Tuesday, March 27, 2007

Shall we hatch this ?

What could be the next move for a PE firm in India ? It got me thinking…! Without having to storm my brain too much, it just occured to me. A buyout…there are quite a few candidates that come to my mind.
What would it look like if a PE firm takes Wockhardt Ltd. private, add significant strategic value, impute explosive growth and then take it back public to make a killing in the process for all stakeholders ?

With that, lets take a look at this company that could sustain an interest payment and debt load required to take it private. I think it is ripe for a buyout by a mid-sized PE firm, and therefore, ripe for the purchase by value oriented equity investors.

Wockhardt [ source : Annual Report 2005 ]
[ Full disclosure - Neither I nor my close relatives and to the best of my knowledge any of my business associates have any shareholding or other interest in this company as of now. ]

It's amazing how Wockhardt, the Indian pharma player has created an integrated global business model with state of art R&D, manufacturing facilities and differentiated marketing strategy during this most difficult year for Pharmaceutical industry which terribly underperformed every stock index. The company is banking on billions of US $ worth critical drugs especially in US and Europe coming off patent in the near future. During the year, its consolidated revenue grew 12.82% to $ 321 MM and PAT at $ 58.43 MM grew by 20.42%.

While writing this now, I have also read the company has acquired Pinewood, the largest generic Company in Ireland helping it achieve a wider wingspan in Europe spread over Germany, UK and Ireland which geography accounts for more than 40% of its revenue growth.

Wockhardt generated $ 39.61 MM in cash from operations in 2005 and is likely to improve that number this year. The company's equity market cap ( as of 03/27/06) is $ 928 MM, with a net cash balance (as of Dec.05) of about $147 MM.

About 73.73% of the stock is held by the founders and the rest of 26.27% is held between Foreign and domestic institutional investors (15.72% ) and public investors ( 10.55%). Currently the stock is quoting at $ 8.48 ( Rs.373.30) at a P/E of 19.8 times. Let’s assume a PE firm offers to buyout the company at a 30% premium to market price ( allowing for bidding frenzy) at $ 11.02 (Rs.485.29) at a P/E of 25.74 times on current earnings. The total acquisition bill would be about $ 1.2 billion.

At a 7% interest rate, the interest payments on $ 1.205 billion ( assuming total buyout ) would be $ 84.35 MM, that is just 57% of $147 MM, which is what the company has consistently generated over the last few years. Since Wockhardt has significant net current asset cushion in its Balance Sheet and only needs about $ 125 MM in maintenance capital expenditures, it's a perfect buyout candidate. With some cost cuts and knocked down expenses, the company could easily generate enough cash to continue operating smoothly.

In fact, it presents an ideal case for a leveraged management buyout with Mr.Habil Khorakiwala and his team in tact, retained for its enormous savvy and experience over the industry besides the international expertise available from its European acquisitions in the recent past. If we can infuse a significant load of external strategic muscle as would help fuel the global ambitions of the company, we've got a multibagger in as much as 3 -5 years as could be relisted anywhere in the world. If the PE firm has a good pharma portfolio in sync with Wockhardt credentials, ah...!

Asking for orders now. [ One of the biggest secrets to dating hot women is having the guts to ask them out in the first place. That’s right. You’ve got to be a man of action, because all of the plotting and planning and dreaming in the world is going to get you nowhere if you don't dare to ask her out :-) ].
Alright Mr.Private Equity, shall we call this a mandate ?

Tuesday, March 20, 2007

Latest trends in Indian PE

A recent report indicates that the share of private equity (PE) investments in listed companies in India, which accounted for as much as a third of all investments in 2005, fell to 22 per cent in 2006. Some of the companies from which PE funds have exited partially or fully in recent times include Punjab Tractors, Simplex Infrastructures, IVRCL and Gammon India. A similar trend of PE exits from publicly-listed companies in the US has also been seen, though the reasons may be different.

In India, this development comes at a time when private equity is gaining currency. With an estimated 100 private equity funds swarming around for deals, India is now one of the fastest- growing private equity markets in the region. And although the stock markets have scaled record highs (despite the current volatility), the preference by private equity for listed companies seems to be changing. How is this to be explained?

