Regulators, companies and investment bankers have to share the blame for the crumbling of M&A deals
By Mohan Sule
Besides injecting life into the primary market, a bull market triggers mergers and acquisitions. After a demand slump, companies dust off plans to expand to capture the buoyant economic mood. Most primary market offerings are to raise funds for organic growth. Friendly and hostile takeovers cut short the incubation period of a grassroots venture. For investors, both routes offer exciting opportunities for wealth creation. A reasonably valued public offering gives ample scope for appreciation on listing as well as a few years later. The inorganic route provides an exit window for the shareholders of a weak prey or an entry into a strong company. The market is happy that cash is being utilized by the predator-company to grow its share, helping improve the return ratios. Yet there is a downside, too. There could be a sudden change in the business environment and delays in execution. A target that seemed apt could prove to be a cumbersome burden due to difficulties in enmeshing different work cultures. Depletion of reserves would mean insufficient spare change to exploit new trends. In addition to all these obstacles, some new problems have cropped up going by a few recent cases. Take the unraveling of the Rs 700-crore Bharti Airtel-Loop deal. Bharti would have consolidated its leadership position in the telecom space, with the Mumbai-based services provider’s three-crore subscriber base. Users of the struggling Loop would have got better services. Despite the obvious advantages, the agreement failed to get regulatory approval. The hitch? Loss of revenue to the Department of Telecommunications as Loop subscribers would be ported to Airtel numbers without paying the mandatory Rs 19 fee.
During the wait, Loop’s subscribers dwindled to 1.2 lakh. Bharti’s stock ended the day of the announcement with a loss of nearly 3%. Loop’s licence is set to expire end November and DoT might not get the Rs 800 crore that the services provider owes it. This is not the first time that Bharti’s shareholders have seen a botched up acquisition. India’s largest telecom company by subscribers gave up the idea of taking over MTN in September 2009 as the South African government wanted India to permit dual listing. This would have allowed sharing of revenue and profit by the two. The cash-cum-stock deal gave Bharti a 49% stake in MTN in return for the latter getting a 36% economic interest in the Indian carrier. However, the Reserve Bank of India refused to concede as the arrangement implied capital account convertibility. So the US$24-billion alliance that would have created the world’s fourth largest telcom services provider covering 24 countries with 200 million subscribers crumbled after eight months of complex negotiations. Trading in the MTN stock had to be suspended for the day by the Johannesburg Stock Exchange after slumping more than 5% on hearing the news. These two cases do not show regulators in a positive light. Many times, the market throws up new situations. Regulators have to act speedily and find a via media till the guidelines are amended to reflect reality.
DoT and the RBI could have shown some flexibility. Bharti could have been told to deposit the portability charges with the regulator till the resolution of the issue and the RBI could have asked Bharti to invest the profit share of MTN in India for the time being. Apart from the regulators, the eagerness of companies to grab opportunities to expand market share without reading the fine print is disturbing. Apollo Tyres’s $2.5-billion (Rs14400-crore) deal to acquire Cooper Tire was called off after the US tyre maker sought judicial intervention to expeditiously close the merger. The Indian company termed Cooper’s decision as “inexplicable” and “a diversionary smokescreen, an unfortunate acknowledgement” of the inability to meet the obligations necessary to complete the transaction. These instances of ambition and impatience overtaking prudence demostrate sloppy due-diligence by investment bankers. The Sahara-Jet Airways acrimony over the deal price after the merger took effect and the bitter experience of Daiichi Sankyo following the takeover of Ranbaxy illustrate that inorganic growth is much as a risk factor as a wealth multiplier. The shareholders of Apollo were saved from a bigger disaster had the Cooper acquisition gone through. Ranbaxy shareholders were bought out at a hefty premium by the Japanese drug maker. Those that remained found a new parent in Sun Pharma. Not everyone is so fortunate. May be the regulator should insist that acquirers contribute a certain percentage of the deal amount to an escrow account with a three-year lock-in to compensate for the loss in market value due to costly missteps.
Tuesday, December 2, 2014
Wednesday, November 19, 2014
Mixed signals
The NDA government is caught between the need for market- oriented reforms and desire to fulfill social obligations
By Mohan Sule
There is growing impatience among foreign investors at the slow pace of reforms in India. Many assumed that Prime Minister Narendra Modi would undertake some radical steps to attract investments after assuming charge end May 2014. Perhaps they had not listened carefully. In his address to the new MPs of his party, he had wondered: If the government does not take care of the poor, who will? In the euphoria of the defeat of the corrupt UPA II government, the market chose to be selective in its understanding about the flexibility of the government in carrying out reforms. The issue is if reforms should be in one sweep or in installments. Diesel pricing has been deregulated but not LPG. The Big Bang reforms of Margaret Thatcher in 1986 transformed London into a global financial hub but also triggered criticism in the aftermath of the collapse of Lehman Brothers in September 2008 that banks embarked on risks not proportionate to their capital adequacy. The P V Narasimha Rao regime in India launched the most comprehensive restructuring exercise India had ever seen. The impact on the economy was equivalent to nationalization of banks and abolition of privy purses. In the era of coalition politics that followed, there was lack of consensus on how much to open up but not on the reforms process. Instability at the Centre, with successive governments lasting for a few months and even days, the foreign exchange crisis that tamed the SouthEast AsiaTigers, and the dotcom bust at the turn of the century ensured that policy makers did not have to do much to discourage foreign inflows. The 2012 verdict of the Supreme Court calling the January 2008 distribution of 122 licences for 2G spectrum on the basis of the first to comply with the conditions as “arbitrary” and “unconstitutional” and the recent cancellation of all coal blocks save four allocated since 1993 was a wakeup call.
