Friday, September 28, 2007

Nothing stops the deal frenzy

And you thought the liquidity squeeze following subprime fiasco has affected the PE appetite for leveraged buyouts… Hardly.

Bain Capital, a private equity firm, decided the 28-year-old Network equipment maker 3Com Corp. still has enough potential to justify a buyout carrying a hefty 44 percent premium to the stock's Thursday closing price of $3.68 per share. At one point in 2000, its shares briefly rose above $100 apiece. For 3Com the $2.2 billion buyout by Bain would mean giving up its independence, but it's gaining freedom from the whims of the market and a chance to expand in China. The cash deal announced on Friday also gives Huawei Technologies, China's largest manufacturer of telecommunications equipment, a minority stake in the technology pioneer - something that could improve its prospects in Asia and raise eyebrows in Washington. 3Com, which faces brutal competition from Cisco Systems Inc. and others, is now a shadow of the high-flying star it became in the late 1990s technology boom. 3Com now counts more than 6,000 employees in over 40 countries, and annual revenue of $1.3 billion.

Here’s yet another and bigger deal. Shareholders of communications and software company Avaya Inc. voted to take the company private Friday, selling it for $8.2 billion to two private equity groups - Silver Lake and TPG that valued its shares at $17.50 apiece. The deal is expected to close by end October. Avaya, based in Basking Ridge, N.J was spun off from the former Lucent Technologies Inc. in September 2000. Shares have jumped more than 25 percent since word of the deal leaked in late May. The deal comes with its set of strings too. The agreement also provides a 50-day "go-shop" provision for Avaya to solicit proposals from third parties. If it ends the merger agreement after receiving a superior proposal from a third party, Avaya must pay Silver Lake and TPG Capital an $80 million termination fee. Also, Silver Lake and TPG Capital must pay a $250 million fee to Avaya if the merger agreement is ended under certain circumstances.

So, la, la, la time for PE firms has not fizzled out. The party is on in the buyout street… Will it have an impact on Avaya Global connect, the Indian company…? Jury is still out.

The Wipro way

Wipro, India's leading IT vendor, it seems have found a way to counter the Rupee appreciation threat to its bottomline. It is also aloof to all the noise around made by most others, in not rushing to the Ministry of Finance or RBI asking to rein in the surging Rupee. It maintains its cool and is moving straight ahead with its stated strategy of inorganic growth, by acquiring companies from diverse geographies.

I am talking about Wipro’s latest acquisition - Oki Techno Centre-Singapore (OTCS) in an all cash deal spread over a period of one year together with all its Intellectual Property Rights as well. The company will also establish a dedicated development centre for OKI to utilise design resource efficiently and enhance product development capabilities.

OTCS is focused on wireless design and has demonstrated innovative capabilities in RF (Radio Frequency) and baseband design. It has a 40 member center with SGD 8.8 M (USD 5.89 M) as the revenues of the fiscal year ended March 31, 2007. The company has key customers in Japan in product engineering space.

Way to go, Mr.Premji. The acquisition will give Wipro a footprint in the large market in Japan and East Asia. I go it’s way better than whining about exchange rates, something over which none has control.

Tuesday, September 25, 2007

Clueless RBI opens flood gates

The rise of the mighty Rupee against a weak dollar has forced RBI to relax its currency regulations. It goes with the usual refrain - “one more step towards full capital account convertibility”. Gee, making a virtue out of necessity? Not so nice, Guv…! How many more steps left? Story behind the story is RBI just woke up and realized that they've lost control of their own industry. Now they're desperately scrambling to get back on their feet. Left with not many options, it opened the floodgates wider praying that some of the incoming dollars may flow back too. Now, know your limits

- Individuals can remit up to $200,000 against $100,000
- Companies allowed to invest overseas up to 400% of net worth overseas against 300% till now

- Partnership firms also allowed to invest overseas 400% of net worth
- Ceiling on portfolio investments by companies raised to 50% of net worth from 35%
- The requirement of 10% reciprocal shareholding in listed Indian companies done away with for overseas portfolio investment
- Companies can prepay ECBs up to $500 million against $400 million now
- Mutual funds allowed to invest an aggregate of $5 billion overseas against $4 billion now

Will it cause a dent ? I doubt. There are not many parking bays available for the greenback than emerging markets. No other market in the world is yielding returns as do emerging markets (EM) like India. China and Brazil have become way too overstretched. Developed markets have been consistent underperformers. That leaves the dollar to leave Indian shores only when Indian companies begin repaying or foreclosing their ECB borrowings made earlier. That’s wheels-within-wheels scenario since prepayments shall be triggered only if there are significant dollar earnings from exports, which is too much to ask when every dollar of export is fetching less and less Rupees. Add to that the Fed rate cuts. The recent 50 bps rate cut by the Fed on September 18 has only accelerated the inflows - FII reacted by increasing their investments in India with $1.54 billion of investments in just 3 days between September 19-21. RBI may use its sponge to mop up dollars, but in July alone, it bought back $11.42 billion.

