As we come to the beginning of the end of the financial crisis, the calls for the blood of bankers have abated. There is universal agreement that the system overall was flawed, and it is unfair to burden a particular group with the full responsibility of our current sorry state.
The time has come to dispassionately step back and ask the tough question. It may or not be unfair, but is it incorrect?
Consider first the arguments for those who claim that the Bankers have suffered enough.
There was a sense of outrage that that the Bankers had not paid for their sins. This is simply not true. As a percentage of their wealth, Bankers have lost more than everyone else combined. Fully 40% of Lehman stock was held by its employees. When that stock was worth $85, the company was worth around the same, in billions of dollars. Every person in Wall Street has the right to claim that they could not foresee the collapse. The original argument was that it took mala fide intent, or stupidity to not have seen the risk. It turns out that stupidity was the right answer, since every idiot on Wall Street was in fact heavily invested in – you guessed it, Wall Street.
Which brings us nicely to point 2. The idiots could not be held responsible, since there was not deliberate fraud. There is today only a perplexing cloud of sub moronic decisions. How, is everyone asking, could we not have foreseen this ? Naturally, we forgive ourselves, and having done that, find it easy to extend the forgiveness to Wall Street. They could hardly be held responsible for the wrong decisions. After all, we made them too!
Finally, we all would like to look at who else we could hold responsible. There is a popular cry that Rating agencies should have done more, or that the entire process of Ratings is intrinsically flawed. Regulatory agencies are also very popular invitees to the whip-them-all parties. Finally, what about the consumer, the buyer of gas guzzling Hummers, the takers of sub-prime loans to purchase houses three sizes too big? Surely, some of the pie, humble or otherwise, belongs to him as well.
These arguments are not unjust, but unfortunately they miss the point. This is not a bad thing – it shows our intrinsic humanity. It takes a special kind of cruelty to turn away from justice for the past and coldly consider what is best for our future. But it must be done. “The greatest good of the largest number” is a disgusting motto, but we it does help in analysing the issues.
I will get to the inconvenient truths, but first let me speculate about why the Bankers lost so much money.
<nasty on>The reason that the Bankers lost so much of their personal money was that they were all overpaid, and behaved exactly like people do when they come into money that they know they haven’t earned. They throw it into the riskiest earnings streams that they can find. That comforts them, because if they lose the money, well then, they did not do such a bad thing after all, since they didn’t take the money home with them. And if they win, well then, this time the money was made by them, so that feels good as well! <nasty off>
Well, that was nasty, but my personal belief in this comes from the incidence of Wall Street Bankers in Las Vegas during the boom years. It really doesn’t take too much intelligence to know that you are playing against the house, so why do such highly educated and well paid people – which probably means that they are intelligent – keep playing these games?
To come to somewhat more factual matters, the arguments for letting Ken Lewis and all the other CEOs “pursue other interests” are as follows.
The current incumbents cannot effect the change we need. It is sad but true that it is only after Obama won the presidency has it become acceptable to admit that it was a mistake to give Bush carte-blanche in Iraq. Only Senator Edwards had the courage to admit that he made a mistake, and in retrospect, it may be because it was one of his smaller ones The current lot will go right back to making original sin #1, forcing really intelligent people to think like idiots because of misguided compensation structures.
Which bring us to point #2. While it is probably correct to absolve the CEOs of fraud, it would be incorrect to absolve them of stupidity. One has to assume that they have blundered, and it would not be right to not hold them accountable for their blunders. In this case, by kicking them out.
The last and final point is simply a rebuttal of the desire to make major changes to the infrastructure, or to the nature of human beings at large. It may or not be feasible to make major changes to the infrastructure and social polity within which Wall Street operates. It is simply not the better answer. We don’t need change around Wall Street, we need it in Wall Street. The best way to effect that change is change the players, not the environment within which Wall Street operates.
The last point is the coldest of them all, because it makes no bones about asking Ken Lewis to lose his job so that we can get on with our lives without having to wait 10 years for a new world order to come into place. But it is also the most important. It is simply the most practical decision to get a new broom to sweep clean.