The adverse fallout of the telecom scam was the policy paralysis for the remaining two years of the UPA II government. The positive outcome is that the activism of the apex court has given rise to the debate on the best possible way to dispose of natural resources. So far, the rulers had used their discretionary powers to reward cronies. There is a welcome realization that this method discourages entrepreneurship, thereby blocking the creation of jobs as well as innovation, so necessary for growth. At the same time, there is acknowledgement that auctioning, though transparent and fair, does not benefit the end users as the government tries to keep the base price high so as not be criticized later for selling the family silver cheaply. Winners try to recoup their investment through high pricing. Also, it fosters status quo. Only those with established deep pockets are in a position to tap the emerging opportunities. The 3G spectrum auction in 2010 saw participation of only seven private bidders. There were a mere five players bidding for just 102 of the 140 blocks in the GSM band in 2013. In fact, the presence of a large number of players in the 2G space earlier had resulted in fierce competition, leading to low voice usage rates. The outcome was deeper penetration of mobile services. After the shakeout, tariffs are once again on the rise. Service providers are happy but not consumers, who are facing less choice.
The decision to keep prices of coal controlled and Coal India intact, while auctioning the cancelled blocks for captive consumption, too, signals a cautious appoach. This could perhaps be to avoid trouble from trade unions on the eve of elections in Jharkand, which has the highest coals reserves in the country. The message is the government views PSUs as a vehicle to ensure cheap goods and services to poor. This is contradiction to Modi’s declaration in the US that the government has no business to be in business. The power generation sector is an example of half-baked reforms. Generators can produce power but pricing is subject to the regulator’s approval. Yet, they have to import coal at market-oriented rates as CIL is unable to meet demand. The government intends to lower its stake in PSU banks to 51% but wants them to be at the forefront of social programmes such as Jan Dhan Yojana, which is a high-cost operation due to the zero-balance requirement. This social outreach will make borrowers happy but not their shareholders just like those of CIL. Should investors stay with PSUs? With the example of the benign neglect of Air India following the entry of private operators and rising NPAs of PSUs even as private banks are proving to be nimble, investors would not be wrong to fear erosion in the value of their holding as the sectors in which state-owned enterprises are monopolies are thrown open to competition.
By Mohan Sule
There is growing impatience among foreign investors at the slow pace of reforms in India. Many assumed that Prime Minister Narendra Modi would undertake some radical steps to attract investments after assuming charge end May 2014. Perhaps they had not listened carefully. In his address to the new MPs of his party, he had wondered: If the government does not take care of the poor, who will? In the euphoria of the defeat of the corrupt UPA II government, the market chose to be selective in its understanding about the flexibility of the government in carrying out reforms. The issue is if reforms should be in one sweep or in installments. Diesel pricing has been deregulated but not LPG. The Big Bang reforms of Margaret Thatcher in 1986 transformed London into a global financial hub but also triggered criticism in the aftermath of the collapse of Lehman Brothers in September 2008 that banks embarked on risks not proportionate to their capital adequacy. The P V Narasimha Rao regime in India launched the most comprehensive restructuring exercise India had ever seen. The impact on the economy was equivalent to nationalization of banks and abolition of privy purses. In the era of coalition politics that followed, there was lack of consensus on how much to open up but not on the reforms process. Instability at the Centre, with successive governments lasting for a few months and even days, the foreign exchange crisis that tamed the SouthEast AsiaTigers, and the dotcom bust at the turn of the century ensured that policy makers did not have to do much to discourage foreign inflows. The 2012 verdict of the Supreme Court calling the January 2008 distribution of 122 licences for 2G spectrum on the basis of the first to comply with the conditions as “arbitrary” and “unconstitutional” and the recent cancellation of all coal blocks save four allocated since 1993 was a wakeup call.
The adverse fallout of the telecom scam was the policy paralysis for the remaining two years of the UPA II government. The positive outcome is that the activism of the apex court has given rise to the debate on the best possible way to dispose of natural resources. So far, the rulers had used their discretionary powers to reward cronies. There is a welcome realization that this method discourages entrepreneurship, thereby blocking the creation of jobs as well as innovation, so necessary for growth. At the same time, there is acknowledgement that auctioning, though transparent and fair, does not benefit the end users as the government tries to keep the base price high so as not be criticized later for selling the family silver cheaply. Winners try to recoup their investment through high pricing. Also, it fosters status quo. Only those with established deep pockets are in a position to tap the emerging opportunities. The 3G spectrum auction in 2010 saw participation of only seven private bidders. There were a mere five players bidding for just 102 of the 140 blocks in the GSM band in 2013. In fact, the presence of a large number of players in the 2G space earlier had resulted in fierce competition, leading to low voice usage rates. The outcome was deeper penetration of mobile services. After the shakeout, tariffs are once again on the rise. Service providers are happy but not consumers, who are facing less choice.
The decision to keep prices of coal controlled and Coal India intact, while auctioning the cancelled blocks for captive consumption, too, signals a cautious appoach. This could perhaps be to avoid trouble from trade unions on the eve of elections in Jharkand, which has the highest coals reserves in the country. The message is the government views PSUs as a vehicle to ensure cheap goods and services to poor. This is contradiction to Modi’s declaration in the US that the government has no business to be in business. The power generation sector is an example of half-baked reforms. Generators can produce power but pricing is subject to the regulator’s approval. Yet, they have to import coal at market-oriented rates as CIL is unable to meet demand. The government intends to lower its stake in PSU banks to 51% but wants them to be at the forefront of social programmes such as Jan Dhan Yojana, which is a high-cost operation due to the zero-balance requirement. This social outreach will make borrowers happy but not their shareholders just like those of CIL. Should investors stay with PSUs? With the example of the benign neglect of Air India following the entry of private operators and rising NPAs of PSUs even as private banks are proving to be nimble, investors would not be wrong to fear erosion in the value of their holding as the sectors in which state-owned enterprises are monopolies are thrown open to competition.
