"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...?

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So I mangle the old signature phrase Ron Reagan used while warming upto Soviet Union - "Trust, but verify"..... I go "hire, but sterilize"

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Parsing the crisis

T.T.Rammohan squeals in Business Standard

On risk management and quality of leveraged assets

“The top investment banks have vanished as a class [not] because they were highly leveraged: In financial institutions, leverage or the ratio of debt to total assets, can be misleading as a measure of financial risk. The management of asset risks is equally important. A financial institution can be highly leveraged but if its assets are of high quality or are highly diversified, the institution is not exposed to high risk….

Investment banks may have had a leverage of more than 20:1 but some high-profile banks in Europe today have even higher leverage. What counts is leverage after adjusting for the risks of various assets. The European banks in question would not be allowed to operate if their leverage was not in conformity with regulatory norms. ….The trouble with the investment banks was not so much leverage as poor asset quality and heavy dependence on short-term funds.”

On short selling

“Short-sellers were right on Lehman, so short-selling should not be banned: Yes, short-sellers were right in sensing that Lehman had more problems than it had disclosed. But, in times of crises, it makes sense to ban short-selling because a fall in share prices sets off a vicious spiral that pushes an institution quickly into bankruptcy. A fall in the value of equity causes leverage to rise, which causes the debt rating to fall. This, in turn, prompts demands for higher collateral, which forces distress sale of assets, which erodes equity value. Before you could say ‘Hank Paulson’, the firm is gone. In financial crises, as in times of war, the normal rules of information must stand suspended and this applies to price discovery [enabled] by short-sellers.”

Splendid. Wonder how well K.V.Kamath’s defense goes down with people!

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Killing I-banks is stifling innovation in structured finance

In a watershed moment, Goldman Sachs and Morgan Stanley last night abandoned their status as independent investment banks (and morphed into larger Universal Banks) in a move marking the end of an era on Wall Street. While the change appears to be a technicality, it means that both banks have equal and permanent rights to access emergency funds from the US central bank, the Federal Reserve – their only lifeline to stay alive. They will also be far more tightly regulated.

Well, in a way the Fed has ruled, though in this late hour of credit crisis, enough is enough. Suddenly I hear all Wall Street honchos, analysts and even erstwhile CEOs of these investment banks publicly admitting that it is the way to go. The era of independent investment banks had to end – as it has, now.

I look back a bit. Is it so simple? Isn’t it a bit ironic that the time-tested business models of the independent I-banks have suddenly become unviable? Were they inherently weak or has it been the lack of prudence that did them in? Or is it the lack of oversight and the unfettered, excessive leverage in ratios of 33:1 to blame?

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Specialists are specialists. They will have to stay that way. Can someone bring cardiology, a specialized domain under general practitioners because a few recent heart surgeries performed by cardiologists have failed?

I have a feeling they are prescribing the wrong medicine for the illness. What do they want, United Socialist States of America?

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The USSR brand of socialism failed because it was founded on anarchist theory – everybody’s property became nobody’s responsibility. Amercian free market economy is based on greed that is just human instinct like lust, envy or anger. They implore one to beat competition and excel. They are creative spurs, not unsystematic or anarchist self-serving socialist wet blankets.

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Get local. A Tata Steel ranked 65th in the global steel industry could acquire a Corus (ranked 5th) because of the liquidity provided by those enabling models. Now it’s going to be a slog all the way for the ambitious. This is like turning off the tap on growth when all that was needed was enforcing stricter compliance by a bunch of alert regulators. There is a strong case for these I-Banks to remain independent for the global economic engine to keep purring. The leverage that provided liquidity to help the poor afford homes is not entirely a bad idea. The level of social benefits that it entailed is not to be easily forgotten. The fault lay in promotion of fallacies like the house prices will always rise. Blame it on running poor credit checks on borrowers and allowing reckless leverage models. At best, are they not simple process lacunae? More importantly, haven't they been emitting strong enough signals for the Fed and SEC to reign them in, which they chose not to? Isn't it something that can happen even now, under Universal Banking? You agree?

I-banking as a division of another commercial bank will sure lose focus, its innovative drive and finesse. It can never be as nimble if it is burdened with the yoke of reserve requirements and Credit-Deposit ratios. It will lead to sub-optimal performance and deals won't get done in the same pace, at least. It will certainly fail to attract the best brains that can thrive only in a liberal, innovative ecosystem that spurs creativity and ingenuity. Can we make do with Levi Strauss type archaic regimes devoid of dynamic innovative spirit? Can we honestly say we never need structured finance innovations (imagine the convenience of a `sale and lease back’ and other factoring mechanisms) with changing times and dynamic business needs? That would be pure tactlessness wearing the masks of precautionary excesses. Just not up.

