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Just a ‘Well Spun’ story could make you miss the ‘Target’

Investors have often been at the receiving end of a story well spun (pun intended). Of course, stories differ from company to company. But the end result is the same, well almost – irreparable blow to management reputation, erosion in market value of the stock & loss of confidence in the investment fraternity. No matter how hard the management subsequently attempts to address and resolve the issue, the dent in reputation doesn’t fade away from the minds of the stakeholders.

Welspun India, the country’s largest home textile exporter, hogged the limelight this month after Target Corp (US) severed their ties with the company for mislabelling cheaper cotton sheets as premium Egyptian cotton, for 2 years! Target has apparently decided to phase out all of its products sourced from Welspun, despite sharing a decade old relationship with Welspun. Target is Welspun’s second largest customer. The pain doesn’t stop there. Bed Bath and Beyond, Walmart & JC Penney too have apparently started probing Welspun’s product claims and accuracy of its cotton certification records. The management sprang into action, to douse the raging fire, by appointing one of the “Big Four” accounting firms to examine its supply systems and processes. But the market was in no mood to forgive and more than 50% of the market capitalisation got eroded over the next couple of days. How the company manages to come out of this crisis is yet to be seen. That said, taking tough decisions and a serious rejig in their quality processes is something that the company will have to invest in to regain trust.

If I recall correctly, the last 15 months has witnessed 3 other instances in which listed entities were punished for corporate governance related issues.  Eros International witnessed a massive sell-off, last July, following red flags being raised on the company’s receivables and user count of its streaming services. Post this, the company tried very hard to assuage investor concerns; delaying the launch of its TV channel, appointing reputed US-based law firms to conduct an independent review of its accounting practices etc. However, more than 80% of the market capitalisation got eroded in the next 9 months following this accusation. Earlier this year, Ricoh India, the darling of the stock market, was pulled up by the regulators on revelations of accounting inconsistencies in the firm over the years.  The Indian arm of the Japanese imaging and electronics major conducted an internal investigation to ascertain its financial position questioning the intent of a few company insiders. The findings of the investigation recently coerced the management to admit that its accounts appear to be have been “falsified” and have agreed to infuse fresh funds to cover the unaudited estimated losses made thereby. However, more than 85% of the stock value got eroded during this process. C Mahendra Exports is another case in point in which the company released their FY15 annual report which was neither signed nor finalised by their auditors! Not only this, the auditors approached SEBI, the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) informing them about the irregularity. The stock doesn’t trade currently but was last traded at Rs.1, down from a high of Rs. 208 it traded at ~2 years back.

Target

We do not intend being judgemental nor intend maligning anyone’s reputation in this note.

However, the above instances throw up some interesting learnings, that can (and should) be implemented.

  • Chasing growth, at the cost of ignoring appropriate processes, can prove to be fatal.
    • As some of the above mentioned examples imply, appropriate business processes were not followed (in our opinion) on account of which the companies faced their respective problems. Audits, internal as well as external, if conducted at frequent intervals, would have revealed gaps in accounting, product quality etc. much earlier.
  • Maintain relationships with your Stakeholders.
    • A well connected world helps information (and misinformation) flow seamlessly. Constant and appropriate communication with your stakeholders – be it customers, shareholders, employees, regulatory bodies etc. will help them understand the company and its processes better and control the damage that could be caused by possible misinformation spread.
  • Follow good governance, allocate accountability.
    • Good governance helps in developing reputation and improve stakeholders’ confidence in the company. The management needs to ensure an effective board composition (including the number of executive and non-executive directors), have adequate policies in place for disclosures/whistle blowers/conflict of interest etc., have sufficient committees to oversee functioning of critical procedures to help avert crisis like those seen in some of the above examples. The top management needs to inculcate a corporate culture of consciousness, transparency and openness. This not only enables the company to maximize the long term value of the company but reflects in the performance of the company.

Corporate governance issues have serious repercussions on companies, qualitative and quantitative. This may include investor perception of an incompetent or fraudulent company management, downward revision of estimated cash flows by analysts, increased litigation costs, increased cost of capital and threat of lowered credit ratings, to name a few.

It is important to remember that building up an organisation and reputation takes enormous time and effort. The same can get tarnished in a matter of moments, severely denting stakeholders’ confidence.

Cheers!!!

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