Let them go bankrupt - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Let them go bankrupt 

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In this issue:
» Citi on its way out
» Welch will like to see GM go bankrupt
» Infosys will continue to hire new employees
» Maharashtra's bleak power scenario
» ...and more!

Now see the mightiest fall. If reports are to be believed, Citigroup - once the largest and mightiest bank in the world - is facing extinction. The ongoing credit crisis has continued to hammer the bank's stock, which fell by as much as 26% yesterday and is now 90% lower than its all time high hit in December 2006. The stock has seen a 66% decline in this month alone.

However the bank is trying its best to soothe nerves. Its management has reiterated that the bank is not in critical condition. "We have a very strong capital and liquidity position and a unique global franchise. We are focused on executing our strategy, including our targeted expense and legacy asset reductions, and we believe the benefits will be seen over time," said a statement released by the bank yesterday.

Citigroup reported four straight quarterly losses totaling US$ 20 bn due to which it raised about US$ 75 bn by selling assets and equity stakes. This includes the cash infusion of US$ 25 bn from the US Treasury. Of course, in the aftermath of the Lehman demise, nobody wants the scenario that unfolded to be repeated all over again. Especially when one of the world's largest financial conglomerate is at stake.

Ambiguity about the extent of damage and losses in the bank's derivatives portfolio and the severity of the domestic consumption downturn is what seems to have spooked Citigroup.

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"Any fool can make things bigger, more complex, and more violent. It takes a touch of genius - and a lot of courage - to move in the opposite direction," said Albert Einstein. India's largest mortgage financing institution HDFC has proven this to the core.

Even when things were at their best, the institution chose to be careful. It lent only for small houses, to salaried credit worthy customers, and only up to 80% of the value of the property. Thanks to its vigilance, the institution is still standing with its head held high, when most other mortgage institutions are on their knees. HDFC's non-performing assets are merely 1% of its loans book and it has little to worry going forward as well, since most of it is well provided for.

Ratio of household credit to personal disposable income (2007)
Source: National Housing Bank, India

"Let them go bankrupt", says the king of restructuring, the former Chairman and CEO of General Electric, Jack Welch. He is a person who many believe to be one of the best CEOs of all time and the one to have been at the helm of many a restructuring exercise himself.

Welch is of the opinion that the US auto industry should not be bailed out. While responding to a query in his regular column in a leading international business magazine, he has suggested that a bailout would only put the companies on a 'life support system', whereas a complete overhaul is the need of the hour. He further opined that these companies have been chipping away incrementally at massive legacy costs and hence, a 'bankruptcy restructuring' where the government could take the role of a financier, could pave the way for a meaningful structural change through the renegotiation with all the stakeholders.

As far as the impact of the current impasse in the US auto market on Indian auto ancillary players is concerned, it goes without saying that those companies that derive a major portion of their revenues from the US 'Big 3' will no doubt be the most vulnerable currently. However, companies that have a diverse set of clients might also face pain in the short term on account of the slowdown in the global auto industry but given the structural nature of the cost pressures, a case for outsourcing will only become stronger in the long run.

If Henry Paulson's words are to be believed, the financial crisis plaguing the world currently is a 'once or twice in a 100 years' event. So Mr. Paulson, do we consider this statement as another from your pack of 'lies' and 'misunderstood realities'? Readers would do well to note that he had recently urged his countrymen to remain confident in the 'soundness and resilience of the American financial system' and that his fellow policymakers were 'on top of the turbulent situation'.

Failure of US automakers' rescue plan led to panic across US stocks yesterday, as the S&P 500 Index closed around 6.7% down, at its lowest point since April 1997. The Dow and Nasdaq closed at their lowest levels since March 2003. Asian markets, while mirroring the US in the morning, closed the day with modest gains.

Stocks in India closed strongly in the positive. The BSE-Sensex closed over 500 points up, led by gains in stocks from the oil & gas and power sectors. Realty was off the radar yet again as the BSE-Realty Index dipped by 2%. The index is in fact 88% down since touching its all time high in January 2008.

