"Let go off all controls, Sardarji (and Pawar boy)"

Why do I welcome decontrol of sugar? Because I have a huge position in sugar stocks in my portfolio :)

That aside, here I found a great ally in that argument. The ET editorial goes controls hurt farmers and industry too. It says our sugar sector has to be freed because –

a) Nearly every aspect of the sugar economy is controlled, often on mistaken assumptions.

b) Ill-timed policies – The govt. banned exports of sugar in 2006 when the global prices were high. That led to a local glut and non payment of farmers’ dues. Govt. can’t fix high cane prices (inputs) and seek to keep product prices low (output) as well. How will the mills pay the farmers?

c) Outdated inflation index - Sugar has to figure low in the inflation index because it is no longer an important household expenditure item. Bulk of the sugar consumption is in the industrial sector. Remove it from the list of essential commodities and treat it like any other product.

d) Meaningless restrictions - Remove distance restrictions between mills. It helps competition and results in efficient price discovery.

e) Lifeline for moneylenders - The statutory minimum price (SMP) for sugarcane and the higher state advised price are fine in theory but do not necessarily protect the farmers. If the mills don’t make profits, they can’t pay farmers on time. This tempts them to get the cane receipts discounted in the market, leaving the local moneylender to make the most of the situation.

So, Dr.M.M.Singh and Pawar boy should sit together and let go of all controls. This is one industry where there is no wastage. Bagasse is used in power generation and molasses is used to make alcohol. Then you have ethanol to mix with petrol to lessen the import bill on crude oil that is inching towards $120 a barrel.

So do it quick. I’ve tipped sugar to my readers earlier. Let me feel like a king :-)
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Differential CRR? That's financial racism.

Finance Minister Chidambaram has a pet peeve. When inflation goes up by a few ticks and he turns to RBI governor Y.V.Reddy for advise, the guv is equally clueless. He knows nothing more than to hike CRR by 25 bps.

A hike in CRR by two tranches of 25 bps each from 7.5% to 8.0% was announced recently by the RBI to suck out excess liquidity from the banking system. But is that enough? It is this predictability that erodes the significance of RBI moves on the economy itself. But stock market nevertheless looks to RBI for direction.

This morning I found Ashok Khemka arguing for nuanced CRR Policy. His key points –

a) Why impose a flat CRR of 8% on all banks’ deposits that looks like a virtual tax? It’s only the sinning few that is responsible for incremental foreign exchange that adds to liquidity. Deposits in domestic currency do not damage the economy. So why not switch to differential CRR on selective foreign exchange inflows (NRI deposits, FII / PE / Hedge Fund inflows) only?

b) Sterilization (mop up of foreign currency by RBI from open market) initiatives have become expensive as reflected by the rise in T-bill yields from 7.4-7.6% from 6.6-7% as was earlier. This taxes the entire economy for the sins of a few.

c) Levy the higher CRR in the designated currency itself. This obviates RBI having to go in for forex mop up later to maintain the exchange rates. RBI can also make that currency reserve available to the needy to buy assets abroad and negates any adverse effect from currency mismatches in international trades.

Great points. But I see those recommendations calling for containment of liquidity by slapping penalties. It is not equal to identifying a mature mechanism that uses the liquidity inflows which is the need of the hour. It amounts to saying `No’ and that is the easiest part. I would look for ways to use that liquidity into creating better infrastructure before foreign investors find another profitable destination outside India. Money is fungible and investors don’t waste much time if they feel they are not welcome here.

Differential treatment is bad. It will mean financial racism. Never do that. Get smart and keep giving them those incentives. You can make hay only while the sun shines on you. Now it is sunny days for emerging markets, especially us. Don’t get smug. Go build better roads, dams, bridges, airports whatever. Don’t slam the door shut on investors. Remember what made Dr.Manmohan Singh open up reforms gate in 1991? We were almost broke. Now don’t get to that point again!

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"No, thanks Ms.Kochchar"

Chanda Kochchar, JMD and CFO of ICICI Bank put up a brave face while announcing her bank’s Q4 results.

This is how she defended additional provisions (in Q4 accounts) because of her bank’s MTM losses in the US – “"We have no sub-prime assets but only exposure to CDOs and CLNs. We have seen no deterioration of our portfolio. The provisioning is only for the MTM losses due to widening of credit spreads. In fact, post March 31, the credit spreads have tightened and we have made a saving of $16 million (Rs 64 crore)….”

In lay terms that means – We haven’t directly make any loans to risky homeless borrowers in US. But we financed some of their crafty lenders by buying their CDO and CLN. Our losses are already deep, so no scope for further plunging. Still we see only a mild recovery, so we prepare you for the worst now so that our shareholders don’t get mass cardiac arrests later. We never hoped the market will improve, but there is a little blip on the screen which we sincerely pray isn’t a dead cat bounce.

ICICI Bank's total exposure to CLNs and CDOs was estimated at $1.6 billion (Rs 4,240 crore), comprising 70 per cent of Indian corporates. The bank has seen an 8 per cent rise in provisions during the fourth quarter to Rs 948 crore, as against Rs 876 crore during January-March 2007. Most of the other private sector banks, such as Axis Bank and HDFC Bank, have seen significant rise in non-tax provisions and contingencies mainly due to provisions for derivatives. ICICI Bank, however, did not disclose the details of its derivative deals.

The bank's net interest margin (NIM) stood at 2.40 per cent as against 2.28 per cent in the corresponding quarter last year. Its cost of funds (COF) has eased to 7.4 per cent from 7.5 per cent. Net non-performing assets to advances increased to 1.55 per cent from 1.02 per cent. Its capital adequacy ratio stood at 13.97 per cent.