How much more can it suck in? And is it advisable? Well, I’ve dealt with that already.


Monday, September 24, 2007

Slap on the face of banking reforms

60 years of independence; Even more years of Indian Banking. But reforms have done little to save our folks from the clutches of loan sharks.

Each time a farmer commits suicide, there is the obligatory reference to high interest rates charged by the usurious moneylender. Predictably, two standard courses of action follow. First, public sector banks are asked to increase their footprint (after the usual ex gratia payments are made to the bereaved families) and two, demands are made to monitor (it used to be ‘regulate’) moneylenders and their activities. While the first is a good thing, it is irrelevant in the current context; the second would be disastrous, given how many households in the country are dependent on moneylenders.

IIMS Dataworks’ Invest India Incomes and Savings Survey 2007 throws up some interesting findings in this context. Of every 100 persons who have taken loans in the country over the last two years, 31 per cent have got loans from moneylenders, compared to 20 per cent from banks.

The short point is that, until institutional mechanisms develop to meet the credit needs of people with different needs (including subprime category) the moneylender is meeting very real needs.

Thursday, September 20, 2007

What will RBI do now ?

The sign of maturity of any economy is in its attainment of functional automation without having the need for frequent policy interventions. In that sense, if central banks gradually loosen their grip and reduce the frequency and magnitude of their intervention and monetary control, the economy should reflect a fair sense of its health through its currency exchange rates in relation to that of others.

But TCA Srinivasa Raghavan in his article has observed that the balance of opinion is in favor of intervention, for some reasons. One is that no central bank chief wants to be held responsible later for not warding off a recession. So he or she does the popular thing. The other reason is perhaps that everyone has learnt from the Asian crisis that when the going gets tough, the credit flow must start going. To choke off the tap is to invite disaster where people who had nothing to do with the problem lose their jobs and property.

So do Bankers that expect the Reserve Bank of India to soften its view on interest rates in the light of the US Federal rate cut. Domestic loans and overseas borrowing may become cheaper, they say.

But I go if central banks intervene, are they not defending or even protecting the bad guys who were indiscriminate in their processes (like subprime lenders that overlooked creditworthiness of borrowers) and screwed up not just themselves, but everyone in the end? Do they deserve to be bailed out? How different is it from the tax amnesty schemes that ridicule many an honest taxpayer?

Banish them all

There’s always big trouble if you take brokerage reports seriously. They analyse everything to death.

I know there are surgical processes for genital rejuvenation, liposuction and buttock implants. Is there something for Analyst annihilation? Me thinks investors world over will only be too happy to pick up the tab.

Every day they brazenly appear on business channels, newspapers (and even your email inbox is not spared) advising you to buy some or other stock. You go by their words and you’ll never get out of it. They talk as if they are economists (they connect Ben Bernanke’s rate cut with the fortunes of Indian Banking stocks and still say “decoupling”), scientists (wax eloquently on the potential of a “new” drug discovery that never takes off) and technologists (a sure dud, it will be) all rolled into one.

Yesterday just five minutes before the market opened, one analyst said Sugar stocks have no scope for another year. He quoted over supply, low prices, policy hurdles and what not. Up they went 20% and hit the upper circuits. It had me in splits.

I have 40% of my portfolio in sugar. All bought at 52 week lows when everyone was busy buying overheated Real Estate, Infrastructure and Power sector stocks. I had another reason. Not one analyst put out a `buy’ on it.

Tuesday, September 18, 2007

Bernanke did it, finally...

It’s a tight rope walk for Ben Bernanke, no doubt. If policy makers cut rates too cautiously, they risk a recession; if they cut them too much or too early, they risk stoking inflation.

In reducing its benchmark interest rate by an unusually large one-half percentage point, to 4.75 percent from 5.25 percent, the Federal Reserve made it clear that policy makers viewed the turbulence and disruptions of the past couple of months as too dangerous to ignore.

The reaction in stock markets was ecstatic: the Dow Jones industrial average jumped 200 points almost instantly and ended the day up 335 points, or 2.51 percent, at 13,739.39.

