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Sunday, January 29, 2012

Essar redefines factoring/assignee to save promoter entities from guarantee

It is not often that I cross-post items across blogs. But having spent 2-3hrs to piece the Essar puzzle together, I thought that the final analysis on the 27% yielding Essar bonds maturing 2016, deserved a wider audience. A rather longish post, but well worth the read(http://specialsituationsindia.blogspot.com/2012/01/27-yield-essar-energy-425-2016.html). For those of you impatient to get to the factoring bit, just fast forward towards the end. For best results, read the other post on Essar, under the same tag.

Monday, January 23, 2012


I read the draft version of this bill(http://mhupa.gov.in/W_new/RealEstate_BILL-2011_OM09112011.pdf) and was quite impressed at some of the provisions. Though laws do not bring about change without good implementation, the Government is atleast thinking on good lines. Essentially, the Act aims to ensure fairplay by promoters, have a single web portal for accessing details of approved projects and to have a single pan India tribunal for disputes. Some interesting clauses below and their implications are detailed below.
  1. INTEREST  RATE SYMMETRIC:- Section2(u) “interest” means...Explanation.- For the purposes of this clause, the rate of interest chargeable from the allottee by the promoter shall not be more than the rate of interest which the promoter would be liable to pay the allottee in case of default. If only this provision was applied to tax laws also(where Government pays 6% pa on delayed refunds while taking 18% interest for late payments, tax payers would be much more happy. On a lighter vein though, this clause will ensure fairplay in contracts.
  2. PROJECT SPECIFIC REGISTRATION:- Section 3. No promoter shall develop any immovable property.. without registering the real estate project and obtaining a certificate of registration from the Real Estate Regulatory Authority established under this Act:  Explanation.- For the purpose of this Act, where immovable property is to be developed in phases then every such phase shall  be considered a standalone real estate project, and the promoter would have to seek registration under the Act for each phase separatel. This would imply that projects need to be registered once on the site, and that even further phases need a distinct registration, which is good.
  3. ESCROW ACCOUNT Section4(3) The promoter shall enclose the following documents along with the application referred to in sub-section (1), namely:-(b) (v) that seventy percent of the amounts realized for the real estate project from the allottees, from time to time, would be deposited in a separate account to be maintained in a scheduled  bank, within fifteen days of its realization for meeting the costs of the real estate project and would be used only for that purpose. Completion risk is one thing that has hogged the limelight. Having an escrow account would entail another audit, but would ensure that the project gets completed on time! Now, residential projects cross funding commercial projects may not happen anymore
  4. TRANSPARENT MARKET DATA:- Section8. (1) The promoter shall..enter all details of the proposed project ..(2)  The information and documents referred to in sub-section (1)..include,- (g) fortnightly up-to-date list of bookings on the basis of the agreement to sell entered with them. This would ensure that buyers have an accurate assessment of which projects are selling, and this information would allow them to make purchase decisions and in negotiations.
  5. 'PRE-FILING CONDITIONS:- Section 9- No promoter shall issue or publish an advertisement or prospectus, or invite any member of the public to buy or book in such projects to be developed or take advances or deposits without obtaining a copy of certificate of registration with the Authority. (2) No promoter shall issue advertisement or prospectus without first filing a copy of such advertisement or prospectus in the office of the Authority/ This borrows several provisions from SEBI Guidelines for equity funding, which is quite interesting in itself! Atleast it would ensure some uniformity in advertisements and 'prospectus'.
However, there is no rose without thorns. The possible cons of the bill are
  1. Excessive reliance on the internet:-Since not all realty buyers may be conversant with English/be digitally savvy, the proposed web portal needs to be in multiple languages, and accessible via other modes like mobile etc. 
  2. Too small threshold limit for Act:-Since projects above 4000sqfeet carpet area are covered, this would realistically cover any decent size building. While this may be the intention of the act, one wonders whether small builders can bear this compliance cost or not. So either build a NSDL/MCA-21 CFC like compliance infrastructure in place, or else increase the applicability limit for the Act
Like most Indian laws, this is high on intentions but it is to be seen whether it is implemented or not. If implemented, it could go a long way in cleansing the Augean stables of realty. 

