CBDT, learn from IRCTC

While some of us may wail over poor internet penetration extending the longevity of high cost off-line systems, IRCTC is proving otherwise. To the uninitiated, IRCTC is India’s online railway reservation facilitator. One look at this report over its results is an eye opener. With the increasing penetration and use of the internet, IRCTC’s ticketing revenue has seen a remarkable increase over the past 3 years ( From Rs 7.04 billion (2006-07) to Rs 17.44 billion (2007-08) and to Rs 39.66 billion last year.

Just wondering. What if CBDT allows Income Tax assesses (and not-yet assesses) to pay a presumptive tax (say a base rate of 10% of total income) online and ask no further questions unless they have incontrovertible proof of evasion? I am sure people will have lesser incentive to evade taxes and that will widen the tax base and reduce the total cost of tax collection which currently is steep and getting steeper.

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Hardening interest rates...? The US will go belly up.

I am a bit flummoxed by C.Rengarajan’s theory that interest rates may harden.

I think we have to distinguish between short-term interest rates and long-term interest rates. In the US, the Federal Reserve does not really control long term interest rates. They can tweak it occasionally through quantitative easing and through the purchases of 7 / 10 / 30 year bonds but what they control is the short-term interest rates (the Fed fund rates). Hear out Ben Bernanke, and you feel the short-term interest rates will stay low for a very long time. In America the fiscal deficit this year will be around USD 2 trillion and I do not think they can cut the fiscal deficit next year because if they cut it, it will have a negative impact on the economy. So I rather think that the fiscal deficit will stay at this level or in my opinion actually even increase. That will lead the Fed to keep interest rates artificially low because should they increase short-term rates meaningfully then the cost of servicing the government debt in the US will escalate substantially. So I think as far as the eye can see, monetary policies in the US will stay expansionary.

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That means US dollar shall remain weak for a very long time and that means most $ funds will find its way to other currencies / asset classes. Liquidity is therefore assured and no bank will have the guts to jack up lending rates because money flow is not going to be tight for quite some time. Then where is the question of rates hardening...?

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The bond dealers are in for some rough times. But then they can't do much else except to squeal and crow for hard rates !!!!

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Predictions of a recovery – V, U, W and now " L " !

Fuck.... They're soon going to run out of letters in the alphabet.

All this talk of shape of the (economic) recovery befuddles me. Can we assume the first step in any recovery is for output is to stop shrinking? But the more interesting question is what shape it will take. The debate centers around three scenarios: “V”, “U” and “W”. A V-shaped recovery would be vigorous, as pent-up demand is unleashed. A U-shaped one would be feebler and flatter. And in a W-shape, growth would return for a few quarters, only to peter out once more.
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America is apparently doomed no matter what. Years of debt driven consumption by consumers is now replaced by debt driven consumption by the government. If it inflates away the debt, the government will be able to pay off its debt but its citizen will all be poorer due to value erosion, leading to a crash in consumption and even higher unemployment. If US doesn't inflate away its debt, then its children and grandchildren will work to pay off interests on that debt for generations, leading to extended depressed consumption and high unemployment. Different path to the same result. So, some predict an `L' shape recovery for America.
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Why is inflation bad? Inflation is a tax on savings while a subsidy to borrowers. If you saved $100,000 today, it won't feel so great when high inflation eats all of it away tomorrow. If you're a borrower, $100,000 is a huge burden on you today, but something you can probably write a check for tomorrow and forget about.

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America's balance sheet recession is different. In this case, the saver is not fellow Americans. They're foreigners (China and other Asian nations). So for Americans, inflation is a remedy that won't make its rulers lose that many votes (so long as inflation does not get out of control). After the Asian financial crisis, East Asia was using export-oriented growth, through undervalued exchange rates, to power growth. The other side of their trade figure is a huge deficit in America which can only exist with an overvalued dollar...which itself can only exist with foreign money from Asia coming in to prop up the dollar. So, high export earnings from Asia were replowed into America, which cannot produce anything of its own because of an overvalued currency but was awash with cheap money...well, banks had to do something with that money, like lend. If they didn't lend, their competitors will. Asia giving so much money to a rich country where they money won't go as far is really unusual.

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This is unusual for two reasons: a) developing countries are in no position to lend (b) US T-bills offer a silly 4-5% return. Asia should therefore invest all of it internally for better healthcare, education and infrastructure in rural areas. Then perhaps they can beat the piffling return they get from US-T bills as they do now, which is again eroded by depreciation of the dollar as they repatriate back home on maturity. This is a great misallocation of resources!

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Still people are fixated at likely shape of recovery, than how best to make it happen.

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New Tag - Rally Buster

Rally Buster. This is the new tag on my blog. It relates to a spooky rumor or news item that pulls the plug on a rally in the stock market. Sugar has been rallying for quite some time because of huge demand (22 million tons) – supply (15 million tons) gap in India. The rally has extended to the US and European commodity markets too because of the news that India, world's most avaricious consumer of sugar is facing this huge a deficit and is in a mood to import in bulk.

