The price of courage and the cost of cowardice

A friend send me a link to a letter made more poignant because it was published posthumously. Lasantha Wickrematunge, the author, and editor of The Sunday Reader, was shot on his way to work on Jan 8, 2009 in Sri Lanka. It describes his resolve to express his opinion on the politics of Sri Lanka, while being aware of the risks to his life. His death, establishes once again the cost that "freedom" often demands from men - the supreme sacrifice. It is men like him that the rest of us have to thank for our freedom, the existence of which we often take for granted.

In contrast, our feckless prime minister and spineless bureaucracy have scored a self-goal with regard to the handling of the post-mumbai-attack situation. Pakistan has now won the game, set and match. From being on the run, they have turned the tables completely - with the latest "umpire" of India's choice (remember, we have chosen to outsource our defence to other countries) David Miliband, the British foreign secretary, hectoring our PM and foreign minister on the need to resolve the "core issues" of Kashmir - a connection which even the Pakistanis have not insisted on making with any degree of conviction. Two interesting view points emerge - one where the UK position is sought to be explained in terms of their own domestic compulsions  and another, which takes a more robust view of how India (mis) handles its strategic goals.

In any case, with the new US president having signalled his willingness to interecede in Kashmir, we can only hope that we have an early election. At least there will be a chance that the democratic process will result in giving the "old bones" some rest. 

Today, the color of hope is black

The crown was missing, but not much else. Pomp and ceremony surrounded the "crowning" of "emperor" Barack Hussein Obama as commander-in-chief of the most powerful army in the world. 

When the speaker introducing the new President emphasised the "peaceful transfer of power", I'm sure many wondered why it should be any different. However, we must not forget how rare it is even in this age in the world to have a leader of a powerful nation handing over power through the ballot rather than the bullet. More so, when the new leader represents a race, that less than eighty years ago, was the target of "white supremacy" groups like the Ku Klux Klan. 

Change induces hope, and the inauguration of the new President of the USA brings hope to more people in the world than can be counted - that the country which, till the previous administration, represented leadership of the "free, democratic" world, would live up to the ideals of freedom and democracy rather than inflict arbitrary suffering on the rest of the world. I join most such in wishing that such hope is not misplaced. Now, however is the time for optimism, not cynicism.

Post the recent attacks on Mumbai, many young Indians decried the Indian democracy, its politicians, and demanded martial law. I hope that this inauguration will inspire people to introspect about the miracle that is the Indian democratic system. A country as poor as India, as diverse as this nation is, regularly elects to the highest offices - people belonging to different minority segments - by religion, caste, and sex. The "inauguration" process does not include praying to the "gods" of one religion only. We can be truely proud of being a secular, democratic republic - the biggest and the best - make no mistake. Lets keep it that way

Jai hind.

Laugh lines

President Bush will be sorely missed in the next few weeks. I doubt his "Bushisms" would survive his stepping down as president. But you never know... it could be I "misunderestimated" him!

A complete list of his faux pas can be found here.

Manas Chakravarty's take on the Business Plan of Raju makes an interesting read.

I think Bush could have used the picture below to understand the Auto (and other) Bail-out. Hope it helps.
And if all this drives you to seek refuge in "God", here is a great illustration of the delusion you are suffering from.

Have a great week ahead

Two minutes of silence

More than fifty thousand families directly, and perhaps almost as many indirectly (Maytas group, other persons involved in Hyderabad real-estate, head hunters and placement agencies) need that silence – as a requiem for their dreams – atleast temporarily. These are the real losers in the scam at Satyam.

For the non-institutional shareholders, my sympathies, for having being on-board at the time when the story blew-up. They are collateral damage. For the rest, institutional investors in particular, it’s an occupational hazard. Investing in companies that adopt dubious practices (exploiting governmental contacts being one among them) is a regular provider of the elusive “alpha”. Much “wealth” has been created at the hands of such dubious managements to provide any long-lasting aversion to such practices.

The Madoff case in the US is an example. A complainant to the SEC two years before the ponzi scheme finally crashed, pointed out several “red flags”. Some related to the behaviour of fund of funds – that are meant to conduct a proper due diligence on funds they invest in. Here are some excerpts

Red Flag #14: Madoff subsidizes down months! Hard to believe (and I don’t believe this) but I’ve heard two FOF’s tell me that they don’t believe Madoff can make money in big down months either. They tell me that Madoff “subsidizes” their investors in down months, so that they will be able to show a low volatility of returns. These types of stories are commonly found around Ponzi Schemes. These investors tell me that Madoff only books winning tickets in their accounts and “eats the losses” during months when the market sells off hard. The problem with this is that it’s securities fraud to misstate either returns or the volatility of those returns. These FOF professionals who heard BM tell them that he subsidizes losses were professionally negligent in not turning BM into the SEC, FSA and other regulators for securities fraud.

