase in SAC from Rs 2145 in earlier quarter to Rs 2273 now. 
2. New adds may be of lower quality yet not be recognized as churn. As announced recently, all new subscribers will get 70 FTA(free to air) channels for 4years IF they recharge for minimum Rs 200 in period of 6months. Given the SAC of Rs 2300 odd now, the minimum revenue they will get in 4years is Rs 200*8=Rs 1600, that too after entertainment tax/content cost etc would be max Rs 1000 or so. Breakeven will not happen if subscribers cotton on to this...
3. Distribution network is 1480 distributors, 114000 dealers, 8567 towns supported by 4 call centres/1600 agents/11 languages. This network is somewhat hard to replicate, and an ingredient of the valuation given to them. But is it worth even 800 crores??
4. MD&A(http://www.dishtv.in/Library/Images/AnualReport2011-12/ManagementDiscussionandAnalysis.pdf)  and investor presentation(http://www.dishtv.in/Library/Images/CompanyPresentation_Oct2012.pdf) both focus on irrelevant metrics and gloss over the earlier aggressive accounting(till FY13, STB was depreciated over 5years but the upfront payment was amortized over 3yrs) and mounting losses. 

On an active base of 10MM subscribers(gross subscribers 13.9MM), the company is valued at an EV of Rs 9600 crores(Rs 1600crs debt consolidated FY12 + 8000crores odd equity). That amounts to Rs 9600/active subscriber or Rs 6900/gross subscriber. Given that the SAC is itself just Rs 2273, and ARPU Rs 159/month(of which hardly 40% accrues to company after content costs etc), this is really irrational valuation.

There are solid academic research like that of Ashwath Damodaran(http://people.stern.nyu.edu/adamodar/pdfiles/Seminars/AIMR3.pdf) on valuing companies in distress/loss making companies. But it is still hard to support such valuation levels. Maybe investors are in for a hard landing.

Will the draft Indian GAAR guidelines discourage creative structuring?

Earlier this year, the Indian Revenue Department released its position paper on implementing the much awaited anti tax avoidance rules, expectedly on pro revenue lines. What was of interest in the paper (http://finmin.nic.in/the_ministry/dept_revenue/Draft_GAAR_GuidelineITAct1961.pdf) besides the illustrations, was the criteria for defining  impermissible avoidance arrangement  as one whose

(a) its main purpose is to obtain a „tax benefit‟, and,

(b) it also has one of the following characteristics:

(i) it creates rights and obligations, which are  not normally created between parties dealing at arm‟s length; (ii) it results in misuse or abuse of the provisions of the tax law; (iii) it lacks commercial substance; (iv) it is carried out by means or in a manner which is normally not employed for an authentic (bona fide) purpose.

It is point b(iv) that bears interest here. Structuring of transactions(for my earlier posts on structuring read these posts    ), needs ample creativity, customization and is often only constrained by the regulations/tax laws which it aims to circumvent. Such an explicit provision will give the Revenue leverage to attack innovative structures, and therefore defeat the first mover advantage of the early adopters. Of course, this may only ensure legal wars over the meaning of ‘normally not employed’ and so on, but this puts innovative structures at risk. Hence, till more clarity on this point, those structuring transactions for Indian clients would be well advised to exercise caution. 

ICAI Award for excellence in financial reporting-an analysis

Now is the time of the year when the Institute of Chartered Accountants of India opens its annual competition for the best presented annual report. The different categories are as per activity(service, infrastructure, manufacturing, non profit, public sector), ownership(public, private) and turnover(>500 crores and others). You can read about it at this link http://220.227.161.86/27423research16945details.pdf. Like many other awards, its reputation was somewhat tarnished post the Satyam scam(as Satyam was an award winner too), but it has bounced back. The object of this post is to educate the reader about the award criteria, and to comment on it. I had also ranked companies’s financial reporting as an academic exercise during my stay in IIM Ahmedabad, so I can claim some expertise in ranking!

