Go tax destruction if you can !

Ok. Indian companies do more and more foreign buyouts and don’t bring dividends from those controlled foreign companies (CFC) back in. Taxman goes sniffing.

I object. Take TATA – Corus deal. The £ 4.3 billion ($ 9.16 bn) deal, has been funded by the TATAs almost entirely by leveraged debt and internal accruals that included diluting stakes in group companies like TCS and other TATA group companies. Now this watershed deal (world’s 65th ranked Indian steel company acquiring 5th largest steel company in the world) would not have been possible except for that adventurous yet high risk mode of financing opted by the TATAs. Should we not permit TATA to park its Corus dividend abroad that could be utilized in repaying TATA STEEL’s leveraged debt? Why bring it back only to tax it? If a company has taken some risk, it is entitled to its share of reward. Going after them like a bloodhound is not just irrational, it is way too regressive.

Paying taxes is a citizen’s duty and I acknowledge that so long as the taxmen don’t choke my oxygen supply pipe in the process. I quote Chanakya’s Arthasasthra - “There should be leniency and caution while deciding the tax structure. Ideally, governments should collect taxes like a honeybee, which sucks just the right amount of honey from the flower so that both can survive. Taxes should be collected in small and not in large proportions". Granted, I shouldn’t expect brazen taxmen to be endowed with regal finesse, but how about rationality?

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I have often condemned the principle behind excise duty – a tax system leftover by our colonial masters that penalized local enterprise - as well. I say it's about time we chucked this agony off our back. My logic, why tax production? Should they not be taxing destruction with equal vigor? Or will that be too much to ask?

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Market declines; off goes PE deals, but law firms connect….

ICICI Venture and Jaypee Infratech have terminated negotiations for the PE player buying close to 10-15% stake for $800 million in the infrastructure company, which is developing project worth $ 25 billion. Earlier Blackstone backed off from buying 26% stake in Hyderabad-based Ushodaya Enterprises (of Eenadu newspapers and television channels) for $275 million. Similarly, Future group’s PE fund Indivision cancelled its deal to buy 4.9% stake for Rs 250 crore in media house Zee TV’s DTH venture Dish TV following the market meltdown that saw Dish TV share prices sliding far below the deal price.

But as they say, lawyers never lose. Allen and Overy, a leading international law firm and Trilegal, an Indian law firm, confirmed their new arrangement involving client referrals, training, consultation and joint marketing.

Allen and Overy say they belong to a “magic circle” – now what is that? I guess it’s a law firms moniker akin to "Big Four" for accounting firms. At least magic circle is more overt a term – the client will realize he’ll be (financially) done in as if by magic….

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Finding the integration watermark

Sri Rajan and Till Vestring of Bain & Co. on post acquisition integration –

A Bain & Company study of 250 global executives with M&A responsibility showed two-thirds routinely overestimated synergies available from transactions. But, at the same time, most understood what drives smooth integration: 80% said integration efforts must be “highly focused on where the value is in the merger. Rajan and Vestring further quote examples of Tata Com-TGN, BP-Amoco amongst others say –

A deal either enhances core business or opens up a new and separate platform for investment; Successful integration can make or break a deal’s trajectory.

Three types of investment thesis – active investing, growing scale and growing scope – require different degrees of integration. When companies have a clear understanding of their investment theses, they can quickly decide where and how much to integrate.

In fast moving, intensively competitive markets companies that don’t get their integration right can pay a heavy price.

It’s an excellent piece, agreed. But I find one missing perspective – of the Customer. For me, (s)he is the center point. Everything revolves around them. When you debate how much to integrate, wear the hat of a customer and ask yourself – how much will the customer benefit if we integrate and if so to what level? Answer that conscientiously and there is your watermark.

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Get your skin in the game

So I read this McKinsey report.

During the past two years, the flood of money into infrastructure funds has been an astonishing $130 billion. Take into account leverage, a billion dollars of equity funding could, in some situations, pay for up to $10 billion in projects. "Where will all the money go?” It asks. I am tempted to add an extension – “[with shrinking margins]”. The need for infrastructure investments in the emerging markets at present is about $1 trillion. I am at ground zero here in India. I can share a few insights.

PE funds here need a new approach – different from typical value creation through financial engineering and rising user demand. So far, they have acted less aggressively to improve operations; indeed, many financial investors still leave such issues to contractors and focus their governance efforts on financial metrics. This model is broken; it’s so yesterday.

So what should PE fund managers do today? I suggest -

a) Lay down norms of good governance. It helps assess risk in a structured way, avoiding unwarranted focus on a single category, such as technical delivery or regulatory compliance.

b) Brief project owners about the complexities by way of foot note to RFP itself. When they see reason, they might even expand their allocated budget. If you’d quoted thin, you’ll come to grief later.

c) Build alliances with Infrastructure specialists. Get some strategic skin in the game. Here’s the twin upside - a better chance of winning traditional deals and turn them around; and the ability to bid for operationally complex and less competitive projects. That’s how you learn to walk away from overpriced deals.

I quote an example. Macquarie and Ferrovial’s co-investment in the UK’s Bristol International Airport, for example, involved upgrading signage systems; renewing check-in, baggage reclaim, and catering facilities; rerouting foot traffic; and installing all-weather landing equipment. The investors also rejuvenated the airport’s retail offering, strengthened the management and sales teams, and even tweaked the system for booking parking spaces. In the four years after the acquisition, the number of passengers using the airport doubled—as did its EBITDA.

I find financial engineering can help PE returns only up to a point. With strategic competence added in, you can man up before the whole world, not just LPs. What do you think…?

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I pat my back

One great upside to blogging as I see it is that you can pick up on a weak signal, apply your own logic, speculate outcomes, post it over the Web and attract comments. Then validate your foretelling skills against what appears in the mainstream media much later. So what’s so great about it? Date stamps. If your deduction of likely outcomes precedes the subsequent endorsement in mainstream media, your logic is flawless. You can rely on it and take critical decisions with greater confidence. It’s a great joy. I’ve had it on quite a few occasions before. Here and Here.

This morning I had yet another. I find the lead editorial in today’s ET endorsing what I speculated three days earlier – on what Reliance Power `out-of-the-box bonus’ means to investors. When tallied point by point, I’ve a few extra points to my credit that’s yet to be spotted by mainstream hacks. Here is the next salvo from R-Power, just as I had guessed.

Meanwhile, I plod on… A sharp logic is indispensable in my line of work – private equity deal scouting and bug fixing :)

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Update : Not sure if R-Power has execution capabilities on the power generation and distribution front. It’s current priority is bonus distribution :-)

At crossroads or just cross eyed ?

Office space rentals have risen 30 per cent in the city central business district Nariman Point and 20 to 25 per cent in Lower Parel in the past year. Leading developers including DLF, Indiabulls, Peninsula and retail pioneer Future Group now are rethinking. Why not convert space reserved for retail malls and hyper markets into large office space…?

But then you have Lakewood malls, the retail arm of Hiranandani (Haiko) zeroing in on supermarkets, lifestyle stores and culture shops as its focus.

An industry at crossroads or is it just cross eyed vision? I'd like to believe it's strategy. But they say, strategy means folding in the future. Not extrapolating the past. Soon we'll figure that out.

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Lead (not so) kindly light

Reliance ADAG group jingled “power on, India on” just before Reliance Power IPO. The stock debuted in the market and put all lights off. When the alley was all dark, Anil Ambani emerges from the shadow holding a candle.

People didn't figure out it was hoax yesterday? Good lord. Pull your heads out of your butts, people....

First, could it be a genuine expression of an overwhelming sense of guilt? A sort of admission – Yes, we overpriced the stock and valuations rode on the Reliance track record more than fundamentals. But bonus shares are not the same as “money back”, it just signifies a reduction in premium. It increases the floating stock and effectively reduces the stock price in the short term. It does not reduce your pain, but now you can see Anilbhai’s face in the candle glow better.

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Second, R-Power has collected only 10% from QIB and 25% from retail investors. It has to collect the remaining 90% from QIB and 75% from investors scarred by its listing inferno. Even if the company forfeits the marginal upfront application money paid by investors wanting to back off, investors could still cut their losses on the unpaid allotment money part and run. That would effectively mean IPO is undersubscribed and hardly can R-power proceed to reissue shares at a discount.

