Lessons from Infosys, Tata Sons: Assess management of company before buying its shares
Recent events at Infosys and Tata Sons have highlighted the importance of assessing the management of a company before you invest in its shares.
Such fights can happen across businesses— family run as well as professionally managed ones. In other words, there is no purpose in favouring one type of management over the other. “Between familymanaged and professionally-managed, which business is better? There is no straight answer to this question. Since wealth is getting created by both, it all depends on the individuals heading the management,” says Hemant Kanawala, Head, Equity, Kotak Mahindra Old Mutual Life Insurance.
Before proceeding further, let’s bust two common myths about management types: “Family managed companies don’t take care of minority investors” and “Managements of public sector undertakings (PSUs) aren’t dynamic.” While some family-owned companies may be prone to short-changing minority shareholders, it’s not the case with all such companies. Family-owned businesses such as Asian Paints, Bajaj Auto, etc. treat minority shareholders as well as any MNC. On the misplaced notion of slack PSU managements, Ambareesh Baliga, Stock Analyst, says, “The general belief that PSU managements are not dynamic is wrong, there are several dynamic CEOs in PSUs.” Arundhati Bhattacharya, the first women chairperson of SBI, is a case in point.
Measuring management efficiency
There are several parameters on which mangements can be assessed. Kanawala emphasises on integrity—how they treat minority shareholders—and capability— how they allocate capital and their ability to increase return on capital. “Both these are crucial,” he says. Raamdeo Agrawal, Co-Founder, Motilal Oswal Securities feels that the passion is another important factor— even the capable may fail to produce results if they don’t have a passion for their business. “The three factors that are critical for a management are: Competence, passion and integrity. When all these come together, you get the best management,” says Agrawal.
Looking at historical performance is another way to measure management efficiency. “The best way to analyse a management is to see whether they have been able to deliver on their past promises,” says Tushar Pendharkar, Head, Research, Right Horizons PMS. For this, investors need to find out promoters’ promises in the past 12-18 months. While some of these come in the form of official company guidance, others may come in the form of promises made during informal interactions with analysts, major shareholders or the media.
If a company’s management has failed to honour its promises, investors need to ascertain the reasons for this. “Business condition is important. If the business condition is bad, even the best managements won’t be able to do much. With tailwind in the business, even mediocre managements get credits for good performance,” says Agrawal. The situation can get complicated for cyclical businesses such as steel, petroleum, etc., as the management has no control on the prices of these global commodities. It won’t be fair to accuse an oil and gas company for not achieving its revenue targets during a period of a sudden fall in oil prices across the globe. What investors can do is to see the management’s effort in controlling its cost. “A good management has to keep on improving on the cost front and should aim to be the lowest cost producer in the world, to emerge winners in the long term,” says Agrawal.
The business environment in which companies operate—whether they are in a highly competitive business or one in which competition is less intense—also determines the need for quality managements. “Average management do fine when the business is not very competitive like the PSU oil companies in India. But great management is needed when the business is very competitive like banks, NBFC, FMCG, etc.,” says Agrawal. The business environment explains why all businesses from the same group are not equally successful. For example, TCS is a huge wealth creators, while Tata Telecom has been a disaster.
Best family-managed businesses
Since most Indian firms are family run, this segment has seen big wealth creators—and destroyers as well.
Note: Only stocks part of BSE 100 or NSE 100 were considered. Stocks selected on the basis of 10-year CAGR. Figures in the line charts have been normalised to a base of 100.
Best performing public sector companies
While wealth creation at LIC Housing is due to its quality management, oil PSUs have been helped by liberalisation of the sector.
Best multi-national corporations
Maintaining the market belief, most MNC managements were able to generate wealth for Indian investors.
Best professionally run enterprises
Though wealth creation seems modest in these firms, they have shown a greater consistency in performance.
Succession planning is critical
Having a great management is important, but even more important is a clear management succession plan. Investors should ascertain whether a company has a clear succession plan in place. “The existing management should place a new management well in advance. Global giants like GE are still running efficiently because of good succession planning,” says Agrawal. A great organisations like Infosys has been suffering because of poor succession planning.
The general belief is that succession will be smooth in family-owned enterprises—it will be just a generational change—while it will be difficult in professionally-managed firms is not entirely true. For example, the succession plan at ITC—from Yogesh Deveshwar to recently appointed CEO Sanjiv Puri—has been reasonably smooth. Deveshwar still continues in a non-executive role. Similarly, the succession planning at Larsen & Toubro—from A.M. Naik to the new CEO and MD S.N. Subrahmanyan—has also been smooth. “Naik’s and Deveshwar’s responsibility now is just to sit at the back and watch the new CEOs drive. This arrangement helps the new management to get full control and helps in a smooth transition,” says Agrawal. “The background of the new CEO also plays a critical role and the succession plan at ITC has been smooth mainly because the new CEO is an insider,” says Baliga. The succession of CEOs in Infosys was also smooth, so long it was among the co-promoters, but it hit a bump when they appointed an outside professional—not groomed by Narayana Murthy.
Indian PSUs is one segment that doesn’t have succession planning but doesn’t suffer on account of it. Also, there is not much opposition in PSUs against ‘outsider CEOs’. “It is not a big issue in PSUs because the government usually follows ‘cadre culture’, and since new appointees are from some cadre—IAS, etc.—any big resistance is unlikely,” says Baliga.
Though the transfer of power from one generation to the next may be smooth in a family-run business, it may not be the most-efficient succession planning. For example, young inexperienced children may become the CEOs of family-run companies. “Though the top honchos a familyrun business may belong to the family, such businesses can still be managed efficiently by bringing in professional talent,” says Kanawala. Some family-run companies have established such a practice. “Succession at Bajaj Auto can be considered a success story, especially since there was no tailwind at that time,” says Agrawal. There have also been instances where a family-run business has slowly became a professionally managed enterprise. Asian Paints is the best case in point.
A valid question is, how to ascertain whether a management handover has been a success or a failure? It is difficult for the investors to assess this immediately. Since the management is appointed to take the enterprise to newer heights, investors need to give them some time—a few years—before assessing them. The market is doing the same with Infosys now. Though Nilekani is back at the helm, Infosys stock has yet not recovered all its losses. This is because the market is treating Nilekani as a short-term arrangement and will wait for the appointment of a new management team. Markets’ insistence on actual delivery is another reason for this. “The market usually waits for actual numbers delivered by the new management. It will reward only if the numbers are good,” says Agrawal.
How perception works
A change in management also usually results in a ‘perception change’ about the company. This is another factor that investors need to consider carefully because perceptions can impact the company’s both positively and negatively. If a company that is weak on corporate governance takes steps to improve its governance standards and make management changes to this effect will be treated positively by the market.
While the market will remain sceptical and wait for several years to ascertain whether a seemingly positive change is real, it reacts fast to a negative change in perception. “Questioning Infosys on corporate governance was unthinkable till two years back, so the market immediately reacted negatively to the governance issues raised by Murthy,” says Baliga.