As a nation weeps...

Aruna Shanbaug, Priyadarshini Mattoo, Baby ‘Falak’, ‘Amanat’... I can go on. Each of these cases of abominable crimes against women has shaken the collective conscience of an entire nation. A familiar cycle follows –

Let’s look at the key issues, setting aside platitudes and tangential discussions:

1. Mindset (not poor education): The educated middle-class often tends to believe (or likes to believe) that perpetrators of these heinous crimes belong to some other part of the society. They don’t. Quite often these criminals are well-educated and have regular jobs or businesses. The issue therefore is mindset and not education. For millennia, men around the world have believed that their physical edge over women translates to “supremacy” over women on all fronts. This “supremacy” is sometimes asserted via sadomasochistic barbarism towards women.
2. Criminal justice system: By any measure, India is woefully short of crime-prevention & investigating personnel (policemen, judges, detectives etc) and agencies/institutions equipped with state-of-the-art technology and modern mechanisms to tackle crimes of this nature. Antiquated laws framed in the 1800s don’t help either.
3. Stigma: “Victims” of sexual assaults and/or rapes often are stigmatized by neighbours and relatives. One often hears of cases where marriage is proposed as a “solution” for a young girl who has been raped (often by a known person) so that the crime may be suppressed without social stigma. “Ladki ki izzat lut gayi, ab iski shaadi nahi hogi” mentality is the root cause behind many girls attempting/committing suicide. Marital rape in contrast doesn’t have as much stigma attached, but as a consequence is often ignored.
4. Sensitivity: UPA Government’s reaction, especially in Amanat’s case (NOT her real name) has caused much anguish and rightly so! Muzzling genuine anger directed towards an insolent State by shutting down nearby metro-stations, imposing Section 144 (incidentally used by the British to prevent Indians from “unlawfully assembling”); using water cannons, expired tear-gas shells and lathi-charging the youth & elderly (see the picture below) leaves you wondering whose side the State is on. In addition, NSUI thugs were allegedly sent in to create a ruckus to derail the movement. Sushil Kumar Shinde, Honorable Home Minister in a shocking display of apathy said: “If tomorrow 100 adivasis die in Gadchiroli, I can’t go and speak to them”. Manmohan Singh, Honorable Prime Minister read out a vapid speech filled with platitudes and ended it with “Theek hai” (seeking approval upon reading out the speech correctly). When the nation sees a crisis, its citizens expect the Government to stand up and respond with compassion and honesty of purpose. I leave it to your judgement to decide how the UPA responded.

Source: IndiaTimes

In times of chaos and madness, it is imperative that we keep our emotions within us and be ruthlessly logical in our thesis. Hence, may I critique a few “solutions” that seem to have become popular:

NON-solutions:

1. Vigilante justice: Gangaajal type solutions tend to be strongly approved when public anger swells beyond a point demanding “instant justice” and the state is seen as ineffective. Unfortunately, this anger does more harm than good (for instance – see the support for this image displaying retaliatory action that’s supposedly the “right punishment” for rapists). The outraged common citizen as well as several public “intellectuals” have called for “cutting off the manhood”, “stoning to death”,  “hanging in public”, “chemical castration”, “immediate death penalty” etc as “solutions”. Countering barbarism with even more barbarism isn’t a solution in a civilized society. “Oh but the perpetrators weren’t civilized so they don’t deserve civility” argument doesn’t hold. The law must be allowed to take its course and the nature of punishment (exemplary vs not, death vs not, etc)  is perhaps best left to the wisdom of courts themselves. 
2. Fast-tracking some cases: This is contentious, but I’m against fast-tracking certain cases if there’s pressure building up underneath arguing for the same. It is a zero sum game because judicial & police bandwidth is finite. Fast tracking a particular rape-case automatically implies going slow on a terrorism case or a different rape case in another part of India. Should one rape case be treated differently from another simply because the media/public has latched on one and not the other?
3. Blaming police: Most policemen I know or have interacted with at different points of time in my life are like you and me – they are ordinary citizens of the country who do their duty sincerely (like you and me) and occasionally screw up (like you and me). It is insidious to think that the policemen are against us or derive some sadistic pleasure by harassing us. What is important to acknowledge is – they sometimes have hard bosses whose orders they simply can’t refuse (just as you or I can’t refuse an office senior’s orders). So when “orders from top” (typically politicians you and I have elected) direct the police to act in a certain way, they usually do. Can you blame them?
4. Martial arts training for women: Particularly dangerous should the woman get over-powered by the potential rapist/assaulter. She can be brutally beaten to death or worse...
5. Removing dark films & curtains on windows of vehicles: May potentially address a small percent of “vehicle rape” cases (doubtful nonetheless), but futile in all other cases. This is a classic example of a specious knee-jerk solution.
6. Having female CMs / heads of coalitions: Has absolutely no correlation with prevention or investigation of a crime, which is an executive and judicial process. Sure, political will helps frame tough laws and energize the executive but I doubt if gender has any role here.
7. Asking girls/people to stay home post 9 pm: This is an escapist solution and a lame admission that the State can't guarantee anyone's security. Isn't the whole point to ensure that people feel safe 24x7?

Unfortunately, there are no easy answers. Nonetheless, let me take a shot at recommending a few solutions:

1. Mindset: Starts at the family level first and then transcends to a societal level. As long as some men continue to assume that their physical edge over women grants them legitimacy to assert their “superiority” on all other fronts, preventing crimes against women will continue to remain a dream. Mindset change is not an overnight process as decades of conditioning has to be undone for new thoughts to settle in. I believe it is possible but it has to start at home and our schools.
2.  Judicial, police and administrative reforms: Several committees and commissions by renowned experts and senior jurists have looked at radical across-the-board judicial, police and administrative reforms to address challenges of modern times. May we start implementing their recommendations to ensure our criminal justice system works smoothly, institutions are allowed to function effectively and rule of law is proactively upheld in all cases? I’m not advocating a police state here, but tough laws and stringent implementation are necessary. While robust institutions are essential for a nation’s progress, it is invariably the underlying political leadership that determines the strength of these institutions. 
3. Stigma: Stigma can be removed if “rape victims” are treated as “rape survivors” (just as accident survivors). Forcefully marrying a raped girl to her rapist only exacerbates the problem – let the girl decide who she wants to spend the rest of her life with. Just as stigma over divorce is now luckily decreasing (atleast in the upper middle class society), I believe stigma over rape will reduce too and this will lead to a gradual increase in reporting of rape/sexual-assault cases.
4. Sensitivity: Sensitivity is crucial since all girls feel unsafe at some level every time a case of rape or sexual assault is reported in the media (“She could be one of us” is an undeniably common feeling that naturally sends shivers down their spine). Greater sensitivity in handling cases like these – first from the police while registering it, to the officers investigating it, the media folks reporting it and finally the government while addressing concerns over security of its citizens, is a basic necessity.

I welcome your comments and suggestions. You may reach me at utsavmitra@hotmail.com or via Twitter @UtsavMitra

Fate of India rests on education of its youth

I work as a pro-bono consultant to the Akanksha Foundation in Mumbai and hence got to see functioning of municipal schools rather well from close quarters. I began reading about the state of education in India, the key challenges and what really needs to be done. Here are my reflections:
http://www.niticentral.com/2012/09/fate-of-india-rests-on-education-of-its-youth.html

Lies, damned lies and UPA’s statistics

Here's a post that first appeared on NitiCentral about the UPA Govt's regular bungling in reporting financial data. Indeed, one tends to wonder whether this is deliberate (one would hope not!). See the full post here:
http://www.niticentral.com/2012/09/lies-damned-lies-and-upas-statistics.html

My speech at the Youth Conference 2012

Folks at Thincquisitive.com have been very kind and have published my speech delivered at the Youth Conference 2012 organized at Delhi University. Here are my notes from the speech (which I broadly stuck to) -- http://thincquisitive.com/2012/08/16/tq-specials-utsav-mitra-speaks/

I welcome your feedback.

