Friday, May 30, 2008

"Ain't got no choice"

“PE firms in no hurry to exit” – reports Economic Times.

“Have they got a choice ?” I ask.

The report goes like this. With the primary market down in the dumps, the M&A route has become the savior of PE firms seeking exits. So far they’ve made 11 M&A exits in 2008 while during January-May 2007 the corresponding number of deals was 25. The number for 2008 also includes a few hypothetical exits – where there had been an IPO by a portfolio company yet the PE firm chose not to exit – in OnMobile Global, Shriram EPC, GSS America and Titagarh Wagons.

I see PE funds making the same mistakes like a retail investor does or worse. The only difference is the retail investor gets into the market at the peak of a bull market, listening to the Dalal Street sandwich/lassi vendor. PE fund managers do it – in much larger scales – despite their networked access, domain expertise and operational agility.

So much for Ivy league MBA, deal closing skills, street smart image and with a brain as shrewd as a sack full of rusty door knobs.


Thursday, May 29, 2008

Bad Karma of congress catches up; It's rollback time

Inflation woes, dull sentiment, Gujjar pressure, Oil price spiral, election reversal in Karnataka – woof…. enough to drive any Government mad. The current congress government is at least clearly lost on ideas. So what? There is always a roll-back option, like hiking the ECB limit for companies.

So now it is $50 million for ECBs against the earlier limit of $20 million, which had been mindlessly imposed last August. For (badly bruised) infrastructure sector companies the limit is up to $ 100 million under the approval route. Will it boost the sector, which requires $500 billion of investments? Hardly. But gives some breather for some projects that are nearing completion. For you, to buy top stocks on the cheap ;)

All in cost ceilings have also been generously revised. So much for levels of despair ;) Over six months LIBOR in respect of ECB for average maturity period between 3 – 5 year borrowings is now up to 200 bps, from 150 bps at present. For borrowings more than five years, the cost has been increased to 350 bps from 250 bps at present.

Other conditions - like the existing $500 million annual limit for companies has been left unchanged. So are the end-use of foreign currency expenditure for import of capital goods and overseas investments, average maturity period, prepayment, refinancing of existing ECB and reporting arrangements.
Call it bad karma catching up with congress...

Tuesday, May 27, 2008

Wanting it all back

When our markets were doing an encore throughout last year, the PE deals soared. Promoters were busy diluting their stakes and there were takers and takers. Now the market has ebbed and the promoters are back with a vengeance – they want it all back.

K.V.Kamath on moderation

K.V.Kamath is not so much known for his wit as much he is for his aggressive growth strategies. But lately I think he seriously tries to humor people.

I was reading this. Here Kamath says "Systematic liquidity is comfortable. We will have to watch carefully before taking any decision to either raise or lower interest rates. Systematic demand is still slack; it does not warrant any tinkering in interest rates."

I often hear bankers saying “lower interest rates and they will come” about credit offtake. Kamath gave that chicken and egg story a spin on its head by saying just the reverse. He is also pinching on the reward points for his top of the line credit card customers (self a victim). Normally ICICI bank is one of the first banks to cut interest rates to grow its loan books. Perhaps he’s not his usual self these days after ICICI bank had to deal with its $100 million MTM provisioning woes on CDNs and CLOs.
I say this "Mr.Kamat, all bad times do pass. This one too will". Hope he continues to be generous with his customers and be his normal self.

Monday, May 26, 2008

Sack all our economists and refund all my taxes

Life isn’t getting any easier for us in India. Try telling me we’re living in one of the fastest growing emerging economies. This blog has been particularly skeptical of the inflation figures (7.82%) put out by our economists, promptly echoed in parliament by Finance Minister. All in a country headed by a veteran economist Dr.Manmhoan Singh. Now The Economist – may not be the last word, but is one journal that carries some shred of credibility amongst its vast reader base spread across the world – stands by me as it says "delays in data collection in India can mean big revisions to inflation... The latest wholesale price rate inflation rate might therefore be pushed up to 9-10 per cent," reports Business Standard.

There is no dearth for basic computing skills in India. India is a net exporter of IT services. Still our data collection methods are so archaic, full of holes and make believe. Could it be intentional to avoid being grilled in parliament by opposition benches? Or worse, do they believe what they say?

Hardly does it bode well in a country where 70% of people’s savings are through state run savings such as Provident Funds, Savings Bank, Term deposits, Post Office MIS yielding 8% returns. And a 10% inflation means they lose 2% of their savings with every passing year. In India, prices are rising much faster partly because food accounts for a bigger chunk of our Consumer Price Index and so the hit is felt way below the belt more by the poor millions. Banning futures trading in several commodities may help cap inflation and public rant. But letting prices rise is a far better way to reward farmers than waiving loans of $16 billion owed by the rich among them to the banks.

The least the government can do is, I repeat, refund all my taxes. Last thing I want is my money going to enrich another loan dodging farmer :-)

Saturday, May 24, 2008

Hoping for a long and sugary walk

Food Prices are soaring. There is a raging debate on bio-fuel v. food production – held responsible for global food shortage.

Philip Bowring in IHT asks why the price of sugar has slumped 20% globally, when those of all other food crops have gone up? He tries to establish a connection between the high price of corn and the low price of sugar. U.S. tariffs, tax breaks and subsidies keep Brazilian ethanol out of America while promoting the production of corn-based ethanol and corn syrups as a sugar substitute. This not only pushes up the global price of corn - the leading exporter of which is the United States - it also drives up the price of wheat, soybeans and other crops as well.