Thursday, November 6, 2014
Big deals
Strategies adopted by issuers of capital and e-commerce sites
to attract buyers have many similarities
By Mohan Sule
Very few companies can claim to earn US$100 million (Rs 600 crore) in 10 hours. The success becomes even more noteworthy if the entity has been in existence for slightly more than a half-a-dozen years. There have been instances of trailblazing companies burning out later, particular in the telecom, aviation and consumer durables space. The reasons include inability to manage the sudden growth, going off the course with wrong calls or the consumers losing attention and latching on to the next promising idea. Therefore, the latest phenomenon of user-visits bringing an e-commerce site to a standstill due to the inability to cope up with the rush, not surprisingly, has triggered opposing views. On one side are those who feel vindicated that India is taking to e-ecommerce rapidly, with falling prices of smart phones and charges for data downloading fueling the habit. The other argument is that the novelty factor of online shopping could wear out soon. Technical glitches and complaints about pricing are signs of buyers’ disappointment and disillusionment. Both opinions, nonetheless, signal that there is much in common in the way companies woo consumers and investors. The first is that it is not necessary to think out of the box to set the cash register ringing. The practice of offering hefty discounts is not new. Several business-to-consumer companies do it all the time. Law enforcing agencies have had to be called to control crowds at huge sales organised on national holidays. In the US, buyers queue up in freezing winter to rush in at midnight to grab goods of throwaway prices on Black Friday, which flags off the Christmas shopping season. What is required is packaging and marketing. The surest way for issuers of capital to create a buzz is by placement of shares with qualified institutional investors on the eve of primary-market debut. Presence of big-ticket investors is taken as a confirmation that the company is on the right track.
The second similarity is the value-for-money offers. Many offline outlets have protested that often items are sold online at less than the landed cost of imports. Pricing becomes a deciding factor during a slowdown. Reasonably priced IPOs have succeeded even in a dull market. Getting the pricing correct means issuers do not have to depend schemes such as safety nets and market making to pull in subscribers. It is important for digital malls to stay away from tricks such as bumping up prices and undertake a token gesture of slashing them later. A distinguishing feature between two companies in an industry is the degree of confidence that they can instill in the stakeholders. Consumers come to equate quality and after-sales service with the brand. Those with transparent corporate governance practices will find it easy to raise funds at attractive valuations in the market. At the same time, adventurism can prove fatal. E-supermarkets in the US are accused of deploying algorithms to alter prices depending on the visitor’s shopping history, which reflects their purchasing power. Indian companies diversifying into unrelated areas such as aviation and telecom have had to suffer massive erosion in value. Window-dressing of accounts, changing accounting policy and reluctance to share setbacks with investors have also cost companies dearly.
Earmarking special days is also an exercise in brand building. This is observed in the capital market, too. Stocks tend to go up on the eve of board meetings called to mull corporate actions. Listed companies have to utilise cash prudently, either capitalising it through a bonus issue or funneling it for capex, to communicate to the market that the company is in good health. Discounting also reveals if a company is relying on volumes to gain share. Many of them have to turn to debt or dilute capital to crank up production without any buffer for a slowdown. The market rewards those with a good operating profit margin. Companies have to streamline processes to make and sell products with a minimal mark-up or convince investors that the premium justifies the outlook. The success of big-deal days also implies that sellers have to create opportunities. Commodity producers, in particular, have to protect from cyclical downturns by widening the customer base. Asset-light stocks are preferred during slowdowns. Another important inference is that there can be different classes of consumers for the same product. Small investors are in for the long haul and are concerned about dividend payout, while institutional investors would look for capital appreciation. Balancing the different pulls of the market is indeed a tough call for companies looking for buyers of goods and equity.
to attract buyers have many similarities
By Mohan Sule
Very few companies can claim to earn US$100 million (Rs 600 crore) in 10 hours. The success becomes even more noteworthy if the entity has been in existence for slightly more than a half-a-dozen years. There have been instances of trailblazing companies burning out later, particular in the telecom, aviation and consumer durables space. The reasons include inability to manage the sudden growth, going off the course with wrong calls or the consumers losing attention and latching on to the next promising idea. Therefore, the latest phenomenon of user-visits bringing an e-commerce site to a standstill due to the inability to cope up with the rush, not surprisingly, has triggered opposing views. On one side are those who feel vindicated that India is taking to e-ecommerce rapidly, with falling prices of smart phones and charges for data downloading fueling the habit. The other argument is that the novelty factor of online shopping could wear out soon. Technical glitches and complaints about pricing are signs of buyers’ disappointment and disillusionment. Both opinions, nonetheless, signal that there is much in common in the way companies woo consumers and investors. The first is that it is not necessary to think out of the box to set the cash register ringing. The practice of offering hefty discounts is not new. Several business-to-consumer companies do it all the time. Law enforcing agencies have had to be called to control crowds at huge sales organised on national holidays. In the US, buyers queue up in freezing winter to rush in at midnight to grab goods of throwaway prices on Black Friday, which flags off the Christmas shopping season. What is required is packaging and marketing. The surest way for issuers of capital to create a buzz is by placement of shares with qualified institutional investors on the eve of primary-market debut. Presence of big-ticket investors is taken as a confirmation that the company is on the right track.
The second similarity is the value-for-money offers. Many offline outlets have protested that often items are sold online at less than the landed cost of imports. Pricing becomes a deciding factor during a slowdown. Reasonably priced IPOs have succeeded even in a dull market. Getting the pricing correct means issuers do not have to depend schemes such as safety nets and market making to pull in subscribers. It is important for digital malls to stay away from tricks such as bumping up prices and undertake a token gesture of slashing them later. A distinguishing feature between two companies in an industry is the degree of confidence that they can instill in the stakeholders. Consumers come to equate quality and after-sales service with the brand. Those with transparent corporate governance practices will find it easy to raise funds at attractive valuations in the market. At the same time, adventurism can prove fatal. E-supermarkets in the US are accused of deploying algorithms to alter prices depending on the visitor’s shopping history, which reflects their purchasing power. Indian companies diversifying into unrelated areas such as aviation and telecom have had to suffer massive erosion in value. Window-dressing of accounts, changing accounting policy and reluctance to share setbacks with investors have also cost companies dearly.
