Of Personal Guarantees and Kingfisher..

See this wonderful ruling. SBI and others have taken this "personal" guarantee, which is not only worthless, but also illegal, since a foreigner has stood guarantee for a loan>>>> -------------------------------------------- Commission to CMD for personal guarantee may be treated as “ploy to divert funds” The assessee claimed a deduction for the “guarantee commission” of Rs. 1.15 crores that it paid to its Chairman Shri. Vijay Mallya. The AO & CIT (A) disallowed the claim on the ground that the so-called guarantee was a mere signature on a document, not backed by specific assets and that as the commission payment exceeded Mr. Mallya’s net wealth of Rs. 70 lakhs, it was an “innovative method of diverting income from the company” and an “unwarranted benefit” to Vijay Mallya. However, the Tribunal allowed the claim. On appeal by the department, HELD reversing the Tribunal: None of the bankers had obtained details of the assets & liabilities of Vijay Mallya in India or abroad. He stood guarantor in respect of total borrowings of Rs. 115 crores and received commission of Rs. 1.15 crores even though his net worth was hardly Rs. 70.47 lakhs. Also, as he was a NRI, the permission of the RBI ought to have been taken which was not done. The assessee paid the MD commission “on the pretext” of paying guarantee commission and it is a “clear case” of “a ploy to divert the income of the companies under his management”. The payment was characterized as commission to overcome the RBI’s directions, the provisions of s. 309 of the Companies Act and was not a lawful payment and could not be allowed as a deduction u/s 37(1). CIT vs. United Breweries Ltd (Karnataka High Court)

Warren Buffet - will he or won't he-- Indian equities

I had written this piece nearly two years ago, for a magazine. Going through it, between then and now, the only thing that has happened is the discovery of the UPA being what it is now. Other than that, things have not changed much in terms of what is or what would be. Read on.................................... As far as I am concerned, the Warren Buffet Graham Dodd School of investment is a complete education in stock picking. Having seen the Indian markets over the last few years, the one thought that comes to mind is that if WB were operating in the Indian markets today, he would perhaps find it difficult to find companies. However, if you take a cycle of twenty years, he would have found many opportunities to buy. WB is associated with ‘value’ investing. India is a ‘growth’ story. ‘Growth’ means buying in at prices that a ‘value’ investor may not buy. If I look at WB/GD for inspiration, the key takeaway is the relevance of Return on Equity in conjunction with the ‘Margin of Safety’. If one uses these two financial measures, today’s markets are unlikely to throw up any investment worthy candidates. It is simply because our markets are today in an orbit that is being justified by the growth potential as well as the fact that when most of the world comprises of blind people, the one-eyed are looked upon with awe. If I look at some of the key qualitative attributes that WB/GD has listed out as pre-requisites for being included in the short list, the following things stand out: i) Find companies that have strong entry barriers and strengths that enable predictability of earnings. One of the examples in the WB domain is Coca Cola. In India, I have not come across an Indian company that has this attribute. It is only some of the multinationals operating in India that has this attribute. Clearly, India is not a business pioneer even in its homeland, forget globally. Companies like a L&T / HDFC come close, but one will have to search hard to find many more; ii) Management quality: Here again, most Indian companies suffer due to management being a family affair. Father passes it to son and so on. The best person for the job is not chosen. So, here again, the list of Indian companies is rather small.; iii) Forever companies: WB says that he would like to stay invested in a company forever. Here most Indian companies fail the test. Where are the Century’s / Nirlons’/ Mafatlals/Singhanias of the yesteryears? They were the blue chips then. Again, one has to stay content with an HDFC or most of the MNC’s who will be there a hundred years from today. You cannot bet on the longevity of an Indian company or management or family. Their capacity to surprise is immense. Apart from the key differences, the other issue is a WB approach may simply fail because we have two classes of shareholders, whose returns are different. The promoter shareholder gets his returns from many sources whereas the non promoter shareholder gets incidental benefits. Corporate governance and capital market regulations notwithstanding, the promoter only lets you see what he wants to let you see. SO, to gain from a WB approach, we need to have the ability to understand the management and take a call on what the odds are of riding his coat tails. The other most important thing, to my mind, is that we have to learn when to sell. The volatility in our markets (illiquid and shallow by characteristic) gives great opportunities. I like to make a shortlist of companies that I like and put against them, prices that I am comfortable paying. And then wait. Surely, in a person’s investment life span, anything from three to five opportunities will come. And the returns will be great. Much better than market returns if I may say so. One must not have the compulsion to invest everything in one go, like a fund manager. (R. Balakrishnan) (balakrishnanr@gmail.com) May 24th, 2010

Keeping away from Equities- Abstinence, sometimes, is healthy..

