06 December, 2010

Hope after the nightmare

Investing in a stock like Mahindra Satyam requires a strong stomach. But there are long-term rewards.

When the Satyam scandal broke out in January, 2009, it stunned everyone. The scandal that was done with allegedly active collusion and participation from several senior functionaries, made investors quite jittery. Even external auditors were not able to find the frauds committed. This is a major problem for shareholders, who are not involved in the direct running of the company.


However, in every misfortune, some will always win. For instance, when there is an earthquake and houses are destroyed, builders and cement companies will benefit immensely. Similarly, when there is turmoil, there are those who would be willing to take the risk, for the chance of a windfall profit. But for that, they need to have a very high risk appetite.

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KEEP A HAWK’S EYE ON:

* The impact of a scandal on the company’s financials
* The commitment of the management to turmoil resolution
* If the company is professionally managed and transparent
* If the company has opened up communication channels with employees, stockholders and customers
* Legal cases and the impact. Getting stuck in a financial suit has the capability to cripple the company
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Warren Buffet, the legendary investor, poured in billions at the height of gloom in 2008. Earlier this year, he purchased 77 per cent of Burlington Northern railroad for about $26 billion, when the economy was not in a very good shape. That is a real long-term bet, in vintage Buffett style. He is willing to wait decades to get returns from his investment. It is all about value.

Similarly, when a company is in doldrums due to a scandal, the intrinsic value will typically fall below its fair value. There is bound to be bad press, which will depress the prices and create tremendous gloom around the company. This is fertile hunting ground for the intrepid investor. However, a savvy investor would invest after due diligence.

GETTING IT RIGHT
What does a savvy investor do? How does he assess whether a company in the midst of a scandal is worth investing in?

One of the prime things to evaluate is whether the scandal is so large as to destabilise the company itself. If it is, the risks are very high indeed. The second thing to look at is the response from the A-team in the company– they would be required to hold fort and steer the company clear from the storm. A committed A-team, is a positive aspect. Here, depth of management becomes critical. Owner-driven companies may have shallow structures and pose major questions about the recovery. There are even more questions if the main owner is implicated, as in the Satyam scandal.

The third thing to look for is the intention of the team to sort the problem and their resolve to come clean and tidy the situation. Here, communication plays a major role. A good team will open channels of communication with employees, shareholders, customers and other stakeholders and clearly inform them about the steps being taken to resolve the crisis. The fourth thing to look at is the nature of charges against the company or the management and the extent of monetary damage. In such situations, there is potential for a plethora of legal cases, which can cripple the company. This, by itself, is a major determinant of whether a company will be able to stand up ever again or not. This assessment could be tricky.

If a new management is brought in, which has credibility, it is to be seen as an extremely positive step. A credible management will re-infuse confidence all round and give the company the chance to stand up again. If there is a move to protect the brand by the new management, it is an entirely positive move. Towards this end, the management might delink the scandal and its perpetrators from the brand, through skillful communication. Ultimately, the brand persona is invaluable and is what enables sale of products and services.

ESSENTIALS
Keeping the flock of clients intact is a challenge for battered firms. However, appropriate interventions and proper communication which isolate the criminal act and delinks it from what the company otherwise stands for, as also seeking their support and co-operation, will be positive for the company. This will help in retaining clients. Similarly, acquiring new clients could be a challenge and the management’s effectiveness in combating the problem will come to the fore in how well they do this.

Employees with deep understanding and experience are an asset for any organisation. It is important that the current employees are retained and their fears assuaged. If successful, this will be one of the greatest positives and give the company its best chance at revival.

An investor who wants to benefit from the huge plunge in share prices in a tainted company has to be hawk-eyed and needs to look at all these parameters before coming to a conclusion and then decide if the company is worth investing in. Admittedly, this is not everyone's cup of tea. There are huge risks involved. The potential for returns is also enormous, if the call turns out right. It could be a multi-bagger overtime, as such companies would be typically available at a deep discount to their intrinsic value.

Published in Business Standard on 3/10/2010

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