Earmarking special days is also an exercise in brand building. This is observed in the capital market, too. Stocks tend to go up on the eve of board meetings called to mull corporate actions. Listed companies have to utilise cash prudently, either capitalising it through a bonus issue or funneling it for capex, to communicate to the market that the company is in good health. Discounting also reveals if a company is relying on volumes to gain share. Many of them have to turn to debt or dilute capital to crank up production without any buffer for a slowdown. The market rewards those with a good operating profit margin. Companies have to streamline processes to make and sell products with a minimal mark-up or convince investors that the premium justifies the outlook. The success of big-deal days also implies that sellers have to create opportunities. Commodity producers, in particular, have to protect from cyclical downturns by widening the customer base. Asset-light stocks are preferred during slowdowns. Another important inference is that there can be different classes of consumers for the same product. Small investors are in for the long haul and are concerned about dividend payout, while institutional investors would look for capital appreciation. Balancing the different pulls of the market is indeed a tough call for companies looking for buyers of goods and equity.
Monday, October 27, 2014
Building confidence
Eliminating the trust deficit between government and industry and companies and investors cannot be selective
By Mohan Sule
While flagging off the Make-in-India curtain raiser, Prime Minister Narendra Modi rightly said there is a trust deficit in the country. For the common man, the government is a pervasive and obstructive force, with rules and regulations. For the government, there is a radical lurking round the corner, trying to circumvent authority. The various regulatory bodies empowered with oversight powers would become redundant if companies were to become transparent. Users would not face quality issues or deficient services. Consumers of injectibles and capsules would not be puzzled over the silence of the domestic watchdog even as some of our topnotch pharmaceutical companies are targeted by the US Food and Drug Administration. Investors would not become agitated over commodity producers diverting a hefty amount as royalty to the holding company or MNC associates to their parents irrespective of the bottom line and asset management companies charging a fixed fee without any link to performance. Indian shareholders would not view with scepticism PSU banks for whom social obligations override business sense, with loan writeoffs encompassing the small borrower to the mighty industrialist having the right connections. Imagine how easy life would be if everyone filed correct returns. An entire industry devoted to monitoring tax payers would be rendered jobless.
Modi needs to be credited for not singling out any section of the society for the state of affairs unlike the previous socialist regimes, which blamed the business community for profiteering and keeping the country in a perpetual state of poverty. Yet the remark threw up four ironies. The first was unsaid but understood. The prominent casualty of the lack of confidence between industry and government is manufacturing. The problem of joblessness cannot be solved by software companies alone. No wonder, the prime minister’s preferred composition of growth is equitable contribution of the three segments of the economy: agriculture, manufacturing and services. This is at odds with the traditional understanding that, as the country develops, the share of services overtakes farm and brick-and-mortar output. The second takeout is that investors have to be wooed with the attraction of quick clearance and stable taxation in spite of the advantages of democracy, demographic dividend and demand. Crony capitalism, unfortunately, has not only drained the country’s resources but also clogged the investment pipeline. The Supreme Court’s judgment cancelling all but four coal blocks allotted since 1993 is an opportunity to clear the cobwebs of entrenched interests. Clear-cut policies on awarding contracts, straightening of ambiguous tax laws that are open to interpretation, ensuring an import taxation structure that is fair to producers of raw materials, intermediates as well as end products, and eliminating the role of middlemen by switching over to e-commerce could perhaps encourage fair business practices.
The third contradiction became apparent during Modi’s US tour. Apart from the issue of liability of nuclear plants, the other thorny issue was protection of intellectual property rights. Besides the tech and entertainment industries, global drug producers face billions of dollars of lost revenue due to copy cats in India. The government’s crackdown on spurious products or even infringement of patents in the local market has been half-hearted so far due to the desire to keep medicine prices low. A sign of the changing times is the stripping of the National Pharmaceutical Pricing Authority from capping prices of non-essentials on the eve of the prime minister’s departure to the US. The fourth dissonance cropped up during Modi’s speech to the United Nations General Assembly, when he exhorted members not to distinguish between good and bad terrorism, not realizing that he had laid himself open to similar criticism by branding FDI in retail as inimical to the country’s mom-and-pop shops while welcoming it in Railways and defence. Protecting one segment of the business comes at the expense of another: farmers, who would get better pricing and a captive market. Better storage and distribution would contribute to lowering of food inflation. The consumer durables industry is an examples of Indian players being swamped by foreign competition yet receiving hardly any sympathy from the policy makers. If employment creation is the focus, it would be better achieved by large malls rather than family-run holes in the wall. Similarly, issuers are able to raise funds quickly by providing privileged access to institutional investors. However, by ignoring the small investors, these companies are blocking the exit routes of these big-ticket investors.
By Mohan Sule
While flagging off the Make-in-India curtain raiser, Prime Minister Narendra Modi rightly said there is a trust deficit in the country. For the common man, the government is a pervasive and obstructive force, with rules and regulations. For the government, there is a radical lurking round the corner, trying to circumvent authority. The various regulatory bodies empowered with oversight powers would become redundant if companies were to become transparent. Users would not face quality issues or deficient services. Consumers of injectibles and capsules would not be puzzled over the silence of the domestic watchdog even as some of our topnotch pharmaceutical companies are targeted by the US Food and Drug Administration. Investors would not become agitated over commodity producers diverting a hefty amount as royalty to the holding company or MNC associates to their parents irrespective of the bottom line and asset management companies charging a fixed fee without any link to performance. Indian shareholders would not view with scepticism PSU banks for whom social obligations override business sense, with loan writeoffs encompassing the small borrower to the mighty industrialist having the right connections. Imagine how easy life would be if everyone filed correct returns. An entire industry devoted to monitoring tax payers would be rendered jobless.
Modi needs to be credited for not singling out any section of the society for the state of affairs unlike the previous socialist regimes, which blamed the business community for profiteering and keeping the country in a perpetual state of poverty. Yet the remark threw up four ironies. The first was unsaid but understood. The prominent casualty of the lack of confidence between industry and government is manufacturing. The problem of joblessness cannot be solved by software companies alone. No wonder, the prime minister’s preferred composition of growth is equitable contribution of the three segments of the economy: agriculture, manufacturing and services. This is at odds with the traditional understanding that, as the country develops, the share of services overtakes farm and brick-and-mortar output. The second takeout is that investors have to be wooed with the attraction of quick clearance and stable taxation in spite of the advantages of democracy, demographic dividend and demand. Crony capitalism, unfortunately, has not only drained the country’s resources but also clogged the investment pipeline. The Supreme Court’s judgment cancelling all but four coal blocks allotted since 1993 is an opportunity to clear the cobwebs of entrenched interests. Clear-cut policies on awarding contracts, straightening of ambiguous tax laws that are open to interpretation, ensuring an import taxation structure that is fair to producers of raw materials, intermediates as well as end products, and eliminating the role of middlemen by switching over to e-commerce could perhaps encourage fair business practices.
