Just talk the talk

Talk about timing. Sometimes you get it so awfully wrong that you become a butt of a million jokes. This morning I read this article “Power of Leadership Economics” by Ashish Singh, MD of Bain & Company India and Chris Zook, the firm's Global Strategy Practice in the ET.

The article talks about the enormous value associated with positions of leadership. They place some findings in support of the economics of leadership. I quote –

“….The typical industry has more than six competitors. In any sector, the two leading players usually capture over 75% of the profit pool, and the company with the greatest market power usually snares about 70% of total profits.

In contrast, followers with a marginal share of the profit pool act as the shock absorbers of the economic system, exhibiting much larger fluctuations and enduring a bumpier ride during downturns. When we analysed 22 pairs of global leaders and their followers — Nike versus Reebok (now owned by Adidas) or Southwest Airlines versus Delta, for example — we found that the average variance in profit margin was three times as great for followers as for leaders….”

Then I recall Standard & Poor’s ‘‘weakest links’’ report [cited by Boston.com] forecasting 75 US companies that will default on their debts in the next 12 months. Of the 93 companies at risk, more than half were involved in takeovers by big-name private equity firms, including Boston’s Thomas H. Lee Partners, Bain Capital, and J.W. Childs Associates. These guys led the LBO march and loaded the portfolio companies with so much of debt that did them in. There are 93 US companies at risk of defaulting on $53 billion in debts, marking a 50 percent jump since last June, when the credit crisis started. Many of these debt-laden companies were involved in giant leveraged buyouts by these monsters.

Bain Capital acquired Guitar Center Holdings Inc. last June for $2.1 billion, putting $650 million in debt on the guitar-store chain’s books, according to Dow Jones & Co.’s LBO Wire, an online report. That debt is rated a B-, giving it junk bond status, according to S&P. The loans were made at time when banks were placing minimal financial requirements on companies — which could make defaults less likely.

Now of all times, the top dogs of Bain & Company chose to come out and talk about “leadership economics” …. Who’s next? Citi, Merril Lynch, UBS, Morgan Stanley…? Leadership it is, truly; in driving companies aground.

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How to get LBOs in...?

Remember how we buy homes taking the mortgage route? We spot a good house, negotiate with the seller, lock the deal down by paying some token advance and finance the deal by mortgaging that property. Simple enough? But ever tried buying a company that way? No, you can't in India. After all, companies have a steady cashflow, substantial assets and if sellers are willing, why should regulators say No? Perplexed?

The regulations bar you from mortgaging the assets of the target company to buy it. Their interpretation - the company can’t raise debt pledging assets that it *wants to* buy. Ok, fair enough. It's like seeking to use your credit card to pay its past dues. What if a foreign company floats a specific SPV to do this acquisition? Can that SPV raise debt to buy the assets of this Indian company? The answer is NO again. Here the reason is foreign companies should bring in fresh capital from abroad to pay Indian sellers. I think this rules were drafted at a time when the country badly needed foreign exchange. Today, we are in a surplus situation. Should this law stand? Indian companies are permitted to borrow from domestic banks for purchasing equity in foreign JVs, wholly-owned subsidiaries and other companies as strategic investments. Indian companies also have the option of funding overseas acquisitions through ECBs. Recently they’ve been allowed to invest up to 4 times their networth abroad.

So what are the typical buyout structures that are allowed? Gaurav Taneja of E&Y says -

a) Foreign holding company – raises the debt overseas for acquiring the Indian company. The hurdle is the assets are in India and may not be allowed to be collateralized against the foreign debt. Another area is exchange rate. The loan is in foreign currency but the earnings are in Indian Rupees. Adverse movements in exchange rates can kill.

b) Asset buyout structure – Foreign buyer floats an Indian arm and injects equity and debt, sufficient enough to finance the asset by asset buyout of Indian companies. There could be issues of stamp duty and VAT but the major hurdle here is it works best only in a 100% buyout situation. Not in a partial acquisition of majority controlling stake.

But I suggest it is a far better alternative than using own equity by companies to buy other companies. At a time when costs of borrowing overseas are going up, we must put our vast forex resources to good use by allowing LBOs in India. Imagine some of the world’s best companies operating from Indian soil! I think that would be wonderful. Exxon, Shell, GM, Chysler, Harvard, Stanford – what if these companies/Institutions were subs of Indian companies/Institutions? In fact, their assets are a much more valuable than that of the borrower. A safe bet for the banks to lend.

So, SEBI – you’ve pretty little time left to get your act right. Play it wise. Anyway you are not extremely bothered about Food Stock or inflation. At lease work with the government and be a flexible, understanding and practical regulator.

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O.P.Bhatt needs to keep his job

Before you could say spunk, SBI blinks.

Yesterday, SBI chief general manager Shyamal Acharya, confirmed that the bank has temporarily discontinued giving loans to farmers for purchase of equipment and said the decision was forced by the high non-performing assets (NPAs) in the segment.

