Weekend reading links

1. FT writes on the railway reforms in UK,

A rejig is sorely needed. More than 25 years after privatisation, passengers continue to be poorly served by a network structure that has encouraged short-termism and a lack of accountability among stakeholders. Regulated fares have risen at twice the rate of wages over the past decade. Several large franchises are struggling not only to operate a reliable service but also to make money. Northern Rail will be nationalised in March. It will be the second to be taken into state hands. Frustrated passengers want radical change; polls show the majority of the public favour wholesale nationalisation... What is often forgotten is that most railway operations have already returned to public ownership: the track, signalling, and major stations are all part of nationalised Network Rail. Adding the train operators would be a relatively small step... the franchising model has run out of steam. It was meant to lead to cheaper fares and more efficient railways. Instead, tightly controlled contract terms encouraged operators to make overambitious bids that could never be delivered, especially when passenger growth did not materialise as expected... The government is expected to replace franchises with “management contracts”. It will receive fare income directly and pay operators based on performance. A similar model has worked well on the London Overground suburban network where Transport for London, which runs the capital’s transport, sets fares and timetables and grants concessions to a single operator.

2. Alphaville points to the story of Southland Royalty, an oil and gas company, owned by private equity firm Encap, which recently filed for bankruptcy. It raises questions about the industry claims that PE offers diversification in so far as the value of its portfolio gyrates far less than in the public markets,

EnCap wrote down the value of its investment in Southland by 25 per cent in early 2019, according to the first person. The October investor report showed that the firm valued its investment in the company at $773.7 million at the end of September, nearly the same amount as the $775.5 million it had invested in the business until then. EnCap wrote down the investment to zero at the end of 2019, a person familiar with the matter said... How did an investment marked at 0.99 times its invested equity collapse so suddenly? It’s not the broader energy market. Since September 30, the Dow Jones US Energy Index is down 7.75 per cent, according to S&P Global Market Intelligence. Perhaps then, as some private equity critics have ventured, it’s that markings in private assets are more mark-to-myth than mark-to-model.

3. NYT has a story about the bankrupt shoe retailer, Payless, highlighting the problems associated with private equity managed companies. Sample this on asset stripping,

In the two-year period ending in January 2015, Payless generated $249 million in “Ebitda,” a common metric for operating profits; paid $352 million in one-time dividends to shareholders; and made $94 million in interest payments. For every dollar that came in the door of the company in that span, it paid out $1.41 to its owners and 38 cents to its lenders. That left the company with less of a financial cushion to ride out any future challenges.

Lack of industry experience by PE managers is another problem, exacerbated by excessive focus on cost-cutting and other short-term efficiency improvement measures which rebound badly in the long-run.

4. Nice visual summary of cognitive biases. The website has some great visualisations. This is a fascinating table of commodity returns since 2010. (HT: Ananth)

5. FT has an article that investigates the opaque power structures the govern Brookfield Asset Management (BAM), the $500 bn Canadian private equity giant,

To unpack the Canadian group’s accounts is to discover not so much a company as a giant, triangular jigsaw board that spreads across the world and covers assets worth $500bn. The pieces are hundreds of corporate entities, all locked together by elaborate contracts, which give 40 people at the top the right to rule huge sections of the puzzle almost as if it were their own. Those insiders wield such power that the companies below them could face risks similar to those of “pyramid control companies”, according to a draft investor disclosure that Brookfield filed with the Securities and Exchange Commission in 2013. (The final version warned instead of risks “associated with a separation of economic interest from control”.)... Yet in interviews, securities filings, litigation records and other documents, a picture emerges of an investment group that defies convention: highly secretive, seemingly obsessed with control and susceptible to family squabbles that have few parallels among its Wall Street peers.

Brookfield's ownership and controlling stakes are complex and opaque, with tight control exercised by Bruce Flatt, its CEO, and Jack Cockwell, who played an important role in turning BAM into what it is today,

BAM shareholders have earned compound annual returns of 18 per cent over the past 25 years. And even if that performance should falter, the two men would be difficult to dislodge, for they own a big piece of a lesser-known company named Partners Limited, which has the power to override the votes of every other Brookfield shareholder. “In form, Partners is a corporation,” explains a two-page memo sent in the mid-1990s to a handful of Peter Bronfman’s employees, and seen by the FT. In substance, it sounds like something else entirely: a routine of “weekly luncheon meetings” that comes with serious financial perks. Conceived as a way for executives to “become a financial partner with Mr Bronfman”, Partners today wields enormous power over Brookfield. Its 40 members own about one-fifth of BAM, but have enough votes to appoint nine of its 16 directors. A dual-class structure means they can also overrule shareholder motions even if they are supported by outside shareholders. The identity of some of those “partners” is not clear. Brookfield named only a handful in its 2018 public filings, although all are said to be current or former Brookfield executives.