Gold is currently trading at US$ 758 an ounce, up by US$ 14 over yesterday's close. After declining from its all time high of US$ 1,030 hit in March, the precious metal has lost considerable ground but has managed to hold on from falling further over the past one month. This is unlike the equity markets that have faced extreme turmoil during this period.

The 8% decline in crude prices yesterday (to US$ 49.7 per barrel) must have upset the already anxious commodity analysts. But not India's premier oil producer - ONGC. It believes that oil prices will rebound to more than US$ 100 per barrel in the long run, thus justifying its US$ 2.1 bn bid for Imperial Energy. The World Energy Outlook report recently published by the International Energy Agency tends to support ONGC's stand.

In the long run, we believe the demand for crude oil is set to rise. Most of the additional demand will be met by the newer deep-sea oil fields. The long term price of crude oil will be set by the cost of production of the additional (marginal) unit of oil. That figure is estimated to be between US$ 60 to US$ 90 per barrel. We also believe input costs such as rig rates will ease from their highs last year and technological breakthroughs will help further reign in production costs. Hence the figure should be in the lower half of the band. Our view of crude price in the long term is US$ 60 to US$ 75 per barrel.

Guess whose words are these - "What we want for this ship is only $25 million because we always charge according to the quality of the ship and the value of the product." A ship-broker? Or a shipping company looking to expand its fleet? No! These words come from a member of the gang of pirates that has hijacked an oil-laden Saudi tanker off the East African coast. How professional can piracy get?

BNP Paribas SA, Europe's third-biggest bank, is reportedly cutting bonuses by more than 70% at its corporate and investment bank after profit plunged by 73% in the first nine months of this year. This announcement comes after its peers like Barclays and Goldman Sachs have already announced slashing bonuses to counter the evaporating profits. What a difference a year can make!

Bloomberg has reported that financial job losses may double to 350,000 worldwide by the middle of 2009. That is around 20% of the global workforce at financial companies before the credit crisis began.

Infosys will continue to hire new employees despite the expected slowdown in its business in the short to medium term. The company's MD and CEO, S. Gopalakrishnan says the following in an interview with The Economic Times - "The US bailout of AIG, the Lehman bankruptcy and related developments have had an overall negative impact and this will be prolonged before we see any recovery. In a recent informal survey among our customers, we found there will be an increase in allocation for offshore work in some cases. We are hiring and will do so more, both onsite and offshore. We believe that due to the skills available, India will be a preferred offshore location."

"Maharashtra has coal stock for only one day," reports The Times of India. A state energy official has indicated that power plants are fighting for survival on a daily basis. This is despite the Central Electricity Authority's norm that power plants should have coal stock to meet at least 14 days' needs. Thermal plants (that run on coal) form around 54% of the state's total power generation capacity. The state energy minister has indicated that while the state is facing a peak shortage of 6,000 MW, the situation is likely to improve in the next 2-3 years. But didn't we hear the same 2-3 years back as well?

It is time Mumbaikars, who have prided on 24-hour power supply, get ready for some blackouts. In the meanwhile, you can implement some power saving tips suggested here.

To our note on Indian banks in yesterday's letter, a reader writes - "Loans in India have less risk of default if correctly approached. Culturally in India, the debt of father is paid off by the son and so on. In other words, even without collateral people had the tradition of paying off their debts without need for recovery agents. At the same time, lenders used to understand the borrower, their requirements and other aspects more. This crude risk management ensured that loans were available when there was need, they were flexible and repaid whenever possible and so on. The purpose of banks is to provide loans. If all loans are considered a liability and a bank rated negative just because it gives more loans, then the system will collapse."

04:09  Today's investing mantra
"Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they're going to be higher or lower in two to three years, you might as well flip a coin to decide." - Peter Lynch
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