He said NPAs under this head had gone up to 17% of the total outstanding amount of Rs 7,000 crore, and such a high level of NPAs was not sustainable. Loans for tractors, combined harvesters and power tillers constitute a small portion of the loans given by the bank to the farm sector. He said that while loans given against such equipment add up to just Rs 7,000 crore, total lending by SBI to the farm sector is around Rs 43,000 crore. NPAs in the farm loan segment as a whole are just 7%. This is higher than SBI's overall proportion of NPAs - barely 3% on total loans of Rs 4,22,181 crore as on March 31, 2008. However, it is significantly lower than the level on farming equipment loans.

And today, they regret. See how SBI deputy MD & group executive (rural & agri business) Anup Banerji covers the management ass. He says the decision to stop lending was not taken by the board. It was a strategic decision taken by the business unit of the bank. “No communication was given from the ministry to resume lending for tractor loans. There has been no pressure from political parties or the government to roll it back, it was the bank’s decision to do so. Given the reactions the decision evoked, we reviewed it and have decided to continue lending.” When you have a gun held to your temple, that’s how you speak !

SBI chairman O P Bhatt too wants to show obeisance to masters. He too regrets the bank having issued that circular. Poor Mr.Bhatt needs to keep his job until he gets hired by a private equity just as his predecessor A.K.Purwar, currently with Nicholas Piramal Private Equity Fund. Who is he confronting? Even P.Chidambaram couldn’t overrule the whims of Sugar Daddy who is the architect of loan waiver. That’s how he rules Baramati and its voters. By helping his cronies treat bank loans as Daddy’s gift, he let them have those funds for keeps so that he can have recourse to it to fund his and his nephew’s election expense. Now his daughter (Ms. Supriya Sule) too has joined in. No code gets violated and Election Commission cannot raise a finger. Look at Mayawati. Has so much of money to run a mighty sovereign. Ask for source – all *gifts* from Dalit cadres that don’t have money to buy even a decent meal, yet marshal enough resources to shower gifts on their leader to *uplift* the downtrodden –as if they are perched somewhere up.

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Why can’t SBI plead a software bug or shortage of forms or heavy load of applicants (because of the heavy rush to borrow since they don’t have to repay) to explain away non-processing of farm loans? They should learn from their PSU oil marketing cousins. With their backs to the wall, Indian Oil and its sister firms started clipping sales of non-branded fuels in Metros and 16 other cities and stopped giving new cooking gas connections.

Oh yeah, I did digress. But I think it’s par for the course. Once in a while I need to let out my steam. I am shocked by the way our PSU banks and Oil Companies are being run. Instead of letting them align with commercial reality, their managements are browbeaten into submission, punishing the public shareholders that unfortunately end up owning the piece of shit. I am angry just as you are. Know why? I am no farmer and hence no loans to skip. Too bad.

That said, “spunk” is hardly the expression associated with PSU bankers. They are all wimps. Meanwhile as a depositor, you may brood at lower interest rates, as a shareholder you could sulk at piffling dividend yields and capital appreciation? Not until the next tide lifts all boats (that has no connection with earnings growth) – just in case if you’ve survived the recent bust and mounting fuel bills!

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Disparate resources - OBS for I-Banking, Pascal's Law for PE investments

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We badly need an OBS type initiative to reform our I-bankers.

No matter to what end effect, I see them going for the same kind of dubious deals, reinforcing the herd syndrome that is ruining the industry. Why clamor for liberalization of ECB norms to borrow more and invest in overowned sectors, only to let your client grieve over inflated liabilities if the currency strengthens? Bulging order book of construction companies is one thing, execution capability is altogether a different world. Do that deal just because everyone else is doing it? They won’t do one thing differently until someone else starts a trend. Nobody wants to start off one.

Another reason why I support a OBS initiative in I-Banking industry is their class thinking, a queer kind of apartheid. A few weeks back I was just having a casual discussion on deal prospects in sugar industry with CEO of a leading brokerage in Mumbai. His first reaction was - “which B-School are you from?” I told him I am not from any and I was in for a more baffling second question – “how do you know so much?”

I would blame the recruiters (and partially the effective B-School PR machine) for having spread false notions that helped build several stereotypes. I believe that good investment bankers need to have enormous common sense, the absence of which explained subprime mortgage crisis in the US. Then comes a basic intelligence to quickly grasp facts relating to a business, the dynamics of the industry and a clear idea regarding the resource requirements of respective managements to take it to the next level. Recruiters still don’t have the tools to assess these skills.

You don’t need an MBA for this. What you need is commitment and a sense of probity. Due diligence is all about commitment to client prosperity and NOT a check list of processes to fill boxes in a valuation questionnaire, as it is widely held. I-Bankers should and can learn a lot in between deals. They must develop a sense of curiosity about industries they don’t know anything about. They must learn to Google and expose themselves to the world outside the cube farm. They can’t say they are busy because we know most work in a deal is for transaction lawyers, whereas these guys compile papers and ensure dispatch to regulators, intermediaries or their client and its shareholders. You can’t blame them because creativity has not been part of B-school curriculum. If they develop a bit of heuristics and get creative, they’ll soon realize the depth of their emptiness. They won’t ask questions like “which B-School are you from” in response to purely common sense laden expressions from a curious but committed observer, making a living by sniffing up deals. They’ll begin to feel a sense of shame, springing from realization of the immensity of their own internal inadequacies - the starting point of self reform.