This from Bruce Flatt, the CEO of Brookfield, has resonance with what "fixers" do,

'Our reputation is that if you have a large transaction, if you have a difficult transaction . . . go to Brookfield.'

The most disturbing manifestation of this opacity and all the questionable and corrupt practices it camouflages is the 2016 deal Brookfield struck to bailout Jared Kushner's Manhattan Fifth Avenue tower, which was it leased wholesale for $1.3 bn covering nearly a century of rent in advance. The article describes the complex financial transaction, involving transfers within the very opaque corporate structure of BAM, that was undertaken to support this purchase.

The Kushner deal was assembled from several pieces of the Brookfield empire. The lease was signed by a company named BSREP III Nero LLC, a possible allusion to the emperor who was blamed for the burning of Rome. That company is owned by a fund called BSREP III, which is managed by BAM and was, at the time, controlled by BPY — all of which placed the deal where global finance blends into geopolitics on the jigsaw. The known links between Qatar and Brookfield all converge on the investment group’s listed property fund BPY. About one-tenth of the fund’s assets are tied up in skyscrapers in Canary Wharf and Manhattan that are co-owned by Qatar, but the connection goes further. Through a sovereign wealth fund, Doha is one of BPY’s biggest investors, holding $1.8bn worth of BPY preferred equity... In the public accounts of BPY, the listed property fund that received Qatari investment, 666 Fifth Avenue has already all but disappeared. Last January, BPY lost control of BSREP III, the private vehicle that owns the building, after reducing its stake to $1bn. New investors piled in, each taking a piece of the Kushner tower, and lifting the private fund’s commitments to $15bn. That influx of cash has not made the tower’s ownership any more transparent. A handful of US pension funds have acknowledged their participation, but few other investors have been identified publicly. Knowledgeable people insist that no Qatari money is involved. Materials reviewed by the FT show that about $3bn of the fund’s total firepower comes from sovereign governments, although they do not specify which ones, and $2bn of it from the Middle East, although the document does not say exactly where. 

6. Ananth points to this excellent article from Simon Kuper on how Netherlands, most parts of which are below sea level or prone to flooding, has "learnt to manage flooding". Its Delta Works project, initiated in the aftermath of the 1953 floods which killed 1835 people, is a network of dams, dykes, sluices and storm barriers that is unmatched worldwide, and has ensured that not one person has died in floods since then!

There are two features of the Dutch model. One, a sense of co-operative management, whereby everyone got together to build dykes to protect the so-called polders, or land parcels below the sea level. The polder model means "to bring all groups together to hammer out a compromise". Two, investments in prevention, even if the incidence of the risk is very unlikely but damage extreme if it happened, and the maintenance of infrastructure created for this purpose.

Dutch prevention has long been a source of much pride among officialdom... Most of the time, though, the Dutch public live in happy complacency about the potential risk of flooding. Their defences have worked so well, at a relatively modest annual price, that most citizens have almost forgotten about them. The Netherlands has spread its spending on flood defences over seven centuries. About half the Delta Fund’s budget of €1.1bn for this year goes on protection against the water... Water boards can also raise local taxes to invest in flood defences, so altogether the Dutch spend about €1bn a year, or just over 0.1 per cent of gross domestic product, on what they call “dry-feet insurance”. Much of that money, as they always tell visiting foreigners, goes on maintenance. All this is cheaper than waiting for disaster and then rebuilding: the World Bank estimates that every dollar spent on flood defences yields returns of $7 to $10... Under the slogan “Room for the river”, it has created lakes, parks and even parking garages designed to flood when necessary so as to divert the waters from inhabited places.

The consensus required for such preventive investment is rare and very difficult to achieve,

Though the Maeslantkering was completed in 1997, foreign visitors often find it futuristic. It consists of two metal arms, each the size of an Eiffel Tower. It’s an open door: ships sail by every few minutes, into and out of Rotterdam. The barrier stands ready to close when the waters rise by three metres. That level hasn’t been reached since its construction... His team spend their days doing maintenance, training and exercise, and carrying pagers ready for the big moment. The door needs to close just once in its lifetime to earn its money: any flood that shuts Europe’s busiest harbour, Rotterdam, could cause hundreds of billions’ worth of damage, one official told me.

7. Good use of regulatory forbearance by the RBI to ease the stress faced by sectors like MSMEs and commercial real estate. Their loans can now be restructured by one year. Further, certain sectors will benefit from lower CRR requirements. These are welcome, if belated, measures.

Another important measure is the decision to go beyond the overnight repo operations and conduct 14-day, 1 and 3 year repo transactions for banks. Theoretically it significantly lowers the cost of borrowing for banks. But this is also effectively printing money.

8. Nice profile of Shiv Kishan Agarwal, the 79 year old Chairman of Haldiram, the Bhujia King.