Sunday, 31 July 2011

Abolish DCF models in circulars

Discounted Cash Flow analysis is a method to value a company (or project or asset), I refer to WikiPedia:

I read an interesting post: on "Where Is Ze Moola":

DCF can lead to large mistakes

I 100% agree with his conclusions. If small changes in parameters lead to big differences in the outcome then one should take the results with a (large!) grain of salt. I think that predicting the future 10 years out is anyhow madness, whichever model is used. I think may be the only possible useful application for DCF is when one wants to compare two similar companies with each other.

As an "angel" investor I receive regularly Business Plan where profits are projected in the area of USD 50 million 5 years out, and we did not invest in them .... apparently we think the projections are "slightly" unrealistic. We did invest in some of them, but even if they "only" reach 1/10th of their forecast in Year 5 we would already be very, very happy. To be frank, I don't even pay attention to them at all, I just look how realistic the forecasts are for the first 2 years until the company is cash flow positive (which is already a major feat).

One of my Corporate Governance recommendations is to do away with the "independent" reports, since they are not independent at all: "whose bread I eat, his song I sing". I challenge the authorities (Securities Commission and Bursa Malaysia) to prove me wrong, to give the statistics how many times the "independent" reports did not follow the Majority Shareholders. I can only remember one single case out of many dozens. That alone already proves how unbelievable biased these reports are, and thus how useless they are (actually, they are worse, they are doing real damage to the Minority Investors).

In brochures where the DCF model is used the underlying assumptions are never revealed. Thus, the minority shareholders can never check or challenge the outcome. And since the reports are so biased, one can safely assume that the DCF valuations are also very much biased.

Which leads me to the following recommendations:
  • Do away with all "independent" reports: they are very biased
  • Do away with DCF valuations in all circulars: small changes lead to big differences making them very unreliable
  • If (unfortunately) DCF models are still used, at least provide the underlying assumptions so that it can be checked how reasonable they are

Saturday, 30 July 2011

Warren Buffet and Charley Munger

Two of my favorite investors are Warren Buffet and Charlie Munger, the managers of Berkshire Hathaway:

Wikipedia: Warren_Buffett
Wikipedia: Charlie_Munger

Buffett, "The Oracle of Omaha" is the more gently one of the two, hardly speaks bad about others, preferring a metaphor instead. Munger is the one who says it as he sees it, he can be very blunt, for that I like him. These are two extremely clever, fast thinking and experienced investors with very good memories for who I have the highest regard. For a long time, their wages have been USD 100,000 per year, they hoped that would be an example for other corporations, unfortunately, it wasn't.

Faithful investors who bought BRK-A shares a long time ago will have been ample rewarded:

Yahoo longterm chart BRK-A

When Buffett bought into the company, the shares was going for around USD 20, not it is trading for USD 111,000.

But, even they can make mistakes. They didn't really see the financial crisis of 2007/8 coming, they had too many investments in financials. Also, their most likely heir to Berkshire Hathaway was David Sokol, who is involved in an ugly scandal, which has the appearance of "front running": buying privately shares of Lubrizol, and then recommending the company to Buffett with the intention of buying over the whole company.

Many books have been written about Buffett, my favorite is: "The Snowball, Warren Buffett and the business of Life" by Alice Schroeder. This book contains almost 1,000 pages and gives a very realistic picture of Buffett's live, so realistic that Buffett was not to pleased with the end result.

