Common sense scuttle-butt

What’s scuttle- butt ?

• Speaking with main street contacts :
• Customers
• Competitors
• Suppliers
• Other industry veterans
• People who are likely to have a real market view of the company -
like ex-employees, former vendors etc.
• The key is to focus on strategic insights rather than just treat it as aa
“channel check” to triangulate the latest numbers
What to focus on ?
• Focus on an “outside in” perspective – what to the company’s
vendors, customers, suppliers, competitors think of the company in a
non-sanitized environment ?
• Getting multiple perspectives from across the value chain and then
embedding them into a mosaic that can be continuously refined
• Triangulate it with numbers, secondary research, industry expert
opinion, customer feedback, competitor perspective and most
importantly financials
Setting the context
• Introducing yourself – sell your vision, not the immediate objective
• A little bit of ego massage never hurt anyone – remember the
counterparty is really helping you here.
• Be nice to secretaries, sales men, simpletons – they tell you stuff that
you can use too !
• Focus on understading facts; seek out how they connect as a
perspective; do not lead the counter party with your own conclusions
• Do a counter dipstick – invert and find out the risks and the reasons
thereof.
What to expect ?
• It’s about inquisitiveness, perceptiveness and persistence :

• A lot of leads will be dead ends – learn to live with it

• Adopt a capitalist than a democratic approach – 1 or 2 guys will provide you
all the key insights
• You can use a “linkedin” approach to use someone to get through to the right
guy – common sense is key
• Open ended questions can lead you onto the next level – ask, digest, prepare
for the next round
• Repeat the above till the entire thesis hangs tightly – reported numbers,
scuttle butt, secondary data/market research data all have to hang tightly to
create a tight thesis.
What you shouldn’t ?
• Don’t jump into conclusions – a very strong positive or a very strong negative view
should not lead you to shut your mind thereafter
• Sampling bias – don’t get swayed by data in company’s strong holds or in the company’s
weak holds. For e.g.., few Infosys employees are going to do cutting edge technology
work
• Don’t expect glowing recommendations – they seldom happen; However, just like on the
web, weak points tend to get exaggerated. For eg., several distributors still complain of
HUL’s high-handed attitude in deciding territories and product bundles.
• Understand that no company can please everyone – and tough business practices often
add value to the shareholder in the long term. Eg., Page industries squeezes distributors
hard at every opportunity – that’s the strength of the brand !
• Never jot down conclusions based on your own inferences – always, always maintain
verbatim notes of the conversations – it helps refine the thesis and helps identify where
one could have wrong in deciphering the information
Triangulate on the process and weed out the
outliers What could be biases are play ?

Is this sample representative of the whole ?

If not, how do we reduce sampling bias ? Do Are these inputs material to
we have enough data points on both sides shareholder value ? If not, ignore
of the bell curve
Converting facts into conclusions
• Focus on distilling running notes into :
• Quantifiable/data driven facts
• Juxtapose the financials into the above facts and develop hypothesis
• Refine the hypothesis based on secondary market data/publicly available
information/opinion of experts/equity research reports
• Refine this – till there are no more gaping holes in the thesis
Scuttle butt can add a lot of value
• Focus on non- popular stocks
• Focus on companies/promoters with a lot of past debt/governance
issues, capital mis allocation issues and hence are valued low by the
market
• Most such ideas start with a strong reference from someone in the
industry (main street) about the company
Investing wisdom

“Who does not see that ?”

“We are looking for situations where we think something is

mispriced. We start with a story, a thesis of why it’s misvalued. There
is no systematic way to do this; it’s like going to a bookstore to
browse for books. We don’t start with “is it cheap?” That’s easy to
find on the computer, but we view cheap as secondary situation. Our
goal is to find situations in which market is mispricing a stock and we
have an edge over the other side of the table – it could be analytical,
informational or temperamental.”
Focus on triangulation
How is the management behaviour
changing ?

