Here is another great piece of news that will make all those people happy who believe in the India story and its continuity:
News Item Begins:
Aeon Retail wants slice of Indian retail pie?
India's great retail rush continues and it’s not just the western giants like Wal-Mart and Carrefour but even East Asian retailers want a slice of the Indian retail pie. The Japan’s largest retailer, Aeon, wants to start operations in India reports CNBC-TV18.
With Japan’s consumers buying less and less in the last few years and Japanese businesses consequently almost stagnating. It’s not surprising that Japan’s biggest retailer wants to head to India. Aeon Retail, a conglomerate of 157 companies with sales of USD 37 billion dollars in fiscal year 2006 has recently conducted its due diligence on the Indian market. Japanese trade experts also tell us the company is now in the process of identifying a local joint venture partner for its Indian retail foray.
News Item Ends:
It’s a great news, because that shows how well the Indian markets are targeted and are very successful in attracting foreign investments not only from the Western giants but now also from the Eastern counterparts like Japan. Chinese products are already making waves in the Indian markets, though a bit unofficially and in an unorganized manner. Japanese retail giant now seeks to enter Indian market and have already conducted lots of studies and surveys in India, so as to formulate an efficient strategy to invest.
However, the most important point that we people fail to notice in the above news item is copied below:
With Japan’s consumers buying less and less in the last few years and Japanese businesses consequently almost stagnating. It’s not surprising that Japan’s biggest retailer wants to head to India.
Now, the interesting point to observe is that we are talking about the business of basic necessities of life, which is the primary stuff the retail stores sell. The news item says that Japan’s consumers are buying less and less. Can there be a slowdown in demands of such products? Well, that the case we have noticed here.
Secondly, we are talking about Japan, which is considered to be one of the top three economies of the world. (I guess Japan is placed 2nd, immediately after the 1st ranked US). With such a large economic value, Japanese consumers are buying less and less over the last few years, which is forcing the largest retail investor of Japan to look overseas.
It is strikingly unbelievable, that in one of the world largest economies, consumers are spending less, so less that giant investors have to head to other countries for investments and maintain profits from their business. Strange, unbelievable, but VERY TRUE.
The news item extends further:
Aeon, which operates some of Japan’s most popular retail chains like Jusco and Topvalu, last year, also acquired the management rights for French retailer Carrefour. But business for the company hasn't been too good and profits in the last four years have been more or less flat with over ninety percent of revenues for the company coming from Japan. Aeon has in the last few years started retail operations in countries like Malaysia, Thailand, Hong Kong, China and Taiwan and India, say sources, is next.
The company we are talking about is not a small company. It has influential presence in a large number of countries. It has the power to buy management rights of French giant retailer Carrefour. Yet, it is being beaten up in its home country, a country which is one of the largest economies of the world.
Size does not matter when it comes to investment and company management. There is no guarantee that a strategy today works tomorrow, a success story in one place can continue in another place as well.
People who still believe that the 8, 9 or 10% growth rate of India is fuelled by all the sectors like IT, Retail, Real Estate, Banking, Telecom, etc., once again I would like to remind that you all may be right in your belief for an uncertain period of time. But if you go to the crux of the issue, it all boils down to the high level of salaries that are being offered by software jobs - The jobs which pay high salary because of foreign inflows in dollars, pounds and euros and which enables people to have enough disposable income.
The more competitive a sector gets, the more risk is there for the investors of the stocks in that sector, because the more chances are there that company profits and performance may be hit by the competitors. Let’s keep a vigil on our investments, play safe and not make highly ambitious and impractical assumptions that the success story will continue forever.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Friday 31 August 2007
Wednesday 29 August 2007
M&A: Balance sheet number game continues at TATA-Corus
It’s time to have a look at the benefits of Mergers and acquisitions in terms of financial results. How companies utilize the benefits of takeover through M&A.
Yesterday, Tata Steel announced a fabulous set of numbers for their financial results. They claim to have a six fold jump in their consolidated profits with Corus which was reported to be 6,388 Crore Rs. as against 1,014 Crores in the same period last fiscal.
Here is the report from NDTV: http://www.ndtvprofit.com/homepage/storybusinessnew.asp?id=40315&template=&cache=8/29/2007%201:55:36%20PM
NEWS ITEM STARTS:
NDTV Correspondent
Wednesday, August 29, 2007 (Mumbai):
The acquisition of Corus helped Tata Steel post a six-fold jump in its consolidated profit after tax at Rs 6,388 crore for Q1FY08.
The Indian company, which is now the world's sixth-biggest maker of the alloy, had recorded a consolidated profit after tax of Rs 1,014 crore in the same period last fiscal.
Tata Steel had acquired Corus for $12.1 billion in early 2007. The acquisition catapulted the company to the sixth spot among the world's top steel players with total production capacity of over 23 million tons a year.
Turnover on a consolidated basis also registered five-fold jump to touch Rs 31,155 crore during the period under review as against Rs 5,748 crore during the previous corresponding period.
Consolidated operating profit increased to Rs 4,904 crore during Q1FY08 as against Rs 1,712 crore in the corresponding period of previous year.
The results also include extraordinary item of Rs 4,121 crore primarily representing actuarial gains due to increase in the yield rates on Bonds held by various pension funds of Corus.
The markets took note of the development and the stock at Rs 644 levels firmed up 6.4 per cent or Rs 38 in noon deals on Wednesday. (with PTI inputs)
NEWS ITEM ENDS:
The company has shown excellent growth - the numbers say it all. The takeover of Corus has given it great positive synergy to report a 6 times jump in profits. Excellent news item, but why has the market responded with only a 6.4% increase in the share price? Actually, the above news item was written during mid-day, at the close of market, the stock price had jumped by 9%.
In terms of percentage, the income has grown by 500% or 6 times. In terms of market price of the share, the increase is only 9%. Why is it that such a good news of 6 fold increase in profits did not take the stock price to a very high level? 500% profit translating to only a 9% increase in share price? Does not make sense to me.
The reasons for only a 9% increase are multiple.
Have a look at the orange color text in the news item above. “The result numbers also include extraordinary item of Rs 4,121 crore primarily representing actuarial gains due to increase in the yield rates on Bonds held by various pension funds of Corus.”
What the company is trying to put forth is the UNREALIZED gains it has made on bond holdings of pension fund of the employees. Pension fund is the right of the employee, the company only manages it. The companies in Europe have a legal responsibility to manage the pension fund for employee, though the fund money actually belongs to the employee. Hence, the gains shown in the company profit do not actually belong to it.
Secondly, they are actuarial gains, unrealized profits on bonds held for pension funds. If they can make profits today, can’t they be in loss tomorrow?
Thirdly, what exchange rate has the company considered for Euro to Rupee exchange? No details are mentioned, which again may be a case of doubt. A few basis point here and there make a big difference in the forex amount.
Let’s deduct the 4121 Crore from the reported profit of 6388, all we get is 2267. On the previous fiscal profit of 1014, it is a 123% or a 2.23 times jump, and not the actual reported jump of 6 times.
Another reason that we should note is that this stock has been hammered severely in the last 1 month. Here is a 3 month price graph from Yahoo finance.
It clearly shows that Tata Steel has lost from the highs of 725 to the lows of 540, which is a clear loss of 26%, that too within a month. What this stock has done yesterday is only made up partly for its 1 month long losses and not necessarily made a profit of 9% in one day.
Yesterday, the market has gone up considerably. The news of good earnings, atleast 2.23 times actual profits, also had the market sentiments in it, so that led the rally of 9% surge in share price. If we get into fine details of 2.23 times profit, there is a chance that the actual profits may not even be 2.23 times.
However, market price have been going up, though only to the extent of 9%. Nobody knows when the prices will take a U turn.
This was just a practical demonstration of how balance sheet and financial figures are utilized for showing profits and good results.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Yesterday, Tata Steel announced a fabulous set of numbers for their financial results. They claim to have a six fold jump in their consolidated profits with Corus which was reported to be 6,388 Crore Rs. as against 1,014 Crores in the same period last fiscal.
Here is the report from NDTV: http://www.ndtvprofit.com/homepage/storybusinessnew.asp?id=40315&template=&cache=8/29/2007%201:55:36%20PM
NEWS ITEM STARTS:
NDTV Correspondent
Wednesday, August 29, 2007 (Mumbai):
The acquisition of Corus helped Tata Steel post a six-fold jump in its consolidated profit after tax at Rs 6,388 crore for Q1FY08.
The Indian company, which is now the world's sixth-biggest maker of the alloy, had recorded a consolidated profit after tax of Rs 1,014 crore in the same period last fiscal.
Tata Steel had acquired Corus for $12.1 billion in early 2007. The acquisition catapulted the company to the sixth spot among the world's top steel players with total production capacity of over 23 million tons a year.
Turnover on a consolidated basis also registered five-fold jump to touch Rs 31,155 crore during the period under review as against Rs 5,748 crore during the previous corresponding period.
Consolidated operating profit increased to Rs 4,904 crore during Q1FY08 as against Rs 1,712 crore in the corresponding period of previous year.
The results also include extraordinary item of Rs 4,121 crore primarily representing actuarial gains due to increase in the yield rates on Bonds held by various pension funds of Corus.
The markets took note of the development and the stock at Rs 644 levels firmed up 6.4 per cent or Rs 38 in noon deals on Wednesday. (with PTI inputs)
NEWS ITEM ENDS:
The company has shown excellent growth - the numbers say it all. The takeover of Corus has given it great positive synergy to report a 6 times jump in profits. Excellent news item, but why has the market responded with only a 6.4% increase in the share price? Actually, the above news item was written during mid-day, at the close of market, the stock price had jumped by 9%.
In terms of percentage, the income has grown by 500% or 6 times. In terms of market price of the share, the increase is only 9%. Why is it that such a good news of 6 fold increase in profits did not take the stock price to a very high level? 500% profit translating to only a 9% increase in share price? Does not make sense to me.
The reasons for only a 9% increase are multiple.
Have a look at the orange color text in the news item above. “The result numbers also include extraordinary item of Rs 4,121 crore primarily representing actuarial gains due to increase in the yield rates on Bonds held by various pension funds of Corus.”
What the company is trying to put forth is the UNREALIZED gains it has made on bond holdings of pension fund of the employees. Pension fund is the right of the employee, the company only manages it. The companies in Europe have a legal responsibility to manage the pension fund for employee, though the fund money actually belongs to the employee. Hence, the gains shown in the company profit do not actually belong to it.
Secondly, they are actuarial gains, unrealized profits on bonds held for pension funds. If they can make profits today, can’t they be in loss tomorrow?
Thirdly, what exchange rate has the company considered for Euro to Rupee exchange? No details are mentioned, which again may be a case of doubt. A few basis point here and there make a big difference in the forex amount.
Let’s deduct the 4121 Crore from the reported profit of 6388, all we get is 2267. On the previous fiscal profit of 1014, it is a 123% or a 2.23 times jump, and not the actual reported jump of 6 times.
Another reason that we should note is that this stock has been hammered severely in the last 1 month. Here is a 3 month price graph from Yahoo finance.
It clearly shows that Tata Steel has lost from the highs of 725 to the lows of 540, which is a clear loss of 26%, that too within a month. What this stock has done yesterday is only made up partly for its 1 month long losses and not necessarily made a profit of 9% in one day.
Yesterday, the market has gone up considerably. The news of good earnings, atleast 2.23 times actual profits, also had the market sentiments in it, so that led the rally of 9% surge in share price. If we get into fine details of 2.23 times profit, there is a chance that the actual profits may not even be 2.23 times.
However, market price have been going up, though only to the extent of 9%. Nobody knows when the prices will take a U turn.
This was just a practical demonstration of how balance sheet and financial figures are utilized for showing profits and good results.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Mutual Fund commission related feedback to SEBI
Bhupesh has left an important piece of information regarding the feedback from individual investors to SEBI, for its proposal on waiving off the entry load charges and distribution costs if mutual fund units are directly bought by the investor from the fund management company.
I believe this is an important piece of information and should be placed as an article, because readers usually don’t read all the comments on the past articles.
Thanks Bhupesh for contributing this. Please keep up the good work!
Information from Bhupesh follows:
SEBI is also asking comments from public upon their "Proposal on waiver of load for direct applications in Mutual Fund schemes". Which can be sent @ ruchic@sebi.gov.in.
Probably you should include this information in your article so that people who feel strong in favor of this proposal can send comments to this id.
-----------
I want share what I have sent to SEBI.
-----------
I vote for this proposal.
1) It will help people switching (penalise) under performing schemes.
2) It will promote brokers to provide 2.5% commission worth of services.
3) It will make Mutual Fund more favorable mode of investment.
4) It will improve productivity in distribution/advertising.
If there are some charges even for direct investing with AMC, It
should not be more then ..
1) Lowest % amount charged from an investor.
( e.g. Nil if a Mutual fund house charge nil entry
load for investment over 5 Cr.)
