Scouring the Valley for deals

Sometimes, if you keep plugging away, you can pull something off — even if it’s daunting during the low points along the way. Yipes, which provides “managed Ethernet services” for corporate customers ran some endless VC funding cycles in the past. Launched in 1998, it had gone through bankruptcy and had raised a whopping $385 million — a seeming impossible amount to generate a profit for its investors. One more symbol of the excess of the Bubble.

Today the company has just been acquired for $300 million by Reliance Communications. Groups like Pramod Haque’s NVP, Focus and Sprout kept investing in the company through the years and probably didn’t make much. In the VC industry, they say any exit is a good exit. The deal works out to about 10 times 2006 revenues. In an earlier interview, CEO John Scanlon told that Yipes was on track to do $70 million in sales this year and is cash flow positive. It had better be.

Reliance also owns FLAG Telecom and this purchase makes them a competitor to Level 3 (LVLT). Yipes extends the reach of FLAG into US metros, especially in the Bay Area and East Coast. The traffic between India and US is on an upswing, and the deal makes perfect sense. Over past couple of years, large corporations have seen their data needs go up exponentially. File transfers, data back-ups, VPNs - all need more bandwidth that what the traditional means can provide. The long-in-the-tooth T-1 doesn’t cut it anymore. Instead an increasing number of corporations are opting for Ethernet-based services.

Yipes is happy to sell exactly that: multi-megabit Ethernet services that were more than a standard 1.54 megabit/second T-1 connection and the expensive DS-3 connections. Reliance will have to keep buying if they want to be competitive in US. It will also be interesting to see how the pros at Yipes handle the meddling family-style management of Reliance, as Om Malik had remarked.

To me, scavenging the Bay area for Bubble leftovers looks to be a good idea. Especially when we have a `fully stuffed’ Reliance ADAG steamroller humming in our backyard, hungry for more….

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India's REIT hand downs

I am not a great supporter of self-regulation because it’ll end up being a free-for-all. The clichéd argument that violators would still abound is no argument for perpetuating lawlessness. But I prefer a quick and crappy regulation anyday to a slow and sturdy one that comes in well after an opportunity has taken flight.

Take India’s regulatory dilemma to let in REITs – similar to SEBI’s dilemma on Hedge Funds. Here the excuse offered is imperfect titles to property, surfeit of black money etc...In the US and UK, they had concerns over these funds too. Nonetheless they were let in with some early guidelines, however skimpy - that quickly helped capture the market opportunity, created jobs and liquidity reigned. But our regulators refuse to read from the same book, let alone from the same page. They are in no hurry to shed the appeal of roadblock contractors and opportunity destroyers. Why do we gladly accept political apathy as the hand we’ve been dealt…?

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Andy Mukherjee drives home the point in this interesting article. Excerpts -

“The REIT debate in India is caught in trivialities -

Should the assessment of the value of properties be based on discounted cash flows or some other method? Should net asset values be disclosed once a year, or every quarter?

Perhaps the assessor should seek a legal opinion on each tenancy agreement to see if it is enforceable in a court of law? How about a due diligence on environmental clearances?

This mentality to codify the minutiae, to make no allowances for the seller's reputation risk or the buyer's intelligence, is a big damper. It's also irrelevant because the real, big risks in property investments in India are outside any valuation model. The ``fair value'' of property in India isn't just unknown. In the present state of the physical market, it's unknowable. That is what really needs to be disclosed. After that, it's ``buyer beware.'' That seems to be the pragmatic approach adopted by the Monetary Authority of Singapore.“
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Well said, Andy… Hope those who matter hear you.

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Renaming greenback

I had recently posted on Chinese surplus ($22.5 billion) and its swelling forex reserves ($1.2 trillion).

Now follows the story of India’s forex groundswell ($214.83 billion) over the weekend. Still we have no trade surplus (as china has) - since our currency exchange rate is integrated well into the global financial system because of which we have an appreciating rupee. Chinese RMB (Yuan) is artificially kept undervalued by about 30% and that accounts for its mighty trade surplus.

Earlier the RBI used to release annual reports on currency reserves. The one linked here is an extract from RBI’s supplement for the week ended 6th July. Talk of changing times….

Chinese had better yield to fervent appeals by U.S Treasury to loosen up RMB. Ben Bernanke gets a stress attack each time he crunches the U.S. trade deficit numbers. Hounded by the treasury, he might as well rename $ as RMB if China doesn't relent....

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Now join the chorus

Just as we thought the sub-prime mortgage woes have abated in the U.S, the after shocks begin.

Going by the news from the Wall Street, two credit-rating agencies stripped away the fragile masks of shaky mortgage securities held by Hedge Funds, exposing their worthless sides. Alarms also were sounded yesterday for the nation's banks when the Federal Deposit Insurance Corp. is looking "very carefully" at how many banks are holding junk mortgage paper, particularly a tainted and repackaged version of the risky junk bonds, known as collateralized debt obligations (CDOs.)

An estimated $1 trillion of CDOs are said to be held by over leveraged funds that could be the first to crack. Ripple effect is sure to be felt across the global economy thanks to the flatness of the financial world.

Infosys Q1-08 results unmasked the first roadkill of a surging rupee. With the stream of bad news that we keep hearing from the U.S, the scope for near-term recovery of the dollar is getting remote.

You chose a flat world…. Now join the chorus – “God bless America !”

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Cost of regulatory moodswings

Life’s a wave for all – has its highs and lows…SEBI is no exception.

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On occasions it’s on a regulatory Viagra and at others just as it has now, it goes flaccid. It’s the same with regulators everywhere.

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In the US Sarbanes-Oxley (SOX) is a poster child for a government act whose cures are worse than the disease. Given several ways to dodge its regulations, if one is intent on doing so, efforts to check will almost always fail. To ensure companies comply with the SOX regulations, the four large accounting firms that do almost all public company audits have raised their fees an average of 78 percent to 134 percent in 2004. Professor Ivy Xiying Zhang of the University of Rochester has calculated SOX has resulted in a cumulative loss of $1.4 trillion for the shareholders of public companies – that’s an average loss of about $460 for every US citizen.

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In India the regulatory cost will be borne by just about 5% of total population that has any exposure to stock markets. Now do your own math...

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You heard me, Mr.Sarin

Has it been a few hours since my last post cautioning Arun Sarin...? It seems he's heard me. Well, I won’t pretend modesty because that’ll be very unlike me. I had timed my hunch very well and might as well take some credit…

Never mind...the message has hit home. Arun Sarin of Vodafone has now come out with a retraction in response to a fuming B.K.Chaturvedi, the then Cabinet Secretary, who denies having been approached by any business house. Chaturvedi said, "India is no Banana Republic that we can give approvals in one day; it takes time and even if there were vested interests trying to scuttle the deal, what is the big issue. It happens everywhere; it is fine as long as we deal with it the right way, which is what we did."

In a subsequent message, Sarin has attempted some damage control by reasoning that his statement was directed not at *regulators* but at *vested interests*. The Anil Ambani Group, the Hindujas, Maxis of Malaysia and Essar had shown interest in the Hutch stake.

It’s o.k, Mr.Sarin… Common sense very often is one of the first casualties for rock star CEOs. And you are way up there…take care…!

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Not so soon, Mr.Sarin...