Third, the R-ADAG group can hardly afford to disillusion investors if it has a series of IPO plans lined up. Its private equity fund is entirely funded by Anil Ambani’s personal wealth and has some huge investments in entertainment, real estate and technology. All these companies will have to go public sooner or later and it’s easier to milk a faithful investor base. That’s a grand strategy and a surefire exit route. It’s a bad idea to choke up that pipe right now.

Fourth, what’s R-ADAG got to lose anyway on the closing price of Rs.372 on the opening day? R-ADAG promoters in fact got a debut valuation at a premium of Rs.355 on its Rs.17/- per share (fully paid-up) investment in the Reliance Power *shell* already. It makes a pomp and show about its magnanimity in depriving itself of the present bonus allotment. The fact is, it already got its bonus as much as 20.88 times over !!!

The hidden pack of beneficiaries could be the usual suspects. Amar Singh, Mulayam Singh and the Bachchan family holdings. Not to forget Reliance Energy's majority holding and its scope for recoupment in the long term...:)
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As a Private Equity dealmaker, I would worry

The government today notified guidelines for Foreign Currency Exchangeable Bonds, that lets companies forming part of conglomerates to unlock some of their investments in group companies.

FCEB is a debt security offered by a company (“issuing company”) and subscribed to by investors living outside India and exchangeable into equity shares of another company (“the offered company”) of the same group, based on warrants attached to the security. Conditions include –

a) Companies to belong to the same group;
b) Offered co has to be listed, FDI/ECB compliant;
c) Not to use funds for stock buys/India real estate;
d) Five years for redemption but can exchange anytime.

This is yet another window for conglomerates in a hurry to monetize rich valuations in a booming market. I can explain. If a company has exhausted its FDI / ECB limits and still needs funds, it has to either raise fresh capital or resort to high cost borrowings. In both cases, the credit rating would suffer and that means higher cost of borrowing. By taking FCEB road, it can swap the FDI/ECB head room available for any other company in the group to raise more funds at the same reduced cost.

What would it entail? More companies from same groups, with or without ready projects would make a beeline to get listed. Now if R-Com has exhausted its FDI/ECB limits, it can raise it under Reliance Power, which is a shell now. Before that is exhausted, Anil bhai will float another company and take it public. One company always to be kept ready with FDI/ECB window open. Remember successive IPOs during early days of Reliance and the later consolidation? Even smaller players like the Modern group of yesteryears from the Ranka stable? Modern Sintex, Modern Denim, Modern Terry Towels – each of them were listed, their stocks rose and fell with little notice. Fundsraising was a chain reaction - one project was used to fund another till the chain collapsed during the late 90’s bear phase.

But then it’s an election year. Reliance has new oil strikes. Uncanny coincidence of timing the new law? Notice the relative calm even in the left benches despite the fuel price hike. Whatever happened to the elementary principle in Finance – every business should sustain by itself? Take life. How long would you stand on other’s legs?

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As a Private Equity deal maker, I would worry.

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Be the Stand-up guy at the gate

Ted Forstmann, a corporate raider immortalized in Barbarians at the Gates for his unsuccessful 1988 bid for RJR Nabisco, flew in on his private jet, presented his offer, and gave Reiman about 30 minutes to make up his mind, without bothering to spend any time with his family.

Now those guys (KKR, Blackstone, Carlyle et al) are here, will that stuff work in India? I say no. Here you have to please even the nannies in the household before you buy some stake. It’s not just easy to pump in excessive leverage, dividend recaps and ripping fees into their Indian portfolio companies and ask them to wilt and watch. Devise new methods. Innovate. I go for a successful PE fund to get going here, it has to have a greater strategic involvement than pureplay financial. Use some hand to spin that wheel of fortune. You can have a killer instinct alright, but have some heart as well. Of the few PE business models that came close, Madison Dearborn scores.

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"Sure as hell will charge a fee"

Here..... Sebi wants to regulate Art Funds now. Entrepreneurs turned neo-art aficionados have lately been getting funny ideas. Who knows? There is always the proverbial worm for the early bird.

So I read their disclaimers in IPO offer documents.

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Of SEBI: “SEBI only gives its observations on the offer documents and this does not constitute approval of either the issue or the offer document.”

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Of NSE: “It is to be distinctly understood that the permission given by NSE should not in any way be deemed or construed that the offer document has been cleared or approved by NSE nor does it certify the correctness or completeness of any of the contents of the offer document. The investors are advised to refer to the offer document for the full text of the disclaimer clause of the NSE.”

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Of the BSE: “It is to be distinctly understood that the permission given by Bombay Stock Exchange Limited should not in any way be deemed or construed that the Red Herring Prospectus has been cleared or approved by the Bombay Stock Exchange Limited nor does it certify the correctness or completeness of any of the contents of the Red Herring Prospectus. The investors are advised to refer to the Red Herring Prospectus for the full text of the disclaimer clause of the Bombay Stock Exchange Limited.”

I agree this is a practice followed by regulators / stock exchanges globally. All of them are spineless freaks that neither have the gall to own up nor wish to let go off their influence. They know that no process of due diligence can be 100% fool proof. In other words, they're sure of their propensity to goof up. Yet, they just want to be there because they are. Wonder what will they regulate in Art? Will they know a Leonardo Da Vinci from a pattern in the ceiling left by some regulatory muck hitting the fan? May be they’ll add a few more lines to their disclosure. Or better still – create an intermediary, that knows even less, (a la merchant banker) to blame everything on.... The more things change, more they're the same.

But sure as hell will charge that fee :)

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Taxmen catch budget cold

Gee… it’s Budget time and our taxmen get their annual bout of xenophobia. They think up new ways of choking all streams of income – inland and foreign, inbound and outbound - and squeeze out more.

So now they come up with the new norms for international taxation. There’s something like a concept paper on “simplified income-tax” (oxymoron?). These include the concept of General Anti Avoidance Rule , Controlled Foreign Corporation, Thin Capitalisation Rule and Advance Price Mechanism.

Mr.Chidambaram, take my advice. Introduce no new taxes. You’re way too rich already. Ask your colleagues to build new roads, highways, dams and airports they promised. For heaven’s sake, don’t come up with new Yojanas or we’ll puke ! If possible, scrap those you can’t run. Tell that gloating Laloo to give us some fast trains. Bombay local trains are an apology for modernity. Fix corruption in PDS and make sure the poor get their ration as per entitlement. Talk to Chinese if you have no clue and learn how to deploy tax rupees in building infrastructure. Elections are around the corner and if you listen to me, your payback will be lucrative – another term at office – that’s what you guys die for anyway… don’t you?

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Ah, but you call it “continuity to enable reform process” – Balderdash !

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Case for a market mashup

So I say if IPOs are a game of chance, why wouldn't the regulators pass over the primary market and allow direct listing into the secondary market? The expression `secondary’ would be redundant then. SEBI might as well silence the grey market rumor mills that emit misleading signals to trap gullible investors. Let Book Running Lead Managers (BRLM) morph into Market Makers. The mechanism could be something like this –

1. The issuer approaches a merchant banker who shall prepare an offer document in compliance with regulations and ensuring adequate disclosures.
2. The draft offer document shall be filed with SEBI for vetting and the final document shall be filed with Registrar. (No need for application forms with non-readable disclosures necessary. Imagine printing cost savings.)
3. The market makers (BRLM in new avatar) shall provisionally register the securities with the depositories and offer a mandatory online two way quote to interested investors for a five day period.
4. If there is enough demand for the security, the entire issue will be subscribed and if not, the unsubscribed portion (above a minimum watermark of say 70% of issue size/volume) shall be extinguished.
5. Issuer shall have the option to pull out the issue at this stage if it is not happy with 70% subscription and credit the sums back to investors online/offline. Alternatively, if the market makers have agreed in advance (hard underwriting) to absorb the 30% unsubscribed portion at the closing price of the 5th day, they can.
   

