»5 Minute Wrap Up by Equitymaster

On This Day - 16 NOVEMBER 2011
Bailout v/s bankruptcy- Which one is better?

In this issue:
» Why big US banks should be broken up into smaller ones...
» IPO process to be overhauled to check price manipulation
» Indian FMCG retail could touch US$100 billion by 2025
» Does India deserve a better credit rating?
» ...and more!
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We are living in times when bailouts are very common across the globe, including our own country. In simple terms, a bailout is a situation where in a failing business is saved from bankruptcy by capital infusion, usually by the government. Back in 2008, when the Indian markets crumbled on the back of the US financial crisis, the government bailed out many sectors that were adversely impacted. Ditto is the case in the European Union (EU) and the US. In order to salvage the euro, the EU is bailing out highly indebted economies like Greece, Ireland and Portugal. In 2008, the US had bailed out banks, investment banks and the automakers. The list is indeed quite long.

In more recent times, there has been a lot of hoopla about whether Kingfisher Airlines, which is facing a serious cash crunch, should be bailed out or not. Of course, we believe that market forces should decide whether a business should survive or shut down. After all, bailing out a business means using public money to save a private enterprise. Society cannot operate on the principle of privatised profits and socialised losses. Moreover, bailouts send out the wrong signals. They incentivise businesses to be reckless, that no matter what they do, the government is always going to come to their rescue. Of course, there is no denying that there can be times when bailouts may be necessary. But they should be reserved only for such rare cases wherein there is a threat of a system-wide collapse.

Going back to the case of Kingfisher Airlines, another question that arises is whether the airline company is right in asking for a bailout. We don't think so. The simple reason being that tomorrow if the company were to make record profits, will it be willing to share those with the taxpayer? Certainly not! How then can it expect to be bailed out using the very same taxpayer's money? Nevertheless, there is a section of society out there that favours a bailout of the embattled firm. For us though, the choice has been clear right from day one. Please do not get us wrong. We are not against the firm and we believe that Kingfisher Airlines is one of the better airlines around. But we have issues with any firm being bailed out. As the developed world has shown, a bailout only amounts to kicking the can down the road and does not solve the real problem. Thus, for a full blown recovery, either a restructuring or a complete elimination of the issue at hand is required.

According to you, should failing businesses be bailed out or allowed to go bankrupt? Share your comments with us or post your views on Facebook page / Google+ page.

 Chart of the day
In the Indian pharmaceutical industry, there have been about 4,000 product launches on an average over the last four years. However, with only 1,400 new launches for the first nine months of 2011 (up till September), the show has been dismal. A remarkable increase in competition and a decreasing pipeline of new molecules are being cited as some of the main reasons for this decline. Since every molecule has about 30-40 competitors, pharma companies will now have to focus more on product differentiation. As such, those companies that lack product development capability will be adversely affected.

Data source: Business Standard
*Figure upto September, 2011

Anyone who has dabbled a bit in Economics would know that monopolies are generally bad for an economy. They are capable of artificially reducing supplies and thus, increasing the price so that exorbitant profits can be made. But the recent crisis in the US has shown that besides being seekers of unfair amounts of profit, monopolies also pose systemic risks to an economy. Well, the US financial sector may not exactly be monopolistic but the fact remains that it is extremely concentrated with assets of five institutions comprising half the industry's total assets. Thus, breaking up these big banks into still smaller ones may be the right thing to do as far as the stability of the US banking system is concerned. This point was highlighted by one of the presidents at the US Federal Reserve. "I believe that too-big-to-fail banks are too-dangerous-to-permit," he is believed to have said. Well, we couldn't have agreed more. But the big question is whether the vested interests would let this happen at all.

The fact that stock markets have ceased to be the most preferred means for raising capital is not lost on the regulator. A few days ago we had written about the stock markets around the world seeing fewer listings and new issuances. The Indian IPO (Initial Public Offering) market has also been the victim of unrealistic pricing and the focus on 'listing gains' which rarely do enough to reward shareholders in the long run. In addition, inadequate compliance with KYC (know your customer) rules have deterred potential capital issuers and investors. The first half of the financial year 2011-12 (FY12) saw 30 companies raising funds to the tune of Rs 50 bn through IPOs. The government's own disinvestment plans have gone awry due to resistance to approach capital markets. SEBI (Securities & Exchange Board of India) is therefore now considering expediting the clearance of IPO offer documents. Companies will have a one-year time to come out with public offers from the date of SEBI clearance. Also, the KYC guidelines will be eased for better compliance. With such policies and better checks in place, the Indian capital markets could certainly serve companies and investors a lot better.

India has been a land of dualities where the affluent urban India residing in cities and towns co-exist with the much larger rural India made up of rustic villages. The stark economic divide led the FMCG industry to focus more on the consuming urban India which accounts for a major share of 66% of the overall consumer good sales. However growing rural prosperity from government sponsored employment programs and rising farm income is slowly changing equations. Picture this, consumer goods such as biscuits, toilet soaps, washing powder, packaged tea and iodised salt contributed more than 40% to overall category sales in FY11. As per market research agency Nielsen, rural India is driving growth in more than 50% of the large consumer good categories.

The per-capita expenditure in rural market is half that of the urban market. But with 150 million households, rural India is nearly three times bigger than urban India holding immense potential demand. Nielsen has forecasted rural FMCG sales to leapfrog from the current US$ 12 bn to US$ 100 bn by 2025. As per the research agency, factors such as higher demand for premium products, brand consciousness and shift from occasional to regular consumption will be the future demand drivers in rural India. FMCG companies have been scrambling to grab a share of the growing clout of rural India. But companies such Hindustan Unilever Ltd (HUL) and ITC Ltd which have developed a strong rural network have a distinct advantage.

In the world of crisis, every country is worried about its credit rating. Be it France or US or the crisis hit PIIGS (Portugal, Italy, Ireland, Greece and Spain). Everyone is worried. Even India. Don't worry, unlike others India is not worried that it would be downgraded. Instead what it wants is for agencies like Moody's to upgrade its credit rating. Currently India's domestic debt and foreign debt are rated as Baa3 (moderate risk) and Ba1 (questionable credit quality) respectively. But these ratings were assigned way back in 2004. The Indian government argues that a lot has changed since. The country has shown growth and resilience even through the current global crisis. At the same time, the government has shown commitment towards reforms. The latter of course is questionable as the government has just 'talked' about reforms and has not really 'carried out' any reforms. But the former point definitely holds true. India certainly deserves some credit for its resilient growth, even if it is just in the form of a credit rating. Not that the ratings have helped any country much but it definitely adds to the 'feel good' factor.

In the meanwhile, the Indian stock markets were trading in the red after opening on a weak note. At the time of writing, the BSE Sensex was down by 154 points (0.9%). Barring FMCG, all sectoral indices were trading in the negative. Red marks were seen across entire Asia with China (down 2.5%) and Hong Kong (down 2.4%) being the top losers.

 Today's investing mantra
"Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell." - Warren Buffett

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