More interesting information in the following blog:

My favorite book about Munger is not available in bookstores, it can only be bought on the internet (there is also a version in Chinese):

The Annual year reports with wisdom from the two:

Jeff Matthews with information about the AGM of Berkshire:

Unsatisfactory handling of complaints by SC/BM

After the damage has been done (the RPT deal went through), SC/BM will look into possible complaints. My experience is that these investigations will go nowhere, I haven’t heard of a single complaint by a Minority Investor ever being approved. Normally SC/BM will drag their feet for a long time (often a few years), stonewalling the Minority Investor, changing the manager in charge many times and then answer with a one line reply that no rule has been breached. No reason will be given, no transparency at all. Investigations have to be conducted confidentially, this is of course correct, but SC/BM is abusing this rule very much. For instance there is no reason whatsoever not to reveal publicly available information why a complaint or argument is not valid. If somebody provides detailed information which rules are broken, then the SC/BM should be able to counter these arguments without breaking the confidentiality of the research. It is extremely disappointing (to say the least) to spend a huge amount of time writing a complaint with all the information gathered, doing all the work for the SC/BM, coming up with large amounts of supporting documents and then to be treated like this. Unfortunately, I have never heard of a different experience. SC/BM has a (very) bad image and most retail investors don’t even bother anymore to file a complaint with them, is my experience.
I can see the following reasons for the highly unethical and unacceptable behaviour of SC/BM:
(a)    SC and BM might be pressured not to take action. For a long time there was suspicion regarding legal matters. Since the publication of the Lingam tape I think no person will have doubts anymore about what might be going on.
(b)    SC and BM are not actually pressured in certain cases but think they are and act accordingly. This is an argument that is often brought forward to explain curious verdicts of judges that make no sense at all. The previous Chairman of the SC was (when he retired) asked by a journalist if he had instructions from above not to take action in certain corporate cases. The Chairmen said he wasn’t. Unfortunately, during his tenure the SC didn’t solve any major case (except of course for the usual illegal future trader and ticking off some small corporate players) although he inherited a huge amount of very large cheating cases of the 1997/98 crisis. Nobody dared to say that the Emperor was wearing no Clothes.
(c)    SC and BM have already approved certain parts in the process, to agree with a complaint means admitting that they made mistakes in the past. Organisations that “police” their own actions will hardly ever take any action against their own people and the SC/BM seems to be no exception. There is really a need for an organisation totally independent from SC/BM to look into these cases.
(d)    It is the "lazy" alternative, it means the manager doesn’t have to make investigations, interviews, research etc. Since the SC/BM doesn’t give any insight in on-going investigations (in itself understandable, but it is easily abused) and the SC/BM never gives any reason for its rejection, it can never be accused of making a mistake in the reason given. No transparency at all of course, but nobody seems to care.
(e)  It has become the norm, for 20 years SC/BM have toed the line, why change?
(f)   The personnel of SC/BM is simply not (always) up to the task and are not able to counter the army of fancy, well-paid advisors the Majority Investor has hired to defend his case. If this is the case, SC/BM should be allowed to use external advisors, but that would mean admitting that SC/BM is not up to the task and that will not be easy.
In my posting about recommendations I came with the following suggestions:
  • A small, fast moving, high-powered, totally independent commission to be formed, which will look at complaints (besides other issues).
  • The top management of SC and BM should make it very clear to all their employees that in the cases of GO’s and RPT’s Minority Investors have clearly the benefit of the doubt, not Majority Investors.
  • All complaints (except very rare, difficult cases) should be handled well within one year, with quarterly updates. A final answer will be provided containing information publicly available.
  • In general, SC and BM really should genuinely start to reach out to retail investors, bloggers etc, they can provide useful insights in corporate affairs, since they are putting their money where their mouth is. There are about 1,000 listed companies, much too much for SC and BM to keep tabs on.
All comments, feedback etc is welcome and appreciated, as usual.

    Friday, 29 July 2011

    RPT's: why do all protective layers fail?