The third contradiction became apparent during Modi’s US tour. Apart from the issue of liability of nuclear plants, the other thorny issue was protection of intellectual property rights. Besides the tech and entertainment industries, global drug producers face billions of dollars of lost revenue due to copy cats in India. The government’s crackdown on spurious products or even infringement of patents in the local market has been half-hearted so far due to the desire to keep medicine prices low. A sign of the changing times is the stripping of the National Pharmaceutical Pricing Authority from capping prices of non-essentials on the eve of the prime minister’s departure to the US. The fourth dissonance cropped up during Modi’s speech to the United Nations General Assembly, when he exhorted members not to distinguish between good and bad terrorism, not realizing that he had laid himself open to similar criticism by branding FDI in retail as inimical to the country’s mom-and-pop shops while welcoming it in Railways and defence. Protecting one segment of the business comes at the expense of another: farmers, who would get better pricing and a captive market. Better storage and distribution would contribute to lowering of food inflation. The consumer durables industry is an examples of Indian players being swamped by foreign competition yet receiving hardly any sympathy from the policy makers. If employment creation is the focus, it would be better achieved by large malls rather than family-run holes in the wall. Similarly, issuers are able to raise funds quickly by providing privileged access to institutional investors. However, by ignoring the small investors, these companies are blocking the exit routes of these big-ticket investors.
Wednesday, October 8, 2014
The chaos theory
The safe-haven status of the dollar and food inflation in India have disrupted linkages between stocks and currency
By Mohan Sule
Once upon a time not far ago, there was a perfect world. The prosperity at the beginning of this century did not come out of the blue but was the result of different stages of evolution. Opportunity for a better life mutated into greed and transcended into lust. A dot transformed into a decimal, bloating into a balloon. Eventually, there was a bust. It took a few years for rays of hope to pierce the gloom that enveloped the globe, which had become closely entwined. Parts of a machine were produced in different corners and assembled in another location and sold someplace else. There was no false sense of nationalism. Instead the race was to build on the core strengths of demography, technology and market. For instance, an exporter of back-office services could be a voracious consumer of fast foods and luxury labels. A nuts-and-bolts hub of the world could have insatiable appetite for commodities. Money was cheap and plenty and sloshed around wherever it was needed. It looked like good times were here forever. Alas, it was not to be. Once again, living beyond means got the better of a prudent lifestyle. Money ran out even as debt piled up. The monetary earthquake shook the foundations of blue-chipped institutions. Some crumbled into dust. September 2008 was the turning point for the financial history of the world just as BC and AD are pegs to chart the age of the globe. A pre-Lehman Brothers has become a lexicon to conjure images of debauchery. It has become a marker for future generations to know that the world would never be the same again.
Going by textbooks, low interest rates encourage risk-taking. The US stock market is hitting record highs on near-bottom interest rates. But instead of plummeting because the US Federal Reserve still doubts the strength of the economic recovery and refuses to raise interest rates, the Dow Jones continues to surge. The picture in India is the reverse. Stocks are sprinting despite high cost of money. Reserve Bank of India Governor Raghuram Rajan has warned of outflow from India on a US bounce-back. The question that will arise on this possibility is: will the S&P 500 benchmark retreat because of competition from debt? And, in such a situation, will the RBI remain on course of lowering interest rates once food inflation falls? The interesting takeout is that India’s central bank will have to second-guess the Fed rather than follow a course dictated by India’s economic indicators. So there could be a strange paradox of the US playing by the rule book of keeping interest rates down to trigger growth and India’s central bank refraining from lowering interest rates on fear of exit of foreign money. The burden of preventing a major disruption in the market will be on the Indian government by ensuring that foreign investors earn return in excess of that back home. Take the comeback of bank stocks despite high non-performing loans. The market is re-rating them in the belief credit offtake will increase as thrust sectors such as infrastructure will have to rely on debt to fund capital expenditure. On the other side, a bubbly stock market is enabling highly-leveraged companies to become light by raising equity to retire debt.
Another lesson that has turned topsy-turvy is that the strength of the currency reflects the economy. Despite near-recessionary condition, the US dollar continues to rule. The acquisition of a safe-haven status means a bear attack drives investors to hoard the greenback and so also a bull-run. The Indian currency, confirming to textbook behavior, turned weak during the slump. Yet it also exhibits a contrary trend. High interest rates should bolster the rupee. Instead, a strong dollar is keeping it suppressed as also RBI’s mop-up from the market to fend of repercussions of any stampede. Now the question is will the rupee depreciate further if interest rates are pared? The Indian currency should gain due to the resultant acceleration in foreign investment on growth prospects getting a boost. If this does not fox traditionalists, then the recent phenomenon of narrowing trade deficit should. Growing imports signal industrial acitivity. A soft rupee, therefore, should widen the gap as India’s imports, particularly those of energy (US$ 450 million in FY 2014), exceed exports (US$ 312 million). Ironically, the chasm is shrinking because of squeeze in gold imports and cooling of oil prices despite tensions in the Middle East. The cause is the slowdown in China, whose FDI hit a four-year low in August. In fact, China, a major exporter of cheap goods, should be cranking up its wheels with consumption in the US poised to look up. Meanwhile, rising food intake, rather than the growing hunger for oil, on the back of economic expansion is keeping consumer inflation afloat in India. Indeed these crosscurrents are the new challenges for central banks and governments as age-old equations are giving way to a new chaotic order.
