Friday, April 27, 2007

Deal sourcing - the old fashioned way

Throughout my more-than-a-decade long career in Investment Banking, both as an external consultant and in my in-house avatar, I have tried several techniques to source deals. From leveraging close personal relationships, affiliated funds, Investment Bankers and industry grapevine to sourcing deals from other financial intermediaries or even participating in downright auctions through club deals.

What did I leave out ?

It is deal flow emerging from proprietary research, which stands out for its enormous value potential and distinct personality trait. I am far more clued in a deal that I have researched upfront, took time to get upclose with the management and have spent enough time studying their strategies translating into results. Well, to the argument that who has the time, my ready answer is “start scanning early”.

On an average, at any given point in time I’ll be tracking at least three prospective investments very closely. At times, not to lose sight I buy some stock personally so that it figures prominently in my portfolio which I keep a close weekly watch on. As a scrupulous deal maker, I get out of the position immediately before I start peddling the deal to PE funds – to qualify for the full disclosure. My previous post here was one such.

This is significantly better than getting into the rat race for more deals without a care for end result, value unlocking potential - that is. Perhaps even better than hiring star leaders or marquee name rainmakers like an Anil Singhvi or a Mohit Bhatnagar who have an exemplary track record in their respective domains. Here’s why. This very domain expertise could prejudice their vision over the prospects of other businesses, giving rise to missed opportunities or having to build an anti portfolio, like the one Bessemer has. As a PE fund manager, the demand on the individual is of a different kind – a pulse for an early opportunity over a broader spectrum and by extension, scope for an earliest, IRR optimising exit.

Longevity of PE as a long time, credible asset class amongst accredited investors depends largely on building outstanding deal sourcing and investment processes. Especially in times like these when there are several sophisticated HNIs and Institutional investors dotting the field, looking for interesting avenues to apply their wealth, brand building thro track record of consistent performance metrics matters all the more.
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Some of the interesting http://www.knowledge@wharton.upenn.edu/ articles on related topics be found here, here, here, and here.
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Saturday, April 21, 2007

A tale of two business models

Born less than decade ago, Google Inc. (NASDAQ: GOOG and LSE: GGEA) now reigns as the most profitable—and probably most powerful—force on the Web. As usual, Google's financial firepower flowed from its search engine. That ubiquitous tool has become the hub of the Internet's largest marketing network and appears to be getting even better at identifying the right ads to display with its search results, which in turn helps elicit more revenue-generating clicks

Google 1st Quarter 2007 results snapshot

Revenues - $ 3.66 b
Net Income - $ 1.0 b
EPS - $ 3.18 per share

No. of employees – 12,238 nos.
End quarter cash balance - $ 11.9 b
Quarterly revenue productivity per employee - $ 299,068

Date of Incorporation : Sept. 7, 1998
IPO : August 19, 2004
[19,605,052 shares were offered at a price of $85 per share ]
CMP of stock - $ 482 [ P/E – 35 ]
Market cap - $ 152 b

Did you say scale ?

What stands out or boggles my mind in more ways than one is the amazing power of an ingenuous yet easily scalable business model that Google espoused. Being less manpower intensive (just 12,238 employees now) and more equipment / server capacity centric, it is least affected by the ubiquitous problem afflicting the IT industry – one of employee attrition.

Pitched against the business model of Indian IT bellwether Infosys Technologies Limited (NASDAQ: INFY) which recently celebrated its 25th anniversary, the contrast is glaring. While it can’t be compared strictly because of inherent diversities, the power of robust business models that enable rapid scaling and by that, shaping the very fortunes of businesses is evident here.

Infosys 4th Quarter 2007 results snapshot

Revenues - $ 898 mm
Net Income - $ 272 mm
EPS - $ 0.48 per share

No. of employees – 72,241 nos. (incl. that at subsidiaries)
Quarterly revenue productivity per employee - $ 12,430

Date of Incorporation : July 2, 1981
IPO : February 1993
[1,378,947 shares were offered at a price of $2.26 per share ]
CMP of stock - $ 42 [ P/E – 22 ]
Market cap - $ 30 b

Here’s where the significance of the business model hits home. While it took 23 years for Infosys (with its strength of 72,241 employees) to notch up a billion dollars in revenues, Google’s business model helped it achieve $ 1.46 b in 2003, in just 5 years of its incorporation and one year before its IPO – with just 1/6th of that strength.