    Related Party Transactions (RPT’s) in Malaysia have a horrible reputation, and for a very good reason, in the large majority of the cases overpriced assets are sold by the Majority Investor to the company it controls for pure cash. Security Commission and/or Bursa Malaysia should therefore be extra alert from the moment that the intention is announced and make sure that all is fair and square. Unfortunately, this is simply not the case.
    It is very important to note that the rules regarding RPT’s are actually in favour of the Minority Investor:
    “fair and equal treatment of all shareholders, in particular, minority shareholders”
    In other words, if there is any doubt, the Minority Investor should be favoured. This rule could and should have been used many times by SC/BM, in my opinion it has never been used, puzzling, to say the least. Why is the SC/BM so biased?
    There are many layers to protect Minority Shareholders, but many horrific cases of RPT’s have still been pushed through, in other words all layers of protection have failed in spectacular fashion. This is in itself is puzzling, and I would strongly advise an independent group to study this in detail.
    The procedure for RPTs is as follows:
    (a)    Directors of a company decide about the RPT: in theory, directors who are not related should decide about the merits of the deal, since it is a related party deal. In practice, there will be a huge amount of pressure on them to toe the line. SC means it well by giving education to directors, asking for a certain quota of independent directors, limiting them to a maximum number of years, etc, in practice it will all not matter for these really big deals. Even Warren Buffet admitted (when he was director) that the pressure to follow is just too big (for instance when Coca Cola used a much too aggressive way of accounting). In Malaysia I have never witnessed any opposition against any plan by Independent Directors. In two cases (the infamous UEM/Renong and the Maruichi deal), 2 directors resigned. In both cases, that was a sign that things were indeed very wrong, and things went downhill from there. Apparently, that is as far as a director can go in Malaysia, and it is very rare.
    (b)   Company announces a RPT, SC and BM can start doing their work: Unfortunately, already in this very important phase often huge errors are made. SC/BM should be very pro-active, insisting on a large amount of relevant information. For instance, if the last audited account is more than say 6 months ago, SC/BM should insist on a set of new audited accounts. At this moment SC/BM should be alert on valuations, and if necessary insist on second opinions.
    (c)    Company sends circular to SC/BM for approval: SC/BM has approved many circulars that were of dreadful quality (I will come with clear examples): which information is withheld, which opinions are unrealistic, which valuations are completely off, which rules were broken, etc, etc, etc. It is my experience that SC and BM focus much too much on form instead of on substance. The fact that these circulars are approved is very important, if from now any complaint by Minority Investors would be sustained against the circular, it would mean that SC/BM has not done its work properly. That is often the case, but to admit that is something else. From now onwards there is no way back anymore, Minority Investors will have no realistic chance at all is my experience and they still haven’t been involved at all.
    (d)   Circular is send to Minority Investors: Although Majority Investors have many months to prepare their circular as much in their favour as possible, minority shareholders are very much hurried into doing their own research and making their decision. Often the time available is about ten days (sometimes even less, depending when one receives the circular by post). The only chance to try to stop the process is to hurriedly file a complaint to SC/BM, to try to get some attention from the media (in practice only The Edge will publish critical letters in English is my experience) and to hope that MSWG is interested to fight the case (in my two examples, Barmada and Maybulk/POSH they weren't). In reality, it is a sheer impossible task, the odds are hugely stacked against the Minority Investors and the clock is ticking.
    (e)    Attached to the Circular is a report by an “independent” advisor: “Independent” reports are not worth the paper they are written on. They always follow the opinion of the Majority Investor (I remember having seen exactly one exception to this rule, besides some irrelevant ones where a company did a General Offer which was below the market price), and because of that alone they should be immediately abolished since they are so clearly biased and the effect is very negative. Majority Investors who want to push through their deals can fall back on the recommendation of the “Independent” report. It also gives a reason to EPF/PNB to follow suit and vote accordingly to the advice. Why do “Independent” advisors follow the Majority Investor? In my opinion, they hope that in the future they will get another corporate deal. They won’t get one from the Minority Investors, so the choice is simple. There might be other, more sinister reasons though, they might for instance be pressured by certain parties to follow the Majority Investor’s opinion. There is zero doubt in my mind that these “Independent” reports should be abolished as quickly as possible. They simply don’t work, and very much decrease the chances of Minority Investors for justice instead of increase.
    (f)     SC/BM could stop the EGM: In reality, I have never seen an example of this. I have zero doubt in my mind that in the Maybulk/POSH case the circular was so biased that the SC immediately should have stopped the EGM. They didn’t, and that is puzzling, what were the motives of the SC?
    (g)    At the EGM Majority Investor will abstain from voting: Although the Majority Investors abstain, related parties might still be able to vote. There is hardly any transparency and the BM is not exactly pro-active. I have never heard of another party being barred from voting. Related parties being able to vote will reduce the chances of the Minority Investors very much.
    (h)    Minority Investors will vote: Unfortunately for the Minority Investors, given the huge odds against them, the misinformation they received in the circular, the hugely biased “Independent” Report, they can hardly expect to win the vote, especially since EPF/PNB will most likely follow the Majority Investor. EPF/PNB are completely not transparent in their actions (although they should be, managing other people’s money), in my opinion they have carried the vote for the Majority Investor in many (if not all) cases. I also fear that they are often (perceived to be) pressured to vote in the way they do.
    Given the above, I have given some clear recommendations to change the whole procedure for RPT's, since the current one simply doesn't work at all.

