The Colombo stock market has experienced several shocks lately. Many are the results of actions taken by two young financial geniuses, namely Dammika Perera, the high net worth investor and his fund manager, Nimal Perera. Together, they have been aggressively buying into several blue chip companies and executed five of the seven acquisitions that took place last year, a record in Sri Lankan stock market activity.
In this exclusive interview, Nimal Perera speaks with Business Today about the complex intricacies of portfolio management and the strategies this dynamic duo implement when investing. They believe that acquisitions of large enterprises is the way forward with a keen focus on maintaining high levels of corporate governance and transparency as well as looking after shareholder interests. He does not believe in luck when trading stocks but advises other investors to hold on to their shares as they will definitely appreciate in a year.
This erudite financial analyst describes the Colombo stock market as rumor driven with far too much dependence on small-time retailers, which is very harmful. In addition, he finds the dearth of consistent fiscal policies and proper regulatory frameworks in the Colombo Stock Exchange (CSE) as the major discourager of genuine foreign investors.
Perera also touches upon the prejudices they faced during the National Development Bank (NDB) acquisition, which has raised some controversy as they were prevented from buying further into the company.
By a Staff Correspondent
Assisted by Sheahan Ganeshan
How long have you been involved in investment banking and portfolio management?
Portfolio management is a complex field and fundamentally involves closely monitoring stock market activity. I was an accountant at Sherman and Sons for about ten years during which time I began stock trading. I was managing the company portfolio, which was worth around Rs50 million at that time, as well as some of the directors' personal portfolios until I left in the early 1990s. In addition, I managed my own portfolio and those of some of my close friends, which did not include Dammika Perera. This was not on any fee basis.
I now manage the funds of Dammika Perera so when I mention investments, I am always speaking on his behalf. I don't manage other people's funds anymore.
For someone who has been in the market for quite a while and seen its ups and downs, how would you compare our market with some others?
I have gone through all kinds of cycles; I have experienced all the ups and downs of the local stock market. Our market is essentially 100% rumor driven and not based on fundamentals. There are very few major players here. A small number of people trade from day-to-day and the others are retailers. There are a large number of retailers with individual brokers who carry out day-to-day buying operations.
The retailers are the most influential people because they have the power to bring down the market. When the retailers begin selling their shares, the institutions and other major investors follow them, and when the price comes down nobody will touch the shares. Then everybody panics and starts selling them, resulting in the entire market falling drastically.
In your view, is this strong retailer influence good or bad for the market?
It has a negative impact. In other countries, retailers follow big institutional investors, but here the big investors and institutions seem to follow the retailers. The automatic result when the retailers start selling and the investors follow is the collapsing of the market, and that is what has happened here. Personally, I go on my own principles and theories with regard to stock trading.
But then again as you just articulated you can't apply any principles and theories because the market is speculative and the retailers are the market makers. You say the prices don't reflect the true intrinsic value of the stocks, but do you think the market indices reasonably reflect the economic strength of the country?
You cannot say that either. When we were buying into the National Development Bank (NDB) about two and a half years ago, the market was down and the price of the NDB share dropped drastically, along with John Keells Holdings and other blue chips. At that time the book value was around Rs40-45 but we were able to buy the NDB shares at Rs28 and after one and a half years we sold it at Rs90-100. The share price doesn't reflect the true value. That is the style of our market.
Just recently some of the brokers, investors and fund managers operating in the country came out strongly through the print media claiming that the market is run like a casino. What have you to say?
I feel it is very wrong to make such irresponsible statements. They were made by a disgruntled individual because he had a bad experience. The stock market is certainly not a casino operation because you do not lose. In a casino you can be nearly 100% sure of losing. If one can hold their stock for at least one year they won't lose. Even if the value of the share drops by 100%, it will appreciate within one year.
So you don't believe in chance or luck in the stock market?
Not at all. You must possess the holding power and adequate funds. If you do not have your own funds or some backing, you cannot manage in this business. If you invest in margin trading, you run the risk of a loss if the market dips.
Do you think the drop in the interest rates contributed towards the recent pick up of the stock market?
Yes, the reduced interest rates greatly contributed but so did the tax amnesty. A lot of people brought their black money into the stock market to make it white. During a short period of time, the country received a lot of funds from overseas, some of which was laundered and which people kept under their pillows. All the undeclared money also returned into the system, which helps to a large extent.
