HOW PROMOTERS CHEAT SHAREHOLDERS…



HOW PROMOTERS CHEAT SHAREHOLDERS…

Siphoning off cash, dumping expenses, selling scrap for cash...dozens of
live examples of the ways companies cheat:-Source:HKG

Indian promoters manipulate accounts and market prices for two (opposite)
reasons. The first is a traditional game, which the majority of them play -
siphoning money from the coffers of a listed company for personal gains.

However, in a bull market, a reverse trend starts. Many of them are not
interested in suppressing profits. They want to overstate revenues and
profits because this boosts their market-cap in a rising market; it helps
them to raise 'free' money.

In the past three years, I have repeatedly expressed doubts about the genuineness of the financial figures of many companies, although foreign institutional investors (FIIs) and many renowned domestic institutional investors (DIIs) were shareholders of precisely such shady companies, even as many brokerage houses print and electronic media were flashing 'buy' recommendations on them.
I mainly track mid-cap and small-cap companies. Large companies are smart enough to camouflage their figures. It is much easier to find flaws in the accounting of small- and mid-cap companies.  

What is the arsenal of tricks employed by promoters to siphon off money or fudge their accounts? How do they pump up their share prices and dump them on the public?

Here are few examples of how promoters do it. These are actual examples,
But we have opted to change their names because the idea is to educate
Investors about management tricks.

  • Suppress Income: Consider textile companies. All of us believe that they
don't make money. This is not true. It is only that the promoters are adept
at hiding margins.  
Some listed companies have at least 15-20 private limited companies, two or three proprietary firms, five or six partnership firms in the promoter's wife's name, in his in-law's name, in the married daughter's name or even in the names of trusted employees who have been working with the promoter for 20-30 years. It sells finished products to private firms that are directly or indirectly owned by the promoters at cost price or even a small loss. Those private firms, in turn, sell the products to the dealer, wholesaler or distributor and make huge profits.

I can definitely say that listed companies like Ramdiya Mills and Karma
Fabrics or Synth Fabrics - have adopted this practice since inception and
continue to do so even now. If you look at their cost structure, it will
become very clear. Ramdiya Mills and Karma Fabrics have large reputed
brands. Since they buy hundreds of crores worth of yarn every year, they
get it at the lowest possible price. They get an additional price benefit by
making cash payments to suppliers. Since the product they sell is a premium
product, these companies ought to have a net profit margin of at least
12%-15% whereas they hardly show a margin of 2%-3%.

Text100 Mills is one of the oldest and reputed cotton textile mills with significant exports. But if you look at the segment-wise results, the cotton division always shows losses.
Where is the money going? Most promoters either invest it in real
estate or benami accounts in India or transfer the money abroad. Of course,
each promoter has a different way of looting the company and siphoning off
money.
The promoter of Ramdiya Mills is a hands-on guy who looks after
practically everything. They do not have senior professionals in purchase,
marketing or branding. Since the promoter takes all decisions, overheads
are also not large. In this category fall companies, like Gofar and other
powerloom companies, whose expenses are those of a powerloom, but selling
price is akin to the organised sector.

In some cases, shareholders' money goes to support the promoter's
lifestyle.
Look at a famous textile company like Monde Fabrics. It has a higher cost
structure - the bigger the brand name, the higher is the number of
employees. Monde's production cost is slightly higher but not high enough
to show losses. Also, they should be able to show very decent profits because
they have the latest technology, wastage is low and the quality is very
good. Their polywool fabric is the most expensive in India but their profit
is negligible. Where is the money going?
The promoter's daily expense is in lakhs of rupees which is all debited to Monde's corporate account. So, although the selling price of Daygod Mills is 20% lower than Monde's, its margin is higher.

  • Under-reporting of revenues is also rampant in the steel industry.
Each listed company has at least six or seven unlisted companies through which
they do a lot of adjustments, depending on the opportunity. They decide
where to show profits and when to disguise them. In this category are
companies like Prism Steel and Modern Metals. Look at Modern Metals and
compare it with River Electricity, a company with a similar profile. River
Electricity did not have captive mines and neither did Modern. But profit
margins of Modern have been very low. Their profits are vanishing through
their unlisted group companies.
Dealing in cash is very common in the steel industry. Cash sales take place and are not reflected in the books. That is why you will find that raw material costs rise disproportionately. I knew a person who used to be with a sponge-iron company near Mumbai. He told me that every year they sell Rs500 crore worth of sponge-iron from their plant, in cash. But all purchases and expenses are being fully accounted in the books along with the promoter's personal expenses.