He urges people that ask why world agriculture is in such a mess - and explains why all the talk about "bio-fuel v. food production" misses the point - to start with sugar. Few commodities are more traded around the world. Yet none is subject to quite so many distortions due to subsidies, price controls and special arrangements. With oil prices sky-high and demand for bio-ethanol rising, surely the cost of sugar should also be going up. It is the largest source of bio-ethanol production, accounting for a big chunk of output from the world's largest sugar producer, Brazil. Sugar from cane is not only a cheaper source of bio-ethanol than most alternatives; it also leaves a smaller carbon footprint.

I too am pretty much *kicked* on sugar. My portfolio is heavily laden with sugar stocks (that is disclosure for you!). My reason – any industry stomped down too hard is sure to get back even stronger. Government has been singularly inhospitable towards this industry and that gave me an opportunity to buy into stocks of sugar companies that's been scraping at the bottom for over couple years now. You can find my views in a series of posts in this blog about the shifting fortunes of Indian sugar industry pretty much on the same lines as Bowring, griping at excessive regulation in the sector. Why, I had even suggested a Sheikh Squeeze strategy if Bush or somebody say global food crisis is because Indians eat more.

And when sugar stocks pull back, I’ll be laughing my way to the bank. I hope that will be one pretty long, enjoyable sugar sweet walk!


Friday, May 23, 2008

Just talk the talk

Talk about timing. Sometimes you get it so awfully wrong that you become a butt of a million jokes. This morning I read this article “Power of Leadership Economics” by Ashish Singh, MD of Bain & Company India and Chris Zook, the firm's Global Strategy Practice in the ET.

The article talks about the enormous value associated with positions of leadership. They place some findings in support of the economics of leadership. I quote –

“….The typical industry has more than six competitors. In any sector, the two leading players usually capture over 75% of the profit pool, and the company with the greatest market power usually snares about 70% of total profits.

In contrast, followers with a marginal share of the profit pool act as the shock absorbers of the economic system, exhibiting much larger fluctuations and enduring a bumpier ride during downturns. When we analysed 22 pairs of global leaders and their followers — Nike versus Reebok (now owned by Adidas) or Southwest Airlines versus Delta, for example — we found that the average variance in profit margin was three times as great for followers as for leaders….”

Then I recall Standard & Poor’s ‘‘weakest links’’ report [cited by] forecasting 75 US companies that will default on their debts in the next 12 months. Of the 93 companies at risk, more than half were involved in takeovers by big-name private equity firms, including Boston’s Thomas H. Lee Partners, Bain Capital, and J.W. Childs Associates. These guys led the LBO march and loaded the portfolio companies with so much of debt that did them in. There are 93 US companies at risk of defaulting on $53 billion in debts, marking a 50 percent jump since last June, when the credit crisis started. Many of these debt-laden companies were involved in giant leveraged buyouts by these monsters.

Bain Capital acquired Guitar Center Holdings Inc. last June for $2.1 billion, putting $650 million in debt on the guitar-store chain’s books, according to Dow Jones & Co.’s LBO Wire, an online report. That debt is rated a B-, giving it junk bond status, according to S&P. The loans were made at time when banks were placing minimal financial requirements on companies — which could make defaults less likely.

Now of all times, the top dogs of Bain & Company chose to come out and talk about “leadership economics” …. Who’s next? Citi, Merril Lynch, UBS, Morgan Stanley…? Leadership it is, truly; in driving companies aground.

Thursday, May 22, 2008

How to get LBOs in...?

Remember how we buy homes taking the mortgage route? We spot a good house, negotiate with the seller, lock the deal down by paying some token advance and finance the deal by mortgaging that property. Simple enough? But ever tried buying a company that way? No, you can't in India. After all, companies have a steady cashflow, substantial assets and if sellers are willing, why should regulators say No? Perplexed?

The regulations bar you from mortgaging the assets of the target company to buy it. Their interpretation - the company can’t raise debt pledging assets that it *wants to* buy. Ok, fair enough. It's like seeking to use your credit card to pay its past dues. What if a foreign company floats a specific SPV to do this acquisition? Can that SPV raise debt to buy the assets of this Indian company? The answer is NO again. Here the reason is foreign companies should bring in fresh capital from abroad to pay Indian sellers. I think this rules were drafted at a time when the country badly needed foreign exchange. Today, we are in a surplus situation. Should this law stand? Indian companies are permitted to borrow from domestic banks for purchasing equity in foreign JVs, wholly-owned subsidiaries and other companies as strategic investments. Indian companies also have the option of funding overseas acquisitions through ECBs. Recently they’ve been allowed to invest up to 4 times their networth abroad.

So what are the typical buyout structures that are allowed? Gaurav Taneja of E&Y says -

a) Foreign holding company – raises the debt overseas for acquiring the Indian company. The hurdle is the assets are in India and may not be allowed to be collateralized against the foreign debt. Another area is exchange rate. The loan is in foreign currency but the earnings are in Indian Rupees. Adverse movements in exchange rates can kill.

b) Asset buyout structure – Foreign buyer floats an Indian arm and injects equity and debt, sufficient enough to finance the asset by asset buyout of Indian companies. There could be issues of stamp duty and VAT but the major hurdle here is it works best only in a 100% buyout situation. Not in a partial acquisition of majority controlling stake.

