Is Warren Buffett A Hypocrite?

In this issue:

» Do banks benefit from debt restructuring?

» More M&A's likely in the banking industry?

» ...and more!

A volatile stock market environment is always a tricky one for investors. And it especially gets tight for big investors and hedge fund managers who are under pressure to find 'winning' stocks for their portfolios. At times, it can get really nasty, and these hedge fund managers resort to verbal fights.

Case in point is Valeant Pharmaceuticals. The warring parties are Bill Ackman of Pershing Square Capital and Warren Buffett and Charlie Munger of Berkshire Hathaway.

What have they been squabbling about?

Here are the facts: The stock of Valeant Pharmaceuticals has shed around 50% in the last one month. The company has come under fire for its dubious accounting practices and its hazy ties with specialty pharmacies, which are allegedly not above board.

Thus, Buffett's partner Munger has vocally denounced Valeant for its 'deeply immoral' practices. Ackman has taken considerable offense at this, which is not surprising considering that he is bullish on Valeant.

What is interesting, though, is the line of argument that he has taken to hit back at Munger and Buffett.

He has questioned Munger's criticism of Valeant when Berkshire has been a big investor in Coca-Cola. As reported in an article on Zerohedge, Ackman opines that Coca-Cola has probably done more to create obesity and diabetes on a global basis than any other company in the world.

So is Ackman right? Is Buffett really a hypocrite?

Despite his legendary status, Warren Buffett has courted his fair share of controversies. He did invest in Goldman Sachs in 2008, even if the investment bank did not meet the 'Buffet-would-buy' criteria.

More recently Buffett received a lot of flak for favouring investments in junk-food stocks, such as Coca-Cola, See's Candies, and Burger King to name a few.

However, we believe that Ackman may have gone a bit too far in his criticism.

If Valeant Pharma is indeed guilty of shady accounting practices, then it is a serious corporate governance issue. Businesses with corporate governance issues more often than not erode the wealth of their shareholders. The genuineness of financials and the overall business is always under question.

There is nothing to suggest that Coca-Cola has corporate governance issues. And there's no question the company's business model and brand power has resulted in multiplication of shareholder wealth. According to Buffett, the idea is to create brands rather than products. Because branded businesses are ultimately profitable businesses. And this is where Coca-Cola has done very well. Its strong brand power has meant that the company's operations throw up a lot of cash with very little investment and no debt on the books. And the company is also able to dole out healthy dividends to its shareholders.

So in that sense, Coca-Cola can hardly be compared to Valeant especially if the latter has resorted to accounting gimmicks to bolster its financials.

So in the current standoff between Ackman and Berkshire, we believe that the latter gets the upper hand.

Do you that Ackman is fair in criticizing Buffett's investment in Coca-Cola? Let us know your comments or share your views in the Equitymaster Club.

--- Advertisement --- Understand This To Make Big Profits From Small Caps... We'll say it right out... Some small caps have great potential! But the key word here, as you might have noticed, is 'some'. Finding those 'some' has been our goal for more than seven years. And we have found small caps that have delivered returns such as 250% in two years, 110% in two years four months, 288% in two years five months, 124% in just seven months, and many more. Now, YOU too can join us in finding and tapping into the huge potential that some small cap stocks possess. To find out how click here... ------------------------------

03:03 Chart of the day

As the Indian banking system continues to grapple with stressed assets, the corporate debt restructuring mechanism has not been of much help to it. Under the corporate debt restructuring scheme, banks waive off the interest component or restructure interest rate downwards to aid defaulting corporate borrowers in loan repayment. As per the Corporate Debt Cell, 24 cases valued at Rs 193 billion have failed to exit successfully in the first half of the current financial year. Only four cases valued at Rs 18 billion have met with success during the same period.

As per the CDR Cell data, the success rate has been less than 35% for 530 cases approved for restructuring by bankers at the cell as on 30 September 2015. Reasons for failure in the CDR include inability by the promoter to bring in the required 2% of the restructured loan amount or poor monetization of non-core assets due to slow economic revival.

As per a survey by Ernst & Young, majority of bankers feel that the CDR forum has been misused by the corporate world. In the first half of the fiscal, the CDR cell has not received any fresh referrals for restructuring and has also not cleared any pending cases. Another reason for banks not being so forthcoming in restructuring new loans is the revised RBI provisions that require them to provide for restructured loans at par with non-performing loans.

Moreover, RBI has also provided a number of other options to banks to deal with stressed assets. These include joint lender forum mechanism for early recognition of stress and 5/25 refinancing scheme for extension of tenure in case of infrastructure projects. Recently, the central bank provided a more powerful tool in the form of strategic debt restructuring (SDR) to help banks clean up their balance sheets. Under the norms, banks have been empowered to convert debt into majority equity holding, change the management or sell assets to recover their dues.

SDR certainly scores over CDR in bringing large corporate borrowers in toeing the line of debt contracts. But banks will be faced with the challenge of finding appropriate buyers for assets within 18 months without compromising on the rights of minority shareholders.

Do banks benefit from debt restructuring?

Apart from giving banks more teeth in setting the house in order, RBI is also keen to infuse growth in the industry. After providing licenses to 11 payment banks and 10 small banks, the central bank has given nod for holding of more than 10% stake in banks by promoters or investors. However, the permission for a larger stake will be determined on the basis of the applicant's integrity, reputation and track record in financial matters and compliance of tax laws. The removal of the decades old cap of 5% of ownership in banks paves the way for mergers and acquisitions and a consolidation in the industry.

After a volatile morning session, the Indian stock markets gained ground in the subsequent hours led by intense buying activity among index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 192 points. Gains were largely seen in IT and auto stocks.

04:55 Today's investment mantra

"If a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with one hell of a result". - Charlie Munger

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Madhu Gupta (Research Analyst).