Beware of FCPA

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

Investors need to be aware of the many factors that can affect the values of their investments, including the often heavy hand of government regulators.  One of the federal government’s weapons to monitor U.S. companies’ international activities is the Foreign Corrupt Practices Act (FCPA).  Passed by Congress in 1977, this law prohibits companies from making payments to foreign government officials in order to win business.  It also requires companies to maintain adequate internal controls and accounting records in their operations.  It seems like common sense, but ethics standards vary widely in the real world.

Example 1: Net 1 UEPS Technologies (NASDAQ: UEPS)

This payment processing company recently disclosed that the U.S. Justice Department and FBI have launched investigations into possible violations of FCPA by Net 1's employees.  Investors were not thrilled to hear the news, as the company’s market value has dropped by roughly 40% since that revelation.  It seems that U.S. regulators believe the company may have made payments to South African officials in order to win a government contract earlier this year.  Net 1’s competitors have also been questioning the awarding of the large contract, with one competitor filing a February lawsuit to set aside the contract.

The company’s customers, who generally don’t have access to the banking system, use its smart cards to engage in a wide variety of transactions through ATMs and point-of-sale terminals.  According to World Bank statistics, the so-called unbanked population is 2.5 billion globally, which represents a significant growth opportunity for the company.  Over the past four fiscal years, Net 1 has grown their revenues by 53.6%, as they have expanded internationally and moved into new business segments.  However, operating margins have fallen in each of the past five years, due to increased competition and the escalating costs of service delivery.  Net 1 has the largest share of the market for retailer and third party payment processing in South Africa, and it was likely trying to solidify its position by winning the new government services contract.  Given the rising implementation costs and legal bills, though, it looks like management may have decreased shareholder value with their recent decisions.

Example 2: Ubiquiti Networks (NASDAQ: UBNT)

This technology company sells a diverse line of networking equipment, including systems, radios, and antennas.  Founded by a former Apple engineer in 2003, Ubiquiti’s products allow its customers to create fast and reliable wireless networks in the radio frequency spectrum, thereby eliminating the high product and deployment costs of traditional networks.  The company doesn’t employ a direct sales force, but it has grown quickly through the development of a community of end users and distributors in over 50 countries.

Ubiquiti's financial results soared over the past four fiscal years, with increases in revenues and operating income of 1475.7% and 1595.2%, respectively, during the period.  However, the company’s lack of control over the entire sales process has resulted in some problems.  In 2011, the U.S. Office of Export Enforcement (OEE) and the Office of Foreign Assets Control (OFAC) launched separate inquiries into the company’s export practices, due to evidence that distributors were delivering products into countries that are on the U.S. embargo list.  Ubiquiti has since modified their operating procedures, but the OFAC inquiry remains unresolved.  More recently, the company’s products have been subject to counterfeiting in certain international markets.  While management is pursuing legal avenues, financial results have taken a hit.  In the first quarter of FY2013, revenues and operating income decreased 22.3% and 42.6%, respectively, versus the prior year period.  As expected, investors haven’t been too impressed, with Ubiquiti’s market value falling roughly 39% over the past year.

Doing Business the Right Way

The moral of the story is that investors need to focus on companies that are holding themselves to a higher standard.  The best example of that philosophy is Berkshire Hathaway (NYSE: BRK-B).  Despite employing over 270,000 people in hundreds of businesses operating throughout the globe, an investor isn’t likely to see the company in the morning newspaper due to questionable business practices.  In its latest fiscal year, the company reported revenues and net income of $143.7 billion and $10.3 billion, respectively, and generated a 14.4% increase in operating cash flow.  Book value has compounded at a 19.8% annual rate over the past 47 years and it should continue to compound at good rates in the future, as long as shareholder-focused managers are running the show.  It is a core holding for the long term investor’s portfolio.

rghanley owns shares of Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services recommend Berkshire Hathaway. 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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