WILL THE NEGATIVE LIST PASS MUSTER?

“The State governments' proposal to exclude certain services from the list targets the fundamental issue of overlap in taxation by the Central and State governments.”

The Union Budget 2012-13 is likely to witness a revolutionary shift in taxation of services in India with the introduction of the negative list of services.

All non-considered biases caused by the present tax system of services, which plays favourites by taxing some services and leaving others out of the tax net, could be done away with the introduction of this list. The present list is of over 125 taxable services.

The Empowered Committee is understood to have proposed a rider that the Centre will exclude areas or activities which fall within the State's jurisdiction, such as construction, entertainment, restaurants, transport of goods and inland waterways, beauty parlours, health and fitness, etc.

They argued that if States are taxing certain activities or propose to charge such services to tax under the GST regime then the Centre should not cover those services for levy of service tax under the negative list, as it would not provide an additional tax base to State Governments in the GST regime.

The arguments of the state governments to support their stand on carving out certain activities from the Centre's ambit may sound reasonable. However, to what extent it gains support under the present constitutional framework needs to be looked at. The State governments' proposal targets the fundamental issue of overlap in taxation by the Centre and the States, which has been a subject matter of intense debate and litigation for a long time.

Given the way these taxes are computed, the taxable value of the contract across the two taxes exceeds the value of the contract. This is a typical example of double taxation due to overlapping jurisdictions.

The negative list, if introduced in the Budget, without consensus and the accompanying challenges, would require humongous effort and a long time frame at a later date to guide the legislation and taxation of service on to the right path and prove a costly affair both to the assessee and the administrator.

The implementation of point of taxation rules, proposed introduction of negative list with parallel changes to the existing legislations and eventually the implementation of GST are right steps in the direction of reshaping the indirect tax regime in India.

However, a clear consensus on the scope of taxation between the Centre and State is a must before we embark on this journey.

Warren Buffett investment principles :

THE RIGHT PRICE TO PAY:

1.    A GREAT COMPANY AT A FAIR PRICE:

Nobody really knows the specific principles that Warren Buffett applies when deciding the price he will pay for a share investment. We do know that he has said on several occasions that it is better to buy a ‘great company at a fair price than a fair company at a great price’.

This tends to agree with the view of Benjamin Graham who often referred to primary and secondary stocks. He believed that, although paying too high a price for any stock was foolish, the risk was higher when the stock was of secondary grade.

2.    PATIENCE:

The other thing that Warren Buffett counsels, when deciding on investment purchases, is patience. He has said that he is prepared to wait forever to buy a stock at the right price.

 There is a seeming disparity of views between Graham and Buffett on diversification. Benjamin Graham was a firm believer, even in relation to stock purchases at bargain prices, in spreading the risk over a number of share investments. Warren Buffett, on the other hand, appears to take a different view: concentrate on just a few stocks.

3.   WHAT WARREN BUFFETT SAYS ABOUT DIVERSIFICATION?

In 1992, Buffett said that his investment strategy did not rely upon spreading his risk over a large number of stocks; he preferred to have his investments in a limited number of companies.

4.    NO REAL DIFFERENCE BETWEEN BENJAMIN GRAHAM AND WARREN BUFFETT:

The differences between Graham and Buffett on stock diversification are perhaps not as wide as they might seem. Graham spoke of diversification primarily in relation to second grade stocks and it is arguable that the Buffett approach to stock selection results in the purchase of quality stocks only.

5.    BERKSHIRE HATHAWAY HOLDINGS:

In addition, consideration of Berkshire Hathaway holdings in 2002 suggests that although Buffett may not necessarily believe in diversification in the number of companies that it owns, its investments certainly cross a broad spectrum of industry areas. They include:

• Manufacturing and distribution – underwear, children’s clothing, farm equipment, shoes, razor blades, soft drinks;
• Retail – furniture, kitchenware
• Insurance
• Financial and accounting products and services
• Flight operations
• Gas pipelines
• Real estate brokerage
• Construction related industries
• Media

6.    INTRINSIC VALUE:

Both Warren Buffett and Benjamin Graham talk about the intrinsic value of a business, or a share in it.  That is, to buy a business, or a share in it, at a fair price. But, having regard to the possibility of error in calculating intrinsic value, the careful of investor should provide a margin of error by only buying the business, or shares, at a substantial discount to the intrinsic value. Buffett is said to look for a 25 per cent discount, but who really knows?

