Saturday, November 29, 2008

PE funds need to talk straight

Private Equity can do with some straight talking.

“One of [PE’s] defining characteristics is never, ever, to admit to a mistake in public. By convention, most buy-out bosses maintain that they anticipated a recession and acted cautiously. In reality, the buy-out industry had its biggest-ever binge just before the bust began. Most big firms paid silly prices for companies using sillier levels of debt.”

I have solid data on PE investments in Indian companies at obscene valuations. Some of them were mandates that I had turned down because the asking price was too high. But there were ambitious investment bankers / fee hungry brokers that went ahead and goaded their PE clients to invest in. Result - every company in PE portfolio has its valuations deep underwater. Recognizing their liberty to keep it locked down for several years, the PE fund managers get away without marking their investments to market. But the pension funds and other investors in the Funds, have regulatory mandates advising them to mark down their investments and disclose the level of erosion.

Now I have mandates from three funds that badly need to reshuffle their portfolio. Tell you what? There are no takers even at this down to earth valuations, not even the owners and majority shareholders!


Tuesday, November 25, 2008

NTMA - asking for bankruptcy

India’s bond market is nowhere near the maturity level of its equity markets. Reasons are not so hard to seek since equity offers ownership while debt carries an obligation to repay. When a debt paper is issued and if it is held till maturity, the obligation to repay rests with the issuer. But if it is allowed to be traded, the issuer gets back in the picture only if the instrument allows recourse. Naturally, when it comes to soverign (or Public Debt raised by Government) debt, our policy makers played safe and entrusted RBI to be the custodian, issuer, manager and Regulator of its financial needs. It suited just fine.

Earlier in the 2007-08 Budget, the monetary and debt management aspects of RBI is sought to be separated. On Friday, the government released a draft Bill to create a statutory corporate body called the National Treasury Management Agency (NTMA) to carry out debt management, cash management and management of contingent and other liabilities of the Centre and states – in the process stripping RBI of this responsibility. Former Finance Secretary S.Narayanan blows the whistle in his Livemint column.

Primarily Mr.Narayanan’s concerns are –

(a) Moral hazard – Minus the regulatory oversight by RBI, that it has ably executed for the last 60 years, NTMA functioning under the budget division of the ministry could become a carte blanche for Finance Ministers to raise funds at will. The propensity for excessive borrowings by the Governments are well documented in the past. Our budget deficits are a direct result of that profligacy.

(b) Mortgage of sovereignty - The draft Bill envisages that government bonds will be available for sale in India and abroad. It means that for the first time since independence, we will be offering sovereign bonds to overseas investors. Earlier, finance ministers and governments have shied away from this, for committing a sovereign to a debt that can be called outside the country has been a very sensitive and emotional issue. It has been a principle so far that the sovereign, the state, would not issue debt overseas.

(c) Fiscal discipline – It will in effect, empower immature policy makers to design debt instruments that they hardly understand. The recent mortgage crisis in the US that is still playing out, breaking banks after banks in the process, stands ample testimony to all likely outcomes.

As the citizen of this country, we’re already exposed to the recursive cycles of inflation and deflation. As a nation of savers, we are already parking most of our savings with the Governments (Post Office savings, PF, PPF, NSS, NSC, RBI bonds, Sr.Citizen bonds etc.) A tradeable bond market will only enable some dubious corporates to stick their trash debt paper to some unsuspecting and gullible public. We know the allegiances of Finance Minister Chidambaram, Petroleum Minister Murli Deora, Telecom Minister A.Raja et al. Now we don’t want self-imposed bankruptcy added to that. Do we?

Not just because Mobius said so

Mark Mobius is an omen. I remember him saying the market is overheated back in 2000 that marked the beginning of market collapse. Now he says India looks attractive and he is serious. He is somebody if he is heading $24 billion in AUM of Templeton. His words carry the weight.

So sleeping tigers, pick up your loose change (if that's all what is left :-) and go for broke. Anyway when you’re down by 60%, you ain't got much choice, have you?
Not just because Mobius said so...

Monday, November 24, 2008

Turnaround strategy for airlines - "shut down"

Vijay Mallya is flamboyant even in the face of absolute ruin. Here he says "This long-awaited initiative will stabilise the aviation industry and provide much needed financial stability to airlines. In response to the initiative from the government, Kingfisher will immediately reduce air fare across the board as soon as the declared goods classification is approved."

