Monday, May 29, 2006

One billionaire's pudding is another's poison

Wonderful article ...

One billionaire's pudding is another's poison

Manali Rohinesh, | May 29, 2006

Managing Partner at TCI New Horizon Fund, Madhav Bhatkuly went to the London School of Economics, LSE, to beef up on the many theories that abound in the field of financial economics.

But he was always intending to come back to India because something here had caught his interest. It was the way the stock market works - the intricacy and the mechanism and the beauty of it appealed to him.

Inspiration & motivation

But another source who lit the fire within him about the stock market was his best friend's father, who was then the chairman of Citigroup. Bhatkuly told CNBC-TV18, "I had a close friend and his father used to be the chairman of Citigroup at that time and he used to lecture at the stock exchange, virtually after every budget. So I was chatting with his son one day and his father was preparing for the budget speech and I asked what is this? He said that I am going to talk about the stock market and the implication of the budget."

He recalled, "So I asked him what is the stock market and how does it really function? So he said if you want to be a part of a very big, successful and famous company but you don't have the money to own it, and you want to own just a small part to be part of the story, then the stock market is the place to go. And actually, in many ways that was the defining moment. It first got me interested, that here was an opportunity to be a part of history or a part of success."

At the LSE, he majored in derivative products. The entire field was new back then so he didn't have many textbooks to study from except the one written by Fischer Black & Myron Scholes, which had come out just a few years before he graduated.

He was lucky enough to study original research. But when he got back to India, he realised that all those theories he studied were of little use. It was really experience that counted.

He began his career with ICICI, which was purely a project finance institution at that time. Madhav recalled, "I was busy going to greenfield project sites and doing spreadsheets and cash-flow analysis on Lotus (software).

"But it was an extraordinary experience. That gave me insight into corporate India and helped and shaped me as an analyst. I think that job really taught me or gave me the bridge between everything that I had learned in theory and the real world - of what drives earnings models and businesses and also to work with entrepreneurs, which I think has actually contributed to the process of investing today."

Investing principles

He doesn't believe that investors reach a magical circle of competence, as supposed by some. But investing is a process of trial and error, just like everything else. He said, "I think with experience and consistently just simply going out and doing the job, you begin to understand some things naturally better than somebody else."

After all, even the billionaires of the world have not made their money following any one holy grail. Benjamin Graham has been quoted telling Warren Buffett, "Warren the money won't make a damn difference to you and I, our wives might just live a little better!"

All the same, some of these successful investors have followed their own path to riches. Warren Buffett has never invested outside the US. On the other hand, Sir John Templeton wanted to go out and buy the entire Indonesian Stock Exchange, the very first time he felt bullish about Indonesia!

George Soros keeps it simple - he buys when the price is not right and sells when it is - the very essence of stock market trading. So, each of these men are rolling in money but have all arrived at it, in their own individual style.

So which style does Madhav call his own? He explained, "If I have to identify myself with one particular approach, at heart I would call myself a value investor. But value can mean different things. Is it prospective value? Is it enduring value? Is it value based on history etc. I spent most of my early career or the last few years as well, in small cap stocks, where perhaps the market efficiencies were higher and maybe because they were illiquid or for whatever other reasons."

Evaluating businesses

He looks at different valuation methods for different businesses. For instance, if it's utility, he may use the discounted cash-flow method but for anything else, he might use a different concept.

He added, "But along with that, it was also important to understand leadership in the business in its entirety. And what I looked for primarily was whether there was hunger enough to inspire that CEO to want to make it into a bigger business. Also, was there a cogent strategy and more often than not if you meet a lot of business leaders, you will find that some of the best or the most successful leaders are very well put together in their thoughts."

Also managements which spend time in execution of strategic visions is what makes "the

difference between a good idea and a successful one." Madhav also believes in getting his facts and figures cross-checked with the mid-level managements of companies.

He explained, "It is important to visit second and third-line managements across the company. To first of all understand whether you were receiving the same soundbytes as you would hear from the top. But more importantly, were there processes. Was there enough in terms of execution capability and deliverable action points built into the system itself."

According to him, Sun Pharmaceuticals and Godrej Consumer Products are two companies, which demonstrated his belief in executing strategies and that had processes in place for doing so.

Indian stories

Analysts need to be able to spot what's going to provide a margin of safety with regard to every stock their looking at. It could be prospective earnings or absolute assets. He spotted this safety point in the shares of Oriental Bank of Commerce, OBC, when it was in the red and was burdened wth NPAs that were not serviced.

He elaborated, "We were the first foreign investors in OBC, at roughly about Rs 55 a share. It went through a terrible period as a result of which it had accumulated non-performing loans in excess if 9 per cent.

"But two years prior to that, there was a change in leadership. There was a new leader who had cleaned the processes. So as a result of, which the company had begun to have a shift towards identification and greater disclosure.

"We also found that interest rates in India had fallen so much, that OBC had 41 per cent of it's book in Indian government bonds or treasuries, and that the unrealised gains on the securities portfolio was greater than the market cap.

"This meant good news - that it could have wiped off the NPAs in one shot! So the margin of safety was very clearly visible."

He found absolutely great value waiting to be unlocked in United Breweries. He reiterated, "I think United Breweries is a very good example of startling value. The company went through two phases.

"One, when it was a consolidated entity and it had non-core assets including 40 per cent holding in McDowell as well as huge real estate holdings. So there was huge value which could be harvested at some point of time."

He added, "If you look at or dissect the management of the business in two facets - corporate governance and market leadership. They have delivered dramatically on market leadership, I mean, here was a company which clearly knew what to do in the market place, Kingfisher made up 40 per cent of the Indian beer market for several years and eventually went up to 50 per cent. Kingfisher as a standalone brand was 27 per cent of India's beer market. So obviously the company knew what to do in the marketplace but it wasn't translating that into profits."

Spotted deals

"When we first looked at just the beer business, we spent a lot of time figuring out what normalized earnings would be because the company had no profits. So what was the intrinsic worth of those profits?

"For that we looked at a company in Sri Lanka called Lion Beer, which was a Carlsberg's joint venture in Sri Lanka. We were just trying to do a little bit of analysis in terms of the dynamics and what the costing was and we figured that the margin of safety was very large and there was an opportunity here."