Go tax destruction if you can !

Ok. Indian companies do more and more foreign buyouts and don’t bring dividends from those controlled foreign companies (CFC) back in. Taxman goes sniffing.

I object. Take TATA – Corus deal. The £ 4.3 billion ($ 9.16 bn) deal, has been funded by the TATAs almost entirely by leveraged debt and internal accruals that included diluting stakes in group companies like TCS and other TATA group companies. Now this watershed deal (world’s 65th ranked Indian steel company acquiring 5th largest steel company in the world) would not have been possible except for that adventurous yet high risk mode of financing opted by the TATAs. Should we not permit TATA to park its Corus dividend abroad that could be utilized in repaying TATA STEEL’s leveraged debt? Why bring it back only to tax it? If a company has taken some risk, it is entitled to its share of reward. Going after them like a bloodhound is not just irrational, it is way too regressive.

Paying taxes is a citizen’s duty and I acknowledge that so long as the taxmen don’t choke my oxygen supply pipe in the process. I quote Chanakya’s Arthasasthra - “There should be leniency and caution while deciding the tax structure. Ideally, governments should collect taxes like a honeybee, which sucks just the right amount of honey from the flower so that both can survive. Taxes should be collected in small and not in large proportions". Granted, I shouldn’t expect brazen taxmen to be endowed with regal finesse, but how about rationality?

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I have often condemned the principle behind excise duty – a tax system leftover by our colonial masters that penalized local enterprise - as well. I say it's about time we chucked this agony off our back. My logic, why tax production? Should they not be taxing destruction with equal vigor? Or will that be too much to ask?

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Market declines; off goes PE deals, but law firms connect….

ICICI Venture and Jaypee Infratech have terminated negotiations for the PE player buying close to 10-15% stake for $800 million in the infrastructure company, which is developing project worth $ 25 billion. Earlier Blackstone backed off from buying 26% stake in Hyderabad-based Ushodaya Enterprises (of Eenadu newspapers and television channels) for $275 million. Similarly, Future group’s PE fund Indivision cancelled its deal to buy 4.9% stake for Rs 250 crore in media house Zee TV’s DTH venture Dish TV following the market meltdown that saw Dish TV share prices sliding far below the deal price.

But as they say, lawyers never lose. Allen and Overy, a leading international law firm and Trilegal, an Indian law firm, confirmed their new arrangement involving client referrals, training, consultation and joint marketing.

Allen and Overy say they belong to a “magic circle” – now what is that? I guess it’s a law firms moniker akin to "Big Four" for accounting firms. At least magic circle is more overt a term – the client will realize he’ll be (financially) done in as if by magic….

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Finding the integration watermark

Sri Rajan and Till Vestring of Bain & Co. on post acquisition integration –

A Bain & Company study of 250 global executives with M&A responsibility showed two-thirds routinely overestimated synergies available from transactions. But, at the same time, most understood what drives smooth integration: 80% said integration efforts must be “highly focused on where the value is in the merger. Rajan and Vestring further quote examples of Tata Com-TGN, BP-Amoco amongst others say –

A deal either enhances core business or opens up a new and separate platform for investment; Successful integration can make or break a deal’s trajectory.

Three types of investment thesis – active investing, growing scale and growing scope – require different degrees of integration. When companies have a clear understanding of their investment theses, they can quickly decide where and how much to integrate.

In fast moving, intensively competitive markets companies that don’t get their integration right can pay a heavy price.

It’s an excellent piece, agreed. But I find one missing perspective – of the Customer. For me, (s)he is the center point. Everything revolves around them. When you debate how much to integrate, wear the hat of a customer and ask yourself – how much will the customer benefit if we integrate and if so to what level? Answer that conscientiously and there is your watermark.

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Get your skin in the game

So I read this McKinsey report.

During the past two years, the flood of money into infrastructure funds has been an astonishing $130 billion. Take into account leverage, a billion dollars of equity funding could, in some situations, pay for up to $10 billion in projects. "Where will all the money go?” It asks. I am tempted to add an extension – “[with shrinking margins]”. The need for infrastructure investments in the emerging markets at present is about $1 trillion. I am at ground zero here in India. I can share a few insights.

PE funds here need a new approach – different from typical value creation through financial engineering and rising user demand. So far, they have acted less aggressively to improve operations; indeed, many financial investors still leave such issues to contractors and focus their governance efforts on financial metrics. This model is broken; it’s so yesterday.