Now wait a minute. That NIM pricks me. If the bank’s COF is 7.4% and NIM is 2.4%, why do they choke my mail box with personal loan offers at 15% + processing charges of 1.5%? That means their overheads are unusually high at 5.2% (15% - 7.4% - 2.4%). I can live with their administrative costs of say 2% more, so it should come to me at a cost of 12% (COF 7.4% + NIM 2.4% + 2% admn. cost) at the most. ICICI marketing should have an enormous resilience to resist its CRM analytics that signals “here’s a good credit risk. Lend to him at 12%”

Poor chaps at ICICI marketing can't do much if their super intelligent bosses decide to screw it all up by financing bad lenders in the US and thought they could pass on the cost of such hits to low risk clients in India. That explains the 3% loadings (offered interest of 15% - optimal interest of 12% at which I would’ve taken the loan) they try to push down my throat.

I say “No Thanks!!!”

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"Happy Birthday, Krish" - with love from PMO

Felt really sweet this morning. Here is why. The best birthday gift from the Government of India. Finally they chose to free sugar industry from its clutches of control. Hope it comes through.

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The liberalisation will mean mills will be able to sell sugar freely in the market. With no cane area reservation, no price controls, no levy obligations, mills will benefit from a direct link between the prices of cane and sugar. The matter is now under the consideration of Prime Minister Manmohan Singh.

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I see sugar stocks gathering momentum. Precisely the moment I've been waiting for ! If you'd listened to my earlier missives, you too should rejoice :) If not, go buy sugar stocks now. My fave is KCP Sugar Industries. Super stock.

Here are my earlier takes. Have loads of fun - if you are well stocked up on sugar stocks as I am :)

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SEBI in a hurry. Did PMO ask for "status report"?

SEBI today unveiled the guidelines for real estate mutual funds (REMF). For SEBI it’s another feather in the cap. Or is it another job done?

THE FINE PRINT

 Real estate mutual fund schemes can only be close-ended, listed on recognized stock exchanges
 At least 35% investment in ready-to-use projects mandated
 Investment in real estate assets, securities (including mortgage backed securities) capped at 75% of the net assets of a scheme
 Caps to be imposed on investment in a single city, project, securities issued by sponsor or associate companies
 Fund houses need valuation by two valuers every 90 days from date of investment
 Mutual funds cannot transfer real estate assets between schemes
 Have to declare daily NAV

Some doubts still persist.

Does SEBI have the expertise necessary to regulate murky real estate sector? Talk of defective title deeds, dated survey / registry documents, arbitrary valuations, diverse stamp duty assessment norms etc. Investors should do well to approach it with care. I would say “avoid”. It only intends to provide liquidity to developers that have bought land at astronomical prices. Now future cash flow from executed projects depend on affordability of buyers.

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Then two valuers declaring valuation every 90 days. Is it possible in a RE fund? The underlying prices may not vary in that frequency at all. What could be the benchmarks? Who will supply data given that most deals are done on part cash, part cheque basis? Now wait a minute. Don't we clearly see seeds of subprime mess being sown here? Creating layers and layers of instruments that eventually masked the real borrower to the bondholder. Will there be a housing loan waiver like a farm loan waiver? Hope someone nips it in the bud before investors - that have little or no way to discover the ture value of the underlying - burn their ass.

Inflation recently crossed 7%. Global liquidity crisis is not yet completely off our back. Has PMO sought status report from SEBI to *save* the beleaguered sector? We live in times when ministers put in a “friendly word” to cabinet colleagues to “save” companies in trouble!

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UTI Ventures' dilemma

"Oooops... I got out! Ok. Let me re-enter..." seems to be the credo surrounding the euphoria around UTI Ventures exit from Excelsoft with 50x returns.

The report says

“Excelsoft posted a net profit of Rs 25 crore on a topline of Rs 50 crore. Sources further indicated that UTI Ventures, in addition to selling its stake to D E Shaw, has invested a further $5 million in this firm at its present valuations.”

Now that’s mysterious if not surprising. Funds exit a venture if their investments fetch valuation far in excess of their internal estimates. In that case, UTI ventures should have just sold its stake and not buy more into the same venture. But here it has done precisely that. What could be the reason?

I think UTI ventures, with the global liquidity crunch and Indian IT vendors giving out cautious guidance, could be a bit unsure of how the company’s fortunes will fluctuate going forward. US Dollar has also been declining much to the dismay of many s/w exporters. So why not lock down the premium that is on offer and still to hold a foot in the door, let’s keep some stake in. The company is operating under 50% gross margins as well.

UTI Ventures’ sell-off pips other big exits in the private equity space like ChrysCapital and Citigroup Venture Capital making 26-30 times their investment in Suzlon Energy, and Baring India selling its 34.73% stake in MphasiS BFL to EDS at about 25 times its initial investment for Rs 1,150 crore. Gaja Capital had monetized its investment in learning major Educomp Solutions by 22.5 times, while ICICI Ventures’ exit from Infoedge (Naukri.com) fetched it 17.5 times higher earnings.

Major players in the education space in India include Educomp Solutions, Everonn Systems and Core Projects & Technologies. The Aditya Birla Group recently picked up about a 5% stake in Core Projects & Technologies for Rs 13.5 crore. Last year, Gaja Capital Partners invested $8.25 million in education support firm Career Launcher. Mauritius-based India-focused fund Helix investments put $12 million in tutorial firm Mahesh Tutorials Educare while SAIF Partners invested $10 million in English training academy Veta.