But I suggest it is a far better alternative than using own equity by companies to buy other companies. At a time when costs of borrowing overseas are going up, we must put our vast forex resources to good use by allowing LBOs in India. Imagine some of the world’s best companies operating from Indian soil! I think that would be wonderful. Exxon, Shell, GM, Chysler, Harvard, Stanford – what if these companies/Institutions were subs of Indian companies/Institutions? In fact, their assets are a much more valuable than that of the borrower. A safe bet for the banks to lend.

So, SEBI – you’ve pretty little time left to get your act right. Play it wise. Anyway you are not extremely bothered about Food Stock or inflation. At lease work with the government and be a flexible, understanding and practical regulator.


Wednesday, May 21, 2008

O.P.Bhatt needs to keep his job

Before you could say spunk, SBI blinks.

Yesterday, SBI chief general manager Shyamal Acharya, confirmed that the bank has temporarily discontinued giving loans to farmers for purchase of equipment and said the decision was forced by the high non-performing assets (NPAs) in the segment.

He said NPAs under this head had gone up to 17% of the total outstanding amount of Rs 7,000 crore, and such a high level of NPAs was not sustainable. Loans for tractors, combined harvesters and power tillers constitute a small portion of the loans given by the bank to the farm sector. He said that while loans given against such equipment add up to just Rs 7,000 crore, total lending by SBI to the farm sector is around Rs 43,000 crore. NPAs in the farm loan segment as a whole are just 7%. This is higher than SBI's overall proportion of NPAs - barely 3% on total loans of Rs 4,22,181 crore as on March 31, 2008. However, it is significantly lower than the level on farming equipment loans.

And today, they regret. See how SBI deputy MD & group executive (rural & agri business) Anup Banerji covers the management ass. He says the decision to stop lending was not taken by the board. It was a strategic decision taken by the business unit of the bank. “No communication was given from the ministry to resume lending for tractor loans. There has been no pressure from political parties or the government to roll it back, it was the bank’s decision to do so. Given the reactions the decision evoked, we reviewed it and have decided to continue lending.” When you have a gun held to your temple, that’s how you speak !

SBI chairman O P Bhatt too wants to show obeisance to masters. He too regrets the bank having issued that circular. Poor Mr.Bhatt needs to keep his job until he gets hired by a private equity just as his predecessor A.K.Purwar, currently with Nicholas Piramal Private Equity Fund. Who is he confronting? Even P.Chidambaram couldn’t overrule the whims of Sugar Daddy who is the architect of loan waiver. That’s how he rules Baramati and its voters. By helping his cronies treat bank loans as Daddy’s gift, he let them have those funds for keeps so that he can have recourse to it to fund his and his nephew’s election expense. Now his daughter (Ms. Supriya Sule) too has joined in. No code gets violated and Election Commission cannot raise a finger. Look at Mayawati. Has so much of money to run a mighty sovereign. Ask for source – all *gifts* from Dalit cadres that don’t have money to buy even a decent meal, yet marshal enough resources to shower gifts on their leader to *uplift* the downtrodden –as if they are perched somewhere up.
Why can’t SBI plead a software bug or shortage of forms or heavy load of applicants (because of the heavy rush to borrow since they don’t have to repay) to explain away non-processing of farm loans? They should learn from their PSU oil marketing cousins. With their backs to the wall, Indian Oil and its sister firms started clipping sales of non-branded fuels in Metros and 16 other cities and stopped giving new cooking gas connections.

Oh yeah, I did digress. But I think it’s par for the course. Once in a while I need to let out my steam. I am shocked by the way our PSU banks and Oil Companies are being run. Instead of letting them align with commercial reality, their managements are browbeaten into submission, punishing the public shareholders that unfortunately end up owning the piece of shit. I am angry just as you are. Know why? I am no farmer and hence no loans to skip. Too bad.

That said, “spunk” is hardly the expression associated with PSU bankers. They are all wimps. Meanwhile as a depositor, you may brood at lower interest rates, as a shareholder you could sulk at piffling dividend yields and capital appreciation? Not until the next tide lifts all boats (that has no connection with earnings growth) – just in case if you’ve survived the recent bust and mounting fuel bills!


Tuesday, May 20, 2008

Disparate resources - OBS for I-Banking, Pascal's Law for PE investments

We badly need an OBS type initiative to reform our I-bankers.

No matter to what end effect, I see them going for the same kind of dubious deals, reinforcing the herd syndrome that is ruining the industry. Why clamor for liberalization of ECB norms to borrow more and invest in overowned sectors, only to let your client grieve over inflated liabilities if the currency strengthens? Bulging order book of construction companies is one thing, execution capability is altogether a different world. Do that deal just because everyone else is doing it? They won’t do one thing differently until someone else starts a trend. Nobody wants to start off one.

Another reason why I support a OBS initiative in I-Banking industry is their class thinking, a queer kind of apartheid. A few weeks back I was just having a casual discussion on deal prospects in sugar industry with CEO of a leading brokerage in Mumbai. His first reaction was - “which B-School are you from?” I told him I am not from any and I was in for a more baffling second question – “how do you know so much?”

