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. 
http://www.moneycontrol.com/news/market-outlook/sp-tulsianpowerinfra-stocksgtlaptech_637010.html

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(http://www.bseindia.com/bseplus/AnnualReport/532775/5327750311.pdf). 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.

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.

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(http://karisma.karvy.com/InvestorGuide/jsp/ICSA/ICSA2010-11.pdf), 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. 

 

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. 

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. 

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(http://gauravsinghal.wordpress.com) for helping build the argument,and discussions on this topic