I look at trailing 12 months P/E of some of its peers listed in Indian exchanges. Educomp solutions (99x), Everonn systems (111x) indicates a strong growth potential for Excelsoft. Why UTI Ventures had been in such a tear? Have some of their limited partners been breathing down Raja Kumar's neck? Quite likely. We haven’t heard any major exit by UTI Venture for a long time now.

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All floaters. No Directors in PE funds.

Private Equity players have been swimming naked. The tide went out and all of them are left clutching their balls. Will the reign of mediocrity in India's PE funds end with this? Or will they still fancy dim witted B-school graduates that acted worse than average Dalal Street operator?

DNA Money analysis shows that, of the 51 PIPE deals in India in 2007, 33 have lost money. That's more than 60 per cent of the transactions. It means two-thirds of PIPE deals are out of money. Check out the big names.

Baring India's stake in JRG Securities is the worst hit, its worth having eroded 71 per cent. Others that have lost more than 50 per cent due to the recent market meltdown are Nalanda Capital in Vaibhav Gems, Al Anwar Holdings in Almondz Global Securities, Fidelity in BAG Films and Media, Orient Global in India Infoline, ADM Capital in Rama Pulp & Papers and Macquarie and Credit Suisse in Sical Logistics.

Deals consummated in 2006 also tell a similar story. Almost 40 per cent of them, or 17 of the 41 PIPEs, have lost money.

Capital International's stake in McLeod Russel India, Carlyle's in Allsec Technologies, Future Capital's and Reliance Capital's in Maxwell Industries, Goldman Sachs Investments' and Voyager Fund's in Spentex Industries, New Vernon's in JB Chemicals and Unichem Laboratories, Clearwater's in Kopran, ICICI Venture's in Geometric Software and Gateway Distriparks and General Atlantic's in Hexaware Technologies, are some of the investments whose values have eroded over 50 per cent from the time the funds invested in them.

It’s time for Indian PE managers to get back to basics. They should shun fancy "Director" designations. They have so far directed nothing. They were all drifters with market sentiment. Should call themselves exactly that or "floaters" as aptly defines their passive roles. Time to unlearn B-School gibberish and start focusing on "uncool" stuff like production, distribution and profitability.

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Better the land prices sink

The official line of bullshit from Real Estate developers is that slowdown is only in residential segment; commercial properties are still in demand. I said cheese off!

Now hear it from the Future Group CEO Kishor Biyani –

“We are about to conclude two deals where we do not have to pay rentals for three years” – No rentals for 3 years? Huh? Hear more. He only expects surplus space to be larger in 2009. Why shouldn’t he?

The man who started off India’s retail revolution can’t be wrong. I don’t want him to be. Real estate in a third world, infrastructure starved, poverty ridden country like India shouldn’t be costing so much. Look at wafer thin retail margins. Can they be housed in expensive real estate? I can understand if India’s IT vendors that once enjoyed a margin of 35% did that. Now dollar has tanked and their margins have also been hit. Uncertainty looms everywhere. Why should real estate be any different?

The land prices/rentals have to sink, otherwise the structures they erect over the land will. You like that?

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Man up, brokers....

Warren Buffet said “You only learn who has been swimming naked when the tide goes out - and what we are witnessing at some of our largest financial institutions is an ugly sight." He was referring to Wall Street I-Bankers pummeled by liquidity crisis.

Closer home, we've got something brewing of the sort... Some of India’s leading brokerages that suffered huge losses in the recent market crash are postponing declaration of Q4 results. Why do they hide behind legally permissible extensions...? Is it not the same tribe that talked down many a stock and businesses that delayed publication of quarterly numbers? Now how ugly they look in the mirror?

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It's time the big boys learned to man up!

Here are some of the big names (Motilal Oswal, Edelweiss, Religare and so on…) struggling to cover their asses :)

Here you have some of my takes on their analysts.

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Vultures waiting to scavenge big builders

Total chaos in the real estate market; but big builders won’t admit!

According to recent reports, home sales have dropped 20 to 30 per cent since last December in the metros. The higher discounts and more sweeteners (now offered by mid-sized developers) are seen as the first sign of a correction looming. These discounts should bleed them badly if seen with the huge interest cost they have to bear on borrowings for funding the race for high cost land acquisition amongst the big developers that was on till recently.

Now the big builders will tell you the slowdown is only on the housing front. For commercial properties, it is business as usual. They want you to believe that. Weak dollar has broken the back of IT and BPO/KPO businesses – the two huge consumers of bulk commercial real estate. Now they are looking at increasing productivity rather than adding to headcount – needing less and less real estate.

Then there is the incremental supply to deal with. Other businesses like textile mills and manufacturing units are fast closing shop in cities [because of falling revenues and higher operating costs] freeing up priced real estate for development. That augmented supply dents the cost of real estate further down.

The excesses of recent years have sucked out the entire liquidity from real estate players. They stretched their finances too thin to buy high price land and now when there is a global liquidity crisis, they are falling short of funds to execute their mega plans. Sample this -

Earlier in 2006, Unitech outbid India’s largest real estate company DLF to bag the 340-acre city development contract in Noida for Rs 1,583 crore. Other landmark deals include DLF buying prime Swatantra Bharat Mills land in Delhi from DSCL for Rs 1,675 crore in 2007; Unitech bagging 1,750-acre plot in Vishakhapatnam for Rs 3,228 crore in 2007; sale by Mumbai Metropolitan Region Development Authority(MMRDA) of nearly 75,350 sq. m. of land in Bandra-Kurla Complex for a total of Rs 2,798 crore in 2007. City-based developer Wadhwa Builders had paid Rs 5.04 lakh per sq. m. for the 16,500 sq. m. plot auctioned by MMRDA, marking the largest-ever deal on the basis of the value per sq. m. Wadhwa paid Rs 831 crore.