You were personally involved in executing five acquisitions last year. Could you explain your investment rationale?
In the last financial year, seven acquisitions took place in Sri Lanka; out of which we were involved in five. This is a record in the Sri Lankan stock market activities. The other two acquisitions were of LOLC and Asian Hotels.
We have two types of investments - strategic investments and stock trading. Sometimes a strategic investment becomes a trading stock. For instance, we bought NDB as a strategic investment but we found it inadvisable to keep those shares and so we decided to dispose of them. Almost all our investments are long term. Dammika Perera is only 35 years of age and has so much more to achieve in his career.
Why did you consider NDB a strategic investment when you only had a 12% stake?
NDB Bank announced its merger with NDB and that potentially made NDB a commercial bank within a short time. Dammika Perera's pet investment is Pan Asia Bank where he is a director and the major shareholder. According to the banking regulations an individual cannot be a director in two commercial banks so he had to sacrifice one of his positions. Thus he decided to resign from NDB.
Initially we wanted to acquire a very large stake in NDB but at the time, certain people involved blocked us by introducing various restrictions. They even prevented Janashakthi from obtaining a board seat after becoming the major shareholder. In order to stop us from acquiring more than our 12% stake, NDB passed a resolution saying that existing directors cannot buy shares. Specifically the three most senior executives didn't like us buying NDB shares and went to various persons and authorities of power and canvassed for their assistance including the treasury. They asked some of the major NDB shareholders not to sell their shares but if they truly wished to, they were requested to sell them to NSB, EPF, ETF or a bank but not to Dammika Perera. They used those exact words. When ADB was selling their NDB shares they told a particular stockbroker not to sell any shares to Dammika but to give it to NSB or ETF because of the campaigning by the connected people of NDB. The same thing has happened to Janashakthi who today have 15% and are the major shareholders. These are the prejudices in the current banking sector.
But why block any sale of shares to Dammika Perera?
I cannot understand the rationale behind their thinking because today the entire corporate sector in Sri Lanka has accepted Dammika Perera as a very competent and respected investor and entrepreneur. He maintains corporate governance and transparency in all his organizations, which is why our shares are actively trading even under depressed market conditions. For example, we had a recent one-for-one rights issue for Connaissance. After increasing our share capital by 100% (we gave it at Rs10) and soon after the rights issue, the share went up to Rs42. That is because of Dammika's reputation and credentials.
"Specifically The Three Most Senior Executives Didn't Like Us Buying NDB Shares And Went To Various Persons And Authorities Of Power And Canvassed For Their Assistance Including The Treasury. They Asked Some Of The Major NDB Shareholders Not To Sell Their Shares."
Under our takeover and acquisition code you are also expected to make mandatory offers to the dissident shareholders?
Yes, we have made five mandatory offers thus far and conformed to the code. Some people takeover companies without giving mandatory offers. Others form companies in other countries and use such companies to make hostile takeovers, but that is not Dammika Perera's policy or style. He always gives public mandatory offers to the shareholders and then takes over the company.
How do you finance your acquisitions, how exactly do you source funds?
Through a combination of internal funds and borrowings. Like many other businessmen, our main source of funds is bank borrowings. We also have our own funds; I have been doing business for the last ten years. Furthermore, we have made profits through our investments. For example, we bought Connaissance for Rs150 million using the gains we made from our divestiture of investments in NDB. Today our investment in Connaissance is worth over Rs1 billion, and that has essentially been a gift from NDB.
Do you believe in the Efficient Capital Market Hypothesis which in simpler terms means that the price of a share is reflective of all relevant market information? Does that hypothesis hold true in this market?
No. Also although the media mentions the existence of several foreign investors in Sri Lanka who are buying up so many shares, it really is not foreign buying. These are local investors who have either migrated from Sri Lanka and are running successful ventures overseas or those who reside in Sri Lanka and make purchases through offshore outfits - it is not that actual foreign funds are investing in the local market. Sometimes shares are bought using black money, which people have invested in foreign countries but channeled into the country using the tax amnesty as an effective conduit. There are only a handful of genuine foreign investors and funds in Sri Lanka. The market is driven by local investors.