    Wednesday, 27 July 2011

    Enforcement is the problem, not the rules

    There are about 200 countries in the world:

    • Ranked by GDP, landmass, population, trade etc Malaysia will be somewhere in the 15th to 40th spot, in the first quarter, a very good position to be in.
    • From a CG point of view (or regarding the quality of the judiciary, police etc.) Malaysia definitely deserves to be in the second quarter of the country list.
    A (very) disturbing disconnect between the two.

    Malaysia always had an excellent set of laws and rules, but enforcement without fear and favor has been very disappointing, to say the least. Other statistics have also not been good, Malaysia’s FDI (once clearly outstripping China’s) has fallen sharply, hundreds of thousands of Malaysians have recently left the country (this number might be very much understated) and the number of expats has been decreasing. Some time ago you could not open a book or magazine about emerging markets and Malaysia would be prominently featured. The last few years I have seen the same kind of books and magazines, and Malaysia wasn’t even mentioned one time. Malaysia once formed 30% of the emerging markets index, currently it is reduced to 3%. For international investors, Malaysia has become a more or less irrelevant country. In the 1997/98 crisis, many companies lost huge amounts of money due to mismanagement or outright fraud, my guess that the total amount of damage is around RM 100,000,000,000. This represented real money from the shareholders and it would have enabled the companies to grow substantially into a multi fold by now. SC and BM had their work cut out for them, but failed completely.
    SC, BM and (indirectly) EPF/PNB (EPF, PNB, LTAT, ValueCap, Khazanah Nasional, Bank Pembangunan Malaysia Berhad etc.) have done a bad job in the last 20 years and Minority Investors rights have been trampled upon. Proof of this is that not a single high profile corporate leader has ever been convicted of a prison sentence. Also, for a Minority Investor it is simply impossible to win a case against a Majority Investor. The few convictions of high profile corporate leaders that have occurred (for instance Tiah & Soh for Omega Securities, receiving a RM 3 million and RM 6 million fine when the total damage was 100 times larger) were more of an encouragement than a deterrent for future bad behavior.

    The Corporate Governance Blueprint 2011 (CGB) more or less assumes that bad CG practices have to do with the rules. I dare to object to this view: the rules have always been good (although they can be improved here or there), the issue has always been enforcement (or rather, the lack of it). Paying a lot of attention to the rules is dangerous since it could be used by certain parties as an excuse for the past.
    The CGB also doesn’t take into account the very disappointing role played by SC/BM, and possible (perceived) pressure applied on SC/BM, “Independent” valuers, EPF/PNB and the MSWG to take certain actions. In Malaysia these possibilities are unfortunately very well possible.
    In my opinion, there needs to be first some sort of retrospection, cleaning and healing before retail and institutional investors will even consider coming back in droves to the Malaysian share market.