With a weak dollar that helps surge in American exports, for a change, the US is no longer the world’s engine of growth; the global economy could now become the engine of American growth.

Academics test drive at hedge funds

Yale University professor Roger Ibbotson

The growing and lightly regulated hedge fund industry is attracting new players — business school professors eager to test their theories in a field known for big risks and occasionally bigger rewards.

Hedge funds are becoming a tempting tool for faculty members looking to sharpen research and giving a Wall Street perspective to their students, all while making some extra money. Economic consultant Peter Bernstein reportedly said the link between academic theory and Wall Street is not new, but the interest among professors to run a hedge fund is.

While hedge funds frequently outperform more traditional investments, some have failed spectacularly. Last year, Connecticut-based Amaranth Advisors wrongly guessed that tropical storms in the Gulf of Mexico would cause natural gas prices to spike. The storms didn't develop and Amarath lost billions within a week, prompting lawsuits and congressional hearings. So did several others that chased subprime debt.

Does this enthusiasm to test drive academic theory explain why there are more busts than booms in hedge fund domain? Why does the expression “up by the stairs and down in the lift” come to my mind?

Tuesday, September 11, 2007

Rewarding the Lemons

Lately, this story from my younger days cross my mind often.
The Emperor Paul, of Russia, was so provoked by the awkwardness of an officer on review that he ordered him to resign at once and retire to his estate. “But he has no estate," the commander ventured. “Then give him one!" thundered the despot, whose word was law, and the man gained more by his blunders than he could have done by years of the most skillful service.

An involuntary smile came to my lips as I think of the ravage caused by subprime mortgage lenders and the liquidity infusion from central banks of US and Europe….

Rewarding the lemons?

Monday, September 10, 2007

Black Swan - CNBC killer?

Thanks to this post by Matt McCall of DFJ Portage Ventures, I could read this splendid write up by Michael J Mauboussin of Legg Mason Capital Management on Strategies. Find the link in Matt’s post.

Stowing away some startling insights for my own recall and for you, my readers.

- The difference in [investment] return has nothing to do with knowledge; and everything to do with emotional and psychological factors. (Curtis M Faith – Way of the Turtle)

- What separates the good from great investors is not knowledge or raw smarts, its but patterns of behavior.

- All investors must be alert to black swans – events that are outliers, have an extreme impact and are explained only after the fact. We get closer to truth if we focus on`falsification’ (seeing one black swan) instead of `verification’ (seeing lots of white swans does not allow for the statement all swans are white; but seeing one black swan does disprove the theory).

- Cognitive errors including loss aversion are often the source of sub-optimal investment decisions. They tend to focus on frequency [of losses/gains] than on its magnitude. Buffet distinguishes between experience and exposure. Experience looks to the past and tries to predict the future. Exposure, in contrast considers the likelihood and impact of an event that history, especially recent, may not reveal.

Great nuggets of wisdom…. I had never been a fan of quant models of investing. (Confession : I had consulted on a quant venture some time back for a friend from the hedge fund world. But that I did for a living… can’t thrust personal beliefs on clients) My logic – no model can predict a million minds and their billion different views that spur investment decisions. Now I am a total heretic. Buffet, Taleb, Mauboussin, Matt and now I, give you one more reason why you should stop watching CNBC that gives rebirth to the breed of analysts that should have long been dead and gone…

Sunday, September 09, 2007

Complex hedges and the quant threat

O.K. So our IT CFOs are getting smart. They no longer settle for currency markets to determine their future. Joining the global trend of using exotic hedges to protect their realizations, they too are getting used to clever bets.

Check this out. Under the tailormade transaction known as STRIPS in market parlance, the corporate can settle the dollar every week, fortnight or month over the next few years, through what’s called a “series of options”. For years few bothered to use it, but in recent weeks there has been a flurry of activity. In the last one month, deals worth $100-200 million have been struck almost everyday.

Good. But coming to think of it, it’s a bet. The management strategizes, the operations team executes, marketing sells it and bills the client. All of them work so hard - only to stake it all in a quant bet? Here I risk sounding like your grandfather. But I am a sworn enemy of anyone trying to define a future thro quant theories and complex hedges. How many CFOs understand the complexity of hedge before they book one? After all, CFO is only an employee and not a shareholder who's ass is on the line if his call goes wrong. At best, he's a bean counter and can plead mea culpa... Since when has anyone been endowed with the power to call future course of a currency !