Advantages are –

• Significant reduction in issue expenses;
  
• Online access to offer document. Facts don’t get mired in fine print;
• No categorization of QIB, HNI and Retail;
  
• The whole issue completed in 5 days, unlike 8-9 weeks that it takes now;
  
• All category of investors to pay the full price they bid; No question of revised bids. Make a mistake, you just will have to buy/sell.
  
• Being a transparent online mechanism, no scope for payment default since there is an instant direct debit to investor’s bank account;
  
• Case for refund only if the IPO is subscribed below 70% or if the issuer chooses to pullout;
  
• Efficient price discovery since price is what an investor is willing to pay and grey market operators get edged out;
  
• Investors don't get sucked in by the media blitz following QIB oversubscription figures;
• The reduced effort of BRLM would enable them to charge lower fee from issuers.
  

In essence, by applying the excellent secondary market infrastructure that we have now (with T+2 settlement) and the prevailing low brokerages, this mechanism is significantly more efficient, issuer and investor friendly and certainly a game of surety than of chance. No more bad listings; No more sudden pullouts.

Mr.Damodaran, if you need help, you know whom to call. Here are some more perspectives from Samir Barua (IIM-A), Rashesh Shah (Edelweiss) and Alok Vajpeyi (Dawnay Day AV).

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All Lights Off

Bing bang IPO of Reliance Power Ltd., is trading at a discount of over 10% today, on its maiden listing…

Slam dunk. Poor investors will be inundated with heavy losses since most of them have borrowed liberally from banks and other lenders that were more than happy to extend short term funds for this IPO. The early hums were on doubling the money in about 25-30 days since the issue was from Reliance stable, that has a reputation for grand listing rewards.

Market sentiment is God. No arguments.

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Names don’t mean much Mr.Khorakiwalla…

This is it. Wockhardt Hospitals backs off. A glowing moniker for investors’ shrunken appetite for IPOs. Emaar MGF is likely to follow suit if it fails to scrape through. The QIB portion of Wockhardt Hospitals IPO was subscribed just 6.44 per cent. The retail portion was subscribed to a far more respectable 51.92 per cent. Some reports reveal that the grey market premium for Reliance Power IPO has significantly declined.

I would leave the downturn in investors sentiment alone for now. What stuns me is that it has happened despite the impressive line up of high profile investment bankers by Wockhardt Hospitals – Citigroup and Kotak Investment Bank. Could they not secure even one time subscription by QIBs? How different are they from other not-so-high-profile I-Banks then? Why didn’t it devolve upon them if indeed they’ve underwritten it? Or have they? No clear answers yet.

As a corollary, can’t we safely imply the success of the issues lead managed by them has also been by default? I would lay it on boom time sentiments and certainly wouldn't attribute it to their subscription procurement skills. Talk of their famed connections and ability to secure huge subscriptions – their principal deal bagging levers.

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A bird tells me India’s I-bankers are a cautious lot. Foreseeing IPOs that lay goose eggs, they do `soft’ underwriting only – responsible only if bidders fail to pay up on allotment. Smart as they are, they don’t do the `hard’ stuff – the kind that obligates them to make it good to the issuer on the unsubscribed portion of the IPO. So, if the IPO bombs without attracting bids, the I-Banker can go scot-free.

In short, the names don’t mean much. Mr.Habil Khorakiwalla, CEO of Wockhardt must be licking his wounds now – or busy returning subscription cheques to investors (within 15 days).

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"We are not REIT ready, pal"

Last week I met two senior private equity players and a couple of I-Banking friends. The former had just closed a $2 billion Real Estate and Infrastructure Fund and the latter wants deals in the sector. Between them they face one common problem. Everyone and his uncle have boarded the infra bus and deals get closed too fast. My business is to drive deals and I can't be happier. But the fact is, before I could say D.E.A.L, I hear they're done. It's frustrating sometimes.

So the trend now is to co-invest with others. I can see why they cringe at that prospect, playing a side-kick, but there's no choice. Take a slice of existing projects or be ready to follow a REIT model. Hey, hang on. Our regulators are still mulling a legislation. Here are some inadequacies from the draft code –

a) SEBI Act in its current form does not permit REIT to be regulated by it. It needs to be amended;

b) Proposed regulation talks of only close ended schemes, yet call for listing of REIT units in a Stock Exchange. But REIT units do not come under the definition of`securities’ under Section 2(H) of SCRA that regulates listing of securities. Go, amend SCRA now.

c) Unlike MF schemes that deal in securities, REITs deal in real estate directly. They own pieces of real estate and live off its rental and capital gains. SEBI has to think hard over its mastery over this new domain.

I have one more question. Last year Blackstone acquired Equity Office Properties (a REIT controlled by Sam Zell) for $39 billion. A little later the real estate market collapsed in the US and Blackstone started selling off these assets in a hurry to minimize the dent. Now, how much sense will a close ended scheme in the draft regulations envisage in a sector that’s infamous for its vicious cycles? What if the closure date happens to be in a phase when the prices have hit bottom?

Normally we hold RE assets for a very long time. Like family jewels, RE asset in India is legacy stuff that keep rolling down generations. When it’s a long term asset, why not leave those REIT schemes open ended?

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For PE funds, caution is the word

For long, PE / VC funds have been encouraging and rewarding innovations. But that’s just restricted to the creativity element in the DNA of portfolio companies controlled by them. Innovative business models, processes, productivity improvements and the like. But there are several culture / country specific factors that influence the metrics used to evaluate companies that meet the “investment grade” parameters set by the PE firm. Here I share some attributes that I have noticed for PE firms to consider while evaluating investments –

a) Value unlocking – Normally PE firms unlock value from portfolio companies through interests, dividends and divestitures. But most Indian companies have an umbrella set up, where the finished product of one could be the raw material for another and so on. Since all these companies are owned by the same family or group, by funding one company, the PE firms are doing a favor to those others giving the entrepreneurs more bang for the buck than the PE firm itself. Nothing wrong with that, if transactions between the various links in the chain are at arm’s length that often is not. They don’t surface in the MIS reports placed before the Board Meeting – being the only instance when the PE firm’s nominee gets to interact with the management. So, call for details.

b) Dance with masters of the game – Like most developing economies, Indian bureaucracy is riddled with nepotism, corruption and red tape. Now wait, don’t just head for the door. That way you are shutting down on opportunities that come with it. Local entrepreneurs have grown up in this ecosystem and they know their way around it. Some are deft players in shifting the right gears while others are still learning. See that as a “competitive advantage” and an essential management skill set. Do some fine combing and be with the adroit team.

c) Law is tight, enforcement is weak – So don’t take the functional judiciary and rule of law for granted. You have to do rigorous diligence on your target investments and check everything not just twice. For eg. while doing a real estate deal, don’t just look for the title to the property, see whether title-holder is in possession as well. Go one step ahead and release a public notice seeking other claimants, if are around. As far as possible, do business with entities that honor their contracts and obligations. That said, don’t see this as a weakness. Learn to duck. It also means if you'd crossed some line, don’t hurry to do term or pay up. Look for fixers first :-)

d) Provide for Exchange rate risk – This is playing out now. PE firms that hurried to buy stakes in companies at stretched valuations must be ruing their double whammy. They no longer command the same high valuations thanks to the recent market crash, a weakening dollar is hitting the export realization of these companies as well. The projections no longer hold. Their customers from US and Europe are reeling under heavy losses, especially banks and mortgage firms that make their future prospects even gloomier. Look for companies with a mix of sufficient domestic customers and export customers with wider geographic/currency spread.

e) Acquisition hurdles – Most Indian companies are family owned and controlled. They don’t let go off control easily no matter how sweet the offer is. It takes a lot of persuasion and coordinated effort to get all family members to agree to quit or even dilute stake. And the whole process has to be quick. Otherwise, it will be seen as a murky family squabble where some are for and other are against the deal; such a specter will demoralize the workforce and would force even competent executives to leave instead of dissenting owners. When good people leave, you may have to revisit the deal before it’s too late, especially if it’s a management `buy-in' you had in mind. So, do it quick; structure it uptight. No management, No deal.

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I am not drunk on that decoupling kool-aid…

When our markets went into a tailspin early this week, everyone including P.Chidambaram came out to comfort the enraged investors. He said India’s fundamentals are strong, our corporate sector is healthy. No cause to worry.