Sunday, January 22, 2012

Private equity careers in India-pros and cons

This time of the year is when final year MBA students in India must get away from the 2 year vacation on campus(just kidding :P) and make up their mind about career choices. For those in the higher ranked campuses, there are options on buy side in campus itself, but even for others, especially with work experience, the off campus route may yield results in later years. While researching for making my own career choices, I did some homework and just want to put those insights below, so that others can benefit from the same. A small request-if you benefited from this, do comment below or share it so that others can also benefit from the same. I hope that readers would atleast read on Wikipedia/do a basic Google also.
  1. Difference from venture capital:-The difference is mainly that VCs are at a much earlier stage, and often take a strategic minority stake. While PEs take a usually majority stake(except in India where they are compelled to go for strategic minority stake) in mature companies in high growth sectors. In the technology space, there is ample overlap but otherwise one would find PEs in any high potential sector but VCs are more of 'smart money' concentrated in technology sectors
  2. Linkage with consultants and investment bankers:-Interestingly, as a Linkedin search would show, Indian PE employees are mostly drawn from consulting firms and investment banks. A reason is that investment banks help in sourcing deals and exiting investments(via IPOs), while consulting firms help in strategic roadmap/due diligence of portfolio companies etc. Depending on the sector of the PE firm, both these skills sets matter, and so the revolving door exists.
  3. Reliable Data on sector:-IVCA Report coauthored by Bain & Company(http://www.indiavca.org/IVCA%20Bain%20India%20Private%20Equity%20Report%202011.pdf) and KPMG annual report on private equity(http://www.kpmg.com/IN/en/IssuesAndInsights/ThoughtLeadership/Return-from-Indian-Private-Equity_1.pdf). Both reports have different perspectives on sectors and returns, and give a good insight into the state of private equity in India. Otherwise, newspaper reports often come on that
  4. The money:-Base pay is quite decent, but the real money is in the 'carry'-i.e 20%(usually) share in the net profits on the deal. Depending on sector, carry takes 5-10 years to be realized(the trend is now on the higher side due to underperforming capital markets delaying exit), and the share goes to the deal team that worked on the transaction. Hence, long term approach matters! 
  5. Few lumpy transactions:-Even a firm like KKR with 35yrs in the industry(it was setup in 1976) has done just 195 investments at a transaction value of $445bn. Hence, it is certainly not like trading with a large transaction turnover. The reason for the lower deal volume is scalability(the holy grail of PE), demanding high investment value(usually not below $50MM in India) and need for greater due diligence since it is an investing decision, not a research decision! 
  6. India specific regulatory and legal issues:-Thanks to the existing securities/financial law framework, things like hostile acquisitions, LBOs, exotic structures etc are easier said than done. And when it comes to sensitive sectors like real estate, retail, media etc, the extent of scrutiny is much more for foreign funding(source of PE funds in India), with the accompanying restrictions on FDI etc. Hence, seeking alpha from clever financial structuring is more difficult here. And with the recent court battle(in the Maharashtra Scooters case, Bombay HC) about the validity of put options on listed equities in shareholder agreements, such controversies are live and kicking. 
  7. Demographics driven sectors:-As the recent runup in the stock price of Hindustan Unilever(and Jubiliant Foodworks) shows, the consumer goods boom in India is live and kicking. And  thanks to the telecom reforms underway, there is hope for the digital divide to be finally bridged, and the present USA internet boom(Facebook/Linkedin/Groupon/Zynga) to catch up in India as well. But that is B2C. In the B2B sectors, realty among others, is expected to benefit fro the urbanization and infrastructure development spend, IF it can get its governance in place. 
  8. Investment Committees:-He who pays the bills calls the shots. Investment committees are often offshore(Singapore/Hong Kong/NY/London) situated where the fund raising happens, and many Indian branches of PE firms still need case-case signoffs. Even for hiring, this dependency is reflected. While it is a good thing for transferring the investment process rigour to the new Indian offices, those with more experience may chaff at the reins.
  9. Bank backed distressed companies crowding out PE:-While Indian firms are not flush with cash like the USA firms(barring Reliance Industries/Piramal Healthcare), the banks more than make up for that. Even basket cases like airlines, steel companies etc often get away with a CDR without having to take drastic changes/reduce promoter equity substantially. Hence, PE companies specializing in turnabouts, often find that banks do not permit the companies to fail!
While my personal preferences are not the subject of this post, one should consider the type of work, comfort level with foreign supervision, exit options, remunerations, long term focus etc before taking a call on the same.