With rising price in steel and cement, construction costs have shot through the roof. The budgets of builders, both big and small, have gone haywire (now it hardly covers 11% lease rental + 8% stamp duty) and they will soon enter the despair zone.

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Vulture funds can't wait to feast on...

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Little steps that matter

Forget the big sugar mills. They are busy fixing their forex gaffes with bankers. It’s the rural sugar farmers’ cooperatives that get innovative in their efforts to beat the glut.

Satara-based Veer Kisan Ahir Sugar Cooperative (VKASCL) has signed a MOU with the German bio-fuel company, Biogas-Nord, to set up the country’s first plant to produce CNG from spent-wash, a by-product. It is a semi-solid waste and its disposal is agony for sugar manufacturers. Biogas-Nord, aided by Elephant Equity PE fund plan to set up a Rs.27 crore plant to produce CNG equaling 7,000 liters of diesel per day. VKASCL will make available land, infrastructure and raw material for the project and, in return, Biogas-Nord will give 5 per cent commission to the sugar cooperative on total sales plus royalty on raw material.

Facing massive over-supply, sugar industry globally is in shambles. The only way to stay competitive is to invest in innovation, discover alternative uses for the crop – power generation, ethanol and biogas fuel production. The costly crude oil [$100+ a barrel] is clearly unaffordable, yet continues to power vehicles, run factories and heat up cold homes. With an oil guzzling world desperately searching for alternatives, every little step helps.
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Suresh Krishna is a safe bet

Suresh Krishna, Chairman and MD of Sundaram Fasteners Ltd., is a shy industrialist. You hardly hear of him outside the industry circles. Yet he delivers, year after year to all his stakeholders.

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Here he is, pulling straws quietly from under his hat.

TVS Logistics Ltd., part of $5 billion TVS group has raised private equity of Rs 100 crore from Goldman Sachs to support its expansion plan. It plans to grow its presence finished goods transportation segment inorganically. TVS Logistics Services is also into commutation solutions for staff transportation and seeks to expand its current fleet strength from 200 buses to 1,000 buses within next two years. Currently TVS Logistics and its joint ventures turnover was around Rs 340 crore. Domestic business contributed Rs 240 crore, while its global business contributed Rs 100 crore.

I’ve been a long term investor in SFL and Suresh Krishna has never let me down. I wish him good luck with his TVS logistics venture as well. My bets are on his scrupulousness and diligence.

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Hangers in don't have it easy

Orchid – Ranbaxy saga has sent chill down the spine of many owners that hang in by the teeth of their skin in drug companies. Dr.Reddy’s Labs, Strides Arcolab among the few.

Promoter group in Strides holds just 18% in the Company and is reportedly stalked by Nicholas Piramal. Recent market crash has knocked down stock prices by over 40% making it easier for raiders to ramp up their stakes. Promoters of DRL hold about 25%.

Market decline exacerbates their vulnerabilities. Shares in Orchid had dropped sharply after Bear Stearns, the troubled Wall Street Investment bank, was forced to quickly sell Orchid stock in the midst of the credit crisis. During the recent crash, stock brokers who held orchid shares on behalf of promoter K.Raghavendra Rao also sold heavily when margin calls got triggered and the stock price hit the rock bottom price of Rs.125. That resulted in a loss of over Rs.75 crore to Rao. Now he also has to find resources to up his stake by warrant conversions to thwart further adventures by raiders.

Life isn’t easy for hangers in! But some are privileged since they belong to the right league!

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This VIX will give you headache instead

Remember Vicks? The balm that is normally used when we catch cold? Now NSE launches VIX - a volatility index reflecting the market’s implied volatility (IV) 30 days ahead. It captures the IV embedded in options prices of stocks included in the Nifty 50 Index.

Thirty days IV is calculated from the best bid-ask price of Options contracts. Higher the implied volatility, higher the India VIX.

What is arguable here is IV as captured by VIX refers to the “implied Value at Risk” (I-VAR) (maximum possible loss) associated with the stock markets and not the size of the price swings. When the market is range bound or has a mild upside bias, volatility will be typically low.

But what it doesn’t say is that IV and VAR indicators are statistical probabilities and are highly questionable. They are not the outcome itself, they are indicative of likely outcomes. Seasoned market players do look at these indicators, but certainly would not swear by their effectiveness and applicability. Option pricing itself is fraught with several abstractions and infirmities, so you can imagine the level of arbitrariness that will go into its derivative indices like VIX.

One word – Avoid. Reason – even its authors don’t fully understand its ultimate impact – no safety nets yet. Gainer will only be NSE that charges a brokerage, no matter you win or lose.

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Big names, Bigger frauds on the smallest of people

So I read this report in Business Standard – CBI quizzes Niranjan Hiranandani, CEO of Hiranadani Constructions for alleged fraud for defaulting on its statutory obligations. Apparently, they have not deposited Employees Provident Fund dues with the exchequer. As per the report, one of the group companies had unpaid PF liabilities running to Rs 160 crore for the financial year 2003-04.

The year 2003-04 rang a bell. I fish out another report published by Business Standard on December 11, 2004, in which several wrongdoings by Ashok Advani’s Business India group (including non-payment of employee dues) have been exposed. That report incidentally had a quote from Niranjan Hiranandani that now looks like he has been hurling rocks while being inside the glasshouse. I quote from that report –

“But Advani was succeeded on the Collegiate Board in November last year by Niranjan Hiranandani (of the real estate firm), and soon a case was filed against Advani.

Hiranandani does not mince his words. "This is the largest fraud and embezzlement in the history of education trusts in India. After I filed an FIR which led to his arrest, I received more than 40 phone calls from top industrialists congratulating me, and they said that I should have done this long back."

