Press "Sell"

So, the stock market has shrugged off its sloth, at least for the time being. The election results that brought back a seemingly stable Congress government clearly turbo charged the markets. That woke up many a sleeping investor and money no longer waits on the sidelines. That bodes well for valuations and for most companies it is clearly up by 50% from October 2008 lows.

They say banks are now all the more willing to lend to enterprises. Rising valuations will recharge the primary markets for sure going by the steady stream for DRHP filings with SEBI.

If that indicates improvement in liquidity (even to Real Estate companies that are now busy taking the QIP routes), I am sure I-Bankers will be on their toes to do M&A deals. But that’s exactly where I come from. When valuations are rising, it’s time that a few Indian companies should be selling out, not acquiring. Imagine if Tata Steel sold out to Corus, Hindalco to Novelis and Tata Motors divesting instead of acquiring JLR during the previous bubble ? They could’ve even reacquired these companies now when valuations of those companies have plummeted and Indian markets see a surge in liquidity. May be this is wisdom in hindsight, but they also say history repeats itself.

So it’s a word of caution from yours truly. More because I am selling my large cap holdings and swapping them for good mid / small caps that return 30% in as much as a week. It’s not a sound parallel I know, but then who can stop a blogger from speaking his mind ?

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Should they junk SATYAM management?

The (A)SATYAM saga is getting messier by the day.

The issue has meandered around a lot of flaky bends. First it was the bid to diversify into real estate defying all norms of corporate governance by disregarding the need for shareholder approval before making a strategic business shift. Then came the relevance of independent directors on its Board, that remained passive to promoter Ramalinga Raju’s initiative to buy grossly overvalued family concerns. Almost all of them have since resigned. What followed was yet another rant on Raju’s wiliness – how could he pull off all this while his stake has dwindled close to nothing (all of his 8.6 % in SATYAM was pledged to institutions to raise funds to finance MAYTAS venture that lost almost 80% of its value in the recent real estate meltdown – the institutions have recalled the loans that Raju could not meet and they sold his entire stake in the open market last week as the story broke).

And the latest is, HP training its guns on SATYAM. Gartner studies say IBM leads the global IT services market with around 7.2% of the market, followed by HP-EDS with around 5.3% of the market. HP overtook second-placed Accenture after it acquired EDS earlier this year. The global market for computer services is estimated to be around $748 billion. Even after the EDS acquisition, through which HP gained over 20,000 employees of MphasiS, it trails both IBM and Accenture in terms of offshore strength. IBM has over 73,000 professionals in India and Accenture some 37,000.

And now a fresh debate. Should the existing management be allowed to continue given their track record of delivering consistent business growth? I too believe that a change could be harmful and are willing to give the existing operational team a chance. Had the management clearly realized its mistake and makes amends on the governance front, it’s better to run with the same bunch that ensures customer comfort and affirms durable relationships. It’s not easy to let go off clients GE, Qantas and regain their confidence in the short term for any new management.

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SIP for Land acquisition...?

And you thought small investors learn from big investors. Well for major corporates in Real Estate it seems to be the other way round.

DLF is setting up a Land Acquisition Fund – by transferring 15% from its annual revenues to its corpus to avail of any good buying opportunity – akin to Systematic Investment Plan (SIP) often recommended to small investors for buying mutual fund units every month. The advantage being, a small investor need not time the market and can take advantage of market at every level by investing fixed sums of money every year.

Good idea? What do you think? Next what? Pay STT and gain LT capital gains exemption?

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Bonding with convertibles

No I am not talking about sexy Alfa Romeos here.

Falling stock prices mean that investors have to increasingly rely on the bond part of the convertible securities for returns.

More than $1.4 trillion of equities worldwide are now on loan, about a third higher than at the start of 2007, data compiled by Spitalfields Advisors, the London-based firm specialising in securities lending, show. Almost all of that is being used to speculate shares will fall, according to James Angel, a professor at Georgetown University who studies short-selling.

Negative Yields Investors were willing to accept negative yields of as much as 11.5 percent in January to buy Reliance Communications Ltd.’s zero-coupon convertible bonds maturing in 2011, as the company’s share price on Jan. 9 climbed to a record 821.55 rupees, 71 percent higher than the 480.68 rupee conversion price set when the $500 million of securities were sold in March, 2006.

Investors are now asking for more than 5 percent yield to buy the bonds of the Mumbai-based company, India’s second-largest mobile-phone operator, as the stock has fallen 48 percent from its record, according to Nomura Holdings Inc.’s prices.

“This market is becoming a busted universe, offering little equity value,’’ as a HK based analyst Viktor Hjort said. “As stock markets are repriced, people should treat the share option portion of a convertible bond just as a lottery ticket and start looking at the asset from pure credit fundamental perspective.’’

But then there are many other wide open, lucrative avenues for ever enterprising investment funds.

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Best hedging strategy : Go Naked

CFOs are taking it on the chin again. Earlier they got the stick from their boards for not foreseeing the fall of the dollar. Now they are held guilty of not anticipating a Rupee fall. Poor bean counters, they’ve nowhere to hide.