Had a call today from a lady advising me that I would be getting a call in a couple a days from a “Commodity Advisor” with information about the gold market. She stressed that she wasn’t selling anything. When I asked where she was from and she replied Hong Kong I knew it was a boiler room operation and she was pre-screening.
As one would expect, I had no luck trying to get her to understand that as I worked at a Mint, I didn’t need anyone telling me about the gold market, I worked it in. I ended up saying don’t get the Commodity Advisor to call me and hung up. In retrospect I regret that, as I now want to know what the scam was so I can share it with you. Hopefully they’ll ignore my request and call back.
First time I’ve ever received or heard about this sort of thing for gold. A sign of the times that gold is going mainstream, now that the cold calling scammers are on to it?
- Siemens Ltd. (14 Jan 2009) sold its IT division to its parent co. and came out with a matter of fact press release to the shareholders and the rest of the world saying it’s divesting a low-margin business. The consideration: Rs.449 crore, for a business that earned Rs.994 crore in revenues and Rs.73 crore in net profit, in effect valuing it at a modest P/E of 6 times. The very same business in 2007 had earned a net profit of Rs.160 crore. Why should Siemens sell this company for such a low consideration? Shouldn’t they be sharing the valuation report submitted by Grant Thorton with shareholders (so that everyone knows the basis for such a low valuation), just like they send their Annual Report? [link]
- Lok Housing & Constructions Ltd. (30 Jan 2009) made an announcement saying all the profits it earned in the last three years will have to be written back. Reason: Customers canceled contracts. Action taken by the Company: It mutually agrees to let legally-bound customers cancel all the contracts, thereby saying that all the profits it reported in the last three years were non-existent! [link]
- Sterlite Industries (India) Ltd. (9 Sep 2008) Board cleared a proposal to restructure its business by transferring the Aluminum business (including stakes in BALCO & Vedanta Aluminum) and the power business (i.e. 100% stake in Sterlite Energy) to Madras Aluminum (a much smaller company with a mcap of less than 1/15th of Sterlite’s). Further, the proposal also included a tranfer of Vedanta’s (Sterlite promoters) 79.4% stake in Konkola Copper Mines in favour of Sterlite Industries for a 1:1 ratio. The transfer of this business would have resulted in a significant jump in Promoter’s holding in Sterlite Industries. Reasons for this restructuring as given by the Management: Increase in efficiency, simplification of corporate structure, and elimination of conflict of interest [link]. The point is not whether the such proposals are fair, but whether companies share sufficient information with shareholders so that they could make an informed decision on their investments. In the case of Sterlite Industries, given the scale of restructuring it was only fair on the part of the Company to disclose basic details like impact on the Profit & Loss Account, the Balance Sheet of each of the three companies, impact of increase in efficiency on profits and profitability, basis for valuing Konkola Copper Mines (one share of which was valued on par with one share of Sterlite Industries), etc. Media reports suggest that protests from certain large foreign funds and a big thumbs down to the share price pushed the management to cancel the restructuring proposal for the time being. [link]
- S R F Ltd. (16 Dec 2008) announced its decision to purchase two businesses of SRF Polymers (the main promoter company for SRF) for a consideration of Rs.151.8 crore [link]. Consider this: when the announcement was made, SRF Polymers had a market cap of Rs.64 crore. Further, SRF Polymers on a cumulative basis has not made any net profit in the last five years. So why should SRF pay Rs.152 crore for a company that is a). loss making, b). has a debt of Rs.130 crore (as of FY08) and is trading at less than half that value on the bourses any which ways? Important data point: SRF’s promoter SRF Polymer and SRF Polymer Investments own 45% in SRF), whereas the group’s real promoters (Mr. Bharat Ram and group) own 74% in SRF Polymers.
- Satyam Computer Services Ltd. (16 Dec 2008) tried acquiring two of its sister concerns Matyas Infra and Maytas Properties, offering handsome valuations for both companies with `un-related’ businesses, but with high promoters (read: the Raju family’s) holding [link, link]. The rest is history, but it was yet another attempt to short-circuit minority shareholders.