Meanwhile, the sugar companies in India were operating nowhere near their full capacities because the raw material (sugar cane) is in short supply. Then we have the socialist mandate of levy sugar (10% production of each sugar mills to be sold to government at Rs.12 per kg even as the going market price is Rs.30 plus) to be supplied by the mills before the rest can be sold in the open market.

Constraints, constraints, constraints for the sector. As if all this is not enough, today the sugar daddy and others in the cabinet have met up to discuss raising the levy sugar quota from 10% to 25% of production to bring down the spiraling sugar prices.

That busted the rally to some extent. The sugar stocks tanked between 4%-8%. The Economist can talk of Astonishing Asian rebound. Given the rally busting tendencies of our policy makers, they may not have to spill much ink on the topic !

On to the worm now

This was pure music....

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Real estate, after the meltdown, was my favorite. DLF to be precise. Don't think I did big bang research that made it quite a find. Just a wistful hunch when I saw the stock languishing at Rs.300 levels. Now I read about the Mutual Funds newfound love for all things realty. Ha!

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The MFs exposure to realty rose from Rs 1.24 bn in March 2009 to Rs 1.71 bn around December 2008 to nearly Rs 11.13 bn by the end of Q1-FY09. By July 09, it rose to Rs.14.21 bn according to this news report in BS.

Nice to feel like an early bird... On to the worm now !!!

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Never blame securitization

Securitization offers many advantages to all participants in the marketplace. Derivatives decrease barriers of entry to a host of markets, increase potential diversification and customization, and enhance liquidity and hedging activities.

Securitization has represented a series of innovations that have brought about greater efficiency but the problem with innovation, almost by definition, is that they outpace the ability of the infrastructure, on both the private and public side, to sustain the innovation.

Now, the system is trying to catch up but we risk an overreaction that may limit the potential of securitization. Hopefully, an understanding that a return to securitization is crucial to economic recovery (by allowing banks to lend more through risk transference) will lead policymakers to resist any misguided populist sentiment.

The new products present challenges for risk managers and regulators alike. It also burdens operations, technology, and settlement systems in the process. In reality, every level of the financial system will need to continually adapt to changing risk and complexity.

Unfortunately, policymakers, almost by default, will always be behind the curve. Because an attractive fee is extracted at every stage of securitization, the agents, or intermediaries, will will always be prone to excesses. Innovation will always outpace the ability of the infrastructure to sustain it and securitization crises will be a recurring phenomenon in the new age global finance, you bet. But try doing away with it, you're only deepening the liquidity crisis.

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The Goldman heyday

What are we to make of Goldman’s Q1 results…? Making $3 b in as many months is indeed recession defying but how much of it is its own making in contrast to the near absence of competition – Citigroup, UBS, Lehmann and its ilk? The Economist says - To the survivor the spoils - and I can’t agree more.

Monday, after market close, Goldman Sachs Group, Inc. reported 1Q09 earnings of $1.66 billion or $3.39 a share, up from $1.51 billion, or $3.23 a share a year earlier. The results were way ahead of consensus estimates of a profit of $1.64 per share.

Higher-than-expected profit was mainly due to strong trading revenue. Of the first quarter net revenues of $9.4 billion, $6.6 billion (34% higher than its previous record) was the contribution from the company’s fixed-income, currency and commodities (FICC) group. High volatility (benefiting the Treasury markets and the Dollar), wide spreads in fixed income and reduced competition in the markets were the main reasons for strong earnings.

However, the areas outside fixed income and currency businesses showed weakness during the quarter. Investment banking revenues were down 30% year-over-year, due to the low activity in the capital markets. Asset management revenues also declined 28% to $949 million.

Again as the Economist says this windfall will likely dwindle soon. The firm may be scooping up market share at quite a clip. But the bigger picture is still far from pretty. Goldman and other survivors will benefit from the coming wave of debt issuance by federal, state and local governments. But dealer spreads are sure to shrink as markets normalise and those that have retreated return to the fray. This is likely to be offset only partially by a pick-up in businesses tied more closely to economic growth, such as advising on mergers and acquisitions.

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Mothers and Corporate Governance

How complicated can the RIL-RNRL dispute get? Very. Well, that’s what it looks like if you look at the arguments from both sides.

RIL’s legal team likes to make it seem like a business dispute between two companies and not a family affair, which I guess is right. RIL also feels that the High Court order has adverse financial implications for the company besides national implications and it gave an unfair advantage to the ADA group based on a family agreement in 2005. Besides, company sources have argued that the ruling, in a way, would override the government’s gas allocation and pricing policy. Then there is the scope for miscarriage of justice since RNRL will get gas at half the cost ($2.34 per mbtu) of what it costs ($4.65) for other gas buyers of RIL. So which way the dice is loaded ?

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For RNRL, it's the MOU that's sacrosanct. Nothing more, nothing less. End of the argument.