Stressing the tragic undertones of the development, Hiranandani pointed out: "I have erected statues of his father in my housing complexes, and he as a son has ruined his name."

Not sure whether EPF Commissioner had been authorized to erect statues of Mr.Hiranandani's father in his office premises earlier. Commonality of allegations however, is shocking. So is the state of the victims - poor, hapless and unpaid employees - in both cases!

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PE gets a knock, SEBI has remorse

Well, there it is. PE deals decline sequentially. [ $3.3 billion mopped up through 97 deals in the March 2008 quarter were lower than 131 deals totaling $5 billion in the December 2007 quarter]. The report cites weak market conditions for the thaw. But there is another reason that it masks – PE portfolios are beginning to look “sinful” exposing callous fund management. The reversals have been dramatic. Recognizing old fashioned due diligence, PE firms are now all the more wary of churning out “weekly” term sheets. Seems they've realized it is not about blind betting on market sentiments, not just about investing other people’s money (OPM) ; it’s also about delivering superior returns. It’s clearly not about letting limited partners grieve!

SEBI on its part has done some self appraisal and has remorse. That's rare! For mere “custody” of draft documents and posting it on its website, apart from “occasional” (to-plug-its-own-mistakes) release of notifications and guidelines, it has been gouging the market players by way of fees. Most of its charges leveled against alleged scamsters have been annulled by High Courts – so much for its “fact-finding” skills! Way too much CYA type “disclosures” emerging from the woodwork. It had to seek atonement some day. So here comes a catharsis.

New funds emerge on the horizon – Saffron Asset Advisors, is planning to launch Rs 300 crore domestic real estate fund, which will invest in non FDI-compliant projects in the country. It manages the real estate investments of NYSE Euronext-listed Yatra Capital, is now planning to launch a bouquet of funds focusing on India.

Recently, New Delhi-based Red Fort Capital announced the launch of its second offshore fund, with a corpus of Rs 3200 crore, to invest in Indian real estate. Red Fort has also launched a Rs 1,000 crore domestic property fund. South Africa’s Old Mutual and Mumbai-based ICS have floated a Rs 2,000 crore property fund and Triangle India Real Estate Fund.

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Make it 100 "Big" steps, Dr.Rajan !

So, Planning Commission's Committee on Financial Sector Reforms Chaired by Dr.Raghuram Rajan is out with its report for comments. Looks like it suggests a primary shift in focus. Instead of mouthing cliches like Bank privatization, Capital account convertibility and priority sector norms that usually make a lot of noise and end up in a whimper, it gets down to micro issues like easing restrictions to open up bond markets for foreigners, tradeable warehousing receipts to collateralize farm credit, securitization of SME receivables and the like.

I see opposition from traditionalists citing meltdown in the US debt markets. They will argue that India has been pretty much resilient because we never had liberal bond markets. As usual, wrong reading of the situation that misses the point - the crisis have been in high yield mortgage paper or subprime (junk) bonds where regulation was lax ; the US equity, treasury and corporate debt markets, despite being close to the epicentre of the crisis, have remained far more resilient than markets in faraway countries.

Liquidity is the key, there is no denying that. Here India has a lot of ground to cover. NBFCs today pass on the credit/ default risk to Banks and Financial Institutions indirectly because they are not allowed a free play by themselves in certain areas (IPO financing, CLO, factoring, hedging etc.). So why not let these risks be absorbed by investors in NBFCs rather than by their creditors/benefactors? That will be an additional line of credit, a far better way to channelise savings to productive avenues instead of locking them up in time deposits.

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The Government and the RBI should quit micro managing investment decisions – exposure norms of Banks, Provident Funds, Superannuation funds and other statutory collections that are now forced to invest in very low yield T-bills or AAA paper. Worse, they manage even PSU bank pay scales! Put in place regulations that ensure a close watch over ROI, encourage “stop loss” culture. Aberrations may occur, but in the long run, focus on optimal returns take the load off the back of government itself, when it’s time to pay back. In that, the government does a great service to itself, in whittling away all that contributes to the escalation of our budget deficits.

Who ever said conservative markets and regulatory caps on participation guarantee protection from risks? In fact, they go to cap rewards than containing risks. Try ceding control and stick with selective yet effective macro regulation for a change. Let RBI target inflation, not exchange rates. It’s an illusion to believe the world can regulate its way out of crises.

I would welcome Dr.Rajan’s 100 small, sorry, Big steps. Indeed in gathering political will and scale of execution, it is bigger still.

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Too much for a single day?

Business Standard cites M/o Commerce release and reports FDI equity inflows in the month were more than the entire annual inflows from 1991-92 to 2004-05. Inflows into India in February stood at $5.67 billion, the highest-ever during any month since 1991. On a year-on-year basis, the Feb inflows were 712 per cent higher than the $698 million inflows in February 2007.

So you took it to mean investment outlook in India remains strong since FDI is usually slapped with lock-in terms. With more money pumped into the system, can inflation be far behind?

So I get to read this and this. Both the key stock indices, the BSE Sensex (down 500 points) and the S&P CNX Nifty (down 124 points), lost some ground yesterday as the government announced a record inflation rate of 7 per cent, a three-year high. The latest surge is partly on account of a jump in metallic mineral prices. The primary articles sub-index, which has a weight of 22.02 per cent in the WPI, rose 1.8 per cent over the previous week on account of a steep 38.2 per cent rise in metallic minerals, a 4.9 per cent surge in vegetable prices and a 1 per cent increase in oilseeds.

It means “expect turbulence till you fly out of inflation headwind” – well that could be about 12-18 months till you get the full impact of all clamp down measures?