So what should PE fund managers do today? I suggest -

a) Lay down norms of good governance. It helps assess risk in a structured way, avoiding unwarranted focus on a single category, such as technical delivery or regulatory compliance.

b) Brief project owners about the complexities by way of foot note to RFP itself. When they see reason, they might even expand their allocated budget. If you’d quoted thin, you’ll come to grief later.

c) Build alliances with Infrastructure specialists. Get some strategic skin in the game. Here’s the twin upside - a better chance of winning traditional deals and turn them around; and the ability to bid for operationally complex and less competitive projects. That’s how you learn to walk away from overpriced deals.

I quote an example. Macquarie and Ferrovial’s co-investment in the UK’s Bristol International Airport, for example, involved upgrading signage systems; renewing check-in, baggage reclaim, and catering facilities; rerouting foot traffic; and installing all-weather landing equipment. The investors also rejuvenated the airport’s retail offering, strengthened the management and sales teams, and even tweaked the system for booking parking spaces. In the four years after the acquisition, the number of passengers using the airport doubled—as did its EBITDA.

I find financial engineering can help PE returns only up to a point. With strategic competence added in, you can man up before the whole world, not just LPs. What do you think…?

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I pat my back

One great upside to blogging as I see it is that you can pick up on a weak signal, apply your own logic, speculate outcomes, post it over the Web and attract comments. Then validate your foretelling skills against what appears in the mainstream media much later. So what’s so great about it? Date stamps. If your deduction of likely outcomes precedes the subsequent endorsement in mainstream media, your logic is flawless. You can rely on it and take critical decisions with greater confidence. It’s a great joy. I’ve had it on quite a few occasions before. Here and Here.

This morning I had yet another. I find the lead editorial in today’s ET endorsing what I speculated three days earlier – on what Reliance Power `out-of-the-box bonus’ means to investors. When tallied point by point, I’ve a few extra points to my credit that’s yet to be spotted by mainstream hacks. Here is the next salvo from R-Power, just as I had guessed.

Meanwhile, I plod on… A sharp logic is indispensable in my line of work – private equity deal scouting and bug fixing :)

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Update : Not sure if R-Power has execution capabilities on the power generation and distribution front. It’s current priority is bonus distribution :-)

At crossroads or just cross eyed ?

Office space rentals have risen 30 per cent in the city central business district Nariman Point and 20 to 25 per cent in Lower Parel in the past year. Leading developers including DLF, Indiabulls, Peninsula and retail pioneer Future Group now are rethinking. Why not convert space reserved for retail malls and hyper markets into large office space…?

But then you have Lakewood malls, the retail arm of Hiranandani (Haiko) zeroing in on supermarkets, lifestyle stores and culture shops as its focus.

An industry at crossroads or is it just cross eyed vision? I'd like to believe it's strategy. But they say, strategy means folding in the future. Not extrapolating the past. Soon we'll figure that out.

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Lead (not so) kindly light

Reliance ADAG group jingled “power on, India on” just before Reliance Power IPO. The stock debuted in the market and put all lights off. When the alley was all dark, Anil Ambani emerges from the shadow holding a candle.

People didn't figure out it was hoax yesterday? Good lord. Pull your heads out of your butts, people....

First, could it be a genuine expression of an overwhelming sense of guilt? A sort of admission – Yes, we overpriced the stock and valuations rode on the Reliance track record more than fundamentals. But bonus shares are not the same as “money back”, it just signifies a reduction in premium. It increases the floating stock and effectively reduces the stock price in the short term. It does not reduce your pain, but now you can see Anilbhai’s face in the candle glow better.

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Second, R-Power has collected only 10% from QIB and 25% from retail investors. It has to collect the remaining 90% from QIB and 75% from investors scarred by its listing inferno. Even if the company forfeits the marginal upfront application money paid by investors wanting to back off, investors could still cut their losses on the unpaid allotment money part and run. That would effectively mean IPO is undersubscribed and hardly can R-power proceed to reissue shares at a discount.

Third, the R-ADAG group can hardly afford to disillusion investors if it has a series of IPO plans lined up. Its private equity fund is entirely funded by Anil Ambani’s personal wealth and has some huge investments in entertainment, real estate and technology. All these companies will have to go public sooner or later and it’s easier to milk a faithful investor base. That’s a grand strategy and a surefire exit route. It’s a bad idea to choke up that pipe right now.