I would blame the recruiters (and partially the effective B-School PR machine) for having spread false notions that helped build several stereotypes. I believe that good investment bankers need to have enormous common sense, the absence of which explained subprime mortgage crisis in the US. Then comes a basic intelligence to quickly grasp facts relating to a business, the dynamics of the industry and a clear idea regarding the resource requirements of respective managements to take it to the next level. Recruiters still don’t have the tools to assess these skills.

You don’t need an MBA for this. What you need is commitment and a sense of probity. Due diligence is all about commitment to client prosperity and NOT a check list of processes to fill boxes in a valuation questionnaire, as it is widely held. I-Bankers should and can learn a lot in between deals. They must develop a sense of curiosity about industries they don’t know anything about. They must learn to Google and expose themselves to the world outside the cube farm. They can’t say they are busy because we know most work in a deal is for transaction lawyers, whereas these guys compile papers and ensure dispatch to regulators, intermediaries or their client and its shareholders. You can’t blame them because creativity has not been part of B-school curriculum. If they develop a bit of heuristics and get creative, they’ll soon realize the depth of their emptiness. They won’t ask questions like “which B-School are you from” in response to purely common sense laden expressions from a curious but committed observer, making a living by sniffing up deals. They’ll begin to feel a sense of shame, springing from realization of the immensity of their own internal inadequacies - the starting point of self reform.

I hope a few of them read this and oblige. If they do, we’ll see more deals from boring segments like commodities, Gems & Jewellery, Auto Ancillaries and processed foods – all industries where nobody pays attention now, where valuations come cheap and are up for grabs. They say PE funds target 25% returns no matter which way the market goes. Ask how many are getting it? Sorry, let me reframe the question – how many are not losing money? Opportunities in stock market are all about attention span. Agreed it calls for steel nerves. Buy into a sector that is under-owned and neglected by all. Sell when everyone wants a piece of it. The commodities sector is beaten so much down and the managements need just financial resilience to weather the down cycle. Soon when it looks up, it sure is going to be a multi-bagger as explained by Pascal’s law in Physics – a small change in pressure is conveyed to every part of a fluid and its surface to create a major disruption. When it does, it won’t be ripples, it would be massive eruptions. Go cash in on that. Have some time to look at something other than consturction, Capital Goods and Infrastructure (and IPL T20 hogwash), where hype masks huge gaps in execution capabilities.

Where is the Rupee headed?

Does anyone really care?

Currency markets, like their stock market cousin spring surprises when people least expect. Almost all exporters and dollar earners and spenders were caught off guard by the recent depreciation of the Rupee. While dollar earners lose the forward premium, the (oil) importers (dollar spenders) never bothered to cover their exposures. Who ever thought appreciation of the greenback?

The reasons for the sudden reversal were not far to seek.

(1) Recovery of the US dollar;
(2) Increased dollar buying by oil companies to meet rising oil import bill;
(3) Sinking capital inflows, choking the supply of dollars; and
(4) Unwinding of positions that were betting on rupee surge.

So where is Rupee headed? Surging oil import bill and expectations of moderating export growth suggest a worsening current account deficit this fiscal, likely to edge past 2% of GDP. It is said that a $10/bbl increase in crude price jacks up the trade deficit by around $6.5-7.0 billion. Higher global crude oil prices also boost remittances, but the net effect of higher oil prices on the current account deficit is still a large negative.

Back in 2002 when the first draft of Goldman Sachs BRIC report was in print, the rupee was at 49 to the dollar. The BRIC report forecast (and still does) that India would be the third-largest economy in the world by 2050 with an amazing 9% growth per year for fifty years. But something went unnoticed - it was in dollar terms. It also said in the first six years the rupee would be stronger by about 13%, which is exactly where it is today. Call it Goldman’s magic touch or just luck. For after all, the rupee didn’t get from 49 to 42 in a steady linearity. It rode up to almost Rs.38 to the $$ before getting to where it is today. So I think the flip flop will continue.

I pity all $$ borrowers that had raised ECBs and left the proceeds unhedged assuming a forever strong rupee. They should be losing some sleep now. The currency — like the broader economy — is mainly reacting to some near-term headwinds that have brought about a welcome correction in hype over the India story. India certainly has a story; at a very basic level. It could do with better education, healthcare and public infrastructure. The Rupee will find its own level depending upon how RBI is coping with its routine of non-intervention, trying to keep volatility low and creating awareness about risk and currency hedging.

Most importantly the Government has to learn to deal with political shocks – finding the Rs 60,000 crore largesse to farmers, then the Rs 25,000 cr largesse towards the government employees happiness fund. All of it will have an impact on fiscal deficit even if it keeps huge oil subsidy as an off-budget item.

So it is total chaos out there. Don’t fret over a number. Stick around and watch the fun and cash in on an opportunity as and when it shows up.

Monday, May 19, 2008

Vacation (in a) spot

Global funds go ballistic over India’s infrastructure scene. Some statistic –

The no. of PE deals struck in the first four months of 2008 were 156 for a total investment of $4.94 billion. Over the same period in 2007, we had 136 deals and $3.42 billion. However, fund houses are going slow on investments seeking reasonable valuations. In April, 08 the no. of PE deals inked was 32 and aggregating $560 million, down from 35 deals worth $1.21 billion in March. In February, the number of PE deals struck was 27 and amounting to $1.48 billion.