- D L F Ltd. (23 Mar 2009) may try to do something like SRF, according to the pink papers, which suggest that the Company is planning to take a controlling stake in DLF Assets, a company owned by DLF Promoters (the KP Singh family). However, there is no official announcement or proposal that the DLF Board had cleared to this effect. But, neither have they denied the news. In a response to a related article carried in the Business Standard [link], DLF said “The Company has been looking at various options from time to time; however, no definite option has been presented to the Board so far for its Consideration“. [link]. In another article dated 1 May 2009, it was reported that DLF has formed a committee of Independent Directors to look at options for DLF with regard to its relationship with DLF Assets Ltd. The Committee will look at various options, which includes a possible acquisition of stake by DLF. [link]
The big question is: Why should DLF buy a company for Rs.6-7,000 crore (as mentioned in the Business Standard report) that owes it more than Rs.5000 crore in dues? The same Business Standard report also makes a mention that the merger of DLF Assets is primarily being done to provide an exit to some of the funds who are invested in DLF Assets. Rumour or reality, we do not know. What we do know is that DLF is under significant financial stress right now. Consider this: For the quarter ended 31 Mar 2009, DLF reported a 74 per cent drop in revenues and a net loss (after adjusting for other income) of Rs.70 crore as compared to an adjusted net profit of Rs.2,141 crore in the year ago quarter.
- Ray Ban Sun Optics India Ltd. (30 Apr 2008) transferred its business of distribution and sale of various luxury frames and sunglasses (that includes Dolce & Gabbana, DKNY, Ralph Lauren, Oakley, etc.), other than RayBan to Luxottica India Eyewear Pvt. Ltd. (a wholly owned subsidiary of the Luxottica group, also the promoters of RayBan Sunoptics, upon the former’s instructions). Effect: Around 40% of Rayban Sunoptics’ revenues came from the distribution business. And even though it was low-margin affair, it did not require any capex from Rayban Sunoptics’ end, so in effect it had a fairly decent ROCE. But, yet it was transferred. After a couple of months, Luxottica de-listed Rayban by making a public offer at Rs.140 per share. Had this business included the trading business, would the minority shareholders not have received more consideration? [link, link]
- Zee Entertainment Enterprises Ltd. (22 April 2009), in its quarterly results press release, announced that it has increased its holding in one of its subsidiaries, Asia Business Broadcasting (Mauritius) Limited, from 60 per cent to 100 per cent. The deal involved a cash payment of USD 56 million (approx – Rs.280 crore) to some Resource Software Ltd., valuing the overall company at USD 140 million (10 times FY09 sales and 20 times FY09 net profit). What made Zee take this step when it any which ways controlled the Company given its 60 per cent holding? Why did it not choose to repay some of its debt on which it paid an interest of over Rs.130 crore in FY09? How justified is it to pay 10 times sales or 20 times profit, given the kind of turmoil we’ve seen on stock markets in the last one year? What does this company called Resource Software Ltd do, who owns it, and where is it located?
Last but not the least, the mysterious case of Orissa Sponge Iron:
Here’s a Company that is currently in the midst of a three-way takeover bid (bid details 1, 2 & 3), with each of the bidding companies willing to value the Company in the north of Rs.600 crore. That for a Company which in the last five years made a cumulative loss of Rs.5 crore. What’s more as of 31st March 2008, it had a debt of Rs.229 crore (which I think has now increased to close to Rs.300 crore, but that’s just a rough estimate based on the interest payments made by the Company in recent quarters).
So where is the profit potential? What are these companies paying for here?
Orissa Sponge has applied for iron ore mines and coal mines in Orissa and is awaiting some final leg clearances from the State Government. But, in the Annual Report for FY2008, the Company makes no mention about the size or the quality of ore in the mines (in a way that would help shareholders appraise the Company’s value and compare the same with its market capitalization). There are news/brokerage reports that suggest that the DCF value of these mines could be in the range of Rs.2000-4000 crore. But, they are all based on unconfirmed reports & estimates. But, if that is indeed the case, shouldn’t the Company be sharing information with minority shareholders to enable them to appraise whether to tender their shares in the ongoing bidding war for control?
Well, it seems that the takeover bid is not the only war the Company is involved in. There have been scores of reports in the media (link1, link2) about the promoters of Orissa Sponge Iron allegedly flouting SEBI’s takeover code and increasing their stake in the Company at various instances in the past. Let me try to simplify things here:
- Orissa Sponge Iron’s total promoter holding in June 2005 was 62.7%.