This article appears in today's Deccan Chronicle (16/4/2012) Uncertainty seems to be the buzz word going around. I am referring to the financial markets where several tussles are going on simultaneously. The fiscal budget did not attract much attention, being viewed by all as an ‘accountant’s” budget and nothing more. A deeper look in to the broad numbers, bring to fore the fear that we could perhaps be faced with a fiscal deficit that is likely to be higher than budgeted. The one chance that we could perhaps restrict it if the government is unable to complete its spending as planned. Given the set of controversies surrounding virtually every government spending actions, it is not unlikely that we could see the fiscal deficit being within budget, albeit for all the wrong reasons. Growth is getting hurt. Global economic condition is one of the reasons. In my earlier piece, I had talked about my dislike for PSU stocks. That is being fortified by the governments actions on cases like Coal India, Indraprastha Gas and the various retrospective amendments that the government is trying to enact. I fear the PSU banks are next in line, with a high probability that the rules for recognition of poor assets will be changed in order to show that the banks are healthier than they are. It would be like changing the name of a disease from cancer to a flu and saying that all is well. Investors do not like uncertainty. Yes, we do not mind going wrong on our assumptions of growth or profitability or the price earnings multiple that the market may assign to a stock. However, one reasonable expectation has to be that the regulators will not step in and take a destructive approach to pricing or controls which result in changing the basic assumptions. Regulatory risks are the worst deterrents to any form of investment. The Vodafone case (without passing a judgement on its merits) started the uncertainty and the other actions on PSU companies are like adding fuel to the fire. It is a well known fact that our equity markets have been thriving primarily on the FII flows that keeps seeking better returns from emerging markets. Our economic growth rates, till the recent couple of years, have justified the faith of the investors. Yes, a temporary drop or slowdown in profits is acceptable. At a time when it looked like we could be the beneficiaries of FII flows due to our relative growth prospects, the regulatory moves have put a ‘pause’ button in to play. I only hope that we do not see further action that could result in a ‘rewind’ button coming in to play. Inflation and interest rates continue to be a worry in this environment of sluggish growth. If revenue expectations of the budget are not met (considering weaker profits, high fuel prices, supply constraints etc) we will be staring at government borrowings over shooting the target. It is also possible that we could see expenditure plans getting pruned given the clouds on virtually all government spending. That could balance out the revenue shortfall, but it would shrink growth. When we are expecting interest rates to come down, we are witnessing the phenomenon of banks raising deposit rates even beyond the year end. Add to this the strain on the loan books of the banks, we are not going to see significant fall in interest rates. Our trade deficits continue to be high and the balancing act falls upon portfolio and FDI flows. That is in turn impacted by capricious government policies. Oil prices continue to remain high. All of this could see inflation being stubborn and stall cut in interest rates. For investors, the options are becoming smaller, with equities looking weak. An entire universe of PSU stocks (oil, coal, gas, banks etc) have been recipients of swings in government policies driven by populism. Quality stocks (FMCG, Pharma etc) continue to remain expensive. The markets that ran up before the budget, seem to be losing steam and could drift lower. A double digit returns from here, in the next ten to twelve months, looks difficult, unless there is a resumption of FII flows. Fixed income continues to be my preferred option for the next one year or so. I will put my money in to bonds that give me a yield of over 11% p.a. In fact, even the tax free bonds look tempting, with yields of near about 9% on a post tax basis. In the event the clouds clear over the equity markets, one of the accompanying factors has to be falling interest rates. If interest rates start to fall, one can look for some capital appreciation in the bonds also. We then sell the bonds (earning the yield plus a small amount of capital appreciation- giving a good total return) and shift back to equities. The key is to buy reasonably liquid bonds of high quality. In buying listed bonds, one does not suffer deduction of tax at source (of course, the government can change it, but cannot do so retrospectively due to practical issues) giving one a longer use of cash.

Governance in PSUs- Great Expectations..

