Author: shyam

Indian IT and Contingent Liabilities

Contingent liabilities are serious future obligations like lawsuits, warranties, etc. that may or may not be a problem. For example, if your parents guarantee your home loan, then if you make all your payments on time and do not default on your mortgage, there is no contingent liability on your parents. If you fail to make the payments, your parents will incur a liability.

Maybe its not a problem yet, but it appears the Indian IT companies are getting into riskier contracts in search of revenue. It used be that Indian IT companies were predominantly “body shops”, i.e., most of the contracts were labor based. An hourly or monthly labor rate was assigned to different skill levels and the contract outlined the total labor anticipated and quality of service goals. However, over the last 3-4 years, there has been a significant uptick in “gain sharing” contracts where the service provider obtains a share in the savings when outsourcing creates permanent cost savings. A gain-sharing contract better motivates the provider to innovate and to reduce operating costs.

The problem is that these contracts are not transparent to investors. How much of the anticipated revenue has been booked upfront? What if there are no “gains”? What if provider has a windfall year and the client decides to renegotiate the formula? Also, are investors aware of the risk-mismatch in contracts between what the provider has with its employees and its clients?

Investors should demand greater disclosure of these contingent liabilities before taking revenue numbers at face value.

Categories

Conglomerates: Heartbreak hotel?

Conglomerates are companies that either partially or fully own a number of other companies. Sprawling conglomerates litter the Indian landscape: from the Birlas to the Welspun Group, they have a finger in just about every pie.

The case for conglomerates can be summed up in one word: diversification. Because the business cycle affects industries in different ways, diversification results in a reduction of investment risk. A downturn suffered by one subsidiary can be counterbalanced by stability, or even expansion, in another venture.

The core of the idea came from a Harvard Business School proposition that management is management. If you could manage an oil business; you could also manage a movie studio, because the basic fundamental principles were the same. But anybody who has actually managed a business knows that success depends on understanding deeply the industry in which one operates. However, the megalomaniac allure of being everywhere and owning everything is hard to resist. After all, managers are also human, aren’t they?

The case against conglomerates can be summed up in two words: size and complexity. Bigger size slows down decision-making while complexity creates confusion. Diversified companies often allocate capital to keep poorly performing divisions alive. The market would have cut them off, but in a diversified firm, good money is thrown after bad. For investors, conglomerates can be difficult to understand – accounting can leave a lot to be desired and can obscure the performance of separate divisions. Behind every Tata company there is the unlisted and opaque Tata Sons lurking in the background.

So should we break up these behemoths and force them to be independent entities? It depends. Research shows that companies with one division operating in a high-growth industry and another in a low-growth industry will generally do a worse job of allocating capital than one with two divisions operating in industries with comparable growth prospects. It means that the Reliance of yore, the vertically integrated petrochemicals major, is an example of a “good” conglomerate. Whereas the new Reliance, the one that wants to be in every vertical possible, is an example of a “bad” conglomerate.

Forewarned is forearmed!

Sources:
spinoffadvisors
CFO.com

Related articles

[stockquote]SHALPAINTS[/stockquote]

Categories Tags

Gold vs. Jewelry

Today’s collapse in Gold took down gold jewelers like Titan (-5.05%), Gitanjali (-2.98%) along with gold lenders like Muthoot (-12.71%) and Manappuram (-9.84%). I understand why gold loan companies might be in trouble if the downtrend continues. The biggest question being whether their customers can top up their LTV given that the collateral is down -13.81% this year? However, unless the jewelry guys got into some nasty hedging bets, isn’t falling gold prices a net positive to them?

Women secretly know that gold jewelry is a bad investment. Trinkets falls 30% in value the minute you take it out of the showroom. The investment angle was something that they use to make men feel better about blowing away money. The drop in gold prices actually makes it more affordable so I would expect foot traffic to retail jewelers would actually increase.

As price decreases, consumers will buy more of the good.

There are significant headwinds affecting gold. Chief among them the ECB’s pressurization of Cyprus’ central bank to sell its gold reserves to help pay for the country’s bailout. That has raised expectations that other distressed euro-zone members might be forced to sell gold as well. Other factors include bearish forecasts such as from Goldman Sachs, the slow improvement in the U.S. economy, and the perception that gold is no longer needed as a safe haven.

However, if you are with me on the thesis that, in reality, jewelry buyers are not buying gold for investment but for consumption, then the drop in gold prices are a net positive to jewelry companies.

Related articles

[stockquote]GITANJALI[/stockquote] [stockquote]MUTHOOTFIN[/stockquote] [stockquote]MANAPPURAM[/stockquote] [stockquote]TITAN[/stockquote] [stockquote]GOLDBEES[/stockquote]

Categories Tags , , , ,

Why I don’t watch CNBC or NDTV Profit or…

I don’t watch CNBC, or NDTV Profit, or ET Now, or… Let me just bunch all of these together and refer to them as CNBC – the pioneer in real-time financial entertainment.

CNBC’s goal is not to make you money, but to sell advertising. In fact, if you use any website or TV channel or magazine that shows you ads, you should understand that the product that they are selling is YOU (to their advertisers.)

The structure of CNBC is to keep you on the edge of your seat. To keep you dependent on them for information on what to do next. They want you to live in fear and react to every little hiccup in the market. The ugly truth is that by the time any news hits CNBC, you, as an individual investor, is far behind the eight ball.

Market timing is nearly impossible. It may be blindingly obvious in hindsight, but at that very moment, even the good lord Brahma cannot tell you whether something has bottomed or topped.

How can you predict where the NIFTY is going to be in a year’s time when cannot even state with certainty that are you are not going to be hit by a truck while crossing the road?

How many of their “experts” are actually accountable to you? How many times have you heard anyone of them say “I don’t know” as an answer to a question?

Does knowing what the CEO had for lunch that day make you an expert in that company?

Does it matter what Ganesha predicts?

Watch CNBC for entertainment value, not for investment advice.

Categories

Thoughts on Inertia

It’s always easier to do nothing (new).

Change is difficult to start.

Fear of making a decision > Benefit of making a decision.

The strong desire to keep things the same.

Listening to the same advice from the same people telling you the same things.

 

Categories