No matter how hard CNBC anchors may try to glorify businessmen, big business everywhere has its murky side. Arun Sarin of Vodafone had this rant at a Global IIT conference in San Francisco. Sarin while calling for more transparency in acquisitions was referring to some of his rival bidders - in $ 11 bn HutchEssar deal which vodafone had won - aiming to scuttle the deal using their political clout.

In May, Vodafone completed the acquisition of controlling stake in India’s Hutch-Essar from Hong Kong-based Hutchison Telecom International Ltd (HTIL). Indian regulations impose a cap of 74% for Foreign Direct Investment (FDI) in Telecom sector. There’s some confusion on the `Indianness' of a 15% slice held by HTIL’s partners and if upheld, would add up the foreign holding for Vodafone and Essar to 89 per cent – that is, violating the FDI cap.
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So get less vocal, Mr.Sarin….you aren’t completely out of the woods as yet...rivals could still be out there…

Rating a crater

The more people working on an M&A transaction, the higher the likelihood the deal is a dog. This is doubly true where one of the Big Four and a Credit Rating agency team is involved.

A Year after US hedge fund DB Zwirn acquired a significant stake in Chennai-based NBFC (non-banking finance company) Dhandapani Finance, it has spotted a crater in the company’s balance sheet. Since the hole is big enough to erode Dhandapani’s capital, Zwirn will now have to look at ways to either recapitalize the balance sheet or plan an exit – as per this report.

When Zwirn had picked up 35% stake, it had appointed the management consultancy firm KPMG to carry out the due-diligence. Apparently KPMG did not find anything materially amiss then. Being a deposit-taking NBFC, Rating agency Crisil had on December rated its fixed deposit at FA+/stable. Fun is, the stake of the hedge fund in the NBFC will go up by an additional 10% when its convertible stock kicks in. All in a company that has a gaping hole for a KPMG diligenced balance sheet....and SEBI lines up rating agencies for IPO grading too - poor souls, retail investors....

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A finger in every pie

Every bull market bring back some old ghosts. Unrelated diversification - as they came to be known is slowly making a comeback. As a strategy, if you thought it had been restricted to giants such as Bharti, Reliance, the UB Group and ITC, think again. Smaller Indian companies, too, are expanding their portfolios.

But there are arguments for and against.

John Matsusaka’s “Corporate Diversification, Value Maximization, and Organizational Capabilities” (Journal of Business, 2001) develops a model in which firm capabilities are unknown ex ante, must be discovered over time as entrepreneurs experiment with different combinations of business units. Hence in a cross-sectional analysis diversified firms may appear to underperform more focused firms, but the unrelated diversification is a necessary step toward the discovery of future capabilities, and is thus value creating.

My own experience tells me unrelated diversification may occur when firms possess excess capacity in “headquarter services.” The conglomerate’s central office, like a consulting firm, provides specialized support and advising services to its portfolio companies, creating value even when there are no operational synergies among the operating units.

Bet big on luck too…

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Infosys-Capgemini...did we get it right?

Read it recently. But why Capgemini? The next sound I heard was the bam bam bam of my head banging against the wall.

May be the mongers got it wrong. The space getting too crowded, Rupee appreciation that shows no sign of relenting, Visa woes, wage inflation and attrition getting out of hand - for Infosys, there never was a better time for a sellout. Organic scale up plans and revenue growth would depend on faster recruitment of skilled engineers that is in severe short supply. May be an Accenture, IBM, EDS or even CG bid for Infosys makes a better sense…

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Infosys management has been assiduous all along and I trust them for their deliberative approach. They wouldn’t load up debt in their balance sheet for acquiring a CG that it cannot discipline. CG is way too big, imbibed a lot of bad habits and is diverse in culture. Founders using the revolving door, rumors of a senseless acquisition….it looks like a dry run to me before a more dramatic something at Infosys…?

Shall we call it a sellout dance…?

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Had we known earlier....

Politicians like tennis more because it’s a game that lets one get the second serve in. In most other games, there's no second chance. By seeming a lot like their business of law making, the sporty metaphor gives them something to lean on. First make a stupid law that defies all logic for some self-serving reason and unleash the damage on the masses. When the goals are met (or emphatically unmet, like a first serve gone wide), try and make amends.

Earlier this year, the Indian Government worried about rising inflation denting its image before the Uttar Pradesh (U.P) elections, banned exports of sugar in a year of bumper production (sugar has a higher weightage in the inflation index). Incidentally U.P also has a large area under sugar cultivation and is home to a number of sugar mills. The move flooded the commodity in the domestic markets and prices slumped. Revenues and stock prices of sugar companies that were star performers suddenly nose-dived and their market capitalization went down almost by 70-80%. Not surprisingly, the UPA candidates were trounced by Mayawati’s BSP at the U.P assembly polls.

Elections over, it was time for the Government to review the wreck and rollback. Here’s the latest “had-we-known-earlier” – for sugar industry. The sense of timing was immaculate - the industry as a whole and its investor community has had hemorrhage already.

Recently I met my friend Rahul, who tracks sugar industry for a living at a leading brokerage. The guy looked a lot younger than his usual plump, flabby self. Asked him what had worked – the Gym or the diet.

He gave a smile and said, “I really didn’t have to go that far. I get enough exercise just pushing my luck.” I believed him.

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Home's where the mortgage is

When Farallon Capital Management, a U.S. hedge fund, and its joint-venture partner, Indiabulls, snapped up an 11-acre property in central Mumbai in March 2005 for $54.5 million an acre, the purchase was called an act of idiocy by local developers. A few months later, when the same joint venture offered $95.5 million an acre for a nearby property, its was the second-lowest bid.

At a time when Indian companies are looking for capital to grow, the recent Finance Ministry guidelines on External Commercial Borrowings (ECB) come as a dampener for most. The official argument for this sudden snap back is that too much money is driving up land prices. It prunes the all-in-cost ceilings over six-month LIBOR for ECB with 3-5 years of maturity by 50 basis points to 150 bps and over five-year maturity, the ceiling is 100 bps lower at 250 bps. It also bans the use of ECB for integrated townships in the fractured real estate sector and worse, it brings preference shares at par with ECB, and to be governed by ECB norms. The total country ECB limit ($22 billion at present) will also be applicable as per this analysis.

Indian companies often buy land banks at huge prices and mortgage it for funding construction cost. Now if the Govt. sets the ceiling on interest rates, the lenders will say “first you folks tell us what you can afford, then we'll have a good laugh and go on from there”….

Perhaps the Government realized its gaffe and the fact that the whole industry runs on layers of mortgage. It has now allowed a breather – albeit with too many strings and a cut off date. In India, we call it roll back....

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All's well until they take to water

ICICI Bank has become a phenomenal cash-gobbling machine a la Blackstone. Both the behemoths suck up to institutional and retail investors who repose a great deal of trust in them. The response to the recent FPO of ICICI bank (issue size $ 5 billion) and the IPO of Blackstone (issue size $ 4.75 billion) are testimony enough.

In the murky financial world, there's no advance warning system for trend reversals. In the rarefied field of aeronautics, the strong tailwind that gives the forward thrust while you're airborne could be your nemesis while landing. The relevance of that allegory to financial markets is quite ominous. Banks make hay while interest rates go up but beyond a point, high cost of borrowing slows down credit offtake. Serial spikes in interest rates as have become a habit with central banks now, do not portend all too well either. Rising bond yields, hint of a looming recession in some markets and a runaway inflation in the other is enough to stir up a market cyclone that turn the best of forecasts upside down. Few emerge unscathed from this onslaught. Expanding capital base may give the bank/fund more headroom to do more big ticket deals (that deploy leveraged capital), but its difficult to pull back when the trend reverses in short notice as it has often in the past. Add to that the truism of cost of equity being higher than that of debt, you're trapped since extinguishing equity once raised is not all that easy. Debt can be retired at will during lean periods when there's little credit demand.