Thursday, January 19, 2012

Analyzing telecom stocks? Keep these pointers in mind

Telecom is a sector which is technically complex(to understand), and full of regulatory quicksand. But for those brave investors willing to risk investing in these stocks, there is still money to be made given the digital divide bridging agenda of the Central Government. So without much ado, here are my pointers
  1. Effective Subscriber base:-Thanks to the lifetime prepaid validity schemes, dual sim phones and other aspects, many subscribers have multiple SIMs, many of which are not in use. So before crediting an operator for its subscriber growth, be careful about the effective subscriber base, as opposed to absolute connections. For example, out of the total  884.37 Million subscribers,  635.39 Million were active on the date of Peak VLR for the month of November 2011 viz 72%.. TRAI gives the overall % broken down by operator and circle, which ranges from 25% for Etisalat to 83% for Vodafone(http://www.trai.gov.in/WriteReadData/trai/upload/PressReleases/859/Press_Release_Nov-11.pdf). Do read this to get the market power in perspective.
  2. Teledensity:-While TRAI and others calculate this simplistically as the subscriber base divided by total population, this does NOT consider the effective subscribers. Hence, the actual teledensity for India's 1.2bn population, is closer to 50%(IF we can assume that kids should not use mobile phones(!), then the figure would be higher). Before using this figure anywhere, be aware of the key assumptions behind it.
  3. Adjusted Gross Revenue:-The statutory license fee is calculated on a different revenue base than adopted for financial reporting(the difference being excluding revenue from certain rural areas/essential services). If AGR is significantly different from Gross Revenue, it could mean fudging the records of anyone/both, as was the accusation by Kotak against Reliance Communications about 2yrs ago.
  4. Minutes of Usage-see outgoing only!:-While reading the TRAI quarterly statistics for June-Sep quarter here(http://www.trai.gov.in/WriteReadData/trai/upload/PressReleases/860/Quarterly-Press-Release-final.pdf), it struck me that even TRAI adds up both incoming and outgoing MOU for counting the total-though it does split them up. Given that incoming calls are generally free in India(barring roaming), the better metric for investors would be outgoing calls MOU(or even better, revenue earning MOU since not all minutes may be charged). 
  5. Understand the value chain:-There are many people vying for the telecom rupee, such as handset makers, VAS providers like Onmobile, patent owners like Qualcomm, service providers like IBM, DTH providers like Tata Sky/Dish TV and so on. Take a big picture look at the profits and revenues across the value chain-I know that needs lots of digging into data and consultancy reports, but the results would astound you as they did me. For example, I did not know that VAS owners get on an average only around 30%-50% of their end user payment, while the operator takes the rest! Also, telecom equipment is the next boom independent of what happens in the voice/data market. While plugging in variables for that valuation/DCF model, such insights are must.
  6. Rerating as becoming responsible by compulsion! TRAI has significantly revamped the regulations on customer service/experience using measures like MNP/stopping spam etc, and recently announced that telecom operators must measure and reduce their carbon footprint by 2020, and improve their energy efficiency. These measures would earn the stocks brownie points when implemented, hopefully aiding their inclusion on certain indices, and thereby broaden the addressable investor base. Of course, this is a quite long term aspect
  7. EV/subscriber not comparable:-While some lazy analysts may compare other emerging market telcos, be aware that the data revenues of Indian telecos are quite low, and also the business model difference(more outsourcing). So, understand the main revenue split/growth drivers of the comparables before resorting to such peer comps. Of course, this warning applies to all companies not only telecom, but the deceptive simplicity of telecom may seduce investors to compare apples and oranges. 
 The above was more a general overview than any stocks specific analysis. Depending on response, I'll delve into some specific stocks later

Tuesday, January 17, 2012

Cash held by foreign subsidiaries of USA companies-so near yet so far

I used to wonder why do companies with ample surplus cash still take debt? The corporate finance rationale of opportunistically benefiting from mispricing in debt markets, do not apply to companies which generate ample free cash flow, and which do not indulge in trading/proprietary investments. Hence I decided to analyze some companies for more light on this subject. 

