Wednesday, December 21, 2011

SP Tulsian's buy on GTL Infrastructure-justified but for the wrong reasons

Whatever the grand old king of Indian stock markets(SP Tulsian) says makes news, so his comments on GTL Infrastructure was no different. You can read them below but the basic rationale was that the asset value of the towers would be more than enough to cover the debt and leave 60% odd upside for shareholders.

This company triggered quite a few red flags from my side namely
  1. Since the promoter(Manoj Tirodkar) was caught up in the Ketan Parekh stocks(K10) earlier and the other stocks involved like Satyam/Cybermedia etc have gone nowhere/crashed. So call it poetic justice or whatever, maybe this was come back time
  2. the company has been in CDR since Aug-11. The results are yet to be announced formally.
  3. Income Tax authorities raided the company(search) in Oct10 but the company claiming it subjudice did not make any provision in its accounts, which were finalized In Nov11. But on Dec20(2011), the Minister of State of Finance gave a written reply on the floor of the Lower House, that GTL Infra had admitted concealing taxable income of Rs 500.65 crores. Now, they have deferred tax of Rs 67 crores(standalone basis) or Rs 167crores(on consolidated basis). But India not having group taxation, even setting of Rs 67 crore deferred tax asset against that loss, it would still amount to a tax liability of atleast 20% of Rs 400 odd crores=>Rs 80 crores, to say nothing of a penalty which can extend to 3x taxable income. This episode raises issues of WHY did the company not provide for this in accounts despite offering that income for tax. Either GTL or the company is lying If the latter is true, it does not reflect well on the governance.
  4. Hard to access investor relations site: When I clicked on the links to download latest annual report/IR ppts, there was an error in both chrome and mozilla. Plus they have this weird norm of having the user enter his details for every download! Not good
  5. Delayed annual report/finalization of accounts:-The annual report was finalized only in November last week, and can be downloaded here( Makes interesting reading especially the consolidated accounts, which remove the complicated group structure that lead to off balance sheet debt
  6. As the table below shows, even at these low valuations, GTL Infrastructure commands an EV/EBITDA multiple comparable to the best in the industry-mature USA operators. It is doubtful whether the industry economics justify an higher multiple for GTL. So even on a deal related valuation, one should check chance of upside

The above points would show that on an asset play basis, the company would face tax, and paying the old tax arrears. Plus lured by the sale proceeds, the taxman may increase the penalty to the maximum permitted by discretion.

However, the positives for the stock are, on a going concern basis
  1. Some towers(company does NOT disclose how many) are under construction, and will add to the EBITDA when operational. The figure of 32,650 towers includes work in progress too.
  2. When they had purchased towers from Aircel at EV of Rs 43 lakh/tower, Aircel had promised GTL 20,000 tenancies @ Rs 3.5lakh(approx) per tower for 3 years viz=>Rs 700 crores/year for 3yrs=>Rs 2100 crores tenancy. Of that, Aircel has fulfilled only 10% of that commitment. As the gross margins are very high in the industry, the more Aircel fulfills that commitment, it will be pure gravy to the bottomline. For example, even 200 Cr/yr from Aircel EBITDA would give a huge valuation boost to the company! But this depends on how effectively GTL can enforce the deal. Expect Aircel to try wriggling out. Some legal battles would be interesting here.
  3. Banks own nearly 20% of the company after invoking promoter's pledge. Hence, the CDR will hopefully not squeeze the shareholders too much
Bottomline:-The stock appears interesting but unless the governance cloud is settled, very risky. At the Dec27th AGM, I intend asking some directed questions to decide what to do next.

Monday, December 19, 2011

Why profitable mobile VAS leader Onmobile Global trades just below book value?

That was the question which perplexed me because the company did not trigger any red flags during my initial scrutiny. Indeed, it has positive cash flows, net debt<0, strong customer loyalty, IP driven, white label B2B player thus insulated from retail customer vagaries  etc. And the company Investor relations materials are quite transparent and frank-in fact the Mar11 edition of the IR ppt even showed that the company had materially underperformed both Nifty and its peers/customers. For that type of chart to appear anywhere, needs gumption and I credit the company for that. Also, they have about 20% revenues on content spending, and they are trying to get themselves to a net revenue model(so that the telecom operator directly pays the content owner) with higher reported margins. For a company to intentionally lower net reported revenues in this dotcom age, is commendable.

But when I noticed the postal ballot results, alarm bell rungs. Nearly 10% shareholders opposed the option repricing, which went through due to the promoters support. Granted but unexercised options(which benefit from the repricing) amount to nearly 5% of the company's outstanding shares, which is not a small number. And the proposed 2011 Options scheme, is almost a similar percentage. Once management has got the disease of repricing options, then one never knows when it will end. However,  this has saving graces that
  1. Indian promoters own only around 14%, balance 34% is with foreign VC fund which went along with the option repricing-so if they found it kosher, why not us
  2. In Dec-11, the company separated posts of Chairman and CEO. 
  3. The lockin period of the foreign VC recently ended, so the VC would certainly be looking for an exit. It would not dilute its holdings via options repricing, unless it is the the interest of the company. VCs are not known for being sentimental. 
  4. Independent directors of the repute of Prof JR Varma would not pass such a resolution routinely.
 But the measure came in for severe criticism on forums like The Equity Desk, and also among some institutional investors as seen by the fact that otherwise postal ballot results read like election results in a banana republic-management wins by 99% or so! Given that, a 6 to 1 margin is quite low and reflects that institutional investors are asserting themselves.

