Wednesday, December 30, 2009

Capital Prudence

One gauge for management which is often overlooked is how they manage the firm’s capital. Do they see the firm’s equity and cash on its balance sheet as valuable resources that belong to the shareholders and think twice about doing funny things with them? Well most management will do funny things when given the chance.

We look at 4 aspects of what crappy management will do:

1. Dilution

Most management couldn’t care less about diluting shareholders’ stake bcos they get the much coveted capital to cover up their mistakes. In Singapore, dumb retail investors actually rejoice when management wants to do rights issue: bcos they can get more shares at a cheaper price! The irony!
When management comes cap in hand to shareholders for money, multiple times in a span of a few years, run for the trees! This is one of the most unforgivable management mistakes.

2. Aggressive Capex

Beware of management that always announce huge expansion projects in the name of growth. Especially, when they are done at the top of the cycle. Most of these projects will not recoup its capital fast enough ie ROI is very low, like maybe 3% (ie 33 years to recoup the investment).

A good management should always be prudent with capex, expanding slowing at a regular pace and keeping expansion cost low.

3. M&A

This is a double edge sword. Some management are very good at M&A and can actually help to grow the company through M&A, however the fact is 70% of all M&A fails (ie 1+1 less than 2). If the management is always looking to do M&A, esp in unrelated fields, beware!

4. Cash Hoarding

Some great companies have such beautiful business models that the companies just overflow with cash as time goes by. You see companies with cash to market cap of 30-50% bcos the business just keeps churning money!

The management mistake then becomes how they keep hoarding the cash and not putting it into good use: like giving back to shareholders. Most management would say that they need the cash for expansion ie doing 2 or 3 stated above. Which destroys shareholders’ value.

Buffett sometimes just buy over the whole firm and dictate that whatever cash that is generated goes to the parent co: Berkshire Hathaway. This is the ultimate trick!

Thursday, December 17, 2009

On Bad Management

Basically, bad management doesn’t have the shareholders in mind. Or if the bad management is the majority shareholder, they don’t have other shareholders’ interest in mind. Their policy is about “Screw You and I Get My Bonus” or “I Win, You Lose”.

On bad management, CK Tang’s recent saga definitely comes to mind. It’s a long story that probably deserves a book trilogy starting with the great CK Tang himself, who built a solid business based on virtues like good customer service, treating employees well etc. His business approach was a very traditional, fundamental approach that sadly had lost its touch in today’s Singapore.

The poor management began shortly after his death some 10 years ago perhaps. Over the past 10-15 years, CK Tang had been able to deliver annual sales of S$160-220mn sadly without very significant growth. Singapore’s GDP has probably doubled in that span of time.

The story for profits is even worse. Net income was negative for the most part with some years losing as much as S$40-50mn. The company did not pay dividend for the most part of the past 10 years and kept throwing money into wasteful ventures, like new CK Tang outlets in KL, Vivocity etc.

If the story had ended here, we are not in a position to scold management too much. Well, admittedly, the world has changed. Department store was a good concept in the 80s and early 90s. High quality lifestyle products all under one roof and brands fight for space in the stores. But the retail scene had since evolved, with brands like LV, Nike, Jimmy Choo having their own stores. And shopping at dept stores wasn’t trendy anymore. People preferred shopping malls, specialty stores and newer stuff.

CK Tang’s management was of course unable to stop this global change. But what was unforgivable was their attempt to take the company private at ridiculously low prices (well that’s subjective, let’s see my argument first ok?). They attempted thrice. During the first two tries, the minority shareholders screwed them by refusing to let go. On the third try, the no. of shareholders that agreed to sell hit the minimum no. and the co. was taken private. Well most people gave up after 10 years I guess.

The co. was taken private at a price of roughly S$200mn. This is lower than what CK has as its equity of S$220mn. Of course CK Tang paid only S$20-40mn to buy out the remaining 10-20% of shareholders. Official valuation of the land that CK Tang has in Orchard Road was about S$340mn (last done some time back). Based on $1200psf - a value that I think represents fair value for property in Singapore, the property alone is worth S$190mn, ie CK Tang’s management thinks that its department store business is worth nothing and they are paying the minority shareholders $1200psf for their portion of the Orchard Road land. Btw, Orchard Road land is now going for $2000psf or is it $3000? Geez I can’t even keep up with the no.s.

