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Getting cheated

By Rohit Chauhan
In Uncategorized
March 26, 2009
3 Min read
24 comments
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I am mad ! very very mad. See this news item on novartis india.

Novartis AG has announced an open offer for Rs 351 per share with the aim of taking their shareholding to 90%. Although they have not stated any plans for delisting, I think once the shareholding reaches 90%, delisting norms could kick in and the rest of the shareholders will be forced to exit the company.

Why am I mad ? See my analysis of novartis here. My conservative estimate of the intrinsic value is around 600-650 (company has a cash of almost 150 rs/ share). Look at it this way – Net of cash, the buy back offer is valuing the company at 800 crs. This is for a company making almost 100 Crs of profit on a capital base of around 30-40 Crs !!

Another view point – The buyback offer will cost the company around 440 Crs. The company has cash and equivalents of around 435 Crs as of december 2008. So the Parent company will be able to increase its holding to 90% without spending a penny from their pocket !!

Should I feel cheated ? May be not. I have known this modus operandi for some time. A lot of MNC’s have cheated their minority shareholders this way. The steps are as follows

– Allow the performance of the company to stagnate for a few years by avoiding product launches and anything else which enhances value
– Hold all the surplus cash during this time period.
– Wait for a bear market to drive your price down to very low levels.
– Announce an open offer at premium to current price, utilising the cash holding
– Try to mask this operation as a shareholder friendly operation by pointing out that the price is at premium to the current price (which is way below intrinsic value).

I have known and written the above earlier on my blog. I have however chosen to ignore my own advice though and would now be paying for it. At the current price, net of dividends, I have made modest returns. However that is not the point – The point is being treated fairly by the management of your company.

Another case – Ingersoll rand : They have announced their intention of coming out with an open offer too. I am not holding my breath on that as they have tried a similar tatic in the past, but were not successful in completing the buyback.

Lesson for me : Management matters more than i would like to accept. A good business with bad management will translate to poor returns.

What next ?
I am going to wait and watch how this open offer will play out. However even if the minority shareholders reject it, don’t expect the management to change or mend their ways. They will continue to ignore the minority shareholder, give poor dividends and will continue to accumulate cash. The best startegy in such a case would be to exit the stock and deploy the capital somewhere else.

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A few thoughts on other instruments

By Rohit Chauhan
In Uncategorized
March 23, 2009
2 Min read
6 comments
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I received the following comment from Raj. I am posting my response via a post. Please feel free to share your comments

Hi Rohit/Everybody,
Can we include below mentioned financial instruments in personal finance and short comments (how easy they are for new investors, who should dabble with them, pros/cons) on them:
A) Commodities
B) Gold
C) Debt instruments
D) Derivatives (options etc.)

Commodities – An easy one for me. I have zilch idea about it. Due to my mindset (value investing, looking at intrinsic value etc), I have not been able to figure out a way to invest rationally in commodities. It does not mean commodities are bad or anything. I just find them outside my scope of competence and would not recommend a new investor to dabble big time in commodities.

Gold – A subset of the above. However I am baised against gold and am a contrarian on gold. The reason for all this excitement on gold is more due to the price run up in the recent past. Look at this chart . Over the past 20+ years, gold has barely doubled giving a return of 3.5% per annum with the entire return coming over the past 5 years. Unless you have some special insight into the demand supply scenario of gold over the next few years, I would not invest in gold based on what others are saying.

Debt instruments – my thoughts on the same here

Derivatives – A short cut to ruin if you don’t know what you are doing. I have personally started looking at these instruments and am currently in the learning phase. I am currently reading and investing in these instruments in a very small way. The idea for me is to test and learn over the next few years before I increase my commitment. This is same approach I adopted when I started investing a decade ago – learn and invest small so that early mistakes are not fatal to your networth and self confidence.

I personally consider derivatives, complex and not an easy way to make money. The upside may be high, but at the same time the risk is high (due to the inherent leverage in these instruments) especially if you are new to investing and have just started out.

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Evaluating various personal finance schemes

By Rohit Chauhan
In Non-equity assets, Uncategorized
March 20, 2009
2 Min read
5 comments
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I typically don’t write much on personal finance. The key reason is that it does not hold much interest for me and does not challenge me. After you have spent 1-2 years reading on investing, evaluating a scheme is quick and easy. In addition, there are a lot of other blogs and magazines which do a better job of explaining personal finance for the lay investor.