- This was increased to 69.3% by December 2006 (by way of conversion of warrants).
- The SEBI takeover code (that was prevalent before the changes made in 2008) mentioned the following about trigger points for making an open offer:
- Regulation 11(1): Between 15% to 55%, an acquirer may consolidate to the extent of 5% in any financial year without an open offer. Any acquisition beyond 5% in a financial year would entail an open offer of 20%.
- Regulation 11(2): Any acquirer who is at or above 55% but below 75% cannot purchase any additional share or voting right without making a public offer for 20%.
- Regulation 11(2A): Any acquirer holding above 55% but below 75% who desires to consolidate his holding may do so by means of an open offer to the extent of the applicable limit for continuous listing.
From the above it is quite clear that the Takeover code requires an open offer to be made in case there is an increase (even if by a single share) in the share holding of an acquirer who is at or above 55% but below 75%. While calculating shareholding, the rule allows the shareholding of persons acting in concert to be added up. In Orissa Sponge’s case, the matter is still open for debate, but there is a possibility that the acquisition violates the Takeover Code assuming that it is proved that all the various entities which were classified as promoters were acting in concert. Further, Orissa Sponge Iron included Unitech Holdings (that held around 7-8% stake in Orissa Sponge during the aforesaid period) as a part of Promoters & Persons Acting in Concert group, despite Unitech group’s claim (as stated in a clarification provided by Mr. Sanjay Chandra to DNA) that it was merely an investment in their personal capacity and that they were never involved in the management of the Company [link]. Funny, Orissa Sponge Iron includes an investor as a promoter, wonder why?
The table below indicates changes in the holding pattern for Orissa Sponge Iron and it makes for quite an interesting read.
||Promoters Hldg as reported
||Addnl share /
||(net of Unitech investment)
||sale of shares (-)
||(of H, L & Cl.)
So where do all the aforesaid instances leave the minority shareholders?
Quite predictably, they remain at a serious disadvantage vis-a-vis the promoters. Promoters may claim that since they own a majority stake in the Company their interest is equally (or more) affected than those of the minority shareholders. Maybe, the argument has some merit. But, are the minority shareholders so unimportant that Company’s do not even share details & justifications for large and important transactions like hiving-off of business units (as was in the case of Siemens, Rayban, et al) or restructuring of businesses (Sterlite) or ownership of strategic assets whose value is significantly greater than what reflects on the Company’s books (Orissa Sponge Iron’s mines)?
What can we do?
- What the regulators need to do is make it mandatory for listed companies to share key material information that relates to important transactions like Business/Capital Restructuring, Scheme of Amalgamations, Purchase/Sale of Assets/Investments to related companies, etc. Usually, in such cases various reports are prepared, viz. a detailed Scheme of Arrangement/Amalgamation (to be submitted to the High Court) or detailed valuation reports (prepared at the behest of the Company by external agencies). Companies should be required to share these with their shareholders just like it is mandatory to send Annual Reports.
- Make the transaction a transparent one, based on which a shareholder can appraise his/her investment. The way to do this was shown to us by Tata Motors, where most of the details of its takeover of JLR were made available to shareholders [link]. We may agree or disagree with Tata Motors on the merits of the acquisition or the price paid for it, but at the end of the day the investor had the option to appraise his or her investment and decide whether to stay with them or walk away.
- Detailed background information of all those involved in a purchase/sale transaction should be provided. For e.g. in case of Zee Entertainment, the Company paid about Rs.280 crore to a company called Resource Software for a 40% stake in Asia Business Broadcasting (in which it already had a 60% stake). Now, what is this Company? What does it do? Where is it located? and who are its promoters? These questions are not to doubt Zee’s intentions, but its a question of being transparent with your shareholders.
- Companies that hold Analyst Meets (one to one or in the form of a gathering) or conference calls usually share a lot more information than that available in the Annual Report or on the Company’s website. And, in most cases this information is not available to minority shareholders and is neither available in public domain. Regulators must make it mandatory for listed Companies to share the transcripts of such analyst meets and concalls in public domain and that too within a stipulated time frame. Again, just the way companies like Tata Motors do it [link].