Friday, December 02, 2005

Educating Riso

I have an interesting story about Riso Kyoiku (TSE Code# 4714), a humble family-run private education company running ju-ku, or cram schools, not dissimilar from America's SAT review courses. It is a story that Elliot Spitzer should be interested in for it exemplifies just how far the investment management business has travelled. But more, It is a tale that reveals the sordid impact of what this reality has wrought. But to fully appreciate it, one needs race through my short course in Financial History from 1979 to the present.

[fade in to an Appalachian-looking cottage with Hay-seed (yours truly) playing banjo on the porch with a mongrel dog buzzed by flied at his feet, and a 1955 Buick upon on blocks in the yard] A long time ago, when I was a boy, in the good old days, when Republicans were socially conservative, AND fiscally conservative (but no less un-hip), a healthy tension existed between those who might have thought it wise to short a stock, and those of a more bullish persuasion who were inclined to buy it from them. They were innocent times. No channel checkers. No one rummaging through your rubbish or supbeoning your e-mails. No hedge fund analysts running around trying to interview disgruntled employees, count cars in teh factory parking lot or bribing doctors affiliated with clinical trials in order to obtain material non-public information. Investors, even large ones it must be said, generally bought stocks because they thought (for better or worse) they were good investments and that their prices would go up in the future because others would recognize the same. And while some even made money in this good old-fashioned kind of way, few bought stocks with the intention that they would make them go up come proverbial hell or high water.

I don't believe there is a clear line of demarcation when money management moved from the discreet rooms and plush carpets of the Trust companies and boutique patrician firms to the big-time, but it probably began in earnest once the horrors of Volcker's bloody massacre of inflation began to dissipate and Reagan's great democratisation of credit providing 24-7 leverage to the masses really took off. These were good years. Vietnam and oil shocks faded, as did "day-glo" and bell bottoms (thank god!). Pony-tails were cropped. House prices rose. Ordinary middle-class Americans began to save, but had very little knowledge or savvy about what to do with it. Not that the rich had any better clue, they simply had enough of the stuff (money) that substantial amounts were left over once the Trust Co had helped themselves such that it didn't matter. And besides, it was bad form to haggle over price as folks at the club might get wind of it and think that one was having "problems".

Recall that CD's were considered bold financial innovations, brokerage commissions were only recently deregulated and the mutual fund was still a novelty. Those who invested directly in stocks typically suffered from bad halitosis. With double-digit interest rates and single digit PE's (that had been double-digit themselves not long before), equity mutual funds were clearly NOT the au fait topic at cocktail parties. Not in 1981. The boom may seem obvious in hindsight (as it always does). The first movers who seized the opportunity grew to inconceivable size - something few could have dreamed of only a few years earlier watching President Carter deliver his "Malaise Speech" in that dark cardigan. If they had been able to conceive of it, maybe a Johnson from Boston, rather than a Kennedy from Chappaquidick would have resided in the large white house atop Pennsylvannia avenue.

With this growth came lower fees. Explicit ones, at least. Granted they wer not much lower, but they were lower. Mostly, however, the heady growth just meant pots of money for the investment management company. But there was competition. Someone was always doing better, and when they did, money flowed to them and THEY grew at a faster pace. Don't shed a tear for the others though. There was plenty to go around. At the same time came Wall Street's resurgence. Greed was Good!, Gordon Gecko told us. MBA's, CFA's, VC's, CEO's, PhD's, all setting their sights on the pots of gold were followed by LBO's, MBS's CMO's IPO's, QQQ's and ECN's. Of course there were some minor setbacks (1987 & portfolio insurance, Gulf War I, LTCM, 9-11), but for the most part, money and credit were easy, easier, and easiest and more or less has remained that way to this very day. Wealth was created and had to be invested. Firms grew, and either ate or were eaten to become ever-larger and more powerful, controlling larger percentages of assets. And this is the opportune moment to point out that the combination of ambition, power, and buckets of other people's money is a certain a recipe for folly and possible financial calamity.

Fast-forward to the miliennium. Jerry Garcia is dead. Johhny Cash is playing a cameo with a grunge band. Netscape, THE Bubble, Enron, WorldCom, Adelphia, Janus "20" Fund, all were tell-tales of "something" in people and America that many obserrvers still seem not to have fully grasped. Games (big games!) were played. Sometimes well (by Jeff Vinik and Cap Research), some less well, like Janus, who let (and encouraged!) investors to pour so much money into the Janus-20 Fund ($30 billion?+) ostensibly focused on "their twenty best ideas" that the annointed stocks therein powered to unimaginable heights. And like Gerry Tsai before her, Helen Hayes was presumed a genius (as was Ameriindo Vilar & First Hand Landis)! Yet there wasn't a one article in Fortune, Forbes or the Wall Street Journal that questioned the wisdom (or queried the market price impact impact) of focusing multiple billions of dollars of liquidity upon non-megacap stocks through open market purchases. Nope. Performance was self-attributed to "amazingly perceptive research analysts" ("one step ahead", we were fallaciously told) and prescient portfolio managers. Kahneman & Tversky have words for these people, and they are technical and not pejorative in nature. But I too have words for them....less techincal... and more plebian descriptors: fraud and stupidity. Not because in 2002 it all went horribly wrong leading to the [deserved?] near-destruction of Janus, but because it was ill-conceived and cynically dishonest from early on creating a redistribution of wealth from those whose need for it in the future will be more, to those whose immediate need for it wasless. And if it wasn't premeditated and cynically dishonest then lord please have mercy upon their very stupid souls!