By Mohan Sule
Once upon a time not far ago, there was a perfect world. The prosperity at the beginning of this century did not come out of the blue but was the result of different stages of evolution. Opportunity for a better life mutated into greed and transcended into lust. A dot transformed into a decimal, bloating into a balloon. Eventually, there was a bust. It took a few years for rays of hope to pierce the gloom that enveloped the globe, which had become closely entwined. Parts of a machine were produced in different corners and assembled in another location and sold someplace else. There was no false sense of nationalism. Instead the race was to build on the core strengths of demography, technology and market. For instance, an exporter of back-office services could be a voracious consumer of fast foods and luxury labels. A nuts-and-bolts hub of the world could have insatiable appetite for commodities. Money was cheap and plenty and sloshed around wherever it was needed. It looked like good times were here forever. Alas, it was not to be. Once again, living beyond means got the better of a prudent lifestyle. Money ran out even as debt piled up. The monetary earthquake shook the foundations of blue-chipped institutions. Some crumbled into dust. September 2008 was the turning point for the financial history of the world just as BC and AD are pegs to chart the age of the globe. A pre-Lehman Brothers has become a lexicon to conjure images of debauchery. It has become a marker for future generations to know that the world would never be the same again.
Going by textbooks, low interest rates encourage risk-taking. The US stock market is hitting record highs on near-bottom interest rates. But instead of plummeting because the US Federal Reserve still doubts the strength of the economic recovery and refuses to raise interest rates, the Dow Jones continues to surge. The picture in India is the reverse. Stocks are sprinting despite high cost of money. Reserve Bank of India Governor Raghuram Rajan has warned of outflow from India on a US bounce-back. The question that will arise on this possibility is: will the S&P 500 benchmark retreat because of competition from debt? And, in such a situation, will the RBI remain on course of lowering interest rates once food inflation falls? The interesting takeout is that India’s central bank will have to second-guess the Fed rather than follow a course dictated by India’s economic indicators. So there could be a strange paradox of the US playing by the rule book of keeping interest rates down to trigger growth and India’s central bank refraining from lowering interest rates on fear of exit of foreign money. The burden of preventing a major disruption in the market will be on the Indian government by ensuring that foreign investors earn return in excess of that back home. Take the comeback of bank stocks despite high non-performing loans. The market is re-rating them in the belief credit offtake will increase as thrust sectors such as infrastructure will have to rely on debt to fund capital expenditure. On the other side, a bubbly stock market is enabling highly-leveraged companies to become light by raising equity to retire debt.
Another lesson that has turned topsy-turvy is that the strength of the currency reflects the economy. Despite near-recessionary condition, the US dollar continues to rule. The acquisition of a safe-haven status means a bear attack drives investors to hoard the greenback and so also a bull-run. The Indian currency, confirming to textbook behavior, turned weak during the slump. Yet it also exhibits a contrary trend. High interest rates should bolster the rupee. Instead, a strong dollar is keeping it suppressed as also RBI’s mop-up from the market to fend of repercussions of any stampede. Now the question is will the rupee depreciate further if interest rates are pared? The Indian currency should gain due to the resultant acceleration in foreign investment on growth prospects getting a boost. If this does not fox traditionalists, then the recent phenomenon of narrowing trade deficit should. Growing imports signal industrial acitivity. A soft rupee, therefore, should widen the gap as India’s imports, particularly those of energy (US$ 450 million in FY 2014), exceed exports (US$ 312 million). Ironically, the chasm is shrinking because of squeeze in gold imports and cooling of oil prices despite tensions in the Middle East. The cause is the slowdown in China, whose FDI hit a four-year low in August. In fact, China, a major exporter of cheap goods, should be cranking up its wheels with consumption in the US poised to look up. Meanwhile, rising food intake, rather than the growing hunger for oil, on the back of economic expansion is keeping consumer inflation afloat in India. Indeed these crosscurrents are the new challenges for central banks and governments as age-old equations are giving way to a new chaotic order.
Conflict of interest
Government as a regulator, producer and user benefits neither the shareholders of the seller nor those of the consumer
By Mohan Sule
The countdown has begun for a decision on pricing of natural gas. The UPA II government had almost doubled the price to US$ 8 per million British thermal unit effective April. The Lok Sabha election in May delayed the implementation. The NDA government end June decided to put off the matter by three months. The outcome will affect the shareholders of Reliance Industries, ONGC and Cairn India as well as those of user industries including power generators, fertilizer producers and refiners making cooking gas. An upward revision could fuel a rally in RIL and, effectively, light up the equity market as the heavyweight has been a laggard compared with other constituents of the benchmark. In the three months to 5 September 2014, the broad market gained nearly 8% compared with RIL’s loss of more than 5%. Importantly, the government is readying to issue shares of ONGC. A favourable verdict can fetch attractive valuation for the PSU. The picture will be opposite for end users. Increase in prices will drive up costs. Inflation is an overriding theme for the electorate, which has generally been satisfied with the performance of the Narendra Modi government after 100 days in office. Yet any reluctance to bump up prices could restrict supplies and slow down GDP growth. No wonder there is anxiety on how the drama unfolds in the next few days. There is certainty that prices will be hiked. The question is by how much and what will be the formula for future.
Pricing of natural gas is one of the many instances that have brought to the fore the divergence of interest of the sellers and the buyers. The coal-scam drama, which refuses to fade out, is a prominent case of cross-connection. The government is the largest producer (Coal India) and also a major consumer (NTPC and Sail, for instance) of coal. It could afford to keep prices low as long as CIL was not listed. The largest foreign portfolio investor resorted to legal action against the government for not allowing prices to reflect demand. Revision in power tariff due to increase in prices of coal is resisted by bankrupt state-owned discoms. The entry of private sector to boost supply has created more problems than being a solution due to the arbitrary allocation of coal blocks. The ensuing fallout was policy paralysis, affecting the producers as well as the users. The result is that neither CIL nor power generators are getting the discounting that companies in an industry with vast untapped potential should be attracting. Sugar is another example. The minimum support prices to sugarcane farmers, a crucial segment of the electorate, is relentlessly increased despite protests from sugar producers, who have to sell a portion of the output at controlled prices. Moreover, exports are controlled. On the other side, government-owned banks routinely complain about piling debts of sugar mills. As a via media, mixing of ethanol, a byproduct of sugar, in petrol has been encouraged to ease the cash-flow problem of sugar producers and reduce the influence of crude oil on fuel prices. This arrangement will ease some of the pain of sugar manufacturers but is not a substitute for withdrawal of government presence from the sector. As such, sugar stocks languish on the trading floor despite India being one of the largest consumers.