Some of the obvious reasons include –

a) Indian market has been one of the best performing markets. It’s time they book some profits now that it’s late in the day.

b) India growth story is continuing and a little churn in portfolio will give every PE that extra % comfort in terms of RoI and enable fresh round of investments.

c) Average deal size in India is still small barring a few. As such it doesn’t justify longer holdings aiming at large scale returns.

d) Natural Indian scepticism wouldn’t let owners dilute substantial stakes in favor of PE firms as they are not sure of the value PE firms bring to its businesses.

e) Looming threat of Government scrutiny over buyout deals – Few examples are of Vodafone acquisition of Hutch Essar, Punjab Tractors exit by PE firm Actis (formerly CDC ) and Burmans, acquired by Mahindra & Mahindra. In the US, it’s the rigor of SOX Act compliance which eases PE firms out of Public listed companies.

As such, now PE investors appear to be more comfortable with a fund of funds model – invest as LPs in other PE firms who are already in the fray. One of my earlier posts explaining the advantages of FOF model is here.

Isle of Man-based Evolvence India Holdings is planning to raise $65 million (Rs 290 crore) through placement of shares on London Stock Exchange. EIH, a private equity fund company which principally targets investments in the Indian subcontinent would place up to 65 million ordinary shares of one dollar per share, a statement to the London Stock Exchange said. The public listing of EIH on LSE's Alternative Investment Market (AIM) will give investors access to a diversified Indian private equity portfolio, while mitigating issues usually associated with private equity investments, such as a lack of liquidity and relatively large minimum investment size.

Evolvence has already invested in Indian PE funds such as IDFC PE, Barings India PE, etc.

US-based Investment bank Thomas Weisel International is planning a $200 million private equity fund of funds for India. The company is also keen on rolling out its asset management business in India, focusing only on institutional investors. The fund of funds, which is yet to close, has already made two investments worth $25 million in IDFC and ilabs.

Sounds cool ?

Monday, March 19, 2007

PE funds – way to go in India II

Just after I’d finished writing my previous post on the subject, there still was this lurk. Have I said it all ? I owe it to the PE fund managers in India to drive home my point - by contrasting it with the US scene, where PE funds had their origin, the mistakes they made and the way they matured. We may still have to tailor it a bit to suit our businesses, the ownership fetish to be addressed, high quality CEO material will have to be nurtured and newer methods of value creation to be learnt.

Let's visit it then and look at the situation there. This will help us avoid the pitfalls if we are intelligent enough to recognize.

To give you a glimpse of the PE canvas, of the record $1.56 trillion spent on mergers and acquisitions in the U.S. last year, PE buyouts accounted for 25% of the action, up from 10% in 2005. PE's firepower has never been greater. Last year firms in the U.S. raised a record $156 billion in new capital. It is believed that the global buyout industry currently has $400 billion available to be invested. With leverage, that $400 billion represents as much as $2 trillion in potential buying power. (To put this in perspective, U.S. mutual funds have more than $10 trillion in assets.)

Private Equity funds, like hedge funds, are classified as "alternative investments," the two are often lumped together. And they do share common ground. Investing in both is limited to those with deep pockets, who can presumably handle the greater risk. Both feature lavish fee structures - variations on the "2 and 20" formula, in which general partners take a 2% fee for simply managing the assets they control and a 20% slice out of any incremental profits they deliver. Both soared in the wake of the 2000-01 market meltdown, which persuaded well-heeled investors that riding the market indexes (Dow 36,000! Nasdaq 10,000!) wasn't automatically going to make them richer.

But here's where they differ. While hedge funds mostly have individuals as investors, PE firms get the bulk of their money from institutions (roughly half from pension funds, another big chunk from banks, insurers, endowments, and foundations, and only 7% or so from individuals). Though so-called activist investors running hedge funds at times noisily pressure public companies into making changes to boost stock prices - think Nelson Peltz or Carl Icahn - most rarely end up owning companies; nor do they want to.