101 on Investing

Three points to note about investment advice that generally floats around:

1. Market movements almost never mirror reality/logic, contrary to what theories such as “Efficient Market Hypothesis” will tell you. As Keynes once remarked “Markets can remain irrational far longer than you or I can remain solvent”
2. Analysis always tends to be post facto. Therefore, with the wisdom of hindsight, past events may be justified. But there’s no guarantee that future events will play out similarly.
3. Most brokers (in the garb of ‘experts’) are paid to peddle stocks on business news channels by certain investors. Use your judgement before committing capital based on hearsay!

We invest in equities to make superior returns on our capital (vs fixed deposits and bonds). There’s greater risk obviously, but we hope our insights/information/luck will help us get to those superior returns. Aim of this post is to analytically think through what the drivers of those returns are and how the math behind it works.

Drivers of Returns:

There are four aspects that primarily move the needle on returns, and all of our investment diligence should therefore be centered on these issues:

1) Growth: Splits out into market growth and market share. Say a market is growing with India’s nominal GDP (15%), and you think the company can gain some share over time (a nuanced sub-segment level understanding of each of the product lines of the company is necessary to make this claim!) You assume that the share gain will be rapid and you underwrite that it would outpace the market by say four points. Implicitly your revenue growth assumption is 20% (16%+4%).

In the ideal world, you want to find a company that has some of the following characteristics (obviously non-exhaustive) to give you comfort about growth & share:

• Strong competitive position in a high-growth industry driven by high barriers to entry (say technology / patents) and brand loyalty (e.g., iPod)
• Scalable business in a concentrated industry that would see a small subset of players capturing an unfair share of the market growth going forward (e.g., 2 wheelers)
• Relatively free from regulatory hurdles and govt/political influence (therefore keep off infrastructure, real-estate etc)
• Low customer churn with long-term sticky contracts (e.g., BPO) or low customer concentration (e.g., retail industry)

2) Margin: You have to take a call on COGS (Cost of Goods Sold i.e. direct costs attributable to the production of goods or raw material costs +conversion/direct costs) and SG&A (Selling, General & Admin expenses). These two are your main cost buckets that flow through to your EBITDA.

EBITDA stands for Earnings before Interest, Tax, Depreciation & Amortization. When people talk about “operating margin”, they refer to EBITDA margin. EBITDA = Revenue – COGS – SG&A. Other costs below EBITDA are depreciation & amortization (both are non-cash expenses), interest on your debt (if any) and taxes.  EBITDA – Depreciation & Amortization – Interest – Tax = Profit after Tax or PAT.

Now that we have the definitions out of the way, you should pay close attention to how you think gross margins (Revenue less COGS) will play out in your investment period. Say you assume it will improve due to price increase (basic inflation + price premium for your products due to better perceived quality) and lower conversion costs. Say you assume you would gain 0.5% of revenue each year on gross margins on account of these two levers. 

You also have to consider SG&A – you could get some leverage from employee expenses, better utilization of facilities etc but could consider increasing spend on sales & marketing. In our case, let us assume all the savings from the former is invested in the latter (i.e. sales) and your SG&A margin remains constant every year.

Therefore, in this case, your EBITDA margin will expand by 0.5% every year (0.5% increase due to gross margin expansion and no change in SG&A) 

3) Multiple: The multiple on EBITDA or PAT is technically meant to be the closest proxy for future cash flows of the company. In reality though, it changes every minute as expectations change depending on macro environment, regulatory changes, liquidity, significant events at other companies etc. To evaluate the “right” multiple to pay, it’s probably wise to compare the current multiple to the five year average to get a sense on how the multiple has moved over time. In the ideal case, you don’t want to be buying off a high. Remember the age-old truism “Buy low, sell high”.