Burning question – what do we do? Left to myself, I would rather go fishing in style, if I get lucky like this guy, David Sneath !

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Curmudgeons are back in fashion

In his last newsletter to his investors, Warren Buffet had cautioned “Look for wide moats around great economic castles.” Anything that looks too good to be true or an instrument that yields higher than average return is worth doing a double check. He was referring to the phenomenal returns that rode on ridiculously high leverage (33 :1) used by Wall Street bankers that resulted in a global credit crunch as the bubble collapsed.

Now I find the sharp markdown in valuations, the global financial turmoil and the general weak state of the equity markets have put the Indian PE industry on a state of high alert. Here is the full article from Outlook Business.

What comes out clearly from the recent turn of events is that the balance of power between the entrepreneur and the investor has been severely altered. Now term sheets don’t get issued in a week. Due diligence regains flavor. Investors are well entrenched in the driver’s seat for now. It’s time for curmudgeons like me to get back in fashion since we advise clients to dilute stake not because they get better valuations, but for other fundamental reasons like cost of debt far exceeding cost of equity or if the client needs to bankroll long term Cap-Ex. We, as a breed of financial rationalists that rely more on common sense, were clearly out of reckoning then.

I remember a client argued with me hard when I advised him against diluting his stake – when all that he needed was short term working capital assistance (retail expansion) - a couple months back, during those peak times. It was to be structured with a front-end bridge finance assistance (60% of funding sought) that was to be converted into equity on the basis of average of the weekly closing prices during the intervening period. The period was to end yesterday when his valuations have dipped by over 45% - a price at which he would've had to dilute much against his interests. I got a call from him telling me how he feels now –

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“I owe you a treat, fella' ” he said. I corrected him "You owe me that deal, mate...!"

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Towards a forex derivative safety net

Soon credit rating agencies will have to factor in solvency of customers before they evaluate and grade banks for their financial stability.

Here are a few more skeletons falling off the cupboard of ICICI bank – customers taking it to court for alleged mis-selling of derivative contracts. Obviously the bank will plead the customer was fully aware of his downside risks while entering the contract. Unless the parties settle for out of court settlement, it could lead to a protracted legal battle.

But I suggest a few measures the banks could take before they enter into complex derivative contracts with customers –

Enter into contracts only with customers that have relationships with the bank for over 5 years;

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Begin relationships with smaller sized contracts – say $ 100,000 ; every year the deal size can go up by 2x;

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Go by net worth linked limits for contract sizes – say aggregate exposure should not exceed 25% of customers’ net worth;

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Banks should make provisions for net exposure on a risk weighted average basis, of about 50% of negative outcome on the day of entering the contract;

All contracts should carry personal guarantees of MD /CEO and all executive directors of the customer to make good the losses to the bank if the customer defaults on its obligations under the contract;

RBI should set up a neutral authority –someone like a Notary Public- to endorse the fact that the bank has explained all possible outcomes of a derivative contract and the customer has completely understood all its risks and grant a certificate to this effect. This NOC should be a pre-condition for entering into a derivative contract. The fact of obtaining of NOC and the extent of its risky exposures should be informed to stock exchanges by the customer where it is listed within 3 days of grant of NOC by RBI.

Update : More spillover – Sundaram Brake Linings v. Kotak Mahindra Bank

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Spunky PE - J.M.Trivedi of Actis

Besides Renuka Ramnath [CEO, ICICI Venture] whom I admire a lot in Indian PE scene, J.M.Trivedi of Actis has demonstrated spunk. Here he is getting a professional CEO for Ahmedabad based Paras Pharma (makers of MOOV, DERMICOOL, KRACK) knocking back family management to a corner.

ICICI and Actis can be counted among the few buyout funds active in India. Most others settle for negotiated PIPE investments in listed firms or do some odd venture capital investments in unlisted firms. Their fortunes glide along the directions of equity markets and fund managers have no active participation besides attending board meetings and scanning dull reports. Nothing of the sort where they take majority control and guide their fortunes themselves. It calls for strategic clarity besides pure spunk. That’s where the process discipline matters.

I wrote about Wockhardt back in March, 2007. Now after the IPO of its subsidiary (Wockhardt Hospitals) got pulled back, the deal looks even better. Mr.Trivedi, why don't you take a look?
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Itching to hit the familiar turf

Too much money can drive people nuts. Perhaps India’s huge reserves – around $300 billion – has exposed the clueless top dogs at M/o Finance and RBI finally concede their inability to deal with a never before situation of surplus. Looks like they are itching to get it out of the way quickly so that they get back to familiar terrains of penury and economic destitution.

Their strategy? To ride on all their inexperience of fund management and set up India’s sovereign wealth fund (swf) to invest in risky energy and financial assets overseas – on the lines of Singapore, Abu Dhabi and even China.

Vinay B Nair of Wharton Center explains why it is a bad idea.

Politicians are famous for economic apathy. But know what it takes for their lot of under-privileged to buy a strip of paracetamol!

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Ambani-Deora Master stroke

Government is in a fix over closure of petrol pumps by Reliance Industries over denial of subsidy on par with public sector companies, with Oil Minister Murli Deora today admitting that dealing with the situation was not easy – BS report.

Fertilizers and Petro products have always been subsidized in India as these are more a political issue than economic. Are they telling us Reliance Industries and Essar Oil entered the business without doing their math?

Anyways, Government is in a dole-out mood. It recently announced a Rs.60,000 crore farm loan waiver. Followed it up with the 6th pay commission costing about Rs.12,000 crore. Now let’s wait for the climax to play out in this grand conspiracy to favor big business. Screenplay seems ready. Film directed by Ambani-Ruia-Deora trio. First phase already won as per grand plan – Murli Deora re-nominated to Rajya Sabha unopposed.