Yeah, then there is the mother factor. Kokilaben is also drawn in to mediate in case the brothers get around to it. Given that both companies are widely held joint stock corporations where there are millions of other shareholders involved, how fair it is to leave business judgments to family members that have never held executive positions in the company or are not adequately trained or exposed (I mean first hand, not of the kind *I-had-been-at-the-dinner-table-with-my-husband-and-sons-as-they-discussed-business*) ? Is that good corporate governance leaving the fate of millions of shareholders to mother of just one among them?

Why not let mothers be mothers for a change? It’s not like wandering into the kitchen sniffing for hot Dhokla and Khandavi that Kokilaben will be happy to engage with all her heart and soul.
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Allow listing of unsecured debt, but mark it "with recourse"

Somasekhar Sundaresan in Business Standard points to the area of ambiguity in SEBI’s latest concoction [SEBI (Issue and Listing of Debt Securities) Regulations, 2008 - (“Debt Regulations”) ] - whether every bond that is sought to be listed has to necessarily be secured to the extent of 100 per cent. He insists SEBI should clarify the issue since Regulation 17 calls for the issuer to simply make a disclosure of intention to create a charge or security and further under schedule 1 of the Regulations (prescribing the contents of the offer document) requires the offer document to contain a summary term sheet that includes “brief information pertaining to the “secured / unsecured” debt securities – meaning the Regulations also envisage issue of unsecured instruments as well.

But Merchant Bankers take the extreme path fearing SEBI reprimand. They advise the issuers that only Debt securities that are fully secured are only allowed to be listed. Quiz them more and they point to Regulation 26(6) that requires the issuer and merchant banker to “ensure that the security created to secure the debt securities is adequate to ensure 100 per cent asset cover for the debt securities.”

Sundaresan says it just means if the issuer is desirous of issuing fully secured instruments, then it has to be secured by assets to an extent not less than 100% of the issue size. Implying in the process, others that are intending to list unsecured debt are free to do so (as there are references to unsecured debt elsewhere in the Regulations and its schedules).

I am concerned. Should SEBI permit unsecured debt to be brought to public market where the participants are not so erudite? Will it not lead to emergence of con artists from the woodwork that will list everything including the toilet paper? Haven’t we learnt anything from the recent two trillion dollar global meltdown? Have we forgotten so quickly that it had its origins in the subprime ( unsecured, junk) bonds that got listed and recklessly palmed off by Wall Street swindlers ? Who has heard anything about a once venerated institution by name “Lehman Bros” lately? The CEO’s first name was “Dick” (Fuld) – incidentally.

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I am no throwback and I certainly don’t believe listing of 100% secured debt would mean guaranteed repayment. Neither do I have any faith in swift realization of underlying security if the debt obligation is defaulted because enforcement of Indian laws isn’t so easy thro our overloaded Courts. But I have a great faith in the agility of the con men in our midst that will rise swiftly to the occasion and exploit a loophole. The expression “unsecured” is enough to make them sit up and take notice. And when their junk papers eventually get listed, they are safely absolved off all their liabilities since the risk is widely distributed [sometime later even credit derivatives (like credit default swaps) will also have to be allowed] and SEBI will gleefully point to the disclaimer that states “SEBI merely ensures disclosure and does not vouch for the soundness of the scheme” etc….. Next what – CDS, CLO, CDO, ABS on the doomed Wall Street lines? Just the way residential mortgages in the US became grist for quantitative portfolio management after they had been re-engineered into instruments that looked much like tradable bonds. The investment efficiencies generated large benefits for both investment banks and consumers but were quickly carried to dangerous extremes. Soon we will be forced to subscribe to the pretense that all of finance can be mathematized. Do that and the next credit bubble won’t be far behind.

By all means, allow unsecured debt to be listed. I am all for liquidity in the debt market. But do build in enough checks to make sure the it stays well within the repaying capacity of the company or at least block so much of its borrowing power from banks and other institutions to the extent to which the company has already geared its balance sheet debt. And most importantly, mark that listed debt "with recourse" – meaning in the event of a default, the issuer and it's founders/promoters will be liable to the holder (in due course) of the instrument and not just the primary allottee.

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Bharti-MTN deal : Sniffer dogs at work ?

My experience with M&A deal structures tells me that the level of distrust between the parties can be gauged by the magnitude of its complexity. By complexity I mean insistence on back to back cross holdings, layered cash and share swaps and other exhaustive clauses in the share swap agreements relating to Board composition, management, operational checks and internal audit.

Going by that, I am not surprised why the stock markets gave a thumps down to the news of Bharti-MTN merger. The Bharti share fell 5.41 per cent to close at Rs 811.85 on the Bombay Stock Exchange, on a day the Sensex rose 26 points.

The deal is not just complex by size, it’s structure too is no less contorted. Sample this. Under the deal, MTN will issue new shares (they prefer to call it “economic interest” instead of plain “shares” – probably an indication of refusal to imply ceding of management control to pacify regulators) to Bharti. The Indian company will also acquire around 36 per cent of MTN’s current paid-up capital from its shareholders at $10.2 per share, entailing a cash outgo of $6.8 billion. The fresh share issue will eventually take Bharti’s shareholding in MTN to 49 per cent.

