Being a citizen of a country obsessed
with cricket, the only run rate that I ever knew was the runs that a batsman
makes per over and that i thought defined the run rate - till recently when I realised
that even businesses (read new e commerce world) are getting discounted and
valued on their run rates. It must be very interesting for those old brick and
mortar industrial houses such as the Tatas in India and Walmart
in the US that
flipkart and facebook are valued more than these over a century old business behemoths. What took billions of man hours to build has now been surpassed in
value by young turks who took their ideas to fruition in a matter of a few
years.
Hats off to these young companies for
what they have created in such a short period of time.
But there is another side to this
story of how the calculations based on ‘run rate’ have brought the world to the
precipice of destruction and collapse.
And 2 sectors, one with which I am
closely involved - hospitality, and one which I am closely watching lately, are
perfect examples of how Bill Gates has done an immense disservice to the human
mankind by inventing that little devil (thats what we will call it from now on), the ‘ + ‘ sign on the excel cell where
you plot the run rate for the shortest period of time between the two cells, drag the cells to a time period of convenience, where the potential
extrapolation of that run rate makes Walmart’s annual sale look pale in
comparison to the run rate and get millions of dollars of funding for the idea
that is yet to hatch.
In late 90’s it was as easy as
registering a domain and coming up with an idea. And a couple of million
dollars could be raised easily and the founders would start surviving on Dom
Perignon in the hope of a Nasdaq listing just a few months from the conception
of that idea.
What happened in early 2000 and the
dot com crash merits no explanation or waste of time of the readers of this piece.
The consultants and investment
bankers who had deployed trillions of dollars of funds (..of HNI’s , pension
funds, 401K in the US etc) in these dot.com companies and earned and digested
their deployment bonuses (because no one ever made any profit) suddenly
became lecturers and advisors on topics such as how the chaos of 2000 could be
avoided.
Relying on the perfectness of the
short human memory, about 7-8 years later these investment bankers got a
brilliant idea and a new scam of CDO’s emerged on the premise that house prices
will go up infinitely and incessantly across the globe and a simple burger flipper
ended up owning 3 houses because of cheap credit and loose control on credit
checks and what followed consumed the likes of Lehman and over a hundred banks
across US and Europe. But the investment bankers had already encashed their
‘deployment bonuses’ and share of the brokerage incomes by doing a circular
trading of these Collateral Debt Obligations and who was left behind holding a
carrot? The commoner who was enticed to buy his second or the third home and the
pension funds and the hard earned money of HNI’s (that was siphoned off by the
likes of Madoff and hundreds of fund managers of these Ponzi schemes).
And - Because many of these
institutions were too big to fail, it was all eventually funded by governments
thereby expanding the balance sheet of the respective central banks and during
this time when people were losing their homes and losing jobs, interestingly the
global sale of ultra luxury goods was at an all time high and there are no
prizes for guessing who was stoking this insatiable demand of these luxury
goods (Louis Vuitton, Hermes, Dom Perignon, Rolex and Cartiers of the world)
Almost 7 years later (I am convinced
that collective short term human memory begins to fade after 5 yrs and is
completely wiped out in 7) we are seeing a frenzy like never before where
people say that ‘this time it’s different’ because the businesses have actual
run rates and e commerce activity has actually taken off and the approx. 16-17
trillion dollars that’s conveniently printed by the US Fed needs deployment and
therefore the same cycle all over again.
While we are yet to see many/any of
these multi billion dollar companies churn any positive cash flow, the
distribution of deployment bonuses is at an all-time high.
I was amazed to hear that a Japanese
company paid out close to 135 million dollars in a year to one of its rockstar
executive for deploying approx a billion dollars in the same time period.
That’s 13.5% in deployment fees/bonus. (this example is over-simplistic but is being
mentioned just to make a point)
Small companies selling salads,
idlis, sandwiches, rotis are getting obscene amounts of funding because they
are allegedly having an exemplary run rate and conveniently someone is seeing immense
potential of growth because of a 15 day run rate which if you extrapolate using
the devil ‘+’ on excel makes this company/portal worth a couple of billion
dollars.
Why?? Because they sold 2 pieces of
their product on the day of the launch and ever since they have been
registering a 100% growth in the last 30 days. And none of the investment
bankers want to miss this opportunity to own these growth stories. Is this
sustainable? I don’t think so. And I am quite sure about it. On the 31st
day of course the run rate isn’t the same but the funds have been deployed for
accelerated value creation.
During the times of irrational
exuberance everyone only talks of growth potential and entrepreneurs only look
at their product and imagine that every single person on the planet is their
potential customer and an infinite demand is assumed and therefore exuberance.
No one realises that in the hyper competitive and efficient market with
negligible barriers to entry any great idea is great only as long as it’s in
the mind.
Hotels are an interesting case in
point. The consultants make the owners spend humongous sums of money on the
basis of the ‘little devil’ and suddenly large investments on land and building
seem recoverable but oops only a handful of hotels in this country have been
able to recover their investments and majority of the hotels chains are reeling
under severe debt and a popular chain ‘Leela’ is almost bankrupt and many other
hotels will take over a hundred years to recover investments going by the
actual run-rate.
But consultants have taken their fees
and are looking for new clients and there is no answerability.
This will continue for ever unless:
- Every fund manager is made a part owner of the businesses where he is recommending investment. 'change the consultancy model from all authority and no responsibility to all authority and all responsibility'
- 80% and not 20% of the compensation of these deployment managers comes out of the positive cash flows of the businesses.
- Consultants are made to move from the model of ‘all authority and no accountability’ to ‘all authority and all accountability’.
- Consultants, investment bankers, and deployment managers aren’t allowed to ‘hit and run’ at the cost of the investor.
Till that historic instance in time some
innocent child again shouts and says that the ‘emperor is naked’ this bubble
will keep getting inflated and will consume the world all over again and if
indicators are anything to go by and if the sum total of all present economic,
political, financial, emotional and judgemental decisions could be plotted on
some model to arrive at a result……
What lies ahead will make the
depression of 1929 look like a walk in the park.
Manu also writes in Huffington Post