2) Maximum of ( [50% of
( e.g. If normal entry load is 2.5% , ( Max [1.25,
1.5]) = 1.5%)
( e.g. If normal entry load is 1.5% , ( Max [0.75,
0.5]) = 0.75%)
I do my research my self where to invest ? how mutual fund have done
in past and what are the current holding of the fund etc .. . I
always used to feel disheartened while giving 2.5 % commission to
broker for channeling my form to Mutual Fund house. They also do not
provide good service of collecting redemption slip.
-----
End of Info from Bhupesh
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Mutual Funds increase exit loads
Some more bad news for the mutual fund investors – major mutual funds are hiking the exit loads on the most popular funds. The proposal from SEBI regarding slashing the entry load has just caused a panic in the mutual fund industry. Mutual Funds have now revised the load structure at the exit point.
As per the news:
Reliance Mutual Fund, Birla Sunlife Mutual Fund and Franklin Templeton Mutual Fund have increased the exit load in as many as six of their equity schemes.
Exit load is the amount of commission you have to pay when you decide to take your money back from the mutual fund you have invested in. For an example, if you invested 10,000 in a mutual fund, and after 3 years it has grown to 12,000 and you decide to take back your money at these levels, you will have to pay exit load on your maturity money. If the exit load is 2%, then 2% of 12,000 = 240 Rs. will be deducted from your maturity money of 12,000 and you will receive only 11,760 as the final amount.
Exit load is typically the 'desirable' kind of load, as mentioned by the fund industry “experts”. They claim that EXIT LOAD acts as a ‘restriction’ to the MF investors, and high exit loads will force the investors to keep the money invested in the fund for long term.
Now think about this: You give your money to mutual fund managers, they invest your money (basically gamble on random things called stocks), they don’t promise you any returns for sure, they take the charges from you for you giving them your money (sometimes annually, sometimes monthly) and now, they want to increase the charges so as to force you not to take back YOUR money from them.
Sometimes, the reasoning stated by the so-called investment industry experts just makes me believe that it is really a world full of monkeys.
Investments are made with the point of view of getting financial freedom. Why and how can a fund manager dictate to me about how and when should I enter and exit in his fund (causing monetary losses in terms of loads), is something that I cannot digest.
I am getting a feeling that even if SEBI’s proposal of slashing the entry load goes through and is enforced, the mutual fund industry will end up coming up with some or the other fancy nomenclature for taking commission from the investor in the name of professional money management.
Prasad has rightly left a comment on my previous post on SEBI’s proposal, mentioning that he has a SIP plan for investing in a scheme. The SIP investment is automatically done through ECS or Electronic clearing system. So though the broker or agent is not involved in the process at all, he still ends up paying the “distribution commission”.
Considering all these (possible) developments and problems, the only way out for the investor is to keep away from the Mutual Funds. Customer is the king! If the majority of the customers decide to say no to a product, there is no way it can be sold. Filing a lawsuit or PIL in the court may take ages for things to get resolved. Best way for people who want to have efficient investment and better money management is to say no to such products, if they believe that these products are doing no good to their money. Be that product be Mutual Fund, Insurance Policy, ULIP, Index Fund or ETF. Each time I exit from a product after I discover that it is not good, I make sure that I write a letter to the company concerned and clearly state the reason why I am exiting from the product. I also send a copy of that letter to SEBI/IRDA or other regulatory authorities. I know that it is something like wasting time, effort and energy, but I don’t see anything wrong in letting people and authorities know what I believe if I have a genuine reason and data to prove my point.
I know readers are desperately waiting for my articles on Derivatives. I want to borrow some more time because explaining derivatives require a lot of figures and diagrams. Preparing them on a computer is a tough task. My job does not allow me to prepare articles fulltime. I’ll start posting the articles once I have am ready with the minimal set to begin with.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
As per the news:
Reliance Mutual Fund, Birla Sunlife Mutual Fund and Franklin Templeton Mutual Fund have increased the exit load in as many as six of their equity schemes.
Exit load is the amount of commission you have to pay when you decide to take your money back from the mutual fund you have invested in. For an example, if you invested 10,000 in a mutual fund, and after 3 years it has grown to 12,000 and you decide to take back your money at these levels, you will have to pay exit load on your maturity money. If the exit load is 2%, then 2% of 12,000 = 240 Rs. will be deducted from your maturity money of 12,000 and you will receive only 11,760 as the final amount.
Exit load is typically the 'desirable' kind of load, as mentioned by the fund industry “experts”. They claim that EXIT LOAD acts as a ‘restriction’ to the MF investors, and high exit loads will force the investors to keep the money invested in the fund for long term.
Now think about this: You give your money to mutual fund managers, they invest your money (basically gamble on random things called stocks), they don’t promise you any returns for sure, they take the charges from you for you giving them your money (sometimes annually, sometimes monthly) and now, they want to increase the charges so as to force you not to take back YOUR money from them.
Sometimes, the reasoning stated by the so-called investment industry experts just makes me believe that it is really a world full of monkeys.
Investments are made with the point of view of getting financial freedom. Why and how can a fund manager dictate to me about how and when should I enter and exit in his fund (causing monetary losses in terms of loads), is something that I cannot digest.
I am getting a feeling that even if SEBI’s proposal of slashing the entry load goes through and is enforced, the mutual fund industry will end up coming up with some or the other fancy nomenclature for taking commission from the investor in the name of professional money management.
Prasad has rightly left a comment on my previous post on SEBI’s proposal, mentioning that he has a SIP plan for investing in a scheme. The SIP investment is automatically done through ECS or Electronic clearing system. So though the broker or agent is not involved in the process at all, he still ends up paying the “distribution commission”.
Considering all these (possible) developments and problems, the only way out for the investor is to keep away from the Mutual Funds. Customer is the king! If the majority of the customers decide to say no to a product, there is no way it can be sold. Filing a lawsuit or PIL in the court may take ages for things to get resolved. Best way for people who want to have efficient investment and better money management is to say no to such products, if they believe that these products are doing no good to their money. Be that product be Mutual Fund, Insurance Policy, ULIP, Index Fund or ETF. Each time I exit from a product after I discover that it is not good, I make sure that I write a letter to the company concerned and clearly state the reason why I am exiting from the product. I also send a copy of that letter to SEBI/IRDA or other regulatory authorities. I know that it is something like wasting time, effort and energy, but I don’t see anything wrong in letting people and authorities know what I believe if I have a genuine reason and data to prove my point.
I know readers are desperately waiting for my articles on Derivatives. I want to borrow some more time because explaining derivatives require a lot of figures and diagrams. Preparing them on a computer is a tough task. My job does not allow me to prepare articles fulltime. I’ll start posting the articles once I have am ready with the minimal set to begin with.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Tuesday 28 August 2007
Google mixup with Reliance Salary advantage fund
It was a pleasant surprise for me to notice that the Google has ranked my blog on the Reliance Salary Advantage Fund better than the official website of Reliance Mutual Fund :-)
May be a temporary goof-up due to the spiders of Google! But yeah, it's better that people get the independent reviews along with the official details :-)
May be a temporary goof-up due to the spiders of Google! But yeah, it's better that people get the independent reviews along with the official details :-)
Monday 27 August 2007
Mutual Funds –Distribution Cost Cutoff suggestion
A more recent and POSITIVE development that has taken place is in the mutual fund industry. SEBI has offered a suggestion to all the mutual fund houses that they should insist on selling the mutual funds directly to the public, instead of going through distributors or better known as “agents”.
SEBI suggests that Mutual Funds charge the customers with almost 2.25% charges in the name of Distribution Costs. This charge is used to pay to the various distributors and agents who help the mutual fund company to sell mutual fund products to the common public. SEBI suggests that Mutual Funds and asset management companies should insist on selling the units directly to the customer through the online website or advising potential customers to buy it from them by visiting their office. SEBI’s suggestion says that the 2.25% charge should NOT be taken from such customers, who are buying the mutual fund products directly from the company, either online or by visiting their office, as there are no agents or distributors involved. Distribution Charge should be taken only from customers who buy through a distributor or an agent.
Here are some facts about the distributor and agent business in India for selling of such financial products:
• 98% of the money for sale of any Mutual Fund or ULIP scheme is collected through distributors and agents
• That means only 2% of the customers actually buy the product directly from the company
• 2% of the above customers are the ones which are themselves other mutual funds or investment firms who invest into a particular product in big amounts and hence save on charges by directly buying it from the asset management company or fund house
No wonder that the entire mutual fund industry has criticized this suggestion from SEBI in one voice. If they adopt to the suggestion from SEBI, it would mean that the distributors will loose the business within no time. More and more of the customers are now using online transactions for banking and trading. They can as well do the same for buying mutual funds.
The distributors are giving the following reason for not liking the idea from SEBI: “since 98% of the business is routed through distributors and agents, the elimination of distribution cost will mean that mutual funds will not get enough customers. This will hamper the investment business in India”
However, the fact is that the investment business in India will grow better and more number of investors will start considering investing in Mutual Funds, if the administrative charges and commissions are reduced. People like me, who are averse to mutual fund investments because a significant portion of money goes into commissions, as explained in my article: Should you trust your mutual fund manager?, will also start considering investmenting in mutual funds.
The above statement from distributors is nothing but a useless reason because they will be out of business very soon.
On the other hand, the fund managers and mutual fund companies dislike the idea because of the following reason: “We will have to invest heavily on having online system to buy and redeem mutual funds and other products. Moreover, we will have to hire and train our staff who could talk and sell to the customers directly. Having it through the distributors helps manage things better”.
Again, yet another vague reason. Almost all of the mutual fund companies have a toll-free number where one can call and get all the details of the mutual fund or ULIP products. Some of the fund houses even allow you to buy the fund units over the telephone, where your call is recorded and transaction details entered into the system. For e.g., I bought my overseas travel insurance policy over the telephone. If the company can have a few people answer the questions of customers on the phone and some even make them buy the products on the phone, why cant the same team be extended to cut distribution cost and help save the investors money and offer them better returns?
Coming to managing online systems, it is also a fact that all the details of customers and agents are managed using online systems only. There is no paperwork actually involved at the company level. Yet, the companies are quoting this vague reason.
The fact is that the heavy charges being taken in the name of distribution costs are not really used in distribution cost. It’s all disguised and inflated figure. Majority of the commission and cost is pocketed at various levels by people in the supply chain, rest is spent on advertising. If you really look at it, then distribution simply involves filling up a paper form, taking the customer’s signature on it and then sending the policy or fund document by post to the customer. I see no reason why someone investing 100,000 in a mutual fund should end up paying 2.25% or 2250 Rs. in the name of distribution cost. Do you think it takes 2250 Rs to fill up a paper application and send the unit document by post to the customer? OR is it justified for the hopeless level of (misguiding) advices that are given to the customer to buy the fund units?
Not sure how far SEBI can take this suggestion. This is India; there are loads of bureaucratic hurdles in implementing anything that is GOOD for the common men. One can only hope that the suggestion from SEBI finds its way to actually being implemented.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
SEBI suggests that Mutual Funds charge the customers with almost 2.25% charges in the name of Distribution Costs. This charge is used to pay to the various distributors and agents who help the mutual fund company to sell mutual fund products to the common public. SEBI suggests that Mutual Funds and asset management companies should insist on selling the units directly to the customer through the online website or advising potential customers to buy it from them by visiting their office. SEBI’s suggestion says that the 2.25% charge should NOT be taken from such customers, who are buying the mutual fund products directly from the company, either online or by visiting their office, as there are no agents or distributors involved. Distribution Charge should be taken only from customers who buy through a distributor or an agent.
Here are some facts about the distributor and agent business in India for selling of such financial products:
• 98% of the money for sale of any Mutual Fund or ULIP scheme is collected through distributors and agents
• That means only 2% of the customers actually buy the product directly from the company
• 2% of the above customers are the ones which are themselves other mutual funds or investment firms who invest into a particular product in big amounts and hence save on charges by directly buying it from the asset management company or fund house
No wonder that the entire mutual fund industry has criticized this suggestion from SEBI in one voice. If they adopt to the suggestion from SEBI, it would mean that the distributors will loose the business within no time. More and more of the customers are now using online transactions for banking and trading. They can as well do the same for buying mutual funds.
The distributors are giving the following reason for not liking the idea from SEBI: “since 98% of the business is routed through distributors and agents, the elimination of distribution cost will mean that mutual funds will not get enough customers. This will hamper the investment business in India”
However, the fact is that the investment business in India will grow better and more number of investors will start considering investing in Mutual Funds, if the administrative charges and commissions are reduced. People like me, who are averse to mutual fund investments because a significant portion of money goes into commissions, as explained in my article: Should you trust your mutual fund manager?, will also start considering investmenting in mutual funds.
The above statement from distributors is nothing but a useless reason because they will be out of business very soon.
On the other hand, the fund managers and mutual fund companies dislike the idea because of the following reason: “We will have to invest heavily on having online system to buy and redeem mutual funds and other products. Moreover, we will have to hire and train our staff who could talk and sell to the customers directly. Having it through the distributors helps manage things better”.
