Monday, June 22, 2009

Financial sector participants - I

Financial services is one of more opaque industries around. The structure of the industry and the reporting lines are fairly muddled. It took me quite a while to understand how the industry is structured and so I thought it would be a good idea to give a broad map of the industry. All in an effort to lower my own guilt at earning a living out of a fundamentally unscrupulous industry (perhaps all industries are like this, but I have only ever been exposed to this one).

Broadly, the industry can be divided into three parts – one bunch of people working with companies, one bunch of people working with markets and a third bunch who we will charitably describe as other jokers (mostly because I do not understand what they do). By industry, I do not include the guys who actually do banking in the true sense of the word. The guys who actually lend you money to buy house, car, or an education. These guys are probably only slightly less clueless, but what makes them far more tolerable is the fact that they generally don’t have huge egos. Also, there are more women in this part of banking. J

Bunch 1 – Guys who work with companies.

The guys who work with companies are the ones that advise companies to issue corporate paper (to “borrow” in English), to “optimise” their balance sheet (there is no English-word equivalent for this) and to buy other companies. This industry is structured in three layers, one big shot guy who has a “board-level” relationship with 4-5 companies in an industry. He has 2-3 guys reporting to him (rising stars) who do the market analysis and are generally sold the dream of being tomorrow’s big shot. This structure is propped up by flunkeys who make the presentations. Now, you might wonder why these guys would be best-suited to give gyaan to CEOs on what companies to buy. How in the wide world would a 28-year-old who has spent all his career (all of 4-5 years) in the financial sector be capable of “advising” on a transaction where one telecom company buys another, you might wonder. But this is how the industry works. Most big deals are done for the sake of one underlying theme, and generally that is not financial. Top management either develops a fetish for a competitor’s product, or develops an ego that demands a bigger company to run, or in most cases is under pressure to “better-utilise” the cash on its balance sheet.

The “board-level” guy plants the idea in the minds of top management, gets his flunkeys to flip a bunch of the presentations, has one of his stars run through this and makes a pitch to the management with a shortlist of 3 targets. Some financials are thrown in for good measure. The flunkeys literally do a match-the-following of “buyers” and “sellers” in the industry and create a laundry-list of possibilities. When some companies fall under the category of potential “buyers” and “sellers”, flunkeys self-actualise. I have heard questions from flunkeys like – Can Atos Origin buy Satyam in order to acquire offshore capacity?. I would reply that Atos has cartloads of debt, and Satyam’s market cap is actually higher than Atos’s. Oh, then can Infosys buy Atos Origin then?, would be the next question. Imagine you going to a vegetable vendor and asking for potatoes and him replying, I don’t have potatoes today, but can I buy your pen instead?

The stars know a lot more about the industries. They would know that Atos hadn’t a chance in hell of acquiring anything and Infosys would rather de-list before they bought Atos. They would shorten the list created by flunkeys, add their “expertise” and bond with the board-guy to discuss possibilities for the sector. They would patiently “crack” new boardrooms, build a potential-deal “pipeline” and wait for one ego to get big enough to cloud judgement. That is pretty much the description of your average M&A house. Till I completed by MBA, I did not even know that companies bought other companies so frequently. I just could not see the reason for this type of transaction. They probably wouldn’t do this if not for this industry.

The other divisions which raise debt, help with rights issues etc, work similarly. There is one bunch that does financial engineering to help companies manage their balance sheet. In India, generally this work is done by assorted auditing firms. Mostly, what these guys do pushes the ethical boundaries; in some cases it is downright fraud. The auditing firm will help you “optimise” your balance sheet. In essence, the company will help you massage your ratios if you want to borrow on favourable terms. Your inventory will be placed with your biggest customer to count it as receivable, your key shareholders will be paid cash dividends, your big lenders will be told they will receive interest, only it will be called dividend from now on. This is called financial engineering. It sullies the good name of engineering.

Will give a few bits on bunch II and III later on.

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