But has he got a choice? He knows he is in deep trouble after having lost 60% of his passengers ever since he cannibalized Air Deccan (the LCC) and hiked the fares. The whole of aviation industry is bleeding as former air travelers flock to not so badly run Indian railways. I used to fly Bombay-Delhi often earlier but after my recent journey by Rajdhani Express (overnight, complete with A/C sleeper, dinner, breakfast, beverages and water), I am a card carrying member of the Rajdhani user club. Soon I’ll be a fan of Indian railways.

I save a lot too in time and money. The airport is an hour’s drive from home, will have to check in at least an hour before and then at the destination, I’ve to pay for the cab for another hour’s drive. The total cost of one way travel between Bombay – Delhi will be about Rs.8500/-. By train, it costs me just one-fourth of that. Given that there is a recession around and the stock markets are scraping at the bottom, the savings don’t hurt at all!

As I see it, there’s one sure way how airlines can get back into black – “shut down”!

Thursday, November 20, 2008

"Never even try"

Dr.Jaimini Bhagwati calls for public sector (government controlled) Credit Rating Agencies (CRA) to deliver objective evaluation of security instruments in the interest of investors.

His concern is genuine since there is just the three globally recognized CRA – S&P, Moody’s and Fitch that run the show. (In India we have CRISIL, ICRA and CARE and that’s it.) He explains how the flawed rating processes of S&P helped rate sovereign rating of GOI bonds lower than that of ICICI bank at one time, an year or so ago. His case – CRAs are paid by issuers and hence there are limitations to the level of objectivity an investor can expect out of them. Need of the hour, therefore is establishment of an Indian public sector CRA to increase competition and provide benchmark standards.

I take off from there. Then what happens? Like PSU oil companies, populist interest will upend commercial imperatives. Our politicians will call the shots. Will RIL bonds get a bad rating if Murli Deora is the Minister in charge? Look how he made GOI intervene in the ongoing dispute between RIL and RNRL in the matter of KG gas distribution. Now imagine Amar Singh at helm – ADAG group companies could be awarded ratings equal or better than sovereign ratings of GOI bonds. Reliance Capital will run M/o Finance, SEBI and Company Affairs. Every shift in incumbency will influenze the rating outlook. Are investor interests protected or are they imperiled as the saga of ambivalence plays out?

Today CRAs have authority but no responsibility. I suggest a participative method – make them what I call `backstop underwriters’ by entrusting a portion of underwriting obligations to CRAs, making them own up to their ratings. This is how it works. If the rating awarded is downgraded within say, a year of issuance or if the issuer defaults in its commitment to the retail investors within that period, then CRA will have to step in and bailout the investor. Investors will be glad to pay a small nominal premium for that reassurance. That way, CRAs can augment their income (fee for backstop underwriting besides rating fee) and ensure the objectivity of their processes as well. Investors get a toe in the door and Issuers save on the retail portion underwriting fee as well. Win win?

Bringing a politician have only complicated issues everywhere. Look what’s happening in appointments of PSU / Nationalised Bank Chairmen, Central and State Police Administration and frequent transfers among Income-Tax bigwigs. Think of Shibu Soren at the helm and imagine what would Anil Agarwal of Sterlite get away with? I go “Never even try”.


"Vaccum before you dream again"

“The stock and commodity markets seem to go just one way and that’s down. Hundreds of millions of market cap eroded, value destroyed. The recession is here to stay and no policy measures, interest rate cuts, liquidity infusion seem to work. OMG, it’s pushing us back to where we started out – point zero.

Not that I am scared. But it’s a daunting task to claw your way back from such depths. I’d managed it with little resource and a lot of will. But I was a lot younger then. Now after a couple decades, if I’ve to repeat that trek, I might have to reinvent. Then I was alone; now I’ve got a family too!”

This was the kinda’ talk that did rounds when a bunch of us old pals met recently. There were software pros, engineers, finance pros and even one professor of economics in the gang. This concern about the future and the hard times that we’re forced to go thro was the common thread.