But what does this have to with the saga of Riso Kyoiku, the humble operator of 50 or so juku schools in and around Tokyo? In the post-bubble meltdown that also hit Japanese stocks hard, Riso was minding it's own business, and fairly well one might add. It had grown it's business beyond many peers and as ambitious people do, garnered a TSE listing. This is not unusual as most juku operators in Japan are for-profit, and numerous are publicly listed - some more time-honored, some more aggressive. Sometime in 2001, the "for-profit" education theme captured the imagination of US investors and the few available stocks had their growth (much by acquisition and in hindsight less-than-scrupulous enrollment methods) were rewarded with doubles, triples, and more. UOPX, APOL, CECO & COCO were present in almost every growth, momentum, and thematic portfolio. By the end of 2003 the private education theme was, as they say "white hot". And so in early 2004, it spilled over to Japan.

It's is hard to know whether such the decision to select and ramp Riso is the result of a mechanical formula for choosing a few active-weight companies which will be annointed "The Ones" (like Neo in teh Matric), chosen above those of its brethren. Perhaps they throw darts. Maybe they write the co names on slips of paper and stuff them inside a paper mache donkey and have a pinata party (the Senior Portfolio Manager getting to swing the bat first?). Maybe it's the sector analysts' call and they, in fact, choose meritocratically on fundamentals. It's only of passing interest and once the stock passes the two-bagger level, matters little to the outcome. As it happens Riso does have growth (both historical and forecasted). And this growth is forecasted to be higher than peers. But this is independent of the cynical disregard for all decorum (and probable legality) in what happened next.

In this instance, the very large American fund management company chose Riso. And they chose. And they chose. And they continued choosing. They chose it for their value funds, their growth funds, their global funds, their country funds. They chose it on Mondays, Tuesdays, and Wednesday, as well as Thursdays and Fridays. For Riso (and it's owners), this must have been like winning the lottery, for they sold some shares. And from when they began choosing to the end of the first quarter, they had taken Riso from YEN 2,500 to YEN12,500 (on a split-adjusted basis). A significant and eye-popping amount of this performance was the first of three following a large stock splits (see my previous post "10 Divided by 1 = 3", for an explanation of the split-ramping anomaly) which must have. This must have been welcome news to the American Co's various portfolio managers who held this previously unknown nano-cap juku operator, and even though their holding may be small, even a 25bp position that quadruples in value can contribute a potentially quartile-changing return.

But things were to get even more curious. By end of Q1 2004, humble Riso was sporting google-like valuations (and returns!). It was quite obviously was no longer a value stock, yet it remained a member in a myriad of style contradicted funds. The owners sold a reasonable number of shares which were apparently hoovered up by "interested parties" who by this time had filed with authorities of >5% ownership. The stock price came off to near it's pre-split ramp price (still 2.3x, it's price at the beginning of the ramp), but leapt to a new high just eclipsing its prior high on the back of rises every day in Jun4 2004 which coincided with this investor acquiring another 6% of the company. Following this quarterly pump, the price again dumped 25%. But a combination of another round of splitting, split ramping, insider sales, and accumulation by interested parties who raised their stake by another 5% to nearly 15% of shares outstanding or about a third of the free-float, took the stock up 27% in the last of Aug, and other 15% in Sept to conveniently set another new high for the end of Q3 2004. Maybe it was causual coincidence that they increased there stake so substantially at higher and higher prices which coincided with important fund valuation periods and random perhaps, but curious all the same. But as an observer of randomness, I have my doubts.

The price fell back 30% into Q4. Maybe this large shareholder was lightening up.
Maybe they were trying to send a message to management that while they have mutual interests in seeing a higher a share price, they will NOT buy any more stock from the owner & family at these high prices. Perhaps the message hit home. For in Q1 of 2005, the co. announced yet another split, vaulting the shares another 35% back to their prior highs. Since then, the American investment manager so enamoured prior, has cut its ownership by more than half to Q3 2005, and the price has nearly halved. One might wonder what would happen to the share price if they unloaded the rest of their position.

But what this is about is our tolerance of obviously manipulative behaviour, without investigation, or even a footnote in the financial, academic or regulatory press. Martha Stewart went to jail for far less (not that I approve of what she did). And the thing is that YOU can't do this at home. And it is a direct result of the size these firms have reached, the placing of their parochial interests as an investment manager in front of the interests of their shareholders and their role as a fiduciary. THIS is where financial history has taken us. THIS is the sad result of size and questonable ethics upon markets. And everyone is poorer - except Mitsugu Iwasa - Chairman and founder of Riso, who has indeed seemingly drawn four aces from his relationship with his institutional investor.

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