I hope a few of them read this and oblige. If they do, we’ll see more deals from boring segments like commodities, Gems & Jewellery, Auto Ancillaries and processed foods – all industries where nobody pays attention now, where valuations come cheap and are up for grabs. They say PE funds target 25% returns no matter which way the market goes. Ask how many are getting it? Sorry, let me reframe the question – how many are not losing money? Opportunities in stock market are all about attention span. Agreed it calls for steel nerves. Buy into a sector that is under-owned and neglected by all. Sell when everyone wants a piece of it. The commodities sector is beaten so much down and the managements need just financial resilience to weather the down cycle. Soon when it looks up, it sure is going to be a multi-bagger as explained by Pascal’s law in Physics – a small change in pressure is conveyed to every part of a fluid and its surface to create a major disruption. When it does, it won’t be ripples, it would be massive eruptions. Go cash in on that. Have some time to look at something other than consturction, Capital Goods and Infrastructure (and IPL T20 hogwash), where hype masks huge gaps in execution capabilities.

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Where is the Rupee headed?

Does anyone really care?

Currency markets, like their stock market cousin spring surprises when people least expect. Almost all exporters and dollar earners and spenders were caught off guard by the recent depreciation of the Rupee. While dollar earners lose the forward premium, the (oil) importers (dollar spenders) never bothered to cover their exposures. Who ever thought appreciation of the greenback?

The reasons for the sudden reversal were not far to seek.

(1) Recovery of the US dollar;
(2) Increased dollar buying by oil companies to meet rising oil import bill;
(3) Sinking capital inflows, choking the supply of dollars; and
(4) Unwinding of positions that were betting on rupee surge.

So where is Rupee headed? Surging oil import bill and expectations of moderating export growth suggest a worsening current account deficit this fiscal, likely to edge past 2% of GDP. It is said that a $10/bbl increase in crude price jacks up the trade deficit by around $6.5-7.0 billion. Higher global crude oil prices also boost remittances, but the net effect of higher oil prices on the current account deficit is still a large negative.

Back in 2002 when the first draft of Goldman Sachs BRIC report was in print, the rupee was at 49 to the dollar. The BRIC report forecast (and still does) that India would be the third-largest economy in the world by 2050 with an amazing 9% growth per year for fifty years. But something went unnoticed - it was in dollar terms. It also said in the first six years the rupee would be stronger by about 13%, which is exactly where it is today. Call it Goldman’s magic touch or just luck. For after all, the rupee didn’t get from 49 to 42 in a steady linearity. It rode up to almost Rs.38 to the $$ before getting to where it is today. So I think the flip flop will continue.

I pity all $$ borrowers that had raised ECBs and left the proceeds unhedged assuming a forever strong rupee. They should be losing some sleep now. The currency — like the broader economy — is mainly reacting to some near-term headwinds that have brought about a welcome correction in hype over the India story. India certainly has a story; at a very basic level. It could do with better education, healthcare and public infrastructure. The Rupee will find its own level depending upon how RBI is coping with its routine of non-intervention, trying to keep volatility low and creating awareness about risk and currency hedging.

Most importantly the Government has to learn to deal with political shocks – finding the Rs 60,000 crore largesse to farmers, then the Rs 25,000 cr largesse towards the government employees happiness fund. All of it will have an impact on fiscal deficit even if it keeps huge oil subsidy as an off-budget item.

So it is total chaos out there. Don’t fret over a number. Stick around and watch the fun and cash in on an opportunity as and when it shows up.
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Vacation (in a) spot

Global funds go ballistic over India’s infrastructure scene. Some statistic –

The no. of PE deals struck in the first four months of 2008 were 156 for a total investment of $4.94 billion. Over the same period in 2007, we had 136 deals and $3.42 billion. However, fund houses are going slow on investments seeking reasonable valuations. In April, 08 the no. of PE deals inked was 32 and aggregating $560 million, down from 35 deals worth $1.21 billion in March. In February, the number of PE deals struck was 27 and amounting to $1.48 billion.

Sign of slackening pace and harder wrangling between investors and fund seekers. Recently a mid-sized I-banking executive told me he’s planning a long vacation, away at idyllic Kovalam beach. He sounded glad because for the last two years, he had no time for anything other than work. Now that mandates have slowed down, he and his tribe are taking a break.

But this morning I read this piece of news. I hope the guy gets to enjoy his full vacation with his family. The way it sounds, he could get summoned soon to make it back home. Balmy beaches and silver sands don’t go anywhere; good times do :-)

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SBI should coach American Banks

What am I to make of this? SBI Chairman O.P.Bhatt had reportedly told Business Standard that the entity may not grow the book aggressively in the present financial year. The card company will work to arrest and bring down defaults, improve asset quality and make all efforts to stop making losses.