The norm is for interested parties to recuse from situations involving conflict of interest. For example, the Telecom Regulatory Authority of India, an autonomous body, oversees the industry, despite having two PSU operators, with the entry of private services providers. Similarly, the Central Electricity Regulatory Commission regulates power tariff. However, going by the valuation of BSNL and MTNL, loosening of control by the government does not necessarily benefit the shareholders of PSUs that had been monopolies when they were listed. Smaller private banks by assets enjoy better discounting than some of the biggest PSU banks due to more flexibility. In that sense, the government failed to mention reforms as a risk factor. Perhaps the belief was that the private sector would remain fringe players in view of the depth of coverage of the government-owned entities. Later events have shown that the margin counts more than volumes. The need for a third-party arbitrator, therefore, is to ensure the economy grows not due to higher pricing but because of consumption, which calls for cost-effective operations, thereby, benefiting the shareholders of both the producer and the users. Institutional investors have to become active to nudge the government to stop disturbing the pricing equilibrium. Otherwise, there will be only IPOs and FPOs from e-malls, food chains, theme parks and multiplexes.
By Mohan Sule
The countdown has begun for a decision on pricing of natural gas. The UPA II government had almost doubled the price to US$ 8 per million British thermal unit effective April. The Lok Sabha election in May delayed the implementation. The NDA government end June decided to put off the matter by three months. The outcome will affect the shareholders of Reliance Industries, ONGC and Cairn India as well as those of user industries including power generators, fertilizer producers and refiners making cooking gas. An upward revision could fuel a rally in RIL and, effectively, light up the equity market as the heavyweight has been a laggard compared with other constituents of the benchmark. In the three months to 5 September 2014, the broad market gained nearly 8% compared with RIL’s loss of more than 5%. Importantly, the government is readying to issue shares of ONGC. A favourable verdict can fetch attractive valuation for the PSU. The picture will be opposite for end users. Increase in prices will drive up costs. Inflation is an overriding theme for the electorate, which has generally been satisfied with the performance of the Narendra Modi government after 100 days in office. Yet any reluctance to bump up prices could restrict supplies and slow down GDP growth. No wonder there is anxiety on how the drama unfolds in the next few days. There is certainty that prices will be hiked. The question is by how much and what will be the formula for future.
Pricing of natural gas is one of the many instances that have brought to the fore the divergence of interest of the sellers and the buyers. The coal-scam drama, which refuses to fade out, is a prominent case of cross-connection. The government is the largest producer (Coal India) and also a major consumer (NTPC and Sail, for instance) of coal. It could afford to keep prices low as long as CIL was not listed. The largest foreign portfolio investor resorted to legal action against the government for not allowing prices to reflect demand. Revision in power tariff due to increase in prices of coal is resisted by bankrupt state-owned discoms. The entry of private sector to boost supply has created more problems than being a solution due to the arbitrary allocation of coal blocks. The ensuing fallout was policy paralysis, affecting the producers as well as the users. The result is that neither CIL nor power generators are getting the discounting that companies in an industry with vast untapped potential should be attracting. Sugar is another example. The minimum support prices to sugarcane farmers, a crucial segment of the electorate, is relentlessly increased despite protests from sugar producers, who have to sell a portion of the output at controlled prices. Moreover, exports are controlled. On the other side, government-owned banks routinely complain about piling debts of sugar mills. As a via media, mixing of ethanol, a byproduct of sugar, in petrol has been encouraged to ease the cash-flow problem of sugar producers and reduce the influence of crude oil on fuel prices. This arrangement will ease some of the pain of sugar manufacturers but is not a substitute for withdrawal of government presence from the sector. As such, sugar stocks languish on the trading floor despite India being one of the largest consumers.
The norm is for interested parties to recuse from situations involving conflict of interest. For example, the Telecom Regulatory Authority of India, an autonomous body, oversees the industry, despite having two PSU operators, with the entry of private services providers. Similarly, the Central Electricity Regulatory Commission regulates power tariff. However, going by the valuation of BSNL and MTNL, loosening of control by the government does not necessarily benefit the shareholders of PSUs that had been monopolies when they were listed. Smaller private banks by assets enjoy better discounting than some of the biggest PSU banks due to more flexibility. In that sense, the government failed to mention reforms as a risk factor. Perhaps the belief was that the private sector would remain fringe players in view of the depth of coverage of the government-owned entities. Later events have shown that the margin counts more than volumes. The need for a third-party arbitrator, therefore, is to ensure the economy grows not due to higher pricing but because of consumption, which calls for cost-effective operations, thereby, benefiting the shareholders of both the producer and the users. Institutional investors have to become active to nudge the government to stop disturbing the pricing equilibrium. Otherwise, there will be only IPOs and FPOs from e-malls, food chains, theme parks and multiplexes.
Sunday, September 7, 2014
The comeback
Retail investors will return to the market not because of any regulations but due to confidence in the economy
By Mohan Sule
Now that the secondary market has heated sufficiently, the focus has shifted to the primary market. Several government-owned and private units are preparing to enter the ring. Some PSUs would be offloading shares to reach 25% public holding, while many others to meet the ambitious Rs 50000-crore disinvestment target for the fiscal. Promoter-driven companies could be issuing equity to lighten debt, fund stalled expansion or build a chest for organic or inorganic growth. It is understandable that the private sector would wait for a frothy secondary market to get rich valuations. But for the government to strike when the mood is bullish suggests lack of confidence in the operational performance of the PSUs, many of whom are monopolies and should be able to draw investors’ attention without difficulty. The idea of enlarging the ownership to ordinary investors can be best achieved when the market is depressed and shares can be sold at attractive prices instead of offering a nominal discount to inflated P/E. Second, most issues would be of modest size. Subscription targets can be met with the participation of domestic and foreign institutional investors. Private sector companies have been placing shares with these investors even during the low phase. So do issuers need retail investors?
