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.