I recall my helpless plight at the SBI branch a few years back (where my family has multiple relationships), when a persistent card salesman almost drove me mad. He repeatedly clamored “sir, it’s FREE. All that you need do is just sign up. We need no salary slips, no documentation, nothing. We are issuing it because of you’re a privileged customer having excellent relationship with us for all these years”. My express statement that I already hold lifetime FREE cards from a few other banks made no difference to his sell-I-will attitude. Wanting to put an end to that nag and sparing a benign thought to his desperate pitch, I had obliged.

Not being a great spender, I’d never used the card till date. But now after a couple years, I receive email from SBI saying that my Annual Fees are due. Yes, on the FREE card thrust upon me asking no documentation and just because the bank thought we are good credit risks and it wanted to treat its A-Listers well.

Now I understand why they play dirty. The report quotes Crisil -

the company's delinquencies have shown an increasing trend and as on September 30, 2007, they were at 5.6 per cent on the past dues basis of over 90 days' past dues against 4.4 per cent a year ago. Along with the rise in defaults, the card company has also seen a rise in its costs. SBI Cards' credit costs increased to 20.8 per cent in the half-year ended September 2007 from 8.3 per cent in the year ended March 2007 and 6.2 per cent in 2005-06.

The company suffered a loss of Rs 150 crore in 2007-08. Asked about any plans to put more capital in FY09 to support business, the SBI chief said, "In March 2008, the bank had infused Rs 250 crore into SBI Cards. At present, there are no plans to pump additional capital, unless it makes losses."

So what does the beleaguered card company do? Go fleece the A-Listers and earn their ire too. I think of the big American banks busy writing down billions of $$ because of bad lending practices. Isn’t there a good consulting opportunity for SBI?

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"Small world, people !"

Michael Gordon in FT calls the Private Equity bluff –

“So now we know. The boom in private equity, which was promoted as the superior business model, based on patient capital, superior management and an alignment of interests, was nothing more than a trick of financial engineering - and a clumsy one at that. The magic of leverage works both ways, as we are discovering…. Private equity as we have come to know it is all about debt - lock, stock and sinking barrel. There may have been better management and better incentive structures in the deals of recent years. But they really contribute nothing to the overall return when compared with the impact of the leverage in the capital structure.”

But before Gordon could call global PE bluff, I’ve called that of the Indian PE masters. Here is my local, factual account. If leveraging had done them in globally, here in India they've been wrecked by smart owners that palmed off sizeable chunks at fabulous valuations. Now they are left to lick their wounds. Small world, huh?

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"ICAI, cast the (AS-32) net wide"

Ok. After the goons make away with the loot, the police arrive. Reads like a climax of a celluloid potboiler? In a way, it is. I am referring to the ICAI’s late awakening to the realities of forex derivative exposures (AS-32) by companies. Here are my safety net guidelines I gave almost two months back. (Me pretty fast, you see :-)

Industry chambers oppose it because they say MTM losses are notional (obligations don’t crystallize until the contract matures or is canceled by the party exposed to it) so long as the positions are open and hence cannot account for it accurately. But they miss the point. Disclosure of MTM losses have only the effect of a provision and not that of a definite charge against profit. So even if those losses don’t crystallize (or it ends in a profit if the sentiment reverses) they can be written back and added to the revenue account as prior period profits (just like tax credits). The only downside is for a trader that sells out fearing dent in share prices over the short term. But then that is their risk reward, so no tears to shed.

But I worry another aspect. Exotic swaps that have a multi-currency structure (fixing the $/Re.rate on the basis of prevailing price of Japanese Yen or Swiss Franc) may not find takers in the event of a crisis. For such products, literally there is no market during such downturns. So MTM would mean bringing the value of the contract to absolute zero or having to make 100% provisioning. These structured products are often sold by foreign banks and the swaps are traded in overseas markets. Now my question is, would it be prudent to MTM the exposure on a cut-off date (say 31st March) or right from the date a party enters into a contract on a daily / weekly basis? Would they have to be accounted for in quarterly results as well?

ICAI will have to explain to avoid any factual distortions in financial presentations. By the way, does AS-32 cover these shenanigans too? I think they should.

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Don't mistake infrastructure for glitzy malls

Well I am not surprised at all after reading this. In fact, I’ve already said what I had to. Here and here.

“PE funds and analysts have become far more cautious in evaluating real estate investments in India. One of the analysts said that some of the funds are tightening norms for valuations after the slowdown and at least 30 per cent of the deals are taking a much longer time to go through because of valuation issues.”

All things that go up will have to come down. That is law of gravity. Imagine real estate prices going up without adequate supporting infrastructure. Say, proportionate expansion of road area or power and water supply? Ask Chennai residents. They've proved that humans don’t need natural drinking water to survive. Their life can be threatened only if the bottled water supply stops. One lash of rain and the city is flooded and the next few days are spent clearing the slush and choked drains. Soon many other cities will follow suit.