Then I read Wall Street’s reaction to Apple’s stunning results. Apple's holiday profit jumped 58 percent. Its computer sales grew 2 1/2 times the overall market. And despite fears of a recession, the iPod maker expects its revenue to grow 29 percent this quarter. Not bad, huh? Well, not good enough for Wall Street. Focusing on Apple's guidance for the current quarter, a forecast for strong growth that fell short of analysts' expectations, investors hammered the stock taking it down more than 16 percent in early trading.

Would you still have faith in the power of earnings to outwit strong negative sentiment? Clearly I am not sold on that. No, I am not drunk on that decoupling kool-aid either…. So take a cue from wall street and resist that urge to buy in Dalal Street for now...

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Go, freeze your balls at Davos

And you thought yes, the US has problems, a credit crunch brought on by reckless mortgage lending - and maybe in commercial property and credit cards, too - but we are safe. Not just us, China, Singapore, Korea and the oil rich Arab neibhors are all doing well. In fact, their Sovereign Wealth Funds are so strong that they are busy bailing out failing Wall Street banks. We are convinced. The global prospects could weather an American storm.

Before we could say `decoupled', the Asian stock markets crashed again. The two-day sell-off in Asian markets is a reminder that the world has been dragged along by the insatiable desire of the US consumer for stuff, much of it made in China. If the US really does slow down, so - goes the fear - will all those factories up the Pearl River Delta whose wages are keeping millions of Chinese happy. To meet the margin calls, traders exited their positions at huge losses and even sold gold and commodities. They fell too. Domino effect. Do you still say we are decoupled...?

Meanwhile our economic chieftains are busy freezing their balls at Davos. Few of them are already there, as seen on TV this morning struggling to part their frost bitten lips to talk to the media. Rest of the pack will be off soon. The theme at Davos is interesting this time around – "the power of collaborative innovation". (If Wall Street catches cold all markets should sneeze… that’s collaboration for you. Isn’t that innovative?) For Chidambaram, there’s no better way to escape the political heat than head for the Alpine ski slopes.

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The Sound of Crash (is deafening)

RBI Guv Dr.Y.V.Reddy has heard us... Or is it the deafening thud of yesterday's market crash? Here he’s going soft on interest rates as opposed to his earlier tough stance against inflation. Ila Patnaik had argued that lower interest rates would help arrest inflation and the Rupee run since India would become a less attractive destination for foreign funds.

That report quotes RBI view calling for end-use restrictions for investments by foreign VCFs because of concerns on foreign capital inflows it is finding tough to manage. Ila Patnaik’s worst fears have come true - the central bank has been absorbing foreign currency inflows to check the rupee’s appreciation, but has ended up adding to the liquidity in the system.

I quote from that BS article. “Abundant rupee liquidity poses risks of higher inflation as it adds to the already high money supply. The year-on-year increase in money supply (M3) as on January 4, 2008, was 22.4 per cent against 20.8 per cent a year earlier and much higher than the central banks target of 18 per cent.”

With a crash like that, I’d rather the Guv comes up with some good news of lower interest rates, weaker Rupee or anything to perk up the market on 29th Jan, when he reviews the credit policy - and resuscitate the annual non-event that it has become lately.

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Go slap FBT on Taxmen....

Look at Finance Minister P Chidambaram getting carried away! Here he is doling out free laptops, free fuel, free mobile calls and training to taxmen for beating tax collection targets. Have they really?

It'll be fun to watch the scene post A&R (assessment and refunds). What if collections net of refunds fall short of targets? Ah, going by the pace of A&R, our taxmen would’ve totted up a laptop each for all their family members by when the returns are assessed and refunds are due. Life's good, mate…

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But then will he slap FBT on those goodies to taxmen too....? If Chidambaram has a sense of fairness, he must.

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"CYA guys.. Now..!"

Ila Patnaik makes her case why RBI should be cutting interest rates right now. (hat tip : Ajay Shah)

Her theory goes so long as there is scope for arbitrage between interest rates in US and India, dollar inflows will continue to drive the inflation and Rupee up. This relationship between Rupee rise and inflation (owing to upsurge in dollar flows) in the Indian economy – where interest rates are higher than that in the US - creates an anomaly in that a cut in interest rates will not only help rein in inflation by slowing down $$ inflows, it will also arrest the surge of the Rupee.

Ms.Patnaik has this view that since US economy is sliding into recession, Fed has more reasons to cut US interest rates. I see that move could further sex up high interest destinations like India (for not just FII/FDI/ECB flows, but also to NRI remittances) and the deluge will only accelerate. Traditional methods that soak up liquidity viz. OMO by RBI, CRR hike etc., meant to rein in inflation and arrest the rupee rise will only add to inflationary liquidity in the system. In effect, a higher interest rate regime instead of containing inflation will end up exacerbating it.

So here you have a paradox. Normally when you cut interest rates, it could lead to inflation propelled by higher credit off-take. But in our peculiar economic situation driven by excess liquidity and a rising rupee, cutting interest rates can effectively arrest dollar deluge as well as the Rupee rise – the twin goals that RBI is struggling to achieve.

Sound argument. But I say the Indian borrowers of foreign currency (ECB/FCCB) in recent times have large bets on a falling dollar to benefit from the exchange rate arbitrage. I doubt whether our CFOs are equipped with rate sensitive AWACS that scan early symptoms… A sudden reversal in RBI stance could wreck many a business and could rock the stock market sentiment as well. So RBI should give out early warnings.

The least that RBI Guv Dr.Reddy could do is to signal them “CYA guys… Now !”

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Irrational Exuberance -II ?

I find Alan Greenspan has already used up the expression “irrational exuberance” to signify the dot com boom of 2000. Then I read this story on Reliance Power IPO in the BS story today. Excerpts -

"….there are several aspects of the issue that leave many observers feeling distinctly uneasy. Here is a company that has no assets on the ground, and no history of project execution, getting a value on the market that is many times higher than established and successful companies in the same field of business, namely power generation. The many risks associated with investing in such a company have been listed in the issue documents, including the uncertainties surrounding some of its projects — like the lack of assured fuel supply. But investors (including institutional investors who are professionals and who therefore should know what they are doing) have not been deterred…”

And you thought institutional investors and professionals got brass balls...? Come on, get a life pal....! They represent a bunch from where even sheep learnt to herd up. Just this one difference. The poor animals have a better reason in that they feel secure when bunched together. These guys do it so that when their calls go horribly wrong, on a peer to peer comparison all will look alike, deep in shit. No one guy will look or smell better than the other.

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Over to Mr.Greenspan. "Now Alan, what would you choose to call this frenzy in this part of the world… IE-II…?"

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Performance by default

Sunil Jain in BS –

“Though the country’s tax collections are rising by leaps and bounds, a recent paper in the Economic & Political Weekly suggests this may have more to do with the growth in the economy than with the efficiency of tax administration.”

He quotes some statistics to buttress his pov.

I can’t agree more. I would even draw a parallel. Haven’t you noticed the same thing with performance of our fund managers in Mutual Funds? Don’t they do the same thing? When markets are near their peaks, all of them brag their chests. NAVs of their various funds are high by default than by design – reducing them to just being punters. But then that’s what you and I do. Why pay commissions and entry/exit loads to these pumpkins?

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Oligopoly in Indian REITs...?

Inox Leisure investing Rs.100 crore in Ajay Piramal’s Indiareit – for a strategic stake as well as “preferred client status” with a ROFR in its future portfolio of RE assets.

The report quotes Industry analysts view that the alliance will help Inox widen access to upcoming real estate projects across primary tire I and tire II cities, thus getting the right customer exposure to multiplexes and branded outlets. Indiareit could ensure preferential access to Inox for these properties. The new alliance would also bring financial support, expertise, presence of leading brands and strong pre lease to developer.

With a handful of REIT/PE funds with mighty financial muscle and just so few parcels of land available, are we not running into an oligopolistic mess? Has Ajay Piramal been inspired by Sam Zell…?

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Oh, what a birthday for Mr.Pandit...

Says the Economist.