7.    DEFINING INTRINSIC VALUE:

Buffett’s concept, in looking at intrinsic value, is that it values what can be taken out of the business. He has quoted investment guru John Burr Williams who defined value like this:

‘The value of any stock, bond or business today is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset.’ – The Theory of Investment Value.

The difference for Buffett in calculating the value of bonds and shares is that the investor knows the eventual price of the bond when it matures but has to guess the price of the share at some future date.

8.    DISCOUNTED CASH FLOW (DCF):

This method of valuation is often referred to as the Discounted Cash Flow (DCF) valuation method, but, as Buffett has said in relation to shares, it is not easy to predict future cash flows and this is why he sticks to investment in companies that are consistent, well managed, and simple to understand. A company that is hard to understand or those changes frequently does not allow for easy prediction of future earnings and outgoings.

Ultimately, the investor must decide upon their own methods of arriving at the intrinsic value of a share and the margin of error that they want for themselves.

Dilution

The recent article I read "Understanding Dilution" by Prof.Sanjay Bakshi, today would like to share my views on the same.

The article mostly talks about how dilution is taking place in the capital market and how investors today are changing.

Long ago, investors were eager to invest in companies that could dream up grand projects that require huge capital. The earnings that were generated through capital into capital intensive projects were given higher price-earnings ratios. But now there is a complete U turn in the way capital market has been performing. Let’s see how this dilution has affected.

Earnings per share Dilution:

EPS is arrived at by dividing its total earnings in that year by the number of shares outstanding. Therefore, when a company issues additional shares, the result is a fall in it’s per share.

This fall is referred to as “earnings per share dilution”.

Intrinsic Value per share Dilution:

What matters is not EPS dilution but intrinsic value per share dilution. Lets understand this difference.

A 25-year old first year MBA student who is currently earning nothing. His EPS is nil & a peon working with the same educational institution being a wage earner has a positive EPS. Now, imagine both of them agree to share their future earnings, such agreement would immediately increase the EPs of the student in a big way but will reduce his per-share intrinsic value.

Managers often forget that while they can take decisions that affect EPS, it is the market that will determine the price earning ration and consequently the stock price. So if an irrational managerial decision increases EPs but reduces intrinsic value, the market will punish the company with low P/E multiple. Conversely, if a sensible managerial decision reduces EPS but increases intrinsic value the market will reward by an increase in P/E ratio.

 Here are a few examples of irrational managerial actions that focus on EPS, instead of intrinsic value per share:

1. Operating Decisions:

 Hindustan Lever spent Rs 108 crores on advertising in 1995. That expenditure accounted for 2.86% of its total sales for that year. Its pre-tax profits for the year were Rs 372 crore. Suppose, HLL had instead decided to stop all advertising Such a decision would have increased its pre-tax profits by more than 25% for 1995 but would have significantly reduced its per-share intrinsic value.

The end result is that cash outflows on account of taxation would be delayed. This would increase the per-share intrinsic value of the business while reducing its current accounting profits and EPS. How many managers do you think would have the courage to take such a decision? Very few indeed.

2. Financing Decisions:

When a company needs funds for its business, it has only two sources - equity and debt. Because, using debt does not result in an increase in the number of outstanding shares, many managers prefer to finance growth out of debt, basing their decisions on the favourable impact on the EPS of the company. They forget that increasing debt also increases the risk of bankruptcy. And markets punish companies that over-leverage their balance sheets by assigning low price-earning multiples to their earnings. So, while EPS may rise, a fall in the P/E ratio may nullify the effect of EPS increase on the stock price.

3. Merger/Acquisition Decisions:

Many promoters run their businesses to build empires not to enhance owners' wealth. Frequently, such managers take decisions that increase the size of their company as well as its EPS but reduce its per-share intrinsic value. Their behaviour can be explained by the following example coined by Warren Buffett.

"If (1) your family owns a 120-acre farm and (2) you invite a neighbour with 60 acres of comparable land to merge his farm into an equal partnership - with you as managing partner, then (3) your managerial domain will have grown to 180 acres but you will have permanently shrunk by 25% your family's ownership interest in both acreage and crops. Managers who want to expand their domain at the expense of owners might better consider a career in government."

Double Whammy Effect:

Companies that are run by managers who do not focus on per-share intrinsic value suffer from a "double whammy" effect. If, for instance, such managers ignore actions that would increase per-share intrinsic value, they would be punished by the markets for ignoring sensible decisions by assigning them a low a price-earning multiple for having missed important opportunities of enhancing owners' wealth. On top of this, the company will also be downgraded on another ground. For, rational investors would not pay as much for the assets lodged in the hands of a management that has a record of wealth-destruction by ignoring such opportunities.

