Wednesday, November 23, 2011

Some India specific reasons for special situations-and how to play them

Too often, I've made the mistake of applying strategies which have worked in the 'developed markets', to the Indian markets. What I forgot were the vast differences in corporate governance, financial disclosures, critical financial media, existence of trader lobby/bear cartels and political.regulatory uncertainty. Each of these lead to special asset situations, which are not having global analogues. I dissect these points below with examples wherever possible, with a suggested playbook approach
  • Corporate governance:-The Anglo-Saxon market model calls for an independent Chairman, to represent the interests of the non management shareholders. But in the Indian context, family owned/promoter dominated companies still dominate, and there is no institutional objection to this. So when the occasional expose occurs of management bribing government officials(Everonn), being jailed(Unitech, Ansal), voting themselves fat pay(Sun TV) etc, it does not reflect on the competence/personal integrity as much as it reflects the culture of entitlement/sense that it is 'payback time' for the blood/sweat/tears invested in growing the company. Therefore, even if the share price temporarily slides in response, it is not likely to have a long lasting effect
  • Financial disclosures:-It is still NOT mandatory for Indian companies to publish a quarterly cash flow statement, and virtually noone does so. That does not make the analyst job easier, to explain the quarterly results fluctuation. But that is just the tip of the ice-berg. Despite having accounting/auditing standards which are globally converged, not all auditors/CFOs are able to apply them well. For example, some annual reports still report inventory with the statement as valued and certified by the management, despite the accounting regulator ICAI issuing an edict against them. So before relying on them, it is better to read the notes threadbare, and then once again. For me, that revealed example of a fertilizer company hiding exceptional one-off gains in other income, huge contingent liabilities of a telecom company which were doubtfully classed, shoddy internal audit/controls systems not being made subject of audit report exception etc. The media recently hyped off Kingfisher's going concern qualification BUT this was published much before Oct-11. Was the press sleeping then? Hence, I suggest that the investor should look for red flags even more carefully for Indian firms.
  • Uncritical financial media:-Sadly, we do not have a Tehelka in the investing space. The closest which comes to that is 'Money Life'(but even they do not equal Tehelka). Financial press(especially Economic Times) are usually reduced to the role of rewriting corporate press releases or foreign news items. Rarely has a financial jugglery been first reported in the Indian press. Papers like Mint are valiantly striving on, but with little success. But, once the slighest whiff of a scam breaks, then all outlets and TV channels carry it, and the market goes haywire while investors try to figure out what hit them. Hence, the person who can catch the breaking news first, profits.
  • Lobbies/Cartels:-The infamous Pyramid Samaira case(involving fake SEBI letters, use of mule's demat accounts, fictitious open offer rumours) was the rare instance of publicly exposing market manipulation. Another example was Kwality, where circular trading boosted the share price to sky high levels. While SEBI detected these and passed punitive orders, the fact remains that cartels can still have a field day, and regulators like Bollywood police, step in when the party is over. Therefore, before buying a momentum driven stock, ask yourself the chances of it being bear driven. Indicators would be non institutional activity, repeatedly hitting circuits etc. 
  • Political/Regulatory:-It is bandied about in investing circles that the son of the ex-finance minister is a major player in the Indian stock markets. One can only speculate at the super profits made possible by having advance information of Govt policies. This would hold for draft policies which have impacted stocks in the past(Mining Bill/Land Acquisition Bill) as also regulatory orders/judicial orders(Sugar SAP in UP, Mining Ban, R-ADAG lawsuit in SC). Hence, much as I would dislike it, being politically well connected would make you ahead of the curve in these developments, to benefit from the resultant special situations.
In my view, the above are all unique to emerging economies(in specific India), and so warrant special consideration. 