VIKRAM PANDIT has just celebrated his 51st birthday, but this will not be the best week of his year. His first set of quarterly results as boss of Citigroup was one for the history books, for all the wrong reasons: a record net loss of $9.8 billion, driven by a whopping $18.1 billion in pre-tax write-downs and credit costs on exposure to subprime mortgages. This was more than even the most pessimistic analyst had forecast—although gossip had pointed to $20 billion or more. But that doesn’t bar the off-shoring vendors including the SWITCH from extracting their pound of flesh.

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It’s their opportunity, stupid…
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Our taxmen will soon get this scent

In an increasingly flattening world, no new taxing strategy could slink under the taxman’s radar for long. They are always on the prowl picking up new excuses to tax the citizen. India’s Finance Minister P.Chidambaram borrowed the concept of Fringe Benefit Tax and Securities Transaction Tax not from US or Europe, but went all the way down under and picked it up from Australia. I am sure he will be closely watching the debate on “carried interest tax” on VCs that is raging in the US.

We had a similar row last year when the Government sought to restrict the “pass through” status for income streaming to VC firms around February 2007.

Steve Brotman of SAVP, a VC firm in New York has a detailed post here. I liked the interesting illustration Brotman has inserted in there.

“Suppose a entrepreneur starts a corporation, and invests $50,000 in it. Then they raise $100,000,000 by selling 80% of it in preferred stock; preferred stock means the investors get paid first, and is quite typical structure with startups. Then the entrepreneur sells the corporation for $300,000,000 after 5 years. Should the entrepreneur who continues to own the 20% piece that he owns, pay capital gains tax of 15% or ordinary income tax of 35%?

Today the law is 15%, as these are long term capital gains.

Now change the word "entrepreneur" to "VC".

Is that OK in your book if a VC creates such a company, and generates capital gains this way?”

I haven’t read US tax law. But in the Indian context, VC firms registered with SEBI enjoy a conditional “pass thro” tax status so that the income is not taxed at the firm level. It is taxed in the hands of the investor when it gets distributed. So if the investor stations himself in a tax haven like Mauritius or Cyprus, they escape with nil taxes. But it is biased against India based VC firms like ICICI Venture since the Indian investors in the fund would be liable to pay tax on their income either by way of LTCG or income tax depending upon the nature of its receipt.

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Debunking two chinese myths

Well, the media is chockfull of reports that China’s economy may not be as robust as it has been made out to be. But should anyone be smug about that? The facts seem to the contrary. The global growth have slowed down.

As is the other popular wisdom, Chinese economy is way too much dependent on its exports and is certain to suffer a dent because rich world’s finances are in trouble. Here again it’s a myth waiting to explode. It seems it’s got to do with the investment led growth and increased domestic consumption, two healthy indicators that drive the Chinese economy.

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My fuel hedge - can I mail my car?

The military situation in Iraq is arguably improving, and Iraqi oil exports are beginning to flow again. Tensions between US and Iran have eased a bit. There are forecasts for a mild late winter in the United States, which should help bolster oil and gasoline inventories going into the spring and summer driving season.

So, why are oil prices going up now…?

Experts say the answer lies in the investment decisions of traders and hedge funds. With the markets in equities, housing, credit and currency shaky in the United States, traders are betting on oil and other commodities as a perceived safe haven. Recent interest rate cuts by the U.S Federal Reserve had underscored for traders the depths of the country's economic risks and led them to buy oil futures.

Vinod Khosla must be a sad man. He has been spearheading the new energy initiatives together with his friends from PE ecosystem and has been making some significant investments in solar and other non-conventional energy sector like wind and biofuel development, but so far they are making only a slight contribution to energy supplies.

To those holding euros or yen, the weakening dollar makes oil and gold look cheaper; they can bid up prices in dollar terms without spending any more of their own currency. Moreover, gold, and nowadays oil too, is seen as a haven when the dollar is weak—so the latter’s drop may be accelerating the former’s rise.

Is there a way to mail my car with me inside? I am a poor guy. I don’t want to be poorer. So what do I do? I bought MRPL stock so that I can offset my fat fuel bill with gains from stock price. That’s my inflation hedge. What say you?

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Yet another swing against insider trading

In a move to curb insider trading, the Securities and Exchange Board of India (Sebi) today proposed that an `insider’ in a company should surrender profits made in any equity-based securities transactions of the company, if both the buy and sell side of the transaction are entered into within six months of the other.

This is the latest in a series of doomed legislations as I would call it. Insider trading regulations have failed to be effective because they seek to achieve the theoretical “level playing field” or “information democracy”. Is it not just human nature to take advantage of knowledge? Does it not happen in other walks of life? Imagine Californian gold rush. Did the first prospectors scream from top of the roof that they’ve struck gold? Should ONGC and Reliance alert other explorers to oil finds? Should we ban scientists from filing patents of their inventions? All these could be construed as insider information, in a way. We all take advantage of the information that we come to possess (with absolutely no sense of guilt) and why shouldn't we?

I feel so long as there are insiders, they will take advantage of knowledge they have access to. That is enterprise. In a way, by default, it automatically places all confidential, price sensitive information in public domain because when insiders buy, it reflects in a sudden spike in share price and volume of trading in that stock. If others are watchful enough, that acts as the best gauge of something brewing. Advanced corporations are now using internal betting markets to tell them what the official chain of command will not. They are inviting their employees to anonymously bet on when projects will really be completed. The results are more accurate.

Legislation have never been known to prevent white collar crimes, it has only stimulated creativity in criminals. Trying to ban it by legislation does not automatically mean plugging that hole and creating a level playing field. It would just tempt the shrewd insiders to devise ways to take a proxy route to exploit the opportunity.

Why don’t we look at it as one of those equity-efficiency tradeoffs? Sure, if we allowed insider trading, then prices would better reflect the firm's true value. But it would be a wealth transfer from price-sensitive traders to corporate insiders. What say you?

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New year, New avenues

I flipped the calendar... It's love all...

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SEBI presents us with a new investment avenue this new year... Real Estate Investment Trusts (REIT) – specialized mutual funds that invest only in real estate - are here. How well they suit the Indian market? How appealing will they be to our investors?

The way it is structured by SEBI, I think it will appeal to those who prefer bank fixed deposits than equity investors. Let’s look at the up and downsides –

a) Compulsory distribution of 90% of its income to investors. That means higher dividend yield and low scope for capital appreciation. This suits fixed deposit mindsets better;

b) An opportunity for small investors to capture the fortunes of commercial real estate market – something they can never dream of owning;

c) A new diversified avenue for investment in times of recession in equity markets; Right time to buy REIT units will be when the economy is slowly coming out of recession when its NAV will be low. That’s when businesses choose to expand and new businesses sprout up in new locations driving RE demand up; Ride the wave and capture the upside.

d) When interest rates are down, dividend yields from REIT units will be higher. Businesses shall borrow more and expand at new locations. Move your FD investments to REIT units.

e) Benefits of professional RE management.

f) Liquidity is assured since REIT units shall be listed at stock exchanges.

Now let’s look at its downsides –

a) Cyclical nature of its income stream. The investors ROI is dependent on the performance of RE market. That makes it risky especially if investors buy REIT units when RE sector is at its peak and will be victims of a bubble burst.

b) Being a close ended fund, REIT units cannot be safely held till maturity. It could be possible that the fund is closed out and units compulsorily redeemed when RE market it not exactly on an uptrend. Does not suit passive “buy and hold” type investors.

c) REIT funds provide a safe exit for early stage PE investors in a RE project. PE funds normally value their projects after discounting their earning on a forward basis. Therefore the investors in a REIT fund will not be left with much on the table when they bite in. That will expose them to the vagaries of RE market.

d) Bloated valuations commanded by early investors (including PE firms, developers) would drive up RE market to unsustainable levels. REIT investors will have to put up with poor dividend yield since they would be buying units at a high NAV.

I have not touched upon the tax issue since CBDT notification on tax treatments has not yet been finalized. I shall revert when it gets done.

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Smaller local deals - way to go in 2008

I am not surprised after reading this. Going by the frenetic acquisitions in the Indian pharmaceuticals space, buyout fatigue is but natural. The strain on the resources of the acquirer post event is phenomenal. The integration of two distant, culturally disparate organizations taxes even the most competent management. You’ve miles to go before the intended benefits of the acquisition – global footprint, larger scale and added market share etc., are realized. Some estimates put the success rate of M&A deals during the last 5 years as low as just 18% globally.