(This column appears in today's Deccan Chronicle / Asian Age)-1st April 2012 A fund manager has taken Coal India to court. The accusation is that the Board of Directors acted on instructions of the Ministry. And this conformation has cost Coal India a lot of money in missed profits. Institutional activism has made its beginning and one hopes that this is a sign to other fund managers (especially the Indian mutual fund ones) that they can actually influence the way a company functions. Most of the PSU companies are but puppets of government policies that are dictated by politics of survival. Take the case of our amazing oil companies. They deal in products where the selling prices are controlled by political motives and the cost price is a function of global prices and government taxes (in fact oil is heavily taxed by state governments also). This results in the oil marketing companies perennially being at the receiving end in terms of cash flows and profits. Of course, the government has ensured that they enjoy a huge monopoly, by bottling competition. Private players like a Reliance or Shell or Essar stand no chance of competing in domestic markets, because the market will not go to them, when they can buy the same products far cheaper at GOI owned petrol pumps, even if they are heavily adulterated. So, the private sector companies survive by importing crude and exporting the finished products. And if we take the valuation of companies like BPCL, HPCL or IOC, we should throw all the rules out of the window. If there was no government intervention in their products, the market cap of these companies would have been anywhere between five to ten times of what they currently are at. In addition to all this, surely, being government owned companies, there must be tremendous inefficiencies. High overheads, low productivity, excess labour, lack of competitive environment and an inability or unwillingness for strategic planning as the CEO role is merely temporary and the Board is appointed by government. More often than not, Board positions in PSUs are used to create parking slots for retired government officials who have been good to their bosses in the sunset of their careers. Anyone in a PSU who is very good, would normally be snatched away by the private sector, unless the position enables one to make money on the side or one is a committed government employee for the perks and pensions that go along with it. Succession planning, project suitability for a company, dividend payouts etc are dictated by the promoter shareholder (GOI) . Given the political equations in this country, it looks very unlikely that companies like our Oil sector PSUs would ever become full fledged private sector companies. The Ministers will never let go of a hen that lays golden eggs. So, whilst the PSU companies have great business franchises and poor competition (a gift of ownership) they do not excite any investor. Sure, a lot of FIIs and domestic institutions like LIC hold shares in all PSUs. To me, the FII is buying in because it feels that at some point, GOI will free their hold on these companies. Domestic institutions hold these, because they HAVE TO. Look at the circus of LIC subscribing to PSU bank shares on ‘private placement’ merely to ensure that the GOI receives some money by this so called ‘dis-investment’. When we invest in shares of PSU companies, we give in to HOPE than to reason. HOPE, that one fine day, the babus will give up the government hold on these companies and let the companies be players in a free market. Well, I do not subscribe to this and if you do, good luck to you. I may be proved wrong, but it will take a few decades and radical change in socialist thinking. Parties like DMK, Communists, TMC will oppose privatisation tooth and nail. And opportunistic opposition, whether it is BJP or Congress, will also oppose it for the sake of opposing it. Ownership and management in private sector is not far better, but they are creatures of free markets. A promoter, who steals excessively from his company, will naturally have lower reported profits. There is no corporate governance in these companies either, but at least they have the goal of higher and higher market capitalisation in order to maximise their wealth. This is a goal that any investor will appreciate and will join the ride. PSU Stocks are preferred by many investors due to the fact that the PSUs enjoy dominant market positions and some of them have control over scarce natural resources. This is precisely what also makes them vulnerable to huge interference from government and its ministers and babus. Most would tend to be run by IAS guys, irrespective of their suitability for the job. And there is often a problem in having a strategic vision and execution. We have often seen PSU banks getting Chairmen whose tenures rarely extend beyond three to five years. Whilst government owned companies may be in great businesses and enjoy dominance, it is not in their blood to care for minority shareholders. So, I would be hesitant to put large moneys in to stocks of PSU stocks. Of course, there was a time when no one wanted these stocks and UTI / LIC ended up ‘buying’ and holding these. The value has gone up manifold from then. But, I am not sure that we can expect anything like that from present levels. Unless, the government vacates the boardroom of these companies in toto, I will not put money in their stocks.