Again, yet another vague reason. Almost all of the mutual fund companies have a toll-free number where one can call and get all the details of the mutual fund or ULIP products. Some of the fund houses even allow you to buy the fund units over the telephone, where your call is recorded and transaction details entered into the system. For e.g., I bought my overseas travel insurance policy over the telephone. If the company can have a few people answer the questions of customers on the phone and some even make them buy the products on the phone, why cant the same team be extended to cut distribution cost and help save the investors money and offer them better returns?
Coming to managing online systems, it is also a fact that all the details of customers and agents are managed using online systems only. There is no paperwork actually involved at the company level. Yet, the companies are quoting this vague reason.
The fact is that the heavy charges being taken in the name of distribution costs are not really used in distribution cost. It’s all disguised and inflated figure. Majority of the commission and cost is pocketed at various levels by people in the supply chain, rest is spent on advertising. If you really look at it, then distribution simply involves filling up a paper form, taking the customer’s signature on it and then sending the policy or fund document by post to the customer. I see no reason why someone investing 100,000 in a mutual fund should end up paying 2.25% or 2250 Rs. in the name of distribution cost. Do you think it takes 2250 Rs to fill up a paper application and send the unit document by post to the customer? OR is it justified for the hopeless level of (misguiding) advices that are given to the customer to buy the fund units?
Not sure how far SEBI can take this suggestion. This is India; there are loads of bureaucratic hurdles in implementing anything that is GOOD for the common men. One can only hope that the suggestion from SEBI finds its way to actually being implemented.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Complex insurance policies to be taken off: follow-up
Fortunately or unfortunately, IRDA has decided to give more time to both Bajaj Allianz and Aviva to take off the insurance policies from the market, which had quite complex charge structure.
In a way, it is good because now the phasing out of the policies would be in a much better manner.
However, the bad point is that the insurance companies can still continue to sell the policies as long as they are not instructed with a deadline to withdraw it. God knows when that deadline will come. Any reader of this blog who may have bought these policies and received any communication from the insurance company or agents, please post the communication in the comments section.
Another important but unfortunate development that has happened is that IRDA/SEBI have reduced the number of training hours for the insurance agents from 100 & 75 to just 50 hours. Readers may note that to become an insurance agent at a certain level, one is required to undergo training.
This training was initially set at 75 and 100 hours, while now it has been reduced to just 50 hours. After doing a fulltime masters course in finance and management and with over 6 years of experience, many-a-times I find it difficult to understand a policy. I am just not able to understand how a 12th class passout (min. qualification required for insurance agents) can be trained in a matter of 50 hours and be let loose to suggest & sell insurance policies to the common public. All he/she ends up doing is suggesting and selling policies that earn them high commission and not necessarily the ones that are beneficial and really required by the customer.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
In a way, it is good because now the phasing out of the policies would be in a much better manner.
However, the bad point is that the insurance companies can still continue to sell the policies as long as they are not instructed with a deadline to withdraw it. God knows when that deadline will come. Any reader of this blog who may have bought these policies and received any communication from the insurance company or agents, please post the communication in the comments section.
Another important but unfortunate development that has happened is that IRDA/SEBI have reduced the number of training hours for the insurance agents from 100 & 75 to just 50 hours. Readers may note that to become an insurance agent at a certain level, one is required to undergo training.
This training was initially set at 75 and 100 hours, while now it has been reduced to just 50 hours. After doing a fulltime masters course in finance and management and with over 6 years of experience, many-a-times I find it difficult to understand a policy. I am just not able to understand how a 12th class passout (min. qualification required for insurance agents) can be trained in a matter of 50 hours and be let loose to suggest & sell insurance policies to the common public. All he/she ends up doing is suggesting and selling policies that earn them high commission and not necessarily the ones that are beneficial and really required by the customer.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Thursday 23 August 2007
Reliance Salary Advantage Fund: Another trap
Yesterday, I saw the promotion of Reliance Salary advantage fund on one of the leading business news channels.
Here is the summary of the offer:
You get salary each month. They advice you to set aside your monthly expenses and other payments that you need to make (like EMI, etc.).
Put the remaining money in Reliance Salary advantage fund.
The money that you put is invested in so called low-risk instruments, which are again mutual funds of reliance like Reliance Liquid Fund.
Their past performance shows that they have managed to get around 6% returns on annual basis.
Although at the end of the table, they do mention that “Past performance may not sustained in future” :- ) Even for a mere 6% past performance annually that too from 1995, they cannot guarantee to sustain it, and they call it salary advantage fund.
You get an ATM cum debit card that you can use to withdraw money anytime. The condition is that in a month, only 1 transaction is free, that too only at HDFC bank ATM. They have not mentioned anything about the charges that you may have to pay for withdrawing money from other ATMs or making more than 1 withdrawal in a month.
Though it is said to be like a liquid bank account, you can withdraw only upto 50% of your invested money – not more than that.
Another disadvantage is that though it is like a bank account, it cannot be used to issue cheques or EMI payments.
One more ambiguity is that the reliance website claims that there are no entry/exit loads; while report on CNBC mentioned that there is a 2.25% entry load. God knows what the truth is. If there is an entry load, reduce it from 6%, you will end up only with 6-2.25% = 3.75% - even less than what is offered by bank account.
There is no mention of the dates for which the investment will be considered for earning interest (like minimum balance between 5th and last date of the month). Such basic things are expected from a newly launched instrument.
The promotion on CNBC sited a “salaried” person, wearing a tie and formal shirt, happily mentioning how satisfied he is with the Reliance salary advantage fund.
-He mentioned that he is assured of 6% returns, as the past performance of the fund has been almost 6%. He is assured based upon the past performance, but the company offering the service is not assured for the returns in the future (as mentioned on their website)
-What has the markets done in last 12 years? Were they limited only to 6% returns? Even the returns from bonds were more that 8%. Probably the salaried person doesn’t know OR he was paid to speak only a few limited sentences for promotion.
-He also mentioned that 6% is better than 3.5% or 4% of what the banks offer. How about the guarantee that the bank gives and uncertainty this fund has?
Now compare it with a bank account or Fixed deposit account. My bank offers me 6% interest rate just for a deposit of more than 3 months. The return is GUARANTEED. If I keep the money for just more than 1 year, I am assured a GUARANTEED return of 9.5% in my FD. Should I still go with reliance salary advantage or should I visit my bank branch or login to internet banking for opening an online FD account?
In essence, this scheme is nothing but another way of presenting a new instrument or service, which is actually not worth it. Somehow, I am now also loosing the trust on the business news channels, about the way they are presenting such things. The promotion appeared to be like a news item – while it was actually an ad. It’s all about promotion and money making business. Let’s be keen on learning about calculating the real numbers, instead of jumping in on any advertisement or advice from a promotional scheme.
This is the official website of reliance salary advantage fund. (Opens in a new window)
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Here is the summary of the offer:
You get salary each month. They advice you to set aside your monthly expenses and other payments that you need to make (like EMI, etc.).
Put the remaining money in Reliance Salary advantage fund.
The money that you put is invested in so called low-risk instruments, which are again mutual funds of reliance like Reliance Liquid Fund.
Their past performance shows that they have managed to get around 6% returns on annual basis.
Although at the end of the table, they do mention that “Past performance may not sustained in future” :- ) Even for a mere 6% past performance annually that too from 1995, they cannot guarantee to sustain it, and they call it salary advantage fund.
You get an ATM cum debit card that you can use to withdraw money anytime. The condition is that in a month, only 1 transaction is free, that too only at HDFC bank ATM. They have not mentioned anything about the charges that you may have to pay for withdrawing money from other ATMs or making more than 1 withdrawal in a month.
Though it is said to be like a liquid bank account, you can withdraw only upto 50% of your invested money – not more than that.
Another disadvantage is that though it is like a bank account, it cannot be used to issue cheques or EMI payments.
One more ambiguity is that the reliance website claims that there are no entry/exit loads; while report on CNBC mentioned that there is a 2.25% entry load. God knows what the truth is. If there is an entry load, reduce it from 6%, you will end up only with 6-2.25% = 3.75% - even less than what is offered by bank account.
There is no mention of the dates for which the investment will be considered for earning interest (like minimum balance between 5th and last date of the month). Such basic things are expected from a newly launched instrument.
The promotion on CNBC sited a “salaried” person, wearing a tie and formal shirt, happily mentioning how satisfied he is with the Reliance salary advantage fund.
-He mentioned that he is assured of 6% returns, as the past performance of the fund has been almost 6%. He is assured based upon the past performance, but the company offering the service is not assured for the returns in the future (as mentioned on their website)
-What has the markets done in last 12 years? Were they limited only to 6% returns? Even the returns from bonds were more that 8%. Probably the salaried person doesn’t know OR he was paid to speak only a few limited sentences for promotion.
-He also mentioned that 6% is better than 3.5% or 4% of what the banks offer. How about the guarantee that the bank gives and uncertainty this fund has?
Now compare it with a bank account or Fixed deposit account. My bank offers me 6% interest rate just for a deposit of more than 3 months. The return is GUARANTEED. If I keep the money for just more than 1 year, I am assured a GUARANTEED return of 9.5% in my FD. Should I still go with reliance salary advantage or should I visit my bank branch or login to internet banking for opening an online FD account?
In essence, this scheme is nothing but another way of presenting a new instrument or service, which is actually not worth it. Somehow, I am now also loosing the trust on the business news channels, about the way they are presenting such things. The promotion appeared to be like a news item – while it was actually an ad. It’s all about promotion and money making business. Let’s be keen on learning about calculating the real numbers, instead of jumping in on any advertisement or advice from a promotional scheme.
This is the official website of reliance salary advantage fund. (Opens in a new window)
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
IPO Plans for Bus service in the IT City – Part I
In a first of its kind IPO by a state-run transport corporation, Bangalore Metropolitan Transport Corporation (BMTC), that runs the city bus service in the tech hub, plans to raise money from the public to add luxury buses on newer routes. SBI Capital Markets Ltd has been appointed as the merchant bankers for the issue and it is expected that the issue will be completed by March 2008.
BMTC, the only profitable public transport corporation in the country, earned a profit of Rs224 crore on an income of Rs887.59 crore for the year till March 2007. It is the only government run Bus Corporation that is running in profit among all the major government run bus corporations in other metro cities. The IPO is expected to come in 2008, only after it makes its way through the bureaucratic procedures.
Many interesting things can be observed here:
• A government run organization in profit?? Seems like a miracle for India, but well, things do happen!
• Planning an IPO, shows the confidence the officials of this organization have in it
• SBI Capital Markets agrees to be the merchant banker for the issue, another positive sign
• Money raised through IPO to be used for expansion and further improvement in client (commuter) facilities
Same way, the Indian Railways have shown profitability, with Lalu Yadav given the entire credit. The moment railways showed profitability, people were all praise for Lalu and the railway department. People writing articles in newspapers or blogs on management and leadership made it hoopla. Everyone was admiring Lalu and his railway-men for transforming railways. There were proposals for railways to be made a public traded company and come out with an IPO, but the government disagreed. I also heard the news (may be a rumor) that one of the owners of India’s leading corporate house has issued the statement that if Railways is given to him for 2 years, he will transform the railtracks into that of gold.
People make noise only after one has proved himself. Swami Vivekananda delivered his lecture in America, only then the Indians realized the mettle of that individual. Rabindranath Tagore got praise and accolades from the British Government, then the public realized the potential of his work. One has to prove himself many times, then only people show trust in him.
Same thing goes with the companies or organizations. A company has to produce products that are better than the rest (or atleast at par with the rest) or services that perform better than the rest, then only are the people willing to bet money with it.
Everyone falls for successful companies and businessmen who have proved themselves atleast for a small duration of time. What they forget is that since the business has proved itself, the world knows about it. The real fun is in identifying businesses about which no one knows :- )
Well, whatever be the case, let’s concentrate our discussion to BMTC and Indian Railways. One has applied for IPO and wants to raise capital for further expansion. Other has also proved itself but it does not want to come out with an IPO. Both are government run organizations, both have labor unions and both work for the public.
Let’s have an initial level analysis of these two.
Lalu’s rail made good profits – credit is given to him. But was it his willingness for transformation or a market requirement?
It was the period when Indian skies were getting many new low-cost airlines. Initiatives taken by Air Deccan, followed by Spicejet, Sahara and other low cost carriers managed to woo away the middle class customers of railways to airlines. These were the people who had the benefit of emerging India, with enough disposable income making it affordable for them to fly. Who would be looking further to the railways for lengthy journeys?
The Freight business of railways was also expected to be hit. What was going on in the passenger segment could have soon been moved to the cargo segment. A typical example of this is the business model followed for Reliance Fresh Retail chain. They are looking forward to using airplanes to ship fresh vegetables from the villages in north to the retail stores in south within a matter of hours, maintaining the freshness of vegetable and other products.
Railways had to do something to counter the competition. Result – Lowering of AC charges, lowering of freight charges, a stick for non-performing employees and a carrot for the rest. Still having proved itself, Railways is not willing to come out with an IPO, while BMTC has already chalked out the plans for IPO.