In return, Bharti will issue 0.5 GDRs for every MTN share it acquires. The Indian promoters will eventually see a dilution of their 45.30 per cent stake in Bharti.

Even if it is to avoid regulatory hurdles, anti-trust allusions or even triggering of open offer requirements to other minority shareholders that can drive up the price ( open offer is triggered when stake in excess of 15% is acquired in an Indian company with the exception for inter-promoter swap or cross holdings), the deal structure is far too complex for execution because the exhaustive approvals and information sharing between the parties called for will certainly limit operational flexibility to a large extent – a factor that has been instrumental for the rapid growth of Bharti (and possibly MTN too) in India.

I see more of mutual suspicion than synergies in this deal. Shall be glad if proved wrong.

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Press "Sell"

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

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

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

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

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You know better than you think you do

Massive inflows into the global equity / commodity markets in the month of April to me is an indication enough that repeated assertions by the talking heads – about money waiting in the sidelines - falls flat in their faces. I think now it’s getting very tenuous––the fund managers, retail investors across the board people are very nervous at these higher valuations. In that sense, I don’t endorse the capability of equity markets to forerun global economic fundamentals that are still weak, at least as weak as they were made out to be in the early days of liquidity crunch in Q1-Q2 of 2008. The expression I guess is, suspended disbelief - as in the super heroes in the movies, when you know humans cannot fly but you believe Superman can fly, so you can enjoy the movie.

That is not to say that we don’t enjoy the current rally while it lasts. The suspended disbelief here is in ignoring the reality of the economic fundamentals. At some point, delusions give way to reason and the tide ebbs all of a sudden. It’s hard to guess what can legitimately support equity valuations much higher than here, almost in any market around the world.

When you can’t guess it, it’s time you respect your fears and retrace a bit. Don’t repudiate your own instinct so much just because it comes to you free and it tells you to keep away from seemingly juicy opportunities, especially after a long, dry spell. Trust your own instinct. Your mistakes might as well be your own, instead of someone else's. Good instincts usually tell you what to do long before your head has figured it out. You know more than you think you do.

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"Indian bankers, don't you carp later"

It’s tough time for banks and borrowers alike. The stiff 5% CRR and 24% SLR leaves banks with no choice but to keep their cost of lending to corporates high. Working Capital has become all the more expensive to businesses at a time when cash flows are squeezed and order inflows have dried up.

I wonder why the banks don’t invest in equities (preferably thro a 100% SPV) of sound companies that come with a Board seat to enable them exercise a closer watch ? Now that equity valuations have come to realistic levels and companies badly need low cost funds to sustain till they get over the recessionary times. For the banks, it would be a great idea to adopt this neo-private equity model because it comes with built in tax benefits since the returns will be in the nature of long term capital gains that are either exempt or are taxable at concessional rates. Since these are in the nature of investments, the SPV’s don’t need any elaborate set-up and can at best be a desk in one corner of its treasury operations wing.

When Henry Kravis comes calling, that’s proof enough that Indian equities are good bets. So bankers, sit up and take notice. Or else, Kravis would have you for lunch and dinner before you say `protection’. Or worse, it could be the turn of J.C.Flowers.

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"Long term? You must be kidding !"

Yesterday, when the Sensex closed slightly above 10,800 mark (Nifty at 3342) I squealed with delight. After a long time, pretty long time that is – I made some money. In the normal course I, a not so sophisticated investor – would have lingered on. But not yesterday, especially since it’s been way too long since I’ve booked some profits.

All kinds of news flows abound. There are the general elections, the March quarter earnings and the good ol’ talk of markets bottoming out. The weather beaten ones like me would not buy any of it, they’d rather be happy if the portfolio doesn’t crack any further. Neither would they invest any fresh funds towards equities. Nobody is in any tearing hurry to abandon caution and get back into equities that have cut and carved them up right down their middle.

But then what’s fueling this rally? Nifty closed at 3033 at the beginning of this year, now stands at 3343 – a surge of 310 points or 10.22%. What has changed in just three months? Have we picked up on some signals that tell us our worst fears of a recession are misplaced? Have the foreign investors – that made and marred our markets – returned? In their own backyard, Wells Fargo sent the stock market on a dizzying rally on Thursday when it revealed that its mortgage applications surged to $190 billion in the first quarter, a sharp increase that would lead it to a record $3 billion profit for the period. Like other big banks, Wells appears to have benefited from a surge in mortgage refinancing because of ultra low borrowing rates engineered by the government and an exodus of competitors. Bank of America, JPMorgan Chase, PNC Financial and others have had similarly strong performances and are expected to post improved profitability when earnings reports are issued next week. Or so, they’d make us believe for now, until another wave of disclosures would tell the world they’d gone horribly wrong again.

As I admitted earlier, I am not so sophisticated to make any sense out of this. I hear a lot of bull crap - investors, mostly foreign institutions, are initiating trading strategies through equity options to bet on the likely rise in volatility blah, blah – but I am in no mood to buy none of that. When I see my stocks rise, I go out and book profits. To hell, with long term. Who knows how long is long term?