They say if we are facing in the right direction, all we have to do is keep on walking. But who knows? Suddenly we feel like a bundle of beginnings. In front of us lay a stone with a hole in it. Who could’ve bothered to drill it? Nature. The drops of rain make a hole in the stone not by violence but by oft falling. That meant something. It really did. You can't go through life quitting everything. If you're going to achieve anything, you've got to stick with something. Consider the postage stamp: its usefulness consists in the ability to stick to one thing till it gets there. The race of life is not always to the swift, but to the one that keeps running. Fall seven times, up eighth.

Coming to think of it, this recession is like a mountain. Nobody trips over mountains. It is the small pebble that causes you to stumble. Pass all the pebbles in your path and you will find you have crossed the mountain. So why despair? It's often the last key in the bunch that opens the lock. You may not be there yet, but you're closer than you were yesterday.

And what if your dreams turn to dust? Simple. Just vacuum before you dream again ;-)

Thursday, November 13, 2008

The serial bailout ?

Following Wall Street rescue, the opportunistic bug seems to have bitten battered Indian businesses. Politicians, the chief patrons of Indian business turn willing side kicks. Recently Praful Patel wanted Airlines to be bailed out until Chidambaram refused to play ball. He just stopped short of restricting it to friend Vijay Mallya (Kingfisher Airlines) and by extension Naresh Goel (Jet Airways) to limit tax payer burden. Air India, the government run airline never mattered to him as much even as it was notching up losses for several years now and making do with ageing airplanes. It suited his friends better to let the country’s premier Airline to bleed. But it just worked out the other way round – the private airlines began to bleed.

So what to do now? Ha, we take a leaf off Wall Street rescue staged by Hank Paulson, ex Goldman Sachs dealmaker. Bail the airlines out too.

Last week, the stock of Las Vegas Sands Corporation collapsed. Bankruptcy seems a real possibility. Indeed, the whole casino gambling industry in Nevada is facing the worst crisis in at least a generation, maybe ever. Casino gambling directly employs more people than the domestic automobile industry. Add in the supply chain for both industries, and casinos still employ almost half as many people as the automobile sector.

So what about a bailout for the casino industry? Ridiculous! Right? What next? Bailout Matka, then drug dealers, Mafia…? [Dr.Vijay Mallya is a liquour baron!]

Monday, November 10, 2008

Mr.Bernard Shaw has been perceptive

"If history repeats itself, and the unexpected always happens, how incapable must Man be of learning from experience" – George Bernard Shaw

So I read Sandeep Singhal, MD, Nexus India Capital ( PE fund) and Pankaj Dhandaria, Director, Transaction Advisory of E&Y, reaffirming India as an attractive Investment destination for PE funds as it has robust financial, legal and regulatory framework, mature markets and although moderated, still being reckoned as a growth economy. The long-term perspects of funds, with 7-10 year lock-ins, is aligned with India’s medium- to long-term growth potential. So isn't it time for all the old rhetoric to make a comeback? You bet -on india’s long term prospects, an aspirational young population, the entrepreneurial spirit, resilience, perseverance and innovativeness of Indian promoters that promises great returns to patient PE investors or so it begins to go.

So I ask, why did they run away…? Have something changed in between…?

Pankaj argues Indian infrastructure and Industrials offer great opportunity since there are several projects now reasonably valued, yet to achieve financial closure. They all need capital.

So it’s been always… They found it so and that’s why they came here… What made them dump it all and run…?
According to Bain & Co, a consultancy, private equity funds invested a total of $1.4bn in 2006, and $3.6bn last year. However, in the year to date aggregate, Pipe investments have totalled $1.4bn.
They had better recognize the problem is with the PE investor mindset. Especially the foreign ones. They chased projects madly when valuations were ridiculously high, deals I thought should never happen, happened. But they haggle for downside protection and guaranteed returns now when demand has slumped and a recession looms. I hear them say as FT quotes it “Private equity firms will no longer invest in straight public equity. If we do these investments, we want some kind of structured protection.” Here’s another from Sri Rajan, Head - PE practice, Bain & Co, India: “Given the current investment climate, the existing Pipe model has lost favor among private equity funds operating in India. Understandably, firms are now looking to invest in ways that offer them downside protection.”
O.k, some late wisdom that. It dawns only when PE investments go deep under water (Blackstone’s $165 M in Gokaldas Exports now down by 51%, it's $150 M exposure in Nagarjuna Construction is down by 69%). So is PIPE investments made by Warburg Pincus, Apax Partners and General Atlantic. Recently one of my clients in infrastructure space sought a valuation of 15x multiple (it used to be valued at 35x earlier which it felt was too low), the PE fund didn’t budge. They insisted the project be valued at 5x. But when market had been at its peak and PE multiples of 50x were offered for companies yet to find as much as a name, they hardly batted an eyelid and emptied their coffers.
So it’s a strange kind of logic, PE investors follow. [Mr. Bernard Shaw has been perceptive, ain’t he?]. Blame it on their B-Schools and chill out...