Tuesday, November 22, 2011

Eon Electric-trading at 1/4th of its free cash on balance sheet

When an Edelweiss stock screener popped up this stock as one with low P/BV, low P/E, 52 week low etc; it triggered my attention to look beyond the screen, and delve into the annual report. And I was not disappointed. The company had sold its fusegear business to a French Co for around 530 crores, and therefore was sitting on cash worth around Rs 280 crores(w/o considering other investments, net current assets, negligible debt). And unlike the typical Indian holding companies, the promoter does not have other listed group companies to sink that cash in. So why is the market valuing the stock at just Rs 68 crore?
From my analysis, some reasons are
  • Cash burn:-Since they divested their crown jewel, they are making quarterly losses of around Rs 6 crore. That is not too surprising
  • Poor use of surplus cash:-The surplus cash is invested in FMPs/debt plans. Even at a conservative 7% short term rate, their quarterly income should be around Rs 5 crores. But they show other income of just 2.2 crores or so, leaving a gap to be explained
  • No promoter buyback from open market:-Despite the huge valuation gap, the promoter has not tried to increase its stake from the open market. This is surprising. Also, the company announced a buyback in Oct-11, only to abruptly withdraw it at the month end
  • Poor/investor unfriendly disclosures:-They do not update their website with the quarterly results. There are no conference calls or investor relations presentations. Shareholders would be eager to know the management's intent to use surplus funds, but the company is mum
  • Low institutional holding:-A FII even sold off its major stake last month. Of course, they tend to follow the herd mentality, so it is not so much of an issue 
However, some positives are
  • Management recent preferential allotment at Rs 70:-While this was a fait accompli since the conversion price was below the market price prevailing then, it would still give the management incentive to boost the share price
  • Promoter holding just 45%:-This does not confer a stranglehold, and leaves room for some investor activism
  • Postal ballot for diversifying business:-The management has announced its intention to change the line of business, and invest the cash there. This should improve the valuation/
My take:-One does not often get to buy a Rs 100 note for just Rs 25. Such opportunities are  rare to come buy, and should be grabbed, in view of the positives outlined above. I know this does not fit the criteria outlined in the earlier post, but this was just too juicy to pass over.
Credits:-Thanks to my IIMA classmate and friend Gaurav Singhal( for helping build the argument,and discussions on this topic

Tuesday, November 15, 2011

Why I purchased SKS Microfinance at Rs 142(all time low!)

SKS Microfinance(ticker SKSMICRO) is a Cindrella turned nightmare. When it got listed last October, it seemed to herald a new dawn for 'responsible finance', 'inclusive finance' etc. The few critics who found the huge investor profits unpalatable, were ignored. But a year past, tables have turned and the stock having lost 82% since inception, it still has few buyers. Let us see why
  • Microfinance backlash in Andhra Pradesh:-Nearly 40% of the gross portfolio is concentrated in Andhra Pradesh, where the state Govt passed a legislation which curbed several business practices such as weekly meetings etc.To its defence, SKS states that other states(nearly 60% of portfolio) have recovery rates as usual(99% or so) and that it expects the Andhra Pradesh HC to rule on the AP legislation soon. 
  • Poor financials:- SKS has faced recovery issues in the state, and has had to write down its books substantially. This has eroded its book value for the past few quarters, to just Rs 163 per share, and there have been operating losses too.
  • Corporate governance and adverse press may lose banking/NBFC license chance:- Though the Reserve Bank announced guidelines for banking licenses, the gold rush has begun. And given the adverse press around sacking of its CEO(just post IPO), reported customer suicides and founder's personal problems; it is unlikely that RBI will prefer SKS over say Tata/Bajaj/Bandhan Microfinance. And while the NBFC-MFI category would suit SKS well for reducing its borrowing costs and conferring tax benefits, that is subject to a possible constitutional challenge. 
  • Central legislative logjam and political crisis in Andhra Pradesh:-Since the past year, Telangana activists have been agitating for a new state to be carved out of Andhra, and have
However, the reason I purchased SKS is
  •  Improved investor relations disclosures:- They have finally learnt the adage 'when in doubt, disclose'. Their investor presentations are consistent and detailed. That allowed me to analyze the operational performance, and appreciate their cost cutting efforts.
  • Potential shortterm upside from central legislation:-The stock had touched levels of Rs 300 odd on speculation that it would get greater regulatory protection/recognition from the RBI by way of banking license/NBFC classification. That issue will be decided by Nov/Dec-11, so there is ample scope for fluctuation till then.
  • Andhra Pradesh HC verdict potential upside:-By Jan-12, the Andhra Pradesh HC is expected to deliver its verdict on whether the State Govt's microfinance bill is within the Indian Constitution or not. While legal eagles are (naturally!) divided on the issue, my take on it is that the bill will be atleast partially struck down, since it infringes the freedom of business of MFIs, without an equal limitation on money lenders.
  • Management change likelihood:-As per media reports, the controversial albeit colourful founder Mr Vikram Akula has been asked to take a non executive role. If that materializes, the stock should move up in relief, given that his distraction with personal matters(bitter child custody dispute with ex-wife) has taken its toll on the company's performance and image.
  • Capital raising chance:-If a PE fund/WB decides to invest, it would be at a premium to the market price as per existing preferential allotment guidelines of SEBI. That would boost the share price for some time
  • Too big to fail like Satyam Computers:-Given the inclusive finance agenda of the Central Govt(and all regulators), it would be embarassing if SKS Microfinance is allowed to rot. That would deter further foreign investments in the sector, and add political risk to the vast number of other risks faced by India. So far, political reasons(especially state level issues in Andhra Pradesh) have bound the hands of the Centre, but it has made its intentions clear through the RBI, and given that the political party at both levels is the same(Congress), the result is a foregone albeit long drawn conclusion
I would not however, hold the stock beyond Jan-12 or Rs 240(P/BV of 1.5), whichever is earlier. That is because the regulatory risks would be largely settled, but not the political ones.