What is the point in putting up millions of square feet of glitzy malls and complexes if there are no decent roads leading to them? This is the bane of our city dwellers. Bombay was the pioneer that led this brand of mindless development and other cities haven’t learned from its travails. Bangalore, Chennai, Kolkata, Hyderabad, Cochin are all developing fast on the roadsides. But road area available remains just the same. Naturally less people would like to visit such places, much less choose to occupy. Fewer will invest. So how do you expect the prices to keep going up?

Town planners will have to work overtime. May be, one can try out PPP route to salvation. Infrastructure companies should be entrusted with the task of developing large townships and no individual developer should be allowed to develop in fractions. The system of build a block first, then dig the road to lay water and sewer pipes and dig again to lay power/data cable should stop. Major slices of Municipal budgets getting wasted on humungous pensions for past employees should stop. Spend it on better planning and efficient execution. That, if anything, would stabilize property prices - not liquidity, not a booming stock market or a surge in demand fueled by higher disposable income with people, because all this can dry up. What is constant is easier access, navigable road network and a peaceful enjoyment of the premises with enough water to drink and power to run your essential gadgets - in the kitchen, at least.

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When it's other people's money....monkey around

My logic hasn’t been out of place entirely. I had this belief that if I have to make it big as a fund manager or in Private Equity, I need to be a good judge of an early investment opportunity. I was too dumb not to take the easier B-school route to PE superstardom. Instead I began using my sparse savings and tried out my luck investing in the stock market to prove myself in an old fashioned way, back in 1995. If I can win with my money, I could do it with others' as well. I needed that validation.

Till date, my least lucrative exit over a one year horizon has been at an ROI of 165%. Now as I told you I started with my sparse savings and I was totally aware of the need to stay liquid to buy into the next opportunity; hence my horizon was restricted to just one year (so that my returns come tax free).

Then come the PE champion investors. I marveled at the ability of these guys that raise huge funds and thought they must be wunderkinder notching up stunning returns. I looked up their profile and thought the degrees from Harvard and Wharton must have magic in them. Everyone had an Ivy League record and some excellent career profile. No wonder they are where they are – right at the top of PE fund houses. Moreover since PE being alternative investment thro negotiated deals, they have access to classified information (`insider information' if I have that) besides some special rights granted by covenants built into term sheets (such as veto, tag along, pay for play, ratchets etc. etc.)

So I thought the game’s up for average folks like me. How do I stack up if the game starts with such a mighty disadvantage? I began to watch their investments in Indian companies (that I relate better) and often wondered why they take exposures in companies at such high valuations. “Silly, they’re from Harvard and Wharton; they are not dumbasses”. “May be, they see value that you don’t - they have access to classified information, you know?” I taunted myself.

But today I read this. The portfolio companies where PE funds invested are all trading at steep discounts to their acquisition price and now the same PE funds are on a Rupee cost averaging spree by mopping up shares from the secondary market to even out the gap. Apax partners bought 11.41% in Appollo Hospitals at Rs.605/- a share. Now they are buying from the market at Rs.505-550 a share hiking their stake to 14.52%. Several others including Standard Chartered PE (in M&M Financial services), Blackstone in Gokaldas partners, Promethean in Nitco Tiles/EIH, New Vernon in Shriram EPC are also hurriedly playing catch up.

Now wait a minute! That’s how I too build my portfolio. How different are these guys? Why are they perched in a higher league? I managed minimum 165% returns over just one year but these guys wait for over 6-7 years to get a CAGR of 25% or even less. I don’t have a Wharton degree alright, but I beat these guys in their own game by many a wide mile. Isn’t that endorsement enough for my stock picking skills? I don’t follow analysts. I just look at managements, their track record, state of health of the business and a few key ratios like ROE, RONW, Debt:Equity and P/BV besides an occasional peep at price/volume charts. By keeping things simple yet systematic, the stocks that I pick end up as sure winners.

Perhaps the awareness that I could go wrong keeps me on the edge. A bit fearful at times that always makes me keep looking over the shoulders even after I invest. The feeling that I am up against informed investors that wield mighty clout never allows me to be smug. Over and above, it’s my own money and I need to be liquid always. These factors have put together a strong foundation for my portfolio architecture. The PE managers can afford to cover their conscience and be reckless. After all, it’s not their money at stake. They do get their management fee whether they win or lose. More than an occasional freebie from stock brokers that manage their portfolio as well. Why should they care? It’s their investors that pay a price.

Now I know why I could be a misfit in a PE environment. No regrets.

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Squeeze the bastards and wreck'em into submission

Finding brokerage houses going cheap now? Not exactly. They are probably hiding more than what they should. The stock prices of Motilal Oswal, Geojit Securities, Indiabulls Financials, Prime Securities all should be actually quoting at just 5% of their existing prices as is being speculated because they are not making adequate provisions for the huge losses they suffered (during the recent Jan 08 market reversal, when stocks declined by over 70%) on their margin lending exposures to their clients.

"It's surprising to know that provisioning and losses announced by brokerage houses do not form even 1 per cent of the entire margin funding business. And, this is at a time when the market has fallen so drastically and the liquidity crisis is still looming large over the system," says investment advisor S P Tulsian.