Let me a list a few criteria I use to arrive at a decision on any personal finance instrument

– What has been the performance of the instrument in the past? If this is a new instrument of scheme avoid
– Has the instrument or scheme out performed a benchmark? If it is related to equity, has it outperformed the index for the last 3-5 years. If not, avoid
– What are the costs involved ? what is the expense ratio, sales load, exit loads etc. The total of all costs should not exceed 2% (typical of most open ended mututal funds which in itself is too high). If the expenses per annum exceed 2%, avoid
– What is the lock in period ? I typically avoid products with lockin periods. Product with high lockin periods do not necessarily perform better than open ended product. They just tie your money up and you can lose flexibility if the performance is poor
– What is the kind paperwork involved ? can I do it online ? I personally hate paperwork and have no interest in running to the bank to fill up forms and fill up paperwork every year.

I finally don’t care what is pedigree of the fund house or whether the fund or instrument is from a reputed bank or AMC. In addition I don’t care if the name sounds good or the sales person is a cute looking girl. I will open up my wallet only if the instrument meets my criterias listed above.

Finally you can see this post where I have listed how I select equity based funds. As you can see, it is not complicated to decide on a personal finance instrument. Most of the times, I don’t bother to look for one and tend to buy mutual funds, stocks or ETFs online directly.

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Why unit linked plans are a bad idea ?

By Rohit Chauhan
In Mutual funds, Uncategorized
March 17, 2009
4 Min read
14 comments
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I recently visited icici and HDFC bank for some personal work and some of the sales folks at these branches went into a sales pitch, pushing their respective unit linked plans. These unit linked plans are a combination of an Insurance policy and mutual funds. The key highlights of these plans are

Highlights
– An annual ‘premium’ payment towards the plan for around 15 years.
– An option to pick from a range of 100% equity to 100% debt plans
– If the primary holder passes away, the nominee get the insurance amount in addition to the accumulated value of the mutual fund component (varies by plan)
– A max total insurance cover of around 12.5 lacs even if the annual premium exceeds 2.5 lacs
– 40% premium charge in year 1, 30% charge in year 2 and 2% thereafter.
– A plethora of other charges some of which are not very clear unless you dig further such as mortality charge, admin charge etc
– A 1.25% fund management charge

Now these sales folks are well intentioned and all that. But frankly my initial feeling was that anything this complicated and convoluted cannot be very good. Lets look at some math

For ex : I invest 2.5 lacs per annum for 15 years in a 100% equity option. So around 1.75lacs are deducted in year 1 and 2 combined and around 5000 rs per annum thereafter. The rest would be invested in a mutual fund of choice.

The insurance component

Lets look at the insurance component first. A pure risk policy (which is what the above is) is currently priced at around 4000-6000 p.a premium for a duration of 15 years. So clearly the insurance component is overpriced.

There is a bumper component which is paid at the end of the policy term which equates 70-80% of the premium. If you look at it in another way, this equals the 70% you pay upfront at the start of the policy.

So in a nutshell, the company is taking 70-80% of the annual premium from you and holding it interest free for 15 years. At an interest rate of around 9% per annum that is 3.6 times your annual premium !!

The 2% annual deduction would get you a similar pure risk policy with all the attendant benefits including tax deductions.

Mutual fund component

Lets look at the mutual funds component – Nothing special here. The company is taking 60% of your premium in yr 1, 70% in year 2 and 90% in yr 3 and onwards and investing it on your behalf for 15 years. At the end of 15 years, you redeem based on the NAV then.

What are the negatives here ?
– For starters my money could be locked for 15 years – a big negative if the performance turns out to be poor.
– The brochures, which I have seen show very average performance for all the concerned funds (most of them, barely beating the index before charges and actually underperforming the index after the fund management fees).
– A plethora of charges I noted earlier, get deducted from the mutual fund component. There is not much clarity in the brochures on the quantum of total charges, but I don’t expect it be less than 1% of the total (maybe more).

Conclusion
A pretty bad investment option. The insurance component is way overpriced !!. The mutual fund component has nothing special in it and has a load of charges attached to it, which will reduce your returns substantially in the long run. I will not be surprised if the banks are getting a hefty commission or good fee from these kind of plans.

My initial feel was that anything this convuluted and complex is a nice way for the bank or AMC to make good money off the fees and leave the investor with poor returns

Recommendations
Buy a low cost pure risk policy for the insurance cover. These policies do not pay anything if you survive ( A happy outcome !! as I have survived) and have a very low premium. For the mutual fund component invest in a low cost index fund or ETF or a decent mutual fund (if you can find one).
Finally, buy something nice for yourself or your spouse/friend with the money you save and send me a gift for saving you this money (just kidding !)

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