But I think it’s far easier to integrate businesses in the same geographies. You can safely discount the cultural diversity element that rocks many deals. They are relatively inexpensive and you can trust your judgments since you’ve been active in the same realm. You can easily upsell your existing products. It’s a win-win and a surer and safer bet than a big ticket, overseas acquisition, where any one of the brands could suffer a dent depending upon the perceptions that surround the deal. If there is one sure winner in a big ticket deal, it’s the I-bankers and the advisers to the deal. The buyer rarely wins in overseas buyouts.

But the record is so much better in strategies that advocate acquiring local brands and strategic domestic investments. I see that trend in Indian Pharma space now - changing their tactics to concentrate on brand acquisitions and strategic investments rather than risky big ticket cross-border acquisitions. Some of my friends in I-banking circles tell me it’s the best time to buy businesses in the US since Rupee is on a record high against the dollar. But I don’t buy that line. You should buy a business only if it’s a sure value add in the long term, because it’s a one-off, game changing stuff. Not just because you have a favorable exchange rate, as matters to the import of raw material / capital goods.

But then my friends are I-Bankers and it suits them well to take that line. They have to get by :)
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Who will be India’s REITmeister..?

So, who will be India’s Sam Zell? Any guesses…?

SEBI has recently nodded in favor of setting up REITs in India. The much-awaited Real Estate Investment Trusts (REITs), which would invest directly in real estate projects after collecting funds from investors through the stock exchanges, are set to see their entry in Indian markets with SEBI putting out draft rules for such trusts. The conditions include –

What interests me most is that even though FDI in real estate is still a much debated issue, Private Equity firms will get an easier exit route. Private equity comes at the beginning and it takes 5 to 7 years for the projects to get ready. Since FDI is not allowed in finished projects, REITs will provide them a platform to exit. When we reckon that over $6 billion have been invested by PE funds in Indian realty companies, entry of REITs are most welcome – for the fund managers….:)

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Many hues of the world

Tom Friedman got it all wrong. Had the world been as flat as he thought it is, why do they scrimp at one end and splurge at the other? In the US and Europe, they worry recession, credit squeeze and speculate the impact of mortgage crisis. In Asia, it’s celebration time. They raise funds from public markets as if there are no tomorrows. Take a look at this data culled from a report from E&Y.

Indian bourses saw over $8 billion worth of initial public offers (IPOs) in 2007, but this is just a shade higher than the world's single-largest IPO by a Russia’s VTB Bank, which alone raised $8 billion. Largest Indian IPO was that of DLF that raised Rs.91.87 billion. ($2 billion plus).

Worldwide IPO activity raised a record capital of $255 billion till November in 2007, including $8.3 billion on Indian bourses. India was the fifth largest market in terms of number of IPOs and the seventh-largest in terms of the proceeds for the year. There were 95 IPOs till November 07 as against 78 IPOs raising $7.23 billion during 2006.

China came out on tops with total IPO proceeds of $54.4 billion through 222 issues. Globally, there were as many as 1,739 IPOs between January and November, while another 91 public issues are estimated to have hit the capital markets during December.

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All happening while US and Europe are wilting under mortgage mess. Did you say we are globalized...?

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Tata-JagRover bet - will it payoff...?

“It is dangerous to substitute return on equity with business hubris when doing deals, and the whole thing had better make business sense” – goes T.N.Ninan of Business Standard on the Tata-Jaguar/Land Rover deal.

Ninan is sceptical even though Ratan Tata is getting both brands for $2 billion, much less than $5 billion paid by Ford to acquire them back in 1989 and further $10 billion that went into Jaguar to refurbish it. Rover is profitable, but Jaguar reportedly lost over $700 million in 2006 and perhaps over $550 million in 2007; it is expected to lose $300 million more in 2008. Rover sells close to 200,000 vehicles a year, but Jaguar sales have been falling quite sharply in its main market, the United States. He wonders whether Tata has bitten off more than he can chew. I am also reminded of Mitchell Madison and Whitman Hart deal where two billion $$ companies merged only to find the combined revenues were far less than $2 billion.

While Ninan concedes – going by earlier Tata buyouts overseas including Corus - that “Tata seems to have a good head for corporate strategy”, he doubts whether Tata would be able to achieve what Ford could not. He cites the examples of recent Sovereign wealth fund investments in Citigroup and Morgan Stanley (there are UBS, Merryl Lynch and Bear Stearns too) where the investors remain passive and would not insist on management control - but Indian acquirers love control. I say they have the chutzpah.

May be Ninan feels Tata could be in for a jam in this deal because of dealer perceptions, as he says “the people whom Tata would want on its side are the dealers in the US, but they seem to think Indian ownership is poor branding”.

My sense is that Ninan’s comparison of Tata-Jag Rover acquisition with fund infusion into American banks by Asia’s Sovereign funds is not quite up. Those funds are basically financial investors that focus on maximising ROI on their forex surplus as a part of their portfolio management strategy. To that extent, it's their fiscal management strategy too. They are concerned more about returns and not where it comes from. They simply don’t have the strategic bandwidth to take control and run diverse businesses that they invest in. Moreover, the managements of American banks like Citi, Merryl Lynch, Morgan Stanley are not bad by themselves going by the size and scale they've notched up. Just that they took a few bad bets that backfired. But that is to be expected because banking is indeed a business of betting on credit risks of varying degrees. What if those bets had paid off? But Tatas (and Lenovo example that he cites) are strategic investors with a track record of running global businesses and it’s not right to put them in the same basket as pure financial investors like wealth funds. The rationale behind their investments are fundamentally different. Tata would have certainly done their math and if the experience of Corus acquisition and its on-going integration is anything to go by, they would make the most of Jaguar-Land Rover deal too.

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Private life insurers - another scam in the making?

The private life insurance industry has sought an additional four-year grace period to carry forward its losses since most insurers have failed to break even, even after eight years of operations. At present, losses can be carried forward only up to eight years. The industry has also sought a separate limit u/s.80-C of IT Act for long-term savings.

But I chuckle and split my gut over something else. They face a problem which LIC never had. Current provisions mandate that insurance companies must list within 10 years of operations. Under Section 6AA of the Insurance Act, 1938, Indian promoters have to scale down their stake to 26% within 10 years of operations. This amendment is being considered by the group of ministers (GoM) set up to examine the comprehensive insurance legislation.

It's catch 22. Insurance companies, which are into their eighth year of operations, might not be ready to go public yet, since they are yet to break even. SEBI mandates a company may list only after three years of registering profits. Insurance companies, however, are already being valued at skyrocketing levels. For instance, ICICI Financial Services — the proposed holding company — has been valued at more than $10 billion post-issue. But its earnings are still negative. How did they get such a lucrative valuation? Who valued them? No answers.

That’s the catch. They've taken the extension of time beyond eight years for granted. Their hand picked I-Bankers have arrived at a valuation based on fees they got. But they can't justify that valuation now since they continue to make losses. If they go public now, they may have to pay the investors to buy their shares. It’s going to be eight years now and they are yet to break the stranglehold that LIC has over its customers and turn cash flow positive. Meanwhile these guys spend millions on advertisements to spread insurance awareness. But clearly, it's LIC that's getting the mileage.

Going by the trend, they will not make a profit in another 10 years or so. So their strategy is, keep running to the government for extension of time. The question is, how long should the government forego its tax revenues to subsidise private insurers’ poor performance…? What public good do they stand for? Should the government wimp out just to enrich Indian promoters when they off-load their stakes? How else do you define a scam?

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Mr.Chidambaram, don't you see the bullshit meter turning red...?

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Never play a stock ; Play the analyst...

Ok, scumbags. You didn’t listen when I tipped you in on Sugar stocks. Now grieve. No, I don’t look at fundamentals. I don’t look at technicals. That’s for friggin’ chartists who make a living by staring at computer screens and fooling the world with their harebrained forecasts that never come true. They work for an end of month paycheck and commissions. You and I bet our hard earned money on the stocks that these guys `think’ would go up… If you do, you’ll be getting out soon. Out of this game.