Their balance sheets show these losses (unpaid dues by clients because of teminals shutting down due to margin pressures) as “loans” instead of “defaults” as they actually are. A loan could be recovered in future. A default is a quantified loss and is a charge against profit. Since reduced profits mean lower EPS, the stock prices could be influenced. Hence their aversion to make full provisions.

But you don’t get caught. Just stay clear of that sector for a while. The lack of demand could pull down stock prices to realistic levels. Squeeze the bastards and wreck them into submission. Remember the period after Harshad Mehta scam when these firms went down the drain? Give them that sense of Déjà vu now that they are asking for it!

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[Update : Just four days later, here’s proof. The market’s got them [brokerages] by the balls. Update 2.0 - Edelweiss Group Company ECL Finance with an exposure of Rs.9.14 billion to its clients lent against securities (that quote at deep discounts now) waiting to be recovered. They call it loans, without disclosing how much is margin funding and how much has been defaulted. Yet they make a provision for only 0.5% of the exposure (Rs.45.50 million). Did you say financial prudence or worse, corporate governance? What is ICAI doing? Is SEBI reading this?

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Why PEs are benign in India

So as I read the views of lawyers, I-bankers and consulting firms, I am convinced that the PE has dug its roots deeply into Indian soil. More importantly, why they are not the usual monsters they are feared to be elsewhere.

Some astonishing numbers before we go further. PE firms numbering 255 at the last count have pumped in over $25 billion into Indian companies over the last four years, with around $17.5 billion being invested in last 15 months in 487 companies. Their nominees fill the boards of over 1000 companies in India now. So far their growing clout has not been perceived as that of a wild beast (remember the book "barbarians at the gate" on KKR-RJR Nabisco deal?) as they’ve been monikered in the west. Perhaps they’ve just been careful or are saying to themselves “it’s a long road. Let’s not get a flat tire early on”.

But I see a few other reasons why PE firms are benign in India –

a) PE buyouts abroad were characterized by high leveraging (raising huge debts on target company’s assets) in the west; mind boggling debt/equity ratios of 50:1 literally did them in. Then PE firms recoup their own investment soon by way of dividend recaps. That reduces their risk to near zero from the start. This is not possible in India because Indian regulations do not permit a dividend recap so easily; neither do banks allow ludicrous leverage levels of the above kind. That makes take-private type buyouts less attractive.

b) Most companies in India are family managed and would like the family shareholding to pass over to the next gen as heirloom. They don’t let go off their holdings so easily. They are not easily lured by valuations. It’ll take a while for them to get there. It’s because most sellouts have a non-compete clause. The family has such a deep grasp of the domain, the intelligence gathered over the generations are irreplaceable. The PE firms that buy in invariably count on that domain expertise to get to their target returns. The pedigree rules in the end. [Update : here is the proof]

c) Asian values of business conservatism are so different from Western values of risk indulgence. That circumspection explains the relatively slow pace of businesses scaling up in India. The businesses having been seeded in tough regulatory environments, a slight easing up of regulations or easier access to bulk capital is all it takes them to leap into the big league as we are experiencing now. I think of ESSAR group – it was almost done to death in late 90’s when steel industry was down in the dumps (it defaulted on its foreign debt obligations) and when the fortunes of steel industry turned in its favor, it leapt back to glory. Its later foray into telecom paid off pretty handsomely in the recent Vodafone buyout of Hutch-ESSAR ($19b) and now it is a major player in a few other sectors like Shipping, Oil exploration and Heavy Engineering.

d) Political affiliations of business families are known to be deep set. Any new investor would view that as a great plus. Though it could be argued that business should flourish independent of politics, it’s always intertwined everywhere. May be to a lesser degree in the west, but it’s a force to reckon with. Remember the forces that came together against L.N.Mittal in the $43 billion Arcelor-Mittal deal? Their fear - Asian managements do not recognize European sensibilities. But it’s politics all the same if not downright racism.

e) General political / judicial dislike for raiders. I would put it as lack of instances of a raider doing a company and all its stakeholders substantial good. If a few buyouts result in explosive growth in shareholder returns, this perspective may change. But you can’t be a PE fund manager and not exit in a hurry. Chrys Capital realized it painfully. It got out of Bharti Televentures investment with almost 5X plus returns on its $300 million investment six years back. As soon as it got out, the sector fortunes turned and in another couple years, the market cap of the company rose eight fold. Chrys Capital is still licking its wounds. So did ICICI Venture exited Air Deccan in a hurry, at a loss. Soon came Vijay Mallya and Capt.Gopinath the Air Deccan founder got a lucrative exit within an year of ICICI Venture’s hurried exit.

So PE firms, it’s a mixed bag here in India. Tread carefully and you could be in for big gains. Try to be a smart ass, you’re in trouble deep. Know why? Entries are the easiest part in investment game; it's the exits that tell men from the boys.

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Own your Investment Bank

What got started as a hobby, a sort of silent mutiny against mediocre employers that lacked agression and nerve has now grown into a full fledged business model. I am talking about my own Private Equity / Venture Capital advisory business that up until now has been a sole propreitory outfit advising startup / expansionary stage companies on a variety of issues elaborated in the presentation embedded on top. (Just mouse over it and click when thumbnail appears).