Continue to Part II of this article
BMTC, the only profitable public transport corporation in the country, earned a profit of Rs224 crore on an income of Rs887.59 crore for the year till March 2007. It is the only government run Bus Corporation that is running in profit among all the major government run bus corporations in other metro cities. The IPO is expected to come in 2008, only after it makes its way through the bureaucratic procedures.
Many interesting things can be observed here:
• A government run organization in profit?? Seems like a miracle for India, but well, things do happen!
• Planning an IPO, shows the confidence the officials of this organization have in it
• SBI Capital Markets agrees to be the merchant banker for the issue, another positive sign
• Money raised through IPO to be used for expansion and further improvement in client (commuter) facilities
Same way, the Indian Railways have shown profitability, with Lalu Yadav given the entire credit. The moment railways showed profitability, people were all praise for Lalu and the railway department. People writing articles in newspapers or blogs on management and leadership made it hoopla. Everyone was admiring Lalu and his railway-men for transforming railways. There were proposals for railways to be made a public traded company and come out with an IPO, but the government disagreed. I also heard the news (may be a rumor) that one of the owners of India’s leading corporate house has issued the statement that if Railways is given to him for 2 years, he will transform the railtracks into that of gold.
People make noise only after one has proved himself. Swami Vivekananda delivered his lecture in America, only then the Indians realized the mettle of that individual. Rabindranath Tagore got praise and accolades from the British Government, then the public realized the potential of his work. One has to prove himself many times, then only people show trust in him.
Same thing goes with the companies or organizations. A company has to produce products that are better than the rest (or atleast at par with the rest) or services that perform better than the rest, then only are the people willing to bet money with it.
Everyone falls for successful companies and businessmen who have proved themselves atleast for a small duration of time. What they forget is that since the business has proved itself, the world knows about it. The real fun is in identifying businesses about which no one knows :- )
Well, whatever be the case, let’s concentrate our discussion to BMTC and Indian Railways. One has applied for IPO and wants to raise capital for further expansion. Other has also proved itself but it does not want to come out with an IPO. Both are government run organizations, both have labor unions and both work for the public.
Let’s have an initial level analysis of these two.
Lalu’s rail made good profits – credit is given to him. But was it his willingness for transformation or a market requirement?
It was the period when Indian skies were getting many new low-cost airlines. Initiatives taken by Air Deccan, followed by Spicejet, Sahara and other low cost carriers managed to woo away the middle class customers of railways to airlines. These were the people who had the benefit of emerging India, with enough disposable income making it affordable for them to fly. Who would be looking further to the railways for lengthy journeys?
The Freight business of railways was also expected to be hit. What was going on in the passenger segment could have soon been moved to the cargo segment. A typical example of this is the business model followed for Reliance Fresh Retail chain. They are looking forward to using airplanes to ship fresh vegetables from the villages in north to the retail stores in south within a matter of hours, maintaining the freshness of vegetable and other products.
Railways had to do something to counter the competition. Result – Lowering of AC charges, lowering of freight charges, a stick for non-performing employees and a carrot for the rest. Still having proved itself, Railways is not willing to come out with an IPO, while BMTC has already chalked out the plans for IPO.
Continue to Part II of this article
(2)-IPO Plans for Bus service in the IT City – Part II
This is part II of the article IPO Plans for Bus service in the IT City – Part I. Please start reading this article from the first part, before proceeding with this part.
The reason and timing for BMTC to come out with an IPO seems justified – expansion plans. But the real reason is that the project is already underway for Bangalore Metro Rail Service. Once that is up and functioning, the BMTC revenues may be hit severely. Despite offering AC accommodation, people still try to avoid buses, while they prefer sophisticated metro rails. Not sure how many of you have observed Metro Rail in Delhi, many high class executives prefer to travel in Metro rail. Buses have another disadvantage of lengthy travel timings and traffic congestions. I have worked in London for a long time. Despite having excellent buses, Londoners still prefer metro rail for travel instead of buses.
The BMTC now wants to capitalize upon its performance, before it is hit by the metro rail of Bangalore.
Coming to Railways – why is it not coming up with an IPO?
Railway is one of the best available modes of income for government as well as for the employees. A big number of businesses are still dependent upon railways for survival. Railways is much-much larger than BMTC and has a country-wide presence. It is one of the biggest employers in the world – but that also comes with the problems of labor unions. It is usually said that if the amount of money, that the railway TTE and Railway policemen collect in the form of bribes, if that money starts to go to the railways, it will be able to build another similar rail network in just 3 years time. Another problem is with the funding that railways may indirectly get from the various business houses, for favouring them with the logistics and support in their preferred regions. Politics is another reason why railways will still remain under government. One of the most sought after portfolios in the cabinet, no wonder that just by announcing a train on a particular route will help a party make a big vote bank. Under so much pressure from the employees, so many unions and political parties backing up, so much from the indirect income, so much for the vote bank, there is no way the government would allow making it go public.
Another thing is that just by going public, no company can become better. How many of us had bad experiences with BSNL services and their non-responsiveness with our problems?
What exactly can be concluded from the above discussion? IPO’s whether from privately run businesses or government run organizations, are issued only under certain circumstances:
• When there is threat to the business
• There is no other source of money available for cheap
• When the company wants to capitalize upon its track record, though it may be aware of the future threat to its business
We common investors just look at the IPO as a quick buck making process. Things work if it clicks; else you get a refund check. Past records have no indications of the future opportunities or threats. No businessman or organization would be a fool to share his profit making business with others, until and unless there is a need or threat to his business.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
The reason and timing for BMTC to come out with an IPO seems justified – expansion plans. But the real reason is that the project is already underway for Bangalore Metro Rail Service. Once that is up and functioning, the BMTC revenues may be hit severely. Despite offering AC accommodation, people still try to avoid buses, while they prefer sophisticated metro rails. Not sure how many of you have observed Metro Rail in Delhi, many high class executives prefer to travel in Metro rail. Buses have another disadvantage of lengthy travel timings and traffic congestions. I have worked in London for a long time. Despite having excellent buses, Londoners still prefer metro rail for travel instead of buses.
The BMTC now wants to capitalize upon its performance, before it is hit by the metro rail of Bangalore.
Coming to Railways – why is it not coming up with an IPO?
Railway is one of the best available modes of income for government as well as for the employees. A big number of businesses are still dependent upon railways for survival. Railways is much-much larger than BMTC and has a country-wide presence. It is one of the biggest employers in the world – but that also comes with the problems of labor unions. It is usually said that if the amount of money, that the railway TTE and Railway policemen collect in the form of bribes, if that money starts to go to the railways, it will be able to build another similar rail network in just 3 years time. Another problem is with the funding that railways may indirectly get from the various business houses, for favouring them with the logistics and support in their preferred regions. Politics is another reason why railways will still remain under government. One of the most sought after portfolios in the cabinet, no wonder that just by announcing a train on a particular route will help a party make a big vote bank. Under so much pressure from the employees, so many unions and political parties backing up, so much from the indirect income, so much for the vote bank, there is no way the government would allow making it go public.
Another thing is that just by going public, no company can become better. How many of us had bad experiences with BSNL services and their non-responsiveness with our problems?
What exactly can be concluded from the above discussion? IPO’s whether from privately run businesses or government run organizations, are issued only under certain circumstances:
• When there is threat to the business
• There is no other source of money available for cheap
• When the company wants to capitalize upon its track record, though it may be aware of the future threat to its business
We common investors just look at the IPO as a quick buck making process. Things work if it clicks; else you get a refund check. Past records have no indications of the future opportunities or threats. No businessman or organization would be a fool to share his profit making business with others, until and unless there is a need or threat to his business.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoids duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Effect of M&A on stock prices – Part I
Continuing further from my previous article about Introduction to MnA, let's analyze how the stock prices behave when there is a news about MnA.
We will take the example of 2 companies which have decided to join hands or one is buying out the other. In most of the cases, a larger company buys out the smaller company. So we will name the companies as BIG and SMALL, so as to have clarity in naming convention. Sometimes it may happen that a smaller company may buy a larger company, just because its owner has surplus cash. The deal between Tata and Corus steel was of the 2nd type because Tata Steel was less in value compared to Corus, but Tata had additional funds from other sources.
But in essence, it's the money value that decides who buys out whom. So even if a small value company is buying out a big value company, the small value company is still considered bigger because it has sufficient money to buyout the other big firm. Hence, we always say that a big company has bought smaller company.
But what matters most to us is how do the stock prices of these two companies behave or react? In general, the stock price of the buying company (bigger company) usually goes down, while that of the company being bought goes up.
That seems to be a strange happening, but let's look at it with a simple example:
Imagine there are 2 balloons of 2 different sizes, one filled with 1 unit of gas and other filled with 10 units of gas. Initially, the 2 are existing as separate balloons. Now suppose that these 2 balloons are joined with a pipe. The following 3 things are possible:
1. Bigger balloon transfers gas to smaller one till equilibrium is established and both balloons become of equal size.
2. All the gas of smaller balloon 1 goes to bigger balloon 2
3. All the gas of bigger balloon 2 goes to smaller balloon 1
If you talk about principles of physics, then option 1 is what happens. How about the stock prices for this kind of joining of 2 companies in case of balloons?
The way the market perceives the news of takeover is also following the same principle, atleast in the short term. Whenever a bigger n financially healthy company takes over a smaller or diseased company, the market sees it as if the funds (like gas in a balloon) will flow from the bigger company to the smaller company, so that the smaller company is brought upto the level of the bigger company and then it can get absorbed in the bigger company completely. Ultimately, the bigger company and smaller company will both become one, but in the beginning for a short period of time, the market perception about the health of the companies and flow of fund is what is explained above.
It is perceived that the bigger company will have to pay for a makeover n upgrading of the smaller company. Hence, smaller company will be in benefit for sometime. Therefore, the price of a company being taken over starts to increase, while that of the company taking over may decrease or stay the same. The other reason for stock price decline of bigger company is because the market may believe that it has paid a heavy price for the acquisition, with regard to the benefit it may generate from the synergies. Hence, in almost all of the cases, it's the smaller company investors who get the benefit of takeover, while the bigger company investors may suffer a loss in the short term.
So for trading activities in the short term, better to be with a small company which may be taken over.
Continue to Part II of this article
We will take the example of 2 companies which have decided to join hands or one is buying out the other. In most of the cases, a larger company buys out the smaller company. So we will name the companies as BIG and SMALL, so as to have clarity in naming convention. Sometimes it may happen that a smaller company may buy a larger company, just because its owner has surplus cash. The deal between Tata and Corus steel was of the 2nd type because Tata Steel was less in value compared to Corus, but Tata had additional funds from other sources.
But in essence, it's the money value that decides who buys out whom. So even if a small value company is buying out a big value company, the small value company is still considered bigger because it has sufficient money to buyout the other big firm. Hence, we always say that a big company has bought smaller company.
But what matters most to us is how do the stock prices of these two companies behave or react? In general, the stock price of the buying company (bigger company) usually goes down, while that of the company being bought goes up.
That seems to be a strange happening, but let's look at it with a simple example:
Imagine there are 2 balloons of 2 different sizes, one filled with 1 unit of gas and other filled with 10 units of gas. Initially, the 2 are existing as separate balloons. Now suppose that these 2 balloons are joined with a pipe. The following 3 things are possible:
1. Bigger balloon transfers gas to smaller one till equilibrium is established and both balloons become of equal size.
2. All the gas of smaller balloon 1 goes to bigger balloon 2
3. All the gas of bigger balloon 2 goes to smaller balloon 1
If you talk about principles of physics, then option 1 is what happens. How about the stock prices for this kind of joining of 2 companies in case of balloons?
The way the market perceives the news of takeover is also following the same principle, atleast in the short term. Whenever a bigger n financially healthy company takes over a smaller or diseased company, the market sees it as if the funds (like gas in a balloon) will flow from the bigger company to the smaller company, so that the smaller company is brought upto the level of the bigger company and then it can get absorbed in the bigger company completely. Ultimately, the bigger company and smaller company will both become one, but in the beginning for a short period of time, the market perception about the health of the companies and flow of fund is what is explained above.
It is perceived that the bigger company will have to pay for a makeover n upgrading of the smaller company. Hence, smaller company will be in benefit for sometime. Therefore, the price of a company being taken over starts to increase, while that of the company taking over may decrease or stay the same. The other reason for stock price decline of bigger company is because the market may believe that it has paid a heavy price for the acquisition, with regard to the benefit it may generate from the synergies. Hence, in almost all of the cases, it's the smaller company investors who get the benefit of takeover, while the bigger company investors may suffer a loss in the short term.
So for trading activities in the short term, better to be with a small company which may be taken over.
Continue to Part II of this article
(2)-Effect of MnA on stock prices – Part II
This is part II of the article Effect of MnA on stock prices - Part I. Please start reading this article from the first part, before proceeding with this part.
