Debt vapor

Thinking of early 90’s when I had just started working….

Indian companies were then extremely under leveraged and over mortgaged. For every Rupee of debt, one had to mortgage Rs.4 worth of assets because Marked-To-Market (MTM) as a concept was totally unheard of. Book Value has been the norm and it suited institutions better. I remember the time when I used to wait outside the offices of GM/ED of Banks / Financial Institutions (FI) who literally rationed loans. We never had extra assets to mortgage as properties worth several times the value of loans have already been locked down by earlier loans and this wait was necessary to get an NOC to create a second charge for a new loan. Still the securities to total debt ratio managed a cool 4 to 1.

Cut to the early `00, the situation reversed. Liberalization meant multiple streams of credit available to Banks/FIs and FII, PE and Hedge Funds entry meant surfeit of money supply that had difficulty in finding room to get parked. Corporates reveled in this new order of things and leveraged themselves to the teeth. They had a problem of finding destinations to invest in. The recklessness fueled by sudden excesses meant bad judgment and funds literally got sucked into projects that turned out to be literal blackholes, from which nothing would come out.

And now we hear this. I am not surprised. Are you? I think history will repeat and it’s time we prepare ourselves to cool our heels at the reception lobby of Banks/FIs waiting to be called in by the GM/ED…or who knows, it could even be outside a Manager’s office at a Bank Branch…!

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Will India's IT vendors turn realty players?

Pune factories going the Mumbai Mill-land way… Turning into expensive real estates. Bajaj Auto looks like exploring turning its Akurdi plant into developed real estate.

Judging by the little or no R&D investment by India’s famed IT vendors, recently endorsed by Indis’s distant 46th ranking in global IT map, what are the odds for Infosys, Wipro and TCS to junk their businesses and turn realty plays? Satyam already has its "Maytas " group (got by reversing “S.a.t.y.a.m”) of companies into which it can morph any day.

Going by the large swathes of land and building they hold, You can’t grudge them that… Benefits? Besides the huge value that they can unlock, here they don’t have to face up to an IBM, Accenture and EDS or to brood about higher visa costs, rising wage costs, Rupee depreciation, poor skill levels, shrinking margins, attrition levels….

Aside of that, few will see any great organic upsides in the near term to their shareholders…

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Wake up to reality

In an IT competitiveness study commissioned by software industry association Business Software Alliance (BSA) and conducted by the Economist Intelligence Unit, the US, Japan, South Korea and the UK ranked the highest among 64 countries in terms of IT competitiveness. The study evaluated countries on factors like skill availability, pro-innovation culture, world class technology infrastructure, a robust legal infrastructure, government support and a competition friendly business environment.

India gets slotted at 46. Don’t tell me you are surprised. I’ve been crying hoarse about India’s IT illusion here, here and here.

To stay ahead in knowledge industry, of which IT is a force to reckon with, significant investments will have to be made in R&D. Indian companies and the government have conveniently ignored strong signals coming from several quarters that cried for innovation. Low end BPO vendors were painting a picturesque landscape as much as labor arbitrage and a weak Rupee would permit and a smug industry got even more arrogated. When the tide turned and both wage cost and Rupee appreciated, the mask got brutally lifted and the naked reality that hid behind the scenes began to look ugly; very, very ugly.

With tax benefits too on their way out and global majors already settling in, Indian Government and its IT industry should quit blowing sunshine up its ass and get its act together. Not for growth, for survival that is. What do you think?

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When a Private Equity deal goes bust

Buyout firms like to present themselves as a can't-fail combination of operational genius and financial support that can heal sick businesses and create thriving companies. But sometimes, as in the case of Aegis Mortgage, genius fails and bankruptcy is declared. The private investment firm Cerberus bought a controlling stake in the Houston-based mortgage lender in 1998, but despite an infusion of cash and talent, Aegis ceased operations on Monday, August 6. Now hundreds of employees have been laid off - all without health insurance. It's a reminder that risky turnarounds can mean real pain for more than just investors raising questions about how Cerberus will treat other ailing companies it has purchased, notably Chrysler.

In India, PE deals are on the rise. Over leveraged transactions be put on watch.

Getting the blend right

The proof of a robust M&A strategy is in its blending. Most acquisitions fail because integration of diverse cultures is never easy. Why not scout for companies with similar culture - you may go. Try that; you’ll never find one. Every company has a unique culture since it is made up of different individuals, their shared beliefs and practices that identify the company to which they belong.