Super-normal returns can be made if you believe that the market is currently under-valuing the company and you have sound reason to believe you are seeing something that the market isn’t and that the market will hopefully come around over time. Many industries have re-rated upwards (e.g., consumer) and many have re-rated downwards (e.g., Mid-tier IT) over time, so it is crucial that you see today’s multiple in perspective and take a call suitably.

In general, market-leaders trade at a slight premium, so if you believe your company (say currently at #2) will eventually be #1 due to superior product innovation, better management etc, you could underwrite a click or two of multiple expansion. Nonetheless, this is one area where you would rather be conservative and wait to buy when there’s a steep correction due to an uncorrelated event.

4) Changes in capital structure: This is a slightly more complex topic and deals with capital structure of a company. It is rarely a driver of returns in India (given high interest costs, regulations etc) so I’m not in favor of a lengthy discussion. But here’s the short of it, for those who are interested:

Say a company in the US is worth $1B and it’s debt to equity ratio is 4:1 i.e. $800M of debt and $200M of equity. You use the company’s current cash flows to pay down say 50% of the debt in your investment horizon. Even if the company’s enterprise value remains constant and nothing else in the business changes materially, you are now left with $400M of debt => $600M of equity i.e. 3x return on your equity simply via debt pay down :) This math gave birth to the LBO industry.

Let us put what we have learned to good use and do some simple math.

Basic math on how returns work:

Say a company has year-end revenues of Rs. 100, EBITDA % of 20% and PAT % of 10%. 

For the sake of simplicity, let us value the company on LTM (last twelve months) Price to Earnings (PE) multiple and say the multiple is 15x. Market cap of the company = 15x PAT = 15 * 10% * 100 = Rs. 150

Now say there are 15 shares of the company. Therefore, each is valued at Rs. 10. You buy say 5 shares from an existing shareholder (technically a ‘secondary purchase’). Now you own 5/15 shares i.e. 33.3% of the company.

Say five years down the line (typical time-horizon for a long–term investor), the company has grown its revenues at 20% CAGR and has been able to maintain EBITDA and PAT margins (over-simplistic, but let us go with this). Assuming the multiple doesn’t change, you would make 20% returns YoY on your 5 shares. Your Rs. 50 now is worth 50*(1+20%)^5 = Rs. 124. Therefore, you have a Multiple of Money (MoM) of 2.5x and an IRR of 20%. Simple?

Let us flex the other variables as well, so everyone has the math clear in their heads:

Say the company’s revenues grew at 20% YoY. Let us now say that the company did a bunch of operational improvements thereby enhancing its margins and say its PAT grew by 25% YoY. Also assume that the market starts loving the company and starts paying a premium on its shares, now the multiple expanded from 15x to 18x. What returns will you make on your 5 shares purchased @ Rs. 10 each?

The simple P&L will look something like this:

Therefore the company’s PAT at exit is Rs. 31, the multiple at exit is 18x, therefore market cap at exit = Rs. 31 * 18 = Rs. 558, up from Rs.  150 at entry.  Share price is now Rs. 558/15 = Rs. 37.2. You own 5 shares, hence your shares are now worth Rs. 37.2*5 = Rs. 186

Therefore, your simple returns are:

MoM = 186/50 = 3.7x

IRR = 3.7^(1/5)-1 = 30%. Neat! :)

Note: This return math assumes none of the following have happened in the investment horizon - dividends/re-caps from excess cash accrued, management options, interim primary infusion, back-leverage and all other second order issues

I will (hopefully soon) come up with a separate post on “Nuances to investing in India” where I will talk about promoter/governance issues, issues with ‘control transactions’ in India, how bankers try and raise expectations etc.

If you’ve reached this part, I am assuming you read the post and I hope this was helpful. I have tried to keep it simple, but if you have any questions, I’m happy to answer them. You can reach me at utsavmitra@hotmail.com