    Recommendation 1: that the following 4 steps will be taken with the results of each step to be made public:
    ·         A truly independent group of experts will do research on the worst cases of the corporate misdeeds of listed companies in the last 20 years

    ·         An evaluation of all that has been wrong, plus the rather dubious role that SC and BM played in it (why have they so seldom taken any action and never against a high profile corporate leader?)

    ·         A constructive, detailed plan of action to right the wrongs

    ·         A clear commitment towards this plan for a better future, to prevent it from happening again
    Needless to say, there will be pain for some involved, but for the good of Malaysia in the long run, I strongly believe this is the right path. How can we ever improve if we are not investigating what went wrong in the first place?

    Recommendation 2: don’t be hypocrite, instead be humble.
    Everybody can hire a PR agency who will write a glossy brochure full with beautiful sentences how well they have done. The SC and BM have done a really bad job in enforcement the last 20 years, both have let the country down hugely causing a long lasting negative effect. Therefore the SC and BM should show much more humility in their brochures, in their speeches and on their website about what has actually been achieved regarding CG matters, there is absolutely nothing to be proud of.

    The last few years, under the current Chairman of the SC, some progress has been booked. A few low profile corporate leaders are caught, clearly more than before, but still never a high profile one. The improvements came however from an unbelievable low base (actually from no base, the previous two Chairmen who held office during and after the crisis of 1997/98 had absolutely nothing to show for), and have been much too slow, a clear case of too little, too late. Also, since 1998 the recessions in Malaysia have been relatively mild, if there would be a large recession comparable to 1997/98 then the number of corporate misdeeds will rise very strongly. SC and BM will (again) not be ready to take appropriate and fast action, Minority Investors will again be hugely disadvantaged.
    EPF, PNB, LTAT, Khazanah Nasional etc, are all in my opinion part of the problem, not off the solution, they had their chance in the last 20 years and they blew it. They could have voted against proposals that hurt Minority Investors, they could have been vocal, they could have been transparent, they could have tried to rally the Minority Investors for just causes, they chose not to do so. These mammoth organizations should change drastically and open up to public scrutiny.