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"ICICI Venture is lying"

Just finished reading this BS report – “PE firms to rethink India strategy”. I say, “they had better” !

The report quotes Vikram Uttam Singh, Head, PE advisory group of KPMG “The Subhiksha incident will make PE firms more cautious on how much of a free hand they allow to a promoter. Some PE funds are concerned that promoters have a wide range of authority in their companies and could look to establish structures that limit some of this authority”.

Here are my observations.

KPMG may have compulsions to take sides with PE firms as their survival depends on such clients. But why does it credit PE firms with so much of naiveté? ICICI Venture had an exposure of 33% in Subhiksha of which it off-loaded 10% to Azim Premji’s PE arm (Zash Investments) for Rs.230 crore – apparently without discussing with Subhiksha itself that was badly in need of cash.

If the same money (Rs.230 crore) was introduced directly into Subhiksha, (instead of buying out ICICI Ventures stake), the company could have been saved to an extent. But I-Ventures wanted to lighten its holding and thought otherwise.

While it’s ok for PE firms to cash out, they need not profess their ability to have long term relationship with their portfolio companies and the “strategic managerial edge” their presence in the Board offers to such companies. When that is the case, what was Ms.Renuka Ramnath (one of I-Ventures nominees on Subhiksha Board and CEO of I-Ventures) doing when she approved the proposal for massive scale up by Subhiksha? Now is she telling us she was not aware of it, even as I-Ventures had the rights to appoint majority of Subhiksha Board? Or does it mean she was too busy to attend Subhiksha Board meeting where such a critical decision was made? Or is she admitting I-Ventures had no monitoring mechanism over its portfolio companies? That’s a bit too much. If I were a LP investor in I-Ventures, I would have taken it to task and would proceed against them for dereliction of duty. A bit too naïve. She certainly can do with some education on sophisticated lying.

Just as in the case of Subhiksha, the first thing PE firms do when they sense trouble is (a) to quietly off-load their stake to an unsuspecting investor and (b) withdraw its nominees from the Board so that they need not defend lawsuits filed against them by unpaid creditors/ bankers / statutory authorities like EPFO in this case.

In simple terms, PE firms are pure fair-weather friends. All talk of strategic advisory services and expertise all are pure bunkum. They have none and they are here just to skim the profits. At the slightest sense of trouble, they chicken out – like the proverbial rats from the sinking ship.

Nothing wrong absolutely. Buy why not say it upfront? Why the façade of management expertise when you know you have none? Why not tell the portfolio investors - “Take the money and pay us back 10 x returns. In case if you goof up, you’re on your own” !

And lastly about KPMG and its ilk of PE advisory groups. How come all those transactions advised by these so-called whizkids yield a negative return soon after the transaction? Are they whizkids or half-baked, mother fucking scumbags that shamelessly face the media and talk ill of the companies they ran a due diligence on and arrived at a "fair market value"? If after all their “expert” due diligence, their projections go haywire, should they not re-examine their processes and find out what’s going wrong? How long should the investing community put up with such sobs that are ready to even chomp client carrots if there is the word "fee" at the other end?

Why would they? They have mastered the art of orifice-licking and carrot-chomping. That should keep them in good stead besides the standard disclaimers that insulate them :-)
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Tweaks and twaddles - is that enough?

As I see the government coming out with serial reform tweaks (FDI norms, Preferential allotments) and bureaucratic twaddles, I worry that we’re operating far beyond our economic knowledge. Every time the administration releases an initiative, I read different reports with diverse opinions. I worry that we lack the political structures to regain fiscal control. Deficits are exploding, and the government clearly wants to restrain them. But there’s no evidence that the UPA / NDA or the non-aligned rest have the courage or the mutual trust required to share the blame when tough decisions are to be taken.

All in all, I can see why the markets are nervous and dropping. And it’s also clear that we’re on the cusp of the biggest political experiment of our lifetimes. If Obama is mostly successful, then the global skepticism natural to conservatives will have been discredited. We will know that highly trained government experts are capable of quickly designing and executing top-down transformational change. If they mostly fail, then liberalism will suffer a grievous blow, and conservatives will be called upon to restore order and sanity.

It’ll be interesting to see who’s right. But I can’t even root for my own vindication. The costs are too high. I have to go to the keyboard each morning hoping Barack Obama is going to prove me wrong.

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Was ICICI Venture CEO Ms.Renuka Ramnath dozing at Subhiksha Board meets?

India’s premier PE firm ICICI venture (I-Venture) with more than $2 billion fund size can’t be so naïve.

I-Venture CEO & MD, Renuka Ramnath says the management of flagging retail chain Subhiksha (in which the firm has a 23% stake and has the power to appoint majority directors in its Board) kept it in the dark regarding the goings on. (She was one of the Board members then). She goes on to add "As a responsible investor, despite being minority shareholders and not having management control, we are talking to all players concerned and trying to seek a possible solution which will be in the best interest of all, including the employees”.

Here is the punch line "We didn’t know what to trust and what was the real intention of the merger” (with a listed NBFC Blue Green Constructions with which Subhiksha sought to reverse merge for widening its shareholder base).