Mike Rogers of PatchLink, has completed 10 acquisitions and two sales during his career and has this interesting Op-Ed in Venture Beat where he shares his magic mantra for a successful inorganic growth strategy. While Mike concedes that there is no such thing as the perfect deal, he goes that it all depends on a sound strategy. You can fix a bad deal structure, you can fix a bad integration, but you can’t fix a bad strategy.

Read it.

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FDI phobia

The machinations for circumventing the 26% FDI limits in Insurance sector has taken a new turn with ICICI Bank’s proposal to transfer its 74% holdings in its insurance ventures to a holding company, ICICI Financial Services Ltd.

ICICI Bank owns 74 per cent each of ICICI Prudential Life Insurance and ICICI Lombard General Insurance, but the bank is 70.88 per cent owned by foreign investors. This means the effective Indian shareholding in the insurance subsidiaries is only about 21.54 per cent, against the FDI norm of 74 per cent Indian ownership.

If ICICI Bank transfers its stake in the insurance companies to the holding company and if that in turn sells a 24 per cent stake to foreign investors, then the effective Indian shareholding in the both the insurance companies will further fall to about 15.62 per cent.

While Finance Ministry has approved this back door hike in FDI ceilings, FIPB and RBI are not so sanguine about it.

I go that when color of money is increasingly losing its relevance in a globalized world, why should there be any ceilings at all? Be it Indian or Foreign Investor, so long as they are subject to TRAI & RBI regulations, there should be no problem. In fact FDI in insurance should be freely allowed since it covers risk and entry of a foreign investor enables cross-border distribution of that risk. Restriction stimulates the temptation to get around it by devising ingenious ways such as the holding company route, which on the surface is appearing rather innocuous. Or may be it is.

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Grow up, Schwarzman

Stephen Schwarzman is a bad schmoozer. That’s a skill he’d rather have if Blackstone, the PE firm of which he is the CEO intends to do more deals in India. In particular, in sectors like media, telecom, real estate and energy where an FIPB approval is needed to relax statutory ceilings on PE investments.

Global private equity fund Blackstone’s proposed investment of $275 million (Rs 11.30 billion) in Ushodaya Enterprises, which runs the Telugu newspaper Eenadu and TV franchise, is stuck with the information and broadcasting (I&B) ministry seven months after the deal was announced.

This could mean trouble for the country’s largest private equity deal in the media space, which requires Foreign Investment Promotion Board (FIPB) clearance.

Arun Sarin of Vodafone learnt it the hardway. Indian politicians and bureaucrats are not so lightweights in that they have a reputation for jamming many a smooth deal. Equally important it is for him to be less of a gas bag afterwards.

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"Go, use the wisdom of Arun Sarin, Mr.Schwarzman..."

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Rediscovering Kirana

Retailers are rushing ahead with their plans, but is there enough demand for the merchandise being sold? Asks Shobhana Subramanian today in BS.

With over 130 to 180 million sq ft of new mall space coming up in the next few years, and much of it in the big cities, the catchment for each mall will reduce. And that could completely alter the competitive dynamics. Abheek Singhi, partner, Boston Consulting Group posits that “A throughput of at least Rs 600-Rs 700 per sq ft per month would be required to sustain gross margins of 30 per cent if rentals are around Rs 40-50 per sq ft.” So, higher rentals of Rs 60-70 per sq ft would mean a much larger throughput. Building the store it seems, is the easy part. Getting cutomers to buy might not be that simple.

After factoring in 39 different licences that a hypermarket requires in India and yields on an average an operating margin of just 6%, what explains the rush (Wal-Mart, Carrefour, EON) for such a low margin business? Volumes ? The slice will be too thin when you’ve too many of them around. Large population shouldn’t be an attraction either since footfalls don’t necessarily mean customers.

In this entire melee, it’s the kirana (corner store) guy who gains. We rediscover the street corner vendor who is fast shedding sloth and getting nimbler by the day. Last time I checked, he does some brisk business in his store that no longer resembles the mess it once was. All items were neatly stacked and in full display. And he home delivers stuff on a phone call and I think that’s a sure win strategy. Competition induced innovation, perhaps !

Even if big ticket retail gets large scale supply chain advantage and can use its direct sourcing efficiencies to keep prices low, it would be interesting to watch how they deal with a nagging bureaucracy and rising rentals. The kirana guy is getting smarter and stauncher – quite contrary to the initial prediction that his breed will soon be extinct.

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Sequoia has balls of brass

Sequoia Capital, arguably Silicon Valley’s most successful venture capital firm, is big-footing one of its most respected investors.