    • Immediately abolish all “Independent” Reports, they are useless and are even hurting the rights if the Minority Investors.
    • All the votes that EPF/PNB are making should be made public, I think everybody is entitled to that, since they are managing public's money.
    • If major shareholders abstain (like in RPT's), EPF/PNB will “voluntarily” also abstain from voting, letting the small shareholders (who put their money where their mouth is) and the private fund managers (who want to optimize long term performance) decide if the proposed deal should go through or not. I think this rule will hugely increase the chance of success for Minority Investors, and will thus be very beneficial for the investing ecosystem. Majority Investors will now have to convince the small investors and the fund managers, so they better come with a decent deal. This rule prevents the possibility that EPF/PNB would vote a certain way, while under pressure.
    • All voting on important resolutions like RPT’s should be made public.
    • Do away with DCF (Discounted Cash Flow) valuations, the minority shareholders never receive the details so they cannot check the validity of the calculations.
    • Bursa Malaysia (BM) will pro-actively check if certain shareholders are linked to the Majority Investor and bar them from voting. In reality, I doubt if this will work well, but at least an attempt should be made.
    • There have only been three really good events in the last 15 years regarding CG in the Malaysian share market: quarterly reporting, the Bursa Malaysia announcements website and The Edge Malaysia. Some quarters want to abolish quarterly reporting. It would be extremely detrimental to give in to these parties, Minority Investors desperately need all the information they can lay their hand on, having had the short end of the stick for so long. Many frauds would have been earlier detected if the SC paid as much attention to the quarterly reports as certain bloggers did, “Where is Ze Moola” is the best of these and was proven right many times. His most famous prediction was the events surrounding Megan Media, a company clouded in controversy: a suspicious RPT, insider selling, suspicious quarterly accounts, fraud detected, much too light sentences for the directors. One blogger can unearth many suspicious cases while the SC with is hundreds of full-time employees, its fancy office building, expensive computer systems and most importantly its special investigative powers can’t? The SC should be ashamed of its performance.
    • A small, special, fast moving, high-powered commission should be formed, completely independent from any other institute. The members will be highly motivated professionals (accountants, lawyers, financial analysts), not to be recruited from employees of SC or BM. This commission will receive all complaints send to SC/BM, they can chose which ones to follow up. Their recommendations to take action will have to be implemented by SC/BM. The advantage is that they will also look into complaints about SC/BM, and being independent they actually can take action. They are also able to spot the usual stonewalling and delaying tactics of complaints from Minority Investors by SC/BM and immediately take action.
    • Minority Investors should receive more time to investigate important issues like RPT’s or GO’s with delisting threat. They will also be able to complain directly to the special commission about possible Minority Investor abuse.
    • The rules regarding GO’s with delist threat and RPT’s have always been very clear, especially Minority Investors should not be disadvantaged, SC/BM should (when in doubt) always give preference to the Minority Investors, not to the Majority Investor as they have done so far. Majority Investors can perfectly take care of themselves, SC/BM don’t have to worry about them, as they have always don’t in the past. The top management of SC and BM should make it very clear to all their employees that in the cases of GO’s and RPT’s Minority Investors have clearly the benefit of the doubt, not Majority Investors.
    • MSWG started disappointedly, it had initially something good going with the new CEO but the momentum has been mostly lost. I think it has to be re-organized, their ties with EPF/PNB will have to be cut (EPF/PNB are part of the problem, not the solution). They can try to follow the example of other, successful watchdog groups (for instance SIAS from Singapore or VEB from The Netherlands) and be much more pro-active and independent. They can also learn from individuals like David Webb from Hong Kong, a highly regarded, extremely sharp fighter for Minority Investors rights who has yet to be proven wrong. To protect MSWG they should have immunity from prosecution (they have been sued before). They can organize joint cases when Minority Investors have been abused and drum up support. They should start to build up a large community of retail investors by hugely increasing its membership. Lots of information from MSWG should be available for free, instead of the current high prices.
    • Make all AGM’s and EGM’s open for all journalists, including from the alternative news providers like MalaysiaKini. In some countries this is normal, journalists can simply report about sharp issues brought forward by Minority Investors but can’t ask questions themselves, unless allowed by the board to do so.
    • SC/BM will make checklists of information that is absolutely necessary in circulars, like timely audited accounts, purpose of investments, sales pipeline, forecasts, DCF projections including the basic data they are based on, etc. Valuations and assumptions will be checked on reasonableness, with special attention to the usual accounting tricks that are used in these occasions (“hard” cash against “soft” values, GAAP, comparable way is misused, etc). SC/BM should very much shape up in this field, until now it has been so disappointing. If necessary, they should get input from outside their organizations and ask the help of credible, independent advisors.
    • SC/BM will have to hugely improve their relationship with Minority Investors, no more stonewalling when Minority Investors come with genuine issues. I have never heard of any retail investor with a positive story about their contacts with either SC or BM, it is really about time that action is taken if the authorities are serious about wooing back the retail investors. According to the website of SC, they will follow-up every quarter on complaints. I haven’t seen a single proof of that actually being done. I think the idea of regular updates is good (also by BM) and should be followed. In principle (except very exceptional cases which should be communicated clearly to the complainant) all complaints should be handled well within one year. The current practice of complaints dragging on for years is simply unacceptable. If Minority Investors come with genuine complaints and offer to come to the SC to offer more information, they should be heard, SC should be interested in this extra information that could be worthwhile. It is about time that finally Minority Investors are taken seriously by SC and BM and are treated with respect.