Throw in a few other companies like TCS, Wipro, Satyam, HCL Tech and not wanting to be outhired, MNCs like IBM and Accenture too open shop locally and adopt massive ramp up from the limited pool of qualified engineers, you create a mecca for job hoppers. They are all in the same turf just to stay competent. Hiring becomes a non-process as anyone who can spell binary is recruited diluting the quality of the hire. Skill gaps are hurriedly addressed by on-the-job training if not on induction itself. If the hires are not on a project, it hits their bottomlines hard. Billability becomes the watchword instead of quality.

This lacuna is being realized now and precisely the reason why Infosys top brass is tempted to rethink the viability of its business model. Related news item is here and my earlier insights here and here.

What do you make of it ?
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[PSI must also place on record the fact that the indian companies mentioned above took birth in the third world aiming to work for the first world. These companies started operations with severe handicaps when Indian businesses were reeling under the yoke of licence raj, a period between 1947-90 when the state policy was riddled with red tape, hostile to businesses, with severe import restrictions even for high end technology. Exports were severely restricted too.
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Despite the ongoing reforms, India still ranks in the bottom quartile of developing nations in terms of the ease of doing business; and the average time taken to incorporate a company or to invoke bankruptcy is much greater.

Google by contrast took birth in the capitalist mecca - USA, and measured by that yardstick, it took off with an inherent advantage.

My purpose here is to bring out the criticality of business and revenue model in shaping the fortunes of businesses alone and not to denigrate the shining Indian star corporates mentioned above.]
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Wednesday, April 18, 2007

Post deal carping

One of my distinct character traits is my ability to go-with-the-flow. But of late the goings-on in the PE industry in India and the way they changed the scale of M&A activity is a bit off putting.

It’s manifesting in the way our companies have the appetite and the financial muscle to make global acquisitions, of companies which are several times their size and value. How many of those transactions make economic sense, to the acquirer as well as its investors? Employee morale downturn is almost a given if the cultural mismatch simmers up too soon and drives the best brains out for a walk. I don’t think the apparatus is ready to calibrate it and M&A firms can’t care less. For them, it’s just another deal.

In the US, there are several examples of multi billion dollar acquisitions that didn’t quite click. Mitchell Madison-Whitman Hart, HP-Compaq, AOL-Time Warner and many more. Learning from all that, Indian companies could do well to undertake extensive post deal planning prior to completion of transaction – perhpas immediately after the due diligence is completed and in principle decision made.

In a recent survey by KPMG, 80% of the companies surveyed were not well prepared to handle the smooth transition and integration of two businesses post deal. Yet we only get to hear more about *culture conflicts* which only rank second biggest challenge in it. Another interesting finding was that it took on an average, nine months for companies to get a grip over post-deal issues. Nearly two thirds of the acquirers failed to realize the synergy target, even as 43% of the synergy target was built into the purchase price. Well, competitive pressures can explain why premiums are justified as there could be many bidders to a deal. But astute deal makers will have to apprise the management and make them see more value in the transaction than the asking price and convince themselves why the price is right.

Acquisitive ego can never be allowed to out-compete valuation math, and that sets a great deal maker apart from a good one. I will always argue that a good deal maker should be quick on the uptake where it comes to understanding the client’s business in under an hour. He can learn as he diligences, but should be making early calls on the expediency of the transaction to the acquirer’s business and compare it with their goal. Private Equity houses are found to be adept handlers of post deal issues than corporations. As per the report, 95% of PE houses surveyed have started post deal planning prior to signing as compared to Corporations with 59% score.

It is important for Indian Companies scouting for acquisitions globally to do their homework on post deal issues well in advance. In default, they will be choking on the buy without being able to run with it, especially if it is funded by high cost debt. When managed well, acquisition of global corporations by Indian companies would be seen as a normal business decision.
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Tuesday, April 17, 2007

What price relationship ?

Ever since I had turned a freelancer 15 months back, I’ve been approached by partners from several Investment Banks each with different intentions. Some wanted to hire me, others wanted business to be channeled their way. It did not surprise me since most of them had read my blogs and had found something common, interesting and worthy of mutual exploration. I had always been open so long as it excited me, be it a position on offer or a strategic partnership on fair terms.

But one thing common in all these tete-a-tete has been the question on *relationships*. They invariably ask “what relationships you have or can bring to us ?”. It made a lot of sense since in I-Banking industry, ready relationships meant not having to waste time on introductions or cold calling investors or PE / VC fund managers, when you have a worthy client. Eventually we rattle out our acquaintances and the conversation goes on.

Some of them act up. They come up with some nondescript client having some hollow business plan with little fundamental strength and ask whether we can get them some investors. Without sounding judgmental, I ask for more information, a web site to search in and anything like an executive summary or some information memorandum or at least a business plan, on the basis of which I can form my thoughts. Some will have that ready, others will say they’ll send it across (mostly don’t come back).