Conclusion:

Managements should focus on maximising the value of their companies, not their earnings per share. Investors should insist on managements who act in ways that increase per-share intrinsic value and avoid ways that reduce it.

Source : http://www.sanjaybakshi.net/Sanjay_Bakshi/Articles_files/Understanding_Dilution.HTM

CORPORATE FINANCE:

What corporate finance is?

Corporate finance is all about every decision that company makes that involves money; it’s what every business has to do. Every business has to make basic corporate financial decision.

To start with Corporate Finance is the Balance Sheet:

Conventional accounting balance sheet:

Conventional Balance Sheet is where you have constraints by accounting rules i.e. accounting standard rule governed on how a balance sheet is set.

On one side how assets are break up: tangible: intangible, short term: long term, financial or non-financial. There are dozen’s to categorize.

On other side is the slice & dice your liabilities into diff category: long term debt-short term debt, non interest: interest debt etc. Then what equity is worth, book value, and then what accountant thinks your company equity is worth.

Financial Balance Sheet:

Financial Balance Sheet is often considered as the simpler balance sheet but at the same time complex. Financial balance sheet is basically in two categories. Investments already made & investments yet to make.

When you invest in growth company much of the value comes from growth assets, investment you going to make in future, other side is borrow or use your money. Now in publically traded company, it can take form of bonds or stock, but basically in debt & equity there is only two ways of raising money. Financial Balance Sheet gives a broader & simpler vision of a company.

The best way is to illustrate a financial Balance Sheet is to show 2 different companies:

Let see Coronet which provides electricity to New York City. Its regulated in such a way that price increases assets by commission, its earning is 3% or 4%, its is a mature company, and other is EBay a company which came out of dot.com, eCom boom for which bulk of value comes from invest in future, and in Coronet value comes from the investments already made i.e. assets in place, these r investment made 20, 50, 70 yrs ago which was around 18billion.There are growth investments as well by small size com which are 3billion were out of 18billion, 80% comes from assets placed & less than 20% from growth investments.

Other side of Balance Sheet is the Amount of Debt Equity that it has is 7billion in debt & 11billion in Equity, so this firm is about 40 in debt & 60 in equity. Which is not unusual for a mature company?

But in eBay 6billion is (assets in placed) investments already made and about 70 billion from growth assets. Other interesting thing is most funding comes from Equity & a tiny slice of debt.

Now let’s relate Firms to its life cycle of company.

EBay is young and firms in early age of its Life Cycle tend to get most value from growth and tend to fund through equity, for very simple reason, they can’t afford to carry debt, can’t service, make interest payments, principle payments wit investments they have not even thought of yet, and they even pay very lilted dividends.

Other spectrum: mature company get bulk value form investments already made, they fund them with significant amount of debt and often pay large dividend this gives what typically a company in Life Cycle does and frame what company is in Life Cycle.

Now let’s think what Corporate Finance is all about:

There are 3 basic principles:

1.Investment Principle:

When you as a business make investments it try to invest in assets, projects, new investments that earn a return which is greater than some minimum acceptable hurdle rate. Every investment has a hurdle to cross and that hurdle should be more for riskier & safer investments the hurdle should reflect the risk of investment and also were you raise the money from which also drive the hurdle rate.

When you think of return on investment: return should be measured based on the Cash Flows on that investment. Counting earnings should reflect when a Cash Flow comes in (cash flow earlier is worth more than later)

In words of the Prof: “No room for garnishing in investment analysis”

Fine investment that earn a return greater than min acceptable hurdle rate.

2. Financing Principle:

Basically mix of Debt & Equity to minimize hurdle rate which is right for your company.

Type of debt should reflect the kind of assets you have, long term assets then long term debt. How much each we want to use and a mix that will min our overall cost of funding our business. Now it costs less to borrow den raise money, reason debt attack advantage as interest expenses but Equty doesn’t. Now it’s not necessary to follow that a company must have 100% debt. In fact it turns out to be cost of funding which is a dynamic process..

3. Dividend Principle:

Which says if u can’t find investment that makes your hurdle rate? Take money out of business as there is no law which says u have to keep reinvesting, but if it is a publicly traded company things get more complicated as u got to return dividend to the stockholders, as dividend, cash or buy back.

You have a single objective in corporate finance i.e. to create a value for your business.

Basic Details:

Hurdle rate: Let’s restate it should be higher for riskier investment and lower for safer once and also it’s a mix of Debt & Equity.