Take the example of Kanaka Leaf. Why did that company become sick? I know a
manager of one of its factories. He tells me that he used to take out 90%
of the stock in cash and pay excise duty only on 10% of the goods. That is one
reason why this firm got into legal trouble and that factory had to be
closed. He was no longer on the payroll; but the owner was still paying him
Rs25,000 per month.
You always know which companies are selling in cash by sniffing around at the commodity markets. Look at the textile company ABC.
If you go to the textile market any time, you can buy ABC products in cash.
There used to be a company called Garvi Fils which closed down. It used to
sell most of its production in cash. In any textile market, you can get a
list of companies which will sell yarn in cash. All of them book expenses
fully; sell in cash and claim that costs have gone up. This is how they
fool investors.

One major way in which promoters enrich themselves is by selling waste (or
passing off even quality material as waste) in cash and pocket the money.
This is rampant in the metals and cable industry. Jewel Steel is the king
Of this. It sells waste as well as fresh material as waste. It even sells zinc
which is used for galvanising. You can go to any metal merchant in Delhi
and enquire how much zinc Jewel Steel is selling and how much copper Melton
Cable is selling in the open market.
This is a common feature of the metal traders in Delhi where almost 80% of the business is done in cash.
Companies sell to wholesalers; wholesalers sell to small converters and so on. There is an active cash market and promoters are able to sell as much of quality
finished goods, raw materials, by-products or waste.

  • Fake Bills:The most common practice among corporates is to buy fake bills for a small price, make the payment against these bills by cheque and
instead of receiving goods, ask for the money back in cash. This is a
common practice among the marwari business houses of Kolkata. They buy bills of Rs10 crore or Rs20 crore ostensibly for raw material purchase and pay for it by cheque. The material never comes to the warehouse; instead they get the money back in cash, minus a tiny commission for the fake bill.
Naturally, the companies show losses or meagre profits. They are not inefficient companies, neither are the promoters fools. They simply siphon off cash by buying the bills and under-report sales. This leads to losses.

When Laltane Solutions made its IPO, some Delhi-based operators regularly
contacted me to say that the stock would list at Rs500 against an issue
price of Rs250. They offered me shares at Rs400 and openly admitted that
they belonged to the promoter. That is how they made money in the stock
market. When you think of operators, don't think of shadowy individuals.
They could well be institutions with a big name and shining public image.

Visher Agro buys wheat from the market, converts it into flour and sells it
to a food company selling branded atta. It is also into rice milling. It is
not selling anything under its own brand name. It is just a converter. The
promoter entered into an agreement with an operator and his share price
rose to Rs200+ from just Rs15; it has now dropped 70% from the highs. He claims to have set up an unlisted company which will set up a 20MW co-generation power plant for which he is in talks with Blackstone. He was making up this story but he could not succeed in raising the money as the operator quit
the counter.

Another trick by Indian promoters is to announce a joint venture (JV) for a
new project. After a while, there are reports about differences between the
JV partners. The money invested in the JV is never recovered. It is written
off over five or seven years. All this is well-planned. The JV is floated
precisely to siphon off money by taking away money invested in the JV. For
instance, Albert Hotels of Bengaluru paid Rs15 crore as its share in a JV
with a Pune-based company to set up a five-star hotel in Pune. It later
pulled out of the venture due to differences over management control and
said it would file a lawsuit to recover its investment.
But industry sources told me that the promoter has already taken back the money in cash and written off the investment in its books. This is a popular trick among marwari companies. They lend money to unlisted companies owned by the promoters either directly or indirectly and the money is never recovered.

As all these examples show, Indian promoters are not stupid or less
intelligent or don't know how to run their businesses. They are actually a
step ahead of other professionally managed companies. They are much more
intelligent, savvy and street smart. They know how to negotiate with
suppliers for the lowest possible price, how to cut costs and how to siphon
off money.
Most of them have trusted people or relatives in key strategic
posts to prevent pilferage. Even while selling, they know how to negotiate
hard to get the highest price. They work hard and make a lot of money but
they don't want to share it with you. Siphoning off cash, dumping expenses, selling scrap for cash...dozens of live examples of the ways companies cheat:-Source:HKG


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