It brazenly demanded that Yale University invest in Sequoia’s risky adventures abroad in places like China, India and in later-stage investing. And when Yale refused, Sequoia reportedly rejected the university from access to its well-performing early stage funds — the ones that in the past have invested in companies like Google and Yahoo.

Sequoia’s aggressive handling of Yale came to light in a memo issued by the university, a highly respected investor because it commits money long term and has long embraced venture capital. The memo was cited today by Rebecca Buckman of WSJ.

Yale has a $19 b corpus that gets invested in many ways. If Sequoia can say “invest…or else” to such a bulge bracket investor, it sure has balls of brass, indeed!

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Go short on India's IT vendors

Wharton’s Jitendra V Singh advises Indian companies to recast their business models to suit the rising Rupee than to expect the RBI to intervene. In support of his argument, he draws the parallel of how Japanese Automakers during the `80s reacted to the rising yen by shifting their low margin operations (and costs) to manufacturing locations in the US. That had the twin advantage of margin protection and reduction in protectionist backlash since the jobs have now turned American.

Is that a good comparison, Mr.Singh ? Check some facts out.

India’s leading IT vendors like TCS, Infosys, Wipro and Satyam squeezed out higher margins (27-30%) from clients not just because of availability of low cost workforce or a weaker rupee, they have also been benefitting from complete exemptions from Indian Income Tax (33.6%) on export income till recently. If operations are shifted out, the tax savings foregone will dent their margins.

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Many state governments also gave them land on long term low leases to build massive complexes to house their army of coders in thousands. These benefits cannot be expected from foreign governments. Moreover, the resale value of their Indian real estate would tumble triggered by the sudden over supply because the governments may choose to terminate their leases if they move out. Now that's a double whammy.

As of now bulk of the revenues of India’s IT vendors come from mainstay operations like ADM, BPO, low end process automation, testing and validation services. Revenues from high end segments like consulting, process automation, license fee, and remote infrastructure / Data centre management have been insignificant. With competing global majors like IBM, Accenture and EDS setting shops in India, wages are also on an upswing. Shrinking supply of competent engineers, higher visa costs and attrition have also not been helping matters either.

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Thus changing their product mix now would mean India's IT vendors having to make significant investments in R&D (read future) to develop high end utility products and building deep domain expertise in clients’ businesses that guarantees productivity improvements upfront (in other words, to partake in clients' business risks also) like the global majors do. These adjustments may (or not) yield gains in the long term, but right now they call for larger cash outlay and would also mean giving up on margins. Neither can the Indian IT vendors be too sure of their own ability to cope if pitted against the behemoths that knew this high end terrain better.

That's why I recommend a sellout. And if they don’t, go short'em all....

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Missing yet another bus

"India's fundamentals are in tact. Sub-prime debacle will not impact emerging markets. It's Yen carry unwinding spooking markets".

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How many time have we heard this ? I am getting tired. Truth is, sell-side analysts have again been caught off-guard. While they were swearing by their spread sheets, the markets tossed and turned. As usual, they were clueless.

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It’s in the air, I can smell it. We've left a market top, and we're nearing the end of an era -- the private equity era as we know it. It hasn't ended yet, and deals are still going to get done, but if you miss the boat on selling at the top, you will have to wait for the next cycle. When will that be…?

The credit markets are in turmoil, interest rates are zooming, and private equity firms aren't going to pay what they've been paying for companies. If you've got a tempting offer to sell your business, take it – before it's too late.

Just as in 2000, when the bubble burst, too much money have been chasing too many deals. Once the good deals were out of the way, the money started chasing bad deals. That rarely ends well.

But a new era of something will start soon. The trick to making lots of money is to get in early. Not necessarily first, but early. So if anybody out there knows what the next financial wave will be, just let me know.

Deal scouting calls for passion

Global private equity giant Blackstone Group is acquiring majority control in Gokaldas Exports for nearly Rs 6.6 billion ($160 m), in the country’s largest management buyout in the textiles industry.

This is Blackstone’s third major deal this year, the other two being a $275 million investment in Ushodaya Enterprises, which runs the Eenadu newspaper and ETV franchise, and a management buy-out of BPO firm Intelenet from Barclays and HDFC for Rs 8.4 b ($ 203 m).