Let's see some examples of how MnA deals have worked in the past, and how have the prices reacted:
Sometimes in 2003 or 2004, Nirma declared that it is taking over a small company called Core Healthcare. Core healthcare was in the business of making distilled water and glucose bottles. At the time when the news came in, core healthcare was supposed to be a "deceased" penny stock, and was trading at petty levels of around 2.5 to 3 Rs.. However, as soon as the rumor of takeover came in, the stock price of core healthcare started to jump. Within a matter of 3-4 days, it touched a high of 27 Rs. From 3 Rs. to 27 Rs. just in a matter of 3-4 days, means a 9 times increase or 800% increase. It even touched a year high of 30 Rs. The actual takeover happened quite late, but the news or better to say rumors, ensured that the markets reacted to it immediately and prices increased.
Goldman Sachs recently bought a stake in IFCI. Result - IFCI prices have been increasing continuously from the levels of 12 Rs. to 65 Rs and even more.
Recent buyout of Air Deccan by Kingfisher is another example of MnA. Deccan needed 200 Crore Rs. by July end to pay its loan that it had taken from the bank. Airline was running in loss and there was no other way to raise money. Ultimately, it had to give in to the pressure and sell itself. However, when the news of Air Deccan takeover was confirmed, the stock price did not show a significant change. The reason - market was already aware of the ailing situation of air Deccan, so it was almost certain that either this airline will collapse or will be bought out. Since there was no such possibility of a complete collapse given the credibility of captain Gopinath or the business operations of the airline, the only way left was a sell off. Hence, the stock price was already increased long time before the news of takeover was confirmed.
Internationally, the Tata -Corus takeover bidding game gave thumbs up to Corus investors, but many Tata investors felt that Tata has paid a heavy price for acquisition of Corus, hence the price went down for Tata Steel. While the bidding was going on, there were offers for Corus from other bidding companies as well. Whenever there use to be a higher offer from the competitor of Tata, the prices of Tata used to go up a bit, but not significantly. Finally, when the game ended, it was the share price of Tata that went down a bit.
As you can see from the above three examples, the market prices are subject to variability in behaviour. Sometimes the prices remain same, sometimes they do increase, and sometimes they decrease. However, one thing is certain and can be clearly observed - It's the market news that immediately changes the prices, irrespective of the time when the actual takeover happens. Once again it proves the Efficient Market Hypothesis, even in case of MnA. What may happen in the long run is uncertain, whether the MnA transaction will be beneficial with positive synergy or whether it will turn out to be a loss making gamble, it is not sure. The result comes out only in the long run and is uncertain. But for trading activities, it's the news that rules the market and the news immediately assimilates all the good and bad aspects of any MnA deal into the stock price, driving it up or down.
How can you and I benefit from the MnA news? Well, I really don't know! :- )
Let's talk about certain cases:
I have a stock that is being taken over, what should I do?
If you are lucky enough to have a stock in your portfolio about which there is a news or rumor for a takeover, then Congratulations! You are lucky to have one of the stocks out of the big universe of more than 10,000 stocks, which is being taken over. Hold on to it and wait for the prices to zoom. If the rumor turns out to be correct, then you can make good amount of money.
I have a stock that is taking over another company, what should I do?
If you have a stock that is taking over some other company, then the decision is yours. If you believe that the acquisition will help create positive synergy, hold onto it for long term and don't worry about the short term price fluctuations. If you are a trader in short term and believe that the news may impact it negatively, you may like to short it or sell off your holdings, to take advantage of price falls that may happen.
I don't have any stock for the companies about which there is news/rumors of MnA deal, should I trying trading by buying/selling any of the involved stocks?
If you don't have any of the stock, either of big company or small company, should you act on news? Well, ultimately it's your call! You have to decide whether to take a bet or not. Just keep in mind that markets are efficient, so jumping in on news is beneficial only to the fulltime traders trading for huge volumes within a span of few seconds, as I've explained in my article on Efficient Markets. If you are lucky with your bet, you'll win.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoid duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Let's see some examples of how MnA deals have worked in the past, and how have the prices reacted:
Sometimes in 2003 or 2004, Nirma declared that it is taking over a small company called Core Healthcare. Core healthcare was in the business of making distilled water and glucose bottles. At the time when the news came in, core healthcare was supposed to be a "deceased" penny stock, and was trading at petty levels of around 2.5 to 3 Rs.. However, as soon as the rumor of takeover came in, the stock price of core healthcare started to jump. Within a matter of 3-4 days, it touched a high of 27 Rs. From 3 Rs. to 27 Rs. just in a matter of 3-4 days, means a 9 times increase or 800% increase. It even touched a year high of 30 Rs. The actual takeover happened quite late, but the news or better to say rumors, ensured that the markets reacted to it immediately and prices increased.
Goldman Sachs recently bought a stake in IFCI. Result - IFCI prices have been increasing continuously from the levels of 12 Rs. to 65 Rs and even more.
Recent buyout of Air Deccan by Kingfisher is another example of MnA. Deccan needed 200 Crore Rs. by July end to pay its loan that it had taken from the bank. Airline was running in loss and there was no other way to raise money. Ultimately, it had to give in to the pressure and sell itself. However, when the news of Air Deccan takeover was confirmed, the stock price did not show a significant change. The reason - market was already aware of the ailing situation of air Deccan, so it was almost certain that either this airline will collapse or will be bought out. Since there was no such possibility of a complete collapse given the credibility of captain Gopinath or the business operations of the airline, the only way left was a sell off. Hence, the stock price was already increased long time before the news of takeover was confirmed.
Internationally, the Tata -Corus takeover bidding game gave thumbs up to Corus investors, but many Tata investors felt that Tata has paid a heavy price for acquisition of Corus, hence the price went down for Tata Steel. While the bidding was going on, there were offers for Corus from other bidding companies as well. Whenever there use to be a higher offer from the competitor of Tata, the prices of Tata used to go up a bit, but not significantly. Finally, when the game ended, it was the share price of Tata that went down a bit.
As you can see from the above three examples, the market prices are subject to variability in behaviour. Sometimes the prices remain same, sometimes they do increase, and sometimes they decrease. However, one thing is certain and can be clearly observed - It's the market news that immediately changes the prices, irrespective of the time when the actual takeover happens. Once again it proves the Efficient Market Hypothesis, even in case of MnA. What may happen in the long run is uncertain, whether the MnA transaction will be beneficial with positive synergy or whether it will turn out to be a loss making gamble, it is not sure. The result comes out only in the long run and is uncertain. But for trading activities, it's the news that rules the market and the news immediately assimilates all the good and bad aspects of any MnA deal into the stock price, driving it up or down.
How can you and I benefit from the MnA news? Well, I really don't know! :- )
Let's talk about certain cases:
I have a stock that is being taken over, what should I do?
If you are lucky enough to have a stock in your portfolio about which there is a news or rumor for a takeover, then Congratulations! You are lucky to have one of the stocks out of the big universe of more than 10,000 stocks, which is being taken over. Hold on to it and wait for the prices to zoom. If the rumor turns out to be correct, then you can make good amount of money.
I have a stock that is taking over another company, what should I do?
If you have a stock that is taking over some other company, then the decision is yours. If you believe that the acquisition will help create positive synergy, hold onto it for long term and don't worry about the short term price fluctuations. If you are a trader in short term and believe that the news may impact it negatively, you may like to short it or sell off your holdings, to take advantage of price falls that may happen.
I don't have any stock for the companies about which there is news/rumors of MnA deal, should I trying trading by buying/selling any of the involved stocks?
If you don't have any of the stock, either of big company or small company, should you act on news? Well, ultimately it's your call! You have to decide whether to take a bet or not. Just keep in mind that markets are efficient, so jumping in on news is beneficial only to the fulltime traders trading for huge volumes within a span of few seconds, as I've explained in my article on Efficient Markets. If you are lucky with your bet, you'll win.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoid duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Wednesday 22 August 2007
Mergers and Acquisitions – Creating Synergies – Part I
Another type of Corporate actions or restructuring that is commonly seen in the market is merger and acquisition or simply abbreviated as M&A. Mittal Steel buying Arcelor or Tata taking over Corus are examples that fall under M&A category. Basically, any transaction that results in one company taking over another company completely or one company joining hands to setup a combined business are typical M&A transactions. The former case falls under acquisition category and the latter constitutes a merger.
Why will two companies go for M&A transaction? Well, there can be multiple reasons for that. But in the simplest terms, let me explain in terms of mathematics:
In simple terms
A + B = AB
However, in case of mergers and acquisitions,
A + B = AB + Synergy
This is the word, Synergy, that proves to be beneficial for both A & B, and that’s what is the driving factor for companies to either merge with each other completely or join hands. The synergy is supposed to be a positive term; if it is negative, then the M&A deal is worthless. But how exactly can we quantify this term synergy?
Let’s take an example: Assume that Air India operates from India to London. So, it can cater to the needs of travelers traveling from India to London only. However, if someone from India wishes to travel to New York, he may not be able to fly Air India, because it is limited only till London. He can do so, but he will then have to arrange tickets on any other airline from London to New York on his own. This will not only cost him money, but it may also require some legal formalities like transit visa at London airport. Ultimately, it’s a loss to the airline. Now suppose that Air India joins hands with British Airways, which operates from London to New York. This will help eliminate many problems and will be beneficial to both airlines as well as passenger.
From the point of view of passenger, he will have the following advantages:
• he will not have to worry about getting a transit visa at London
• no worry about collecting the luggage and again check-in at the London airport for travel between London and New York
• he will pay less for a collective booking, instead of 2 separate bookings
• he may get advantage of collective airmile points as the 2 airlines are now offering joint services
From the point of view of Air India & British Airways:
• Both airlines will be able to get additional income from the passengers of 2 countries
• Both airlines can work efficiently with less no. of staff
• Both will get access to new markets on sharing basis. For e.g. British Airways can now look forward to providing travel arrangements for British passengers on Air India flights from London to Singapore, via Mumbai & Air India can now serve Indian passengers from Mumbai to Sweden, via a BA flight from London.
The above, and several other points, constitute the so-called synergy from an M&A transaction.
Another example, say Bank of Baroda operates in South & west India, while Dena bank has good presence in north and east India. Both these banks can join hands and offer shared services to the customer at low costs, for e.g. sharing each others ATM and branches. GTB bank was supposed to have this kind of arrangement with ICICI and UTI bank, before it went burst.
In case of Arcelor Mittal, the synergy was supposed to come from the 2 different product ranges. Mittal steel is in the business of low-grade steel, while Arcelor is in the business with high grade steel production. The two join hands and jointly sell products of two varieties. Major benefit can come in the form of cross-selling new products to existing customers. For e.g., an existing client of low grade steel can now be offered high grade steel, with the relations that have been built by one company helps in cross selling products of the newly acquired company.
In case of Tata-Corus, the synergy is supposed to come from Tata getting access to the European markets.
Recent acquisitions in Indian aviation industry, Jet buying Sahara and Kingfisher buying Deccan are some other examples. Both airlines are expected to benefit from catering to a much wider customer base and reduce costs under the same name and work efficiently with less no. of staff. Another major benefit is in terms of reduction of poaching, pilots of one airline will have less job-switching options after consolidation in the aviation sector, and hence operations will be smooth. The airlines have to pay less license fee under the same name & hence will improve saving.
Continue to Part II of this article
Why will two companies go for M&A transaction? Well, there can be multiple reasons for that. But in the simplest terms, let me explain in terms of mathematics:
In simple terms
A + B = AB
However, in case of mergers and acquisitions,
A + B = AB + Synergy
This is the word, Synergy, that proves to be beneficial for both A & B, and that’s what is the driving factor for companies to either merge with each other completely or join hands. The synergy is supposed to be a positive term; if it is negative, then the M&A deal is worthless. But how exactly can we quantify this term synergy?
Let’s take an example: Assume that Air India operates from India to London. So, it can cater to the needs of travelers traveling from India to London only. However, if someone from India wishes to travel to New York, he may not be able to fly Air India, because it is limited only till London. He can do so, but he will then have to arrange tickets on any other airline from London to New York on his own. This will not only cost him money, but it may also require some legal formalities like transit visa at London airport. Ultimately, it’s a loss to the airline. Now suppose that Air India joins hands with British Airways, which operates from London to New York. This will help eliminate many problems and will be beneficial to both airlines as well as passenger.
From the point of view of passenger, he will have the following advantages:
• he will not have to worry about getting a transit visa at London
• no worry about collecting the luggage and again check-in at the London airport for travel between London and New York
• he will pay less for a collective booking, instead of 2 separate bookings
• he may get advantage of collective airmile points as the 2 airlines are now offering joint services
From the point of view of Air India & British Airways:
• Both airlines will be able to get additional income from the passengers of 2 countries
• Both airlines can work efficiently with less no. of staff
• Both will get access to new markets on sharing basis. For e.g. British Airways can now look forward to providing travel arrangements for British passengers on Air India flights from London to Singapore, via Mumbai & Air India can now serve Indian passengers from Mumbai to Sweden, via a BA flight from London.