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Oh, really? A firm in which a leading PE firm has a 23% stake and the firm knows "nothing" about decisions as critical as a reverse merger? It was all over the media back in June, 2008 when Subhiksha acquired 40% stake in the little known listed entity Blue Green Constructions. The Board (in which I-Venture has majority) Meeting in which the acquisition was to be ratified was reportedly held on June 30, 2008 and then Ms.Ramnath didn’t seem to object.

The fact is, had the back door listing strategy worked well, I-Venture would have exited the firm lock, stock and barrel thro divesting its stake either in the open market or thro a secondary exit to other PE firms. The manner in which it “quietly divested” 10% stake for Rs.230 crore to Azim Premji’s PE arm Premji Invest back in September 2008. While I-Venture could dupe Azim Premji, it couldn't dupe the public investors since the merger didn't go thro.

Now why would a PE firm exits in a hurry if it wasn’t in control of the company and wasn’t aware of the murky goings on? Normally if there is a listing possibility, PE investors would rather wait for the market to discover the price. Even if one were to buy Ms.Ramnath’s argument – that Subhiksha did not submit audited accounts beyond March, 2007, it should have disclosed the fact to Mr.Premji which it clearly did not. I-Venture looked after its own interests, to hell with the company, co-investors or employees. But no one would blame the PE firm for that because it just cashed out on an opportunity. But you can’t excuse it if it says it was kept in the dark by the investee company management, despite wielding majority control of its board and in a company where it has a substantial 23% stake.

It’s a little too naïve – to expect the world to believe Ms.Ramnath. It’s ok if she chickened out fearing prosecution when legal notices (from unpaid vendors, employees, EPFO) started flying in. That's when she along with her colleague exited the Board of Subhiksha. But then it also means she wasn't exactly awake all the while at those Board Meetings leaving Subhiksha MD Mr.R.Subramonian to run the business as he did.

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"You need their money, honey"

So long as they were part of the ruling coalition led by Congress party, the Left played spoilsport and scotched every effort to relax FDI norms in specific sectors. They were vociferous against relaxing FDI in retail, telecom and insurance sectors. Now that they were out and recession is in, the government made the best use of the opportunity to throw FDI floodgates open. Now they say equity investments routed through companies in which majority ownership and control is in the hands of Indians would be treated as fully domestic equity.

Till now, the norm was that foreigners would be deemed to have an indirect stake in any investment made by the JV company in proportion to the stake held by them in the JV. In the revised norms, now there is no concept of any indirect holding, so long as the parent JV has a majority Indian holding.

Now, it’s not as if eyebrows aren’t raised.

The principal criticism is that now FDI will be linked to ‘control’ and ‘legal ownership’, completely divorced from “economic ownership”. But I can safely vouch - from my own experience while undertaking due diligence in several JVs that I'd been involved - the fact that FDI norms were easily got around even earlier by inserting specific clauses that vested control with the minority foreign partner, especially in strategic JVs. It just boiled down to who needs who more. If the business needed the strategic expertise that a foreign partner had but the stupid laws don’t let them have control, the majority Indian partners have little or no option to cede `control' discreetly to the minority than not to have access to the expertise at all. Shareholder agreements have vested in the minority foreign shareholder executive authority, super minority provisions to vote against a resolution, demand consent, right of first refusal, etc. Sectoral FDI caps in telecom, insurance and media have given birth to creative holding (thro preference shares / stock warehousing by domestic HNIs on behalf of foreigners) structures. Sometimes even lenders have better rights than majority shareholders in highly leveraged situations.

Laws should certainly regulate, not thwart opportunities. Sooner they realize it the better. But now the economic reality has given our government and its regulators a much clearer vision that they badly needed.

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Stimulus ain't free nor funny

It’s a busy season for stimulus packages that run into billions of dollars and sometimes even a trillion or two. (Suddenly `a million' sounds like small change!) For the announcers perhaps it gives them a few fleeting moments at the grandstand, but the global economies and its constituents including the stock markets are hardly pleased. The doubts don’t just linger around the quantum and quality of diligence behind these initiatives, it harp more on its viability – because they know their governments just don’t have so much money.

We thought Tim Geithner will be an improvement over Hank Paulson, at least in terms of practicality as he began by distancing himself from the `tentative steps’ of his predecessor even though he had been consulted upon. Anyway, the first vibes fail to soothe. For all the tough talk, however, the new plan, which will deploy the second half of the $700 billion Troubled Asset Relief Programme (TARP), was frustratingly light on detail.

Cut to home. Yesterday, the Government of India announced fresh borrowing program. As against Rs.2,22,154 crore raised in the ten months to January 2009, it intends to raise further Rs 46,000 crore (almost 21% of debt to date) between February 20 and March 20. Predictably, bond market reacted, sending yields higher (the additional supply will depress prices and push up yields). Though the RBI, the government’s debt manager, made haste to say the additional borrowing would be conducted in a non-disruptive manner, markets are not convinced.

