Thursday, August 30, 2007

Rediscovering Kirana

Retailers are rushing ahead with their plans, but is there enough demand for the merchandise being sold? Asks Shobhana Subramanian today in BS.

With over 130 to 180 million sq ft of new mall space coming up in the next few years, and much of it in the big cities, the catchment for each mall will reduce. And that could completely alter the competitive dynamics. Abheek Singhi, partner, Boston Consulting Group posits that “A throughput of at least Rs 600-Rs 700 per sq ft per month would be required to sustain gross margins of 30 per cent if rentals are around Rs 40-50 per sq ft.” So, higher rentals of Rs 60-70 per sq ft would mean a much larger throughput. Building the store it seems, is the easy part. Getting cutomers to buy might not be that simple.

After factoring in 39 different licences that a hypermarket requires in India and yields on an average an operating margin of just 6%, what explains the rush (Wal-Mart, Carrefour, EON) for such a low margin business? Volumes ? The slice will be too thin when you’ve too many of them around. Large population shouldn’t be an attraction either since footfalls don’t necessarily mean customers.

In this entire melee, it’s the kirana (corner store) guy who gains. We rediscover the street corner vendor who is fast shedding sloth and getting nimbler by the day. Last time I checked, he does some brisk business in his store that no longer resembles the mess it once was. All items were neatly stacked and in full display. And he home delivers stuff on a phone call and I think that’s a sure win strategy. Competition induced innovation, perhaps !

Even if big ticket retail gets large scale supply chain advantage and can use its direct sourcing efficiencies to keep prices low, it would be interesting to watch how they deal with a nagging bureaucracy and rising rentals. The kirana guy is getting smarter and stauncher – quite contrary to the initial prediction that his breed will soon be extinct.

Wednesday, August 29, 2007

Sequoia has balls of brass

Sequoia Capital, arguably Silicon Valley’s most successful venture capital firm, is big-footing one of its most respected investors.

It brazenly demanded that Yale University invest in Sequoia’s risky adventures abroad in places like China, India and in later-stage investing. And when Yale refused, Sequoia reportedly rejected the university from access to its well-performing early stage funds — the ones that in the past have invested in companies like Google and Yahoo.

Sequoia’s aggressive handling of Yale came to light in a memo issued by the university, a highly respected investor because it commits money long term and has long embraced venture capital. The memo was cited today by Rebecca Buckman of WSJ.

Yale has a $19 b corpus that gets invested in many ways. If Sequoia can say “invest…or else” to such a bulge bracket investor, it sure has balls of brass, indeed!

Sunday, August 26, 2007

Go short on India's IT vendors

Wharton’s Jitendra V Singh advises Indian companies to recast their business models to suit the rising Rupee than to expect the RBI to intervene. In support of his argument, he draws the parallel of how Japanese Automakers during the `80s reacted to the rising yen by shifting their low margin operations (and costs) to manufacturing locations in the US. That had the twin advantage of margin protection and reduction in protectionist backlash since the jobs have now turned American.

Is that a good comparison, Mr.Singh ? Check some facts out.

India’s leading IT vendors like TCS, Infosys, Wipro and Satyam squeezed out higher margins (27-30%) from clients not just because of availability of low cost workforce or a weaker rupee, they have also been benefitting from complete exemptions from Indian Income Tax (33.6%) on export income till recently. If operations are shifted out, the tax savings foregone will dent their margins.
Many state governments also gave them land on long term low leases to build massive complexes to house their army of coders in thousands. These benefits cannot be expected from foreign governments. Moreover, the resale value of their Indian real estate would tumble triggered by the sudden over supply because the governments may choose to terminate their leases if they move out. Now that's a double whammy.

As of now bulk of the revenues of India’s IT vendors come from mainstay operations like ADM, BPO, low end process automation, testing and validation services. Revenues from high end segments like consulting, process automation, license fee, and remote infrastructure / Data centre management have been insignificant. With competing global majors like IBM, Accenture and EDS setting shops in India, wages are also on an upswing. Shrinking supply of competent engineers, higher visa costs and attrition have also not been helping matters either.
Thus changing their product mix now would mean India's IT vendors having to make significant investments in R&D (read future) to develop high end utility products and building deep domain expertise in clients’ businesses that guarantees productivity improvements upfront (in other words, to partake in clients' business risks also) like the global majors do. These adjustments may (or not) yield gains in the long term, but right now they call for larger cash outlay and would also mean giving up on margins. Neither can the Indian IT vendors be too sure of their own ability to cope if pitted against the behemoths that knew this high end terrain better.

That's why I recommend a sellout. And if they don’t, go short'em all....