1. ·         Compliance with statutory/regulatory norms
2. ·         Quality of financial reporting(‘clean’ audit report without qualifications/adverse comments)
3. ·         Adequacy and presentation of financial information by using schedules, cross references, subtotals, rounding off, charts/graphs/comparative highlights, financial ratios. Interestingly, ‘lucidity, clarity and comprehensively’ from the angle of individual/small shareholders is also rewarded here maybe for inclusiveness!
4. ·         Extent, nature and quality of non financial information including HR accounting, CSR activities, MD&A of company and subsidiaries, risk management, governance/ethics etc.

The award criteria in my view, miss out on the following important elements of the annual report

• ·         Segment Reporting-this should explicitly get weight(most companies escape by stating just one reportable segment!)
• ·         Intangible Assets-Few companies disclose their patents and other IPR. Hence, this should be incentivized, to allow shareholders to spot the next Apple :P
• ·         Too much importance to CSR/ethics-this is activity which the company spins, not necessarily which it does well. Rewarding mere reporting of this seems inappropriate, as it is unaudited information and often spinned too well
• ·         In this digital age, using the web version effectively and uploading high resolution coloured pictured form of annual report is not rewarded. In an era where electronic version is sent by default to those shareholders having email IDs on record, this aspect assumes importance.
• ·         Other information like investor presentation, conference call transcripts, videos etc are not evaluated at all. This being useful non financial information helping to interpret the financial reports, should certainly get some weightage. 

Understanding telecom retail in India-some pointers

At the outset, let me clarify that I do not consider myself an expert on telecom(or on anything else for that matter :P). This blog post is only based on certain observations/analyses and inferences during personal visits to telecom stores in Mumbai and Bangalore. For modern trade(malls etc), this may not apply due to space issues and also as they often do not carry the entire product range.

1. Commoditized SIMs/data cards: Thanks to the relatively low margins that retailers make on SIM activations, the poor SIM salespersons are given a stall outside the main store(!) with a packet of forms etc. So it is abundantly clear about their pecking order in the hierarchy of things!
2. Single brand versus multi brand stores:- All the operators be it Airtel, Idea, Vodafone, Reliance, Aircel all have exclusive outlets, which seem to focus on the consumer experience and awareness. That is why in the outlets I've seen, the focus is more on 1-1 selling and wider display of products/schemes, rather than the claustrophobic multi product strores I've seen(like The Mobile Store), that focus on max yield per square foot
3. Recharges not always sold in telecom outlets:-As that involves manual effort and all, many don't find it profitable to sell these recharges..indeed its mostly the kirana stores and other non exclusive outlets that sell these. 
4. Handset demos often not given:- Shops are aware that customers often check out the devices in the shops and then shop for it online. This problem is for books also, but there one cannot avoid showing the book itself unless its plastic shrinkwrapped(which may bring down sales though..). So often only the expensive/fancy phones are displayed but not the entry level handsets below Rs 10,000. And demos are given only for displayed products, few retailers will open the box and show you. 
5. Multi brand recharges/devices/data market:- Most retailers give a wide bouquet of all the popular operators, so there is no brand loyalty at the retailer level. So often the same retailer will have nameboards showing his name from all the main operators! 

Anyways, given that around 90%+ of Indian voice market is prepaid(and from early indications the data market seems going the same way), the front end is resembling a FMCG set-up. For fixed line, a DSA setup seems to work due to the unique economics of that business. 

Telecom industry economics 101-a primer

Telecom pricing has always seemed opaque, random and complex. But there is logic behind the seeming madness, which I try to explain below