So the land value that CK Tang has on its books could be easily more than half a billion if today’s prices were used, or if the land was redeveloped. Basically, the minority shareholders got taken out at a cheap price.

Of course, CK Tang maintains that there is no plan to redevelop its Orchard Road flagship, they think what they paid the minority shareholders is fair. It would be really interesting to see if they announce plans for redevelopment in the future. Then it would confirm that they were all-out to screw shareholders all along.

In my opinion, CK Tang is a complete dud as a shareholder entity. Even as a consumer, I would think twice shopping at CK Tang after seeing that is how management treats people. It IS a good thing that it’s gonna get delisted and hopefully never file for listing again.

Tuesday, December 01, 2009

If you don’t know the jewellery...

Buffett lives by a few simple rules throughout his life. He has acquired them over the years and found them to be useful rules to live by. He and his partner Charlie Munger believes in such simple logic. Charlie Munger used to say that there are really just a few big ideas in life. There are no secrets to become rich, or to be successful, or to be whatever you want to be. The so-called secrets are simply ideas/rules that we know so well but we fail to apply them. Or our emotions overrule our logic and deter us from applying them rationally. The simple rules are like these listed below:

1. Early bird catches the worm
2. Live within your means
3. Bang for your buck, value for money, go for bargain
4. Keep things simple stupid
5. Be fearful when others are greedy

So today, we look at a similar one that Buffett came up with: “If you don’t know the jewellery, at least know the jeweller”. The idea behind is really simple. You must know that the management of the company is good and trust them to do the right thing. You may not know whether you are really buying a real gem or a useless piece of rock at the jewellery store, but if you know that the jeweller is honest, wants to help you whole-heartedly, (unfortunately no such retailer exist in Singapore, ALL retailers are out to screw the customer), well then perhaps you can trust him to select a good gem for you.

Buffett doesn’t know everything about businesses. He admits that he doesn’t know nuts about technology. But the good thing is Buffett has perhaps mastered the art of sizing people up. He has been meeting people for over 50 years, for goodness. Well some times he screws up (like maybe Salomon Brothers…), but most of the time, he meets up with people in the top management, gets to know them and if they are up to the mark, he trusts them to make the right decisions for shareholders.

This is perhaps the major reason why he bought BYD, the Chinese battery maker. He probably placed two layers of trust here. Trusting Mid American Energy to know enough about BYD to buy a stake. And trusting BYD’s management as well. Apparently he flew to China to meet the CEO, now the richest man in China, and was very impressed. He definitely know nuts about batteries and technology, so it’s really about knowing the jeweller.

In stock analysis, we always like to look at financial ratios like ROE, operating cash flow, margins, balance sheet strength etc. It’s quite no a brainer once you know a thing or two about financial statement and just divided one no. by another. The insight here is actually thinking about who made those no.s? Ultimately, it’s the people in the business. The top management, middle managers in the company and the company staff.

Company ABC’s average ROE for the past 5 years is 15%, therefore we can expect it to be 15% as well when the economy recovers. Or we can expect it to grow to 20% bcos they have a new product, or perhaps the industry average is 20%, so they should make 20% in time. Well, only if the top management has the leadership, determination and drive to make that happen. People make the numbers. Superior management made the 15% ROE and have the capability to bring it higher. Crappy management cook the books. And there's a lot of crappy management around.

But as small time retail investors, how do we get to know management well enough? Yes it’s difficult. It is true that retail investors may not access management from meeting them, talking to them directly, but we can still judge by their actions, their business plans and get to meet them during AGMs. Sometimes, things get so blatant that any Tom, Dick or Harry investor would stay 500 miles away from stinky management.

It takes a while (like a few years) to gather information about managements of listed companies and also experience to determine if what the management did was good for the shareholders. This means to read beyond what our "high quality" press media reports, decipher the news in the context free of any hidden agenda.