Sign of slackening pace and harder wrangling between investors and fund seekers. Recently a mid-sized I-banking executive told me he’s planning a long vacation, away at idyllic Kovalam beach. He sounded glad because for the last two years, he had no time for anything other than work. Now that mandates have slowed down, he and his tribe are taking a break.

But this morning I read this piece of news. I hope the guy gets to enjoy his full vacation with his family. The way it sounds, he could get summoned soon to make it back home. Balmy beaches and silver sands don’t go anywhere; good times do :-)

Saturday, May 17, 2008

SBI should coach American Banks

What am I to make of this? SBI Chairman O.P.Bhatt had reportedly told Business Standard that the entity may not grow the book aggressively in the present financial year. The card company will work to arrest and bring down defaults, improve asset quality and make all efforts to stop making losses.

I recall my helpless plight at the SBI branch a few years back (where my family has multiple relationships), when a persistent card salesman almost drove me mad. He repeatedly clamored “sir, it’s FREE. All that you need do is just sign up. We need no salary slips, no documentation, nothing. We are issuing it because of you’re a privileged customer having excellent relationship with us for all these years”. My express statement that I already hold lifetime FREE cards from a few other banks made no difference to his sell-I-will attitude. Wanting to put an end to that nag and sparing a benign thought to his desperate pitch, I had obliged.

Not being a great spender, I’d never used the card till date. But now after a couple years, I receive email from SBI saying that my Annual Fees are due. Yes, on the FREE card thrust upon me asking no documentation and just because the bank thought we are good credit risks and it wanted to treat its A-Listers well.

Now I understand why they play dirty. The report quotes Crisil -
the company's delinquencies have shown an increasing trend and as on September 30, 2007, they were at 5.6 per cent on the past dues basis of over 90 days' past dues against 4.4 per cent a year ago. Along with the rise in defaults, the card company has also seen a rise in its costs. SBI Cards' credit costs increased to 20.8 per cent in the half-year ended September 2007 from 8.3 per cent in the year ended March 2007 and 6.2 per cent in 2005-06.
The company suffered a loss of Rs 150 crore in 2007-08. Asked about any plans to put more capital in FY09 to support business, the SBI chief said, "In March 2008, the bank had infused Rs 250 crore into SBI Cards. At present, there are no plans to pump additional capital, unless it makes losses."
So what does the beleaguered card company do? Go fleece the A-Listers and earn their ire too. I think of the big American banks busy writing down billions of $$ because of bad lending practices. Isn’t there a good consulting opportunity for SBI?

Friday, May 16, 2008

"Small world, people !"

Michael Gordon in FT calls the Private Equity bluff

“So now we know. The boom in private equity, which was promoted as the superior business model, based on patient capital, superior management and an alignment of interests, was nothing more than a trick of financial engineering - and a clumsy one at that. The magic of leverage works both ways, as we are discovering…. Private equity as we have come to know it is all about debt - lock, stock and sinking barrel. There may have been better management and better incentive structures in the deals of recent years. But they really contribute nothing to the overall return when compared with the impact of the leverage in the capital structure.”
But before Gordon could call global PE bluff, I’ve called that of the Indian PE masters. Here is my local, factual account. If leveraging had done them in globally, here in India they've been wrecked by smart owners that palmed off sizeable chunks at fabulous valuations. Now they are left to lick their wounds. Small world, huh?

"ICAI, cast the (AS-32) net wide"

Ok. After the goons make away with the loot, the police arrive. Reads like a climax of a celluloid potboiler? In a way, it is. I am referring to the ICAI’s late awakening to the realities of forex derivative exposures (AS-32) by companies. Here are my safety net guidelines I gave almost two months back. (Me pretty fast, you see :-)

Industry chambers oppose it because they say MTM losses are notional (obligations don’t crystallize until the contract matures or is canceled by the party exposed to it) so long as the positions are open and hence cannot account for it accurately. But they miss the point. Disclosure of MTM losses have only the effect of a provision and not that of a definite charge against profit. So even if those losses don’t crystallize (or it ends in a profit if the sentiment reverses) they can be written back and added to the revenue account as prior period profits (just like tax credits). The only downside is for a trader that sells out fearing dent in share prices over the short term. But then that is their risk reward, so no tears to shed.

But I worry another aspect. Exotic swaps that have a multi-currency structure (fixing the $/Re.rate on the basis of prevailing price of Japanese Yen or Swiss Franc) may not find takers in the event of a crisis. For such products, literally there is no market during such downturns. So MTM would mean bringing the value of the contract to absolute zero or having to make 100% provisioning. These structured products are often sold by foreign banks and the swaps are traded in overseas markets. Now my question is, would it be prudent to MTM the exposure on a cut-off date (say 31st March) or right from the date a party enters into a contract on a daily / weekly basis? Would they have to be accounted for in quarterly results as well?

ICAI will have to explain to avoid any factual distortions in financial presentations. By the way, does AS-32 cover these shenanigans too? I think they should.

Thursday, May 15, 2008

Don't mistake infrastructure for glitzy malls

Well I am not surprised at all after reading this. In fact, I’ve already said what I had to. Here and here.