The above, and several other points, constitute the so-called synergy from an M&A transaction.
Another example, say Bank of Baroda operates in South & west India, while Dena bank has good presence in north and east India. Both these banks can join hands and offer shared services to the customer at low costs, for e.g. sharing each others ATM and branches. GTB bank was supposed to have this kind of arrangement with ICICI and UTI bank, before it went burst.
In case of Arcelor Mittal, the synergy was supposed to come from the 2 different product ranges. Mittal steel is in the business of low-grade steel, while Arcelor is in the business with high grade steel production. The two join hands and jointly sell products of two varieties. Major benefit can come in the form of cross-selling new products to existing customers. For e.g., an existing client of low grade steel can now be offered high grade steel, with the relations that have been built by one company helps in cross selling products of the newly acquired company.
In case of Tata-Corus, the synergy is supposed to come from Tata getting access to the European markets.
Recent acquisitions in Indian aviation industry, Jet buying Sahara and Kingfisher buying Deccan are some other examples. Both airlines are expected to benefit from catering to a much wider customer base and reduce costs under the same name and work efficiently with less no. of staff. Another major benefit is in terms of reduction of poaching, pilots of one airline will have less job-switching options after consolidation in the aviation sector, and hence operations will be smooth. The airlines have to pay less license fee under the same name & hence will improve saving.
Continue to Part II of this article
(2)-Mergers and Acquisitions – Creating Synergies – Part II
This is part II of the article Mergers and Acquisitions – Creating Synergies – Part I. Please start reading this article from the first part, before proceeding with this part.
However, though it is easy to quote examples as above, but synergy is highly subjective and abstract term. How do you actually quantify the value in terms of numbers, say, for e.g. the reduction in poaching of air pilots? And it is not necessary that the M&A transaction always produce positive synergy. The result can be negative also. For e.g. today Jet and Kingfisher have acquired a majority of Indian skies. Suppose tomorrow government gives nod to overseas airlines to come and serve internal Indian routes. In that case, there will be a fierce competition and the M&A that is appearing to be of a positive synergy, it may turn out to be negative and even the acquirers of today may be acquired tomorrow by bigger fishes that may come to the sea.
How does this M&A business work and how do companies decide which business to acquire?
You may be working for a big reputed MNC having offshore center in India, but the fact is that the founder of this Indian unit will be earning hefty money at the billing hour rate model, for each hour you work, while you are given a fixed salary.
Nothing in this world works without commission or brokerage. The same thing goes with M&A. Investment Banks keep on looking for clients who are willing to acquire or merge with others, or clients who want to be acquired for the need of money. These investment banks have dedicated teams that keep visiting some or the other companies and tell them that if they merge with or acquire someone, how their business will grow OR if they sell themselves, how much money they can raise. Once the companies are fine with the proposal of the investment bank advisors, the investment bank advisors start looking for counterparty. They read the balance sheet and financial reports of both the firms, attempt to do all kinds of nasty calculations and finally make a transaction summary, informing the “fair value” of the company to be acquired. At this point of time, the company that is willing to sell itself will have to decide that it needs more or is it fine with the valuation. In case the news spreads out that so and so company is up for sale, other interested companies will start making offers for them. The competition begins like bidding, and the highest bidder wins the game. For e.g. Tata had competition from a Brazilian steel company for Corus, while Mittal faced stiff competition from other steel giants while grabbing Arcelor. Ultimately, the highest bidder wins. The most important thing to note is that in the process of bidding, the acquiring company may end up paying a much higher price than expected, for the synergy the acquisition may create. It sometimes becomes a prestige issue for the acquiring company, if it fails to acquire, even if the company has to pay a hefty price.
Whatever be the case, the investment advisors from investment banks make a high level of commission, which may range anywhere from 2% to 10%. When the deal is worth billions of dollars, who would not love to get a piece of cake? So the motivation factor of the valuation and bidding process becomes “GET THE DEAL DONE” – whatever may be the final outcome for the acquiring company (and the shareholders)– who cares as long as I am getting my commission.
For Arcelor Mittal deal, there was no single investment bank offering advice to Mittals, but a consortium of 3 or 4 banks comprising big names like Goldman Sachs, Morgan Stanley, etc. Same was the case on the Arcelor side, there was a joint team of 3 banks. At the end of the deal, each got a BIG piece of cake for their “valuable valuation”. Hence, the reason for M&A deal may not be just the case of a foresight of a positive synergy. It can as well be for prestige issue for the bidding companies or the misguidance by the investment banking advisors or similar such reasons.
The world is full of examples where the 2 companies joining hands have created high level of positive synergies. It is equally true for the negative synergies also. The world is equally full of examples where companies ended up in big losses for M&A transactions.
The impact can come in any form – directly or indirectly- and can affect anyone and everyone. For e.g. the reputed financial services organization ADP based in US, lost its major clients when the client was acquired by another competitor firm of ADP. Result, ADP lost its business. ADP had nothing to do with the M&A deal that was going on with its clients. Instead, the deal went through smoothly. Suddenly, one fine day the news came in that the clients will not be using the ADP products any further. Who can make guesses or predictions about this kind of business impact?
Looks like this article has now grown lengthy enough to continue further. I have lot more to tell on M&A, but for the moment, I believe this should be sufficient for introduction to M&A, the reason for M&A and what drives the M&A transactions.
Tomorrow, I will touch the real issue: How are stock prices affected by such M&A deals or even with M&A news or rumors. Keep visiting!
Keep visiting this blog for further content.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoid duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
However, though it is easy to quote examples as above, but synergy is highly subjective and abstract term. How do you actually quantify the value in terms of numbers, say, for e.g. the reduction in poaching of air pilots? And it is not necessary that the M&A transaction always produce positive synergy. The result can be negative also. For e.g. today Jet and Kingfisher have acquired a majority of Indian skies. Suppose tomorrow government gives nod to overseas airlines to come and serve internal Indian routes. In that case, there will be a fierce competition and the M&A that is appearing to be of a positive synergy, it may turn out to be negative and even the acquirers of today may be acquired tomorrow by bigger fishes that may come to the sea.
How does this M&A business work and how do companies decide which business to acquire?
You may be working for a big reputed MNC having offshore center in India, but the fact is that the founder of this Indian unit will be earning hefty money at the billing hour rate model, for each hour you work, while you are given a fixed salary.
Nothing in this world works without commission or brokerage. The same thing goes with M&A. Investment Banks keep on looking for clients who are willing to acquire or merge with others, or clients who want to be acquired for the need of money. These investment banks have dedicated teams that keep visiting some or the other companies and tell them that if they merge with or acquire someone, how their business will grow OR if they sell themselves, how much money they can raise. Once the companies are fine with the proposal of the investment bank advisors, the investment bank advisors start looking for counterparty. They read the balance sheet and financial reports of both the firms, attempt to do all kinds of nasty calculations and finally make a transaction summary, informing the “fair value” of the company to be acquired. At this point of time, the company that is willing to sell itself will have to decide that it needs more or is it fine with the valuation. In case the news spreads out that so and so company is up for sale, other interested companies will start making offers for them. The competition begins like bidding, and the highest bidder wins the game. For e.g. Tata had competition from a Brazilian steel company for Corus, while Mittal faced stiff competition from other steel giants while grabbing Arcelor. Ultimately, the highest bidder wins. The most important thing to note is that in the process of bidding, the acquiring company may end up paying a much higher price than expected, for the synergy the acquisition may create. It sometimes becomes a prestige issue for the acquiring company, if it fails to acquire, even if the company has to pay a hefty price.
Whatever be the case, the investment advisors from investment banks make a high level of commission, which may range anywhere from 2% to 10%. When the deal is worth billions of dollars, who would not love to get a piece of cake? So the motivation factor of the valuation and bidding process becomes “GET THE DEAL DONE” – whatever may be the final outcome for the acquiring company (and the shareholders)– who cares as long as I am getting my commission.
For Arcelor Mittal deal, there was no single investment bank offering advice to Mittals, but a consortium of 3 or 4 banks comprising big names like Goldman Sachs, Morgan Stanley, etc. Same was the case on the Arcelor side, there was a joint team of 3 banks. At the end of the deal, each got a BIG piece of cake for their “valuable valuation”. Hence, the reason for M&A deal may not be just the case of a foresight of a positive synergy. It can as well be for prestige issue for the bidding companies or the misguidance by the investment banking advisors or similar such reasons.
The world is full of examples where the 2 companies joining hands have created high level of positive synergies. It is equally true for the negative synergies also. The world is equally full of examples where companies ended up in big losses for M&A transactions.
The impact can come in any form – directly or indirectly- and can affect anyone and everyone. For e.g. the reputed financial services organization ADP based in US, lost its major clients when the client was acquired by another competitor firm of ADP. Result, ADP lost its business. ADP had nothing to do with the M&A deal that was going on with its clients. Instead, the deal went through smoothly. Suddenly, one fine day the news came in that the clients will not be using the ADP products any further. Who can make guesses or predictions about this kind of business impact?
Looks like this article has now grown lengthy enough to continue further. I have lot more to tell on M&A, but for the moment, I believe this should be sufficient for introduction to M&A, the reason for M&A and what drives the M&A transactions.
Tomorrow, I will touch the real issue: How are stock prices affected by such M&A deals or even with M&A news or rumors. Keep visiting!
Keep visiting this blog for further content.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoid duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Monday 20 August 2007
Share Buy back and Earning per share EPS-Part I
In my previous article, I had given An introduction to corporate actions, and how it affects the share price.
In this article, I’ll quote a live example of how companies use corporate actions or corporate restructuring to gain benefit and goof up the financial figures.
Really increasing revenue, sales and earnings is not the only way for corporate to show profitable figures. Smart kind of capital structuring can work wonders. Share buyback is one such excellent way of making a nice, healthy and profitable balance sheet, as illustrated in the following example:
When most of us talk about midcap or smallcap growth stocks, we talk about relatively young companies with new products or services that are growing at a fast rate, typically 20% to 25% per year or higher. This figure is available in the balance sheet and quarterly reports and is reported under the EPS or earnings per share.
This value of EPS, typically indicates how much income has each share made. EPS is widely followed in the industry, not only by researchers but also by individuals to track the performance of the company. How can this figure be manipulated?
Let’s discuss a case here: There is a company called Utah Medical products and is listed in NASDAQ. It is in the business of making Medical Instruments. For the past 5 years ending in year 2002, this company has been growing at a staggering rate of 20% per annum. The share price has increased from $7.5 to a high of 18.5$ which is more than 150% profit. How can a company continuously maintain such track record?
One way is to make real profits. Another way is to take advantages of corporate restructuring and corporate actions. Utah Medical Products used a combination of both – mainly of the latter.
The revenues of Utah MP did not grow much. From a high of $42 million in 1997 to $27 million in 2001, the revenues have actually come down. Yet, the earnings per share have increased from $0.5 to a high of $1.15, which is almost 125% increase in the period 1997-2001.
This high value of EPS was from smart Share Repurchase or share buyback plan. How does it work? In simple terms, a company invests money into projects and earns profit. This profit is a certain amount – may be in millions of dollars. This total amount of money is then divided by the total no. of shares, to calculate Earnings per Share or EPS. The reason why EPS becomes important and highly common factor for analysis is because it simply tells you how much each share of a company is earning. This gives a good parameter to judge companies and select between 2 shares. If you want to select between IBM or Microsoft shares, EPS can be a decisive factor.
(2)-Share Buy back and Earning per share EPS-Part II
This is part II of the article Share Buy back and Earning per share EPS – Part I. Please start reading this article from the beginning, before proceeding with this part.
So suppose, there are 100 million shares of Utah MP, and are currently trading at 2$ each. So the total value of the company stands at 200 million $. Suppose the company generate an income or earning of 50 million $.
Hence, the EPS of the company becomes = Total Earnings/Total no. of shares
= 50 million/100 million = $ 0.5
Now the company decided to buyback 10 million shares from the investors, at the market price of 2$. So, the investors will be paid a total of 20 million $ and the company will receive 10 million shares from the investors. Hence, the remaining no. of shares will be used to calculate EPS on the same total earnings:
Hence, the EPS of the company becomes = Total Earnings/Total no. of shares
= 50 million/90 million = $ 0.55
This is a clear-cut increase of more than 11% in EPS. Therefore, without actually generating extra earnings or income, the company can still show profitability and increase in EPS year-on-year.
Experienced researchers and equity research teams while looking at EPS also take these factors into consideration, like share buyback or corporate actions. However, we common investors fall victims to such things. If you look for EPS on Google, you will find most of the financial sites mentioning that we should look at past records of continuous growth in EPS year on year. What we fail to realize is how to take into consideration the effects of share buyback and other corporate actions, which are used as effective tools by the companies to make a fool of investors by presenting bloated figures.