There’s a third group which is more adventurous. They say, “we are putting together that information, but we need your help here”. Probe a little deeper what *help* they need, it would be something like a company in a deep mess, founder having a history of siphoning off funds, out to leverage the buoyant sentiment in the stock market by merely changing the name of the company and its objects clause. Anything goes here, a financial services company could be renamed into a clean energy company or a textile mill resurrected as an Infotech venture. Surprisingly they quote examples of many that have gotten away and they’d be right since I knew of some myself.

The relationship they seek is for palming off such deals. I had often wondered - how can these people be so na├»ve that just because you have a prior relationship with a PE fund, they’ll be ready to invest in a doubtful venture ? Every PE fund does a scrupulous due diligence on each deal that comes before it that it wants to invest in. I am yet to come across a PE firm that would invest in a business just because it was brought along by a reputed investment bank. All of them have their own internal well laid investment processes and every deal will have to go thro that filter. When that being the case, relationships don’t get you investments – it’s the fundamental strength of a business and how well it resonates with the PE firm’s objectives, in the way it stacks up as a sound investment destination.

If I were to look for a potential candidate or partner, I would look for independent research capabilities, ability to draw insights, the instant relationship building ability and sound knowledge of the PE industry in India, which firm likes what industry, domain expertise, latest rounds of funds raised etc. Asking for ready made relationships can only be of use if you have a superb client needing no introduction. For the rest, you need people who can look straight in the eye of the managements and tell them to get their things organized before seeking investor participation.

Wouldn’t you agree ?

Monday, April 09, 2007

The QIP deep dive

As early as January, 2006 a report by the SEBI-committee raised concern over the growing number of Indian listed companies tapping funds through the GDR/FCCB routes, on account of its time and cost effectiveness adversely impacting the depth of the domestic markets. While the number of follow-on public issues in domestic markets during 2001-02 to 2004-05 period rose from zero to six, the number of GDRs/FCCBs from listed Indian companies grew by three-fold from three to 42, the report had said.

On the basis of this report, SEBI came out with a solution in May, 2006 in the form of Qualified Institutional Placements or QIPs, which were significantly less cumbersome than IPO filings. As per the guidelines, issuers will have to allocate a minimum of 10 per cent of such placements to mutual funds. For each QIPs, there shall be at least two allottees for an issue size of up to Rs 250 crore and at least five allottees for an issue size in excess of Rs 250 crore. "Further, no single allottee shall be allotted in excess of 50 per cent of the issue size," the guidelines stipulated. The securities issued through QIPs will be equity shares or any securities other than warrants that could be converted into (or exchangeable) with equity shares, SEBI said in a circular.

The placements of these specified securities could be made only to Qualified Institutional Buyers (QIBs), while a minimum of 10 per cent in each such offer should be allotted to mutual funds, the regulator said. Promoters or those related to the issuers are barred from participating in such issues. Owing to these advantages, companies took to it happily.

But now since the market has been in a bearish mode for the past few weeks, the floor price stipulation (being the higher of the six-month weekly average or 15-day weekly average of the quoted prices) in the QIP guidelines have begun to adversely affect the issuances. The floor prices based on the SEBI formula are now higher than their current market prices. The floor price is again applicable from the date of the enabling resolution by the board. Of late, prospective issuers are finding their floor prices higher than their current prices. While SEBI doesn’t allow the QIP issuer the flexibility to revise the price downwards, investors wouldn’t be willing to come in at a price higher than the prevailing market price. Catch 22 of sorts.
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Will SEBI relax its floor price norms for QIPs or let it lose flavor ? Keep watching this space.
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Thursday, April 05, 2007

Time for ICICI Venture to mull an IPO…?

I keep reading about the phenomenal success of Fortress IPO and related reports and had also chronicled it in one of my earlier blog posts. Going by this Fortune article, it seems the world’s still awestruck and clearly has not had enough. It as well reminds Blackstone is next in line to hit the road.

Excerpts -

“On the night before Fortress Investment Group became the first hedge fund to trade on the New York Stock Exchange, Wesley Edens and the other four principals celebrated in a manner that befits the firm's intentionally low-key profile. They gathered at a bar on the Upper West Side of Manhattan.

By the next day's closing bell, though, Edens could afford more than just beer and pretzels: His shares from the IPO were worth approximately $2.3 billion. Six weeks later, on March 22, Blackstone Group followed suit when the private-equity shop revealed plans to raise $4 billion in an upcoming IPO.

Since that news broke, Wall Street has been buzzing about who will be the next firm to announce plans for an IPO and invite the public into a world once reserved for high-net-worth individuals and institutional investors.”

