Wednesday, August 08, 2012

Some ways promoters withdraw money from their companies

Business Standard has an article how promoters are using royalty payments to move money from under the nose of shareholders. The article is very bare and except one tactic, don't seem to have any more details on tactics used. 

Incidentally, I discussed this as one of the forms way back with some people wanting to know some mechanisms that achieve this. Some, I have discussed in my ebook on Investing in Real Estate Developers. So let me discuss some here - some are ways and others are points of observations. And then you tell me some you know of. These may not constitute legal fraud but are definitely morally uncomfortable.
  1. Some promoters use a brand or business mark as separate asset and house it in an separate business entity which is exclusively held by them. The group companies must pay to use this brand or mark at a price that is agreed to by the board. Kingfisher from UB group uses this technique. Tata also uses this technique.
  2. Real estate developers use three or four different means:
    • Some Real estate developers choose to deal with "exclusive sales agents" which are promoter held companies buying from listed companies. Naturally, the listed company has lower realizations that actual markets allow. In many cases I have found listed real estate developers sales (on per sq. feet basis) to be lower by 15-25% of rates prevailing the location of their projects. This allows developers to show that their pricing is reasonable and hence their pre-sales is 100%.
    • Real estate developers also have related party land bank buying entities and their land procurement cost is significantly lower than that of listed entity. Naturally, the margin in this related party transaction can be adjusted as per situations. For example, when the listed company is likely to raise capital in next 3 years these margins are depressed leading to expanding margins in listed entity.
    • Pricing extras separately also helps share of revenue to be directed into other vehicles. Thus, parking is sold separately to sales agent while apartments are sold separately, one by listed entity and other by closely held promoter company.
    • Another way for developer is to sell to REIT and sell out the REIT at lower risk discounting factors. This inflates the asset values based on occupancy which is 90%+ at the time REIT is getting listed and drops significantly later. The key occupier is of course and exclusive rental-sales agent.
  3. Some promoters build into their sales expenses "management oversight expense". This is generally charged as percentage of revenues and usually is very small figure say 0.5% and can be termed slightly differently.
  4. Group Forex agency margins are another way promoters use. This is applicable for conglomerates or at least firms that have multi-geography locations with separate entities. The conversions on forex are routed through a separate group entity which is privately held. This agency marginally increases the cost and passes them to promoters. This used to be a viable approach in the past when there were lot of restriction on Forex dealings.