Fourth, what’s R-ADAG got to lose anyway on the closing price of Rs.372 on the opening day? R-ADAG promoters in fact got a debut valuation at a premium of Rs.355 on its Rs.17/- per share (fully paid-up) investment in the Reliance Power *shell* already. It makes a pomp and show about its magnanimity in depriving itself of the present bonus allotment. The fact is, it already got its bonus as much as 20.88 times over !!!

The hidden pack of beneficiaries could be the usual suspects. Amar Singh, Mulayam Singh and the Bachchan family holdings. Not to forget Reliance Energy's majority holding and its scope for recoupment in the long term...:)
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As a Private Equity dealmaker, I would worry

The government today notified guidelines for Foreign Currency Exchangeable Bonds, that lets companies forming part of conglomerates to unlock some of their investments in group companies.

FCEB is a debt security offered by a company (“issuing company”) and subscribed to by investors living outside India and exchangeable into equity shares of another company (“the offered company”) of the same group, based on warrants attached to the security. Conditions include –

a) Companies to belong to the same group;
b) Offered co has to be listed, FDI/ECB compliant;
c) Not to use funds for stock buys/India real estate;
d) Five years for redemption but can exchange anytime.

This is yet another window for conglomerates in a hurry to monetize rich valuations in a booming market. I can explain. If a company has exhausted its FDI / ECB limits and still needs funds, it has to either raise fresh capital or resort to high cost borrowings. In both cases, the credit rating would suffer and that means higher cost of borrowing. By taking FCEB road, it can swap the FDI/ECB head room available for any other company in the group to raise more funds at the same reduced cost.

What would it entail? More companies from same groups, with or without ready projects would make a beeline to get listed. Now if R-Com has exhausted its FDI/ECB limits, it can raise it under Reliance Power, which is a shell now. Before that is exhausted, Anil bhai will float another company and take it public. One company always to be kept ready with FDI/ECB window open. Remember successive IPOs during early days of Reliance and the later consolidation? Even smaller players like the Modern group of yesteryears from the Ranka stable? Modern Sintex, Modern Denim, Modern Terry Towels – each of them were listed, their stocks rose and fell with little notice. Fundsraising was a chain reaction - one project was used to fund another till the chain collapsed during the late 90’s bear phase.

But then it’s an election year. Reliance has new oil strikes. Uncanny coincidence of timing the new law? Notice the relative calm even in the left benches despite the fuel price hike. Whatever happened to the elementary principle in Finance – every business should sustain by itself? Take life. How long would you stand on other’s legs?

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As a Private Equity deal maker, I would worry.

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Be the Stand-up guy at the gate

Ted Forstmann, a corporate raider immortalized in Barbarians at the Gates for his unsuccessful 1988 bid for RJR Nabisco, flew in on his private jet, presented his offer, and gave Reiman about 30 minutes to make up his mind, without bothering to spend any time with his family.

Now those guys (KKR, Blackstone, Carlyle et al) are here, will that stuff work in India? I say no. Here you have to please even the nannies in the household before you buy some stake. It’s not just easy to pump in excessive leverage, dividend recaps and ripping fees into their Indian portfolio companies and ask them to wilt and watch. Devise new methods. Innovate. I go for a successful PE fund to get going here, it has to have a greater strategic involvement than pureplay financial. Use some hand to spin that wheel of fortune. You can have a killer instinct alright, but have some heart as well. Of the few PE business models that came close, Madison Dearborn scores.

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"Sure as hell will charge a fee"

Here..... Sebi wants to regulate Art Funds now. Entrepreneurs turned neo-art aficionados have lately been getting funny ideas. Who knows? There is always the proverbial worm for the early bird.

So I read their disclaimers in IPO offer documents.

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Of SEBI: “SEBI only gives its observations on the offer documents and this does not constitute approval of either the issue or the offer document.”

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Of NSE: “It is to be distinctly understood that the permission given by NSE should not in any way be deemed or construed that the offer document has been cleared or approved by NSE nor does it certify the correctness or completeness of any of the contents of the offer document. The investors are advised to refer to the offer document for the full text of the disclaimer clause of the NSE.”