I took time off to think what if our local Private Equity firms decided to go public ? Would they fetch similar buoyant response ? The existing listed PE firms like IDFC an Infrastructure focused financial powerhouse ( P/E 18.6, Market Cap $ 2.13 billion) and ILFS Investment Managers a pureplay PE firm (P/E 24, Market Cap $ 76 Million) have been doing well for themselves in comparison with the broader market. But the big fish of them all is ICICI Venture, which is the Private Equity / buyout arm of largest new generation Bank ICICI Bank, with funds under management in excess of $ 2 billion. It would be interesting to watch if ICICI Venture decides to go public and the likely valuation that it might secure – given the dynamism demonstrated by its CEO Mrs.Renuka Ramnath, it is not totally out of whack to speculate.
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And if it chooses to hit the road, here’s what Mrs.Ramnath and her team can aspire for - more or less.

Being comfortable in the limelight may be what finally determines who does and doesn't go public. Given that affairs of ICICI Venture are pretty much transparent, and its very much in the limelight already for Mrs.Ramnath’s stellar fundraising capabilities, if at all there’s anything to hold back, it could only be its investors privacy concerns than one of its likely valuation.
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I'd like a slice of the action....What do you think ?
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Tuesday, April 03, 2007

Leveraging NIFTY 50...

Just finished blogging a management buyout op, I am dreaming up something else. When you keep getting wild ideas, why wake up ?
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Often when PE activity is very high in any market, the first signal that emerges is that the stocks are underpriced and valuations are attractive. Scratch beneath the surface we stumble upon factors like low cost of funds, low gearing of companies, higher scope for dividends, better yields etc.

Currently if you look at the downturn in Indian equity market, a confluence of all these factors can be seen across the spectrum.

Let me start out by saying that I don't think that stocks are necessarily overpriced at this level, but I don't think the private equity deals necessarily signal massive underpricing anymore. Compared to the past, there is much more money out there in the hands of these investors, and it's all money that they have to get invested or they don't get paid.

Even with stocks fairly valued, with high yield and leveraged loan markets pricing risk so low in recent years, PE firms can still pay a fair price and make killer returns. The point is really seeing if the returns are that great on a risk adjusted basis. Leon Cooperman , previously strategist of Omega Advisors Hedge Fund did his own study back in the 80s which showed if you levered the S&P500 to the same capital structure of typical LBOs, it would beat average PE fund returns. I also believe Prof Kaplan at U Chicago has done some research questioning how strong PE returns really are.

PE funds just take the "market" aspect out of the companies they buy, add some leverage and wait for the returns to be generated. I think the biggest reason it's so easy for PE funds to take these cos private is because investors are so myopic and will take a 20% premium rather than allow management/company to continue doing what they are doing and ultimately wait for the market to assess a higher valuation.

Back a decade or so, with a couple hundred million dollars, they could sit back and wait for a fat pitch that they could knock out of the park. Now, with billions to invest and many more competitors out there bidding up all the really nice deals, it's tough to wait for the same types of situations. So what I think a lot of the larger firms will end up doing is taking private firms with a target return lower than in the past. They will likely end up looking a lot more like mutual funds that can take much more concentrated positions, and benefit from being the controlling shareholder. Also similar to mutual funds, in order to put their money to work they'll have to be more consistent buyers through various market conditions.

Don't get me wrong, returns aren't going to look like public market returns, they'll still bring in returns that pass that, but by less than in the past. It just can't be expected that with all of the money out there and the increased competition that the buyers can be as discriminating as they once were on the deals they choose or the price they pay.

So as these big buyout deals continue, I'm keeping in mind that “take-privates” might not be as solid a market signal as they once were. May be, a few months down the line, we can think of lowly geared companies in the NIFTY 50 to lever up a bit and be eligible candidates in the take-private orbit. Will they ?

Presently in India as the market unwinds, a few smart PE funds are even exiting quietly. ICICI Venture Capital has sold a 3.25% stake in Deccan Aviation for about Rs.32 crore to UBS securities Asia, thro an open market deal for around Rs.94 a share, bringing down its stake in low cost carrier to about 10-11%. As early as 2005, ICICI Venture had acquired around 19% in a pre-IPO deal, valued at Rs.65-70 per share. The Deccan aviation scrip closed at Rs.88 on Tuesday, while the 52 week high was Rs.162. It appears the sale has translated into a 40-45% RoI over a two year period for ICICI Ventures. Considering the volatility in the market and accentuated bad times for aviation sector as a whole, by not waiting for the tide to turn in its favor to higher levels, ICICI Ventures did make a smart move indeed.

Watch this space, just watch ( no noise, or else I'll wake up) for more fun.