This seems to be the thrust of A.V.Rajwade’s article in BS. He says some instruments are so complex that it can take investment banks' computers entire weekends to value them! Can't agree more. The best hedge I go is constant investment in R&D led innovation to reduce costs, improve operational logistics and expand margins without affecting the cost to consumer. The day you think that's not possible and wait for exchange rate hedges to save your bottomline, it's time you exit the business and head for the hills. Because, you're on your way down...

Mallya's Spyker deal is not just hype and glory

Not many would have sensed the spirit behind Vijay Mallya’s co-investment in Skyper, a Formula1 team. Knowing his penchant for high life and fast cars, may be it just got swept aside as just another Mallya indulgence.

Yet it appears the deal between Vijay Mallya - Chairman and CEO of Toyota sponsor Kingfisher Airlines – and Dutch entrepreneur Michiel Mol - Spyker’s Formula One Director might just make incredible business sense.

Here’s to why. It might just give a uniquely high-impact advertising forum by providing sustained brand visibility for the 90-odd minutes of a race. Importantly, given the increasingly stringent limits in Europe on liquor and tobacco advertising — two significant Formula 1 income-earners — the sport is making inroads into Asia. China and Bahrain are recent entrants to the calendar, Singapore follows next year and, who knows, it may be India after that (Mr Mallya heads the local racing body). These will provide Mr Mallya with an entrĂ©e into high-value Asian markets to grow his airline and liquor businesses.

Especially after Narain Karthikeyan raised the profile of Formula One racing in India when he became the first Indian to compete in a Grand Prix with Jordan in 2005. Now Mallya believes his purchasing Spyker could boost it still further. With a local hero behind the wheels, the Indian viewership also might shoot up. If anything, that could be a bonus of sorts.

Saturday, September 08, 2007

Debt vapor

Thinking of early 90’s when I had just started working….

Indian companies were then extremely under leveraged and over mortgaged. For every Rupee of debt, one had to mortgage Rs.4 worth of assets because Marked-To-Market (MTM) as a concept was totally unheard of. Book Value has been the norm and it suited institutions better. I remember the time when I used to wait outside the offices of GM/ED of Banks / Financial Institutions (FI) who literally rationed loans. We never had extra assets to mortgage as properties worth several times the value of loans have already been locked down by earlier loans and this wait was necessary to get an NOC to create a second charge for a new loan. Still the securities to total debt ratio managed a cool 4 to 1.

Cut to the early `00, the situation reversed. Liberalization meant multiple streams of credit available to Banks/FIs and FII, PE and Hedge Funds entry meant surfeit of money supply that had difficulty in finding room to get parked. Corporates reveled in this new order of things and leveraged themselves to the teeth. They had a problem of finding destinations to invest in. The recklessness fueled by sudden excesses meant bad judgment and funds literally got sucked into projects that turned out to be literal blackholes, from which nothing would come out.

And now we hear this. I am not surprised. Are you? I think history will repeat and it’s time we prepare ourselves to cool our heels at the reception lobby of Banks/FIs waiting to be called in by the GM/ED…or who knows, it could even be outside a Manager’s office at a Bank Branch…!

Friday, September 07, 2007

Will India's IT vendors turn realty players?

Pune factories going the Mumbai Mill-land way… Turning into expensive real estates. Bajaj Auto looks like exploring turning its Akurdi plant into developed real estate.

Judging by the little or no R&D investment by India’s famed IT vendors, recently endorsed by Indis’s distant 46th ranking in global IT map, what are the odds for Infosys, Wipro and TCS to junk their businesses and turn realty plays? Satyam already has its "Maytas " group (got by reversing “S.a.t.y.a.m”) of companies into which it can morph any day.

Going by the large swathes of land and building they hold, You can’t grudge them that… Benefits? Besides the huge value that they can unlock, here they don’t have to face up to an IBM, Accenture and EDS or to brood about higher visa costs, rising wage costs, Rupee depreciation, poor skill levels, shrinking margins, attrition levels….

Aside of that, few will see any great organic upsides in the near term to their shareholders…

Tuesday, September 04, 2007

Wake up to reality

In an IT competitiveness study commissioned by software industry association Business Software Alliance (BSA) and conducted by the Economist Intelligence Unit, the US, Japan, South Korea and the UK ranked the highest among 64 countries in terms of IT competitiveness. The study evaluated countries on factors like skill availability, pro-innovation culture, world class technology infrastructure, a robust legal infrastructure, government support and a competition friendly business environment.

India gets slotted at 46. Don’t tell me you are surprised. I’ve been crying hoarse about India’s IT illusion here, here and here.

