Realty barons demand unbelievable bailout

Dec 17, 2008

In this issue:
» Real estate barons' absurd demand
» It's back to square one for Indian politics
» US Fed sets a new record
» GE's initiative
» ...and more!

Although they may not comprehend the market environment correctly, Indian real estate majors are comprehending one thing to perfection, the US Fed's attempt at bailing out the troubled mortgage securities industry. What else could explain their similar demand to the Indian government? As per a leading daily, some real-estate companies are planning to ask the Government to buy out their unsold flats at current market prices and sell these at a later date. This suggestion was apparently put forth by one of the Delhi headquartered and listed real-estate companies as one of the many ideas to be hard sold at the Planning Commission tomorrow. What this essentially means is that these real estate players now want to be bailed out by the Indian tax payer's money. It certainly cannot get more ludicrous than this. We wonder what made them assume that the government would bow to the idea of acquiring assets, whose values could easily fall further.

Enough is enough! The demand should indeed be met by a strong rebuttal with the government asking these companies to set their house in order. Furthermore, unlike mortgage based securities, flats can remain illiquid for many years at a stretch, resulting in capital blockage. Letting few of the companies incur losses or even fail could lead to better sense prevailing the next time around. However, not all suggestions by these companies turned out to be unreasonable. Entering into JV with states, which can provide land as equity and higher tax incentives for home buyers were some of the better ideas that were doing the rounds.

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If you thought the Indian real estate sector is in bad shape, wait until you learn the fate of its US counterpart. As per reports, housing starts in the US for the month of November have come in a whopping 47% lower than same month last year, its worst ever performance since 1959, when the data was compiled for the first time ever. For the uninitiated, a housing start means the start of construction of a new residential project and the total housing starts data is considered to be a very important economic indicator in the US. A weak data transforms into lower consumer spending on everything ranging from cars to consumer durables, which in turn means lower overall economic growth. Thus, if the housing start is any indication, things continue to look bad on the US economic growth front.

Proving that their rare show of solidarity in the aftermath of the Mumbai terror attacks was just that, India's two major national parties are back to doing what they do best, pulling each other down. The bone of contention this time around is the new anti-terror law that was tabled in the parliament yesterday and some provisions made public. While the opposition party has welcomed certain provisions like the setting up of a National Investigation Agency, it wants some provisions to be changed or made stringent so that the law becomes more effective. The ruling party however will have nothing of the sort, arguing that introduction of more stringent provisions could also lead to the abuse of the law. We are of the opinion that while genuine differences are indeed welcome and should be debated forcefully, what has also vitiated the environment is the unwillingness of both the parties to let the other walk away with the sole credit of the creation of the law. It's time indeed that we moved beyond such petty politics.

Talking of politics, the vibes coming out of the Ministry of Finance are not very reassuring either. While the country's Prime Minister is supposed to be at the helm of affairs, thanks to the recent reshuffle, he is nowhere to be heard in the media. It is either the head of planning commission who has been giving out the sound bytes or the erstwhile FM, Mr. Chidambaram. Is this yet another extension of Mr. Singh's normal practice of working behind the scenes or there is more to it than meets the eye? We hope for the former because there are several unfinished agendas left behind by the former FM. Better still, how about a full time FM? That move will certainly be welcomed.

Since the bailout funds have not been sufficient to revive the US economy and prevent it from succumbing to another spasm of economic depression, the country's central bank has resolved to pump prime the economy. It is willing to do so even at the cost of flushing cheap dollars which could stoke inflation at a later stage. The Federal Reserve has cut its key overnight interest rate to a range of between 0% and 0.25%, and is prepared to sustain the unprecedented low levels for some time to come.

Source: Federal Reserve
There are, however, concerns that even if this measure fails to deliver the desired impact, the Fed will have very few tools left to resort to for stimulating the economy. Although the central bank has already spoken of measures like purchases of long-term US Treasury notes, given the country's pitiable leverage position, it seems a risky proposition. In explaining the reason behind the rate cut, the Fed has stated that the US economy, which has officially been in a recession for a year, was in danger of getting weaker, and that the risk of inflation had decreased 'appreciably'. Infact, with the CPI (consumer price index) falling by 1.7% YoY in November, economists are now worried about a deflation. Other central banks, notably the Bank of Japan, have taken interest rates down to near the 0% level in the past.

How do tables turn in commodities! Until a few months back, oil consumers were literally begging the cartel of oil producers, OPEC to increase production and stablise the burgeoning crude oil prices. Now that the ground beneath oil demand and consequently oil prices have caved in, it's the turn of the oil producers to worry.

