Investment Advisory Service

Thursday, 22 December 2016

Wit, wisdom, ethics and cholesterol

I came across a beautiful talk by Padma Bhushan Dr. B M Hegde where he regales the audience with his wit and wisdom.

His talk packs a punch with mantras to live a healthy life, meaning of culture and ethics, ills with modern medicine and how much is too much when it comes to cholesterol.


Monday, 14 November 2016

Thoughts on recent volatility


"Condoms aren't completely safe. My friend was wearing one and got hit by a bus". For many years, I couldn't understand the meaning of this quote by Robert Rubin, ex-Secretary of Treasury of United States. It means that while thinking about risk factors- a new and potentially unthinkable lethal risk can emerge from nowhere and take one down. It's the black swan risk or risk of the "unknown unknown".

For the first time, I understood it when Ramalinga Raju of Satyam spoke "Satya" and informed the world about ghost cash in his company and how he had taken everybody for a ride - independent directors included. Coupled with global recession, markets went into a tailspin with this news and a lot of stocks fell down 50-70% in a matter of weeks. There were a lot of companies selling below cash because people stopped believing in cash held by companies.

However, if asked to point with certainty now, the month and year of the Satyam crisis, a lot of us might make a wrong guess. If you are guessing it right now, let me give you the answer : Satyam scandal broke out in January, 2009. So, in  a span of 7 years, market has shrugged off the crisis of confidence in Indian companies and has come out with newer highs. That's just one example- there have been many such global and domestic challenges which surfaced and subsided with time. It point towards another concept that problems get solved as they always have as they always do. So, no matter how grave the issue, it will get solved given enough time.

In the last few days, some major upheavals have happened. The issue of corporate governance at the House of Tatas, election of Mr Trump as the President of US and demonetization of Rs 500 and Rs 1000 notes in India. The black swan or should I say a "fleet of  black swans". 
First lets talk about the Tata Group. There are accusations flying thick and fast from both sides. There are many versions of the same story. We don't know and will never know what's the correct version. So, there's no point spending time reading and thinking about that. However, there is lesson to be learnt. Business comes first always and every time, management comes second always and every time.
The second issue is about Mr. Trump. The world is in a shock. I think people are more shocked about their own assessment going wrong (of Hillary becoming the President) rather than Trump becoming the President. The world's best experts, commentators, political readers, investors, reporters, big data analysts : all have gone wrong and wrong by a wide margin. That reminds me of Niels Bohr quote "Prediction is very difficult especially if it's about the future". We need to remember this and remind ourselves, whenever in doubt.

I don't think it matters a lot as to who is the President of the United States. The only thing that I think matters is "Is there a President ?". As long as the answer is yes, it's alright. As history teaches us again and again, a bad government is better than no government. So, as long as there is a democratically elected president in the world's largest economy, things will work out fine. Some policies will be good, some would not be so good but things will be okay on a wholesome basis.
The third and the most important issue is the demonetization of the existing high currency notes in India. The first effect is that people now are cashless and clueless. Over time, people will have cash in their pockets to spend so that's not a big problem. The second more important thing is that people are clueless. A large part of Indian economy is informal cash economy. Some of the businesses have a mix of A business (formal accounted business) and B business (informal unaccounted business). A large number of businesses are completely in B. There is no trail of money in the whole value chain. Those businesses will be the hardest hit. They don't have much clue whatsoever to dispose off the cash that they already have and also as to when and how will they resume their businesses. As of now, everyone and everything seems shocked and frozen. It may take time for cash and people to come back.
We don't know how much time it might take ? It might be a few months or a few quarters or even more. Nobody knows. By the time the dust settles, a lot of businesses might get massively hit and lot of businesses might shine.
What do we investors need to do ? One thing we need to do is to focus on the businesses we own and see if the recent events have reduced the strengths of those businesses. The cash flows would surely become volatile given the external factors but if the businesses are inherently strong, the cash flows would come back even if with a delay.

And if businesses are strong and managements are good and we have not bought stocks with debt, we just need to remind ourselves to :
(i)  hold on to our nerves

         (ii) hold on to our stocks

Monday, 31 October 2016

The Case of Noida Toll Bridge

The following note is a brief summary of the order pronounced by the High Court of Allahabad in matter of Noida Toll Bridge Limited. The emphasis laid on some parts is mine and may not be a part of the judgement. 

