Shrinking capital is hurting India - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Shrinking capital is hurting India 

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In this issue:
» Global pharma keen to up stake in Indian arm
» Property prices in China are likely to halve
» Torrid times for private equity
» Satyam's woes far from over
» ...and more!!

India Inc. tasted blood in its hey days of 2006 and 2007. Easy access to foreign capital helped companies envisage aggressive organic growth and ambitious inorganic growth plans without having the wherewithal to service the liabilities. However, with the change in economic and business cycle, the same is coming back to haunt the over-zealous companies. Drying up of foreign capital seems to be hurting India Inc's growth plans harder than ever before.

It all started with the government's well-intended easing out of norms for foreign direct investment (FDI) and especially, external commercial borrowings (ECBs). What started as a benign move virtually led to a dramatic rise in the inflow of foreign capital. As per the Economic Times, aggregate FDI inflows increased by 30% YoY in 2007. During the first half of 2008, FDI inflow increased by more than two and a half times over the same period in 2007. However, the change in risk appetite after that led to a massive 60% drop in inflows. With the domestic money market becoming tighter thanks to the RBI's policy measures, Indian companies have to rejig their growth plans.

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Global pharma majors are increasingly looking to up their stakes in their Indian arms. The latest to join the bandwagon is Pfizer Inc., which is planning to raise its stake in Pfizer India from 41% currently to 75%. Readers would do well to recall that just a few weeks ago Swiss drugmaker Novartis AG had announced its intention of upping its stake in Novartis India to 90%.

But why has this trend suddenly begun to emerge? One is obviously the fact that the stock prices of the Indian arms are available at attractive valuations. This coupled with the fact that the Indian pharma market is poised to grow at a faster rate than the pharma markets of the developed world has probably compelled the parent companies to adopt this move. Having said that, this move raises some concerns over the intentions of the parent, which could be looking to transfer wealth from minority shareholders to itself. If at all these companies had best intentions in mind, a share buyback would have been a more prudent option given the ample cash that the Indian arms have on their books. Thus, what investors need to note going forward is whether the parent is more forthcoming in terms of launching new products in India and furthering the growth prospects of its Indian arm.

China's cup of woes continues to brim over. As reported in the Financial Times, Cao Jianhai, a professor at the Chinese Academy of Social Sciences, which is a leading government think tank, has predicted that property prices in China are likely to halve over the next two years. He has stated that an apparent rebound in the property market was unsustainable over the medium term and was being driven by a flood of liquidity and fraudulent activity rather than real demand. For instance, average urban housing prices across 70 cities in China were up 0.2% in March on a sequential basis breaking seven months of sequential declines. However, Mr. Cao contends that the same is due to real estate developers using fake mortgages to offload apartments on to the books of state-run banks and also due to the real pent up demand from urban citizens. Thus, this rebound is likely to be short-lived.

Similarly, in India too, while property prices have come off their highs, there are expectations of a further stall. However, the MD of HDFC has stated in no uncertain terms that property prices have fallen enough and any further reduction will be difficult to come by.

Debt can be created out of thin air by the government. But debt cannot be used to fund a start up. Debt requires safety of capital and most start ups would barely make the cut given their initial volatility in profits. Enter equity. Private Equity (PE), one of the most lucrative sources of financing for startups is going through a torrid time. As per Economic times, PE deals have dropped a staggering 87% during the March quarter on a YoY basis and 56% on a sequential basis. The reason? Increased risk aversion. Most PE firms operating in India get their own funding from overseas institutions like pension firms, asset management companies and insurance companies. Thus, with these institutions wary of lending more to risky asset class like PE, the flow of funds to the latter has virtually dried up. Furthermore, promoters and PE firms are increasingly looking the other way in the all important matter of valuation, given the heightened uncertainty about the future.

Warren Buffett's investment in Goldman Sachs had raised quite a few eyebrows. It seemed puzzling at a time when investment banks were collapsing like nine pins. But the move is slowly turning out to be the right one. As per Fortune, Goldman Sachs has posted a US$ 1.8 bn profit in 1QCY09, thus turning around from the red in the previous quarter. It is also planning a US$ 5 bn issue of shares in order to facilitate paying off its TARP debt (it had received US$ 10 bn and is keen to repay as soon as possible). Among business segments, fixed income, commodities and credit products did well, while advisory, investment banking and asset management performed poorly. It may be noted that the stock has risen around 70% in the last month. Interestingly, several Indian stocks have also made similar gains.

At the end of it all, it was Tech Mahindra who emerged as the winner and will now take charge of Satyam, the beleaguered software giant. Taking into account the lowest bid, which came in at Rs 20, many experts feel that Tech Mahindra's offer price of Rs 58 is way too steep. If that is indeed the case, to leave enough profits on the table, the company may have to resort to large scale layoffs at Satyam. And first in the firing line could be the latter's bench strength, which as per a leading daily stands at about 13,000 employees. Even if we consider the valuations reasonable, a lot of insiders are of the opinion that Satyam's erstwhile management had far too many people on the company's rolls than required. Hence, either ways, the excess flab will most likely be cut by way of large scale layoffs. Also at risk is the appointment of 6,500 odd freshers, whom the previous management had already issued appointment letters. Clearly, Tech Mahindra or no Tech Mahindra, woes for some of the people at Satyam are far from over.

Forecasters may be getting increasingly bullish about the improving prospects of sales and profit growth for Indian companies; ahead of the result season. However, despite some enthusing signs in the global economy, the export data for the month of March 2009 suggests some tempering down of expectations. India exported goods and services worth US$ 170 bn in FY09. In doing so it missed the target of US$ 200 bn for the fiscal.

As per Mint, the decline of 31% in exports in March 2009, the sixth straight monthly fall, is the biggest drop on record, considering data going back to 1995. Further, the fall in exports which is much sharper that the 22% recorded in February 2009, is expected to continue till September this year. With sectors such as textiles, gems and jewellery and auto (which are the largest Indian exporters) being in a restructuring mode due to high leverage, a slower pick up in exports may bring in greater distress.

The Indian markets remained closed today on account of Dr. Ambedkar Jayanti. As far as the global markets are concerned, barring Japan (down 1%), the Asian indices closed in the positive. European indices, too, are trading firm currently. As reported on Bloomberg, while crude oil prices rose by 1% to US$ 50.5 a barrel, gold prices also rose by 1% to US$ 899 an ounce.

04:56  Today's investing mantra
"If past history was all there was to the game, the richest people would be librarians." - Warren Buffett
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2 Responses to "Shrinking capital is hurting India"

Achyutha H

Apr 15, 2009

If some super natural force can make the money in Swiss banks to come back to India, the shrinking capital hurting India would not be there. Sir, do you have any method, other than supernatural power force, to get back the Swiss bank money belonging to India?


Johnson Mathew

Apr 14, 2009

Dear Sir, Thank you very much for your usual response on issues. It would be benefitted if you put a review about the reports of Amit Goel appeared in Valuenotes. Below is the link to read his report. Appreciate your doing the needful. Impending Economic Collapse Of 2009 & Beyond 3Feb08.asp?ArtCd=142275&Cat=T&Id=2 Thanking you, Johnson Mathew

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