Jan 12, 2009|
Is Satyam a cigar butt?
A banner outside the Churchgate railway station in Mumbai reads, "Satyam Maha-ghotala. Zimmedaar Kaun?" Its English translation would be "Satyam's big scam. Who's responsible?" The banner is advertising a seminar to discuss the course of action for shareholders in the company. Well, a lot of ink has already spilled over questioning who's responsible for the scam that was unearthed last week. And the fingers keep turning towards various parties - auditors, audit committee, independent directors and bankers. The fact is that all these parties are equally responsible for the part that each had to play in the making of this the scam.
We had an internal meeting the day after the Satyam-Maytas transaction was brought down on the ground due to investor opposition. We discussed the question - "What should an investor do with cases like Satyam?"
A point of discussion was that the company's business model was not bad, its management was. And considering Warren Buffett's statement that "if a management with a bad reputation tackles a good business, the reputation of business prevails," the idea was that the Satyam's business could have been a good investment opportunity given that the valuations came down to 'attractive' levels.
Another line of thought was that investment into such a company (or similar ones) was not worthwhile, whatever be the valuations. This is because you as an investor will not trust these people who are closest to handling 'your' assets ('your' because you being the shareholder, are a part owner of the company. The managers aren't!).
However, if there were to be a (positive) change in the management, auditors and independent directors, the decision to invest/not invest can be thought over again.
Warren Buffett calls this kind of opportunities as 'cigar butts' (disgusting but good for one last puff) - lousy companies trading at deep discount to their working capital or sometimes even cash.
Now here is what Buffett had to say on this topic of cigar butts in his 1989 annual report to shareholders of Berkshire Hathaway - "If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the 'cigar butt' approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the 'bargain purchase' will make that puff all profit."
That's Buffett's view on investing in troubled companies at very cheap valuations.
However, here is what he said further:
"Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original 'bargain' price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces - never is there just one cockroach in the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return that the business earns."
Read again - "...never is there just one cockroach in the kitchen." Satyam's case has proven this to the core. Countless cockroaches are coming out of the company's kitchen which its Chairman had used to cook the books.
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