Neeraj Monga: India Is An Immature Market

Neeraj Monga
Age: 40
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.

It’s no secret that on any ratings on governance, corruption or transparency, India ranks very low.

Clearly, it is the entire socio-economic character of the country that comes under the scanner. Now it stands to reason corporations are also run by the same people, so there’s no reason to believe that corporations will be better than the rest of Indian society.

When we started in India, we said we’ll lead a revolution. In a market like India, with hundreds of brokers fighting for business, there is no way to stand out except by writing hard-hitting reports.

Since then many other research institutions are coming up with hard-hitting reports. I believe we’ve opened the floodgates.

Q. What is the business or revenue model that allows you to do so?
A. Currently we are marketing our research only in Hong Kong and Singapore, both being places where a lot of India’s foreign capital comes from. We’re gaining traction there even as we get hundreds of queries from India. The queries are mostly from retail investors and some institutional firms who want it free of cost.

For instance with RCom, we had many special requests from international investors because it interests multiple stakeholders—Chinese banks that have lent it money; Barclays and HSBC who have significant exposure; PE funds who are considering buying a stake; equipment vendors.

Still, it’s difficult to market IP in India but we’re hoping that as our business scales up, it will become incumbent upon Indian money managers to subscribe to our research.

Q. Which are the top three countries around the world where you see the potential for ‘research arbitrage’, so to speak? Why?
A. I would think they are China and India for sure. Brazil has a language problem because of Portuguese, while Russia is primarily an oil and gas story driven by macro view on commodities.

Q. There are a few research analysts/firms that have stood out in the past few years. There’s Muddy Waters, Bronte Capital, Andrew Left of Citron Research, Rick Pearson—all of them of the short seller variety. Then there’s Horace Dediu of Asymco, who seems to spot fantastic insights buried within public filings of companies like Apple, Nokia and Microsoft. Where does Veritas fit in?
A. We want to write the best bottoms-up and fundamental research. We do this by looking through accounting to understand normalised operating procedures and governance structures to see if there is siphoning of funds.

I knew short sellers are considered bad but that is a misconception. Short sellers just believe a company is overvalued. Also remember, the downside of a buy is often limited, but the downside of a short is nearly unlimited. Hence, by definition, short sellers are better informed and come with more defensible opinions and better homework. But Indian organisations, of course, like to call all negative stories as being driven by short sellers, using boilerplate language created by their PR agencies.

Q. Do you think the stock market is mispricing or giving higher valuations for some companies because they are effective liars? Why?
A. Now valuations in general in India may be higher because of higher growth prospects. But often it’s because people are not looking at fundamentals. It appears that opinion here is formed based on some “technical analysts” in the media who spew stuff like “buy or sell with stop loss” and have a view on a new stock almost every day. There’s no control on them front-running or proprietary trading.

If you read some of the news stories in India, it appears people believe that just because an organisation is big and its management is in the media, it must be worth investing in. They place a lot of faith in print and TV journalism assuming that if it’s on TV, then it must be true. But if that were the case, then the stock market should be touching 50,000.

Q. What are the three most effective ways you’ve spotted companies use to get higher stock market valuations?
A.(1) Hiding losses in subsidiary companies without consolidating.
(2) Not accounting for expenses on the P&L but writing off through reserves.
(3) Undertaking related party deals to inflate sales and profits.

Q. What is the valuation metrics you rely on most to conclude upon a company’s true valuation?
A. Valuation is more an art than a science. We read financial statements to understand what managements are saying and if it tallies with what they’re reporting. If not, then why not? Our reports take time, sometimes up to three months. They’re not two-page releases with the company logo.

Q. How important are the promoter’s background or information not found in the balance sheets?
A. Not important at all. We only look at what companies are reporting. And if something is not documented, then it’s just hearsay. Using that would open us to unnecessary criticism.