The developments in the Tata Group have certainly sent ripples down the stock markets. We have in the past seen several family disputes creating uncertainties in specific stocks, but perhaps this one has more noise around it. We have seen PSU banks getting used for meeting political ambitions and aspirations. Professionally managed companies have abused their power by venturing in to businesses that destroy capital. And in another development, the courts stuck down the contractual rights of Noida Toll Bridge to collect its legitimate dues. We can talk about endless examples including the Birlas or the Ambanis or Infosys or L&T etc where division of companies or mergers or capital allocation decisions were driven by promoter interest rather than the common good.
Essentially, in every business, there are two big risks that are not given enough importance. The first one is ‘promoter’ risk. What I mean by this is the worry that the promoter will be reckless in capital allocation and destroy share values. For example, when a promoter buys a private aircraft or acquires some family owned company etc the shareholder is generally the loser. The other big risk is always that of succession and division of the company. Here, personal promoter interests drive things. By and large, as non-promoter shareholders, we do not have much choice.
Nowadays, the institutional investors are supposed to play the role of protecting minority interests, but here also we see nothing significant happening. Right from the days when the government stepped in to bale out the Escorts promoters, the government too has sided with promoters rather than minorities.
The second important risk is ‘regulatory’ risk. This is very relevant in sectors like oil, coal, pharma, etc where the government rules can change the picture for a company. Include the banks and NBFCs that can laugh or cry depending on the RBI’s whims and fancies.
We take a pragmatic approach and try to anticipate that regulatory oversight will reduce as trade gets freed. We also assume that things will go logically. Once in a way, we will get some shocks from the legal framework too- recall the legal acrobatics in Indraprastha Gas or the recent one in Noida Toll Bridge. Clearly our legal framework is a huge risk factor. Sometimes, there could be socio political compulsions which can change the fortunes of an industry — microfinance, utilities are prime examples. So how does one factor in these two risks
It is impossible to eliminate these two risks. So the way to approach is make a small checklist and take a balanced view.
Promoter risk is inherent in every company. What I have to assume is that they are also interested in the stock price as much as I am. Thus, I would like it if the promoter has a large holding. The lower the holding, the higher is the risk of poor practices. One clear test of promoter ability would be use the RoCE (return on capital employed) over the past decade or so. When it comes to promoters without a track record, it is just a throw of the coin. Promoter risk matters lots more in industries or businesses that are very asset light, especially in technology related businesses. The more mature the business; the lower would be the promoter risk in my analyses.
When the promoter has many companies, the worry level tends to be higher. Inter-company dealings and cross holdings are warning signs.
Family interests generally over ride shareholder interests. We cannot ensure human integrity. When it comes to money, power and ambition, logic and fairness are victims.
The key thing is to make sure that all our fortunes are not tied to any single promoter. Diversification becomes important here also. I thus avoid any promoter group investment where he has more than one or two businesses. Two is the outside limit. Multiple business interests would mean that I run the risk of merger, consolidation etc of poor businesses. And good businesses subsidising bad.
There would be some rare professionally-managed businesses (with diversified ownership) that do well for periods of time. At some point, some professional will have unchecked ambitions and greed that will diminish shareholder value.
As an investor, I am always prepared for promoters to spring unpleasant surprises. In the next column, I will take up the issue of regulatory risk in our investments. The writer is a veteran analyst and can be contacted at balakrishnanr@gmail.com