1. Fair usage policy which restricts the user speed for 'unlimited speed' beyond certain limits, attempts to invert the Pareto principle on its head. After all, the specious logic used for fair usage policy is that a few users by their huge usage lower the overall experience for everyone else. Agreed, but that is what the Pareto principle is all about. By trying to avoid that, this is a novel experiment to avoid that here(i.e socialize the usage in a way). However, it does seem a success-logically and financially
2. Call termination charges are levied by the destination network, and impose a lower ceiling on calls tariffs between operators. But for intra-operator calls, this is not applicable(except within circles where due to separate license norms, they are subject to separate P&L and transfer pricing), and so operators can offer it at near zero prices(like say 2paise for a minute!). There, the pricing would probably factor in opportunity cost of using the spectrum(since that is a finite resource) and other network effects, but not out of pocket costs.
3. Like Dominos, Subway and Starbucks which sell a base and try to earn superprofits on the top-ups/upsize options, those economics/rationales apply more so to telecom, with its low incremental costs per minute. So lessons from the F&B industry can be profitably applied here
4. The cost structure from the operational side is largely fixed(spectrum, network) except for companies like Airtel which have a per-time slot cost structure thanks to innovative deals with their service providers. From the marketing side, channel partners get a fixed fee for customer acquisition, and therefore churn is very expensive for telcos which cannot recoup that fee(that is why an upfront fee/activation charge/registration fee is usually charged, that generally goes to recoup these upfront costs).
5. Telecom is intimately linked to customer behaviour(how they talk, listen to music, surf data) and so like food, it is VERY local. That is why tariff plans are also localized, and increasingly with the special offers/'best plan suggestion'; telcos are trying to refine their price discrimination by targeting offers to the n=1 target segment.

Will try to explain more later, but this is all for now. 

TCIs lawsuit against Coal India-legally and morally flawed

I wrote a post on this at my other blog, do take a look(http://apoliticallyincorrect.blogspot.com/2012/05/tci-sues-coal-india-morally-and-legally.html). While I rarely toe the Government line, this issue seemed too unfairly portrayed in the mainstream media to pass up!

Tricks Indian companies play to fool investors now-I

This time of the year is earnings season in India when companies declare their full year results for the financial year Apr11-Mar12(most companies follow this year end due to the tax laws mandating this year for assessment purpose, but many others follow different year ends like June, July, Dec and so on). While reading several earnings releases, I observed some interesting things which I share in this post

1. Delaying the release of results:-While most companies do not publicly disclose their financial reporting calendar, if a company has delayed reporting its earnings significantly as compared to previous years, that is a clue of financial distress. The company may be cooking its books or trying to get financial support to avoid being singled out for 'going concern risk'. Recently, this was done by the R-ADAG group companies, GTL group and others.
   
2. Extending the financial year:-Companies do this to buy time or just to avoid reporting poor results(hence add a quarter or two to make the 'year' better'. Or else, for the same reasons as explained above(i.e 'going concern risk'). I suspect that Bartronics has sought an extension for the same reason.
3. Limiting auditor's scope:-In case of Shree Renuka Sugars, Bartronics etc, the auditors audit less than 20% of the revenue/assets/cash flow, leaving the rest to other auditors. While accounting and auditing norms permit this and have standards on the auditor's duty in this behalf, the fact remains that audit risk goes way up in this case as auditors may miss out on channel stuffing and other unusual transactions.
4. Releasing interim 'unaudited results' rather than audited/reviewed results:-While Indian listing regulations permit a maximum 10% deviation in significant items(revenue/earnings etc) of the actual audited numbers from the 'interim numbers', that leaves significant scope for companies to tinker around with accounting estimates, especially for those hovering on the verge of losses. While I''m yet to prove any such case, I'm on the look-out for it this season.
5. Changing presentation to hide details of unusual items:-for instance, Bartronics(again!) had an 'other income' exceeding its operating profit but did not explain that details anywhere in its earnings release/presentation. and why would it, it is better off for investors to assume it is operating profit without delving too much into the details.

Stay on the lookout for tricks in disclosure/presentation. More on this later.

