Thursday, April 03, 2008

Curmudgeons are back in fashion

In his last newsletter to his investors, Warren Buffet had cautioned “Look for wide moats around great economic castles.” Anything that looks too good to be true or an instrument that yields higher than average return is worth doing a double check. He was referring to the phenomenal returns that rode on ridiculously high leverage (33 :1) used by Wall Street bankers that resulted in a global credit crunch as the bubble collapsed.

Now I find the sharp markdown in valuations, the global financial turmoil and the general weak state of the equity markets have put the Indian PE industry on a state of high alert. Here is the full article from Outlook Business.

What comes out clearly from the recent turn of events is that the balance of power between the entrepreneur and the investor has been severely altered. Now term sheets don’t get issued in a week. Due diligence regains flavor. Investors are well entrenched in the driver’s seat for now. It’s time for curmudgeons like me to get back in fashion since we advise clients to dilute stake not because they get better valuations, but for other fundamental reasons like cost of debt far exceeding cost of equity or if the client needs to bankroll long term Cap-Ex. We, as a breed of financial rationalists that rely more on common sense, were clearly out of reckoning then.

I remember a client argued with me hard when I advised him against diluting his stake – when all that he needed was short term working capital assistance (retail expansion) - a couple months back, during those peak times. It was to be structured with a front-end bridge finance assistance (60% of funding sought) that was to be converted into equity on the basis of average of the weekly closing prices during the intervening period. The period was to end yesterday when his valuations have dipped by over 45% - a price at which he would've had to dilute much against his interests. I got a call from him telling me how he feels now –
I owe you a treat, fella' ” he said. I corrected him "You owe me that deal, mate...!"

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