Archive for the ‘Views on news’ Category.

 

I am mad ! very very mad. See this news item on novartis india.

Novartis AG has announced an open offer for Rs 351 per share with the aim of taking their shareholding to 90%. Although they have not stated any plans for delisting, I think once the shareholding reaches 90%, delisting norms could kick in and the rest of the  shareholders will be forced to exit the company.

Why am I mad ? See my analysis of novartis here. My conservative estimate of the intrinsic value  is around 600-650 (company has a cash of almost 150 rs/ share). Look at it this way – Net of cash, the buy back offer is valuing the company at 800 crs. This is for a company making almost 100 Crs of profit on a capital base of around 30-40 Crs !!

Another view point – The buyback offer will cost the company around 440 Crs. The company has cash and equivalents of around 435 Crs as of december 2008. So the Parent company will be able to increase its holding to 90% without spending a penny from their pocket !!

Should I feel cheated ? May be not. I have know this modus operandi for some time. A lot of MNC’s have cheated their minority shareholders this way. The steps are as follows

–        Allow the performance of the company to stagnate for a few years by avoiding product launches and anything else which enhances value
–        Hold all the surplus cash during this time period.
–        Wait for a bear market to drive your price down to very low levels.
–        Announce an open offer at premium to current price, utilising the cash holding
–        Try to mask this operation as a shareholder friendly operation by pointing out that the price is at premium to the current price (which is way below intrinsic value).

I have known and written the above earlier on my blog. I have however chosen to ignore my own advice though and would now be paying for it. At the current price, net of dividends, I have made modest returns. However that is not the point – The point is being treated fairly by the management of your company.

Another case – Ingersoll rand : They have announced their intention of coming out with an open offer too. I am not holding my breath on that as they have tried a similar tatic in the past, but were not successful in completing the buyback.

Lesson for me : Management matters more than i would like to accept. A good business with bad management will translate to poor returns.

What next ?
I am going to wait and watch how this open offer will play out. However even if the minority shareholders reject it, don’t expect the management to change or mend their ways. They will continue to ignore the minority shareholder, give poor dividends and will continue to accumulate cash. The best startegy in such a case would be to exit the stock and deploy the capital somewhere else.

 
 

Did I catch you on that ? are you expecting someone would be able to predict that for everyone ?

For the last one year, there has been an army of people trying to predict the end of the bear market. Most of the so called pundits were expecting the global recession to end by Q1’09. Now the predicitions have shifted to Q3’09 or towards the end of the year. The same pundits were predicting oil to touch 200 dollars a barrel. As the saying goes – If I had a penny everytime a bozo made a prediction, I would be rich !

I would suggest you to read N N taleb’s books – Fooled by randomness and The black swan which talks of this bias. All of us have this strong desire to predict and see patterns. It is a strong, innate human tendency which causes most of us to seek predicitions of the future and see patterns where none exist. The problem with markets is that there are often no such patterns and the future can rarely be predicted accurately for a long period of time. Yes, some so called gurus can get one predicition correct, but that does not mean that this person has some special ability to see the future.

If you predict often, you will be correct a few times too. There is considerable research into the accuracy and success rate of such predictions and most of the studies point to less than a 50% success rate. That is worse than a coin toss !!

How to invest without predicting the market ?
So how does one invest, if one cannot predict where the market will be in the future ? I think there is a big mis-understanding that one has to know where the market is going, to be a successful investor.

If you plan to invest in an option which will expire at a fixed time, then you will need to predict how the market will perform during the duration of the option. However if you are able to identify a good company with a sustainable competitive advantage, which is likely to do well over the next few years, then you are likely to get a good return on investment.

As the company does well, the underlying intrinsic value is bound to increase. When this happens, the gap between the price and the value will increase (assuming the price is stagnant ) and the stock will be get progressively more undervalued. In most of the cases (not necessarily all), this undervaluation will create an upward pressure on the stock price. In most of these cases, the gap closes suddenly and the returns are made quickly over a very short interval of time. It is however diffcult to predict when this will happen.

So what happens if the price takes longer to recover ? Well, if the intrsinc value is increasing, then you have an opportunity to increase your holding as the gap keeps getting larger and the returns should be better when the gap finally closes.

So why does’nt everyone do it ?
For one, it is painful to watch your stock stagnate over long periods of time. If you look at price to validate your decision, then a stagnant price only increases your self doubt and anxiety. Most investors are not wired to ignore the price and focus on the intrinsic value. That also explains why it is diffcult to practise value investing.