Governance issues apart, the company is still an Indian player(75% revenues from India, though it aims at 50% foreign revenues by FY13-14) and the TRAI regulations on commercial communications/VAS confirmations etc have hit it. Also add the fact that telecom is in a relative slumber, and you see why investors are not very enthused about the company. That is a pity because
  1. its ability to breakeven(cash flow basis no less!) in its Latin American operations within the first year itself, points to its execution ability. 
  2. And despite the EU crisis, the extent of debtors(via dues from telecom operators) greater than 6 months, is quite less. 
  3. The company has showcased its innovative nature quite well with innovations like zero balance missed call(!)-a truly Indian phenomenon-and is ahead of the curve so far.   
So I guess the stock is due for rerating, and I'll revisit it later if it still seems attractive.

Wednesday, December 14, 2011

Time to buy ICSA at a price to book multiple of just 0.19?

When I saw the stock pop up during a routine stock screen, I was stupefied. After all, the company has been profitable, not been caught in any scams(yet) and has a well decorated annual report. A P/E of 1.25, dividend yield of 5.5% and price to book of just 0.2 would imply a screaming buy ordinarily. But having learnt from hard experience that the market is usually right(or at the very least there is fire behind every smoke!), I decided to probe deeper. And the first place is the annual report(, which I read from the back to start(like a Japanese comic novel). Some points
  1. Liquidity;-For Mar-11, of the Rs 67 crore cash balance, only 6 crore was liquid. Rest was margin money, fixed deposits lodged with Banks etc,  against letter of guarantee issued and so illiquid. That might make the company dilute later
  2. Debtors:-To fund the debtors increase of 284 crores Rs, the company had to take out long term debt of nearly the same amount. Higher leverage apart, that makes the asset quality a tad suspicious. 
  3. Inventory:-Note 7(pg 89) has the red flag in notes to accounts that Inventories are physically verified and certified by the management. That usually implies that the auditors are atleast partially washing off their hands
  4. Heavy Contingent Liabilities:- As of Mar-11, the contingent liabilities included Bank Guarantees given to various government departments to the extent of `38,043.18 Lakhs and letters of credit of `11,043.73 Lakhs. Given the precarious liquidity position, even if a fraction of that is invoked, the company will be in distress.
  5. Non objective Board:- 4/4 directors share the surname 'Reddy' and the other one does not inspire confidence. This board would seem just a rubberstamp. To their credit though, the directors did attend all the 30 meetings/yr conducted in 2010-11
  6. Power sector paralysis:-Due to mounting SEB loans, generation companies are finding it difficult to tie up financing. The fiscal deficits and policy paralysis at Delhi is delaying decisions for awarding those contracts which ICSA depends on
  7. Inadequate segment disclosures: One would need to know the extent of the debtors which are government departments/PSUs, since that would affect the risk of delayed payments/political risk. The company does not disclose this.
I know one can find a dozen negatives if one probes enough about anything. The positives though are
  1. innovative business model matching government priorities
  2. ready product slate after policy paralysis ends
  3. Technology driven company into smart grids
  4. Well presented annual report-so some institutional interest can sustain
  5. Present in several corporate rankings for growth, profits etc. 
 My final call:-The stock being a midcap and with other appealing options out there, I would monitor this stock closely for a chance of 5x multibagger, but initiate investments only when there is clarity on the debtors(of company) and power sector fate

Why do indian real estate companies trade at low price to book(P/BV) multiples?

A Mint article today caught my attention when it pointed out several stocks trading at price to book multiples of <0.5. More of these stocks belong to the infrastructure sector, more especially realty.
The graph to the left shows what  took place in the sector, which saw dotcom like P/BVs only to see them dissipated later on.