To stay ahead in knowledge industry, of which IT is a force to reckon with, significant investments will have to be made in R&D. Indian companies and the government have conveniently ignored strong signals coming from several quarters that cried for innovation. Low end BPO vendors were painting a picturesque landscape as much as labor arbitrage and a weak Rupee would permit and a smug industry got even more arrogated. When the tide turned and both wage cost and Rupee appreciated, the mask got brutally lifted and the naked reality that hid behind the scenes began to look ugly; very, very ugly.

With tax benefits too on their way out and global majors already settling in, Indian Government and its IT industry should quit blowing sunshine up its ass and get its act together. Not for growth, for survival that is. What do you think?

Monday, September 03, 2007

When a Private Equity deal goes bust

Buyout firms like to present themselves as a can't-fail combination of operational genius and financial support that can heal sick businesses and create thriving companies. But sometimes, as in the case of Aegis Mortgage, genius fails and bankruptcy is declared. The private investment firm Cerberus bought a controlling stake in the Houston-based mortgage lender in 1998, but despite an infusion of cash and talent, Aegis ceased operations on Monday, August 6. Now hundreds of employees have been laid off - all without health insurance. It's a reminder that risky turnarounds can mean real pain for more than just investors raising questions about how Cerberus will treat other ailing companies it has purchased, notably Chrysler.

In India, PE deals are on the rise. Over leveraged transactions be put on watch.

Saturday, September 01, 2007

Getting the blend right

The proof of a robust M&A strategy is in its blending. Most acquisitions fail because integration of diverse cultures is never easy. Why not scout for companies with similar culture - you may go. Try that; you’ll never find one. Every company has a unique culture since it is made up of different individuals, their shared beliefs and practices that identify the company to which they belong.

Mike Rogers of PatchLink, has completed 10 acquisitions and two sales during his career and has this interesting Op-Ed in Venture Beat where he shares his magic mantra for a successful inorganic growth strategy. While Mike concedes that there is no such thing as the perfect deal, he goes that it all depends on a sound strategy. You can fix a bad deal structure, you can fix a bad integration, but you can’t fix a bad strategy.

Read it.

FDI phobia

The machinations for circumventing the 26% FDI limits in Insurance sector has taken a new turn with ICICI Bank’s proposal to transfer its 74% holdings in its insurance ventures to a holding company, ICICI Financial Services Ltd.

ICICI Bank owns 74 per cent each of ICICI Prudential Life Insurance and ICICI Lombard General Insurance, but the bank is 70.88 per cent owned by foreign investors. This means the effective Indian shareholding in the insurance subsidiaries is only about 21.54 per cent, against the FDI norm of 74 per cent Indian ownership.

If ICICI Bank transfers its stake in the insurance companies to the holding company and if that in turn sells a 24 per cent stake to foreign investors, then the effective Indian shareholding in the both the insurance companies will further fall to about 15.62 per cent.

While Finance Ministry has approved this back door hike in FDI ceilings, FIPB and RBI are not so sanguine about it.

I go that when color of money is increasingly losing its relevance in a globalized world, why should there be any ceilings at all? Be it Indian or Foreign Investor, so long as they are subject to TRAI & RBI regulations, there should be no problem. In fact FDI in insurance should be freely allowed since it covers risk and entry of a foreign investor enables cross-border distribution of that risk. Restriction stimulates the temptation to get around it by devising ingenious ways such as the holding company route, which on the surface is appearing rather innocuous. Or may be it is.

Grow up, Schwarzman

Stephen Schwarzman is a bad schmoozer. That’s a skill he’d rather have if Blackstone, the PE firm of which he is the CEO intends to do more deals in India. In particular, in sectors like media, telecom, real estate and energy where an FIPB approval is needed to relax statutory ceilings on PE investments.

Global private equity fund Blackstone’s proposed investment of $275 million (Rs 11.30 billion) in Ushodaya Enterprises, which runs the Telugu newspaper Eenadu and TV franchise, is stuck with the information and broadcasting (I&B) ministry seven months after the deal was announced.

This could mean trouble for the country’s largest private equity deal in the media space, which requires Foreign Investment Promotion Board (FIPB) clearance.

Arun Sarin of Vodafone learnt it the hardway. Indian politicians and bureaucrats are not so lightweights in that they have a reputation for jamming many a smooth deal. Equally important it is for him to be less of a gas bag afterwards.
"Go, use the wisdom of Arun Sarin, Mr.Schwarzman..."