The PE shop known for its appetite for large global deals (Hilton Hotels - $26 b, EOP - $ 36 billion including debt of $16.5 b) appears to have tweaked its strategy in India, settling for a lot smaller deals. I wonder the viability of this strategy since it could eventually lead to problems of scale or even oversight. The string-of-pearls strategy is quite cumbersome for an 11 people strong PE firm to manage on the trot given the bureaucracy it may have to deal with in India.

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Of course, one can’t find many companies of the size of a Hilton or EOP in India easily but if they can look closely, they might as well zero in on some real sweetspots. I have earlier written about one here. If approached rightly, it’s a terrific deal at $1.2 billion. There are a few more available if looked at closely, not like a professional investment banker who does it for a fee, but by a committed PE fund manager driven by pure passion for such deals.

If you need help Mr.Akhil Gupta, you know whom to hire :)

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The brief Rupee gig

Equity markets needed an excuse to correct and they took to US subprime woes and unwinding of Yen carry like bees to honey. Result, Yen is appreciating against the USD and USD is appreciating against a basket of currencies including the Indian Rupee. It was almost a celebration when INR touched Rs.41.385 against the USD after hovering around Rs.40.50 levels since mid July with no signs of a recovery.

Traders might be under the impression that the U.S. has exported some of its subprime risk to Europe and, as a result, will be able weather most of the risk of a subprime fallout. But it's a mistake to think they exported all of it. Many U.S. banks have a lot of assets not only in mortgages but in real estate. If foreclosures spike, then banks could suffer an even worse fate. The deep gash in the US economy is for real. I don’t think the dollar rally is sustainable. If it gets better, the US currency and bond yields would rise and the dollar will slide. If it gets a whole lot worse, the dollar's still going to slide.

For example, if the stock market gets a lot worse, foreigners will start to panic about their investments in the U.S. But even if the panic subsides, the dollar's value still might decline if investors go back to their favorite trade: shorting the dollar against a basket of currencies.

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Don't rush to buy those IT stocks now... The Rupee rally is still not done.

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Leadership menopause

The private equity industry is accused of poaching some of the best brains from the mainstream businesses. Corporate luminaries (Jack Welch of GE, Lou Gerstner of IBM, Jacques Nassar of Ford to name a few) have bolted in droves for private equity, the freewheeling world where investors buy slumping companies and try to turn them around to sell or take public, risking billions of dollars in the process.

All brilliant minds and high performers, no doubt. Their track records speak for them. Profligacy has never been their virtue and all of them balked at cost spirals. I often wonder how they approve of the clearly unsustainable leverage deals brokered by the private equity firms they end up working for, to finance bulge bracket acquisitions. Steven Pearlstein of Washington Post has this eye opener on the recent Avaya deal by Texas Pacific (where Millard S. "Mickey" Drexler, ex-CEO of Gaps Inc. works)

How can they fling caution to winds as soon as they switch to private equity? Has it got to do with the new found freedom from Sarbanes Oxley going to their head…? Or do they undergo a hormonal imbalance during the autumn of their careers ?

But come to think of it, Blackstone boss Schwarzman sure had that close call with change of life. How else do you explain his selling a stake to China, awful hurry to take Blackstone public and indulging like there are no tomorrows only to invite that Congressional tax slap…

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The great PE bull’s tiring

What made me say that?

Last week US Foodservice, an American wholesaler being bought by private-equity groups, cancelled a $3.6 billion bond-and-loan deal when lenders balked at the lack of protection they were being offered. In Australia, private-equity firms pulled out at the last minute from the country's biggest takeover, complaining of the high cost of debt. This week the sale of a British retailer fell into confusion, after two private-equity bidders withdrew. The prospect of dwindling returns makes buy-out firms reluctant to club together to buy the big companies they covet; banks, meanwhile, are growing wary of offering their own capital as “bridge” finance. Shares in Blackstone, a private-equity chieftain that listed on the stock market last month, have fallen below their offer price.

Rising long-term interest rates have pushed up the cost of borrowing. Sensing a shift in the economics of the industry, creditors around the world have started questioning the easy money offered to private-equity firms, which feed off risky types of debt. The debacle in the US sub-prime mortgage arena has opened many eyes, or so it seems.

For Indian promoters betting on lucrative valuations fueled by PE bidding wars, it spells trouble. What an opportunity they missed…

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Asset base

You just need one puff on higher margins to get hooked. Then it becomes a habit that you can’t kick. Indian IT vendors like Infosys, TCS, Wipro, Satyam have all been addicted to this margin fixation.

Even stock markets gave them a higher PE multiple of 25-30x owing to their phenomenal growth fueled by these margins. Sustaining that growth seems a bit difficult since dollar depreciation, wage escalation and higher visa costs are taking a heavy toll.

