Wall Street Bonuses Needs A Revamp

I kept quiet when anger was spilling all over the streets over the millions of bonuses paid to some AIG executives. Technically, the guys (they were all guys) were entitled to the bonuses because it was written in their contracts. The new CEO had no choice but to honour those contracts. However, there are also a legal and an ethical side to the issue. AIG has had to take so much money from American taxpayers in order to stay afloat. If the American taxpayers did not fund the bailout, there would be no AIG and these executives would never ever see a cent of their so called contractual bonuses. You sign a contractual bonus to protect yourselves from uncertainty. In that sense there may be some credence to them getting the bonuses. It is precisely from these kind of fallouts which causes the executives to sign those bonuses. Realistically, many of those who got the bonuses were not part of the unit which got AIG into trouble, most of those have left the building already - those ones responsible for creating and selling Credit Default Swaps on the CDOs.

The public isn't really angry about greed on Wall street, thats a given, greed is Wall Street. The public's anger is you shouldn't get bonuses for doing a shitty job. People are losing their jobs because of the financial crisis brought on by the "bad things on Wall Street", they are seeing their home values being decimated because of that, they are seeing their retirement fund being wiped out by half because of that ... and you still want your bonuses??!!!

Now its confirmed that these AIG bonuses would be taxed at 90%. That was a popular new law which was put in place to clawback the sums paid out. The ramifications from all this is that the banks who also took TARP and other government money may find themselves in similar hot water should they also pay out exorbitant options and bonuses. Thats why Goldman Sachs and a few others have come out to address the "new compensation scheme" for its bankers. Many of the banks new scheme basically puts most of the bonuses in the form of options and may only vest after a certain period, usually 3 years. There will also be clawback clauses which means that options may be taken back if future years see a huge dip in profits before they vest.

Bank of America and Citigroup are a bit stupid when the CEOs said that they may be raising the senior executives salary packages to compensate for the fact that they will only receive mostly share options that will take longer to vest as bonuses instead of cash. That is a slap in the face of what the spirit of the "new compensation scheme" is trying to achieve. They are just trying to find a way around the new paradigm, not working with the new paradigm.

I have argued in previous postings that there has to be a new way of determining compensation. The whole shebang in tying in senior executives compensation to "share price performance" only is flawed. This cause instructions and strategy from the top to MAXIMISE profits on limited deployment of capital. It encourages excessive risk taking to rake in profits - bankers would bet with 10x leverage on capital on market direction and will stand to collect when it turns out well, but if it goes the other way, hey, I will resign and look for another firm to ply my trade. There is no real punishment for mistakes on huge bets but there is great rewards for guessing correctly.

The mistake in linking bonuses only to share price compensation also result in management to immediately use any positive cashflow to buyback shares, as this would enhance eps and thus boost share prices. As their share options will rise in value when the share price move higher, management will be quick to do share buybacks. You can go through a number of research papers and they will confirm that companies doing share buybacks always under perform the rest of the market. Buying back shares may not be the most prudent thing to do. Management has to be incentivised in planning for longer term, and to make acquisitions and disposals to sustain their market share growth - all of which requires a more diligent use of cash flow and capital. Many of the banks are in trouble now because of their wafer thin capital adequacy. In good times when they raked in profits, most of it was sent to buyback shares. Now that they need to have more capital, they are forced to sell lucrative assets and/or sell more new shares at very depressed prices - both kicking the minority shareholders interest in the face.

My view is that an executive's compensation and bonus should be tied to a matrix of:
a) share price performance
b) eps enhancement
c) prudent returns based on capital deployed
d) making sure the company stay within defined boundaries of acceptable leverage, debt ratio and debt servicing
e) allowing management to only buyback a maximum of 2% of outstanding shares a year
f) the bulk of the bonuses should be based on a review every 3 years on how well management has planned and execute their longer term strategy in ensuring market share growth

We basically need to reduce substantially the quantum of bonuses paid out annually, and move to a bigger sum being based on a 3 or 5 year period. It encourages longer term planning, less shuffling of assets, less misuse of cash reserves.

What I lost last year . .

p/s photos: Angelababy (yes, that's her name, what a marketing coup)

How Not To Do A Deal - Modular & Blue-I

As reported in The Edge Daily, Modular Techcorp Holdings Bhd has obtained the approval from the majority of the shareholders to buy a major stake in telecommunications services provider, Blue-i Network Sdn Bhd for RM21.5 million cash. Some shareholders had queried Modular's board over the acquisition of the 70% stake in Blue-i. The EGM, which was held in Kuala Lumpur on Nov 2, lasted over four hours. The acquisition of Blue-i will be funded by bank borrowings of RM10 million and the balance from its internally generated funds.

Dali: Why was the deal in cash? Would it not be better to issue new shares to Blue-I vendors? Or a part cash, part shares deal?

... and why was the meeting held on the week of Deepavali/Hari Raya holidays.. isn't it more prudent to have hold the meeting during a time where the public would not be taking extended leave... or is it that the company wanted less people to attend... I believe, if the deal is solid, and the terms are fair, plus the deal is value enhancing - I would want to ensure that all shareholders get to have a say in approving the deal, especially when it is a "substantive" deal relative to the size of Modular...

