Is all Income Value Accretive ?

In equity markets, when evaluating businesses, whether an investment is sought to be made through an IPO / secondary market or private equity investments (PIPE deals / unlisted Co's), to my mind any prudent investment manager / investor evaluating Company financials, profile and the business model would seek answers to two principle questions

1. How big can this become (scalability) ?

2. How sustainable will this be (returns on capital employed) ?

It therefore follows that one would make an assessment of value of business on sustainable profits / turnover / cashflows & at what Internal rate of return (IRR) the cash flows are again likely to be re-invested (right scaling up of business!).

What can be sustained ? Only that which adds value and is something which would survive by natural selection i.e. fit to withstand competition and grow. This is then a quality test and not a quantum test (which i presume models would not capture, since this is not binary but will put to use one's experience and judgement).

Across all media valuation multiples are reported using total earnings i.e. the earnings no does not even provide for a simple differentiation between earnings from regular business activities and earnings attributable to other income. It is without dispute clear to me that media cannot be expected to provide sustainability calls on earnings but, atleast a better earnings no can be reported.

The last quarter ended Dec 07 results earning per share growth has almost entirely been on account of increases in other income, which to my mind go straight to the bottomline (one may check CMIE data or broker aggregate results updates for the top 100 cos or so), thereby inflating the earnings no (EPS) and consequently lowering the valuation multiples (making things look cheaper or rather less expensive than they are !!!

Rising other incomes is a cause of concern. The concern is - are companies booking profits on some of its investments to show / maintain profit growth or deploying surplus cash on its balance sheet in the equity markets / banking system to generate higher income. In the former case, it is an indication of a slowdown in earnings which the Company does not want to acknowledge and the latter indicates that the Company does not have avenues to deploy additional cash thereby affecting the IRR at which cashflows are invested & consequently the sustainibility of current earnings. Beyond a certain level, this is also a corporate goverance issue.

How do exemptions or incentives become loopholes ?

One permanent feature of laws - Various small loopholes are sought to be plugged, huge glaring loopholes are left untouched.

Let me draw an analogy to taxation laws to explain. Over the years we have seen politicians and film stars becoming owners of poultry farms, hotels, software and other export firms, and agricultural land depending on the scope for laundering unaccounted income at minimum cost in the form of payment of taxes. (In markets - black and/or illegal money being routed through multiple sub-account registrations, p-notes etc)

Even today agricultural income is left untaxed (markets - companies doing pre-ipo placements at with institutions / FII generally at lower valuations) which is the reason why film stars, politicians are keen to acquire such land. I am sure our politicians must have acquired construction firms and multiplexes, to take advantage of the tax holidays for laundering their ill gotten gains.

One would argue that these exemptions are meant to incentivise certain types of economic activity and are not really loopholes. Most politicians or persons interested in laundering their money donot have the patience or the inclination to really carry out the concerned activity, and merely create paperwork to show such activity is being carried on, though it is not really so. The loop hole is therefore created due to inadequate verification of facts. A proper inquiry will certainly throw up the correct facts but unfortunately for obvious reasons, the will is often lacking. I however, continue to believe that good rules are bad substitutes for character.

I recollect having heard Mr.Nani Palkhiwala (one of this last few sessions on the budget which I had a chance to be part of) - "Bad economics may temporarily be good politics; but politics should be behind a fiscal law, and not in front of it."

Executive Summary (as part of the prospectus filed with SEBI for IPO/FPO/Rights/Takeover-Merger document)

A typical prospectus filed with SEBI would be around 250-300 pages minimum. The very reason it is filled is to provide investors with full disclosure on the Co making the offering. With around 2-3 IPO's/FPO's every fortnight (that has been the trend every month over the last 2 years) going through each prospectus is very difficult for a retail investors (especially those not having finance background...and what about junta who donot know English....should we not have a hindi version atleast....may be not Gujrathi !).

I just wonder why can SEBI not insist on having an Executive Summary (3-4 pages) as part of the prospectus, which can just include relevent & important information which is already covered in the whole document. Currently, brokers make a synopsis 3-4 page reports with thier recommendations and provide thier views...(i wonder each house has its own opinion based on analysis...nothing wrong with this....but why should a layman who would want an independent executive summary of the offering not have it in 3-4 pages but be required to read through the whole document or refer to broker reports...assuming he has access to them!)

What is to be included and not included in the executive summary can be rule based..in the same manner the rest of the document (prospectus) operates...useful references to pages can also be provided if someone wants to look at details....am sure a software & a reader to correct the results can handle this.

To start with

I remember Mahatma Gandhi saying in his book "My experiments with truth"

'One cannot do right in one area of life whilst he is occupied in doing wrong in another; life is one indivisible whole.'

I reckon this point of wisdom is profound. A commitment to excellance is not just reserved for a few select areas of our life - it must be reflected in everything we do. Our diet must reflect our commitment to excellance. Our personal habits must reflect our commitment to excellance and our thoughts must reflect our commitment to excellance.



May I be able to extend this commitment to this blog.