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Issuers should take Merchant Bankers to task

Talk of clumsy merchant banker allowing semantic distortions and when hauled up by SEBI, refuses to yield. Outcome? Botched business plans of issuers!

SVPCL, a Hyderabad based manufacturer of computer stationery floated its IPO in October last year, and raised Rs 34.5 crore. Though the issue was fully subscribed, BSE denied permission for the shares to be listed on the exchange because of an apparent misstatement in DRHP. This was because UTI Securities, the lead merchant banker responsible for post-issue compliances, had expressed its inability to give an undertaking as required by BSE under Section 73 of the Companies Act, 1956.

The IPO, which got subscribed little over one time, was stalled after BSE refused listing permission as the company had inadvertently mentioned on the cover page of its red-herring prospectus that at least 50% of the net issue to the public shall be allocated on proportionate basis to QIB. The legally appropriate term to be used was ‘up to’, and not ‘at least’.

Why not the merchant banker be hauled up for errant drafting that they do? Should they not make it up to the issuers? Who is responsible for semantic distortions creeping into DRHP?

What else the issuer pays fee to the merchant bankers for? If they were to draft it, why would they hire a merchant banker? The CFO and Company Secretary can sit together with lawyers and bring about even an IPO, except that SEBI mandates appointment of Merchant Bankers. Now that it has lost the case against the exchange, SVPCL must file proceedings against UTI securities for refund of fees and for damages...

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Something is gotta' give

As I sat listening to that lilting Phil Collins number – "One more night...."



"Please give me one more night, give me one more night
One more night cos I can't wait forever
Give me just one more night, oh just one more night
Oh one more night cos I can't wait forever...."

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Something rhymed deep inside... A chime....?

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Yeah, got it! My friends working in I-banks have just one prayer these days - God, give us just one more bubble - like that famous Phil Collins song... First, some M&A deal stats –

No. of transactions - 663 in the H1-07 to 467 in H1-08, with a sharp slump in deal value dipping by over 40% from US$38.4 billion in H1-07 to US$21.4 billion in H1-08. The active sectors include Pharmaceuticals, IT&ITeS, Banking & Financial Services (BFSI) and Real Estate. The outbound investments accounted for US$ 8.2 billion of M&A activity spread over 96 deals.

Financing overseas acquisitions has been tougher owing to the global market conditions and high interest rates. The global crisis sprang from expanding credit squeeze, high oil prices and rising inflation and now they cause slowdown in M&A activity in H1-08.

Even the macro numbers aren’t giving room for hope. The Prime Minister’s Economic Advisory Council (EAC) has revised the growth rate down to 7.7% for 2008-09 from its earlier estimates of 8.5% (and last 4 year average of 8.9%). Rubbing salt in the wound, It also expects inflation to scale 13% soon. Takeaways –

Trade deficit is likely to widen to 10.4% of GDP in 2008-09 compared to 7.7% in 2007-08. Merchandise imports would grow to $332 billion, Exports would grow to $205 billion, leaving a deficit of $127 billion. Export growth could be $22.5% while import growth would be higher, thanks to high crude prices.

High oil import bill and a decline in capital flows are pushing current account deficit to an all-time high of 3.2% of GDP during 2008-09. The estimated deficit for the year is $41.5 billion. In Q1/Q2 of 2008-09, deficit could be over 4.5% of GDP. The estimated 3.2% current account deficit for 2008-09 is more than double the deficit of 1.5% in 2007-08. The only year when it crossed 3% was 1990-91 — when it touched 3.1%, as we were facing a major foreign exchange reserve crisis. The silver lining now is that forex reserves stand at over $300 billion — far above the comfort level.

Capital flows would decline to $71 billion in 2008-09, far lower than the previous year’s $108 billion. Despite the decline, the net addition to forex reserves would be $30 billion.

Now to fiscal mismanagement. The government comes down heavily on private sector for not being transparent about its currency losses. But when it comes to its own affairs, it sweeps a lot under the carpet – think off budget Oil / Fertilizer subsidy funded by bonds that pose serious risks to the extent they are unfunded in the budget. But then you can’t speak much about that.