Time to go long on RIL and Essar…?

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Dance of the bands

SEBI lifts price bands for non-IPO listings here.

Currently, the stock exchanges impose a price band on first day of trading / resumption of trading post corporate actions like merger, de-merger, capital reduction, CDR / capital restructuring, revocation of suspension, direct listing on another exchange etc. Now SEBI feels that in such cases there is no need for price bands because they restrict normal price discovery.

This has been my pet peeve too. Why not open up price bands for IPO as well? SEBI has been mulling over this for quite some time. In a free market, nobody can wish away volatility and price discovery can only be a function of demand and supply. There could be scope for manipulation by some operators but their span of control is limited. Driving the stock prices up or down by artificial intervention of operators come at a high cost and associated risk. The best way is to let a few players suffer the carnage. Mostly these operators are funded by promoters of companies to see their net worth zoom on the listing day. When a few get scalded, caution will rule and normalcy shall prevail. Allow some casualties.

It also seeks to extinguish the perilous grey market for securities – regarded as one of the primary concerns of Mr.C.B.Bhave, the new SEBI chief as soon as he assumed office recently. He seems to be a fast cat, having already enabled short selling by acting out lending and borrowing mechanism. Now it’s time he pays attention to my no-band philosophy on IPO price discovery as well.

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Who is SEBI trying to protect? The small investor? Nobody is a saint. Everyone big or small, comes here because she is greedy. Regulation is welcome to the extent anarchy doesn't get a reception. Taking regulation too far by imposing price bands is meddling. Let the markets rule.

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Farm loan waivers and Investment bank bailouts

John Ruskin said “the highest reward for man's toil is not what he gets for it, but what he becomes by it.” I wonder what will he make of the global financial system that never seem to learn from its mistakes.

Have governments and central banks finally aligned? Or have they all run out of ideas? I certainly see character here. Very charitable one at that. I see across the board farm loan waiver in India (a massive $15 billion bill on the tax payer) and a massive bailout of failing investment banks in the US. The fed backed it up by cutting interest rates – sixth cut in a row since September,2007.

I see parallels that feed systemic excesses –

In the US, the financial services industry has defied gravity by using debt, securitization and proprietary trading to boost fee income and profits. Why care for capital adequacy if the tax payer is obligated to bail them out? In India, farmers have been pampered for long – tax exemptions, loan write-offs and yet keep them clustered under priority sector. Why repay a debt if it’s likely to be written off?

The value of outstanding credit-default swaps in the US financial system, for instance, has climbed to a staggering $45 trillion. In 1980 financial-sector debt was only a tenth of the size of non-financial debt. Now it is half as big. In India, outstanding agricultural credit is currently less than 10% its net NPA. A couple of waivers like this, and it will get there.

Leverage process practised by Wall Street has turned investment banks into debt machines that trade heavily on their own accounts. Goldman Sachs is using about $40 billion of equity as the foundation for $1.1 trillion of assets. At Merrill Lynch, the most leveraged, $1 trillion of assets is teetering on around $30 billion of equity. In rising markets, gearing like that creates stellar returns on equity. When markets are in peril, a small fall in asset values can wipe shareholders out, as it did with Bear Stearns and many others.

Globally, salaried tax payers can't escape tax cuts because they get checks after deduction of tax. That comfort is making governments smugger and they're emboldened to write more loans off, bailout wrongdoers in one swoop. It is not within our power to not let them cut taxes before they cut our checks. But with a bit of initiative and aided by a stroke of luck, we can certainly turn farmers or investment bankers and benefit from the largess that won’t stop any sooner :-)

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FCCB has a short fuse

The Rupee appreciation and market declines have struck a double whammy to Indian corporates – especially those who have raised funds thro FCCB route during the boom times. I am not surprised. Most of them raised FCCB debt because it was available or worse, I-bankers goaded them into it. Now they grieve. Here is the Business Standard story.

It says “Non-conversion into equity may erode profits by 12% in FY09: Study”. I fear the erosion could be lot more if the study has provided only for annual interest outgo on FCCB borrowings. Let’s figure it out by a case study.

Take Amtek Auto (featured first in the list of companies in that report). It has $250 M (Rs.1000 cr.) in outstanding FCCB liability. I checked its operating profits [BSE CODE:520077] for CY 2007 (being the trailing four previous quarters) and its operating income is Rs.460 crores. (I hope the company follows prudent norms and accordingly assume the pro-rata interest on FCCB is included in the interest figure for respective quarters.) Now, after providing for depreciation and taxes, the company has a net income of Rs.257 crores.

As per the table, the market price of the stock is currently quoting at a 35.2% discount to the agreed conversion price of Rs.414. FCCB is due for maturity on June 2011. If the stock price goes further down or if it maintains below the conversion price, the liability shall remain as debt in its balance sheet and the company will have to provide for its repayment. Given the gloomy outlook, I don’t see the market getting back to its Jan 2008 peak levels any sooner and so would recommend providing for repayment of its principal (Rs.1000 cr) out of current profits. That would call for creation of a FCCB redemption reserve and transfer a sum of Rs.250 crore each year for 4 years between 2008-11. That would leave a net income of Rs.7 crores.