Also incorporated in brackets and in italics are my thoughts on some of the arguments/ counter arguments put forth by different parties to the case. My thoughts should not be construed as comments on the judgement. This is an academic exercise to understand reasoning behind the order and risks undermining the contracts, more so when one of the parties is an instrument of the State.

To fully understand and get a grip on the arguments, you should read the complete order at this link.

CASE: Public Interest Litigation (PIL) No.  60214 of 2012

Petitioner: Federation of NOIDA Residents Welfare Association

Respondent No. 1:- NOIDA Toll Bridge Company Ltd

Respondent No. 2:- NOIDA

Respondent No. 9:- IL & FS

Matter at hand: This is a public interest litigation challenging the levy and collection of toll as User fee by NOIDA Toll Bridge Company from the commuters for using the Eight-lane DND Flyway having stretch of 9.2 km. from NOIDA to Delhi.

The Concession Agreement was executed on Nov 12th, 1997 between the Noida Authority, IL&FS and Noida Toll Bridge Company Limited.

Crux of the case:

1.   Submission of the petitioner :

a) Cost of construction of the project plus reasonable returns (no figure has been supplied for reasonable returns) have been achieved by the Concessionaire. Now, there is no justification for continuing the toll.

b)  Based on the formula in the concession agreement, till 31.3.2016, the total cost of project based on 20% assured returns reached a figure of Rs. 5,000 Crores plus. This amount will go on increasing further in view of the formula adopted in Article 14 of the Concession Agreement to determine the Total cost of project. The Total cost of Project can never be recovered and the bridge will never be free from levy of Toll.

      (Courts will be inclined to take a very strong view on this point. Any project aimed to have a limited life for collection of fee, if transforms itself to a perpetual money collecting machine, courts might not take a kind view. This kind of an agreement is like bonded labour.)  
c)    Various clauses of the Concession Agreement are against the public interest.

d)  There is no cap on the Total Project Cost and O&M expenses which are to be ultimately borne by Users.

e)  No tender was invited before grant of contract for DND Flyover, there was no advertisement, no bidding. It was a clandestine deal that too with the view to benefit a private company at the cost of public. The award of the contract is, therefore, in violation of Article 14 of the Constitution of India.

(This is a charge with very serious ramifications. If the award of contract is in violation of the Constitution, it can be declared null and void. Calculation of returns and shortfall of returns will be out of the picture, then)

f)  Only the cost of actual construction and some reasonable amount towards maintenance of roads can be recovered that too only by the State Government which can charge the toll tax. 
(Only the State Government is allowed to charge the toll tax, and nobody else. That puts the whole agreement allowing Noida Toll Bridge Company to charge user fee bad in law.)

g) The action of NOIDA in awarding the Concession Agreement dated 12.11.1997 in favour of NOIDA Toll Bridge Company i.e. the Concessionaire fails to satisfy the test of reasonableness and public interest as has been laid down by the Apex Court in M/s. Kasturi Lal Lakshmi Reddy vs. State of Jammu & Kashmir.

2.   Submission of NOIDA

NOIDA has admitted in its counter affidavit that Section 14 of the Agreement read with Annexure 'F', i.e. the method of computing total project cost is not in public interest. The Concession Agreement, therefore, is not serving public interest. The unfair, untenable and irrational clauses in the contract make it arbitrary, unjust, opposed to public policy and amenable to judicial review.

 3.  Response of Noida Toll Bridge Company Limited

a)   The present petition is liable to be dismissed on the ground of latches. (From Wikipedia: Laches from Old French laschesse refers to a lack of diligence and activity in making a legal claim)

The petitioners herein did not challenge the project when it commenced rather the residents of NOIDA at that point of time wrote to the Chief Minister and the Government to fast-track the project as there was urgent need for another connectivity between Delhi and NOIDA.

The Steering Committee was chaired by the Secretary of the Ministry of Urban Affairs and Development, Government of India (presently Ministry of Urban Development), however, the Ministry of Urban Development has not been made party in the petition.

The plea of violation of Article 14 of the Constitution of India is not available after so many years.