If one goes by the acreage of real estate assets developed by these vendors during their growth years, the value of which is now many times over, they won’t lose too much sleep over stagnating margins.

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Kirana choice

Indian market research consultancy Market Pulse spoke with close to 350 consumers in Delhi, Mumbai and Chennai to understand their attitudes to modern retail and their spending patterns.

The typical Wal-Mart customer earns less than the US national average income. And some reports say that one in five customers does not have a bank account; that’s twice the national average.

The Indian approach to big-box retail is slightly different. The less affluent still walk down to the corner store and call the bania (shopkeeper) to deliver their month’s groceries. Despite all the hype around malls, Kirana (corner store) accounts for 94 per cent of the $320 billlion organised retail trade in India. That ratio isn’t going to change anytime soon, so manufacturers would do well to pander to the convenience stores.

More on those interesting findings, here.

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Tata Ste(a)l deal

In the midst of sub prime mortgage woes, there’s been little interest for bonds and CDOs. Even in such a scenario, when Tata Steel has managed to raise $725 million through foreign currency convertible alternative reference securities (CARS), which was oversubscribed by more than two times. There is a greenshoe option of $150 million, which has not yet been exercised.

Tatas have always been an excellent credit risk. Yet, I was a bit curious about its timing and even more about the structure of this bond.

The CARS will be convertible at an initial conversion price of Rs 876.6225 a share, which is at a premium of 35 per cent to the company’s closing share price on the National Stock Exchange of India as on August 6, 2007.

The CARS carry a 1 per cent coupon and the effective YTM is 5.15 per cent. The outstanding CARS, if any, at maturity will be redeemable at a premium of 23.3419 per cent of the principal amount.

Current 3M Libor is 5.36%. Considering this Tatas got a fair deal as it’s long term money. The redemption premium of 23.34% on outstanding CARS must have been alluring to the lenders but when you factor in an asset like Corus in its bag, Tata Steel stock have only one way to go – up. Hence conversion is almost a given and question of outstanding CARS may not arise.

I wouldn’t rule out a buyback initiative by TATAs close to conversion or maturity (not known now), knowing their preference against dilution of controlling stakes. Call it Tata Steel deal now, closer to maturity don’t be surprised if it looks like a Tata Ste(a)l…

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New kid on the block

“When liquidity gets tight, innovate” – seems to be the credo for PE firms.

Imagine this new device. A Private Equity firm needs $300m to invest in a company but has decided to expose it to $100m only. It lures in a Bank with higher ROI bait and gets it to lend $200m on its behalf into say, 8% preferred stock/FCCB. The company is capitalized with $300m now. So the Bank gets $16m and the PE firms gets $8m. The PE firm turns over its return ($8m) to the Bank in return for stock appreciation / conversion benefits to which the Bank is not entitled. If the stock doubles, the investment is worth $600m which the PE firm sells and returns $200m to the Bank. PE firm nets a cool $400m upon its original investment of $100m and the interest turned over to the Bank. In the PE block, they call it “Asset Swap”.

Sexy…?

Shishir Prasad has elaborated it in The Economic Times.

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Bears beware

The notion that corporate profits still have more room to run on the upside is no minority vision. The bulls are still in control of the psychological tone that permeates our markets and investment predictions generally. Wednesday’s crash and today’s revival could be one source of the tone, but there are plenty of other wells of optimism to draw on. PE investor confidence is another.

Thomson Financial data finds PE investments in India during the year have touched $2.49 billion, as against $1.05 billion in Hong Kong, $1.47 billion in Singapore and $752.2 million for the Chinese market. The total PE funding in India is nearly equal to the PE funding that has come into Hong Kong and Singapore together. So far, 29 PE deals have been struck in India this year, next only to Australia (67) in the entire Asia Pacific region. Though there were 28 PE deals in China, the size of the deals were much smaller. While the average size of the deals in India is $85 million, the deal size in China was only $26 million and $188 million for Australia.

India is also a hot-bed for strategic buys, which include M&A activities, with $29.74 billion worth of strategic deals being struck, again the third highest in the Asia Pacific region. While Australia leads the pack with $76.07 billion of strategic deals, China reported $36.88 billion of such deals. There were a total of 331 M&A deals worth $44.34 billion in India in the first seven months of 2007, as compared to 328 M&A deals worth $10.36 billion in 2006.

Bears beware…!

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Sugar Daddy

Want a play in power, go bet on sugar stocks...NOW !