What is common between Apple, Microsoft and Qualcomm? Each of them have sizable cash and cash equivalents held in foreign subsidiaries, which would be subject to USA taxes of upto 35%, if repatriated via dividends. Indeed, those companies had escaped USA taxation(at global level) on the earnings of their foreign subsidiaries, by declaring that they had a permanent intention to keep those earnings offshore. So what does it mean for shareholders of those companies? Microsoft admits in its 10K that Of the cash, cash equivalents, and short-term investments at June 30, 2011, approximately $45 billion was held by our foreign subsidiaries and were subject to material repatriation tax effects. .....As of June 30, 2011, approximately 68% of the short-term investments held by our foreign subsidiaries were invested in U.S. government and agency securities, approximately 12% were invested in corporate notes and bonds of U.S. companies, and 5% were invested in U.S. mortgage-backed securities, all of which are denominated in U.S. dollars.
  1. Companies may find it more rational to borrow money for paying their dividends, instead of bringing the cash back. 
  2. Companies may find foreign acquisitions more attractive, to utilize their trapped cash. 
  3. While expropriation risk is minimal since companies would not risk certain jurisdictions, the host country may be tempted to balance its budgets by the levy of witholding tax to ensure that earnings do not escape its juridiction. Hence, a CASH TRAP is quite likely.
  4. Reduced liquidity domestically:- As Qualcomm states in its 10K Our cash, cash equivalents and marketable securities at September 25, 2011 consisted of $5.7 billion held domestically and $15.2 billion held by foreign subsidiaries. Of the amount of cash, cash equivalents and marketable securities held by our foreign subsidiaries at September 25, 2011, $13.5 billion would be subject to material tax effects if repatriated. Due to tax and accounting considerations, we derive liquidity for operations primarily from domestic cash flow and investments held domestically.
While the above examples are mainly of technology companies, any company with global operations like GE also falls under this class.

Qualcomm's perspective on patent wars

At times, reading annual reports is like hunting for a needle in a haystack. I experienced this while reading FY11 10K(annual report) of the CDMA technology owner Qualcomm(http://sec.gov/Archives/edgar/data/804328/000123445211000360/qcom10-k2011.htm). While most of the risk factors were boilerplate, one particular risk factor made interesting reading while QCOM complained that some of its customers were resorting to measures to avoid paying fair royalties. While the strategic use of patents has been detailed in the popular press(patent wars, patent bubble, patent trolls etc), few companies have been so forthright in their financial reports, and hence it warrants a read. Also, while patent challenges are the most common tool reported in the media, there are other ways to finesse patent challenges by using competition law, standard setting, contractual challenges, open source etc to achieve the same end. That is precisely what Strategic Management of Intellectual Property Rights(SMIPR) aims to achieve, and as such these strategies are a classic case. Below are relevant extracts of the risk factor(emphasis supplied by me).  Keep in mind that QCOM is not objective, but it does reflect the rights owner's perspective.
A small number of companies, in the past, have initiated various strategies in an attempt to renegotiate, mitigate and/or eliminate their need to pay royalties to us for the use of our intellectual property in order to negatively affect our business model and that of our other licensees. These strategies have included
(i) litigation, often alleging infringement of patents held by such companies, patent misuse, patent exhaustion and patent and license unenforceability, or some form of unfair competition,
(ii) taking positions contrary to our understanding of their contracts with us
(iii) appeals to governmental authorities
(iv) collective action, including working with wireless operators, standards bodies, other like-minded companies and other organizations, on both formal and informal bases, to adopt intellectual property policies and practices that could have the effect of limiting returns on intellectual property innovations and
(v) lobbying with governmental regulators and elected officials ..seeking the imposition of some form of compulsory licensing and/or to weaken a patent holder’s ability to enforce its rights or obtain a fair return for such rights.

Sunday, January 15, 2012

Will the RBI guidelines on bank staff compensation lead to spur in FRM demand?

In Jan-2012, the RBI(India's banking regulator) announced the Indian version of the Financial Stability Board(FSB) guidelines of 2009, which set principles for banking compensation that aims to align risk with return, ensure independent director oversight etc. The principles can be read here(http://rbi.org.in/scripts/NotificationUser.aspx?Id=6938&Mode=0) and are effective from the Mar12 fiscal onwards.

While the principles come as no surprise for risk taking staff(clawback/deferral etc), what is interesting is the recomendation for higher base pay for control function staff, as can be read below.
2.2 Guideline 4: For risk control and compliance staff
2.2.1 Members of staff engaged in financial and risk control should be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the bank. Effective independence and appropriate authority of such staff are necessary to preserve the integrity of financial and risk management’s influence on incentive compensation. Back office and risk control employees play a key role in ensuring the integrity of risk measures. If their own compensation is importantly affected by short-term measures, their independence will be compromised. If their compensation is too low, the quality of such employees may be insufficient to their tasks and their authority may be undermined. The mix of fixed and variable compensation for control function personnel should be weighted in favour of fixed compensation.
2.2.2 Subject to the above, in devising compensation structure, banks may adopt principles similar to principles enunciated for WTD/CEO, as appropriate.

