Tuesday, October 13, 2009

The game that public listed companies play

I recently got to know an Indian businessman who hails as a managing director from one of the leading solar companies back in India. Through some discussion with him as an experienced practitioner, someone who has been through the ups and falls in business for the last 25 years, I gleaned new insights. This is a man who is of exceptional drive, outstanding salesman pitching skills, voracious appetite for opportunities anywhere in the world.

He simply made one simple comment, "You know Joe, managing a public listed company is a totally different ball game from that of a privately held company." I pondered on what he said while he just smiled at me with his shrewd eyes looking straight at me - what a simple yet immensely profound statement that was.

Company equity as the most valuable asset to any businessman

For the true businessman, the company entity is usually synonymous with the founder and it is unthinkable to divorce into two distinct entities. The company is the work of the founder that is built upon endless years of toiling and tears, and what the businessman have is equity in the company, which should be his most valuable thing. Therefore, equity in his own business should always be the last thing that a businessman will want to part away with.

This begs the next question then: when should a businessman part with equity? This will be based on a question of cost/benefit. According to business startup professional consultants, (I happen to know one who is actively teaching in NUS), there are certain pre-conditions that must be met before a businessman considers parting his equity: firstly, the other party shares the common vision for the company; secondly, this new partner either brings value to the table through capital injection or has a set of skills/knowledge/contacts/reputation that will bring the company another quantum leap forward; thirdly, rewarding loyal and capable staff - you part a bit of your equity to someone who has stuck with you through thick and thin, so that you build a sense of ownership and loyalty in them.

Of course, be mindful that good friends does not mean good partners. Friendship should never be the basis for setting up a partnership. However, alternative means of showing appreciation like profit-sharing schemes can be adopted.

The sad fact of life

Ask the experts and they will say, "the most profitable companies are usually privately held companies". This makes perfect sense that a passionate businessman will definitely want to keep a dollar-churning machine in his own backyard, quietly generating returns for himself. A highly profitable business can grow organically by rolling it's own profits year over year; it can finance it's own expansion.

I am a skeptic. After meeting a few dynamic and shrewd businessmen who have been in their fields for 20 over years, I tend to believe that all businessman who go for public listing of their company are looking to cash out of their own business, either partially or fully, for a tidy sum. It is a form of exit strategy basically. But all of them will nicely hash it under the lovely reason of raising capital for expansion. This may not be necessarily true for all, but definitely, I will say it applies for 90% of the case. Put me in that situation, I will do the same too. Idealists, face it, this is the sad fact of life.

Playing the game of a public listed company versus that of a privately held company

Allow me to illustrate this in a simple example: in a private company, I will not sign a deal of US$20million if I know I am going to suffer a loss of US$2million; it makes zero economic sense for me. BUT, in a public company, I might consider signing that deal even though it will make a loss. Imagine this: holding a press conference to announce that I have signed a US$20mil deal; media splashes this in the front page, stock price skyrockets multiple folds over the next few days, and I can sell off some shares for a pretty tidy profit. In good times, news of directors selling off stakes are glossed over in the media by the reported US$20mil deal and the US$2mil loss will not surface in the annual reports until the contract is completed in say, 3 years.

And wind it forward. 3 years from now, the business cycle is now in the recessionary stage, share prices dip a lot in general, I report a loss of US$2million, I tell the public, this is inevitable as the whole industry is suffering from a economic recession and the company is not spared either, but we will do our best to maximize shareholder's interests. Then I take advantage of the situation and buy back my company shares as equity is much cheaper now, and this puts out a very favourable signal for all investors because they view insider buying as a positive sign. In the end? The company signed a loss making deal, but I made a profit from selling out at high prices and then increasing my stakes back at a lower price. No one will possibly ever know that I signed a loss-making deal that costs the company US$2mil.

That's the key. The game of a public listed company is played through the eyes of the media, a strong public confidence in the company precedes, if not, is as important as the real profitability. Without strong public confidence, you risk major investors in the company starting to sell out their shares and jump ship, bankers may start calling up to recall loans or re-rate your credit standing, cut your credit line, suppliers start losing confidence and will accept no deferred payments, only cash upfront. This starts a downward spiral that ultimately affects the company cashflows and ultimately threatens its survivability. You need to tightly manage public expectations, if not, there will be a serious backlash. Based on my past few years observation on SGX, companies that keep an active and well-managed public relations (PR) with the media and the analyst agencies respond better in terms of stock prices to any company announcements like 20% profits, etc. But to the companies that purely focus their efforts on their core business, their share prices seldom budge.

In contrast, the privately held company accounts to no one by the businessman himself, he owes it to himself to keep his balance sheet strong and cashflows positive.

Game over for the retail investor? No, put your eggs in the basket still, and watch out for any danger signs

The same old mantra applies, company CEOs that frequently feature in the financial headlines for days after days, beware beware beware. And take note of companies that have a sudden change in key appointment holders like the CFO resigning just weeks before the results are released. This is a serious indication that there are some major moral/principle disagreements between the board members (e.g. distortion of reporting the truth in financial statements)

It does not mean we should stay away from investing in public listed companies too, because there are still a lot of credible and serious businessman out there who truly need that capital for expanding their market presence. We can partake in the expansionary journey and make our hard-earned money work harder for us. And of course, you are in safer hands of a company that quietly makes its profits, distributes it to shareholders quietly, silently develop new capabilities and market them, stays away from the limelight of any public media.