So why do I say it’s not boding well for the economy? Government borrowing being seen as risk free, the rate at which it borrows gets set as the floor rate for all commercial lending. As such, borrowings by all other entities are seen as risky and so the mark up on interest rates go up. That drives the cost of funds up and hence the government cannot push banks to keep lending rates low to stimulate the economy.

Yet they call it stimuls. Now, isn’t that funny?

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"Enough of draw down"

say the Limted Partners (investors) in PE funds to the Fund Managers that let them down.

When I titled this blog as “General Partners V. Limited Partners” , it was pretty much apt for the situation then. General Partners that make the most critical investment decisions in their PE funds were held accountable for its outcome by the Limited Partners that funnel those funds. When investments don't yield desired returns, it's time for GP's to brace up for an LP interrogation, often that ended in LP deserting the funds and GP's earning a bad reputation. In the PE small world, word is out fast and that means near death for the GPs. They can't hop jobs so easily.

Now the situation has been upended. The new flip is that the Limited Partners are advising the General Partners not to press draw downs. May be, it's the liquidity crunch and absence of leverage that chokes many a LP funnel. But I like that in one way because somewhere the indiscretion has to end. The choice of investments they make is abysmal. Worse is the follow up supervision and near absence of timely strategic interventions. It’s not buy and hold anymore, buy and sleep seems to be the strategy for some.

"Outrageous"

Sometimes you get to read funny combination of headline news. Today I had one such - on Wall Street bonuses and another on PE firms unlikely to invest now.

Even as the whole world reels under recession triggered by Wall Street excesses, they have no qualms in collectively showering upon themselves billion $ bonuses as usual. Barack Obama felt it’s “outrageous”. Indeed.

Another is not so retchy, yet funny. Now that valuations are at their near lowest, PE firms are unlikely to invest. May be they are waiting for hyper valuations to return so that they can stir in right earnest burning bigger holes in their investors’ pockets!

What they teach only at B-schools ?

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After thoughts governments

Placing a fielder after the ball gets struck

This is my favorite cricket metaphor. It typifies a late riser, usually a fielding team captain that moves around his fielders to spots after the ball gets hit and not before. Smart batsmen will sense this and occasionally mislead the fielding team by offering unorthodox strokes to spots where they are not so good at stroking (say, a right hand batsman playing a risky shot to the gully or extra cover on the off-side) – it’s just a ruse to rattle the field so that he can freely score at his favorite spots where there shall be no fielders. Smart captains normally set a field and make sure his bowlers bowl to the field, not letting the batsmen settle down.

Our administrators are of the former variety - of late risers. When our real estate market was red hot, global strategic and financial investors including PE were making the major mistake of investing large amounts of money in overvalued assets, our government came down with a slew of regulations – P-Note bans, setting high water marks for FDI, classifying convertible debentures as equity etc. They made sure that they punctured the swell until there was nothing but flat tires. Now after the investors are gone, the globe in a recession, real estate developers are broke, sense prevails.

The government is tweaking FDI regulations to exempt mixed development projects from the $10 million capitalization requirement, reduce the project size to 10 acres (from 25 acres) and cut the minimum built up area to 10,000 (from 50,000) square feet. The lock-in of three years after the date of completion of the project shall continue. The only condition is that 50% of the area will be kept open for hotels / tourism activities, shall be subject authority supervision and residential buildings shall not be put to use otherwise.

It was pretty much the same thing that RE developers earlier clamored for. Now after they are long broke or even dead and gone, the government is waking up to the idea. Anyway, I will stock up on some real estate stocks - expecting a rally :-)

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Tax cuts or higher public spending - which is better recession remedy?

This is often a confounding question that baffles governments and right thinking citizen alike. Arguments fly back and forth – tax cuts generate higher disposable income that goes to buy stuff and keeps demand buoyant. The opponents figure saved tax money just stays locked in. It doesn’t create jobs because businesses have put on hold large capex spends.

But then economic stimulus has its own detractors as well. Increased public spending on infrastructure, healthcare and education have long gestation periods. Committing the tax payer’s money to long term projects especially in recessionary times is not exactly sensible because there is no guarantee that businesses will continue to make profits in future years on which the government can expect to collect more taxes and keep those jobs in tact.

Here’s how to think about this argument: it implies that we should shut down the air traffic control system. After all, that system is paid for with fees on air tickets — and surely it would be better to let the flying public keep its money rather than hand it over to government bureaucrats. If that would mean lots of midair collisions, hey, stuff happens.

The common knowledge is that tax cuts are not always better than public spending. Tax cuts work when a particular industry is marred by business cycle or has been subjected to excessive levies or if it contributes to larger public good, like say clean tech. In general otherwise, public spending provides much more bang for the buck than tax cuts — and therefore costs less per job created — because a large fraction of any tax cut will simply be saved.

This suggests that public spending rather than tax cuts should be the core of any stimulus plan. But rather than accept that implication, conservatives take refuge in a nonsensical argument against public spending in general.

But I would rather weigh it on case to case, time to time than offer a sweeping solution.