Just hope something is gotta’ give! Another bubble...? I don't mind... ;)
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Disparate resources - OBS for I-Banking, Pascal's Law for PE investments

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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.

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India M&A deal book

Orit Gadiesh, Chairman of Bain & Co., co-authors a piece in today’s ET after taking a look at Indian M&A deal book. He looks at it from three perspectives.

Deal size & volume - From Jan-Oct 2007, Indian companies closed outbound deals totaling $34 billion, exceeded China ($13 b) and Russia ($15b) combined. During 2003-07, the annual deal sizes grew at a CAGR of 108%.

Success rate – Too early to tell. But one-third seems to be a fair guess keeping in line with US and Europe.

Domestic M&A – Inbound deals by companies in India was only 8% of outbound deals, or $2.6 billion in the first ten months of 2007. Why so? a) lack of access to leveraged financing b) Firms are mostly family managed and are reluctant to sell.

Sounds good… But don’t make these mistakes.

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New chic in town

TATA group is into everything. Well, almost.

You name it, they have it - Automotives, IT, Steel, Hospitality, Retail, Tea, Coffee, Insurance, Investments and a lot other. I sometimes wonder how long can they miss out on the lucrative business of Investment Banking. The business is strong that even one time boutiques like Avendus and MAPE Group have grown big in a very short time. Take a look at the incessant flow of M&A deal traffic (TATA must have paid quite a bit themselves recently) and you can see it. An old war horse like the TATA group cannot stay away from commercial sweet spots for long.

I am not too sure whether I vibed with him, but Ratan Tata probably had an epiphany on similar lines. They are getting into it now. Here’s the story for you – TATA CAPITAL is hatching.

All you CEOs of I-Banks, your people now have one more place to go....A very good one at that. So just get liberal with employee bonuses and keep them happy. Not exactly the time to worry about margins !

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What price relationship ?

Ever since I had turned a freelancer 15 months back, I’ve been approached by partners from several Investment Banks each with different intentions. Some wanted to hire me, others wanted business to be channeled their way. It did not surprise me since most of them had read my blogs and had found something common, interesting and worthy of mutual exploration. I had always been open so long as it excited me, be it a position on offer or a strategic partnership on fair terms.

But one thing common in all these tete-a-tete has been the question on *relationships*. They invariably ask “what relationships you have or can bring to us ?”. It made a lot of sense since in I-Banking industry, ready relationships meant not having to waste time on introductions or cold calling investors or PE / VC fund managers, when you have a worthy client. Eventually we rattle out our acquaintances and the conversation goes on.

Some of them act up. They come up with some nondescript client having some hollow business plan with little fundamental strength and ask whether we can get them some investors. Without sounding judgmental, I ask for more information, a web site to search in and anything like an executive summary or some information memorandum or at least a business plan, on the basis of which I can form my thoughts. Some will have that ready, others will say they’ll send it across (mostly don’t come back).

There’s a third group which is more adventurous. They say, “we are putting together that information, but we need your help here”. Probe a little deeper what *help* they need, it would be something like a company in a deep mess, founder having a history of siphoning off funds, out to leverage the buoyant sentiment in the stock market by merely changing the name of the company and its objects clause. Anything goes here, a financial services company could be renamed into a clean energy company or a textile mill resurrected as an Infotech venture. Surprisingly they quote examples of many that have gotten away and they’d be right since I knew of some myself.

The relationship they seek is for palming off such deals. I had often wondered - how can these people be so naïve that just because you have a prior relationship with a PE fund, they’ll be ready to invest in a doubtful venture ? Every PE fund does a scrupulous due diligence on each deal that comes before it that it wants to invest in. I am yet to come across a PE firm that would invest in a business just because it was brought along by a reputed investment bank. All of them have their own internal well laid investment processes and every deal will have to go thro that filter. When that being the case, relationships don’t get you investments – it’s the fundamental strength of a business and how well it resonates with the PE firm’s objectives, in the way it stacks up as a sound investment destination.

If I were to look for a potential candidate or partner, I would look for independent research capabilities, ability to draw insights, the instant relationship building ability and sound knowledge of the PE industry in India, which firm likes what industry, domain expertise, latest rounds of funds raised etc. Asking for ready made relationships can only be of use if you have a superb client needing no introduction. For the rest, you need people who can look straight in the eye of the managements and tell them to get their things organized before seeking investor participation.

Wouldn’t you agree ?