Tuesday, August 21, 2007

Missing yet another bus

"India's fundamentals are in tact. Sub-prime debacle will not impact emerging markets. It's Yen carry unwinding spooking markets".
How many time have we heard this ? I am getting tired. Truth is, sell-side analysts have again been caught off-guard. While they were swearing by their spread sheets, the markets tossed and turned. As usual, they were clueless.
It’s in the air, I can smell it. We've left a market top, and we're nearing the end of an era -- the private equity era as we know it. It hasn't ended yet, and deals are still going to get done, but if you miss the boat on selling at the top, you will have to wait for the next cycle. When will that be…?

The credit markets are in turmoil, interest rates are zooming, and private equity firms aren't going to pay what they've been paying for companies. If you've got a tempting offer to sell your business, take it – before it's too late.

Just as in 2000, when the bubble burst, too much money have been chasing too many deals. Once the good deals were out of the way, the money started chasing bad deals. That rarely ends well.

But a new era of something will start soon. The trick to making lots of money is to get in early. Not necessarily first, but early. So if anybody out there knows what the next financial wave will be, just let me know.

Deal scouting calls for passion

Global private equity giant Blackstone Group is acquiring majority control in Gokaldas Exports for nearly Rs 6.6 billion ($160 m), in the country’s largest management buyout in the textiles industry.

This is Blackstone’s third major deal this year, the other two being a $275 million investment in Ushodaya Enterprises, which runs the Eenadu newspaper and ETV franchise, and a management buy-out of BPO firm Intelenet from Barclays and HDFC for Rs 8.4 b ($ 203 m).

The PE shop known for its appetite for large global deals (Hilton Hotels - $26 b, EOP - $ 36 billion including debt of $16.5 b) appears to have tweaked its strategy in India, settling for a lot smaller deals. I wonder the viability of this strategy since it could eventually lead to problems of scale or even oversight. The string-of-pearls strategy is quite cumbersome for an 11 people strong PE firm to manage on the trot given the bureaucracy it may have to deal with in India.
Of course, one can’t find many companies of the size of a Hilton or EOP in India easily but if they can look closely, they might as well zero in on some real sweetspots. I have earlier written about one here. If approached rightly, it’s a terrific deal at $1.2 billion. There are a few more available if looked at closely, not like a professional investment banker who does it for a fee, but by a committed PE fund manager driven by pure passion for such deals.

If you need help Mr.Akhil Gupta, you know whom to hire :)

Friday, August 17, 2007

The brief Rupee gig

Equity markets needed an excuse to correct and they took to US subprime woes and unwinding of Yen carry like bees to honey. Result, Yen is appreciating against the USD and USD is appreciating against a basket of currencies including the Indian Rupee. It was almost a celebration when INR touched Rs.41.385 against the USD after hovering around Rs.40.50 levels since mid July with no signs of a recovery.

Traders might be under the impression that the U.S. has exported some of its subprime risk to Europe and, as a result, will be able weather most of the risk of a subprime fallout. But it's a mistake to think they exported all of it. Many U.S. banks have a lot of assets not only in mortgages but in real estate. If foreclosures spike, then banks could suffer an even worse fate. The deep gash in the US economy is for real. I don’t think the dollar rally is sustainable. If it gets better, the US currency and bond yields would rise and the dollar will slide. If it gets a whole lot worse, the dollar's still going to slide.

For example, if the stock market gets a lot worse, foreigners will start to panic about their investments in the U.S. But even if the panic subsides, the dollar's value still might decline if investors go back to their favorite trade: shorting the dollar against a basket of currencies.
Don't rush to buy those IT stocks now... The Rupee rally is still not done.

Wednesday, August 15, 2007

Leadership menopause

The private equity industry is accused of poaching some of the best brains from the mainstream businesses. Corporate luminaries (Jack Welch of GE, Lou Gerstner of IBM, Jacques Nassar of Ford to name a few) have bolted in droves for private equity, the freewheeling world where investors buy slumping companies and try to turn them around to sell or take public, risking billions of dollars in the process.

All brilliant minds and high performers, no doubt. Their track records speak for them. Profligacy has never been their virtue and all of them balked at cost spirals. I often wonder how they approve of the clearly unsustainable leverage deals brokered by the private equity firms they end up working for, to finance bulge bracket acquisitions. Steven Pearlstein of Washington Post has this eye opener on the recent Avaya deal by Texas Pacific (where Millard S. "Mickey" Drexler, ex-CEO of Gaps Inc. works)

How can they fling caution to winds as soon as they switch to private equity? Has it got to do with the new found freedom from Sarbanes Oxley going to their head…? Or do they undergo a hormonal imbalance during the autumn of their careers ?

But come to think of it, Blackstone boss Schwarzman sure had that close call with change of life. How else do you explain his selling a stake to China, awful hurry to take Blackstone public and indulging like there are no tomorrows only to invite that Congressional tax slap…

Monday, August 13, 2007

The great PE bull’s tiring

What made me say that?