In India, you bet on politics. I always do. I bet on the minister. More influential he is, more loyal his voters are. That's why I tipped sugar stocks. Look at this “sweet” guy Sharad Pawar, Agriculture Minister. He answers my wish list to the T. I know how his mind works. I’ll share it with you. This guy loves just two things - the sugar belt of Baramati and BCCI, one of world's richest sports (Cricket) bodies. Let’s keep cricket out for the time being. The folks over there at Baramati, eat sugarcane for breakfast and molasses for lunch. They sleep on mats made out of cane leaves and wear sugar coats for dinner. They don’t drink water, they feast on cane juice. They all die of diabetes and the chemists there have made their fortunes just by selling insulin. The only thing they know is to vote this guy Pawar back to power. That’s it – isn't it simple enough? Either they are at the cane fields or at the polling booth. That's how they lead their lives. He will give us more of good news on Sugar because he needs those sugar coated votes. The folks at Baramati don’t vote if it isn’t dude Pawar’s name on the ballot. So I say, buy sugar stocks. As much as you can. I do. Never sell your sugar stocks so long as you got this Sugar Daddy at the top and as long as analysts keep talking it down. Sell them only if pawar man leaves the deck or when analysts talk it up.

Now mill owners, keep a steady supply of Ethanol even during weak season. Daddy will hike the blending ceiling from 10% to as much as you can make. He’s struck a deal with that Deora guy at Petroleum ministry. They’re on phone all the time. When they meet in public, they wink and nod a lot. Export subsidy? Granted. Kamal Nath won’t object. A deal there too. Co-generation ? Go ahead. Life’s good. That's my fundamental and technical analysis for you. What say you...?

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Don’t believe a word those friggin' analysts say. They all will trash a sector while their broking bosses are stocking up on it. When they’ve had enough, they’ll talk as if that’s going to be the next big thing. That’s when you should dump your stocks and rip those suckers.

Don’t play the stock. Play the fuckin' analyst. You heard me….!

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IFCI Snafu

It's all badly fucked up at IFCI.

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If I were the FM, I would say this to IFCI management -- "Get that sand out of your cracks, guys. This stuff is hard work, now don't botch this up".... You should see the muck that gets raked over by our guys at IFCI that screwed up the Sterlite-Morgan deal. Let me put it this way. Some of its Board members aren't going to see such cushy jobs ever again. Too many perks for running a company aground. Then the government steps in with some concessions. As if by godsend, the real estate market too turned hot and suddenly the textile mills and other companies owning large swathes of land or belonging to sectors in the limelight (a la steel and cement) in IFCI's long NPA list became highly valued - by default. Now the jokers in IFCI board want to claim credit for turning it around when in fact, all they did was to try and turn it upside down – something that they almost accomplished. Someone in IFCI told me these guys pop a Viagra a day even to get up and walk straight....

Now they also want private investors to buy 26% but can’t let go off management control. If you add in the additional 20% public offer the investor will have to make, the new investor will end up holding 46% stake in the company for just 25% of management control (just two out of eight board seats) and no rights to appoint CEO. Now who will agree to that?

IFCI stock had lost 23% in the markets on Thursday. What if it were a Private sector management that announced the deal, named the bidder the day before and screws it up the next morning…? SEBI will be all over them for misleading investors for talking up and spooking the market intentionally.

Next time IFCI has a suitor, I suggest go put shock collars around its management. If they try to act up, they get through the invisible fence -- boom. Unconscious. They wake up in some casualty ward, never to be back at their desks again.

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Infrastructure revamp...? Plan for relocation too

Vinayak Chatterjee has a nice take on new measures required to catalyze badly needed infrastructure investments.

Chatterjee has cited several refreshingly fresh initiatives included in two special committee reports DPCR and SCR.

But aside of what is contained in that summation, not just the socialist in me, but the sensible capitalist also still don’t see how they are going to relocate those who get displaced when new infrastructure comes up. You invest billions of dollars in creation of new infrastructure and don’t plan for relocation of those that used to make a living out of the pre-displaced environs and that’s terrible. In China, they are facing a backlash because of this. Let’s not repeat it in India because here we don’t rule with an iron fist. Our governments live from election to election or worse till a mid-term poll in these times of coalition governments.

The short sighted acts like this breed Mayawatis and C.K.Janus here… The former wanted to build shopping malls around Taj Corridor (and gobbled up Rs.1.75 billion in the process) and the latter defiled the pavements of Kerala Secretariat. Haven’t we had enough of them and their antics…?

Please.

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The in and out economy

First we raced to globalize. Then we hurried to decouple. But did we…? If so, why this…?

Will someone please give me a new expression…?
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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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Friendly rip-off

So you’re puzzled why your trades in T segment always face “technical snags” and the shares never get delivered on the 3rd day. Here is why.

Every transaction in the ‘T’ group has to compulsorily result in deliveries; the buyer or seller cannot square off his position intra-day. Often, many sellers are unable to meet their delivery obligations for a variety of reasons. Unlike in other segments, T segment stocks are not auctioned. The seller’s positions are *closed out* by levying a 20% penalty on the seller that gets credited to the buyer, to make up for non-delivery. So if you buy a stock for Rs.100 on Monday and the seller fails to deliver, on Wednesday, you’ll get a credit equaling 20% of its Tuesday’s closing price. If that is Rs.90/-, you'll get a credit of Rs.108/- (120% of Rs.90)

Here is where the *friendly* broker rips you off. On the settlement day, the broker gets the details of his pay-in and pay-out obligations on his work station from the exchange at 1:30-2:00 pm. Occasionally he will find that some of the purchase positions of his clients in ‘T’ group shares have been closed out, and the prices of those shares are now trading at a price lower than what his client had bought them for. He then buys those shares at low prices and credits them to your account. In the process, he gets to pocket the Rs.18/- differential credit from closed out positions that originally belongs to you.

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Now you know how brokerages quickly get into billion $$ leagues....

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Controlled bleeding or cauterization...?

Agreed, not so upbeat title for an Economist story with no hemal touch. But as an opener, it isn’t entirely out of place either. The metaphor fits in water tight. Excerpts -

"That was the unappealing choice facing UBS, a Swiss bank which has been badly hurt by the carnage in America’s mortgage market. Today, the bank opted for the latter. First it opened the wound, by announcing a hefty $10 billion write-down on its exposure to subprime infected debt. UBS now expects a loss for the fourth quarter, which ends this month. It may end up in the red for the entire year. Then came the hot iron: news of a series of measures to shore up the bank’s capital base, among them investments from sovereign-wealth funds in Singapore and the Middle East."

[It started with Merryl Lynch, then Morgan Stanley and Citi Group bringing up the rear.] "Why then did this new batch of red ink still come as a shock? The answer lies not in the scale of the overall loss, more in UBS’s decision to take the hit in one go. The bank’s mark-to-model approach to valuing its subprime-related holdings had been based on payments data from the underlying mortgage loans. Although these data show a worsening in credit quality, the deterioration is slower than mark-to-market valuations, which have the effect of instantly crystallising all expected future losses."

Will this bloodbath end, ever…? Loss of reputation for a conservative bank like UBS is deep enough cut. What is worse is the impact that has exposed the fluidity of its capital adequacy ratios at the tier 1 level. Of course, it has rich friends ready to pitch in. The white knights include sovereign-wealth funds (GIC, Singapore) and rich middle east investors that have pledged support to shore up its bottomline by infusing SFr 19.4 billion. Marrying bigger-than-expected write-downs with bigger-than-expected boosts to capital looks like the right treatment in this environment. But UBS still cannot be sure that its problems are over.

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The box needs fixing

So Deloitte runs a survey on the potential return for PE firms in India, going forward. It says Global private equity firms are expecting lower returns from India in the next six months as a booming economy and stock market drive up valuations. The basis ? Callow statements like this - “There is no more low-hanging fruit. India has been discovered. We will see more moderate – 20-25 per cent – returns going forward.”

The PE firms can do with a bit of open mind and flexibility. They have to innovate and adapt. You can’t make money in India by just transposing the same business process that are followed in the US or Europe. Result – they keep whining on their clichéd gripes (a) ban on leveraged buyouts (b) families that own businesses are reluctant to sell (c) restriction on issue of convertible preference shares and other regulatory impediments.