Wanna stay in the game? Keep to those sagely rules of thumb of smart investing.

Tuesday, September 8, 2009

Cigar Butt Picking and S-chips

What are 'cigar butts'?

'Cigar butt' is a termed coined by Warren Buffett, the world's richest man. It refers to listed companies that are good for just "one last puff", and one school of thought in stock investment originating from Benjamin Graham (aka founding father of value investment) is to pick up cigar butts, or stocks that are trading at a net tangible asset value that is higher than its current stock price. That is like equivalent to buying an asset at less than what it costs, with little regards for the profitability or stability in cashflow generation of the company. This is done in the hope that one day, when business turns arounds, the share price will appreciate enough for the investor to sell off at a decent profit - that is the "one last puff" Buffett was referring to, otherwise also termed as a 'net-net' share.

The obsolescence of 'cigar butt' - seeing value beyond apparent value

This philosophy of 'cigar butt' persisted for many years, but this was until Buffett met his good friend Charlie Munger, who is instrumental in shaking up the archaic foundations of value investment philosophy net tangible assets as the premise. Munger, a corporate lawyer, had plenty of experience in corporate law matters and he is the person who brought a brand new investment paradigm by insisting that intangible but real aspects of a business must be taken into valuation. These intangible aspects include the brand value, goodwill with existing suppliers and customers, and the reputation of the company; valuing a business based on net tangible asset (NTA) value paints an unrealistic and obscured picture of the company. It was Munger, who made the frugal Buffett believe that it is worth paying a much higher price for See's Candy that has tangible assets worth less than its current share price.

The risks of cigar butt picking and value investments

I was having an "intellectual sparring" with my younger brother about the philosophy and methodology of investing. My younger brother is a value investor who adopted the idea of "collecting as many cigar butts as possible", whereas I am a person who adopts multi-faceted perspective on the valuation of a company. He shared with me his extensive research into this SGX listed company called Changtian chemicals that is trading at like Price-Earnings Ratio of 2 (i.e. theoretically the company only takes 2 years of pure profits to match its current share price -> this is a ridiculous market valuation because the median of PE ratio is about 10~15 for SGX) with little current liabilities and hoards of cash, trading at 'net-net' price. Changtian Chemicals is a China-based company that is listed in Singapore, market players call them 'S-chips'. PE of 2 and NTA more than price -> Such kind of statistics can give you a very sizable safety margin that Buffett (pre-Munger era) might raise an eyebrow at first glance, but a closer examination and Buffett might just say otherwise.

Why not cigar butt picking for S-chips?

Firstly, the value investor in Singapore is already significantly disadvantaged as compared to counterparts in the United States with a very sluggish market response to good undervalued stocks. Experienced folks will tell you that value investment is for the long haul, requiring a patience of at least 2~3 years before the market re-prices the stock. Even then, there's a very real risk of de-listing, or acquisition by private investors who have the financial muscle to offer the retail investors ridiculously low price offers. There have been so many classic examples, like Pokka (see
here), because the market has persistently shown its disdain for such a boring business, the parent company in Japan has decided to delist.

Secondly, there is a significant number of corporate scandals for S-chips in recent years, including big giants (or so, as touted by the media) Ferrochina to China Aviation Oil. Unless you really understand the company and the industry inside out, there is good reason to doubt the integrity on any S-chip company. Even if the companies like Changtian prove to be honest businesses, the scars of these scandals will overshadow everything else and it is very likely an impossibility for the market to re-price and allow you to encash your investment in the next 5-10 years.

So, cigar butt picking for S-chips? Beware, you may never get that one last puff.

Sunday, March 22, 2009

The End of A Beginning

Evolution of investment approach into a higher order

It has been some time since I submitted any additions to my own investment blog. I should say my interest in investments and businesses has evolved to a higher order. From being a keen third-party business observer and investment analyst to actually blazing a trail of my own - I am leaving my cushy job as a well-paid aviation engineer, to venture into real estate development in China with my Dad.

The salaried investor is immune to business risks of their investment holdings, whereas, the traiblazing businessman shoulders it all - the risks, the pain, the failures, the profits, the joy of being in control. Moving from a 3rd party investor towards being the businessman, investor all together - that is definitely an evolution of an investment approach to a higher order.

Taking stock

My holdings

Till date, a majority of my savings are held up in big stakes in 3 key companies: Adampak (largest), ASL Marine and Apex Pal. All of which are purchased in recent months at rock-bottom prices and all of which I know are in safe good hands of a keen management holding majority stakes. I will continue monitoring the performance of these few companies. In particular mention, Adampak, if it can indeed live up to its expectations as a crown jewel in the waiting.

Development of a sound investment philosophy

This blog has served me well. It has provided me a good forum to articulate in crystal clarity my own investment methodology and the how-to, from the mental model to the initial stock selection to an eventual decision to lock in. And it should serve others well too. I think that what is articulated here is self-sufficient, like a little Swiss Army Knife, for anyone to jumpstart on the ins and outs of investment. For the accidental surfer who knows nothing about investment but keen to know more, read the articles, and the samples on Adampak, which provides a good model of how in-depth an analysis should go - beyond numbers and reports.

Looking forward

Looking forward, it is not likely that I will have regular postings to this blog. But do not be mistaken, this is just the end of a new beginning. When inspiration and new insights are gained in terms of business or investment philosophy, I will have fresh postings. Wish me well, and thanks to my blog readers.