Last week US Foodservice, an American wholesaler being bought by private-equity groups, cancelled a $3.6 billion bond-and-loan deal when lenders balked at the lack of protection they were being offered. In Australia, private-equity firms pulled out at the last minute from the country's biggest takeover, complaining of the high cost of debt. This week the sale of a British retailer fell into confusion, after two private-equity bidders withdrew. The prospect of dwindling returns makes buy-out firms reluctant to club together to buy the big companies they covet; banks, meanwhile, are growing wary of offering their own capital as “bridge” finance. Shares in Blackstone, a private-equity chieftain that listed on the stock market last month, have fallen below their offer price.

Rising long-term interest rates have pushed up the cost of borrowing. Sensing a shift in the economics of the industry, creditors around the world have started questioning the easy money offered to private-equity firms, which feed off risky types of debt. The debacle in the US sub-prime mortgage arena has opened many eyes, or so it seems.

For Indian promoters betting on lucrative valuations fueled by PE bidding wars, it spells trouble. What an opportunity they missed…

Friday, August 10, 2007

Asset base

You just need one puff on higher margins to get hooked. Then it becomes a habit that you can’t kick. Indian IT vendors like Infosys, TCS, Wipro, Satyam have all been addicted to this margin fixation.

Even stock markets gave them a higher PE multiple of 25-30x owing to their phenomenal growth fueled by these margins. Sustaining that growth seems a bit difficult since dollar depreciation, wage escalation and higher visa costs are taking a heavy toll.

If one goes by the acreage of real estate assets developed by these vendors during their growth years, the value of which is now many times over, they won’t lose too much sleep over stagnating margins.

Monday, August 06, 2007

Kirana choice

Indian market research consultancy Market Pulse spoke with close to 350 consumers in Delhi, Mumbai and Chennai to understand their attitudes to modern retail and their spending patterns.

The typical Wal-Mart customer earns less than the US national average income. And some reports say that one in five customers does not have a bank account; that’s twice the national average.

The Indian approach to big-box retail is slightly different. The less affluent still walk down to the corner store and call the bania (shopkeeper) to deliver their month’s groceries. Despite all the hype around malls, Kirana (corner store) accounts for 94 per cent of the $320 billlion organised retail trade in India. That ratio isn’t going to change anytime soon, so manufacturers would do well to pander to the convenience stores.

More on those interesting findings, here.

Tata Ste(a)l deal

In the midst of sub prime mortgage woes, there’s been little interest for bonds and CDOs. Even in such a scenario, when Tata Steel has managed to raise $725 million through foreign currency convertible alternative reference securities (CARS), which was oversubscribed by more than two times. There is a greenshoe option of $150 million, which has not yet been exercised.

Tatas have always been an excellent credit risk. Yet, I was a bit curious about its timing and even more about the structure of this bond.

The CARS will be convertible at an initial conversion price of Rs 876.6225 a share, which is at a premium of 35 per cent to the company’s closing share price on the National Stock Exchange of India as on August 6, 2007.

The CARS carry a 1 per cent coupon and the effective YTM is 5.15 per cent. The outstanding CARS, if any, at maturity will be redeemable at a premium of 23.3419 per cent of the principal amount.

Current 3M Libor is 5.36%. Considering this Tatas got a fair deal as it’s long term money. The redemption premium of 23.34% on outstanding CARS must have been alluring to the lenders but when you factor in an asset like Corus in its bag, Tata Steel stock have only one way to go – up. Hence conversion is almost a given and question of outstanding CARS may not arise.

I wouldn’t rule out a buyback initiative by TATAs close to conversion or maturity (not known now), knowing their preference against dilution of controlling stakes. Call it Tata Steel deal now, closer to maturity don’t be surprised if it looks like a Tata Ste(a)l…

Friday, August 03, 2007

New kid on the block

“When liquidity gets tight, innovate” – seems to be the credo for PE firms.

Imagine this new device. A Private Equity firm needs $300m to invest in a company but has decided to expose it to $100m only. It lures in a Bank with higher ROI bait and gets it to lend $200m on its behalf into say, 8% preferred stock/FCCB. The company is capitalized with $300m now. So the Bank gets $16m and the PE firms gets $8m. The PE firm turns over its return ($8m) to the Bank in return for stock appreciation / conversion benefits to which the Bank is not entitled. If the stock doubles, the investment is worth $600m which the PE firm sells and returns $200m to the Bank. PE firm nets a cool $400m upon its original investment of $100m and the interest turned over to the Bank. In the PE block, they call it “Asset Swap”.


Shishir Prasad has elaborated it in The Economic Times.