So what does this mean for those of us who don't wear pinstripes or dine where the elephants bump? Are we moving into an era when we have both a public and a private economy in the same way we have a public and a private educational system? Do Blackstone and its peers really take broken companies, mend their wings, and set them free in the public markets? And how big can PE get, anyway?

Cheap debt is the rocket fuel for this, but it's not the only driver. In terms of governance, management focus and strategic decision-making, the PE model is usually superior to that of publicly held companies. Otherwise they’ll end up holding the hot potato. There are only two ways for a PE liquidity event. Flipping the portfolio company to another PE or to take it back Public. On both options, the invariable question they face is “what were you doing with it so far ?”.

They had better show value. Unlike the quick-hit artists at hedge funds, PE is a long-term investor who succeeds only when its companies succeed. That's typically followed by the it's-all-about-the-talent chorus. “Today anyone can raise equity and borrow money," says the Carlyle Group's co-founder David Rubenstein. "What's rare are two things: a deal everyone isn't clamoring to get into, and people who know how to operate the companies we buy. Given a choice between hiring an experienced investor for our firm and landing a guy who's run a leveraged buyout, I'd take the latter."

Amen, adds Michael Milken, whose nearly single-handed creation of the junk-bond market in the 1970s gave rise to the first great LBO wave of the 1980s. "The concepts and financial structures that we introduced back then - and that were rejected as too radical and poorly understood - are now in every introductory textbook," says Milken. "But success then and now mostly depends on finding great people. The difference is, where I only backed strong individuals who wanted to start or buy a business - Steve Wynn in gaming, Len Riggio in books, Craig McCaw in cellular, and Bill McGowan in telecom - the PE industry today has the scale to first buy up assets and then match them up with the right managers."

Another difference between Milken's era and today is that instead of merely bankrolling entrepreneurs, private-equity firms are co-opting CEOs. There are the elder statesmen - Lou Gerstner, Jack Welch, Larry Bossidy, Jim Kilts, John Browne, and many more - who have joined PE firms rather than retire to the golf-and-board-of-directors circuit.

They have learnt it the hard way in US. We have a better template now that needs to be customized to suit local businesses. We must do better since they’ve committed a lot of mistakes before us which we must avoid. We may commit new mistakes, learning newer lessons while on the run. That learning capability should differentiate us. Are our PE fund managers listening ?

If not, watch out for the train wreck ahead. What do you think ?

Thursday, March 15, 2007

Private Equity - Way to Go in India

As the markets continue their dance of death, I snuck a wistful glance at the PE funds which up until now were cutting deals by the dozen. Almost all investments now have declined by over 50%, construction / brokerage stocks in particular.

The deals still continue, but on a very selective basis strictly playing by the rules.

I’ve been watching global markets over the last decade with particular interest to Indian equity and its investor psyche. I don't claim any phenomenal ascension of knowledge over a space as dynamic as equity markets, where emergence of a credible pattern ever is highly improbable. I believe in open systems, randomness of life events ( would gladly throw darts on bulletin board any day ) and that markets are no exception.

“Why bother, then ?” - you might ask. Well, when has absence of definition or randomness of events stopped a blogger ?

I base my theories neither on historical movements nor on future trends. I use none. I neither get turned on nor off by the J-curves or sinking slopes. I’d rather use a more predictable element – that of management psyche. Almost 85% of Indian businesses are owned and controlled by business families, handed down over generations. There are occasional family feuds that erupt, but the fallout has seldom been a sellout to professionals or to Private Equity. The division has been among families themselves, ably assisted by professionals though.

The psyche of the family management has more or less been consistent over fairly long periods of time. Most of them are conservative and traditionalists. Even the younger generations that inherited the business, despite their Harvard and MIT degrees acquiesced as they slowly settled down in their business. They used the modern technology and other tools in their business, but never tried hard enough to dismantle the ancestral philosophies that stood translated as corporate culture. Amongst others, it gave absolute dominance over the Board, having the last word in everything - well, who wants to upset such a setting !

When something ain’t broken, why fix it ?