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Cogeneration of power, still marginal in the government’s energy supply program, is set to become mainstream by 2017 – goes Prabha Jagannathan in The Economic Times.

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She quotes a recent KPMG report on the Indian sugar industry (Sector Roadmap for 2017) to drive home her point.

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The green energy opens up a $$ revenue stream too. Co-gen has proven revenue potential in the CDM (clean development mechanism) based carbon credits that apply to the sugar industry. The total carbon credit potential for 9,700 mw of exportable co-gen power is in the range of 48 million carbon credits per year, which is estimated at Rs 21.50 b ($53 m) per year.
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At its optimum potential, the industry can meet a good 6% of the additional power requirement by 2017 and generate almost 48 million carbon credits. Currently the total power capacity in India is 128 GW and the requirement is estimated at 306 GW by 2016-17. Against that, the current bagasse-based exportable power is estimated at 847 mw. This could go up to 9,700 mw by 2017, according to projections in the report, she says.

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If you find rollicking power stocks too expensive, go long on sugar - tommorrow's multibagger !

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In my other blog

The hedge attraction

It happened one night

Prize catch

Bailout is for wimps
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Taking BPO Public

When is the right time for a BPO to go Public?

The question is troubling many Indian BPOs wanting to get listed. The industry seems divided. Suggested BPO critical mass range between $100-250 million in revenues to get listed in NASDAQ and a modest $25m is enough to get listed in India's BSE.

Currently the BPO industry is operating at 10-12 per cent EBITDA margins and command a P/E multiple of 18-25. KPOs have higher EBITDA margins of about 15 per cent. Many BPOs are wary of getting listed on BSE as the industry knowledge is poor.

A BPO sees some merit in going public. Besides the fact that investors get to monetize their stake or having cash reserves to buyout other BPO assets (like in the case of Genpact), it will also have a better image since it will be subjected to frequent compliance / process audits and its affairs are open to shareholder scrutiny.

Unlike an IT company, setting up a BPO is capital intensive. Experts say it takes about $6,000 per seat to set up a BPO while a software company can be set up at an investment of about $2,300 per seat. Thus unless you have over 2,000 employees and are profitable, one should not even think of an IPO. While private equity is always an option, an IPO can offer 10 times the valuation.

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Hamlet's soliloqy comes to mind... To be, or not to be (public)...!

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Stopping at nothing

Arvind Singhal, Chairman, Technopak, has a nice rant in Business Standard this morning on evolving Executive Compensation scene in India.

Arvind raises this issue – “what exactly determines (and should determine) how much professionals should be paid for a given level of intellect and hours spent on-the-job.” He reflects and concludes that life isn’t fair on all.

He’s got a point. But even in companies that pay very well, attrition is uncontrollable. What does that mean? Is there another domain that is more lucrative or rewarding? Or is it just reckless poaching? The only way to discipline is by laying down proper metrics to measure performance and reward in proportion. Notice that `D’ (as in `Development’) in HRD is long gone and it’s just HR now - an admission of collective despair, perhaps. It's like saying "sorry guys, we can only pay. Develop on your own". And they do that by voting with their feet. Why brood then? It’s this missing "development" aspect that prompts people to leave. Sooner they get that D back in, there’s hope. Remember, wage escalation minus relative growth would mean increased overheads, lower ROI. That means a dog's life for the shareholder - a character that's been taken for granted far too long. The day he stages a walk out with his capital, it'll be curtains for executives' glitzy life on reflected glory. Think of that mortgage on the Penthouse just bought !

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ACE Refractories gets flipped

ACE is flipped.

I had written earlier that ICICI Venture is on a lookout for a buyer for ACE Refractories that it bought out from ACC for Rs.257 crore. A first for an Indian PE firm to buyout a manufacturing company then, for flipping it later.

ICICI Venture seems to have done it in style. ACE Refractories have been sold to Imerys of France for Rs.550 crore, yielding 100% return over two years.

Good going, Renuka…

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The trouble with more's

Rupee appreciation has cheered many a big corporates that had huge forex loans. But CFOs and auditors are jammed over its presentation to the taxman.

That is, the forex gain has two accounting options.

The gain can be (a) credited to the Profit & Loss Account or (b) represented in the Balance Sheet by crediting the gain to Fixed Asset account (reducing the cost of the asset).