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Of the BSE: “It is to be distinctly understood that the permission given by Bombay Stock Exchange Limited should not in any way be deemed or construed that the Red Herring Prospectus has been cleared or approved by the Bombay Stock Exchange Limited nor does it certify the correctness or completeness of any of the contents of the Red Herring Prospectus. The investors are advised to refer to the Red Herring Prospectus for the full text of the disclaimer clause of the Bombay Stock Exchange Limited.”

I agree this is a practice followed by regulators / stock exchanges globally. All of them are spineless freaks that neither have the gall to own up nor wish to let go off their influence. They know that no process of due diligence can be 100% fool proof. In other words, they're sure of their propensity to goof up. Yet, they just want to be there because they are. Wonder what will they regulate in Art? Will they know a Leonardo Da Vinci from a pattern in the ceiling left by some regulatory muck hitting the fan? May be they’ll add a few more lines to their disclosure. Or better still – create an intermediary, that knows even less, (a la merchant banker) to blame everything on.... The more things change, more they're the same.

But sure as hell will charge that fee :)

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Taxmen catch budget cold

Gee… it’s Budget time and our taxmen get their annual bout of xenophobia. They think up new ways of choking all streams of income – inland and foreign, inbound and outbound - and squeeze out more.

So now they come up with the new norms for international taxation. There’s something like a concept paper on “simplified income-tax” (oxymoron?). These include the concept of General Anti Avoidance Rule , Controlled Foreign Corporation, Thin Capitalisation Rule and Advance Price Mechanism.

Mr.Chidambaram, take my advice. Introduce no new taxes. You’re way too rich already. Ask your colleagues to build new roads, highways, dams and airports they promised. For heaven’s sake, don’t come up with new Yojanas or we’ll puke ! If possible, scrap those you can’t run. Tell that gloating Laloo to give us some fast trains. Bombay local trains are an apology for modernity. Fix corruption in PDS and make sure the poor get their ration as per entitlement. Talk to Chinese if you have no clue and learn how to deploy tax rupees in building infrastructure. Elections are around the corner and if you listen to me, your payback will be lucrative – another term at office – that’s what you guys die for anyway… don’t you?

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Ah, but you call it “continuity to enable reform process” – Balderdash !

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Case for a market mashup

So I say if IPOs are a game of chance, why wouldn't the regulators pass over the primary market and allow direct listing into the secondary market? The expression `secondary’ would be redundant then. SEBI might as well silence the grey market rumor mills that emit misleading signals to trap gullible investors. Let Book Running Lead Managers (BRLM) morph into Market Makers. The mechanism could be something like this –

1. The issuer approaches a merchant banker who shall prepare an offer document in compliance with regulations and ensuring adequate disclosures.
2. The draft offer document shall be filed with SEBI for vetting and the final document shall be filed with Registrar. (No need for application forms with non-readable disclosures necessary. Imagine printing cost savings.)
3. The market makers (BRLM in new avatar) shall provisionally register the securities with the depositories and offer a mandatory online two way quote to interested investors for a five day period.
4. If there is enough demand for the security, the entire issue will be subscribed and if not, the unsubscribed portion (above a minimum watermark of say 70% of issue size/volume) shall be extinguished.
5. Issuer shall have the option to pull out the issue at this stage if it is not happy with 70% subscription and credit the sums back to investors online/offline. Alternatively, if the market makers have agreed in advance (hard underwriting) to absorb the 30% unsubscribed portion at the closing price of the 5th day, they can.
   

Advantages are –

• Significant reduction in issue expenses;
  
• Online access to offer document. Facts don’t get mired in fine print;
• No categorization of QIB, HNI and Retail;
  
• The whole issue completed in 5 days, unlike 8-9 weeks that it takes now;
  
• All category of investors to pay the full price they bid; No question of revised bids. Make a mistake, you just will have to buy/sell.
  
• Being a transparent online mechanism, no scope for payment default since there is an instant direct debit to investor’s bank account;
  
• Case for refund only if the IPO is subscribed below 70% or if the issuer chooses to pullout;
  
• Efficient price discovery since price is what an investor is willing to pay and grey market operators get edged out;
  
• Investors don't get sucked in by the media blitz following QIB oversubscription figures;
• The reduced effort of BRLM would enable them to charge lower fee from issuers.
  