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But right now, all's well. Besides the eagerness to capture the prevailing high valuation, it's the higher float that matters to both these cash-guzzlers. Nothing is off-limits for them now.

Barring one. K.V.Kamath and Stephen Schwarzman together should never go on a sailboat. If one of them falls overboard, the other - if unsure of his mate's swimming skills - would be loath to hold up the life preserver and ask "hey, can you `float' it alone?". The one in water might mistake it for talking business at that ungodly hour....

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The GAAP relief

CFOs of transnational corporations hate it. They have to present periodic financial reports in the format prescribed by the regulators of respective countries, as there's often a mismatch of income/expense recognition norms. Not just a repetitive exercise, precious man hours are lost by engaging people to assist the foreign consultants in making out original spreadsheets. Many have openly expressed their ire at this phenomenal wastage of time, money and effort (increases the bulk of the Annual Report/proxy statements, higher incidence of printing/mailing charges) all for something that an ordinary shareholder (who merely looks at stock price / dividend) would hardly care.

Some relief for the disheartened souls. The US SEC recently took a step towards allowing foreign public companies to choose international Financial Reporting Standards (IFRS) or US rules (GAAP) when filing data with the agency. [Big Four stand to lose a good deal, though.] Read the full report here.

The reason why I am a big fan of cashflow statement is that it is recognized by all. Cash is real, something that an investor can easily correlate to a transaction – capital or revenue, equity or debt. Cash flow statement enables better intra-business as well as inter-business comparison too. No ambiguity at all.

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Income statement on the other hand, is an abstract estimate structured for complying with tax (and other) laws, where the taxman is `expected to believe’ the contention of the company. If (s)he doesn't buy your argument, fallout could be fresh demand for taxes. If you persist, you could be in for a protracted litigation cost of which may outweigh the disputed liability itself.

Can’t wish away income statements just yet – not until the tax laws are altered to recognize income in a simpler way that everyone can understand. Any takers ?

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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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When the tide turns

Shocking to see how the tide turns.

Reality seems to be playing out now. To directly compete with VC firms, cash-rich large cap Indian companies in diverse fields like healthcare, manufacturing and retail are also creating PE funds to tap the SME business investment opportunity. Ranbaxy now has Religare Securities, Dalmia (Cement) group has Landmark-Holdings, Pantaloon Retail (Future group) has Future Capital adding to the crowd of strategic investment majors like Intel Capital, Siemens VC , Applied Ventures etc.

Earlier startups could never meet the stringent norms and soon VC firms began deserting them to focus on expansion stage companies in the SME segment that matched their `no-risk’ instincts. Government of India reacted to this shift in attitude (that turned many a risk taking VC into speculators) and duly pulled the rug from under their feet by withdrawing (pass through) tax concessions granted to them.

In business, good times last till competition catches up. Particularly in Fund management, opportunities last only till the strategy is kept under wraps. Normally others sense it well before the buck rolls in.

More number of players is good. Will there be enough quality deals for all of them ? Perfect condition for a shakeout…Oops…they call it `consolidation’ perhaps !

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Consolidation in Indian skies - putting the cart before the horse ?

The frenetic activity in India’s fledgling airline industry [Jet-Sahara, Kingfisher-Air Deccan, Air India-Indian] intrigues me no end. I normally am tempted to go by the general opinion of investors across the world about this industry, which in summation is that - a profitable airline is a dysfunctional one.

There’s this favorite airline industry stat, offered up by a recent Bloomberg article:

Historical profits: $18 billion
Historical losses: $32 billion

Internationally, the performance of aviation industry has been characterised by boom and bust cycles with a period of robust growth in operations and profits giving way to losses and an inevitable search towards consolidation. This is in the very nature of the cost structure of airline operations where fixed costs such as aircraft lease rentals, depreciation and staff costs could be as high as 50 per cent of sales. Even a marginal decline in traffic volume or a nominal addition to capacity arising from the entry of new players can undermine the viability of incumbent operators. The current wave of consolidation sweeping the Indian skies may appear to be in accord with the global trend, but is actually different in one respect. The consolidation is happening even before the industry has achieved a state of stable and orderly growth (and hence the title). The sector was opened to private competition, just a few years back. The period since then has witnessed one of the most exceptional record of buoyancy in national prosperity. In the event, the new entrants can perhaps be pardoned for viewing the future with an optimism that in hindsight may not only be regarded as excessive but did not prepare them to withstand the pressures of the market place.

Get this perspective from none other than legendary investor Warren Buffett:

"If I'd been at Kitty Hawk in 1903 when Orville Wright took off, I would have been farsighted enough, and public-spirited enough -- I owed this to future capitalists -- to shoot him down."

Seems the airlines are in bad need of a visit from the business model doctor.

It seems Vijay Mallya and Naresh Goel have different ideas. Well, you can argue there are millions of Indians that haven’t had their maiden flight experience as yet, who would love to take to the skies if the fares are affordable. How easy a task is that - coming to think of soaring oil prices, high lease rentals, wage inflation, shortage of pilots and trained in-flight, maintenance and repair crew.

Well, who am I to say that? John M Keynes quote captures it best as he says -

“A large portion of our positive activities depend on spontaneous optimism rather than on mathematical expectation…If animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but mathematical expectation, enterprise will fade and die.”

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Won't you join me in raising a toast to that ?

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Era of mega equity offerings ?

Just as one thought it is curtains for DLF IPO, another is raising its hood.

ICICI Bank’s domestic issue is part of a $5bn capital raising program. In addition to the local issue, ICICI Bank plans to raise another $2.5 b from the issue of American Depository Receipts.

In addition to the equity issues, ICICI Bank is also raising money by selling shares of the holding company for its insurance businesses. The timing of the stake sale in the holding company would be determined by clearances from RBI and IRDA.

This week, ICICI Bank received permission from the Foreign Investment Promotion Board to sell up to 24% equity in ICICI Holdings. However, the bank will be offering only 5% to international investors.

“China is possibly 10 years ahead of us. Even if the top four banks in India are put together, the size would be lesser than that of the fourth largest Chinese bank. The combined market capitalisation of all banks in India would be lesser than half of the M-cap of China’s second largest bank,” points KV Kamath, MD & CEO, ICICI Bank.

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ICICI Bank, has a market cap of about $ 19.89 b that is the highest among financial services companies in India. ICICI Financial Services, the holding company for its insurance and asset management business, has been valued at $10.94 billion. Goldman Sachs, Swiss Re and Nomura, along with two other investors, have picked a 5.9% stake. Of this, Goldman Sachs has picked up 2.02% stake.

A few swallows (few days of downturns of stock indices) do not a summer maketh - and we thought the India story is played out. Can’t be more wrong.

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The DLF dilemma

To invest or not to ?

DLF IPO never ceases to surprise by contrasts. The moment I finish reading a news that says overwhelming response by Institutional investors to its mega IPO, there’s another article which elaborates why the IPO should be dumped by investors.