Its chairman Ibrahim Hussain told reporters after the EGM that shareholders' queries ranged from the fair price to the synergies from the purchase. He said Modular would be able to leverage on its existing market of over 15 million bank card holders and university clientele to develop post-issuance applications using Blue-i’s mobile communications, computer and internet protocol solutions. Ibrahim said the exercise, expected to be completed by the fourth quarter of year, would contribute positively to the group for the financial year ending Dec 31, 2006 as Blue-i had made a profit guarantee of not less than RM6 million for FY06.

Dali: Blue-I's vendors are guaranteeing RM6 million profit for 2006... you know, you can easily list with RM6 million profit on Mesdaq... heck, even half the companies on Mesdaq don't make RM6 million a year (I am just guessing here, too lazy to do actual research, but I don't think I am wrong..). So, to give up a listing status, for what... for the client base that Modular has?? Still, there are better ways to do that, Blue-I could have a joint venture with Modular to do the same thing, and still keep its independence and still go for a listing! Why? Why? Why?

For the proposed acquisition, Modular Techcorp has inked a share sale agreement with vendors Alex Sashitharan Rajadurai and Ng Boon Choong, who held 600,000 ordinary Blue-I shares of RM1 each, representing a 50% of Blue-I’s paid up capital. Both vendors are also two of the directors of Blue-I. Under the guarantee, Blue-I must make a minimum net profit of RM6 million for the financial year ending Dec 31, 2006. In the event of a shortfall in the net profit, the retention sum of RM4.2 million would be used to make up for the shortfall and the vendors would pay any remaining difference.

Dali: ..... Tell you what, I can even give a better guarantee to Modular, I will give a profit guarantee of RM12 million (double that of Blue-I's vendors) for 2006. Since I am getting RM21.5 million, I don't care if Blue-I makes ZERO profit in 2006 as RM21.5 million minus the RM12 million that I would have to make up would still leave me with RM9.5 million cash.

For the financial year ended Dec 31, 2004, Blue-i’s net profit stood at RM1.14 million on a revenue of RM19.95 million. He said Modular would also be able to tap into Blue-i’s network of retail and corporate customers to further enhance the business of applications of bank cards for financial transactions. “Modular believes that the established network of call shops under Blue-i and its ability to deliver innovative products would give the company the competitive edge,” he added. He said the company had plans to make inroads into other countries over a year, replicating its smart card technology and also market Blue-i’s products overseas.

Some Questions That Needs To Be Answered

1) Why an all cash deal? This type of deal brings out a lot of queries. For a typical company with a limited history such as Blue-I, a more prudent deal option should have been considered. How about a deal to buy 33.3% of Blue-I now by issuance of new shares in Modular, with Blue-I vendors to guarantee profit of RM6 million for 2006, and a stipulation that the vendors cannot sell their shares till guarantee is met. If the guarantee is not met, the shares will be sold to make up for profit guarantee shortfall. Upon satisfctory completion of profit guarantee in 2006, it will trigger an option by Modular to buy another 33.3% for RM7 cash. Now isn't this a more prudent deal?!!

Don't do a deal that insults the intelligence of an average investor; or lowers the integrity of the stock exchange and its regulators; and one that tramples on the rights of the minority shareholders - we are all smarter than that, and this is not the 80s or 90s anymore!!!

2)If the deal is so good, why doesn't Blue-I vendors take Modular shares instead, cash is cash but a good scalable deal means 1 + 1 = 3 or even 7, hence taking Modular shares would be better.

3) Why is the guarantee only for one year? And as I have pointed out earlier, the guarantee does not make sense as the vendors can screw around with guarantee and still wind up taking home almost RM10 million cash. Has this deal been really well thought out? My, my, there are more holes in this deal than a block of cheese... and smellier too!

4) RM21.5 million for a 70% stake equates to valuing Blue-I at RM30.7 million. At that purchase price, Modular is paying for 26.9x historical PER. What is even more absurd is its NTA is just RM1.45 million. RM30.7 million market cap and only NTA of RM1.45 million.... hello... anybody home??? That kind of valuation is still justifiable... if you are Skype, Shanda, EBay or Alibaba.com... or if you hold a patent/technology advantage... any thing... don't be shy here... Blue-I is a simple company leveraging on technologies that are already 5-10 years old, plus much of it Redtone has already conquered... why the exorbitant premium???

5) Where are the directors? Have they been asking the right questions??? What about the independent directors?? Why does Modular go and borrow RM10 million to fund the deal?? Isn't it better to issue new shares in Modular?? The silence is deafening.

WHY ISN'T MORE PEOPLE HIGHER UP ASKING THESE QUESTIONS????
At the end of it all, anyone who has had a few years experience in investments or finance will know what the Modular/Blue-I deal is all about... the thing that makes me angry is the sheer audacity and blatantness of the proposal... come on, at least try and structure a much better deal so that our intelligence is not insulted (if you must beat your children, don't let us see the blue-black marks lah..)