The marginalisation of retail investors, ironically, began as reforms gathered pace and gave rise to sunrise sectors such as tech, telecom, education, media and logistics. Many of the players in the old industries have become large caps due to the licence raj, which raised barriers for new entrants without the right connection. In contrast, the need for capital of the new sectors is modest compared with producers of, say, steel and capital goods. As such the emerging industries’ reliance on retail investors is far less than that of old economy companies. For instance, e-commerce businesses have no problem raising capital in the incubating stages. Yet many of these ventures are bigger by value than decades-old manufacturers as return from nascent industries has the capability to outstrip that from mature industries. During the dot-com bubble at the turn of this century, traditional earning matrix such as cash flows was junked in favour of esoteric parameters such as eyeballs. The valuations assigned made no sense to retail investors trying to comprehend their potential without any previous markers. The ensuring crash confirmed their fears. The changing investment landscape, however, has brought into focus the indispensability of retail investors. Venture capitalists and private equity managers pump in funds in the hope of exiting at bumper profit on listing. Angel investors reap the initial growth benefits. By the time they begin trading, these enterprises have achieved critical mass and future growth may not be at the same pace as in the past. Retail investors enter at a high point, with the promoters pricing shares exorbitantly based on past performance (minimum three years of profit to list). This is another reason for them to shy way from the primary market.
The role of Sebi, too, needs to be scrutinized. On the eve of the government preparing to flag off its big-ticket divestment program, the regulator goes through the now-familiar exercise of tightening investor protection rules and adding more features such as expanding the retail quota, introduction of marketing-making and safety net, stipulating discount to the offer price, and increasing the maximum investment limit. At the same time, it eases the cost and time required by issuers to raise money through the wholesale route. For instance, placements with qualified institutional investors do not have a lock-in as in preferential issues. If anything, book-building has created confusion rather than succeeding in coaxing retail investors. Most issues are bid at the higher range for fear of being left out, particularly from desirable offerings. Importantly, the price band is determined based on the response of institutional investors. Proportionate allotment has given rise to multiple applications from the same household, pushing aside the small investor. So there is a strange picture of wary retail investors caught between a confused regulator and expedient issuers. As the mood of the sulking market has undergone a change post May 2014, issuers are once again readying to target retail investors despite no fresh carrot dangled by the regulator to protect capital and enable them to earn higher return than fixed-income products. The lesson is that no amount of tweaking of rules will bring back retail investors as would the confidence that the economy is going to be in a better shape tomorrow than it is now.
By Mohan Sule
Now that the secondary market has heated sufficiently, the focus has shifted to the primary market. Several government-owned and private units are preparing to enter the ring. Some PSUs would be offloading shares to reach 25% public holding, while many others to meet the ambitious Rs 50000-crore disinvestment target for the fiscal. Promoter-driven companies could be issuing equity to lighten debt, fund stalled expansion or build a chest for organic or inorganic growth. It is understandable that the private sector would wait for a frothy secondary market to get rich valuations. But for the government to strike when the mood is bullish suggests lack of confidence in the operational performance of the PSUs, many of whom are monopolies and should be able to draw investors’ attention without difficulty. The idea of enlarging the ownership to ordinary investors can be best achieved when the market is depressed and shares can be sold at attractive prices instead of offering a nominal discount to inflated P/E. Second, most issues would be of modest size. Subscription targets can be met with the participation of domestic and foreign institutional investors. Private sector companies have been placing shares with these investors even during the low phase. So do issuers need retail investors?
The marginalisation of retail investors, ironically, began as reforms gathered pace and gave rise to sunrise sectors such as tech, telecom, education, media and logistics. Many of the players in the old industries have become large caps due to the licence raj, which raised barriers for new entrants without the right connection. In contrast, the need for capital of the new sectors is modest compared with producers of, say, steel and capital goods. As such the emerging industries’ reliance on retail investors is far less than that of old economy companies. For instance, e-commerce businesses have no problem raising capital in the incubating stages. Yet many of these ventures are bigger by value than decades-old manufacturers as return from nascent industries has the capability to outstrip that from mature industries. During the dot-com bubble at the turn of this century, traditional earning matrix such as cash flows was junked in favour of esoteric parameters such as eyeballs. The valuations assigned made no sense to retail investors trying to comprehend their potential without any previous markers. The ensuring crash confirmed their fears. The changing investment landscape, however, has brought into focus the indispensability of retail investors. Venture capitalists and private equity managers pump in funds in the hope of exiting at bumper profit on listing. Angel investors reap the initial growth benefits. By the time they begin trading, these enterprises have achieved critical mass and future growth may not be at the same pace as in the past. Retail investors enter at a high point, with the promoters pricing shares exorbitantly based on past performance (minimum three years of profit to list). This is another reason for them to shy way from the primary market.
The role of Sebi, too, needs to be scrutinized. On the eve of the government preparing to flag off its big-ticket divestment program, the regulator goes through the now-familiar exercise of tightening investor protection rules and adding more features such as expanding the retail quota, introduction of marketing-making and safety net, stipulating discount to the offer price, and increasing the maximum investment limit. At the same time, it eases the cost and time required by issuers to raise money through the wholesale route. For instance, placements with qualified institutional investors do not have a lock-in as in preferential issues. If anything, book-building has created confusion rather than succeeding in coaxing retail investors. Most issues are bid at the higher range for fear of being left out, particularly from desirable offerings. Importantly, the price band is determined based on the response of institutional investors. Proportionate allotment has given rise to multiple applications from the same household, pushing aside the small investor. So there is a strange picture of wary retail investors caught between a confused regulator and expedient issuers. As the mood of the sulking market has undergone a change post May 2014, issuers are once again readying to target retail investors despite no fresh carrot dangled by the regulator to protect capital and enable them to earn higher return than fixed-income products. The lesson is that no amount of tweaking of rules will bring back retail investors as would the confidence that the economy is going to be in a better shape tomorrow than it is now.
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