That puts me in a mood to quip.

Take gripe (a) – leveraged buyouts are banned. So what? That's why we didn’t have a credit crisis and points to a credible lending process that insulates Indian banks from global crises. The fact that doubtful debt can’t be bundled with a good credit risk and palmed off to unsuspecting bond investors is a sign of systemic maturity. [Indian banks faced a crisis 10 years back when most of our PSU banks had high NPAs because major borrowers didn’t repay. They siphoned the funds to build their personal assets even as their companies were going broke. Now that's plugged].

On gripe (b) families don’t sell out - because they feel one of them will be shortchanged in the process by the dominant share owning family member. Search for recent scuffle at Patni (computers) and Bajaj (Auto) families. The strategy here for PE firms is to get upclose with the family and broach the subject thro an investment banker that is close to the management. Choose the wrong messenger and you lose the deal. For that you need someone that is pretty much clued in… Why not me? Yeah, You can try.

The gripe (c) is on choice of instruments. Yes, convertible preference shares have been banned in construction and real estate since PE firms took that route to breach the FDI limits prescribed for the sector. PE firms lent against convertibles and the money was never repaid. In effect it was indirect infusion of equity since the loans were convertible into common stock. They used that to jack up their stakes in real estate companies that had huge land banks. You try to break a law and you're sure to be canned. But they can pitch for specific projects. Use a strategic investor, that is a professional consulting / EPC firm that can capitalize (thereby part-fund) the project cost. There are several other ways but then I can't blog everything here. I need to make a living too, pal....

If you are creative enough, there are ways to have the cake and eat it too… I’ll tell you what’s the problem. Investment banks don’t innovate. They just want to ride the coat-tails of their colleagues in the west. No, I am not asking you to start thinking out of the box. If one has to do that often, then the box needs fixing. It's a bit like walking between raindrops, agreed. Or a closer parallel will be learning to drive on a pot-holed road without getting a flat tire way too often. The day you get it right, you'll sight opportunities here all the more.

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Back to gold standard...?

Here is a new insight into our swelling foreign exchange reserves.

The frenetic build-up of forex reserves has lost pace with reserves growing by only $1.2 billion during the week ended November 30 to $273.5 billion. Of the $1.2-billion increase in reserves, $546 million came from an increase in the value of gold. The increase in foreign currency assets was just only $694 million - according to the figures released by the Reserve Bank of India (RBI) in its weekly statistical supplement (WSS).

The RBI has the challenge of maintaining the desired level of liquidity in the market, which it has been through sale of bonds. But this too entails a cost as these bonds need to be serviced at fairly high rates.

Should RBI dump the dollar and switch to good old gold standard, at least a part of its kitty…? If you look at the way the dollar is plunging against global currencies, it makes awesome sense….

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Don't hire an engineer when you need an accountant

Ashish K Bhattacharya rants on the poor accounting literacy of MBAs. He seems to be quite modest in that he restricts it to students not wanting to specialize in finance; but I go even the specialists are no better.

Map it to reality. It’s almost six months since MBA bankers in Wall Street began counting losses on CDO’s built into sub-prime mortgages. Heads roll, albeit with bumper payoff. Numbers fly. Here, here and here. But they’re still counting. Most of these MBAs have engineering background and they are supposed to be good, sorry; brilliant at math….!

But look at what these “financial engineers” have done to the credit markets. They invented the time bomb – subprime derivative time bombs I mean. The exotic derivatives that the MBA designed, called CDOs kept all liabilities off balance sheet and investors had no idea what they were letting themselves in for if borrowers go broke. They did and that’s why they are still counting.

This is the leitmotif of this whole thing: Half baked MBAs played havoc with mortgage banking. They write loans just to build the book, thinking they will worry about risks later. But now it's later.

Financial Risk management has long ceased to be the preserve of conscientious accountants that feared risks, knew the law, respected disclosure, and lost sleep over declining ROI. Now it’s the domain of MBAs that contrive fabulous stock options and packages for themselves. Or worse, it’s usurped by robots and algorithms. That’s how it becomes financial engineering. Shareholder who? They ask. Look at the exotic derivatives that hid more than they revealed. A shareholder is often the last to know the exact liabilities of the business, a piece of which he actually owns.

Hire MBAs by all means. But make sure they have their fundamentals right and their feet stays rooted to the ground.

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Bihar shows the way...

To attract investment in sugarcane-based industries, the state government amended the Bihar Sugarcane (Regulation of Supply and Purchase) Act, 1981, earlier this year, allowing sugarcane juice to be directly used to produce ethanol or rectified spirit and for co-generation of power. For sugarcane-based industries,the state is also offering a capital subsidy of 10 per cent of the investment, subject to a Rs 100 million ceiling.

Result –

Reliance Industries, Tata Chemicals, Bharti Enterprises’ Fieldfresh and Indian Oil are among several large companies that have evinced interest in leasing closed sugar mills that the Bihar government is offering, mainly to exploit opportunities to make ethanol to meet mandatory petrol blending norms that were introduced this year. Other companies that have acquired the request for qualification (RFQ) forms are public sector Bharat Petroleum and Hindustan Petroleum, and Renuka Sugars, Upper Ganges Sugar, Dhampur Sugar and India Glycols.

Closed for more than a decade, these mills together have a financial liability of Rs 700 crore under various heads and the funds raised by leasing them will be used to clear the liabilities. Last month, the Bihar government decided to offer 15 closed mills belonging to the Bihar State Sugar Corporation on a long-term lease of 60 years, extendable by 30 years, on the recommendation of SBI Capital Markets. Of the 15 mills, eight have been reserved for sugarcane-based industries such as sugar mills or distilleries for ethanol or alcohol production. The remaining seven can be used for industries that may not be sugarcane-based.

A pre-bid meeting is scheduled on December 8 in New Delhi.

Contrast this to what happened in UP that prompted me to send out a wish list. And we call Bihar backward…!
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Gisele Bundchen should stick with me

I am concerned for the stunning super model Gisele Bundchen - not that she’s losing any of her luscious curves. She’s sexy as ever. But just how wise has she been in switching to Euro?

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Even Central Banks, having spurned the chance to diversify out of dollars when a euro could be bought for 86 cents, are unlikely to want to switch now when the price is close to $1.50. Against conventional benchmarks like purchasing-power parity, the euro looks dear against the dollar. So it could be a bad time to swap from one horse to another.

The Economist concludes a full blown dollar collapse could be disastrous. What lends the dollar's decline an air of crisis is that the world's bloated currency reserves are crammed with depreciating dollar assets. Foreign-exchange stockpiles have almost tripled to $5.7 trillion since the beginning of the decade. China alone has $1.4 trillion of reserves. Japan's $1 trillion or so make it the second-largest holder. To the extent that dollar-holders act like an informal cartel, the biggest dollar-holders will set an example. Japan seems unlikely to start selling its huge dollar reserves—if anything it might intervene to prevent the dollar falling further against the yen. A crash might be averted if China holds fast too, because it recognizes how self-defeating dumping dollars would be to such a large owner of American assets.

In this period of swelling reserves, the dollar has retained its pre-eminence. It still accounts for nearly 65% of identifiable currency-stockpiles, according to the latest IMF data. This is broadly in line with its historical share. Factor in the dollars hoarded by China and Middle Eastern oil exporters (not included in the IMF breakdown) and the dollar's share may be higher still.

The dollar's place as a reserve currency always seems to be questioned when it falls. Weakness in 1977-79, 1985-88 and 1993-95 was each time met with predictions that governments were about to switch their reserves into another currency. A burst of high inflation, which undermined the dollar in the late 1970s, made that slide as serious as today's scare is. Between 1978 and 1980 the Treasury sold $6.4 billion of “Carter bonds”, mostly denominated in Deutschmarks, to raise funds to defend the dollar. In January 1980 the gold price reached a record $835 (around $2,250 in today's prices) as investors sought an alternative store of value. And when the dollar fell to ¥81 in 1995, many—including the Economist —saw it as the beginning of the end of its reserve-currency status.

So I lay my bets on the greenback still. Someone please ask Gisele to stick with me -)

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