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 - until I recently learnt that even businesses (read e-commerce enterprises) are getting discounted and valued on their run rates, defined by Investopedia as "how the financial performance of a company would look if you were to extrapolate current results out over a certain period of time." It must be disconcerting for those old brick-and-mortar industrial behemoths such as the Tatas in India and Walmart in the US that Flipkart and Facebook are valued more than they are.
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 calculations based on "run rate" have brought the world to the precipice of destruction and collapse.
A sector with which I am closely involved, hospitality, is a perfect example of how Bill Gates has done an immense disservice to humankind by inventing that little devil, 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. Millions of dollars are poured into funding ideas that are yet to hatch based on little other than their impressive run rate.
"Millions of dollars are poured into funding ideas that are yet to hatch based on little other than their impressive run rate."
In late 90s it was as easy as registering a domain and coming up with an idea. If the idea was scintillating enough, the millions of dollars in funding were not far behind. The owners could crack open the Dom Perignon as they waited for a NASDAQ listing just a few months from the conception of that idea.
What happened in early 2000 and the dot com crash is well documented.
The consultants and investment bankers who had deployed trillions of dollars of funds (of HNIs, pension funds, 401K in the US etc) in these dot.com companies and earned and digested their deployment bonuses (because profit bonus was elusive) suddenly became lecturers and advisors on topics such as how the chaos of 2000 could be avoided.
Relying on short human memory, about seven to eight years later these investment bankers got a brilliant idea and a new scam of Collateral Debt Obligations (CDOs) emerged on the premise that house prices would go up infinitely. Even a humble burger flipper ended up owning three houses because of cheap credit and loose control on credit checks. What followed consumed the likes of Lehman Brothers 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 CDOs. So, who was left behind? The average Joe who was enticed to buy his second or third home and the pension funds and the hard- earned money of HNIs (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, the mess was all eventually funded by governments thereby expanding the balance sheet of the respective central banks. Interestingly, while people were losing their homes and jobs, the global sale of ultra-luxury goods was at an all-time high -- there are no prizes for guessing who was stoking this insatiable demand for fast cars and bejewelled watches.
Almost seven years later (I am convinced our collective memory begins to fade after five years and is completely wiped out in seven) we are seeing a frenzy like never before, with people saying that "'this time it's different" -- because the businesses have actual run rates, e-commerce activity has taken off and the approximately US$ 16-17 trillion that's conveniently printed by the US Fed needs deployment. It's the same cycle all over again.
While few of these multibillion dollar companies are churning out 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 in a year to one of its rockstar executive for deploying about billion dollars in the same time period. That's 13.5% of deployment fees. (This example is simplistic I'm trying to make a point)
"Consultants [should be] made to move from the model of "all authority and no accountability" to "all authority and all accountability"."
A company essentially selling salads, idlis, sandwiches, rotis is getting obscene amounts of funding. Investors see immense potential because of a 15-day run rate which if you extrapolate using the little devil "+" on excel makes this company/portal worth a couple of billion dollars.
Why? Because they sold two items on the day of the launch and have been registering a 100% growth in the 30 days since. Investment bankers don't want to miss the opportunity to own these growth stories. Is this sustainable? I don't think so. On the 31st day, of course, the run rate isn't the same but the funds have been deployed for accelerated value creation.
During these times of irrational exuberance everyone talks only of growth potential. Entrepreneurs are wildly optimistic about their products and assume everyone will want in. No one realises that in a 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. Reality: only a handful of hotels in this country have been able to recover their investments, while the majority are reeling under debt. Many hotel chains are reeling under severe unserviceable debt, a case in point being the popular chain Leela which is almost bankrupt.
But the consultants have taken their fees and are looking for new clients and there is no answerability.
This will continue forever unless:
- Every fund manager is made a part-owner of the businesses where he is recommending investment.
- Eighty percent 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.
Until that historic instance in time when some innocent child again shouts and says that the "emperor is naked" this bubble will keep expanding and will consume the world all over again. If indicators are anything to go by, what lies ahead will make the depression of 1929 look like a walk in the park.