The issue opened on Monday 11 June. On the second day, the issue was subscribed by 1.28 times. However, the retail investors have not given warm response to the country's biggest IPO, as the retail portion was subscribed merely 0.101 times.

Valued at the higher end of the price band, the company would be the eighth largest by market capitalisation, post-listing. With negative cash flows and current earnings abysmally low compared with future projections, the company is demanding its price relying solely on its vast land holdings, the value of which is not clear.

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They've got balls, yeah !

I was a bit ahead of time then. I am referring to a few US based entrepreneurs interested in raising VC funding for their businesses who had approached me earlier. The businesses were robust, had global delivery models, could’ve been easily replicated in cost advantaged locations – yet Indian VCs weren’t interested. Remember, it happened at a time when most Indian VCs were crying hoarse about lack of investible ideas available locally.

Imagine my relief when I found ICICI Venture has bought out the venture investors from the Seattle, Washington, based Radiant Research for an undisclosed sum.

ICICI Venture has bought out the stake of the original venture capital backers of Radiant who had stayed invested in the company for about 10 years. “Our original venture capital investor group had been involved with Radiant since our inception in 1998. This change in ownership represents a natural transition from a start-up company to an established company with the financial resources to strategically advance all of our late phase service offerings,” said Pamela Spaniac, CEO of Radiant Research. “We are particularly excited about the potential for international expansion opportunities that ICICI Venture will provide.”

Now at least I know one Indian VC that has balls – to look beyond boders.

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The Good, The Bad and The Ugly

I came across some interesting bits of news today. All related to DLF in some ways.

The Good – DLF IPO subscribed 41% on day one. The QIP portion is fully subscribed. The initial public offering of real estate major DLF, which is expected to mop up Rs.96.25 billion ($2.40 billion), received 41 per cent subscriptions within an hour of opening on Monday.

The Bad – Analysts say the issue is overpriced and figure that the concentration of DLF land bank in Gurgaon (near Delhi) does not bode very well for the prospects of the company. Sample these -

Brokerage house Enam said: "At the upper band of Rs 550 the stock trades at a significant premium to our base case valuation of Rs 404. We believe the stock is overvalued and initiate coverage with Sector Underperformer rating and a price target of Rs 404."

Raising concern about DLF's over-dependence on Gurgaon, Angel Broking said that this is a big concentration in one city, considering the fact that Gurgaon is a satellite town and it took DLF 30 years to develop the 3,000 acre DLF township.

The Ugly - After a brief respite, the city [Gurgaon] is again sweating under unscheduled power cuts. New Gurgaon, like DLF and Sushant Lok, seems to be the worst-hit. DLF phase II suffered a power cut on Tuesday night, while phase III has been experiencing unscheduled cuts for the past two weeks. Read the full report here.

DLF issue could have very well done without these bits. What do you think ?

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FCCB rope trick

“FCCB offers thrive, especially when stock market and the economy are booming. Investments are made with an objective of generating certain amount of returns and reinvesting the money in other instruments. Once expected returns are earned, investors can exit without waiting for maturity of the bonds,” says Kiran Vaidya, head of investment banking, Religare Securities. Corporates are also benefited in that they can raise funds at a premium which is added to reserves and helps strengthen their net worth position, he said.

What Kiran - like most other I-Bankers - obviously misses out is its impact on the issuer (company) when Rupee is appreciating like it does now (1$= INR 40.50). The FCCB that stood as debt (borrowed when 1$ fetched INR 45) in the company’s books, becomes a high cost equity upon conversion (now when INR is dearer). Besides the impact of (unintended) cheap conversion, it dilutes earnings and has also to be serviced for life unless bought back. It's a triple whammy for the issuer !

Here’s what I think. Why not issue FCCB with the caveat - if the issuer’s domestic currency appreciates beyond a (hurdle rate) % during its pre-conversion term, the issuer shall have the option to repay the debt at an additional % point of interest over what has already been contracted…Law as it stands now, does not seem to have anything against this condition.

I think that would have saved the day for many issuers today. What do you think ?

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Did you say valuation ?

Earlier during my career, I had known several companies where owner CEO `A’ meets another owner `B’ at some party and talk deal. It could either be a total buyout or acquiring one of its divisions or brand or some assets. No due diligence, no valuation exercise, not even verification of asset quality or title. In owner CEO situation, you can’t ask questions. Just do it.

But will TATA do something like it ? It seems when driven by despair, even they would.

The Tatas are paying Rs.140 per share for acquiring Mount Everest Mineral Water, which values the company at around Rs.4.60 billion($115 m). For a company with an annual turnover of Rs.250 million ($6.25m), it’s a very steep price. Mount Everest’s net profit in the quarter ending December 2006 was a mere Rs.3.3 million ($82.5 k). Earnings per share added up for the four quarters ending December 2006 amounted to only 53 paise ($ 0.013).

After Vodafone buyout of HutchEssar, yet another case of acquisitive ego defying valuation math…full story here.

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"Simplifly"

Capt.G.R.Gopinath, Founder & CEO of Air Deccan, India’s low cost carrier (LCC) is a smart man.

Just as everyone was about to write it off as a sick airline headed for its grave, yesterday this wiry ex-soldier of Indian army quietly palmed off a 26% controlling stake to Vijay Mallya’s Kingfisher Airlines for Rs.5.50 billion ($137.5 m) – Rs.155 per share (IPO was at Rs.150/- a share). In the process getting a return of almost 6 times his original investment of about Rs.930 m ( $ 23.25 m). As per the deal terms, he will continue as Chairman of the Company. The company had a last quarter loss of Rs.2.21 billion ($55.25 m) and its EPS is a cool negative figure. Coming to think of it, the strategy is fairly simplistic and well executed - go float a capital intensive business, shake down the whole market by suicidal pricing, break the back of existing established players almost forcing them either to buy you out (to stop bleeding price cuts threatening their very existence !) or to go out of business and eventually sell it to one of them and make 6 x returns...ain't that smart...?

Now to a little abstraction. Remember the Captain did it in India, a hotbed of spirituality where your good karma never goes unblessed or unrewarded. True to his words, he made air travel affordable for many a cost-conscious, VFM minded people (not necessarily poor) and he can safely count on all of their blessings. In particular, of those who could make it only because Deccan made it affordable for them, at real low cost – “Simplifly” goes its slogan – without a worry and no frills.

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Now with $137 million in his pocket, in all probabilities, this Captain would want to do more of good Karma. Unless he makes it clear, every industry has reason to worry !
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Can Subhash Menon be cool with this ?

Subhash Menon must have found it overvalued if he didn’t say “Oops, I missed it” ! Or has he had his fill with Azure and Syndesis under his belt ?

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I was a bit surprised to see him letting go off Cibernet to PE firm Warburg Pincus. Who am I to guess ? It could even be that he felt SubexAzure’s leadership in telecom OSS space is so formidable that the solutions portfolio offered by Cibernet [of financial settlement of voice, data, and m-commerce transactions, inter-company billing protocols, roaming administration tools and financial settlement programs] looked just plain vanilla.

Taking a close look at the services provided by Cibernet to over 300 wireless operators across the globe, SubexAzure will have to go some length before it can be the Full Monty in this space. Subhash may keep his nose to the grindstone, but the kind of revenues, customer portfolio and market share presented on a platter by Cibernet is alluring. Fresh from the acquisition and integration of Syndesis, he could be excused for feeling pleasantly weary if not suffering from acquisition fatigue.