Gold bubble worse now than in 2010/2011? RBI ED V.K Sharma feels so

One reason why the RBI is a thought leader, is that it promptly uploads any speeches/presentations of its senior management, thereby allowing media and others to analyze and report it. And many of those uploads have been fantastic-be it the Governor's caution on value of audit, Dy Governor's views on treating customers fairly, 10 commandments for a banking career, real reasons for inflation etc. One such fantastic insight was hidden away in a speech titled The Framework for Pre-Empting Systemic Financial Risks, an inaugural Address delivered by Mr. V.K. Sharma, Executive Director, Reserve Bank of India, at the World Risk Workshop 2012, organized by R-square RiskLab at Mumbai, India, February 6-7, 2012. Now, looking at the title itself, one might yawn at another post facto subprime crisis analysis. But in reality, this speech was quite incisive, not for the old idea of a gold bubble, but for cross triangulating it and backing with facts(read it here http://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=675)

1. If one looks at the recent readings, there is incontrovertible evidence that there is yet again a huge under-pricing of risks in the financial system and, therefore, it is not a question of if, but when, generic asset bubble caused by manifold increases in balance sheets of central banks will burst.
2. Specifically, currently the global liquidity has become a bigger concern than it was in the pre-2007 period what with ultra-low and near-zero policy rates and major central banks’ balance sheets 1.50 to 3 times their pre-2007 levels, adding about USD 4 trillion in incremental central bank liquidity
3. the over-valuation of gold - what we can also call gold bubble - with reference to 7 competing asset classes varied from 78% against highly correlated metal prices proxied by LMEX, 62% against WTI crude, 109% against US Treasuries proxied by JP Morgan index, and roughly 230-275% against Credit Default Swap index, Dow Jones, the US dollar index DXY and the US home price Case-Shiller index 

 The table below as explained in his speech is quite self explanatory. But what is alarming is that despite the talk about financial stability, regulation etc, things have actually worsened in the last 15months. I agree that taking data for period Mar00-Feb10 may have a base effect, since the starting point was in the dotcom aftermath. But a 10yr data set looks quite robust to me. And then, one must admire the methodology he has applied(past price history). It would have been great to apply earlier data from the 90s etc but then data quality may have been an issue. 

Insights from Damodaran on Corporate Finance-II

Source:-http://people.stern.nyu.edu/adamodar/pdfiles/cf2E/mgtobj.pdf  of Damodaran. 
Aswath Damodaran(Professor at Stern School at Business) is a famous authority on valuation and corporate finance. His website reflects the richness of his practical experience, command on theory and research expertise(he's one of the few academics who uses real world data exceptionally well as his valuations of Groupon/Linkedlin etc show on this blog). Anyways, enough on him, this post reproduces a few highlights of corporate finance, which are quite insightful.Earlier, I blogged on some other insights(http://financeandcapitalmarkets.blogspot.com/2012/02/corporate-finance-some-complied-loose.html) which readers may find useful

1. The above 2 diagrams depict the contrast between the ideal world and the real world. Most Bschools focus on the ideal world but it is the diagram on right which we should care about. The above 3 diagrams themselves can summarize tomes of corporate governance books/laws.
2. The need for debt covenants -stockholders maximize their wealth at the expense of bondholders
1. • Increasing dividends significantly: When firms pay cash out as dividends,lenders to the firm are hurt and stockholders may be helped. This is because the firm becomes riskier without the cash.
2. • Taking riskier projects than those agreed to at the outset: Lenders base interest rates on their perceptions of how risky a firm’s investments are. If stockholders then take on riskier investments, lenders will be hurt.
3. • Borrowing more on the same assets: If lenders do not protect themselves,
   a firm can borrow more money and make all existing lenders worse off
3. Markets are not as shortsighted as they are claimed to be-There are hundreds of start-up and small firms, with no earnings expected in the near future, that raise money on financial markets
   If the evidence suggests anything, it is that markets do not value current earnings and cashflows enough and value future earnings and cashflows too much.The market response to Investment Announcements of research and development and investment expenditure is generally positive 
4. Corporate cross holdings-alternate corporate governance in Germany, Japan, India-At their best, the most efficient firms in the group work at bringing the less efficient  firms up to par. They provide a corporate welfare system that makes for a more stable corporate structure.At their worst, the least efficient and poorly run firms in the group pull down the most efficient and best run firms down. The nature of the cross holdings makes its very difficult for outsiders (including
   investors in these firms) to figure out how well or badly the group is doing. In my personal view, this is a reason for conglomerate discount or premium depending on how the group does..