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2018 Annual Letter

2018 was a disappointing year for us. Disappointing not just because of the negative performance, which obviously was painful, but more so because of our unforced errors. Poor choices caused about one-third of our negative performance. Rupee depreciation and indiscriminate mid-cap selling caused the rest, in roughly equal measures. We spent the entire Q2 letter dwelling on our four problem stocks so we will not rehash it here. We fixed the problems when we found them, even though the temptation to “just wait things out” was quite high at the time. We have a process for handling bad outcomes, and we stuck with it. For that, we are proud of ourselves. Now we just have to work on being less stupid when buying. That’s work in progress.

During the second half of 2018 we were busy stock searching, and soul searching. Stock searching resulted in two new positions, which we describe at the end of this letter. Not much changed in the soul department. We still believe that India has tremendous ground to cover. It’s overflowing with young, hard-working, and ambitious people. Yet it is so grossly underserved. Sure, many of its citizens are poor, but that’s just half the story. The other half – the real half, is the breathtakingly poor systems of governance India has endured for seven decades. That second half is now getting fixed; in its own haphazard Indian way, but in a big way nonetheless. And that is truly exciting.

Take, for example, India’s new bankruptcy process introduced two years ago. Out of the first twelve cases, which made up one-fourth of the banking system bad debt, half have been resolved. In each case the promoter who ran the firm into the ground is out. This may not sound like a big deal to those familiar with a developed market framework like Chapter 11. But for India this is absolutely radical. Large promoters tend not to lose their fiefdoms in India, despite serially defaulting. You get the loans evergreened, you shove the cases into a painfully slow legal system, you buy your own distressed assets via related entities. You do what it takes but you never let go. The new bankruptcy process is an attempt to change all that.

Thus far close to 800bn Rupees have been recovered. Another 1.2trn is imminent. More importantly, every time a promoter tries finding loopholes the law-making body tweaks the law. It’s vigilante-justice and it’s ugly, but it’s working. Other such examples include the recent Goods and Services Tax, and the Real Estate Regulation Act. Every one of these regulations will be agonizing in the short run. For decades, people have conducted their business a certain way; that old way is becoming prohibitively expensive.

2018, for instance, was a bumper year for corporate governance scandals. First, a few dozen auditors resigned without signing off on their clients’ annual financials. Then some bankers got sacked. A few of them will likely get prosecuted for encouraging the cronyism. In a couple of high-profile cases, owners who were unable to settle bank loans fled the country and are now fighting costly extradition battles. Companies with stock-pledges are getting pummeled, which is forcing the pledgees to liquidate the stock collateral, further pressuring the stock price. Weak corporate governance, for long considered the cost of doing business, is now a front-and-center issue.

We don’t know how long the malaise will last. But we know this: a) it will eventually result in a far better business climate, and b) it will throw up some big winners, and big losers. Our investment process, designed specifically for this, will stay the same. The only slight tweak we’ll make is to put an even greater emphasis on the promoter quality. In this long-drawn business transformation we only want to partner with folks who have a demonstrated track record of shareholder stewardship. They will be the winners.

One final point; this is election year in India. Things are about to get populist and socialist-like, which tends to spook the markets. Already, the Congress party has promised a minimum income guarantee. As elections draw closer (April – May) things will get noisier. We take great care in making sure that our companies and their promoters are not overly politically levered. So the earnings prospects of our portfolio companies will not change, but their stock prices can swing considerably. We are not terribly worried about that.

In closing, these are exciting times for India. While the country remodels itself, a few well-run Indian companies will make spectacular amounts of money. We intend to make the best of this immense opportunity. As always, we are grateful for you to be a part of our journey.

If you have any questions regarding this letter or your portfolio, please do not hesitate to ask.


Rahul Bhatia Aniket Khera


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