The downside is that capable professional managers felt stifled, came in and went after short stints. The ones who stuck around, willingly putting up with the drudgery, became deadwood, felt unwanted here and anywhere else. With no strategic inputs from the resigned-to-their-fate executives who ran the business, the owner often had to rely on external consultants for ideas, who served up ad hoc quick-fixes the owner `liked' than what the business `needed'. Besides being easy, it streamed them steady revenues. Did you say corporate governance ? You must be nuts !

So that’s it. Absence of strategic direction puts them at a clear disadvantage. I had done a little analysis and had quite a few insights. I found most of the family businesses characterized by –

a) low operational and working capital leverage that became a drag on their performance. Can be easily restructured and put on a high growth path.

b) fully depreciated equipments and other operational assets indicating the need for modernization of equipments. Besides affecting productivity, it is limiting the scope for tax savings offered by higher depreciation.

c) The adverse effect of owner and CEO being one. Decisions lacked the boldness expected of a non-owner CEO upon being influenced by the risk-averse nature of the owner.

d) Little or no focus on sales promotion, brand building or market expansion. While shipment volumes are higher, realization and margin pressures are glaring.

e) A claustrophobic mindset which does not allow for exploration of opportunities for inorganic growth thro strategic alliances / M&A with others having state of art technology and market access.

f) Adoption of sub-optimal capital budgeting techniques leading to accumulation of more debt for both short and long term resource requirements. Results : skewed debt equity ratio leading to bad credit rating and higher interest outgo. Dilution of equity being a strict No No even for capex.

This is not all. I have built my deal scouting and origination strategy around those deficiencies as I am thinking of associating myself with a PE fund shortly.

PE funds normally wait for I-Bankers to bring deals to them. I-Bankers depend on their *connections* to get deals. I’ve never seen a banker undertake proprietory research, identify a needy client, make that cold call to present a winning strategy which could culminate in a deal. Instead, I see them persistently knocking the doors of corporates which never needed them since already they were doing well. Recently in an interview, Subhash Menon, Owner/CEO of Subex Azure ( NSE-SUBEX-Quote ) was saying how I-Bankers never entertained him when he needed them most during his initial days and now when he built everything up himself, they are all over the place with deals and more deals.

In India, because of this situation of predominance of family business, PE funds should hire shrewd ones that think its cool to do proprietory research and having the capacity to identify those who need them badly. It’s time they stop hiring wet-behind-the-ear greenhorns with *connections*. It’s cool to say “I know Mr.X, CEO of XYZ Inc personally” having sucked up to him at some party where (s)he gate-crashed, rather than admitting her friendship with a startup founder who needed support.
It could be that Mr.X doesn’t need support because his personal portfolio resembles that of a leading mutual fund, or worse, he could be a limited partner in a PE fund himself !

Wednesday, March 07, 2007

Ad budget for Law firms ?

Why not ? Market they will, if that’s what it takes to float their boat.

With the increasing number of M&A transactions, the number of law firms have also grown. It is looking more like any commodity business. Soon you’ll be surprised to find a wal-martish, “hire us for an acquisition, we’ll do your eventual Chapter 11 filing free” or worse, a “balance transfer facility” incentive to switch your existing lawyer and sign up with another. “We are not a Bank, so no processing charges or penal interest” could be thrown in for good measure !

Well, for now it seems the marketing strategies of other businesses are fast catching up with legal profession. Accounting firms have already been doing it for quite some time now in the guise of advertising their transactions and not the firm.

Zusha Elinson of The Recorder quotes John Hodder, CMO at Orrick, Herrington & Sutcliffe, "All firms are spending more on marketing. The market is increasingly competitive and there are a lot of firms out there and it's about finding what differentiates your firm from the others." [ Note : The CMO stands for Chief Marketing Officer and we are talking law firms here ! ]

Am Law 100 firms budgeted an average of $9 million -- or 2.2 percent of their gross revenue -- for marketing last year, according to a new survey by Boston-based BTI Consulting Group that polled about 60 percent of Am Law firms.

Read the full report here.

Would we get to see Crawford Bailey & Co or Nishith Desai & Associates hoarding around the world cup 2007 cricket grounds at the Carribean ?

No bets.

The story of Chrysler Goodwill

What it has produced isn't so much a case of two rights making a wrong, as three rights making a left.