“PE funds and analysts have become far more cautious in evaluating real estate investments in India. One of the analysts said that some of the funds are tightening norms for valuations after the slowdown and at least 30 per cent of the deals are taking a much longer time to go through because of valuation issues.”

All things that go up will have to come down. That is law of gravity. Imagine real estate prices going up without adequate supporting infrastructure. Say, proportionate expansion of road area or power and water supply? Ask Chennai residents. They've proved that humans don’t need natural drinking water to survive. Their life can be threatened only if the bottled water supply stops. One lash of rain and the city is flooded and the next few days are spent clearing the slush and choked drains. Soon many other cities will follow suit.

What is the point in putting up millions of square feet of glitzy malls and complexes if there are no decent roads leading to them? This is the bane of our city dwellers. Bombay was the pioneer that led this brand of mindless development and other cities haven’t learned from its travails. Bangalore, Chennai, Kolkata, Hyderabad, Cochin are all developing fast on the roadsides. But road area available remains just the same. Naturally less people would like to visit such places, much less choose to occupy. Fewer will invest. So how do you expect the prices to keep going up?

Town planners will have to work overtime. May be, one can try out PPP route to salvation. Infrastructure companies should be entrusted with the task of developing large townships and no individual developer should be allowed to develop in fractions. The system of build a block first, then dig the road to lay water and sewer pipes and dig again to lay power/data cable should stop. Major slices of Municipal budgets getting wasted on humungous pensions for past employees should stop. Spend it on better planning and efficient execution. That, if anything, would stabilize property prices - not liquidity, not a booming stock market or a surge in demand fueled by higher disposable income with people, because all this can dry up. What is constant is easier access, navigable road network and a peaceful enjoyment of the premises with enough water to drink and power to run your essential gadgets - in the kitchen, at least.

Monday, May 12, 2008

When it's other people's money....monkey around

My logic hasn’t been out of place entirely. I had this belief that if I have to make it big as a fund manager or in Private Equity, I need to be a good judge of an early investment opportunity. I was too dumb not to take the easier B-school route to PE superstardom. Instead I began using my sparse savings and tried out my luck investing in the stock market to prove myself in an old fashioned way, back in 1995. If I can win with my money, I could do it with others' as well. I needed that validation.

Till date, my least lucrative exit over a one year horizon has been at an ROI of 165%. Now as I told you I started with my sparse savings and I was totally aware of the need to stay liquid to buy into the next opportunity; hence my horizon was restricted to just one year (so that my returns come tax free).

Then come the PE champion investors. I marveled at the ability of these guys that raise huge funds and thought they must be wunderkinder notching up stunning returns. I looked up their profile and thought the degrees from Harvard and Wharton must have magic in them. Everyone had an Ivy League record and some excellent career profile. No wonder they are where they are – right at the top of PE fund houses. Moreover since PE being alternative investment thro negotiated deals, they have access to classified information (`insider information' if I have that) besides some special rights granted by covenants built into term sheets (such as veto, tag along, pay for play, ratchets etc. etc.)

So I thought the game’s up for average folks like me. How do I stack up if the game starts with such a mighty disadvantage? I began to watch their investments in Indian companies (that I relate better) and often wondered why they take exposures in companies at such high valuations. “Silly, they’re from Harvard and Wharton; they are not dumbasses”. “May be, they see value that you don’t - they have access to classified information, you know?” I taunted myself.

But today I read this. The portfolio companies where PE funds invested are all trading at steep discounts to their acquisition price and now the same PE funds are on a Rupee cost averaging spree by mopping up shares from the secondary market to even out the gap. Apax partners bought 11.41% in Appollo Hospitals at Rs.605/- a share. Now they are buying from the market at Rs.505-550 a share hiking their stake to 14.52%. Several others including Standard Chartered PE (in M&M Financial services), Blackstone in Gokaldas partners, Promethean in Nitco Tiles/EIH, New Vernon in Shriram EPC are also hurriedly playing catch up.

Now wait a minute! That’s how I too build my portfolio. How different are these guys? Why are they perched in a higher league? I managed minimum 165% returns over just one year but these guys wait for over 6-7 years to get a CAGR of 25% or even less. I don’t have a Wharton degree alright, but I beat these guys in their own game by many a wide mile. Isn’t that endorsement enough for my stock picking skills? I don’t follow analysts. I just look at managements, their track record, state of health of the business and a few key ratios like ROE, RONW, Debt:Equity and P/BV besides an occasional peep at price/volume charts. By keeping things simple yet systematic, the stocks that I pick end up as sure winners.

Perhaps the awareness that I could go wrong keeps me on the edge. A bit fearful at times that always makes me keep looking over the shoulders even after I invest. The feeling that I am up against informed investors that wield mighty clout never allows me to be smug. Over and above, it’s my own money and I need to be liquid always. These factors have put together a strong foundation for my portfolio architecture. The PE managers can afford to cover their conscience and be reckless. After all, it’s not their money at stake. They do get their management fee whether they win or lose. More than an occasional freebie from stock brokers that manage their portfolio as well. Why should they care? It’s their investors that pay a price.

Now I know why I could be a misfit in a PE environment. No regrets.

