Tunnelling

Tunnelling is a deceptive and often illegal practice where a company's controlling shareholders or senior managers divert corporate assets or profits for their personal gain. Think of it as insiders secretly digging a tunnel to siphon away the company's treasures, leaving the other investors, known as minority shareholders, with a devalued and plundered business. This isn't just about taking cash from the register; it's a sophisticated form of theft that can be disguised through complex corporate manoeuvres. These actions directly harm minority shareholders by transferring wealth that rightfully belongs to all owners of the company into the pockets of a select few. Tunnelling undermines the very foundation of fair markets and trust, making it a critical risk for investors to understand and identify.

Insiders have a playbook of tricks they can use to tunnel resources out of a company. While the schemes can be complex, they usually fall into a few common categories.

This is the most direct method. Insiders use their influence to orchestrate deals that benefit themselves at the company's expense.

• Unfair Asset Sales: The company might sell a valuable asset, like a factory or a brand, to another private company owned by the controlling shareholder for a ridiculously low price.
• Overpriced Asset Purchases: The reverse can also happen. The company buys an asset from an insider's private entity at an inflated price, effectively funnelling cash directly to the insider.
• Transfer Pricing: In a group of companies, one entity might sell goods or services to another related entity at non-market rates to shift profits to a privately-owned part of the empire.

Money itself can be tunnelled through questionable financial arrangements.

• Shady Loans: The company might provide large, interest-free (or very low-interest) loans to its controlling shareholders or their other businesses, with little expectation of ever being paid back.
• Excessive Payments: This includes paying exorbitant fees for “management consulting” or “advisory services” to entities controlled by insiders, even when few real services are rendered.
• Exorbitant Compensation: While high pay for great performance is normal, tunnelling occurs when executives award themselves and their cronies unjustifiably massive salaries, bonuses, and perks that drain company resources.

For a value investor, tunnelling isn't just a minor issue; it's a deal-breaker. The entire philosophy of value investing rests on buying a business for less than its real, underlying worth, or intrinsic value. Tunnelling directly attacks and destroys that intrinsic value. The cash, assets, and profits siphoned off by insiders are value that will never reach you as a minority shareholder. It’s like buying a share in a treasure chest, only to discover the captain has a secret trapdoor to empty it before you get your cut. This practice is the ultimate sign of poor corporate governance and untrustworthy management. Legendary investor Warren Buffett has famously stated he only invests in businesses run by able and honest people. Tunnelling is a five-alarm fire signalling that management is not working for all shareholders. No matter how cheap a stock seems, if the people in charge are actively stealing from the company, you're not getting a bargain—you're buying a ticket on a sinking ship.

Spotting tunnelling requires a bit of detective work. While you might not find a signed confession, you can look for clues in a company's reports and behaviour.

• Persistent Related-Party Transactions: This is the biggest red flag. Scrutinize the annual report for frequent and significant related-party transactions—deals between the company and its managers, directors, or major shareholders. While not always sinister, they demand extreme skepticism.
• Opaque Corporate Structures: Be wary of companies with a dizzying maze of subsidiaries, especially if many are located in offshore jurisdictions with weak disclosure laws. Complexity can be used to hide questionable fund transfers.
• A Dominant Owner with Absolute Power: When a single founder, family, or controlling shareholder has an iron grip on the board of directors and executive suite, there are few checks and balances to stop them from helping themselves.
• Weak Legal Protections: The risk of tunnelling is often higher in emerging markets where laws protecting minority shareholders may be less developed or poorly enforced.
• Illogical Business Decisions: If a company consistently makes decisions that don't seem to maximize profit for all shareholders—like buying a failing company owned by the CEO's brother—it's time to ask who is really benefiting.