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L&T had no other option

As more than active observer of stock markets, I was just wondering what would I do if I were heading Larsen & Toubro, that bought 4% of Satyam stock at Rs.170 apiece earlier this month, after which the stock just collapsed to Rs.20 levels...?

I would have just bought up more. Not just for averaging, since L&T has an infotech arm that isn't going anywhere, this is the best opportunity to hire a company that has some marquee customers like GE.

And they seem to have done exactly that... I, like anyone else was stunned by the volume of over 300 million shares that got traded in NSE and BSE tody. First I thought it was the interest because of new suitors (iGate). Later I get to know L&T was buying up. But it certainly didn't hurt... I exited my positions when the stock touched 39.25 and made a neat profit...

Will re-enter tomorrow between Rs.35 - 40 levels, if I get it.... I feel L&T should still be bying up until its 15% with them and then proceed to make an open offer for further 20% and as usual I wouldn't wait to tender, will just exit during the melee in the market and retreat to the sidelines...

IIP numbers, a mirage?

Oil price is down, inflation is down, Rupee is down, Exports don’t look up. Still Banks don’t cut lending rates enough in proportion to cut in repo and CRR nor do they start some serious lending. This has created a sort of optical illusion in our IIP numbers that got released yesterday. The index showed an increase of 2.4 per cent over November 2007, which is not a great performance but apparently different from the 1.4 per cent decline in the previous month. However, the base effect seems to be largely responsible for both numbers. The October base was relatively high, with the index having grown by about 12 per cent in October 2007, while the November base was just the opposite, with the index having increased by a mere 4.9 per cent over the previous year. Stripped of the base effect, the optical improvement disappears and there is little question that the industrial sector is in a virtually no-growth period. On the face of it, this is likely to persist for some time. Even if the successive interest rate cuts and the various other measures that have been taken by the Reserve Bank of India and the government are enough to reverse the slowdown, the effects are unlikely to be visible until later in the year.

If the slowdown in manufacturing, gems & jewellery and other sectors is largely attributable to high interest rates, then the recent rate cuts must favor a turnaround in these sectors, though the cuts have not gone far enough. The missing link, of course, is the apparent reluctance of banks to lend money to people who might want to buy houses, cars or appliances. Until this flow of credit begins, a turnaround is not in prospect. However, the conditions, in terms of liquidity, are hopefully being put into place.
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ASATYAM COMPUTERS books weren't cooked; that was 3D virtual reality

Here, I suspected it's no longer SATYAM.... Now I stand vindicated...

Speculations glaore. I go it's all worthless. May be it's worth the value of some pricey real estate that it occupies in India's southern city of Hyderabad provided its overcooked balance sheet has truth enough in its declaration of the company's debt-free status. Otherwise, one would assume that even the properties may have been pledged or worse, being that of a software company, it's created out of 3D virtual reality. Something as in Second Life.

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I begin to doubt the Indiaworld acquisition that Sify (Satyam Infoway, sister concern of Satyam then) did for a mind boggling Rs.499 crore ($115 million in 1999 $). Did money really changed hands to that nondescript entrepreneur Rajesh Jain, CEO of Indiaworld? If so, why is he still stuck with some never-to-start startup? People with $100 million certainly will have a lot more options that the world would be curious to track. I have this feeling the price that Sify paid would have been far less, far far less and bulk of the money would have been stashed away by Rajus in some secret tax haven accounts.

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But then they also say the liabilities are underfunded to the extent of Rs.1230 crore (about $24 million) that Raju has arranged by pledging his shares. Anyway, too bad that Raju used a wildlife metaphor while attempting to clear his conscience in his letter to the Board- "it was like riding the tiger and not knowing how to get off without being eaten" - and disgrace the animal.

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It sure is a murky mess and it's only getting murkier. But there are some bravehearts too... And I sure can't stop envying the folks that were short on the stock yesterday...!
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After SATYAM-MAYTAS, it's HIRCO-HIRANANDANI

It's the scam season, no doubt... First came MADOFF that made-off with billions of $ of investor funds, then closer home it was SATYAM COMPUTERS being sought to be shortchanged by its founders currently holding 5.3% minority stake by exchanging their loss making businesses in lieu of huge cash in Satyam balance sheet. To hell with valuations, due diligence or even corporate governance.

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After SATYAM-MAYTAS fiasco, here's another; Hiranandani (Builders) attempts to take co-investors for a ride by opting for a merger with loss making family business HIRCO Developments with its AIM listed outfit HIRCO. The investors are irked because the decision is taken without undertaking appropriate valuation of the target, eerily similar to the Satyam deal that fell through because of shareholder revolt. In the Satyam deal, the promoters of SATYAM COMPUTERS (later found to be holding less than 6% stake) had decided to buyout their family concern MAYTAS infrastructure and MAYTAS properties both real estate businesses heavily in debt by using $1.6 billion cash in SATYAM's balance sheet. Later all the independent directors in its Board had to tender resignations owning up moral responsibility for their tacit concurrence by remaining passive during the Board meeting at which the issue was hush hushed.

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Why does the expression chutzpah come to my mind...?

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