Saturday, May 10, 2008

Squeeze the bastards and wreck'em into submission

Finding brokerage houses going cheap now? Not exactly. They are probably hiding more than what they should. The stock prices of Motilal Oswal, Geojit Securities, Indiabulls Financials, Prime Securities all should be actually quoting at just 5% of their existing prices as is being speculated because they are not making adequate provisions for the huge losses they suffered (during the recent Jan 08 market reversal, when stocks declined by over 70%) on their margin lending exposures to their clients.

"It's surprising to know that provisioning and losses announced by brokerage houses do not form even 1 per cent of the entire margin funding business. And, this is at a time when the market has fallen so drastically and the liquidity crisis is still looming large over the system," says investment advisor S P Tulsian.

Their balance sheets show these losses (unpaid dues by clients because of teminals shutting down due to margin pressures) as “loans” instead of “defaults” as they actually are. A loan could be recovered in future. A default is a quantified loss and is a charge against profit. Since reduced profits mean lower EPS, the stock prices could be influenced. Hence their aversion to make full provisions.

But you don’t get caught. Just stay clear of that sector for a while. The lack of demand could pull down stock prices to realistic levels. Squeeze the bastards and wreck them into submission. Remember the period after Harshad Mehta scam when these firms went down the drain? Give them that sense of Déjà vu now that they are asking for it!

[Update : Just four days later, here’s proof. The market’s got them [brokerages] by the balls. Update 2.0 - Edelweiss Group Company ECL Finance with an exposure of Rs.9.14 billion to its clients lent against securities (that quote at deep discounts now) waiting to be recovered. They call it loans, without disclosing how much is margin funding and how much has been defaulted. Yet they make a provision for only 0.5% of the exposure (Rs.45.50 million). Did you say financial prudence or worse, corporate governance? What is ICAI doing? Is SEBI reading this?


Why PEs are benign in India

So as I read the views of lawyers, I-bankers and consulting firms, I am convinced that the PE has dug its roots deeply into Indian soil. More importantly, why they are not the usual monsters they are feared to be elsewhere.

Some astonishing numbers before we go further. PE firms numbering 255 at the last count have pumped in over $25 billion into Indian companies over the last four years, with around $17.5 billion being invested in last 15 months in 487 companies. Their nominees fill the boards of over 1000 companies in India now. So far their growing clout has not been perceived as that of a wild beast (remember the book "barbarians at the gate" on KKR-RJR Nabisco deal?) as they’ve been monikered in the west. Perhaps they’ve just been careful or are saying to themselves “it’s a long road. Let’s not get a flat tire early on”.

But I see a few other reasons why PE firms are benign in India –

a) PE buyouts abroad were characterized by high leveraging (raising huge debts on target company’s assets) in the west; mind boggling debt/equity ratios of 50:1 literally did them in. Then PE firms recoup their own investment soon by way of dividend recaps. That reduces their risk to near zero from the start. This is not possible in India because Indian regulations do not permit a dividend recap so easily; neither do banks allow ludicrous leverage levels of the above kind. That makes take-private type buyouts less attractive.

b) Most companies in India are family managed and would like the family shareholding to pass over to the next gen as heirloom. They don’t let go off their holdings so easily. They are not easily lured by valuations. It’ll take a while for them to get there. It’s because most sellouts have a non-compete clause. The family has such a deep grasp of the domain, the intelligence gathered over the generations are irreplaceable. The PE firms that buy in invariably count on that domain expertise to get to their target returns. The pedigree rules in the end. [Update : here is the proof]

c) Asian values of business conservatism are so different from Western values of risk indulgence. That circumspection explains the relatively slow pace of businesses scaling up in India. The businesses having been seeded in tough regulatory environments, a slight easing up of regulations or easier access to bulk capital is all it takes them to leap into the big league as we are experiencing now. I think of ESSAR group – it was almost done to death in late 90’s when steel industry was down in the dumps (it defaulted on its foreign debt obligations) and when the fortunes of steel industry turned in its favor, it leapt back to glory. Its later foray into telecom paid off pretty handsomely in the recent Vodafone buyout of Hutch-ESSAR ($19b) and now it is a major player in a few other sectors like Shipping, Oil exploration and Heavy Engineering.

d) Political affiliations of business families are known to be deep set. Any new investor would view that as a great plus. Though it could be argued that business should flourish independent of politics, it’s always intertwined everywhere. May be to a lesser degree in the west, but it’s a force to reckon with. Remember the forces that came together against L.N.Mittal in the $43 billion Arcelor-Mittal deal? Their fear - Asian managements do not recognize European sensibilities. But it’s politics all the same if not downright racism.

e) General political / judicial dislike for raiders. I would put it as lack of instances of a raider doing a company and all its stakeholders substantial good. If a few buyouts result in explosive growth in shareholder returns, this perspective may change. But you can’t be a PE fund manager and not exit in a hurry. Chrys Capital realized it painfully. It got out of Bharti Televentures investment with almost 5X plus returns on its $300 million investment six years back. As soon as it got out, the sector fortunes turned and in another couple years, the market cap of the company rose eight fold. Chrys Capital is still licking its wounds. So did ICICI Venture exited Air Deccan in a hurry, at a loss. Soon came Vijay Mallya and Capt.Gopinath the Air Deccan founder got a lucrative exit within an year of ICICI Venture’s hurried exit.

So PE firms, it’s a mixed bag here in India. Tread carefully and you could be in for big gains. Try to be a smart ass, you’re in trouble deep. Know why? Entries are the easiest part in investment game; it's the exits that tell men from the boys.