It’s a dog-eat-dog world out there. No room for let ups.

I'm just a freelance I-Banker and a blogger. Subhash should know better.

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Ruias could use some sleep, badly !

Ruias must have been losing sleep ever since the Vodafone deal.

Good reason to think so since the Ruias are getting ready to *monetize* 33% that they hold in HutchEssar (now Vodafone Essar) – apparently to raise around $4.5 billion debt for overseas acquisitions (of non telcos).

“The fund-raising proposal will put the financing at a loan-to-value ratio of 82 per cent, which is quite high for a deal backed by shareholding in an unlisted company,” a banker reportedly said.

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That's it...Ruias could use a safety valve. The deal is all about an unlisted company, valuation on paper, futuristic…ah, ever so many strings. Even as the deal was underway, several eyebrows have been raised over the stratospheric valuations offered to [HutchEssar] the unlisted, loss making telco having negative cash flows – purely on the basis of 22 m subscribers [ cost of acquisition = $ 852 per subscriber].

While there could be the buffered comfort of that put option, [which allows the Ruias to sell their 33 per cent stake in the company over the next 3-4 years in the open market at a minimum benchmark price] in the dog-eat-dog corporate world, you can’t sleep in peace unless you cash it all in – which Ruias are yet to - especially when the fortune has been a chance event, happened by bid frenzy instead of sweat and toil.

Is it blind leading the blind or a house divided against itself that hurried Ruias to monetize ?

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Ruias could use some sleep, badly.

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Between an SEZ here and an SEZ there…in China

When the people of Uttar Pradesh elected Mayawati’s BSP with a thumping majority (overthrowing Mulayam Singh’s Samajwadi Party), her first item in the agenda for governance was a given – review all SEZ cleared by the Mulayam Singh, the former Chief Minister of the State.

In one of its most significant decisions since assuming power, the Mayawati government in UP has announced its intention to refer the allotment of 1,200 acres of land to Reliance Anil Dhirubhai Ambani Group for setting up an SEZ, to the Union government for review.

I also had a lookback at Nandigram riots in West Bengal (over Tata's SEZ) where the Left rules – for several decades now.

I was reading Vinnie's post on instant Chinese cities (Thanks Vinnie, for the pointer) and felt a bit wistful. How long would it take for our people to learn from our enterprising neighbors?

Excerpts from NatGeo article -

“In 23 minutes, they designed an office, a hallway, and three living rooms for factory managers. On the top floor, the workers' dormitories required another 14 minutes. All told, they had mapped out a 21,500-square-foot (2,000 square meters) factory, from bottom to top, in one hour and four minutes. Boss Gao handed the scrap of paper to the contractor. The man asked when they wanted the estimate."How about this afternoon?"

The contractor looked at his watch.

It was 3:48 p.m.

"I can't do it that fast!"

"Well, then tell me early in the morning."

That’s how they do it in China. We bloody well understand and fast…

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Communism in China ? Are you kidding ?

The turn of events in China clearly shows that capitalism doesn’t need democracy. Capitalism’s wide diffusion of economic power offers enough incentive for investors to take risks with their money. But capitalism doesn’t necessarily provide enough protection for individuals to take risks with their opinions.

But that’s old news. The latest is that the Chinese are ready to walk the extra mile and do the unthinkable – To let private equity manage a piece of their huge forex kitty, shaming even the most capitalist of countries that view private equity with skepticism. In one final fling, Chinese are ready to consign to hell the Mao Zedong brand of philosophy that shunned private enterprise. I like that gutsy bit - no place for anything that stands in the way of progress – not even venerated ideology.

As per plans, the Chinese government would acquire a $3 billion stake in the Blackstone Group, the private equity firm, in the country’s first effort to diversify its $1.2 trillion in foreign-exchange reserves beyond US treasury bills and into commercial enterprise.

An investment agency modeled after Temasek (the investment arm of the Singapore government and owned 100% by the Ministry of Finance) in China would effectively create the world’s largest hedge fund – voila ! Some analysts say that the China fund’s investment of billions of dollars in the global financial markets could push global asset prices higher, affecting American and European stocks, bonds and interest rates, as well as the value of energy and natural resources in Africa and the Middle East.

Full story here.

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Dr.Manmohan Singh, Mr.P.Chidambaram and Guv Y.V.Reddy- even you are having problems with the surge of $$ inflows, aren't you ?...and you wrung your hands in despair while letting the Rupee appreciate...look at your smart neighbour and take a leaf or two - NOW...!

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Yet another gatecrasher…!

If you believe in something, go for it. This is the only way to really find out. Mathematically, the naysayers are right 95% of the time, but believing you’re in the 5% is what makes VCs they are.

Just as Ankur Srivastava, MD of DTZ brings out this report which talks about oversupply of commercial office space (in Chennai, it’s excess by 200% as they say) in Indian cities, Oak Investment Partners, the US based VC fund is setting up a Real Estate VC fund in India with a $ 200 m corpus. Can we call it the Symposium effect ?

Normally if you enter in an oversupply situation, the downward price pressure (or rental pressure, we are talking about real estate here) would take a long time to stabilize. That’s when leveraged investors (who have mortgaged the properties to Banks to fund their buys) begin to get margin calls from Banks and feel squished. Warren Buffet, the legendary investor's saying “the markets can remain irrational longer than you can stay solvent” comes to my mind.

I have often wondered why the Bubble horn is still not blowing. Aside of occasional rants by Deepak Parikh, Chairman, HDFC Ltd., India’s leading player in real estate and housing finance, not many seemed really concerned. [“How many malls can afford to pay Rs 100-150 or Rs 200 per sq foot? Look what happened to Crossroads (India's first mall). Only restaurants are left because food sells and the Piramals have sold out. The same thing is going to happen to other malls. There are many international brands, but they too cannot afford to be present in every mall”...Mr.Parikh squeals]

If you are riding the wave, why rock the boat....Welcome to party, Mr. Jerry Gallagher and prov'em all wrong !

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Happy flippin' ...Renuka !

Ever tried turning an ocean liner like you do a speed boat ?

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Nah… When you want to turn a speedboat, you turn the wheel. For an ocean liner, you have to plan two days ahead. RMS Titanic couldn’t swerve the iceberg because of it. The only tribe that seems to have managed it so well is Private Equity managers. The ocean liner metaphor here is to a Public company and the speed boat is what it becomes in the hands of private equity. I am referring to the art of buying out companies, sprucing them up and staging lucrative exits. It calls for a lot of guts.

I really wish the trend to pick up in India. Like many firsts to its credit, ICICI Venture can deservedly bag this too – why not…when it’s slogan is “fueling your aspirations”. If she can pull it off, Renuka Ramnath, CEO will surely be tap dancing her way to office soon after laughing her way to the bank.

As per this report, ICICI Venture, the country's largest venture capital firm, is likely to make a return of four times on its cost of acquisition. It had acquired the refractories business from ACC for about Rs 250 crore in 2005. Of that roughly 40% (Rs 100 crore) was equity and the balance was debt. ICICI Venture expects the prospective buyer to shell out Rs 550 crore. Taking out the debt portion of Rs 150 crore, the return on its investment will be Rs 400 crore, equalling four times returns.