Red Flag #15: Why would a fund of funds investor believe any broker-dealer that commits fraud in a few important areas – such as misstating returns and misstating volatility of returns – yet believe him in other areas? I’d really like to believe in the tooth fairy, but I don’t after catching my mother putting a quarter underneath my pillow one night.

Can you spot the similarities?

Many business leaders have appeared on TV expressing surprise, dismay and shock. I wonder why. Indian companies have been consistently ranked amongst the most prone to bribery. “Public works” ranks on top as the area most corrupt. Satyam promoters had a background in construction. Can it be that companies that are willing to bribe others, are going to be the epitome of probity when it comes to their own operations? Surely, we cannot rank amongst the world's worst without large companies in the country being a party to this practice. This combined venting to consternation seems to me to smack of the same hubris – the search of which brought Satyam to its demise.

Instead of repeatedly denouncing Satyam, we need to do some soul searching here. Can society ever create the incentive structure that balances what is needed for survival against the greed for wealth. Till then, people in glass houses….

Independent directors - new incidents old problems

After the recent botched attempt by Satyam to merge with a company belonging to the "promoters", the role of independent directors on the boards of companies had been brought into focus. Now comes the news that the Andhra police are looking at ways to implicate Mr. Nimesh Kampani in a case which relates to defaults by Nagarjuna Finance.

In the case of Nagarjuna, it appears that Mr. Kampani was not on the board at the time when the company defaulted to depositors. Prima facie, it appears to be a case of harrasing a person for something over which he would have had little control, and perhaps no knowledge. This, once again, highlights the need to have a specialised law enforcement division within the police force that deals with white collar financial crime.

However, it also calls into question the role of and expectations from independent directors. If they are not to be held responsible for day-to-day executive decisions, and have not proven themselves capable of acting on behalf of minority shareholders when it comes to strategic decisions, why have them? And, when does one penalise inaction (at best) and malafide action (at worst) on the part of independent directors? Is loss of reputation a good enough penalty, or should there be a more serious penalty including possible financial liability and/or possibility of imprisonment. In all this, we should not forget that a company with a properly functional board would benefit from the experience and oversight of external members who monitor corporate performance and keep the management on their toes.  

Agency theory just got more complicated. 

Deja Vu.. more words, no action

As I write in the new year, I hoped to start on positive note, reflecting hope of a more secure India. Instead, realization strikes that a mere change in the calendar changes nothing. 

The home minister also pointed out that it was up to Pakistan to ensure that such terror acts were never repeated by its citizens against India. "The price they will pay if this is repeated will be enormous," he warned.

This was Mr. Chidambaram on NDTV last evening, but could easily have been any other incumbent over the past two decades. I can imagine the snickers of derision this would have invoked across the border. What, can I ask, has the "price" been for all the attacks inflicted on us. The attack on Mumbai came not six months after the Indian embassy in Kabul was attacked. We used the same words, the same empty promises of retribution, the same attempt at "building international opinion" against such attacks. Yet, Mumbai was attacked, as it seems now, with impunity. 

In the same interview, the home minister was asked about what India was looking for, and his response was - that India seeks a "guarantee from Pakistan" that such attacks will not be repeated. Haven't we been there before? What guarantees and from whom. Importantly WHAT will we do if such a guarantee is flouted. In fact, WHY are we NOT taking those steps TODAY?

In the past, all that the perpetrators of such crimes had to do was to wait for a change of political guard. In fact, with the present spineless dispensation, the attackers do not even have to bother for a change. Mumbai alone has been targetted twice in the past 2 years, and other Indian cities have been brought into the fold of such attacks with impunity.

We are admonished that "war is not a solution". The question is - are we not already at war for the past two decades? What will it require to call India at war - an attack on parliament ... er.. that already happened. What about an attack on India's key economic structures, the stock exchanges, the business districts in metros et al .... er... tick that off too. Well, I guess an attack on Indian property overseas would be an act of war... that too! I guess, since we have geriatrics ruling the country, the only definition of war would be an invasion across the border - but you know what - that happened too...

I recommend that we disband the Indian Army. After all what we need is a National Relief Force - that will take care of people in the event of a natural disaster (currently the most active use of the Indian National Army). As for guarding the borders, or taking on hostile neighbours, we have already exported that task to the "international community". I wonder if there is anyone who can put out a set of condition under which the Indian armed forces will be called upon to act - I doubt it will ever happen despite the need and the provocation. What, therefore I ask, is the need to incur the cost to maintain such a huge force - much better to divert the resources into policing and other activities which we can do within our borders.

The cold war did not ignite into a nuclear war simply because of the doctrine of MAD (mutually assured destruction). The simple construct behind that was the willingness and ability to use WMD's if required. Once one party to a conflict knows that the other is not willing to escalate it no matter what the provocation, simple game theory will suggest that there is no protection against attack. India has repeatedly shown itself unwilling to escalate. Therefore, the enemy can chose its time, place and method of attack, and we have to defend (if that) from a position of weakness. The fact that this simple principle is ignored by the powers-that-be smacks of complete pussilanimity at best and treachery at worst. 