(These are weak arguments in my view. I believe that there is never a wrong time to do the right thing.)

b)  NOIDA is a signatory to the agreement, it cannot dispute the clauses of the agreement and it is not permissible for NOIDA to challenge the agreement after so many years. 
c)  It is submitted that scope of interference in contractual matters for adjudicating the constitutional validity relating to economic policy matters of State is neither within the domain of the Courts, nor amenable to judicial review.

d) The power to levy the User fee can be traced to Section 6-A of U.P. Industrial Area Development Act, 1976 read with New Okhla Development Area (Levy of Infrastructure Fee) Regulations, 1998 framed under section 19 of the Act, 1976. The validity of these provisions is not subject matter of challenge in the present PIL.

e)  The amount of user fee paid by the commuters is also independent and does not get affected by the increasing value of the total cost of project.
(This again is quite a weak argument. If the term of the agreement gets extended due to shortfalls in returns, the commuters would have to pay to use the bridge and hence it is not independent of total cost of the project. This argument doesn’t have legs to stand.)

f)    Amendment to the terms of the contract is under negotiation between the parties.

g)  Doctrine of Unconscionable Contract” is not applicable in relation to the Concession Agreement. This doctrine is attracted in a case, where the contracting parties have grossly unequal bargaining power, to the point where free consent may not be presumed on behalf of the weaker party.

h)  In case the concession agreement is considered unconscionable, even by applying the “Doctrine of Severability”, the concession period of 30 years will remain intact.

i)   Doctrine of Frustration of Contract” shall not apply as it is the case of default of NOIDA itself.

           4.    Comments of the Honourable High Court of Allahabad

a)   Where the public interest is affected, the power of judicial review will be permissible even in contractual matters.

b)   The Government has the freedom in the matters of contract; the decision/action of the Government is to be tested on the touchstone of “Wednesbury principles of unreasonableness”. If there is procedural impropriety, the court would intervene and set right the decision making process.

c)    Under UP Industrial Area Development Act 1976; there was no provision of levying “User Fee” on the date of the Concession Agreement, Nov 12th 1997. Only the Government could levy toll or User Fee. A private company couldn’t do that. Insertion of Section 6 A to the Act was made through an Amendment to the regulations on 14.08.1998 which is after the execution of the concession agreement i.e. 12.11.1997. There is no retrospective operation of Section 6 A which is specified in law.

 In Zile Singh vs. State of Haryana and others, the Apex Court held in paragraph '13' as under:-

 “It is a cardinal principle of construction that every statute is prima facie prospective unless it is expressly or by necessary implication made to have a retrospective operation. But the rule in general is applicable where the object of the statute is to affect vested rights or to impose new burdens or to impair existing obligations. Unless there are words in the statute sufficient to show the intention of the Legislature to affect existing rights, it is deemed to be prospective only 'nova constitutio futuris formam imponere debet non praeteritis' __ a new law ought to regulate what is to follow, not the past."

 Hence, sub-delegation of power to levy and thereafter collect the toll/user fee upon a private company under the Concession Agreement is bad.

 (This is an important point. On the date of execution of the concession agreement, the State Government did not have the power to authorise any private player to levy and collect fee. Due to lack of a legal provision to do so, the whole concession agreement then becomes illegal.)

 d)   In Breen v. Amalgamated Engineering Union (1971) 2 QB 175, Lord Denning MR said: "The discretion of a statutory body is never unfettered. It is a discretion which is to be exercised according to law. That means at least this: the statutory body must be guided by relevant considerations and not by irrelevantly. If its decision is influenced by extraneous considerations which it ought not to have taken into account, then the decision cannot stand. No matter that the statutory body may have acted in good faith; nevertheless the decision will be set aside.

e)  Agreement/ Contract itself hit by Article 14 of the constitution of India and therefore, liable to be declared null and void.

 In light of the above arguments more elaborately dealt upon in the order, the High Court pronounced that no user fee can legally be levied/ charged by the Concessionaire and in light of the facts that the concessionaire has already recovered the cost of project in addition to reasonable returns, the Concessionaire cannot collect any user fee from the commuters, hereon.