Saudi Arabia, the world's biggest producer of oil, has called for an output cut of 2 m barrels per day. Important OPEC members like Iran and Venezuela are also in favour of this latest cut. The cartel wants non-OPEC members like Russia to also reduce production. It may be noted that this proposal is in addition to a cut of 2 m barrels per day that OPEC had announced earlier. OPEC members have already implemented a cut of 1.7 m barrels per day.

The once revered investment bank Goldman Sachs posted its first loss (US$ 2.1 bn in the fourth quarter) as a public traded company. Significant losses occurred in company's special situations group, which invests in everything from bankrupt nursing homes to golf courses in Japan, as the value of those assets had to be marked at much lower prices. Goldman shares have now lost 69% of their value in the year so far. A direct fallout of this tough financial landscape has been the top executives foregoing their bonuses and the company planning to cut 10% of its workforce. Interestingly, after reporting this loss, the company's shares rose 10%! This was because the results were better than the worst of the investors' expectations.

There was some light at the end of the tunnel. The company's Tier 1 capital ratio, a key measure of a bank's ability to absorb losses, was 15.6% at the end of the quarter, as compared to 11.6% in the previous quarter. Besides this, selling US$ 5.75 bn in equity shares, an additional US$ 5 bn in preferred shares to Warren Buffett's Berkshire Hathaway and an injection of US$ 10 bn as part of the Government's bailout plan further shored up capital. Just a year ago, even when the credit crisis had already started unfolding, given the aura surrounding Goldman, it was felt that the bank would emerge relatively unscathed from the subprime mess. But that was not to be. Goldman reporting a loss means that the financial turmoil has left no stone unturned in entangling everybody in its web.

General Electric (GE), one of the largest companies in the world, has long been known for the consistency with which it always either met or exceeded its quarterly earnings targets. But yesterday, the company decided to drop the practice of giving out specific quarterly earnings guidance.

This comes on the back of the embarrassment the conglomerate had to face after falling short of its guidance in the first and third quarters of 2008, which contributed to erosion of the company's credibility and to a steep slide in its stock price. GE CEO Jeff Immelt described this by saying "We had a difficult communication year, I wouldn't sugarcoat it." We hope other companies are listening.

In an announcement made a few hours back, Satyam, India's fourth largest software services company has called off its intentions of investing in two promoter group companies dealing in infrastructure projects. This is seemingly on the back of severe criticism that the management faced after it announced this move yesterday.

The 55% decline the company's ADR (American Depository receipts, or shares listed in the US) yesterday must also have led to this change in management's intentions of making a deal that would have been detrimental to you, the minority investor in Satyam.

As a matter of fact, the company yesterday announced its 'diworseification' into infrastructure business. The management termed it a good move at a time when the software services business is facing slowdown.

What is indeed more shocking is that Satyam planned to spend US$ 1.6 bn to buy stakes in two promoter group companies - Maytas Infra and Maytas Properties. Simply put, the cash on Satyam's balance sheet, a part of which is owned by you, would have been shifted to the promoter of Maytas, which is the same promoter family. Maytas is in fact owned and managed by the son of Mr. Ramalinga Raju, the Chairman of Satyam who himself has a very small (8.6%) stake in the company.

We believe that by entering into this deal without the approval from other shareholders in the first place, Satyam brought tremendous insult to corporate governance practices that India Inc. otherwise boasts of. There is now a feeling of disgrace on the practices that the management adopted to transfer your money to its family and that too without needing your approval. A better use of excess cash on the balance sheet could probably have been by way of higher dividends, or share buyback.

If the today's share price erosion to the tune of more than 30% is any indication, going back on these detrimental intentions has not resulted into a face saving exercising for the company. Although it might serve as a brute reminder to other companies that were harboring such notions.

And unfortunately, Satyam is not the lone player with such intentions. We earlier talked about how minority investors of Reliance Infrastructure (erstwhile Reliance Energy) were duped by the company's promoter who transferred the company's power assets to another group company (Reliance Power) that came out with a mega IPO earlier this year.

In the meanwhile, barring the Indian benchmark, most of the other major Asian markets edged higher for the day. Investor fatigue seemed to have finally set on the BSE-Sensex as heavy profit booking, especially towards the closing hours saw the index lose as much as 2.7% during today's trading session. Weakness is also being observed across European markets currently. As far as the US markets are concerned, rate cuts by the Fed that bought interest rates to record low levels buoyed investor sentiments resulting into a broad based rally. Crude oil also edged higher, its first upmove in four days, as OPEC got ready to implement its biggest production cut to date.

Today's investing mantra
"When ten people would rather talk to a dentist about plaque than to the manager of an equity mutual fund about stocks, it's likely that the market is about to turn up. When the neighbours tell me what to buy and then I wish I had taken their advice, it's a sure sign that the market has reached a top and is due for a tumble" - Peter Lynch

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