I am referring to the troubled automaker DaimlerChrysler which lost $1.475 billion in 2006 and is put up for sale.

Daimler-Benz AG paid $36 billion for the company in 1998, but industry analysts now place its value at anywhere from nothing to $13.7 billion. Estimates vary with the value placed on assets such as brand names, factories and materials, all weighed against Chrysler's estimated $19 billion long-term liability to pay health care benefits for unionized retirees.

Some analysts say the liability exceeds the value of the assets, meaning that German parent DaimlerChrysler AG would have to pay someone to take Chrysler. Others say the company is worth more to the right buyer.

As two private equity firms examine Chrysler's books and consider making offers to buy the company this week, they'll be grappling with a question whose answer is uncertain: How much is the automaker worth ?

"It's a hard thing to really figure out, and the uncertainty is what the health care liability really means," said David Cole, chairman of the Center for Automotive Research in Ann Arbor. "If that were removed, then it's a wholly different game."

Chrysler was once bailed out with the support of Federal Loan guarantees in the 70’s. Now the Automaker is back in trouble.

The fun is that it’s value varies with the type of buyer. A private equity firm could take the company into bankruptcy, shed its union contracts and then break it into pieces for sale at a handsome profit, he said.

GM could sweep its estimated $50 billion retiree health care liability into Chrysler's and negotiate a deal with the United Auto Workers union to take on the cost at a discounted rate. GM, Cole said, could save billions of dollars on its health care liability by buying Chrysler. If that were done, it could make a pretty good case that GM would be the ideal suitor.

Read the full story here.

This is what I call as going down in style. Even as you go broke, there are so many suitors with higher and higher bids. They call it Goodwill - what you pay more than the firm’s intrinsic worth, that is.
Welcome to Corporate derring do !

Tuesday, March 06, 2007

Some JV puzzles solved – by Pat Love, marriage therapist

I was particularly fixated by this interview with Pat Love, marriage therapist. Much as it would clear up the doubts of many a young men and women on the choice of their dates, it answered a lot of my queries why a great company often walked into a JV relationship with a mediocre or downright bad company. I just switched the `boy’ and `girl’ metaphor in this interview for corporate partners in a JV.

Some excerpts :

Q: Why are bad boys so irresistible?

Pat Love: Bad boys are handsome and elusive, and that triggers attraction. But it's largely a societal issue. We are programmed by our culture to think that chemistry is love. We are constantly stimulated-by work, television, shopping-and we tend to move on if we're not excited. Also, some women's brains are wired to interpret anger and petulance as love because of their early negative experiences with men.

Q : What about bad girls ? Do you think that’s as much a phenomenon ?

Pat Love: Oh yes, there are bad girls. They're usually very attractive women who feel entitled. They're used to getting everything, and they know how to work a crowd.

Q : Why is it dangerous to be with a bad boy?

Pat Love: Well, they're unreliable. They don't feel an obligation to have a relationship. It's important to understand that when a woman has sex, she releases oxytocin and bonds with her partner. Oxytocin is called the "snuggle chemical." It triggers orgasm, but it's also released when a mother breast-feeds. It makes you feel close and connected and vulnerable. The effects of oxytocin are offset by testosterone, so a high-testosterone person doesn't bond from having sex. And there you have it: Bad boys don't get attached! They say all these wonderful things, and you get this chemical rush that lowers your defenses. But he could be gone the next day. He could lose interest.

Q : Do bad boys ever change, or is that just what we want to believe?

Pat Love: Most don't change. When they get old, then they're with somebody who has clout because of youth and beauty. Look at Michael Douglas and Catherine Zeta-Jones. She has youth and beauty; he has power and status.

Q : What about bad boys who give inconsistent signals? Bad boys who snuggle?

Pat Love: If you want a rat to push a bar forever, don't give him a pellet every time he pushes-then he'll only push when he's hungry. If you take away the pellet, he won't push the bar at all. But if every now and then you give a rat a pellet, he will push the bar forever. It's called intermittent reinforcement. That's the way to get a woman forever; throw her a little tidbit every now and then.

Now I know whom to consult before finalizing a JV partner. Seriously, this is much better than many a Big Four feasibility report.