The above principles would imply a high base pay, skewed towards fixed amount. The last time the compensation of employees was delinked from their business unit performance(as happened for equity research analysts whose bonus was delinked from investment banking revenues), that did not reduce the pay much as banks still set bonus in a black box type approach, which DOES consider investment banking revenues as well. But because RBI has plugged the loophole of high bonuses in its guidelines, it should ensure a good fixed pay. 

Qualifications like FRM are not as popular(yet) as CFA in India, because the risk function is still not as respected/well paid. But with such remuneration norms coming in place with the elevation of the rusk function, this should change. One of the reasons Goldman Sachs has been relatively unscarred by any crisis, is the competence and organizational profile of its famed control function. The sooner other banks realize this, the better it is for the industry and for risk management professionals.

Friday, January 13, 2012

Learnings from Sandeep Parekh's course on Securities Regulation at IIM Ahmedabad

I must confess that before this course, I'd not heard of Sandeep, even thought he's a noted securities lawyer(having argued the Azadi Bachao Andolan case, and was ex-Legal Head of SEBI). But after the course, I must say that his rather unique style was really useful to me. Some key takeaways from the course
DISCLAIMER:- Based on personal memory/notes, so any errors in this are most likely mine! 
  1. Securities are not produced-they are created. And being intangible evidence of ownership in something tangible('company'), the prospectus needs to specify clearly WHAT that something is. 
  2. Administrative(or quasi judicial), civil and criminal penalties can ALL be levied in a case, as the double jeopardy bar applies ONLY to criminal proceedings
  3. He felt that insider trading hurts dealers and speculators the most as they trade the maximum volumes without having access to inside data like how one-off insiders do. That is a very interesting view since I felt that people 'in the market' like these would also have access to that information eventually. 
  4. Indian security law does not start and end with SEBI Act/regulations, it includes whole host of other regulations like Companies Act, Exchange regulations etc. 
  5. Ignorance of law is no excuse, so before executing any major corporate decision, one should consider the securities law consequences especially those of informing exchanges, insider trading, market manipulation, stock option repricing etc. 
  6. In case big trades are executed, risk always exists of insider trading/manipulation accusations. Hence, document the trade internally and try to back it up with external research reports if any.
  7. Unlike quasi judicial bodies like SAT, SEBI has legislative, administrative and judicial powers.
  8. The 'Enforcement Dept' does not actually enforce anything, but argues for SEBI during appeals..
  9. For fraud, one would need to prove mens rea, omission when duty to speak/commission, reliance, loss causation and materiality, damages and transaction causation. In plain English, that would mean a hell lot of stuff! 
  10. If primary liability exists and abettor aware of it, then 2ndary liability possible if knowledge of that.
  11. Care, Diligence and Loyalty are main fiduciary duties
The course was a lot more than that, but now my fingers ache from typing out so much! Overall a very interesting course and reflects his creativity in the course design and use of prezis for creating the slides.

Sunday, January 1, 2012

Notes to accounts-so overt that they are covert

The rather odd title stems from the fact that I'm back from watching the new Sherlock Holmes film released yesterday in India. It chronicles his fight with the criminal mastermind Prof Moriarty. While some purists may decry the 'James Bond' nature of this film, it has still stayed faithful to the vital elements of the book. The cinematic adaptation is great and has some one liners including the one where Holmes explains to Watson(as they are riding away in an open car) that their overt behavior makes it covert viz people are so distracted by the obvious that they may not give importance to it.

This is same for notes to accounts where the financial disclosures become so boilerplate and technical, that investors stop reading it, and companies can virtually get away with murder. This is not true just in India. In USA, the homeground of analysts and financial history, the darling of the stock exchanges Enron got away with mentioning its SPVs in its voluminous 10Ks, and very few analysts caught on(albeit the ones not influential enough to change the general herd mentality). And those who believe in the efficient markets hypothesis, may trust that someone has done that analysis of notes, and so the information should be priced in. But in a country where few equity research analysts are CAs/have requisite accounting background, this does seem too much to expect. Hence, the expectation of investors that they can freeload on someone else's research, may not be true. As I highlighted before on my blog, companies have disclosed vital information relating to litigation, seasonality, managerial remuneration etc but it is an open question how many see it.  This may seem a rant, but I sincerely believe that even public information can hold goldmines of data, if it has not been properly analyzed before OR if others have failed to connect the dots.