"Fear has its use, but cowardice has none. ... The trouble is that we often die many times before death overtakes us." - Mahatma Gandhi

A recent article from Brahma Chellany in the Hindustan Times, makes some interesting points. 

As our home minister jets to the US to seek to provide "proof" of the source of attacks, some questions come to mind - 

1) What if the US continues to do what it has done so far (provided the ISI funding for creating taliban, ignore the proliferation of AQ Khan, and even now - paid to Pak over $10bn under G W Bush) - which is, to look at it the "evidence" from its own perspective and tell India to go sit at a negotiating table. 

2) Assume that for a change, we have US support - what if the Pakis do not respond to US "pressure"? As soon as pressure built up post the Mumbai attack, transport vehicles headed for Afghanistan from the US were burnt up - underlining US dependence on Pakistan for logistics support. What is the next step if they just ignore US pressure?

3) What if China (who we are now approaching, much like we are the US) assures support, but tacitly continues to provide succour to the Pakis

Finally, some of the prescriptions to India are already in - this article by a UK professor tells its own story...

Finally, India should also reach out to ... work with the US to provide assurance to Pakistan which can undercut the paranoia of the Pakistan Army and ISI, not least with respect to India’s role in Afghanistan. 

So now, we are to assuage the feelings of the ISI too.

In the meanwhile, the Israeli attack on Hamas continues, and, as the US puts it, Hamas should behave itself.

Have a great 2009

Amen

Improving the odds in equity investing - I

Erudite books and articles on investing gloss over or ignore one of the most important investment rules - alignment of interest of the company managers/major shareholders with the minority shareholders. It is assumed that an independent board, shareholder activism, stock options to managers, or good old greed will ensure this. Not so.

First, let me give some examples of what I mean - and why this is not the same as "management quality". Till the early nineties, it was assumed that investing in multi-national corporations was a sure fire way to make money. Post liberalization (early 1990's), this changed. Dividends fell, splits reduced, and profit growth slowed. While this could partly be attributed to greater competition from domestic companies, it was largely because liberalization allowed the overseas (majority) shareholders alternate mechanisms to reward themselves at the expense of domestic shareholders. Unfair transfer pricing was regularly resorted to (foreign owned pharma companies are a prime example). As was the setting up of wholly owned subsidiaries (e.g. P&G) by the overseas parent to the detriment of the prospects of the listed company (the list of such companies is long and illustrious !). Clearly, the management quality had not changed, only the incentives had.

It does not even have to be the machinations of some evil, greedy "promoter" with his grubby fingers in the cookie jar. The Gujarat governments recent diktat to state owned enterprises to pay 30% of pre-tax profits to the government in the form of a donation (?!) is a case in point. Similarly, the Central governments' use of the state owned oil companies to subsidise consumers while paying absurdly high taxes, penalises the minority shareholder.

Strangely, high shareholding by the principal shareholder does not seem to generate alignment. This is particularly true when the company has assets (say land) which are not being priced at prevailing market value -  if the asset value (notwithstanding its current income generation) is more than the enterprise value. There is, almost invariably, an attempt by the principal shareholder to either take the asset out of the books of the public company, or to increase shareholding - usually through an merger with an over-valued, privately owned, company. Alembic and Cadilla have both tried/done this. 

Even if the majority shareholder does not try to "strip" the assets, the market will surprisingly refuse to recognise the value in the company - till there is a requirement to raise capital in such a company. All "holding" companies come in this category. Many tend to be illiquid - which is taken as a reason for the dis-interest of the market (or, it is the other way around?). Holding companies often trade at 60% discount to holding value, for long periods of time. Here, it is not in the interest of the principle shareholder to "unlock" value and therefore it will not happen. Minority shareholders can wait till their patience runs out, and the current holder sells to another unsuspecting soul in search for a "value" stock.  

On the other hand, an alignment of interest can work wonders. This, ofcourse, will not make a bad business good. Nor will it change the business profitability (though sometimes I have seen this magic happen). However, what it will do, is that it will increase the chances to make money when the going is good. Average businesses will deliver superior returns. Lets take a few examples:

United Breweries group has had a stranglehold on the liquor/beer business in India for decades. However, only when it became necessary to increase market capitalization to (a) ward off the threat of take-over by overseas corporates (b) raise capital for acquisition, and di-worsification (I borrow from Peter Lynch) - that a group restructuring was initiated and the stock price multiplied. 

State owned company shares move up as soon as the government announces a dis-investment program. Logically, an increase in supply of stock, without any change in the outlook of the company, should have the reverse effect.

Decoding managment motivations is perhaps as important as poring over the notes to accounts.