Does ownership matter (or why I dislike PSU stocks)

( This article appears in the latest issue of Moneylife)One thing that is clear to all of us now is that when selecting stocks, a conservative investor has to look at ownership as well as the nature of business as two primary selection points. Of course, we have all the fundamental and technical analyses that one is comfortable with, but to me, these two factors will form the basis for primary inclusion or exclusion. As regards nature of business, there are many measures and I will simply state that I like companies that have business which is not vulnerable to regulatory fiats and are in the top two or three of their industry. Also, I prefer businesses that are consumption driven (FMCG, Pharma, Housing Finance etc) rather than a business to business model. For me, more important is ownership. The thing I will avoid is government of India ownership. This may sound surprising given the fancy for stocks like PSU Banks, BHEL, Coal India and its likes. I am comfortable not having any of these in my stock portfolio amongst my core holdings. Government of India ownership is an issue with me because the business focus is simply absent. There is no continuity in a business plan as the CEO’s keep changing frequently and no one person is allowed to have a long range vision and carry it through. Perhaps the concerned ministries do have some kind of plans for companies in their fold, but it is subject to the personal whims and fancies (apart from political pressures) of a particular minister. And none of the considerations could actually be helping the company to earn more money. If one says that the role of a PSU is to look beyond profits, then my submission is that these companies should be delisted. Let the government become the sole owner and do what it pleases. Once an outside shareholder is included, the main obligation is to create value for the shareholder. And this can be done only by generating more profits. This means that companies like the public sector banks, should be free to lend where they want. They should not be compelled to lend to any group or sector which the government directs it to do. As a shareholder, my concern is that the bank is being forced to lend in to high risk areas and not at the best possible pricing. I know this sounds very commercial, but investing in shares is a commercial decision and not a patriotic act. I can write books about the flaws in the public sector management capabilities and delivery, but in short, I will skip investing in shares of companies belonging to this promoter. Having excluded the public owned companies, we are left with the private sector companies. By no means are these saints. In fact, in most cases, I am hesitant to even shake hands with the promoters, for fear of losing my fingers. Most promoters use the companies as their personal fiefdoms, providing money plucking opportunities to kith and kin. The shareholders get what is left. The returns that come to the promoter shareholders and the others shareholders are two different things. However, over the last few years, most promoters have realised that long term wealth creation (by having high share prices) is also important, the other shareholders also gain. For instance, if I own 70% in my company, I may prefer not to siphon out a couple of crores since the increased reported EPS would help to increase market capitalisation by a greater amount. This goal is in sync with the other shareholders. Personally, I put my investments in Indian promoter companies under ‘speculative’ rather than investment category, simply because I cannot take anything for granted and want a higher level of alertness. I never know when a promoter may sell the business, take a personal ‘non compete’ fee and then use the money to do a strange business. For most Indian promoters, other shareholders are nothing but ‘nuisance’ value, albeit essential. So, when I get in to private sector promoter companies, I know the risks, but am betting on the fact that a higher share price is the common goal. I also know that the promoter is going to take home something far higher than what other shareholder gets, but I look at it as the price one pays for entrepreneurship. Of course, in the private sector, there are also foreign owned companies. Here I am a bit more comfortable since they are all focused on remitting as high dividends as possible. The flip side is the transfer pricing and royalty leakages which happen. However, by and large, most MNC companies listed on our bourses (HUL, Colgate, Nestle etc) have been great investments and as a universe, surely score over Indian family owned companies, from an external shareholder point of view. There is another category of ownership, where there is no single group of person in control of the shareholding. These are mainly run by professionals and are focused on business growth and profits. To name a few, these include companies like HDFC, CRISIL, L&T, ICICI, Infosys etc., It is possible that in these companies, one person may have an overbearing presence, but these companies will live beyond the individual. Here I am more comfortable that the family ownership model. It would be great if all family owned companies ultimately transform to this model. It looks very unlikely in India, where ‘family’ is important- whether it is company or country.

