Invest Globally, But Investigate Locally

Nick is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In a recent piece in The Economist on corporate intelligence (“The Bloodhounds of Capitalism”), the focus was less on spying, and more on how decision-makers are using investigators to figure what is going on at their own companies.  Put off by the track record of incompetence, double-dealing, and compromised Big Four accounting firms, hedge funds, private-equity firms, and pension funds are turning to Sherlocks (or cheaper Watsons rather) instead of simply relying on public documents.  (Interestingly for those into disruption, some firms like Kroll, described by the New Yorker as "the private CIA," are even expanding into the Big Four's accounting turf as well.)

Even without the budget or staff of Goldman Sachs (NYSE: GS), the average individual/retail investor could follow suit and go beyond 10-Ks and also read accounts by ex-employees, activist investors, and others that have become clearinghouses for the disgruntled and the concerned – such as re:Auditors maintained by Forbes columnist Francine McKenna.

While some companies may just be bad at corporate governance and looking to prevent major catastrophes while they get their house in order as fresh scandals erupt elsewhere, the article highlights a trend among emerging market companies to “self-investigate” to (a) discover any problems that may not occur to them, but would be concerns to Western investors, and (b) use their “clean bill of health” as part of their overall credibility package.

Moreover, the article hits upon not only an interesting economic indicator, but an area of the financial statements that might pique the interest of savvy investors:

Assignments linked to mergers and acquisitions have dwindled along with the number of deals, but other areas are expanding. One big source of work is the growing complexity of business regulation. Multinationals can never be sure that some employee, somewhere has not violated America’s Foreign Corrupt Practices Act, or some other anti-bribery law.

The Mintz Group has also found that the due-diligence segment of its business had increased 40% over the last couple years, which prompted President James Mintz to quip to The Economist, “We tell clients to invest globally but investigate locally.”  Similarly, Kroll’s Tom Hartley points out in the article that their impressive growth is a result of, “business we win in America but serve in Asia, driven by the export of Western ethics.”  The growth of depositary receipts (DRs/ADRs) which is a more formal way of exporting Western ethics is likely to fuel these trends as convenience and circumstance compel emerging market companies to list in the US (and even those traded OTC have key standards that must be met and expose them to American oversight.)

While the still prestigious Kroll’s decline may have coincided with scandals and other integrity issues mostly linked to its former parent company Marsh & McLennan (NYSE: MMC).  Kroll also provides insight into what can happen to FTI Consulting (NYSE: FCN), a corporate intelligence firm identified by The Economist as currently, “the best in the business,” and best known for being in the lead investigator on the Madoff affair.  A number of Kroll personnel now staff FTI and other firms, and their exodus from M&M's Kroll likely contributed to the decline of Kroll and was prompted by management losing its way.

However, unlike the Big Four accounting firms or the handful of premium consultancies like McKinsey which hold effective monopolies on top-tier clients, the corporate intelligence market is far from consolidated and FTI (though lucrative according to The Economist with “revenues of $177m and a profit margin of 17% in the first six months of 2012”), could suffer a similar fate – especially as it lacks the deep pockets of a parent company.  The Motley Fool’s Seth Jayson recently concluded that, “For the last fully reported fiscal quarter, FTI Consulting's year-over-year revenue shrank 6.7%, and its [accounts receivable] grew 3.4%. That's a yellow flag. End-of-quarter DSO [the number of days' worth of sales owed to the company] increased 10.8% over the prior-year quarter. It was up 6.5% versus the prior quarter. That demands a good explanation,” and Jayson also observed that FTI’s operating margin was continuing to dip below its historic five-year average.

Still, of all the contenders in the sector, FTI has been the most aggressive and may prove to be the Facebook to Kroll’s MySpace – although people may be more interested in the LinkedIn or be holding out for the sector’s niche Twitter.  To muddy the metaphor further, a Kroll scion, K2 Intelligence has teamed up with Facebookie Peter Thiel’s Planatir to go after Madoff victims that actually did rather well.  Though K2's business model hinges on marketing the story they craft based on their data-crunching capabilities rather than the traditional sleuthing.

Another concern is that such sensitive undertakings are eventually an area that larger firms will prefer to keep in-house and that may in the end make a firm like FTI less able to grow and expand in the non-niche part of the sector.  A passing look at Goldman Sachs’ job postings over the last year shows an increasing rate of business intelligence-related hiring (especially in FTI and other’s bread-and-butter technology functions).  This might also have something to do with Goldman rethinking their investment into intelligence group Stratfor (especially after its continuing Wikileaks drama that has also pulled in Goldman).

Moreover, the recent investigative journalism of News Corporation (NASDAQ: NWS) that precipitated the division of the company and an earlier and unexpected succession are remarkably similar to many of the strategies and techniques used by business intelligence agents.  In the end, an attempt to defend themselves through “self-investigating” or other means may find many companies inadvertently running afoul of the Foreign Corrupt Practices Act whether or not they use a professional service.

There may be a reason why FTI is the sole business intelligence firm willing to go public.  Until there are more to compare, this might be a sector needing more circum'spection by investors.


Nick Slepko (hukgon) has no position in any company mentioned here at the time of publication.  The Motley Fool recommends Goldman Sachs Group, Inc.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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