Thursday, November 10, 2011

Criteria for stocks featured on this blog

Given the great uncertainty in India and abroad of all kinds-political, social, economic; some new scandal or Black Swan event makes it to breaking news, with inevitable repercussions on  stocks. Stocks oscillate by 10% or more due to news about potential open offers(Indian affiliates of MNCs), takeover battles(PVR Cinemas), income tax raids(realty companies), top management arrest(Money Matters, Anshal Housing, LIC Housing Finance, Everonn), regulatory sanctions(telecom cos, SKS), sudden taxation impositions or rulings(coal taxes in Australia and Indonesia made Indian power stocks fall..). But much of this is noise, and may quickly dissipiate. Therefore, the stocks I would feature in the blog would have the characteristics outlined below, which would hopefully filter the chaff from the wheat
  1. Management Quality/Integrity:-This is not negotiable. Ideally, first time entrepreneuers or those who have devoted their prime to the company, have too much invested in it to let it fail. Hence, these kind of promoters would be preferred.
  2. Too Big to fail:-The company should have some political clout, economic significance or importance so that it is not allowed to fail.  Alternately, support by group companies is great.
  3. Business model impact:-The news should not adversely affect the business model, even if it is perceived to.
  4. Magnitude of price  change:-I would prefer a 30%(or more) price decline, to ensure that the noise element has not affected.
  5.  Ugly ducklings:- As Peter Lynch said, the best time to buy is when there is blood on the streets. Hence, these stocks should be viewed, at the time of writing, as ugly ducklings. This would be readily apparent from media mention
  6. Far below internal comparable:- The stock should trade close to its book value(even better if it trades for below the net cash on books!). Barring that, it should now be far below recent deal prices(QIP, preferential allotments). However, I would entertain a deviation to this rule if the valuations v/s peers are much lower.
  7. Realistic chance for repricing:-There should be a chance for the stock to correct back to normal. This criteria of mine, would ordinarily rule out holding company discount valuation plays, because the promoters are not likely to offload any time soon, and hence

Why this blog?

Unlike in the Western countries, asset turnarounds are not yet popular in India. For every Wilbur Ross who could turnaround SpiceJet, there are umpteen opportunities which cannot be availed of by specialist hedge funds or 'vulture funds', because of the economic, legal and social environment. Let me cite some examples
  • Domestically financed Leveraged buyouts are not possible because banks cannot finance for the purpose of takeovers. While this prudent guideline set by the Indian banking regulator RBI has doubtless saved banks from succumbing to the bubbles(dotcom, IT, realty, plantation), it also means that the market for corporate control is limited
  • Takeover law in India(mainly SEBI SAST guidelines) for listed companies prohibits poison pills etc. However, the need for Government/Regulatory approval hangs like a sword of Damocles over any prospective hostile(or even friendly acquirer). The example of this is the Cairn India buyout by Vedanta, which took nearly 1yr to get cabinet approval, which was witheld ostensibly on security concerns, but the open secret is that this was done to settle political issues. Political issues can still stall deals.
  • Indifferent investors:- Investor activism in India is rare. Barring Ms Sucheta Dalal and a few investor associations, nobody looks out for the interests of the small investor. Even SEBI can only do so much. It is known that few investors bother to open the annual reports and other corporate information mailed to them.
  • Insolvency proceedings are infamously slow, and even the laws giving teeth to secured debt holders(SAFESI Act, CDR mechanism) are open to judicial scrutiny.  
  • Independent and critical media is rare. Mint, Tehekla, Money Life, firstpost and a few others valiantly strive to report objectively and do investigative reporting. But otherwise, most financial papers/media limit thenselves to broadcasting corporate press releases. Hence, even when the rare analyst digs out some dirt, very little publicity is given.
By this blog, I hope to direct the attention of Indian equity investors to the special situations opportunities out there, so that they can profit from it.

What is it in for me? Since I would like to dabble in this field(whether it be as personal investing, career choice, writing etc), this would hopefully help reach out to like minded people.