But then, why haven't we been able to attract good prospective foreign funds into the country?
The present political makeup in this country is such that fiscal policies do not remain consistent. In one year the government declares tax holidays or concessions for BOI companies but after two years they discontinue the concessions. This affects our integrity and deters prospective investors. We do not have consistent fiscal policies on capital market activities. So naturally potential investors will not trust our policies and principles, and thus will not risk their investments.
Are you implying that our regulatory framework is weak?
Yes, and this is the key reason for a limited amount of foreign investors entering the market. Three years ago the government lifted the tax on share trading but they plan to reimpose it this year. This predictability does not help build investor confidence.
Another problem is the flawed rules and regulations of the Colombo Stock Exchange. If one wishes to give a mandatory offer, they have to provide a bank guarantee stating that they have sufficient funds to acquire the balance available shares. We had to give bank guarantee of Rs1 billion for the acquisition of Royal Ceramics. How investor friendly can such policy be?
Returning to your acquisitions, how do you select your targets?
We do not conduct any feasibility studies or project evaluations on the companies we propose to acquire. We only obtain their balance sheet. If the required quantity of shares is available and if the price is right for us, we go ahead with the deal. We have analyzed all 242 companies listed in the Colombo stock market and found that there is nothing else for us to buy at the moment.
We don't believe in extensive research. If we carry out exhausting research, we will never be able to buy any company in Sri Lanka. For example in the case of Asian Hotels, several parties were conducting research and analyses but ultimately it was John Keells who suddenly decided to buy it. Even with our takeover of Connaissance, many existing shareholders wondered why we were buying it. But we knew the value of the Connaissance properties and understood their potential. We bought Connaissance for below Rs10 a share with a total investment of Rs150 million inclusive of rights. We repaid most of the company's debts and it is now a debt-free enterprise that is doing very well.
If acquisition decisions are that simple why are feasibility and due diligence studies conducted at all? The whole process can be short-circuited thus saving a whole lot of time and money.
We are more in line with Western principles and thus our thinking is different. People don't like our culture. They don't believe in sharing their opinions. For instance if two parties are involved in a similar business and wish to attack a particular mutual enemy, it would be advisable for both to launch a common campaign but people don't like such campaigns. I don't think companies in Sri Lanka, particularly banks, finance and leasing companies can survive without merging. Mergers and acquisitions are the world trend today. We have to work together and cooperate. If we don't, we won't be able to run companies successfully in the future.
Do you view acquisition of Colombo based hotels favorably?
As someone from the leisure industry, I believe that having a Colombo based hotel in your portfolio is favorable as well as advisable. We are also thinking of such a Colombo hotel takeover. It is a major asset to any portfolio because of the huge real estate value.
Is the real estate value alone enough to justify the investment? For a business the asset has to be productive and profitable to maintain or improve the return on capital employed. As a market observer, do you think Asian Hotels would add any value to JKH shareholders?
Basically if any capable management sees good value in certain companies or properties, it is always advisable for them to go ahead with the acquisitions. In the case of the Asian Hotels takeover, I feel that JKH bought it at a premium. There were plenty of opportunities for them to purchase shares below Rs20 but they ended up paying over Rs30 per share. Acquisitions do add value to the shareholders.
To me, the best managed company in Sri Lanka is John Keells Holdings, and it also has the best board composition and a good work culture. There are no major shareholders representing the board, there are no controlling groups and thus no one party has any vested interest. Today, Vivendra Lintotawela is the chairman but after another two or three years someone else will take over. Only a few conglomerates including JKH and Hayleys give substantial dividends and bonuses to the shareholders. JKH looks after their stakeholders very well.
How do you add value to your investments?
We add value to those companies we have acquired as strategic investments. Examples are Connaissance de Ceylan, Royal Ceramics, Reefcomber, Horizon and LB Finance.
In the case of Horizon it is the first time in Sri Lanka that an existing hotel has been completely demolished. Horizon was a three-star hotel with over Rs250 million worth of assets but we hope to replace it with a new hotel. We have published our proposals and architectural drawings, and have explained our financing plans to the stock exchange. As a result of our credentials, even after demolishing the hotel and with the restructuring of Connaissance taking place, the share was trading at Rs16. This is proof that we have added value to the company.