Saturday, November 08, 2008

"Hire, but sterilize"

Ok. So the global financial meltdown offers a very good opportunity for Indian Investment Banks and Brokerages to poach back talent from global peers.

As the hirers seem to reason, the investment bankers with global experience could win some bulk institutional clients for their masters and will be adept at selling exotic derivative instruments etc. as they have a better understanding of such products.

But hey, wait a minute… Is it not the same tribe that brought their clients (and Masters) down by inventing toxic `Yen Carry’, `MBS’, `CDO’ and `CLO’s that finally did them in? Who will want a re-run...?
So I mangle the old signature phrase Ron Reagan used while warming upto Soviet Union - "Trust, but verify"..... I go "hire, but sterilize"

Wednesday, November 05, 2008

Welcome the SME exchange

I can’t wait for the SME exchange to arrive. I have at least 20 mandates from SMEs that form majority of my client list to raise capital in the region of Rs.5 crores - Rs.50 crores. During the crunch times like this, Banks are too cagey and they just act up. Local financiers are hawkish and money doesn’t flow exactly at remunerative costs.

SME exchanges can bridge the gap since it could bring together savvy public looking for portfolio diversification. SEBI has rightly set the minimum lot for investment at Rs.1 lakh so that investors with requisite savvy and having the optimal risk appetite only participates. I welcome it for yet another reason – it would give significantly higher visibility to future large cap contenders as could be multi-baggers as well in the short to medium term…

Who is calling the money shots?

Who is India’s monetary authority? Is it RBI or Ministry of Finance? Traditionally RBI it is but of late the center of gravity is shifting more towards North Block. The pattern is too obvious not to be noticed—the real decision-makers are now in the central secretariat in New Delhi. Ideological divide, perhaps? RBI remains the statutory authority, but it is an open secret that the man in charge is P Chidambaram. A peskily independent RBI governor has retired, and a strong-willed finance minister has made sure that he will not be faced with another situation where his views are either ignored or not acted upon.

First, a new governor of Reserve Bank of India was appointed and, in a symbolic departure from past practice, the new incumbent went across directly from the finance ministry. Then, a new ‘liquidity committee’ was set up, chaired by the finance secretary. Now, a new economic advisor with a strong background in finance has been appointed in the Prime Minister’s office. A day later, the finance minister calls the heads of the state-owned banks with the intention announced in advance that he wants bank lending rates to drop. On cue, immediately after the meeting, one bank chief after the other announces interest rate cuts.

Critics of Dr.G.V.Reddy (Raghuram Rajan and Percy S Mistry) often argued the western orthodoxy that RBI should focus on a single objective of achieving a target rate of inflation. They usually oppose central bank interventions in the currency market, want quicker movement towards capital account convertibility, greater integration with global financial markets and the introduction of sophisticated financial instruments. But traditionalists supported Dr.Reddy with the counter-view that the financial crisis that has gripped the western world is not an advertisement for financial integration, that India can do without the periodic financial crisis that has consumed other developing countries with open capital accounts.
I like a hybrid. Coming from a business family and community, one can understand why Chidambaram is hawkish on stock markets (except in matters of FDI ceilings where he surprisingly shoots down CCEA and DIPP moves seeking to allow FII to breach them). While RBI should indeed be the strategic authority, constructive suggestions from Ministry of Finance and other regulatory authorities can be heeded if not obliged. Controlling inflation is indeed the primary responsibility of RBI, but inflation is not the outcome of monetary logistics – it is rooted in market demand and supply imperatives. RBI can at best control money supply, hike or cut CRR, SLR or Repo rates but it can’t stop you from paying a higher price or ask you not to buy stuff. It could not even bring down the inter-bank call rates that hover around 11-12% as opposed to the normal 2-3%, despite the recent rate cuts. That can only be possible if the economy has multiple sources for fund flows. It can infuse or squeeze out liquidity to an extent, but it can never replace a generous flow of funds coming from a buoyant global sentiment. Over-indulgence by either would lead to catastrophic outcomes.


