Neeraj Monga: India Is An Immature Market
Designation: Head of Research, Veritas Investment Research
Education: MBA, Richard Ivey School of Business, Canada
Career: Investment research at Veritas since 2000 after spending one year with Bain & Company as a consultant
Q. Your recent report on RCom was called ‘House of Cards’, the one on UB Group was called ‘Pie in the Sky’, on RIL and RCom, ‘Brothers in Arms’, and on DLF, ‘A Crumbling Edifice’. Is there an underlying connection between these names?
A. We would like our report titles to outline essentially the entire thesis of the report and tell a reader instantly what to expect. We hold an annual contest for the best research report title to promote exactly this.
Q. In your latest report you say “don’t believe” in either RCom’s book equity or asset base. Why?
A. In our estimate, their book equity includes gains of roughly Rs 22,000 crore made by revaluating assets that have been passed through subsidiary companies controlled by the same management. Instead, what is important in the market is the underlying cash flow of a company.
When the Supreme Court recently cancelled some of RCom’s licences, together with many others’, the company wrote off the receivables against their reserves. But prior to that, they had been taking the EBITDA earnings [earnings before interest, taxes, depreciation, and amortisation] from the same business to their P&L.
Another item from their financial statements talks about an advance of Rs 950 crore to a vendor who subsequently failed to deliver, and [which] had to be written off as a loss. But if such a large amount being advanced and written off were true, where are the details of the suppliers, the reasons and lawsuits?
The other issue we have with RCom owes blame partly to Indian accounting standards. Take the case of organisations that have raised debt abroad to fund their operations. Now with the depreciation of the Indian rupee against the US dollar, companies should normally be booking losses on their P&L accounts on their foreign debts. Instead, Indian standards allow them to value their own assets at a higher rate. Which means that suddenly you find a company in telecom valuing, say, its base stations at Rs 10,000 crore instead of the Rs 5000 crore they were worth earlier, to reflect the change in the dollar-rupee rates. But the reality is telecom assets start devaluing the moment you purchase them!
Q. You’ve also said RCom should’ve declared a loss of $288 million in 2012 instead of a profit of $166 million. How does one even make sense of such variations?
A. My advice for laypeople is to simply not invest in Indian equity market. Don’t pay any attention to media channels that focus on equity. Building and accumulating wealth comes from diligence over time.
Q. What is the “governance discount” you apply to a company’s valuation? Why is RCom’s governance discount 50 percent?
A. RCom has around Rs 7,000 crore of loans and advances on its books as assets. But everybody knows this company is highly indebted. So why don’t they deleverage by selling these loans and assets? What is the guarantee these aren’t equally fictitious like the Rs 950 crore advance which later became a loss?
Given such a track record, we wanted to apply a ‘governance discount’ to the company. Now whether that should be 50 percent or 25 percent could be a matter of debate. In fact, my next report will say that valuation is entirely irrelevant.
Q. Do you see Veritas as a disruptive force in the analyst sector?
A. We’ve been in the business for 11 years and in Canada, where we’re headquartered, we’ve been clearly disruptive.
When we write a report there that is critical of a company, people do take notice and managements go out of their way to ensure that our concerns are addressed to both investors and us.
It appears to me that India specifically is an immature market that is run as a personal fiefdom of a few corporate groups. As you dig deeper, you realise financial statements are very unreliable. Most private businesses are run on a very thin sliver or equity, with financial institutions providing loans, yet not doing enough due diligence or raising tough questions.
Most debt covenants are a function of net equity, instead of cash or EBITDA generating capacity. So many companies have a holding company structure where they move assets from company A to company B to company C. It’s like you reselling your own house to yourself, saying it’s worth more each year.