An interesting observation within the companies that you have taken over is that you continue to maintain the management and status quo after the takeover unlike other acquirers.
That is another of Dammika's strict policies. We believe that the existing management knows their business well, and we trust these people. If they have robbed the company, we will obviously show no mercy but if they are genuine, they can keep working for as long as they like.
"To Me, The Best Managed Company In Sri Lanka Is John Keells Holdings, And It Also Has The Best Board Composition And A Good Work Culture."
You mentioned earlier that although there are some 200 plus companies listed on the Colombo stock exchange, you see no good future takeover prospects among them. Why do you think the market is so limited?
The problem is that in our market, there are no shares to buy; everything is closely held. Out of all the companies that are listed, only about a 15% stake of the total capital is trading in the market, and some companies are quoted just for their namesake. An example is Carsons Cumberbatch that has a very small share capital of which nothing is being traded in the market.
There are numerous respectable companies in this country such as the family concern businesses like Maliban and Munchee. Those companies should enter the stock market as well. If they offer 20% of the shares they do not have to be afraid of being bought out.
You appear to be focused on quick growth through predatory activity. Why not build any businesses from scratch?
It is very difficult to start up large companies and it is not viable, nor advisable. For example if we were to establish a hospitality giant like Connaissance, it would cost well over Rs1 billion and would take over three to four years to complete. Then how much longer will it take to enjoy the return on that investment?
To set up any company, one must raise substantial capital, which in turn requires credibility. I am 100% certain that if Dammika Perera is to go public with any of his companies, most people will subscribe because he has maintained dignity, good corporate governance and transparency to the highest standards. Unfortunately, some people have formed mushroom companies and gone public to raise funds but are no longer in existence because they did not have any support.
We feel that company acquisitions are a fast track approach and the best way forward. In addition, with the manner that local banks are managing their funds, it is very easy to conduct restructuring programs.
Isn't this the very reason that good family controlled businesses are afraid of going for public listing?
Family controlled businesses are good as long as they keep the controlling interest or 51% or else someone will grab it. Opportunities are few, so everyone is trying to acquire an enterprise. There are a limited number of companies, shares, and not enough good investors in the local market.
What about Richard Pieris, a family controlled conglomerate that became a victim of its own success by exposing itself as a potential takeover target?
The main problem at Richard Pieris was their lack of unity. If you can't have unity in your own family, how can you expect to maintain unity within the company? They could have retained controlling interest if they were keen on managing the company. A classic example is the Tata Company in India where the family has only 10% of the issued capital but is still managing the company because they maintained good corporate governance and transparency. If investors receive their return on investment, they will be content.
What are your views of the government's plan as per the recent budget to impose a 15% withholding tax on profits from share trading?
Governments have to tax people otherwise they cannot exist. However they shouldn't tax the profits made on sale of shares; they should impose a tax on sales proceeds, like a separate levy charged by the exchange. The Ministry of Finance has stated that this tax is only for corporate bodies while the Inland Revenue Department claims that it is for everybody. The retailers are always trying to take the lead role in bringing the share prices up as well as down but they may be saved from the 15% surcharge, which is not correct. However no one truly knows who is to be charged. The government needs funds for growth and development so they should charge taxes but they should follow consistent policies.
The market took a dip in November 2003 and there appears to be no significant recovery any time soon. With your insights into the market, what do you predict?
There will not be any change in stock market activity immediately. I don't understand why people have panicked. The machine is still running and nothing has stopped. People are too concerned with rumors. For example, if it is rumored parliament is to be dissolved and a general election is in sight, the market collapses. Similarly, if someone says that there won't be any election or that peace talks have resumed, the market rises. This is not a good pattern or behaviour.
Under such fluctuating and volatile conditions, are you still steadfastly prepared to go ahead making investments and acquisitions?
We will continue to buy if the price is right. It is a matter of holding the shares for one year and after that, it will change. The economic conditions in Sri Lanka are not like it was previously. The economy is growing, interest rates are low, and there is a high growth rate of at least 4-5% this year. Therefore people will continue to invest in company shares.
I also have foreign enquiries for potential acquisitions, but the problem is with good immediate targets. We are committed to our pursuance of an active role in the market and maintain an open mind toward more investment and restructure activity.