But is this only a general market phenomenon? Not really.  The graph above shows that ever since the CNX Realty price to book dipped below 10 in June-08, it has steadily gone downhill till then, while the general market has recovered. Why is this so? Why do investors distrust the sector to the extent of not even wanting to pay for book value, while the reality of land shortages, housing requirement and rising housing prices exists? To understand this, the points below may help
  1. Depends on the target market-Commercial or Realty(basic or luxury). While realty IS in under supply, the same cannot be said for commercial real estate, where over supply does exist.
  2. Location Location Location! Two projects in the same city may have drastically different rates. Hence to value the project, investors need market intelligence or reliable rates, both of which are missing in the Indian markets. Peter Lynch's dictum of investing in what you know, could not be more relevant than in realty where there is little substitute for inspecting the project site!
  3. Volatility+Leverage=Dynamite:-The real estate sector takes on high debt, and is subject to regulatory volatility(permits, FSI, planning). Also, most purchases today are financed by bank loans, and therefore the bank policies of credit both to builder and flat buyer, makes a difference. Given that past 13 interest rate hikes by RBI and fears of stagflation, prospective flat buyers are not willing(or able for that matter!) to get adequate debt
  4. Sticky housing prices:-While Economics 101 would advocate reducing the house prices to ensure swifter offtake, builders do not wish to destroy their future market. Also, given the amount of bribes given to secure the site, they also cannot lower prices beyond a point, although construction costs may be just around Rs 1200/acre. 
  5. Persistent debt:-When you have low housing purchases and prices are not dramatically lowered, then one incurs interest while still holding the inventory. And from Mar-11 to Sep-11, India Inc has not materially lowered the debt(with maybe exceptions of DB Corp/DLF). 
  6. Governance Issues/Political Linkages:-The sector is associated with politicians and the mafia, and that taint applies to nearly all companies. Hence, when a good governance crackdown occurs like Lokpal, these companies would be caught in the cross hairs
  7. Peculiar organizational structure:-The use of partnership firms/JVs/LLPs is an industry practice to derisk balance sheet/allow SPV lending/purchase land w/o alerting others, but that leads to murky consolidation issues and lack of oversight on those JVs.
  8. Related Party transactions:-Promoters often have their HUFs/partnership firms/raw material supplying firms as group companies, with which listed companies transact. Naturally, that is not a good recipe for corporate governance.
  9. Industry practices on loans and deposits
    1. Mobilization Advance:This is given to the EPC contractors as an advance for starting work. if the project is held up for any reason, this advance is difficult to get back, more so if the ongoing relationship with vendor is not there
    2. Interest Free performance deposit:-For land purchase deals, an industry practice is to give  an advance termed as 'interest free performance deposit'. Like author advances in the publishing industry, this is ostensibly an asset but not if the worst case happens-then years of arbitration are needed to get it back. Lesson to be learnt-be wary of both above.
  10. Land title issues & subsequent litigation:-There being no land bank in India, title is presumptive not conclusive, and challenges can hold up the project, as also claims of inadequate land acquisition/forged title deeds. The most recent example of it is farmers demanding their land back in Greater Noida
  11. Accounting:-The percentage completion method links revenue recognition to a complex formula depending on customer advances received and/or construction costs incurred. For reasons other than receiving progress payments on time, revenue recognition can be boosted by
  12. Non diversifiable risks:-Unlike other companies which can diversify their product portfolio and markets, doing so in realty does not bring any advantages. In fact, the loss of local knowledge/expertise/contacts may make that geographic diversification increase overall risks! That is why companies are mostly localized.
A longish list, but very few new factors(most of these are industry specific). Then why this dislike towards the industry? One can single out #3,#4,#5,#6,#11 as key factors in the limelight now, which makes investors push for flight to safety. In another post, I'll examine the valuation complexity with the case of HDIL. 


Tuesday, December 6, 2011

How to avoid group think/tunnel vision in your economic understanding

One would associate the title of this post  with a management book rather than this blog! The reason this post exists, is because to have the courage to be contrarian, one should try to avoid group think-or the vice of thinking like everyone else based on what the mass media says.

As the famous fund manager Sir John Templeton had said, the best time to buy is when there is blood on the streets. Like most good advices, that is logically acceptable but hard to implement because of liquidity issues(people may be sitting on unrealized losses and be low on cash) and due to analysis paralysis and other traps. They also may fall prey to mass media induced panic and hysteria. To avoid that, some points which I have found useful are
  • Look beyond the headlines-preferably with data:-Before acting on headlines, try to support/refute it with data. In this age of Google Public Data Explorer and other publicly available data sets, one really has no excuse for avoiding that.
  • Diversify your news sources:- However good the source may be, never stock to just 1 newspaper/magazine/blog. Diversify.
  • Read globally focused magazines: Economist/Forbes are 2 good examples of that, as also their online blogs/archives/editions.
  • Blogs:- Individuals are usually free of any editorial pressures/compulsions to be politically correct. So find a few quality blogs and then
  • Non mainstream media: Tehelka, Al Jazeera are examples of this
  • NGOs:-They often raise issues which blow up later. So be aware of the top of mind NGO issues like Africa farmland grab, China environmental crisis, food security etc. That may help later. 
  • Multilateral Agency Reports/Updates:-While the World Bank/IMF/FAO/WIPO/WTO may have a pro Western slant, the fact remains that they have tons of useful data, and often come out with insightful research reports on various aspects. Some recent examples of it are the ADB report on innovative infrastructure financing in India, FAO study on agricultural farm land etc. As these reports rarely get reported but reflect top quality thinking, one does not lose by reading them, to see if they fill any gaps in understanding. 
Hopefully, all the above will help you refine your own mental models.