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UBS Securities is believed to be advisor to ICICI Venture for the sale of ACE. If ICICI Venture is successful in selling ACE, it would be its first exit from a company, in which it has made a complete buyout. Other companies where it has gone in for a buyout include Infomedia India (formerly, Tata Infomedia) and VA-Tech India (engineering services firm).

The ease with which you flip, is a function of timing and discretion. The next opportunity that’s lying in wait often prods it and the cycle rides on. Too bad these guys not being at the wheel of the Titanic on that fateful night…!

Happy flippin’….Renuka !
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If you can't score, try shifting the goal post

Steve Pavlina says the best way to “win” an argument is to go for an entirely different goal than trying to prove the other wrong.

This also seems to be the strategy of Rajeev Chandrasekhar, [currently VC with Bangalore based Jupiter Capital as well as a Rajya Sabha M.P] who seem to be fairly upset about the recent stamp of approval given by FIPB to Vodafone-HutchEssar deal. Rajeev was previously the majority shareholder and head of BPL Mobile before it was sold to Essar Teleholdings in a deal valued over $1 billion. He is outraged since the Foreign Direct Investment (FDI) policy of the Government stipulates a maximum 74% ceiling for FDI in Indian Telecom sector, HutchEssar deal managed to slip through the policy net (by recognizing the 15% proxy holdings of two individuals as "resident holdings" - who were clearly surrogate stand ins for the foreign owners).

The background. In February, Vodafone had acquired Hutchison Telecommunications International Limited's (HTIL) 52 percent holding in the Indian company Hutchison-Essar, in which the Ruia-controlled Essar group is the junior partner with a 33 percent stake, 22 percent through a foreign holding firm. The remaining 15% is *ostensibly* held between Hutch CEO Asim Ghosh and Analjit Singh, MD of Max India, both reportedly Indian residents. Technically therefore the FDI sectoral caps have not been violated by HutchEssar by virtue of 26% stake is still held by Indian nationals (11% Essar, 15% Asim-Analjit joint holding). Smart move indeed.

Rajeev wants to know "is it the case of the government that where there is sectoral cap, any Indian citizen (or entity) standing proxy for foreign source of capital is enough to satisfy our requirement of being an Indian investor," in his letter questioning this model that is rampantly finding favor in the country.

"The question is not attempting to target any one company, but rather I am raising this issue as an issue of principle to start a debate about our country's approach towards foreign investment, the loopholes in our approach and the disrespect of the laws of our country by a few foreign investors. I have posed similar questions recently pertaining to foreign investment in Land on coastal areas," he groans.

Reasons for his carping are not hard to seek. BPL's Investment Bankers and Lawyers (hired by Rajeev for BPL-Essar deal) were not so ingenious in putting together a deal structure which technically could pass muster before FIPB and stay well within the FDI sectoral restrictions. Instead they just threw the rule book at him without much thought – the 74% sectoral caps for FDI investments in Indian Telecom sector had restricted his options and made him sell to another Indian Telco leaving no scope for fuelling a bidding frenzy as happened in Vodafone-HutchEssar deal. While HTIL, by smartly categorizing the 15% holding as stake held by residents, managed to pull it off at a stratospheric valuation of $11.1 billion for the 52% stake in HutchEssar. By this yardstick ($852 per subscriber), BPL divestment should have yielded much, much more than what Rajeev got from Essar. It’s an open secret that both Asim Ghosh and Analjit Singh stood proxy for HTIL, the holding company of Hutch and have several restrictions which forbids them from divesting it on their own to any other third party.

Now you know why I felt Rajeev is going for a different goal (newfound patriotism which urges him to raise the issue of disrespect for Indian laws and even threat to national security since it's too late to wreck the deal) instead of trying to be right !

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What do you think ?

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2 and 20 has now become 3 and 50 !

Warren Buffet called them “2 and 20 managers” [Hedge Funds that charge 2% of funds managed as fees and 20% of profits as carry] and said this much – “when a man with the money meets the man with the experience, the man with the experience ends up with the money and the man with the money ends up with the experience”.

Call it the Groucho Marx problem: Of late Investors trying to put money into hedge funds frequently find that the managers they want do not want their cash.

Just as Groucho complained that he would not join any club that would accept him as a member, even very wealthy investors can find themselves faced only with hedge funds they do not want to invest with. As a result, some investors are resorting to devious tactics to get stakes in the best hedge funds.

Perhaps Mr.Buffet has been naïve to the latest phenomenon of mismatch of supply and demand that has given rise to the tendency of successful fund managers to jack up their fees — to 3% a year and 50% of profit in the case of SAC Capital — and impose long lock-ins, preventing customers from getting their money back for as long as five years. He might now call them “3 and 50 managers” – so long as they stick with those numbers.

Many of the industry's biggest names — Steven Cohen of SAC Capital, Paul Tudor Jones of Tudor Investment, Louis Bacon of Moore Capital, Steve Mandel of Lone Pine Capital and others — do not need to expand existing funds further and often believe that more cash would hurt their returns. Even when they find they have the capacity to take more money, they typically turn to their existing investors first.

But investors who know the tricks of the industry might be able to find cracks in the door. The most obvious way to get into a closed hedge fund might appeal to Groucho, but most people would shy away from it: Simply send your money to the fund's depository bank and rely on the fund's automatically issuing units, as LAtimes reports here.

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ARC or debt collectors ?

The activities of Asset Reconstruction Companies (ARCs) finally seem to have picked up in India. Using the topicality of the subject, I had made an earlier post here. The pace of reforms in this billion $ industry was somehow slackening. To enthusiasts like me, it used to be more exciting to watch the paint dry or the grass grow. Ah, but then they do give some mild surprises like what I found in The Financial Express here.

I somehow keep asking myself this question. Our Banking system itself has been subjected to a fairly high level of oversight by both RBI and Finance Ministry. They have to maintain a 9% Capital Adequacy Ratio (CAR), SLR, CRR requirements imposed by RBI through its annual credit policy besides the regulations flowing from Banking Companies (Regulation) Act. Despite such elaborate supervision, Banks have managed to create a mountain of overdue loans or non-performing assets (“NPA”).

If it happens despite regulations, may be it’s time to relax them. Something similar is brewing in the US over Sarbanes Oxley Act, where there is a mounting pressure to loosen the strings by the Government. Otherwise ARCs merely end up being debt collection agents of the Banks rather than resuscitators of ailing businesses or turnaround artists. Vulture funds or Private Equity model should work fine, though with some brutal maneuvers deservedly on borrowers who dodged repayments, that led to the NPA creation in the first place.

Deal sourcing - the old fashioned way

Throughout my more-than-a-decade long career in Investment Banking, both as an external consultant and in my in-house avatar, I have tried several techniques to source deals. From leveraging close personal relationships, affiliated funds, Investment Bankers and industry grapevine to sourcing deals from other financial intermediaries or even participating in downright auctions through club deals.

What did I leave out ?

It is deal flow emerging from proprietary research, which stands out for its enormous value potential and distinct personality trait. I am far more clued in a deal that I have researched upfront, took time to get upclose with the management and have spent enough time studying their strategies translating into results. Well, to the argument that who has the time, my ready answer is “start scanning early”.

On an average, at any given point in time I’ll be tracking at least three prospective investments very closely. At times, not to lose sight I buy some stock personally so that it figures prominently in my portfolio which I keep a close weekly watch on. As a scrupulous deal maker, I get out of the position immediately before I start peddling the deal to PE funds – to qualify for the full disclosure. My previous post here was one such.