Where do we go from here ?
For starters, stop trying to figure when the bear market will turn. If your imvestments are based on the market turning soon, you could be in for a lot of dissapointment if that does not happen.

I personally watch CNBC, read the news and listen to all possible predicitions from all and sundry, but only for entertainment. Whenever some tries to give me an elaborate reason on when the market will turn or the recession will end, I have a single thought in mind – ‘How the hell do you know ?

What am I doing ?
I am reviewing my current holdings. The Q3 results have been announced for most of my holdings and I am in the process of analysing the same.

In addition I am focussing on learning about behavioral finance and biases. I would be updating my templates based on my learnings and would be re-analysing my holdings again. It is quite possible I may discover that I should exit some holding and some bias is holding me back. I will be posting such analysis when I come to such a conclusion.

 
 

update 9-Jan
When it rains, it pours ! for satyam it is pouring bad news.
I am reminded of buffett’s comment – There is never a single cockroach in the kitchen.

There are no suitors coming up. Who wants to be associated with a tainted brand ! The value of an IT company comes from three sources – its brand/ reputation, customer relationship and employees. The brand/ reputation is the foremost and a damage to this asset can destroy the other two.

Satyam, with a new board may be able to rebuild the company (though not to its former glory) partly. However the company is facing a cash crunch and if it is not able to get cash for operations, then it could be in serious trouble. Getting a loan is not going to be easy, if the books have been cooked and the banks cannot trust your accounts.

Once clients feel there is a risk, they may press the panic button too. It is not easy to change a vendor, but i will not be surprised if clients have not started working out a contigency plan.

Finally, this episode will impact Indian IT in the long run. Do you think clients will trust other companies as easily as they have in the past ? With Indian companies vying with IBM and the likes for billion dollar deals, trust and faith is far more important. This episode is going to make life diffcult for all the vendors.

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A few days back, I wrote about corporate governance in Indian companies. I hardly expected this – a full fledged fraud at satyam. I was shocked to say the least. Satyam is not a fly by night operator. There were some concerns on the coporate governance (forget the peacock or whatever ‘bird’ award), but what has come out is not some corporate governance lapse, but outright cooking of the books.

Bad intentions
I personally have no idea of the intentions of the management. However from the letter and from what I have seen in the past on such incidents, is that the start of such a fraud is small and not with malice. The management typically is not able to meet the numbers and fudges the numbers a bit to meet the targets with the hope that they will be able to cover the gap in subsequent quarters. However the gap does not get covered and the management resorts to even more manipulation to meet the numbers till finally they hole is too big to cover. This happened with Enron, worldcom and several other companies during the dotcom bubble in the US.

Bankruptcy
Is satyam headed for bankruptcy ? I don’t think so. This is not a bank where there could be a run on the company. That said, there is more pain ahead and the critical thing to watch over the next few quarters would be how the company manages its customer relationships and employees, which are the bigger assets than the cash on the balance sheet.

Possible to know before hand ?
I received a comment on how to calculate the value of the company if the numbers cannot be trusted ? My response is – you cannot. The entire basis of investing is ‘trust’. When you invest your money in a company, you trust that the management is honest and presenting the true picture. You trust the auditors to be doing their job when they certify the accounts. Clearly both the management and the auditors blew it at satyam.

You can expect articles to come out on how it was evident that something was wrong at satyam. I would say that is complete bullshit. I have not analysed the satyam annual reports till date and plan to do so now to see if it was possible to know the fraud before hand. Most of the times there are red flags on aggressive accounting which would give you a clue that something is not right. You can use these red flags to stay away from the company. However it is very difficult to detect fraud from the public filings such as annual and quarterly reports.

What now?
Such incidents are not unique to India. They have happened in other countries around the world. What is different is the kind of punishment for such a fraud. In the US, the CEO of Enron was  sentenced to 24 years in jail. The US law is very strict with white collar crime and gives out harsh punishment for such crime.

In india, I doubt much will happen. We treat white collar crime as no crime. This incident is going to cast a major shadow on all indian companies. If satyam could fudge cash of 5000 crs+, what about all the smaller mid and micro cap companies which have some unknown auditors and a weak to non-existent board.

I hope investors now demand tranparency from companies and vote with their feet (sell !) if the management is not transparent.

Lesson for us
As an investor I can think of two ways to handle such an eventuality – avoid companies where corporate governance is suspect and diversify.

This is a complete tragedy, especially for the 53000+ employees who have worked for years with the company and now face this for no fault of theirs.