Are financials tying up to main street

info ? What is on the ground info indicating ?
Additional data points
• Linkedin- profiles of senior management, jobs and their description
• Glass door/employee reviews
• Tweets by company/senior management
• Facebook posts of KMP – how much of their “heart”is into the
company ?
• Freudian slips in AR and in interviews
Investing wisdom

“You make most money when you have a

contrarian thesis to the market and you are
right “
Case study : “Being Dumb” brand of Black
Buck Maan
• “Being dumb” brand of casual wear was a part of a medium sized textile
company
• “Being dumb” donated about 3-5 % of its sales to a charity owned by a
leading Bollywood actor Black buck Maan who is quite popular in the
cow belt
• The brand grew to more than Rs. 200 Cr. Over 5 years with EBTIDA
margins in excess of 20 %+ and ROCE’s of 30 %+
• The parent company decided to carve this out into a separate listed
company through a de-merger
Chew on these facts
• High Debt-equity ratio
• Promoter pledging issues
• Mass resignation of independent
directors from the board
• Stock price fell 90 %
• Company had not released the
AR for 2016 until after Nov’ 16
• Rumours of the contract with
BlackBuck Maan not getting
renewed after the first term
• Strong brand
• Unique, blue ocean positioning
• Caters to the growing 300 mn +
hindi speaking middle class in
north, west and central india
• Sales growing at 20-25 %
• Positive feedback from retailers,
industry experts
What did we do ?
• Speak to 5-6 retailers from across India – including in South
(where brand pull was likely to be lower) to see how franchisees
(EBO’s) were doing
• Spoke to 2-3 industry experts to understand if the brand’s
positioning was indeed unique and sustainable
• Find out the factors causing the brand pull and consequently
what alternatives were available to customers
• Find out risks to the thesis and how substantial they could be
What did we figure ?
• Brand’s positioning was unique (first celebrity and charity led
apparel brand in the country) and surprisingly, premium (on par
with foreign brands)
• Good feedback on quality of fabric/designs used
• Brand pull of the celebrity was enough to draw in walk-ins
without any large SG & A
• SSG was healthy ranging from 5 – 15 %
• Distribution head room to grow was immense
• Reasonable popularity amongst the diaspora too
What were the grey areas ?
• 30% of sales is exports – are these numbers for real ?
• Contract renewal – is there a black swan risk
• What happens in case of death/accident/permanent damage to
Black buck maan ? Will the brand suffer ? ( we concluded it will not)
• Can they sustain these EBITDA margins ? (we think not)
So, would you buy ?
• Yes
• At a 60-80% discount to peers
• Big 4 appointed as auditor
• Improving professionalization – linkedin shows plenty of professionals joining the
company at senior roles.
• Those promoters (with chequered past) not on the board of directors
• Improving governance/disclosure
• Positive feedback on the brand and head room to grow
• Entry of reputed investors (post us buying) gives us confidence – what are they seeing
that Mr. market is not ?

That said, we are cognizant of the risks mentioned and would not make it a large position
given the blackswan nature of the risks (“high downside on low probabilities”). Monitor
these risks – the key is always to protect the downside risk.
Investing wisdom

"To us, investing is the equivalent of going out and betting

against the pari-mutuel system. We look for a horse with one
chance in two of winning, and that pays three to one. In other
words, we’re looking for a mispriced gamble. That’s what
investing is, and you have to know enough to know whether
the gamble is mispriced."
Caveats
• Scuttle butt does not work :
• In case of large companies with multiple products lines and with operations in
multiple geographies
• In case of companies where corporate governance is dubious and there are
lots of RPT
• When the technology/product is fast changing (eg., mobile phones, fads that
change in weeks)
• When sales cycles are lumpy and unpredictable – for eg., in enterprise sales a
single large win can offset months of slack and idle.
Other lesser known resources
• Credit ratings on the companies over a period of time
• Using social media for stock research
• http://seekingalpha.com/article/3759026-investing-forensics-age-
social-media
• Linkedin profiles of the company
• Glassdoor reviews
• Facebook page/google searches/reviews
Varadha.r1@gmail.com
Twitter : varadhar1