All that glitters is not Gold

We as Investors, often overlook the most crucial aspect of running a successful business - The Human Aspect. The success of any business is directly proportional to the quality of the people behind it's wheels.

The great Warren Buffet has emphasised time and again that quality assessment of management is of utmost importance and should be carried out before the acquisition and not after the money has been committed.

A great business at a fair price is superior to a fair business at a great price

People put undue emphasis on competitive advantage, attractive valuations, and miss out on the bigger picture. All we care about is the price we pay in comparison to the intrinsic value we are getting, which fails to factor the human aspect that will ultimately determine the company's trajectory.

The desired combination of Great Management and Great Business can help enhance shareholder value, which should be at the heart of any enterprise.

Similar to an airplane crash, Corporate Governance Failure is an event who's probability of occurrence is very rare but the impact can be extremely catastrophic.

India is no stranger to Corporate Governance disasters, with infamous scams like The Harshad Mehta Scam or The Satyam Scandal, and more recent Ponzi schemes like The Torres Scam.

But, what prompts someone like Ramalinga Raju to resort to unethical practices like falsifying financial statements when the business appears to be doing seemingly fine.

Major reasons for Corporate Failures:

• Fraudulent Management

Let's start by addressing the elephant in the room. If the Intent of the Captain is corrupted, the ship is bound to face a certain doom. Similarly, if the intention of the management is create value for themselves at the cost of shareholder value, the business will suffer.

Everyone in our country is well-acquainted with Saharashri Subrata Roy and pyramid scheme of the Sahara India Pariwar, which defrauded upwards of 3 crore Indians in a scam involving approximately ?25,000 crores.

A Hansal Mehta series titled "Scam -2010" is scheduled to be released this year, which has been condemned by the Sahara group and are contemplating to take legal action.

• Economic Distress

The compulsion to post good results amidst a financially weak economy and underperforming sector in order to meet the previous guidance can be nerve wrecking and can lead to book dressing to inflate numbers. Wasn't this the classic case of Satyam scandal.

In the wake after Dotcom bubble crash in early 2000s, every IT company in India took a hit due to their dependency on US and were projecting subdues numbers in the upcoming seasons. Ramalinga Raju in order to manipulate the stock prices overpromised and was soon met with the reality of having no choice left but to inflate the numbers.

It all came crashing down on January 7, 2008 when the burden of guilt overweighed his conscience and he admitted the trickery. What I believe is if a business does well, the stock eventually will follow. But if the business does poorly, the stock has no hope.

"It was like riding a tiger, not knowing how to get off without being eaten" - Ramalinga Raju in his letter to the Board

• Mismanagement of Capital allocation

As Warren Buffett famously said: “The job of a CEO is capital allocation, and if they are not good at it, they shouldn’t be CEO.”

While Effective capital allocation can help create shareholder wealth and ensure long-term sustainability, poor capital allocation can erode shareholder wealth gradually.

The dizzying rise, and even more vertiginous fall of "WeWork" can be studied as an exemplary case-study of how extravagant expansion fuelled by unceasing cash burn is not tenable. The company that was once valued at $47 billion eventually filed for bankruptcy, all in a matter of 5 years.

Read this Forbes article to get a better insight at the Timelines.

• Working Capital Problems

Working Capital is like life pouring oxygen, whose existence is often overlooked but the scarcity of which can be life-threatening. Working Capital problems have put more companies out of business that unprofitability.

Kingfisher Airlines, once a symbol of luxury aviation was brought to it's knees due to capital problems, mismanagement and excessive debt which lead to the company defaulting on its payments.

The company's debt was increasing rapidly to fund day-to-day operations which is not what borrowings should be primarily used for. It should be used to fund the company's growth not to just keep it afloat. The borrowings spiked 10x in a matter of 6 years, which was more than the company could honour.

The company relied heavily on short-term credit from it's fuel suppliers, airports and lessors since majority of its aircrafts were on lease. As of result, the payables were way higher than the receivables since its own expenses like maintenance and salaries had to be paid upfront, creating a working capital deficit.

All of this eventually led to their aircrafts being grounded due to delayed payments to fuel suppliers and airports.

Kingfisher did not fail because it went out of demand, it failed because of mismanagement and poor financial decision-making.

Hope you all enjoyed reading the article as much I enjoyed writing it. I sincerely wish it added some value to your understanding as it did to mine.

Stay tuned!