This is significantly better than getting into the rat race for more deals without a care for end result, value unlocking potential - that is. Perhaps even better than hiring star leaders or marquee name rainmakers like an Anil Singhvi or a Mohit Bhatnagar who have an exemplary track record in their respective domains. Here’s why. This very domain expertise could prejudice their vision over the prospects of other businesses, giving rise to missed opportunities or having to build an anti portfolio, like the one Bessemer has. As a PE fund manager, the demand on the individual is of a different kind – a pulse for an early opportunity over a broader spectrum and by extension, scope for an earliest, IRR optimising exit.

Longevity of PE as a long time, credible asset class amongst accredited investors depends largely on building outstanding deal sourcing and investment processes. Especially in times like these when there are several sophisticated HNIs and Institutional investors dotting the field, looking for interesting avenues to apply their wealth, brand building thro track record of consistent performance metrics matters all the more.

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Some of the interesting http://www.knowledge@wharton.upenn.edu/ articles on related topics be found here, here, here, and here.

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A tale of two business models

Born less than decade ago, Google Inc. (NASDAQ: GOOG and LSE: GGEA) now reigns as the most profitable—and probably most powerful—force on the Web. As usual, Google's financial firepower flowed from its search engine. That ubiquitous tool has become the hub of the Internet's largest marketing network and appears to be getting even better at identifying the right ads to display with its search results, which in turn helps elicit more revenue-generating clicks

Google 1st Quarter 2007 results snapshot

Revenues - $ 3.66 b
Net Income - $ 1.0 b
EPS - $ 3.18 per share

No. of employees – 12,238 nos.
End quarter cash balance - $ 11.9 b
Quarterly revenue productivity per employee - $ 299,068

Date of Incorporation : Sept. 7, 1998
IPO : August 19, 2004
[19,605,052 shares were offered at a price of $85 per share ]
CMP of stock - $ 482 [ P/E – 35 ]
Market cap - $ 152 b

Did you say scale ?

What stands out or boggles my mind in more ways than one is the amazing power of an ingenuous yet easily scalable business model that Google espoused. Being less manpower intensive (just 12,238 employees now) and more equipment / server capacity centric, it is least affected by the ubiquitous problem afflicting the IT industry – one of employee attrition.

Pitched against the business model of Indian IT bellwether Infosys Technologies Limited (NASDAQ: INFY) which recently celebrated its 25th anniversary, the contrast is glaring. While it can’t be compared strictly because of inherent diversities, the power of robust business models that enable rapid scaling and by that, shaping the very fortunes of businesses is evident here.

Infosys 4th Quarter 2007 results snapshot

Revenues - $ 898 mm
Net Income - $ 272 mm
EPS - $ 0.48 per share

No. of employees – 72,241 nos. (incl. that at subsidiaries)
Quarterly revenue productivity per employee - $ 12,430

Date of Incorporation : July 2, 1981
IPO : February 1993
[1,378,947 shares were offered at a price of $2.26 per share ]
CMP of stock - $ 42 [ P/E – 22 ]
Market cap - $ 30 b

Here’s where the significance of the business model hits home. While it took 23 years for Infosys (with its strength of 72,241 employees) to notch up a billion dollars in revenues, Google’s business model helped it achieve $ 1.46 b in 2003, in just 5 years of its incorporation and one year before its IPO – with just 1/6th of that strength.

Throw in a few other companies like TCS, Wipro, Satyam, HCL Tech and not wanting to be outhired, MNCs like IBM and Accenture too open shop locally and adopt massive ramp up from the limited pool of qualified engineers, you create a mecca for job hoppers. They are all in the same turf just to stay competent. Hiring becomes a non-process as anyone who can spell binary is recruited diluting the quality of the hire. Skill gaps are hurriedly addressed by on-the-job training if not on induction itself. If the hires are not on a project, it hits their bottomlines hard. Billability becomes the watchword instead of quality.

This lacuna is being realized now and precisely the reason why Infosys top brass is tempted to rethink the viability of its business model. Related news item is here and my earlier insights here and here.

What do you make of it ?

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[PS – I must also place on record the fact that the indian companies mentioned above took birth in the third world aiming to work for the first world. These companies started operations with severe handicaps when Indian businesses were reeling under the yoke of licence raj, a period between 1947-90 when the state policy was riddled with red tape, hostile to businesses, with severe import restrictions even for high end technology. Exports were severely restricted too.

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Despite the ongoing reforms, India still ranks in the bottom quartile of developing nations in terms of the ease of doing business; and the average time taken to incorporate a company or to invoke bankruptcy is much greater.

Google by contrast took birth in the capitalist mecca - USA, and measured by that yardstick, it took off with an inherent advantage.

My purpose here is to bring out the criticality of business and revenue model in shaping the fortunes of businesses alone and not to denigrate the shining Indian star corporates mentioned above.]

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Post deal carping

One of my distinct character traits is my ability to go-with-the-flow. But of late the goings-on in the PE industry in India and the way they changed the scale of M&A activity is a bit off putting.

It’s manifesting in the way our companies have the appetite and the financial muscle to make global acquisitions, of companies which are several times their size and value. How many of those transactions make economic sense, to the acquirer as well as its investors? Employee morale downturn is almost a given if the cultural mismatch simmers up too soon and drives the best brains out for a walk. I don’t think the apparatus is ready to calibrate it and M&A firms can’t care less. For them, it’s just another deal.

In the US, there are several examples of multi billion dollar acquisitions that didn’t quite click. Mitchell Madison-Whitman Hart, HP-Compaq, AOL-Time Warner and many more. Learning from all that, Indian companies could do well to undertake extensive post deal planning prior to completion of transaction – perhpas immediately after the due diligence is completed and in principle decision made.

In a recent survey by KPMG, 80% of the companies surveyed were not well prepared to handle the smooth transition and integration of two businesses post deal. Yet we only get to hear more about *culture conflicts* which only rank second biggest challenge in it. Another interesting finding was that it took on an average, nine months for companies to get a grip over post-deal issues. Nearly two thirds of the acquirers failed to realize the synergy target, even as 43% of the synergy target was built into the purchase price. Well, competitive pressures can explain why premiums are justified as there could be many bidders to a deal. But astute deal makers will have to apprise the management and make them see more value in the transaction than the asking price and convince themselves why the price is right.

Acquisitive ego can never be allowed to out-compete valuation math, and that sets a great deal maker apart from a good one. I will always argue that a good deal maker should be quick on the uptake where it comes to understanding the client’s business in under an hour. He can learn as he diligences, but should be making early calls on the expediency of the transaction to the acquirer’s business and compare it with their goal. Private Equity houses are found to be adept handlers of post deal issues than corporations. As per the report, 95% of PE houses surveyed have started post deal planning prior to signing as compared to Corporations with 59% score.

It is important for Indian Companies scouting for acquisitions globally to do their homework on post deal issues well in advance. In default, they will be choking on the buy without being able to run with it, especially if it is funded by high cost debt. When managed well, acquisition of global corporations by Indian companies would be seen as a normal business decision.

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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 ?

The QIP deep dive

As early as January, 2006 a report by the SEBI-committee raised concern over the growing number of Indian listed companies tapping funds through the GDR/FCCB routes, on account of its time and cost effectiveness adversely impacting the depth of the domestic markets. While the number of follow-on public issues in domestic markets during 2001-02 to 2004-05 period rose from zero to six, the number of GDRs/FCCBs from listed Indian companies grew by three-fold from three to 42, the report had said.