THE BUDGET- DONT FRET THE SMALL THINGS

(This appears in today's Deccan Chronicle/Asian Age) The budget changes nothing as far as our investment strategies or themes are concerned. If anything, it reinforces the tried and trusted routes. First let me talk about a couple of supposedly new things that this budget talks about. A new scheme called Rajiv Gandhi Equity Savings Scheme is proposed. The scheme would allow for income tax deduction of 50 per cent to new retail investors, who invest up to Rs. 50,000 directly in equities and whose annual income is below Rs.10 lakh. The scheme will have a lock-in period of 3 years. We have to wait and see what the ‘permitted’ equities that this scheme will cover. It is very unlikely that this deduction will be allowed for any universal investment. For, if it is so, I will happily buy shares or Infosys or HDFC or HUL or ITC and laugh my way. I can buy every year. So, I think they will limit it to either IPO’s or shares in PSUs or some such things. To me, if they let us invest in any share, it is a bonanza. Imagine buying quality shares at a meaningful discount! I only hope that they do not make it like the ELSS in mutual funds. It is unfortunate that the ELSS schemes have done poorly as compared to open ended diversified schemes. One would think that a three year lock in would help the fund manager to take a better view, but our fund managers seem to be at a disadvantage when they get money that is medium term, with no calling back for three years. The other interesting thing that stands out to me is the clear superiority of buying gold in the ETF form rather than physical. This budget imposes many financial burdens on buying jewellery. The budget proposes a tax collection at source on purchase in cash of bullion or jewellery in excess of Rs. 2 lakh. This looks like it is aimed at curbing black money, but my feel is that people will continue to buy in cash without an invoice. For those of us who would like to invest in gold, physical gold now becomes less attractive and the ETF route becomes a winner again. This has no TDS, no ‘making’ charges and no excise duty etc., In fact, one of the fund houses has recently launched a gold ETF where you can get physical gold in exchange if you have more than 10 grams equivalent in the ETF. Wonder what the authorities are going to do to this mode. Technically, one can beat the TDS route by redeeming for less than Rs.2 lakh worth in one transaction. In jewellery, it may not be possible to split the bills if a single piece costs more than two lakh rupees. A small reduction in the Securities Transaction Tax does not make too much difference to anyone, since the absolute amounts are going to be miniscule. It may help someone who is a compulsive “Buy Today Sell Tomorrow” punter. The one big negative thing for retail investors is the imposition of TDS on debenture interest when the interest payment exceeds Rs.5,000/- in a year. If one has a lakh of rupees in debentures and the annual interest is Rs.10,000/-, there will be deduction of tax at source. The present rate is 10% and maybe this would apply. This will be a big negative for the retail bond investor. Many senior citizens I know are within the taxable income limit and put substantial money in to bonds because there is no TDS. Now, they will have to live with lower returns. Yes, they will get a refund if they file returns and wait for one to three years. Most senior citizens I know will have a problem filing returns since they will have to find a consultant and spend money on it. I hope the government has a relook at this and like in Fixed Deposits, let the investor file a form for non deduction of tax at source wherever applicable. On the one hand, the government talks about broadening the bond markets and here they create operational problems. This budget will of course make many things expensive for us. The benefits that we have got are miniscule. Our hope and prayer should be for reduced inflation and lower oil prices. Do not lose much sleep over changing investment strategies or philosophies. R. Balakrishnan March 17th, 2012

Vodafone vs the GOI

The Vodafone affair is now a much debated one. There are many who want to see the 'foreigner' paying his due on a massive chunk. And there are those who think that the government is being foolish in its pursuit that will only deter new investments. I am totally opposed to this 'retrospective' announcement that the GOI is talking about. Hopefully, the Supreme Court will knock it down. What is the sanctity of a commercial deal, if you have the threat of post facto governmental action at a distant point in the future? Is the move of government a well thought out one or is it one more weapon in the armoury of certain politicians to get at some targets? Intriguing. The Vodafone case is funny indeed. Vodafone did not make any money. They bought the business from Hutchison Essar combine. So, if anything, money is made by Hutch/Essar. According to the government, Vodafone is guilty of not deducting tax at source on the payment they made to Hutch/Essar. Now, did the government even try to ask for money from Hutch/Essar who actually sold the business and made their money? Apparently, the government feels that it has no hold on Hutch and so cannot pursue Hutch. Vodafone is an easy target because they have business interests in India which can be put at risk by the government of India. To me the issue is not one of losing out tax revenues. It is a question of how legislation ought to be drafted and what is the comfort that even an Indian can have in his own government. And what about Essar, which should also have made some money from the sales? Has the government approached them for collecting any money? I have no idea, Sir. The government also had a requirement that any tax payer can be asked by the tax authorities to revisit his records for the past eight years. Now, they have increased it to sixteen years!! So much more business for document storage companies and so much more avenues for pre emptive bribe collection .