Bears beware

The notion that corporate profits still have more room to run on the upside is no minority vision. The bulls are still in control of the psychological tone that permeates our markets and investment predictions generally. Wednesday’s crash and today’s revival could be one source of the tone, but there are plenty of other wells of optimism to draw on. PE investor confidence is another.

Thomson Financial data finds PE investments in India during the year have touched $2.49 billion, as against $1.05 billion in Hong Kong, $1.47 billion in Singapore and $752.2 million for the Chinese market. The total PE funding in India is nearly equal to the PE funding that has come into Hong Kong and Singapore together. So far, 29 PE deals have been struck in India this year, next only to Australia (67) in the entire Asia Pacific region. Though there were 28 PE deals in China, the size of the deals were much smaller. While the average size of the deals in India is $85 million, the deal size in China was only $26 million and $188 million for Australia.

India is also a hot-bed for strategic buys, which include M&A activities, with $29.74 billion worth of strategic deals being struck, again the third highest in the Asia Pacific region. While Australia leads the pack with $76.07 billion of strategic deals, China reported $36.88 billion of such deals. There were a total of 331 M&A deals worth $44.34 billion in India in the first seven months of 2007, as compared to 328 M&A deals worth $10.36 billion in 2006.

Bears beware…!

Sugar Daddy

Want a play in power, go bet on sugar stocks...NOW !
Cogeneration of power, still marginal in the government’s energy supply program, is set to become mainstream by 2017 – goes Prabha Jagannathan in The Economic Times.
She quotes a recent KPMG report on the Indian sugar industry (Sector Roadmap for 2017) to drive home her point.
The green energy opens up a $$ revenue stream too. Co-gen has proven revenue potential in the CDM (clean development mechanism) based carbon credits that apply to the sugar industry. The total carbon credit potential for 9,700 mw of exportable co-gen power is in the range of 48 million carbon credits per year, which is estimated at Rs 21.50 b ($53 m) per year.
At its optimum potential, the industry can meet a good 6% of the additional power requirement by 2017 and generate almost 48 million carbon credits. Currently the total power capacity in India is 128 GW and the requirement is estimated at 306 GW by 2016-17. Against that, the current bagasse-based exportable power is estimated at 847 mw. This could go up to 9,700 mw by 2017, according to projections in the report, she says.
If you find rollicking power stocks too expensive, go long on sugar - tommorrow's multibagger !

Thursday, August 02, 2007

In my other blog

The hedge attraction

It happened one night

Prize catch

Bailout is for wimps

Taking BPO Public

When is the right time for a BPO to go Public?

The question is troubling many Indian BPOs wanting to get listed. The industry seems divided. Suggested BPO critical mass range between $100-250 million in revenues to get listed in NASDAQ and a modest $25m is enough to get listed in India's BSE.

Currently the BPO industry is operating at 10-12 per cent EBITDA margins and command a P/E multiple of 18-25. KPOs have higher EBITDA margins of about 15 per cent. Many BPOs are wary of getting listed on BSE as the industry knowledge is poor.

A BPO sees some merit in going public. Besides the fact that investors get to monetize their stake or having cash reserves to buyout other BPO assets (like in the case of Genpact), it will also have a better image since it will be subjected to frequent compliance / process audits and its affairs are open to shareholder scrutiny.

Unlike an IT company, setting up a BPO is capital intensive. Experts say it takes about $6,000 per seat to set up a BPO while a software company can be set up at an investment of about $2,300 per seat. Thus unless you have over 2,000 employees and are profitable, one should not even think of an IPO. While private equity is always an option, an IPO can offer 10 times the valuation.
Hamlet's soliloqy comes to mind... To be, or not to be (public)...!

Wednesday, August 01, 2007

Stopping at nothing

Arvind Singhal, Chairman, Technopak, has a nice rant in Business Standard this morning on evolving Executive Compensation scene in India.

Arvind raises this issue – “what exactly determines (and should determine) how much professionals should be paid for a given level of intellect and hours spent on-the-job.” He reflects and concludes that life isn’t fair on all.

He’s got a point. But even in companies that pay very well, attrition is uncontrollable. What does that mean? Is there another domain that is more lucrative or rewarding? Or is it just reckless poaching? The only way to discipline is by laying down proper metrics to measure performance and reward in proportion. Notice that `D’ (as in `Development’) in HRD is long gone and it’s just HR now - an admission of collective despair, perhaps. It's like saying "sorry guys, we can only pay. Develop on your own". And they do that by voting with their feet. Why brood then? It’s this missing "development" aspect that prompts people to leave. Sooner they get that D back in, there’s hope. Remember, wage escalation minus relative growth would mean increased overheads, lower ROI. That means a dog's life for the shareholder - a character that's been taken for granted far too long. The day he stages a walk out with his capital, it'll be curtains for executives' glitzy life on reflected glory. Think of that mortgage on the Penthouse just bought !