Most big companies are unwilling to take the forex gains to P&L account. The forex gain, as income would increase their Minimum Alternate Tax (MAT) ) liability, which is often kept pushed to the floor. There is some confusion over prescriptions in Accounting Standards (AS-11 by ICAI) and what the law provides (Sch.VI of The Companies Act, 1956)

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A windfall doesn't always mean all round cheer, right...?

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Keep it simple, mate

“Use the proprietary Bubble Analysis of the Relative Risk and Return Analysis of Mutual Funds.” Screams the 3 page newsletter from Prudential ICICI MF.

Followed a four chart illustration of “Bubble Analysis” - You just lost me, pal…When you know it’s a bubble, why analyze? Just keep off, you damn fool !

Your B-school modelling sucks, mate. Tell me something new, something I don't know. Just say "buy this stock" and make sure clients make money. Ain't that sweet n' sexy ? You bet.

Get real ! Stop being a stupid jerk wasting time on bubbles and newsletters. Sniff around for better stories and when you have one, come back and ask for my orders…

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Riding the Jockey

Interesting coverage on Madhusudhan Kela, the star Fund Manager of Reliance Mutual Fund by Bloomberg. I liked his focus on absolute returns and small town wisdom speak –

“You have to identify the jockey. Then the jockey will ride the horse.''

“You get the shade today because someone planted a tree a long ago”.

So far so good… now read this.

“We have had three years of learning now and the overall investment philosophy is well-defined. We have detailed spreadsheets and questionnaires for every company that we start covering. We have a checklist of processes and rules on how to invest in large-caps and how to invest in mid-caps, what can qualify and what can't, etc.."

here’s where the smugness creeps in -

I go now that he’s making the mistake most of his tribe make. Over time they tend to relax. Catty instincts blunt and systems and protocols takeover. Market is quite unforgiving on softies. It just strikes. Not many have been able to face up to it.

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Be on your toes, Madhu... we love you for that !

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Can't keep my hands off you, baby...

Déjà vu. Earlier it was the NDA government that fingered India's oil marketing companies IOC, HPCL and BPCL. Then the game was between Ram Naik, Petroleum minister and Arun Shourie, Minister for Disinvestment. Ram Naik opposed privatization of Oil PSUs (needed the fleet of cars, trucks and guest houses for his election campaign, used his power to allot petrol pumps and gas agencies to his cronies) whereas pro-reform Arun Shourie (believed the Government had no business in running businesses) was hell bent on privatizing them. As and when Arun Shourie opened his mouth, the markets loved it and stock prices of Oil PSUs went up ; and they tanked when Ram Naik countered – giving you a clear weekly arbitrage opportunity.

Recently the `idearupt' govt. spooked the market cap of Sugar industry - wanting to smart one up on inflation, it banned exports in an year of record output at the cane fields - by over 70%. Now its guns train cement stocks.

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When P.Chidambaram, the Harvard educated, charming Finance Minister of India (FM), spoke to the press after the Budget 2007 presentation in Parliament, he cautioned the Cement companies on profiteering. Cement companies did not heed him and upped the prices citing higher demand and higher input costs. Then came the the May 17 debacle. Hardly had the market recovered in cement stocks from that shock, India’s trade practices regulator MRTPC on Tuesday ordered a probe into the business practices of 14 leading cement manufacturers. These manufacturers colluded to hike prices, alleges a preliminary report by MRTPC’s investigative wing.

Big business is sex and FM is a charmer. Nothing will keep the two away for long…

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The McKinsey Annuity

Global consulting firm McKinsey advises businesses and usually gets paid. It might as well be its first, having to move the Bombay High Court against two of its big ticket clients [Reliance Industries (RIL) and Reliance Communications (RCom) ] for non-payment of its bill - in this case a fee of Rs. 270 million ($ 6.7 m). As events went, after patriarch and founder Dhirubhai Ambani’s death, the Reliance group had split right down the middle between the two feuding sons' camps in June 2005. Elder son Mukesh Ambani got Reliance Industries (petrochemical, oil and gas businesses), younger Anil settled for the group’s power, telecom and financial services businesses. McKinsey had signed an agreement back in 2001 with RIL before the split, to roll out RCom.

The terms had also offered McKinsey some top ups if RCom revenues were to cross the high watermark of Rs 10,000 crore ($2.46 b) which it did last year. But when McKinsey presented its claim to RCom, it refused payment stating that the deal was between RIL and McKinsey and RCom is not a party to it. Neither would RIL pay up since RCom has since been spun off and now it belongs to the Anil Ambani camp, with which it stands daggers drawn on several issues.