My take on the industry can be found here, here and here. If you think like me and have put in over a decade in the industry, you know what I mean. Now that the markets are a lot sober and deals harder to come by because owners think their businesses are undervalued. PE/VC firms are not getting enough deals at the same pace as they raise funds. We need to bridge that gap, fast. It's the time to put well intentioned and innovative deal structures (not removed from the realm of common sense) to work. The excitement and the reward are ours, up for grabs.

That's why I chose this moment to assemble a strong in-house team, catalyze and grow big. I am looking for experienced, entrepreneurially inclined analysts / investment banking professionals (from financial / operating streams) with just one caveat. Be ready to *own* a piece of this enterprise to be based out of Mumbai (initially). With our enlightened vision, unstinted support and excellent connections, I hope it should grow into a mid-sized investment bank within about three years from now.

Do you have what it takes...? Just write in with your resume and investment potential to me at kmonyb [at] gmail [dot] com

Update : Here is more proof of opportunity I am after - big firms saying no to (not so) small mandates. Small players never had it better. What keeps you on hold? Enough of helping your boss get rich. Grow so big and rich, I mean rich enough not to waste your time. Do write in or drop a comment to this post!

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Squeeze the Sheikh of every last Dirham and....

On Sunday US President George W Bush blamed India for rising global food prices, provoking a backlash from Indian politicians, who retorted that the US policy of promoting corn-based ethanol in motor fuel supplies has had bigger impact on world food prices.

Now I felt like a good laugh. Here is the President of the most powerful nation in the world asking a third world country of 1.1 billion people not to eat. Bad advise. Has the debilitating American economy dented Bush administration’s straight thinking skills? May be India can solve world food problem as he’d like to think; but should it starve itself in the process?

I think of a natural hedge. Oil prices surge above $122 per barrel. India is a net importer of oil and the price rise leads to inflation of over 7%. How about revoking the ban on export of non-basmati rice and exporting the grain at $ 2000 a ton to OPEC nations? Could it not offset oil price rise?

Squeeze the sheikhs of every last Dirham…. And buy their oil with some of it.
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Boys cancel capital; Men own treasury stock

Not too sure whether I could stomach this. Share buybacks in India totaled $1.1 billion from nine deals so far this year. True spunk in times of inflation, crude price spiral and liquidity concerns. Boards must be having wholesome breakfasts I guess :)

Besides the recently concluded Madras Cements buyback, the others that have been lined up are of Reliance Energy, Great Offshore, Mastek, Patni Computer, Gujarat Flurochemicals, JB Chemicals, Sasken Communication and Goldiam International.

But I wonder why Indian laws mandate "cancellation" of shares bought back. Is earnings beef-up (because lesser no. of shares now stake a claim to enterprise earnings) the only motive? I think that's a very myopic outlook because you are compromising on long term resources. It betrays a lack of enterprise long term vision. Is there a guarantee that the company could raise capital in future at a lesser cost than the portion that got canceled? What about time taken to raise it? Will opportunities wait till you raise capital? Enterprise is all about sudden opportunities. Capital adequacy helps swift exploitation of an opportunity. The shareholders (both existing and those cashing out) may be enriched in the short term but they are also giving up quite a bit of future capital productivity.

So why can’t companies be allowed to hold at least a part of capital bought back as Treasury stock in their balance sheet?

The significant advantage could be that treasury shares have the potential to restore the distributable profits used when shares are bought back. The distributable profits used to buy back shares are lost when the shares are cancelled. Purchases into treasury still count as a reduction in shareholders' funds but, on the sale of shares out of treasury, the sale price will replenish the distributable reserves up to the amount lost on their acquisition. Any profit made by the company on a sale of treasury shares must be credited to the share premium account. This ability to recreate distributable profits, not available on a share buyback and cancellation, means that it is likely that shares bought back in future will be held in treasury up to the permitted levels.

Just as in the laws of UK, allow it with some restrictions –

- seek shareholder approval

- prevent companies from buying shares into treasury during close periods or when they are in possession of unpublished price-sensitive information, other than in certain limited circumstances;

- express ban for insiders to buy or sell stocks from or into treasury portfolio;

- prescribe ceilings based on net worth

- treasury stocks are denied the right to vote, dividends but are entitled to bonus shares;

Another benefit from treasury holdings is that these shares can be later applied towards employee stock options to reward talent. In the U.K., transfer out of treasury stock towards Employee stock option programs are exempt from stamp duty unlike employee stock option trusts where the company has to bear the trustee fee besides bearing the burden of stamp duty on transfer of shares held by the trust.

SEBI chief C.B.Bhave is known to be a man of action. I suggest he should check out procedures with UK Listing Authority for allowing treasury stock treatments. I hate the expression “cancel”, especially if it is used in relation to capital - not so easily found nowadays :-)

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Indian infrastructure. Big numbers, high hopes!