How to measure Risk: Through the eyes of marginal investors in business.

Marginal investors : Most likely they are the investors to set price on your company’s stock which is most in pub coma will be owned a lot of company nd trades that stock frequently doen by the founders, investors, FII etc.

Debt Equity mix: what cost you borrow money & raise Equity and take some kind of weighted avg.

Returns: cash flows are clean way of thinking about returns, accounting earning will be subject to whatever discreetly choices you make as an accountant as even small changes move earning around. CF and earning are different but den you want to concentrate more Cash flows then u want to wait and win Cash Flows bring some Quality concerns into the corporate financials final return value which reflects Cash Flow and its timing.

1 issue every 1 has....:

How much cash is too much cash: It depends on how much you trust the managers of the company.

One way is to think of dividend principle: when should I return to stockholder?, When we choose to return then should I pay dividend or buy back answer is as simple as your Stockholder like dividends give dividend or buy back think who your stockholder are.

CF has 1 single objective maximum value of your business, pick good investment, fund them right and pay right amount of dividend.

Source: aswathdamodaran\webcast

Financing Strategy

The key issues to be addressed while formulating a financing strategy for a firm are:

• What should be the capital structure of the firm ?
• Which financing instrument should the firm employ ?
• What method of offering should the firm use ?
• Which market should the firm tap ?
• When & at what price should the issue be made ?
• What should be the distribution policy ?
• How should a firm communicate with its investors ?
• What should a firm do to improve the standard of corporate governance ?

These issues are inter related for pedagogic convenience we will discuss them sequentially.

1. Capital Structure:

           The two broad sources of finance available to the firms are the Shareholder's fund & Loan fund. Shareholder's fund mainly come in the form of equity capital & retained earnings and secondarily in the form of preference capital. Loan fund come from a variety of ways like debenture capital, term loan, deferred credit, fixed deposit & working capital advance.

Now what are the key considerations in determining the debt equity ratio of the firm ?

·         Earnings per Share

EPS which is simply equity earnings divided by the number of outstanding shares, is regarded as an important financial number that firm would like to improve.

Hence we need to understand how sensitive is EPS to changes in profit before interest & tax (PBIT) under different financing alternatives

·         Risk

The two principle sources of risk in a firm are business risk & financial risk.

Business Risk refers to variability of profit before interest & taxes, which is influenced by demand, price, input price variability & proportion of fixed costs.

Financial Risk represents the risk emanating from financial leverage.

·         Control

In the basic ways of raising additional finance i.e. right issue of equity capital, debt finance & public issue of equity capital carry the issue of control. As there can be dilution of control or carry high/low risk and costs.

·         Flexibility

Flexibility here refers to the ability of a firm to raise capital from any source it wishes to tap. It provides maneuverability to the finance manager.

·         Nature of assets

If the assets are primarily tangible, debt financing is more used. On the other hand if the assets are primarily intangible, debt financing is less used. The major explanation here is that lenders are more willing to lend against tangible assets than intangible assets.

2. Financing Instruments:

Equity & Debt come in variety of forms and are raised in different ways.

Sources of Capital:-

·    Equity:

1.      Equity Capital

2.      Preference Capital

3.      Internal Accruals

·         Debt:

1.      Term Loans

2.      Debentures

3.      Working Capital Advances

4.      Miscellaneous Sources

3. Methods of Offering:

There are different ways of raising finance in the primary market: Public offering, Right issue, & Private placement.

Public Offering:

A public offering or public issue involves sale of securities to the members of the public. The 3 types of public offering are the initial public offering (IPO), the seasoned equity offering, and the bond offering.

1.      Initial public offering (IPO):

The First public offering of equity shares of a company, which is followed by a listing of shares on the stock market.

2.      The seasoned equity offering:

As companies need more finance, they are likely to make further trips to the capital market with seasoned offering or follow on offering

3.      The bond offering:

Bond offering process is similar to IPO but have some differences like:

Prospectus of bond offering has company’s stable cash flows.

They are offered through 100% retail route as book building is not appropriate.

They are secured against the assets of issuing company.

Debt issue cannot be made unless the credit rating is done.

It’s mandatory to create debenture redemption reserve.

Right Issue:

It involves selling securities in the primary market by issuing rights to the existing shareholders. When company need additional equity capital it has to issue first to the existing shareholders on a pro rate basis.