On the basis of this report, SEBI came out with a solution in May, 2006 in the form of Qualified Institutional Placements or QIPs, which were significantly less cumbersome than IPO filings. As per the guidelines, issuers will have to allocate a minimum of 10 per cent of such placements to mutual funds. For each QIPs, there shall be at least two allottees for an issue size of up to Rs 250 crore and at least five allottees for an issue size in excess of Rs 250 crore. "Further, no single allottee shall be allotted in excess of 50 per cent of the issue size," the guidelines stipulated. The securities issued through QIPs will be equity shares or any securities other than warrants that could be converted into (or exchangeable) with equity shares, SEBI said in a circular.

The placements of these specified securities could be made only to Qualified Institutional Buyers (QIBs), while a minimum of 10 per cent in each such offer should be allotted to mutual funds, the regulator said. Promoters or those related to the issuers are barred from participating in such issues. Owing to these advantages, companies took to it happily.

But now since the market has been in a bearish mode for the past few weeks, the floor price stipulation (being the higher of the six-month weekly average or 15-day weekly average of the quoted prices) in the QIP guidelines have begun to adversely affect the issuances. The floor prices based on the SEBI formula are now higher than their current market prices. The floor price is again applicable from the date of the enabling resolution by the board. Of late, prospective issuers are finding their floor prices higher than their current prices. While SEBI doesn’t allow the QIP issuer the flexibility to revise the price downwards, investors wouldn’t be willing to come in at a price higher than the prevailing market price. Catch 22 of sorts.

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Will SEBI relax its floor price norms for QIPs or let it lose flavor ? Keep watching this space.

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Time for ICICI Venture to mull an IPO…?

I keep reading about the phenomenal success of Fortress IPO and related reports and had also chronicled it in one of my earlier blog posts. Going by this Fortune article, it seems the world’s still awestruck and clearly has not had enough. It as well reminds Blackstone is next in line to hit the road.

Excerpts -

“On the night before Fortress Investment Group became the first hedge fund to trade on the New York Stock Exchange, Wesley Edens and the other four principals celebrated in a manner that befits the firm's intentionally low-key profile. They gathered at a bar on the Upper West Side of Manhattan.

By the next day's closing bell, though, Edens could afford more than just beer and pretzels: His shares from the IPO were worth approximately $2.3 billion. Six weeks later, on March 22, Blackstone Group followed suit when the private-equity shop revealed plans to raise $4 billion in an upcoming IPO.

Since that news broke, Wall Street has been buzzing about who will be the next firm to announce plans for an IPO and invite the public into a world once reserved for high-net-worth individuals and institutional investors.”

I took time off to think what if our local Private Equity firms decided to go public ? Would they fetch similar buoyant response ? The existing listed PE firms like IDFC an Infrastructure focused financial powerhouse ( P/E 18.6, Market Cap $ 2.13 billion) and ILFS Investment Managers a pureplay PE firm (P/E 24, Market Cap $ 76 Million) have been doing well for themselves in comparison with the broader market. But the big fish of them all is ICICI Venture, which is the Private Equity / buyout arm of largest new generation Bank ICICI Bank, with funds under management in excess of $ 2 billion. It would be interesting to watch if ICICI Venture decides to go public and the likely valuation that it might secure – given the dynamism demonstrated by its CEO Mrs.Renuka Ramnath, it is not totally out of whack to speculate.

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And if it chooses to hit the road, here’s what Mrs.Ramnath and her team can aspire for - more or less.

Being comfortable in the limelight may be what finally determines who does and doesn't go public. Given that affairs of ICICI Venture are pretty much transparent, and its very much in the limelight already for Mrs.Ramnath’s stellar fundraising capabilities, if at all there’s anything to hold back, it could only be its investors privacy concerns than one of its likely valuation.

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I'd like a slice of the action....What do you think ?

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Leveraging NIFTY 50...

Just finished blogging a management buyout op, I am dreaming up something else. When you keep getting wild ideas, why wake up ?

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Often when PE activity is very high in any market, the first signal that emerges is that the stocks are underpriced and valuations are attractive. Scratch beneath the surface we stumble upon factors like low cost of funds, low gearing of companies, higher scope for dividends, better yields etc.

Currently if you look at the downturn in Indian equity market, a confluence of all these factors can be seen across the spectrum.

Let me start out by saying that I don't think that stocks are necessarily overpriced at this level, but I don't think the private equity deals necessarily signal massive underpricing anymore. Compared to the past, there is much more money out there in the hands of these investors, and it's all money that they have to get invested or they don't get paid.

Even with stocks fairly valued, with high yield and leveraged loan markets pricing risk so low in recent years, PE firms can still pay a fair price and make killer returns. The point is really seeing if the returns are that great on a risk adjusted basis. Leon Cooperman , previously strategist of Omega Advisors Hedge Fund did his own study back in the 80s which showed if you levered the S&P500 to the same capital structure of typical LBOs, it would beat average PE fund returns. I also believe Prof Kaplan at U Chicago has done some research questioning how strong PE returns really are.

PE funds just take the "market" aspect out of the companies they buy, add some leverage and wait for the returns to be generated. I think the biggest reason it's so easy for PE funds to take these cos private is because investors are so myopic and will take a 20% premium rather than allow management/company to continue doing what they are doing and ultimately wait for the market to assess a higher valuation.

Back a decade or so, with a couple hundred million dollars, they could sit back and wait for a fat pitch that they could knock out of the park. Now, with billions to invest and many more competitors out there bidding up all the really nice deals, it's tough to wait for the same types of situations. So what I think a lot of the larger firms will end up doing is taking private firms with a target return lower than in the past. They will likely end up looking a lot more like mutual funds that can take much more concentrated positions, and benefit from being the controlling shareholder. Also similar to mutual funds, in order to put their money to work they'll have to be more consistent buyers through various market conditions.

Don't get me wrong, returns aren't going to look like public market returns, they'll still bring in returns that pass that, but by less than in the past. It just can't be expected that with all of the money out there and the increased competition that the buyers can be as discriminating as they once were on the deals they choose or the price they pay.

So as these big buyout deals continue, I'm keeping in mind that “take-privates” might not be as solid a market signal as they once were. May be, a few months down the line, we can think of lowly geared companies in the NIFTY 50 to lever up a bit and be eligible candidates in the take-private orbit. Will they ?

Presently in India as the market unwinds, a few smart PE funds are even exiting quietly. ICICI Venture Capital has sold a 3.25% stake in Deccan Aviation for about Rs.32 crore to UBS securities Asia, thro an open market deal for around Rs.94 a share, bringing down its stake in low cost carrier to about 10-11%. As early as 2005, ICICI Venture had acquired around 19% in a pre-IPO deal, valued at Rs.65-70 per share. The Deccan aviation scrip closed at Rs.88 on Tuesday, while the 52 week high was Rs.162. It appears the sale has translated into a 40-45% RoI over a two year period for ICICI Ventures. Considering the volatility in the market and accentuated bad times for aviation sector as a whole, by not waiting for the tide to turn in its favor to higher levels, ICICI Ventures did make a smart move indeed.

Watch this space, just watch ( no noise, or else I'll wake up) for more fun.