Now imagine the dent in the EPS. It’s earnings are currently at about Rs.16 per share. After creating the FCCB redemption reserve, it’s net income would stand reduced to Rs.7 crores and the resultant EPS would be Rs.0.63. Give it a liberal PE ratio of 16 as at present, even then the stock price would be a dismal Rs.9.90. That’s the emerging picture if FCCB leverage is taken out. The company may either choose to recap it with other means of finance of equal amount to sustain its liquidity and operating leverage. Even then, with the cost of debt going up, it may not be able to borrow at those low FCCB levels of 5.5%. This means higher interest outgo and lower EPS in the event the company is not able to accelerate its revenues or improve its margins. Both the options are unlikely since the company caters to auto sector that is rate sensitive and runs on low cost financing for sale of vehicles. That spells disaster for shareholders.

Now I have nothing against Amtek Auto as such. I just picked it up as it was figuring on top of the list in that table. But then this is a sufficient case study that highlights what over-indulgence during boom times can entail. Don’t bite off more than what you can chew.

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A new kind of oil hedge

Ask Diana Farrell and Susan Lund in this McKinsey quarterly report dissecting the motives of sovereign wealth funds -

“How will state investors behave as public shareholders or owners of companies in foreign markets? Will they seek to maximize value creation and long-term growth, or will their investments reflect the political objectives of their governments and the interests of businesses in their home countries? Financial markets require the free flow of information to function efficiently. The presence of huge, opaque players with non-economic motives could distort the pricing signals that other investors need...

…..Can higher oil prices really be good for the world economy? As we have seen, petrodollars are creating inflationary pressures in markets for illiquid investments, such as real estate, art and companies. If the pressures move beyond those markets, the potential asset price bubbles could burst. So far the world economy has accommodated higher oil prices without a notable rise in inflation or an economic slowdown, but this may change in the future.”

I see an indirect oil price hedging opportunity here for net importers. Create a vibrant, deep local financial market across asset classes, rich with intermediaries that optimally deploy the huge surpluses of SWF. Whatever they lose by incremental oil bill can be hedged by tax revenues from incremental fee income generated by local SWF managers. Oil importing nations after all, can’t keep paying fat import bills forever by printing currencies :)

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Now I'm getting ideas. My daughter's been an avid painter ever since her junior school. I've archived some of those amateur works of art that look a lot better than a few of those auctioned for over a million $$ and probably bought by (who else?) SWF managers. Thinking of auctioning a few of them to help meet my fuel bills for the rest of my lifetime ;-)

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I want all my tax back, NOW!!!

Swaminathan A Iyer suspects political ploys initially hailed as master-strokes often end up as flops. He refers to the Rs 600 billion ($15 b) farm loan waivers announced in the budget. It writes off 100% of overdues of small and marginal farmers holding up to two hectares, and 25% of overdues of larger farmers.

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People holding two hectares of farm lands – small farmers?

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And how do you think it will be funded? By selling off PSUs at a time when the market tank rate is 3% per day and stock prices are down by about 35% on an average, across the board.

Economist Surjit Bhalla says less than 5% of farmer loans to banks are overdue. If so, then the 95% who have repaid loans will not benefit. They will be angry at being penalized for honesty. The beneficiaries will include some of the truly distressed who merit relief, but will also include cynics who can afford to repay but have not done so, anticipating a waiver.

Gets me thinking. I’ve been paying income tax for over 15 years. I patiently put up with potholed roads, blackouts and erratic water supply all these years hoping that the underfed millions need to be attended first. Despite the rampant corruption in PDS, I am one of its greatest fans. After all, I was a beneficiary for the first 20 years of my small town life. I wanted to earn more so that I could pay more tax that goes to feed more underfed and malnourished kids. Not the gorilla cronies of a pot bellied Sharad Pawar, Laloo Yadav or O.P.Chautala.

Seriously Mr.Chidambaram, you just lost me. It’s game over. Now gimme’ all my tax back!!!

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It's the election eve stupid !

Ask me why I don't buy PSU bank stocks. Or why I stock up on sugar stocks...!

If you own any business, you’re supposed to have a say in its affairs. You expect to be consulted, at least by postal ballot, before taking critical decisions. But in PSU banks, it's as if you've surrendered all your equity so that it solely rests with the government. You just commit the capital and shut up. The government plays the big brother and writes off huge loans. It has happened before and it has happened in 2008 budget as well. Farmers owe banks $15 billion that stand as assets in the bank’s books. Last week FM wrote off all of them in one swoop, before you said bottomline.

The finance minister P.Chidambaram walked out from a live post-budget television interview, upset at repeated questions on how the government would fund the Rs 600 billion ($ 15 b) loan waiver by public sector banks he had announced. Of course, he returned to complete the interview.

That’s why I don’t own PSU bank stocks. Exactly why I stock up on sugar… You get it cheap and the business benefits from populist largesse like this. Remember, you live in a democracy and it's the election eve stupid !

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Making compliance less PITA

One the most mundane acts that enterprises do everyday is compiling reams of data for compliance purposes. The data painfully extracted and filed, not much attention is paid to it until its time for the next filing. Many CFOs have often rued this fact and some have even confided the futility of this effort. I remember asking them “why don’t you just go use that information for your business purposes as well?”

To which, I am yet to get a convincing reply.

I recently found Brian Scheld and Sean Culbert of IBM debating the same question. I am glad there are like thinkers. Excerpts -

"Slowly, financial institutions have come to the realization that successfully competing in an accelerated, data-clogged business environment requires an enterprise capability that permits them to quickly access, integrate and deliver data that can be used to make lightning-fast decisions related to regulatory compliance, risk management, customer retention and profitability. The trend is called convergence, and it refers to an enterprise-wide alignment of governance, policies and processes to enable the quick and efficient sharing of business information among multiple stakeholders."

"...In essence, data convergence can help financial services institutions link their overall business strategies to their enterprise risk-management strategies by offering a graduated path from basic information-based regulatory compliance to a tighter management of business processes and risk, and then to fully optimized performance and value creation."

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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