Tricky situation for McKinsey. So it will be for the High Court Judge too, I guess. Further the $ 6.7 m Mckinsey bill also looks more like a milestone based annuity to me…

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Won’t be surprised if the Judge refers it to Insurance Regulator for fairness opinion…!

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Heads I win...

Results season throws up a lot of fun. I can’t stop laughing.

Satyam too joined the list of IT majors battered by the rising rupee. The INR surged by nearly 7% against the USD in Q1-08 with every 1% rise shaving off 30 basis points(0.3%) operating margins. Aiming to join the $2 billion league this fiscal, Satyam suffered a sequential slip of 3.88% in net profit for the Q1 ended June 30 to touch INR 3.78 billion ($93.4 m).

Here are some carpings.

Addressing the media, Satyam CFO V Srinivas said, “In dollar terms, we have grown by 10% and rupee terms, the growth is 3%. The 7% difference represents the rupee impact. Revenue would have been higher by Rs 138 crore if the rupee impact was not there.”

Last year when Rupee was declining, has he ever said - “we’ve actually lost market share, but our revenues have been propped up by an appreciating $ against Rupee” – Nah....

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Kirusa gets it right

When ARPU from mobile users declined, the telcos (carriers) embraced VAS for boosting revenues and profitability. IAMAI-IMRB Survey put Indian VAS market at about $ 700 m initially of which just 24% was shared with content providers. This muscle flexing by telcos had nipped many a VAS service provider in the bud.

Another reason why Mobile VAS do not take off in India is unimaginative and mindless content that nobody needs. Movie downloads, e-mail, web surfing, SMS contests that destroy more value than add, is shunned by the paise-pinching Indian user that likes to roam pre-paid. Watch a movie on a pint-sized screen? Nah... Cast votes by paid SMS on questions posed by news channels ? Forget it. I had lost count of number of VAS startup business plans I had trashed for unimaginative content.

I felt so glad to read Kirusa, a leading mobile VAS provider, announcing the closing of $10 million Series C financing. The funding, led by VCs Nexus and Helion comes after several carrier wins by Kirusa, and the high growth in the Voice SMS space. Now this is what I call being creative - a service millions of users in Asia pacific would love to have – a tribe that abstained from texting since they know only to dial numerals and speak. But Telco ARPUs could be hit further since many calls would now end in 30 seconds flat by voice text.

It leaves money in customer’s pocket and I’d drink to that…keep going Kirusa !

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Scouring the Valley for deals

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

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

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

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

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

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India's REIT hand downs

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

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

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

“The REIT debate in India is caught in trivialities -

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

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

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

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Renaming greenback

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

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

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

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

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Now join the chorus

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

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

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

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

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

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Cost of regulatory moodswings

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

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

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

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

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You heard me, Mr.Sarin

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

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

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

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

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Not so soon, Mr.Sarin...

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

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

Rating a crater

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

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

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

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A finger in every pie

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

But there are arguments for and against.

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

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

Bet big on luck too…

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

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

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

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

Shall we call it a sellout dance…?

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Had we known earlier....

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

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

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

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

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

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Home's where the mortgage is

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

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

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

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

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All's well until they take to water

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

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

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

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

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The GAAP relief

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

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

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

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

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

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New chic in town

TATA group is into everything. Well, almost.

You name it, they have it - Automotives, IT, Steel, Hospitality, Retail, Tea, Coffee, Insurance, Investments and a lot other. I sometimes wonder how long can they miss out on the lucrative business of Investment Banking. The business is strong that even one time boutiques like Avendus and MAPE Group have grown big in a very short time. Take a look at the incessant flow of M&A deal traffic (TATA must have paid quite a bit themselves recently) and you can see it. An old war horse like the TATA group cannot stay away from commercial sweet spots for long.

I am not too sure whether I vibed with him, but Ratan Tata probably had an epiphany on similar lines. They are getting into it now. Here’s the story for you – TATA CAPITAL is hatching.

All you CEOs of I-Banks, your people now have one more place to go....A very good one at that. So just get liberal with employee bonuses and keep them happy. Not exactly the time to worry about margins !

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When the tide turns

Shocking to see how the tide turns.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Era of mega equity offerings ?

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

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

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

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

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

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

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

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The DLF dilemma

To invest or not to ?

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

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

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

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They've got balls, yeah !

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

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

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

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

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The Good, The Bad and The Ugly

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

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

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

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

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

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

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

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FCCB rope trick

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

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

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

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

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Did you say valuation ?

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

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

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

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

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"Simplifly"

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

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

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

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