Realty sector is getting hot; yet again

While the housing sector experiences a slump with investors vanishing from the market and end users finding rising interest rates a major hurdle to buy their dream homes, the broader realty infrastructure sector remains hot. Leading PE funds such as Blackstone, 3i, ICICI Venture, Axis have all raised major rounds focused on Indian infrastructure sector.

Why this rush towards Indian real estate and infrastructure?

According to estimates from ICICI Securities, the Indian real estate market is worth $57 billion, and is expected to grow at a compounded annual rate of 13% to touch $105 billion by 2012. This would require investments worth $85 billion across the residential, commercial, retail and hospitality sectors. On infrastructure, the Indian government has forecast the need to spend $492 billion over the 11th five-year plan ending 2012.

As such, the investment climate for this sector has been hot, and funds, both domestic and global, have been queuing up for a slice of the action. Did you say liquidity crisis...?

No wonder I am finding myself in a funny kinda’ situation.

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Not alone, not at all

I find myself in a funny kind of situation now. Around six months back, I was flooded with queries from owners of landbanks across India for investors in their projects. Valuations were reigning high then and deals were difficult to cut since investors found nothing much left on the table for them.

Now the valuations have declined and I have a slew of big ticket investors (including a couple funds that just closed billion $ rounds) looking for some big ticket deals in the infrastructure / Real Estate sector. But projects are hard in coming since nowadays companies feel they are valued too low and if they could wait a while, the projects would fetch desired valuations.

In either case, I feel stumped. Most of my friends in I-Banking/strategic advisory circle feel the same way. It’s almost an year since they’ve formally closed any deal. When sentiments are extreme, deals are difficult to close. I thought may be it’s difficult because I run on my own and may be with some institutional tailwind behind me, could’ve closed some large deals. But now I learn it’s the same scene everywhere. Only that they’ve larger overheads to bear with transaction support teams needing to be paid even as they have no transactions to support :-)

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Buying a shell calls for skill

Heard this on the grapevine a few days back from my deal sourcing network. Mrs.Radhika Saratkumar, Southern Film and TV personality and holding over 51% founding stake in Radaan Mediaworks is desirous of diluting her stake. As usual I began my initial scanning and looked up the company, its business and operational framework. The company has established a formidable reputation as leading southern production house and Ms.Radhika is known to be a very balanced person with whom artists love to work with unlike Ekta Kapoor who is known to be quite domineering.

But then take Ms.Radhika out of the game, the company loses its radiance. She is the creative centre of gravity as far as its operations are concerned, which is production of TV soaps mainly for the southern audience. A couple of media investors whom I had talked to felt it could be a good buy if Ms.Radhika agrees to continue assisting the business. But creativity has to come from heart and after she cashes out, you can’t expect the same level of inspired originality that has been the hallmark of her work so far.

Later I heard, Ramesh Vangal of Katra group with diverse business interests is eying that stake. May be he has an ace up his sleeve.

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IIM/IIT to sell only premium fuels; Corporations join in

When Government won’t let them raise prices for fuel despite higher input costs, the PSU oil marketing companies stopped selling low cost fuel at their stations. In many outlets, they sell only premium fuel that’s free from price curbs.

A few days back, the Government wanted reservation for SC/ST/OBC students in IIT/IIM and even wanted private sector to give them reservations. They also were to be charged lower fees by these institutes.

Now will these institutes and companies in the private sector develop a premium product to get around those impositions?

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Keep the lights on UMPP

Liquidity crisis, it seems has affected only undeserving projects.

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The funding commitments which have been secured for the Rs 17,000 crore ($4.2 billion) "ultra mega" power project (or UMPP) at Mundra in Gujarat should silence the critics of the UMPP policy. When the idea was floated a couple of years ago, there were doubts about the ability and willingness of companies to come forward and build such large (4,000 Mw) projects. And even if there were some brave companies who were to step forth, they were expected to have trouble finding financiers.

Now the skeptics have been shot down. Not only has there has been a long list of bidders for these projects, now the first such project to get off the block — backed by Tata Power — has also managed to secure long-tenor funding of up to 20 years despite the sub-prime crisis.

A host of public sector banks, led by the State Bank of India, have committed Rs 5,550 crore to the project. About half of the non-rupee funding of $1.8 billion has been sourced from the IFC and the ADB for a 20-year period. There is also a funding commitment from the Export-Import Bank of Korea and the Korea Export Insurance Corporation, which can be linked to the fact that a Korean firm, Doosan Heavy Industries, has bagged the order for project equipment (boilers). Then there is the equity contribution of Rs 4,250 crore by the promoters of the project, which is to be based on imported coal.

The BS editorial says there are lessons. First, it helps to think big. The larger the project, the lower is the effort per Mw required to push it through. Secondly, the government needs to work on "pre-cooking" more infrastructure projects, so that some basic work on greenfield projects is done before they are offered to private investors. The UMPPs, for instance, were housed in shell companies floated under the public sector umbrella and they piloted the clearances and supply linkages, and also signed provisional power purchase agreements with the buyers of power.

Not all things Government does warrant criticism.

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"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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