Here is the exact data for Utah MP and how it worked:
| Year | 2001 | 2000 | 1999 | 1998 | 1997 |
| Shares Outstanding | 5210 | 5978 | 7197 | 8273 | 8495 |
| EPS ($) | 1.15 | 0.9 | 0.76 | 0.6 | 0.5 |
Over the 5 year period, the company continuously kept on buying back the shares and hence ended up showing a 125% rise in EPS, from 0.5 to 1.15$. Though there was some real growth and a continuous decline in revenue, majority of these figures were bloated because of such schemes of buyback.
As we can observe from the above example, EPS figure may appear to be pretty interesting and effective tool to make a comparison for stock picking or stock selection. However, care should be taken while observing the historical data. One should keep in mind that there may be a big possibility of a corporate action or corporate restructuring, which will result in high values of EPS. As demonstrated above, Utah MP bought back the shares continuously for 5 year period, resulting in a fantastic growth in EPS year on year. People in the accounts department of the company are experts in such tricks. Researchers who are educated know how to adjust the calculations. Individual investors like you and me get trapped with these jazzy numbers. In fact, any data presented on balance sheet or financial results should be looked upon with a doubt, as one figure is derived from the other.
Keep visiting this blog for further content.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoid duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Effects of Corporate actions on Stock prices: Part I
Today, let me cover some details about the corporate actions that affect the stock prices drastically. It is an important aspect of stock trading and should be given thorough consideration.
What are Corporate actions, or commonly known as CA?
Any decision by the corporate, or a publicly listed company, that changes its valuation structure in terms of stock structure is known as corporate action. Let me explain this with an example:
Suppose a company decides to list itself on stock exchange by offering a portion of its shares to public through an IPO. Suppose, the company is divided into 100 million parts called shares. Each share is sold at 20 $ each. Of the 100 million shares, the promoter or the actual owner decides to keep 80 million shares with him and sell remaining 20 million to the public at the rate of 20 $ a share. So, when the IPO is fully subscribed, it will give him 80% ownership in the company (with 80 million shares) and 20 $ * 20 million shares = 400 million dollars of capital money, which he can utilize.
Hence, a structure is formed for the company, after it is listed on the stock exchange. In this structure, the company has a total of 100 million shares (including that of the promoter). The total value of the company will be calculated as follows:
Total value or Market Capitalization = Total no. of shares * Price of each share
Since the price of shares keep changing everyday and every minute, the market cap or market value of the company keeps on changing accordingly. However, the structure of the company remains the same, atleast in terms of no. of shares, which remain the same at 100 million.
Any news item or action that is directly dependent upon or affects the no. of total shares, is considered as corporate action.
The simplest example of a corporate action is dividend payment. Suppose a company declares a dividend of 2$ a share. Hence, since it has a total of 100 million shares, it will have to payout a total of 200 million $ as dividend. Since this news item or action is directly dependent upon the no. of shares, it constitutes a Corporate Action.
Another example: Stock Split
Let’s say the stock price of the above mentioned company has increased drastically. It started with 20 $ a share and reached 2000$ a share in 5 years time. Though it a good news for the investors, it may sometimes become a problem for the company.
The problem comes in the form of lack of liquidity– which means due to high stock prices, it may not be possible for people to easily buy and sell shares, as they will need big amounts of money to buy and sell shares. Obviously, people will find it more convenient to buy a 20$ share than buying a 2000 $ share. It becomes more important for retail investors like you and me, to have liquidity in the market in terms of lower stock prices. If I have only 500$ to invest, I can buy 25 shares of a company trading at 20$. But I cannot buy a quarter of a share of a stock trading at 2000$.
So, from the point of view of company, when the stock price rises drastically, it becomes important for it to make it affordable to the common man, so that trading can continue smoothly. A simple way to do it is to go for a stock split. Here is how it works.
Total no. of shares: 100 million
Price of each share: 2000 $
Total Value of the company: Shares * Price = 100 million * 2000 $ = 200,000 million $
The company decides to go for a stock split in the ratio 1:10. This means that the each existing share of the company will be split into 10 shares. So the total no. of shares will become 10 times. However, since the total value or the market value of the company is not supposed to change, the price will get adjusted by a factor of 1/10.
After stock split:
Total no. of shares: 1000 million
Total Value of the company = same as that before stock split = 200,000 million $.
So price of each share = 200,000/1000 = 200 $ each.
Hence, the initial price of 2000 $ is now changes to 200 $ and the owners of the shares have 10 times more no. of shares than they had before the stock split.
The first example of dividend payout was a type of corporate action that directly depended upon the no. of shares. The second example of stock split was a type of CA that changed or affected the total no. of shares. Hence, they constitute the corporate actions, as they affect the company details at the corporate level.
Continue to Part II of this article
What are Corporate actions, or commonly known as CA?
Any decision by the corporate, or a publicly listed company, that changes its valuation structure in terms of stock structure is known as corporate action. Let me explain this with an example:
Suppose a company decides to list itself on stock exchange by offering a portion of its shares to public through an IPO. Suppose, the company is divided into 100 million parts called shares. Each share is sold at 20 $ each. Of the 100 million shares, the promoter or the actual owner decides to keep 80 million shares with him and sell remaining 20 million to the public at the rate of 20 $ a share. So, when the IPO is fully subscribed, it will give him 80% ownership in the company (with 80 million shares) and 20 $ * 20 million shares = 400 million dollars of capital money, which he can utilize.
Hence, a structure is formed for the company, after it is listed on the stock exchange. In this structure, the company has a total of 100 million shares (including that of the promoter). The total value of the company will be calculated as follows:
Total value or Market Capitalization = Total no. of shares * Price of each share
Since the price of shares keep changing everyday and every minute, the market cap or market value of the company keeps on changing accordingly. However, the structure of the company remains the same, atleast in terms of no. of shares, which remain the same at 100 million.
Any news item or action that is directly dependent upon or affects the no. of total shares, is considered as corporate action.
The simplest example of a corporate action is dividend payment. Suppose a company declares a dividend of 2$ a share. Hence, since it has a total of 100 million shares, it will have to payout a total of 200 million $ as dividend. Since this news item or action is directly dependent upon the no. of shares, it constitutes a Corporate Action.
Another example: Stock Split
Let’s say the stock price of the above mentioned company has increased drastically. It started with 20 $ a share and reached 2000$ a share in 5 years time. Though it a good news for the investors, it may sometimes become a problem for the company.
The problem comes in the form of lack of liquidity– which means due to high stock prices, it may not be possible for people to easily buy and sell shares, as they will need big amounts of money to buy and sell shares. Obviously, people will find it more convenient to buy a 20$ share than buying a 2000 $ share. It becomes more important for retail investors like you and me, to have liquidity in the market in terms of lower stock prices. If I have only 500$ to invest, I can buy 25 shares of a company trading at 20$. But I cannot buy a quarter of a share of a stock trading at 2000$.
So, from the point of view of company, when the stock price rises drastically, it becomes important for it to make it affordable to the common man, so that trading can continue smoothly. A simple way to do it is to go for a stock split. Here is how it works.
Total no. of shares: 100 million
Price of each share: 2000 $
Total Value of the company: Shares * Price = 100 million * 2000 $ = 200,000 million $
The company decides to go for a stock split in the ratio 1:10. This means that the each existing share of the company will be split into 10 shares. So the total no. of shares will become 10 times. However, since the total value or the market value of the company is not supposed to change, the price will get adjusted by a factor of 1/10.
After stock split:
Total no. of shares: 1000 million
Total Value of the company = same as that before stock split = 200,000 million $.
So price of each share = 200,000/1000 = 200 $ each.
Hence, the initial price of 2000 $ is now changes to 200 $ and the owners of the shares have 10 times more no. of shares than they had before the stock split.
The first example of dividend payout was a type of corporate action that directly depended upon the no. of shares. The second example of stock split was a type of CA that changed or affected the total no. of shares. Hence, they constitute the corporate actions, as they affect the company details at the corporate level.
Continue to Part II of this article
(2) Effects of Corporate actions on Stock prices: Part II
This is part II of the article Effects of Corporate actions on Stock prices . Please start reading this article from the beginning, before proceeding with this part.
There are several other types of corporate actions: Rights issue, spin-offs, mergers, acquisitions, share buy-back, etc.
An important question is: whether these corporate actions create any value for the company?
Theory says there is no benefit of CA; Practical cases refute the theory.
As per the theory, (Miller Modgiliani postulate), there is no value created by corporate actions or corporate restructuring. The reason is that the net value of the company remains the same. For e.g. as I’ve quoted in my previous article, about news based trading, Around 2-3 years back, Balaji Telefims (The Saas-Bahu serial TV Company led by Ekta Kapoor), was trading at Rs. 105. It declared a dividend of 16 Rs. a share. Within 1-1.5 minutes the price of the stock reached 121-122 Rs. I acted on this news an hour later and purchased the shares at 122 Rs. After the dividend expiry, the price fell back to 102-103 levels (later even to 85 Rs.). I got the dividend, but I got nothing better than the market price, instead I paid more than the market price after the ex-dividend date.
However, due to the dividend declaration, there was some price change in the market. So practically, there is some effect of corporate actions on the stock prices and valuations.
Lets take the case of a stock split. A colleague of mine acted on a stock split news of a penny stock: IQMS Software. The stock was trading at around 8 Rs. when the news of 1:10 stock split came in. Immediately, the price started to increase and touched a high of 13 Rs. My friend bought this stock in big numbers at 11 Rs. After the stock split, the price had changed by a factor of 10, i.e. his buy price of 11 Rs. was now Rs. 1.10 and the no. of stocks he bought was multiplied by 10 times. He invested a total of around 1.5 Lakh Rs. for purchasing this stock. However, after the split, the stock price started to decline, touched a low of 0.36 Rs. and as of today, it is 0.75 Rs. My friend is waiting since last 2 years just to recover his money. The stock has never made to his buy price of 1.1 Rs.
Even though the prices fell back to as low as 0.36, there were changes in the initial levels – from 8 Rs. to 13 Rs. People who managed to book profits were happy, those who couldn’t, are still waiting (like my colleague).
However, in practice, due to corporate restructuring actions, there is obviously some change. For the case of stock split, the change is in the form of more liquidity being induced in trading. Hence, the prices show an upward trend. Whether one can capitalize upon that change and how much he can gain, is still a question that leads to high level of uncertainty. The MARKETS ARE EFFICIENT –hence, everything is reflected immediately in the price. One may be lucky enough to get a piece of cake, just by chance. How long will that piece grow, no one knows. When it will start contracting, no one knows. Stock splits of companies like Reliance or Mahindra have proved to be positive in the near past, though there have been instances where rights issues of companies like Ballarpur Industries have failed and resulted in value decrease.
In practical essence, corporate actions do add some value to your holdings. The value may be positive or negative. It may be in terms of liquidity being induced, or due to a part capitalization of your holdings (like paying a dividend). Whether you want to act on any such news or keep away, is your choice.
This article was to introduce corporate actions and how it affects the market prices.
In the next article, I’ll give examples of how companies make a fool of investors by taking advantages of the corporate actions and improve their balance sheet figures. Please visit this blog tomorrow as well.
Keep visiting this blog for further content.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoid duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
There are several other types of corporate actions: Rights issue, spin-offs, mergers, acquisitions, share buy-back, etc.
An important question is: whether these corporate actions create any value for the company?
Theory says there is no benefit of CA; Practical cases refute the theory.
As per the theory, (Miller Modgiliani postulate), there is no value created by corporate actions or corporate restructuring. The reason is that the net value of the company remains the same. For e.g. as I’ve quoted in my previous article, about news based trading, Around 2-3 years back, Balaji Telefims (The Saas-Bahu serial TV Company led by Ekta Kapoor), was trading at Rs. 105. It declared a dividend of 16 Rs. a share. Within 1-1.5 minutes the price of the stock reached 121-122 Rs. I acted on this news an hour later and purchased the shares at 122 Rs. After the dividend expiry, the price fell back to 102-103 levels (later even to 85 Rs.). I got the dividend, but I got nothing better than the market price, instead I paid more than the market price after the ex-dividend date.
However, due to the dividend declaration, there was some price change in the market. So practically, there is some effect of corporate actions on the stock prices and valuations.
Lets take the case of a stock split. A colleague of mine acted on a stock split news of a penny stock: IQMS Software. The stock was trading at around 8 Rs. when the news of 1:10 stock split came in. Immediately, the price started to increase and touched a high of 13 Rs. My friend bought this stock in big numbers at 11 Rs. After the stock split, the price had changed by a factor of 10, i.e. his buy price of 11 Rs. was now Rs. 1.10 and the no. of stocks he bought was multiplied by 10 times. He invested a total of around 1.5 Lakh Rs. for purchasing this stock. However, after the split, the stock price started to decline, touched a low of 0.36 Rs. and as of today, it is 0.75 Rs. My friend is waiting since last 2 years just to recover his money. The stock has never made to his buy price of 1.1 Rs.
Even though the prices fell back to as low as 0.36, there were changes in the initial levels – from 8 Rs. to 13 Rs. People who managed to book profits were happy, those who couldn’t, are still waiting (like my colleague).