Before the mortgage crisis hit the developed world, the surge of dollars into India strengthened the Rupee. It gained about 12% from Rs.44 to Rs.39 and all hell broke loose with India’s exporters. Businesses had to protect their margins and they sold dollars forward hoping the currency to keep its downward drift. Now the reverse is happening. The Rupee has weakened by 7% and is touching 42.50 to the dollar. There is an opportunity loss (of Rs.2.50) here since the exporters have already sold their dollars forward (at Rs.40). For those exporters who have taken leveraged options (selling 2 calls and buying 1 put to maintain a zero cost hedge), they face a cash loss since two calls would be exercised by the option buyers against one put exercised by the exporter.

Heads I win, tails you loose, huh….? Take my word. When you earn exchange windfalls next time, book those profits into a separate Exchange Fluctuation Reserve and don’t take credit for it as business income in your revenue account. The surplus realization is anyway available to you in the form of working capital. You didn’t earn it because of your endeavors. It just happened. Not many CEOs will like it, I know! Use the same reserve to write off losses you suffer when exchange rates turn adverse, some day in future. That way your ass won’t get laid on that fired up grill. No risky hedges called for; just go naked.
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Lend but don’t call back

Looks like India has its own subprime disaster in the making. ICICI Bank recently took the unprecedented step of paying Rs 15.5 lakh in the form of fixed deposit and insurance covers to the family members of a Mumbai borrower who committed suicide allegedly after being harassed by recovery agents of the bank, there was a case of recovery agents being beaten up when they approached a borrower to ask for payment against overdue amounts.

Until recently, personal loans were one of the most sought after segment by banks after they found that individual lenders default rates were far lesser than corporates and other organized borrowers. They relied on agents to press recovery from defaulters and mostly it worked. Now this segment has also crept up to `organized’ category – at least in beating up recovery agents that come calling – the threat of willful default looms large even by those who can afford to repay.

Time to short banks? ICICI, HDFC, Indusind, Centurion Bank of Punjab have all built up a good deal of personal loan books. Great shorting bets, I guess…

What do you think…?

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Strange things the Rupee does

The relentless run up of the Rupee has one major outcome. It drove xenophilic Indian companies like Infosys to focus on burgeoning Indian markets. Even as IBM, Accenture, Microsoft, Oracle, HP and other IT majors drove in to have a slice of the Indian market, Infosys was unmoved, stayed riveted westwards. It didn’t like the low margins. Sat smug under the illusion that juicy 25-30% margins that it kept gouging from overseas clients will remain forever.

I had written earlier about the short life of those obscene margins here and here and the folly of ignoring the domestic market. After getting dented in earnings and sensing a fast eroding market cap (and the worth of his own holding besides that of other co-founders), it looks like Kris Gopalakrishnan has heard me.

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It's another thing that he hardly had another choice...

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Getting the blend right

The proof of a robust M&A strategy is in its blending. Most acquisitions fail because integration of diverse cultures is never easy. Why not scout for companies with similar culture - you may go. Try that; you’ll never find one. Every company has a unique culture since it is made up of different individuals, their shared beliefs and practices that identify the company to which they belong.

Mike Rogers of PatchLink, has completed 10 acquisitions and two sales during his career and has this interesting Op-Ed in Venture Beat where he shares his magic mantra for a successful inorganic growth strategy. While Mike concedes that there is no such thing as the perfect deal, he goes that it all depends on a sound strategy. You can fix a bad deal structure, you can fix a bad integration, but you can’t fix a bad strategy.

Read it.

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Go short on India's IT vendors

Wharton’s Jitendra V Singh advises Indian companies to recast their business models to suit the rising Rupee than to expect the RBI to intervene. In support of his argument, he draws the parallel of how Japanese Automakers during the `80s reacted to the rising yen by shifting their low margin operations (and costs) to manufacturing locations in the US. That had the twin advantage of margin protection and reduction in protectionist backlash since the jobs have now turned American.

Is that a good comparison, Mr.Singh ? Check some facts out.

India’s leading IT vendors like TCS, Infosys, Wipro and Satyam squeezed out higher margins (27-30%) from clients not just because of availability of low cost workforce or a weaker rupee, they have also been benefitting from complete exemptions from Indian Income Tax (33.6%) on export income till recently. If operations are shifted out, the tax savings foregone will dent their margins.

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Many state governments also gave them land on long term low leases to build massive complexes to house their army of coders in thousands. These benefits cannot be expected from foreign governments. Moreover, the resale value of their Indian real estate would tumble triggered by the sudden over supply because the governments may choose to terminate their leases if they move out. Now that's a double whammy.

As of now bulk of the revenues of India’s IT vendors come from mainstay operations like ADM, BPO, low end process automation, testing and validation services. Revenues from high end segments like consulting, process automation, license fee, and remote infrastructure / Data centre management have been insignificant. With competing global majors like IBM, Accenture and EDS setting shops in India, wages are also on an upswing. Shrinking supply of competent engineers, higher visa costs and attrition have also not been helping matters either.

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Thus changing their product mix now would mean India's IT vendors having to make significant investments in R&D (read future) to develop high end utility products and building deep domain expertise in clients’ businesses that guarantees productivity improvements upfront (in other words, to partake in clients' business risks also) like the global majors do. These adjustments may (or not) yield gains in the long term, but right now they call for larger cash outlay and would also mean giving up on margins. Neither can the Indian IT vendors be too sure of their own ability to cope if pitted against the behemoths that knew this high end terrain better.

That's why I recommend a sellout. And if they don’t, go short'em all....

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