Private Placement:

It is an issue of securities to a selected group of persons not exceeding 49. This can be done in two ways i.e. Preferential Allotment & Qualified Institutional Placements (QIP)

How do various Methods of Offering Compare

	Public Issue	Right Issue	Private Placement
Amount that can be raised	Large	Moderate	Moderate
Cost of issue	High	Negligible	Negligible
Dilution of control	Yes	No	Yes
Degree of Under pricing	Large	Irrelevant	Small
Market perception	Negative	Neutral	Neutral

4. Markets:

A firm planning to raise finance may tap one or more of the following capital markets:

Indian Capital Market:

A firm accessing this market has to conform to the regulations of the Securities and Exchange Board of India (SEBI).

Euro Capital Market:

The euro capital market is a global market beyond the purview of any national regulatory body. Firms get an access to this market through instruments like Global Depository Receipts (GDRs), & Euro Convertible Bonds (ECBs).

Foreign Domestic Capital Market:

Indian firms need to obtain clearance from Indian authorities as well as the regulatory bodies of the foreign country.

How do the three markets compare in terms of following points:

	Indian Market	Euro Market	Foreign Domestic Market
Access	Easy	Restricted	Highly Restricted
Market	Small	Large	Large
Cost of Issue	High	Low	Low
Disclosure & Transparency	Less onerous	Onerous	Highly Onerous
Price/Rates	Not so attractive	Attractive	More Attractive

5. Pricing & Timing:

The firm issuing securities has to determine when and at what price should its issue be made. Since pricing & timing are closely related they may be discussed together.

Following points are to be remembered while resolving this issue of pricing & timing:

Decouple Financing & Investing Decision:

Investing & Financing decision do not synchronise often so it is important to decouple them. As Warren Buffet says:”Therefore, we simply borrow when conditions seems non-oppressive & hope that we will later find intelligent expansion or acquisition opportunities, which as we have said are more likely to pop up when conditions in the debt market are clearly oppressive. Our basic principle is that if you want to shoot rare, fast moving, elephants, you should always carry a loaded gun”.

Never Be Greedy:

If present conditions are favourable for a certain type of financing, take advantage of it. Driven by greed, do not wait for an even better possible tomorrow. The advice of Bernard Baruch for the stock market investors “Leave the first 10 percent & the last 10 percent for someone else”.

Ensure Inter-generational Fairness:

Tapping the equity market when it is buoyant does not mean that the firm should price its equity issue far above its intrinsic value. If it does so, the existing shareholders will benefit at the expenses of new shareholders.

6. Distribution Policy:

It’s concerned with issues like how much of its earnings should a firm apy by way of dividend, what are the implications of bonus issues & stock splits, and when does it make sense to buy back shares

Key considerations Influencing Dividend Policy:

·         Earnings Prospects

·         Funding Requirements

·         Dividend Record

·         Liquidity Position

·         Shareholders Preference

·         Control

7. Investors Communication:

To ensure that the intrinsic value of the company reflected in its stock price, the company should communicate intelligently with the investors. What a company should do and should not do in this respect can be appreciated by understanding how the stock market really works.

As Bennett Stewart & David M Glassman put it:”Stock prices, like all prices, are set not by averaging investors; they are set ‘at margin’ by the smartest money in the game. The herd is led by influential investors-lead stress as we call them. They care about cash flow and risk; they are not fooled by accounting illusions”.

Given dominant role of ‘lead steers’, the company should bear in mind the following guidelines while communicating with the investors:

·         Deemphasise Financial Disclosure.

·         Avoid Financial Hype.

·         Cut ‘Lead Steers’ into the Planning Process.

8. Corporate Governance:

Corporate Governance is concerned basically with the agency problem that arises from the separation of finance and management, or refers to the constraints that managers put on themselves or those investors to provide funds ex ante and check misallocation of resources ex post facto by managers.

It covers issues like the legal rights of investors, role of large investors, the system of electing the board of directors, the composition of the board & various sub-committees etc

A great deal of concern has been expressed in recent years about the poor quality of corporate governance, in general, in India.

This was also echoed in the 1999 Budget speech of Union Minister Yashwant Sinha when he said” if investors have to be drawn back to capital market, companies have to put their houses in order by following internationally accepted practices of corporate governance. This is necessary to enhance investors confidence”.

My First Blog...:)

I'am super excited to start my own blog.
But first i must confess that i read quite few on various topics from articles, books & various sources of learning so here, in this blog would share my random thoughts & views on what ever i read & learn.
Even would give my sincere Thanks to our Prof.Anoop Waghmare without whom i would have never thought of doing this. Thank you Sir.
& Hope you'll enjoy my blogging...