However, in practice, due to corporate restructuring actions, there is obviously some change. For the case of stock split, the change is in the form of more liquidity being induced in trading. Hence, the prices show an upward trend. Whether one can capitalize upon that change and how much he can gain, is still a question that leads to high level of uncertainty. The MARKETS ARE EFFICIENT –hence, everything is reflected immediately in the price. One may be lucky enough to get a piece of cake, just by chance. How long will that piece grow, no one knows. When it will start contracting, no one knows. Stock splits of companies like Reliance or Mahindra have proved to be positive in the near past, though there have been instances where rights issues of companies like Ballarpur Industries have failed and resulted in value decrease.
In practical essence, corporate actions do add some value to your holdings. The value may be positive or negative. It may be in terms of liquidity being induced, or due to a part capitalization of your holdings (like paying a dividend). Whether you want to act on any such news or keep away, is your choice.
This article was to introduce corporate actions and how it affects the market prices.
In the next article, I’ll give examples of how companies make a fool of investors by taking advantages of the corporate actions and improve their balance sheet figures. Please visit this blog tomorrow as well.
Keep visiting this blog for further content.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoid duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Friday 17 August 2007
Accounting/Auditing firm PWC in trouble for Global Trust Bank problems
It has been 3 years now since Global trust bank collapsed.
It was a Saturday in 2004, when the news came in about GTB bank being ordered to close down by the regulatory authorities. There was a widespread panic among the account holders of GTB bank. They were afraid about the money they had deposited in GTB bank accounts. Many private organizations had their employee’s salary accounts in GTB banks. All these people panicked. Moreover, since the news came in on Saturday, no one could do anything. ATMs were blocked, all bank branches closed. Account holders gathered at ATMs and branches with their debit cards and check-books, but no one was allowed to withdraw money from their accounts.
Banks are considered to be safest organizations – this assumption is very incorrect. The world of finance is full of examples where centuries old major banks have collapsed within a matter of days. Barings bank, GTB bank, just to name a few.
Situation was worse for the shareholders of GTB bank. Being a Saturday, there was no trading. Coming Monday, when the markets opened, there were only sellers and no buyers. The stock went down from 8 Rs a share to 2 Rs. and later to zero. The bank had collapsed completely and the stock investors were the ones who lost miserably. Though I was fortunate enough not to have any holdings of GTB stock in my portfolio, but I still cannot forget the look on the face of a colleague who had GTB stocks worth 30,000. That day, 30,000 of his holdings were translated to zero, or a 100% loss.
Later, Oriental bank of commerce acquired GTB. The bank account holder’s money was safe, but the people who lost dearly were the stockholders of GTB.
No equity research analyst, no fund manager, no auditor was able to predict the destiny that GTB stock had met. Instead, it was suppose to be an emerging star of the banking midcaps.
Why am I raising this issue of GTB today after 3 years? No, I’m not going to quote it as another straightforward example of risk in equities, but I want to highlight another debate that has recently begun.
Accounting firm Pricewater House Coopers or PWC was responsible for auditing the bank records of GTB. Banks have a class of assets or holdings, which may result in losses. This falls into the category of NPA or Non-performing assets. The higher the value of NPA for a bank, the worst is its performance. For example, NPA may be coming from the defaulted loans that bank has given to people who defaulted on payment on loans and bank has no way to recollect it back.
Pricewaterhouse coopers was doing auditing of the records of GTB bank and yesterday it came to light that PWC did not report the high level of NPA that GTB bank had. Instead, while doing accounting, it reported a very low level of NPA which was way below the actual figure. Now, the regulatory authorities are going to launch an investigation in which PWC practices have become questionable. PWC can face severe problems, which may include barring it from continuing accounting or auditing work in
The point that I’m trying to make is that it took 3 years for the regulatory authorities to just come up with the charges against the alleged malpractices and the firms and people involved. How long further it will take for the truth to come out, I guess even God cannot tell. Even after the truth is revealed, can the stockholders of GTB get anything – NO. All they can do is repent on their investment decision and think about maintaining caution for further investments. The truth is that the bank collapsed in just 1 day – though being advised as a midcap star performer just few days back.
No fund manager or researcher could guess the destiny of GTB bank. The reason, all their recommendations and investment decisions were based upon the balance sheet analysis, profit and loss account – which ultimately proofed to be erroneous. It’s all there in the past – what will be happening in the future no one can tell with confidence.
Trusting the balance sheets, profit and loss account, Earnings per share EPS, or similar such figures reported in the quarterly or annual financial results can be very risky. It’s easy to say that if there are any problems in the financial reports, the management and governing body members will be put behind bars. However, the truth is that it’s the investors like you and me who loose money. What would an investor get if the financial officer of a bankrupt company is sent to prison? The investor gets nothing – instead he looses his investment. By the time the reality is revealed, it’s too late.
Chasing midcap performers is easy, taking risk is also easy. Let’s just keep in mind the case of GTB bank – 3 years, yet to trace the culprits.
Keep visiting this blog for further content.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoid duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Thursday 16 August 2007
Complex Insurance Policies to be taken off
Not sure how many of you have missed an important news item yesterday.
The IRDA or Insurance Regulatory Authority, which sets the standards and protocols for the insurance companies to operate and sell the insurance policies, has issued a notice to some insurance companies regarding their policies.
The notice is issued for taking off the policies from the markets which are very complex in nature, especially in terms of the way they charge commission. The problem identified by IRDA is with regard to the insurance policies having highly complex commission structure. “Better Late than Never” – atleast IRDA woke up to take some action against the freely flowing insurance markets, which appeared to be completely insane and out of control.
The two worst hit insurance companies are Allianz Bajaj (with its Super Agent) and Aviva (offering UNCERTAIN “Kal Par Control” – by deducting CERTAIN heavy charges today itself). These are the 2 companies which have highly complex commission charges structure for their insurance policies.
Readers are advised to go through the COMMENTS SECTION of my previous article Insurance v/s Investment v/s Tax savings – agent based business . There, Shashi had asked me about explaining the commission structure of the UnitGainPlus Single Premium Policy from Allianz. Here is how the policy was charging commission and administration fee to the investors:
You invest 2 Lakh in this policy. The policy mentions that 98% of your money will be invested while ONLY 2% will be the charges. This gives the impression that 98you’re your money will be invested. But the truth is that first, 98% of your money will be invested, so you would be given Policy Units worth 98% of your money. From these units, they will deduct further charges, by canceling the units from your account. Here is what the policy mentions:
-Policy Administration Charge: Rs 600 per annum deductible monthly through cancellation of units, inflating at the rate of 5% per annum.
What this means? Though your invested amount will be 98% of 2 Lakhs, they will recover the admin charges by first investing your 98%, and then immediately canceling some of the units equivalent to 600 Rs. per annum. Moreover, this charge will keep on increasing at 5%, meaning, each year the admin charge will keep growing at 5%. Another problem is that the charges are deducted each month. This means that the compounded value of your investment will suffer severely.
-Fund Management Charge: The fund management charge would be levied on NAV and the rate is as follows: Equity Growth Fund 1.75% p.a., Equity Index Fund II 1.25% p.a., Liquid Fund 0.95 % p.a., and Bond Fund 0.95% p.a.
Now what's the point in paying 1.75% charges each year in the name of fund management? All charges again deducted by canceling the Units.
This policy is doing nothing but making a fool of the investor (as other policies do too) by disguising the charges. First they say that 98% of the money is allocated and you get units worth 98%. Then they deduct their charges by cancelling the Units that too on a monthly basis. Smart People,
IRDA has woken up to these malpractices and disguised commission charges. Not only Allianz Bajaj policies, but also AVIVA policies will come under fire. IRDA has issued a notice to these insurance companies to withdraw these complex commission policies and replace them with more transparent policies within 15 days.
I would say IRDA has now started to do its real job – to regulate the insurance markets, commission charges and agents.
I would expect IRDA to further take disciplinary actions and instruct these companies to refund the charges that have taken so far on these insurance policies.
Most important and a better action would be to tighten the rules for selling the insurance policies – It would require defining strict guidelines for insurance agents who sell these policies without even they themselves understanding it. Best would be to have a certification exam from IRDA, only after qualifying the exam should a person be eligible to sell the policies. Presently, any person with a 12th class qualification can become a LIC agent. When educated engineers, doctors, etc. in metro cities are not able to understand the policy terms and conditions, imagine how the situation would be in small towns where people are not that well versed with finance. Agents exploit them to a much larger extent. If the insurance companies are penalized for floating such complex policies, even the agents should be penalized for selling these – by a partial refund of their commissions to the policy holder.
I would like to follow up on this article from the people who have bought such policies. Maybe you’ll get a notification from your insurance company in a few days, mentioning the withdrawal or replacement of your existing policy. Please do let me know what is given to you – a new policy or a sum of money. I will be happy to analyze if things have improved or worsen or remained the same. Please post the details in the comments section.
Keep visiting this blog for further content.
Please read the comments and post your views and queries in the comments section which helps in open discussion and avoid duplicity of questions.
You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.
Wednesday 15 August 2007
Compounded Interest rates: The magic of compounding - Part I
Very often we hear this term: Compounded interest rates. What is it and how it really works?
Let’s look into details of this because this term is widely used across all kinds of investments: Banks, Fixed deposits, PPF, even stock markets and other forms of businesses. In this article, I’ll also illustrate how our investments in stocks, FD etc. are affected by compounded interest rates or returns.
Assume that you have 10,000 dollars. There is a special bank account (say of type A) that is offering you 10% interest rate compounded annually while there is another bank account that is offering you same 10% interest rate, not compounded, but simple interest rate (say of type B).
So, suppose you decide to invest 10,000 each in both these accounts and you want to remain invested for 10 years long period. Since bank account A offers you compounded interest rates, the interest earned in year 1 will add to your principle amount of 10K, and this total will become the principal for next year.
This is how your money will grow in bank account A for the next 10 years:
| Year | Total | Interest | Net after Interest |
| 1.00 | 10,000.00 | 10% | 11,000.00 |
| 2.00 | 11,000.00 | 10% | 12,100.00 |
| 3.00 | 12,100.00 | 10% | 13,310.00 |
| 4.00 | 13,310.00 | 10% | 14,641.00 |
| 5.00 | 14,641.00 | 10% | 16,105.10 |
| 6.00 | 16,105.10 | 10% | 17,715.61 |
| 7.00 | 17,715.61 | 10% | 19,487.17 |
| 8.00 | 19,487.17 | 10% | 21,435.89 |
| 9.00 | 21,435.89 | 10% | 23,579.48 |
| 10.00 | 23,579.48 | 10% | 25,937.42 |
In case of account B, the interest earned in year one will not be added to your principle amount of 10K. Instead it will be paid to you. Hence, your eligible principle for each year will remain 10K and this is how it will grow in bank account B:
| Year | Total | Interest | Net after Interest | Income |
| 1.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| 2.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| 3.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| 4.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| 5.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| 6.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| 7.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| 8.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| 9.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| 10.00 | 10,000.00 | 10% | 11,000.00 | 1,000.00 |
| | | | Total Income | 10,000.00 |
Therefore, at the end of the 10th year, you will get back your original principle amount of 10K and over these 10 years, you would earn 1000 Rs. each year (as interest), so your total will be 10K + 10K = 20K.
Now compare the total maturity amounts from the 2 different bank accounts A & B. Bank account A with compounded interest option gives you 25,937 $, while simple interest account B gives you only 20,000 $. Definitely, in terms of money earned, you are getting more in compounded interest option.
In terms of percentage gains, income from compounded interest bank account is 30% higher than that from simple interest. Hence, this appears to be a more attractive option.
However, nothing in this world comes for free. The 30% extra income that you are receiving from compounded interest comes at a cost. The cost is in the form of loss of freedom and access to both the principle amount and for the interest earned. For compounded interest amounts, you cannot withdraw your principle amount of 10K or any of your interest earned during the entire investment horizon of 10 years. While in case of simple interest account, your principle may be locked, but you have freedom to utilize the interest amount of 1000 each year.
When we think about long term investments, we are basically willing to forego the invested money for the entire investment horizon. If that is the case, then it’s always better to opt for compounded interest. For e.g., when you open a fixed deposit account (FD), you have the option to specify how do you want your interest to work
- Interest should be reinvested (Compounded Interest)
- Interest should be paid to you (Simple Interest)
Another example that can be quoted here is of the tax saving bonds. These bonds come with a lock in period of 3 years and pay the interest annually. So at the end of each year, you receive a check (cheque) for the interest amount you earned on your investment. Therefore, this interest amount does not add up to your principle and hence your investment in bonds becomes that of a simple interest account.
So depending upon your need, you should select the right option.
Now, let’s get into some more details, carrying forward the same discussion to stocks, mutual funds and other forms of investments. We usually hear these kinds of statements, from novice investors, business experts and guest speakers on business news channels:
“Stock Markets are giving 15% returns each year”
OR
“Stock returns have been excellent since we are seeing 20% profit in stocks each year for the last 10 years”
These statements are quite commonly heard. But what’s the truth and how does it really work?
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