This is quite a complex situation in my opinion. The whole business and its earnings stream are now overcast. More than returns, the constitutional and legal validity of concession agreement is in question. If the Supreme Court were to uphold the judgement of the Allahabad High Court, the whole business of Noida Toll Bridge stands to get decimated. Only time and the Supreme Court will tell which way the shareholders of Noida Toll are headed.

Wednesday, 5 October 2016

How Buffett and Ajit Jain together saved Lloyd’s, Pink Floyd and the Queen?

This one statement by Buffett says it all when it comes to brilliance of Ajit Jain- Head of Berkshire Reinsurance. Curious to know more about insurance, reinsurance and Ajit Jain, I studied one of the largest reinsurance deals that Buffett and Jain did : Reinsurance of Lloyd's Equitas.

How Lloyd's came to the point of imploding and taking down with it the Queen and Pink Floyd ? How did Buffett and Jain together saved everybody ? (and made money at the same time)

You can download the note here.

Monday, 15 August 2016

A Potential Disrupter in the Making

Ride hailing services or taxi aggregators have taken the taxi market by a storm. Customers are happy with the services and drivers feel good with the financial returns and freedom which comes along. Drivers driving traditional taxis are rattled with the development and car makers are feeling uncertain about the future. Many more allied businesses and services will get disrupted as we move into the future. And many will find opportunities within this space.

One such potential disrupter can be the quadricycle. Please read my thoughts here.

Wednesday, 20 July 2016

Look before you leap

Rohith Potti, a fellow value investor is analysing a company under the current internship program. In one of our discussions, I mentioned that I also observe the shareholding pattern of  a company and changes in the shareholding pattern before taking the final decision to invest.
Rohith asked if any confusion can be created by studying the shareholding pattern, because somebody credible might be buying and somebody credible might be exiting the company at the same time and would it not create dissonance in our minds ?
I think that's a good question and my thoughts are as under :
I think it is important to know a lot about a company that we are planning to invest in and knowing about the shareholding pattern and its changes over a period of time might be important. It is possible that we might make mistakes in our judgement. But over a period of time, we should try to improve the process by focusing on weights that we put on each piece of information that we get.
I can recall 2 instances where studying the shareholding pattern helped me in the past. Once, a large global investor was selling the shares of a company that I was invested in. Intrigued by the selling, I tried to find out the reasons for the sale. There could be 2 reasons :(1) Either the sale is justified because of the deterioration in fundamentals. So, you need to go back and check the investment thesis. It prevents you from being complacent. (2) The selling is for completely non-economic reasons which has nothing to do with fundamentals of the company. 
In this particular case, I found out that the sale is due to the redemption pressure that the investor is facing and has nothing to do with the intrinsic value of the company.  That gave me confidence that when the redemption pressure subsides, the price of the stock should follow the value. Drawing confidence from that analysis and also the lower price of the stock, I was able to enhance the position size.
The second instance was about a company that I was interested in but something within me prevented me from investing. I was not very sure about the health, safety and environment practices of the company. And anything found wanting on that front could decimate the business and earnings power of the company in the long run. While checking the shareholding pattern, I found a university endowment invested in that company. Curious to know, I read up on that university. I read that the university has very high standards of due diligence when it comes to their investments both quantitative and qualitative; including health, safety and environment. That gave me confidence because a large investor with a stated practice of due diligence & ability and means to conduct that diligence had finally invested in that company. That was a strong vote of confidence for me.   Satisfied with that I was able to take a call to invest in the company.
So, sometimes looking at these pieces of information can provide a lot of qualitative factors which can help us take the final call.
This brings to my mind the process used by Munger. Please see the following excerpt from the Poor Charlie's Almanac.

Munger's check-list includes the current price, volume and trading considerations as well. Does it mean he is trying to assess the technical parameters before investing ? Yes. But is he investing technically ? The answer is no. Out of sheer curiosity, we should know whatever is knowable about the business and the security that we are planning to buy. Most of the time, this information might not throw any substantive clues but sometimes, something very important might jump from the data points that we are looking at. So, we should learn how much weight to put on the data points that we observe.

Two, also notice Munger's timing of looking at this information. This is the final filter. He is not using this data to accept or discard ideas in the initial screening.
Likewise, we are not to accept or discard ideas at the initial screening based on the shareholding pattern or changes in it. But in the final selection, I think we should look at it.