In essence, by applying the excellent secondary market infrastructure that we have now (with T+2 settlement) and the prevailing low brokerages, this mechanism is significantly more efficient, issuer and investor friendly and certainly a game of surety than of chance. No more bad listings; No more sudden pullouts.

Mr.Damodaran, if you need help, you know whom to call. Here are some more perspectives from Samir Barua (IIM-A), Rashesh Shah (Edelweiss) and Alok Vajpeyi (Dawnay Day AV).

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All Lights Off

Bing bang IPO of Reliance Power Ltd., is trading at a discount of over 10% today, on its maiden listing…

Slam dunk. Poor investors will be inundated with heavy losses since most of them have borrowed liberally from banks and other lenders that were more than happy to extend short term funds for this IPO. The early hums were on doubling the money in about 25-30 days since the issue was from Reliance stable, that has a reputation for grand listing rewards.

Market sentiment is God. No arguments.

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Names don’t mean much Mr.Khorakiwalla…

This is it. Wockhardt Hospitals backs off. A glowing moniker for investors’ shrunken appetite for IPOs. Emaar MGF is likely to follow suit if it fails to scrape through. The QIB portion of Wockhardt Hospitals IPO was subscribed just 6.44 per cent. The retail portion was subscribed to a far more respectable 51.92 per cent. Some reports reveal that the grey market premium for Reliance Power IPO has significantly declined.

I would leave the downturn in investors sentiment alone for now. What stuns me is that it has happened despite the impressive line up of high profile investment bankers by Wockhardt Hospitals – Citigroup and Kotak Investment Bank. Could they not secure even one time subscription by QIBs? How different are they from other not-so-high-profile I-Banks then? Why didn’t it devolve upon them if indeed they’ve underwritten it? Or have they? No clear answers yet.

As a corollary, can’t we safely imply the success of the issues lead managed by them has also been by default? I would lay it on boom time sentiments and certainly wouldn't attribute it to their subscription procurement skills. Talk of their famed connections and ability to secure huge subscriptions – their principal deal bagging levers.

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A bird tells me India’s I-bankers are a cautious lot. Foreseeing IPOs that lay goose eggs, they do `soft’ underwriting only – responsible only if bidders fail to pay up on allotment. Smart as they are, they don’t do the `hard’ stuff – the kind that obligates them to make it good to the issuer on the unsubscribed portion of the IPO. So, if the IPO bombs without attracting bids, the I-Banker can go scot-free.

In short, the names don’t mean much. Mr.Habil Khorakiwalla, CEO of Wockhardt must be licking his wounds now – or busy returning subscription cheques to investors (within 15 days).

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"We are not REIT ready, pal"

Last week I met two senior private equity players and a couple of I-Banking friends. The former had just closed a $2 billion Real Estate and Infrastructure Fund and the latter wants deals in the sector. Between them they face one common problem. Everyone and his uncle have boarded the infra bus and deals get closed too fast. My business is to drive deals and I can't be happier. But the fact is, before I could say D.E.A.L, I hear they're done. It's frustrating sometimes.

So the trend now is to co-invest with others. I can see why they cringe at that prospect, playing a side-kick, but there's no choice. Take a slice of existing projects or be ready to follow a REIT model. Hey, hang on. Our regulators are still mulling a legislation. Here are some inadequacies from the draft code –

a) SEBI Act in its current form does not permit REIT to be regulated by it. It needs to be amended;

b) Proposed regulation talks of only close ended schemes, yet call for listing of REIT units in a Stock Exchange. But REIT units do not come under the definition of`securities’ under Section 2(H) of SCRA that regulates listing of securities. Go, amend SCRA now.

c) Unlike MF schemes that deal in securities, REITs deal in real estate directly. They own pieces of real estate and live off its rental and capital gains. SEBI has to think hard over its mastery over this new domain.

I have one more question. Last year Blackstone acquired Equity Office Properties (a REIT controlled by Sam Zell) for $39 billion. A little later the real estate market collapsed in the US and Blackstone started selling off these assets in a hurry to minimize the dent. Now, how much sense will a close ended scheme in the draft regulations envisage in a sector that’s infamous for its vicious cycles? What if the closure date happens to be in a phase when the prices have hit bottom?

Normally we hold RE assets for a very long time. Like family jewels, RE asset in India is legacy stuff that keep rolling down generations. When it’s a long term asset, why not leave those REIT schemes open ended?

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