Welcome to mezzanine... but will it work...?

Hard times call for novel solutions. Real estate sector took it in the chin and is deep in trouble. Bankers don’t lend, properties don’t sell, investors shun the asset class and even Private Equity that once was its messiah wouldn’t take to it kindly.

In comes Mezzanine financing. It is a debt-like instrument consisting of cash income and an equity-linked component, sandwiched between debt and equity on a company’s balance sheet. Here usually a strategic investor (say a PE firm) funds a company through debt and equity. The net cost of investments is 20-25%. Of this, 15-20% is paid as interest on debt and the remaining 5-10% is offered to the private equity investor as warrants at zero cost.

Now my question. The real estate sector lost its sheen when land prices rose to obscene levels and construction inputs like steel, cement, equipment and consumables became unremunerative. The final product, a house or commercial unit could not be sold at a reasonable cost. When liquidity dried up, the highly capital intensive real estate sector lost its only lifeline for working capital – Bank / PE funding. That was the death knell.

So how is mezzanine structure going to solve the problem of absent cash flows? When you expect the payback in the form of part interest and part stake, cash flows matter all the more. How will the borrower meet the interest obligations? Equity may come cheap, but if the sector takes longer to recover and people continue to give priority to survival than property acquisition, how do they expect valuations to improve? Even if valuations improve, with equity markets in a downward trend, how long will they stay put with value erosion and no interest income?

Clearly more than a missing link here. May be the structure envisages high margin collateral to cushion the downside. But most real estate companies are already highly leveraged, no cushion will offer complete comfort ;-)

Saturday, November 01, 2008

No more band-aid; Need bold fixes

Just got back after a vacation to Mussoorie hills for over a week. Had a great time driving around the hills and eating choicest Punjabi, Tibetan, Chinese and South Indian food. It had been more of a `getaway’ - unless someone truly wanted to witness the market mayhem.

Now back to work. The first thing that strikes me in the morning is the now almost daily paean from Mint Street. They have done it several times in the recent past. Tell me – does it really matter?

If RBI is serious about liquidity reinfusion, it should by now have realized that the cuts of 50 basis points or 100 bps are loose change in these times of massive financial drought. Cash flows of businesses are fast drying up; the ones that have cash to spend are fearful of counter party risk. No one is trusting the other. There is no real economic exchange.

So I have a one line agenda for this crucial Monday meet, if it is meant to be that – facilitate Economic Exchange. Let's call it EE.

If the meet were ever to yield a positive outcome, it has to be by way of drastic measures. I for one think post cut repo rate at 7.5% is still a bomb. It has to be around 5% levels so that banks that borrow can make some meaningful credit forward. Why do I say this? I am glad my bank deposits earn me 11% if I park it in my mother’s (a senior citizen) name, but I am equally wary that the bank has fewer avenues to deploy that high cost money. How many takers will lift credit at rates higher than 14% (assuming that bank will have an administrative cost of 2% leaving it a margin of just 1%)? If ever they do, what business will earn still higher return so that they are able to pay it back to the bank? So I worry about the sustainability of that higher return that I get before moving on to worry about the probability of retrieving my capital.

So this is what I suggest to D.Subbarao, RBI guv. He shouldn’t just stop at cutting rates, he should inspire the banks to lower their lending rates and deliver EE. Money flow has to resume. Liquidity is the current that can drive the economy forward. We’ve all experienced it during the bull years April 2003 – Sept 2007 and we know the difference now. I would even go FM and SEBI should be infected by RBI’s bold moves. It should leave the doors open for every serious investor to walk in with his money and do business on our markets. That's EE for you. Short term measures and band-aid type fits and starts don’t mean much in these hellish times.
How about tax exemptions for equity investments for the next two years? Cut Dividend distribution tax? Lower income tax rates leaving more money in the hands of the investors? Think on these lines and surprise us on Tuesday morning bozzos... and see the markets giving a thumps up to that ;-)