Thursday, May 08, 2008

Own your Investment Bank

What got started as a hobby, a sort of silent mutiny against mediocre employers that lacked agression and nerve has now grown into a full fledged business model. I am talking about my own Private Equity / Venture Capital advisory business that up until now has been a sole propreitory outfit advising startup / expansionary stage companies on a variety of issues elaborated in the presentation embedded on top. (Just mouse over it and click when thumbnail appears).

My take on the industry can be found here, here and here. If you think like me and have put in over a decade in the industry, you know what I mean. Now that the markets are a lot sober and deals harder to come by because owners think their businesses are undervalued. PE/VC firms are not getting enough deals at the same pace as they raise funds. We need to bridge that gap, fast. It's the time to put well intentioned and innovative deal structures (not removed from the realm of common sense) to work. The excitement and the reward are ours, up for grabs.

That's why I chose this moment to assemble a strong in-house team, catalyze and grow big. I am looking for experienced, entrepreneurially inclined analysts / investment banking professionals (from financial / operating streams) with just one caveat. Be ready to *own* a piece of this enterprise to be based out of Mumbai (initially). With our enlightened vision, unstinted support and excellent connections, I hope it should grow into a mid-sized investment bank within about three years from now.

Do you have what it takes...? Just write in with your resume and investment potential to me at kmonyb [at] gmail [dot] com

Update : Here is more proof of opportunity I am after - big firms saying no to (not so) small mandates. Small players never had it better. What keeps you on hold? Enough of helping your boss get rich. Grow so big and rich, I mean rich enough not to waste your time. Do write in or drop a comment to this post!


Wednesday, May 07, 2008

Squeeze the Sheikh of every last Dirham and....

On Sunday US President George W Bush blamed India for rising global food prices, provoking a backlash from Indian politicians, who retorted that the US policy of promoting corn-based ethanol in motor fuel supplies has had bigger impact on world food prices.

Now I felt like a good laugh. Here is the President of the most powerful nation in the world asking a third world country of 1.1 billion people not to eat. Bad advise. Has the debilitating American economy dented Bush administration’s straight thinking skills? May be India can solve world food problem as he’d like to think; but should it starve itself in the process?

I think of a natural hedge. Oil prices surge above $122 per barrel. India is a net importer of oil and the price rise leads to inflation of over 7%. How about revoking the ban on export of non-basmati rice and exporting the grain at $ 2000 a ton to OPEC nations? Could it not offset oil price rise?

Squeeze the sheikhs of every last Dirham…. And buy their oil with some of it.

Monday, May 05, 2008

Boys cancel capital; Men own treasury stock

Not too sure whether I could stomach this. Share buybacks in India totaled $1.1 billion from nine deals so far this year. True spunk in times of inflation, crude price spiral and liquidity concerns. Boards must be having wholesome breakfasts I guess :)

Besides the recently concluded Madras Cements buyback, the others that have been lined up are of Reliance Energy, Great Offshore, Mastek, Patni Computer, Gujarat Flurochemicals, JB Chemicals, Sasken Communication and Goldiam International.

But I wonder why Indian laws mandate "cancellation" of shares bought back. Is earnings beef-up (because lesser no. of shares now stake a claim to enterprise earnings) the only motive? I think that's a very myopic outlook because you are compromising on long term resources. It betrays a lack of enterprise long term vision. Is there a guarantee that the company could raise capital in future at a lesser cost than the portion that got canceled? What about time taken to raise it? Will opportunities wait till you raise capital? Enterprise is all about sudden opportunities. Capital adequacy helps swift exploitation of an opportunity. The shareholders (both existing and those cashing out) may be enriched in the short term but they are also giving up quite a bit of future capital productivity.

So why can’t companies be allowed to hold at least a part of capital bought back as Treasury stock in their balance sheet?

The significant advantage could be that treasury shares have the potential to restore the distributable profits used when shares are bought back. The distributable profits used to buy back shares are lost when the shares are cancelled. Purchases into treasury still count as a reduction in shareholders' funds but, on the sale of shares out of treasury, the sale price will replenish the distributable reserves up to the amount lost on their acquisition. Any profit made by the company on a sale of treasury shares must be credited to the share premium account. This ability to recreate distributable profits, not available on a share buyback and cancellation, means that it is likely that shares bought back in future will be held in treasury up to the permitted levels.

Just as in the laws of UK, allow it with some restrictions –

- seek shareholder approval

- prevent companies from buying shares into treasury during close periods or when they are in possession of unpublished price-sensitive information, other than in certain limited circumstances;

- express ban for insiders to buy or sell stocks from or into treasury portfolio;

- prescribe ceilings based on net worth

- treasury stocks are denied the right to vote, dividends but are entitled to bonus shares;

Another benefit from treasury holdings is that these shares can be later applied towards employee stock options to reward talent. In the U.K., transfer out of treasury stock towards Employee stock option programs are exempt from stamp duty unlike employee stock option trusts where the company has to bear the trustee fee besides bearing the burden of stamp duty on transfer of shares held by the trust.

SEBI chief C.B.Bhave is known to be a man of action. I suggest he should check out procedures with UK Listing Authority for allowing treasury stock treatments. I hate the expression “cancel”, especially if it is used in relation to capital - not so easily found nowadays :-)