Index!!

Have you wondered why inspite of the index performing so well, your portfolio of stocks has never done as good as it should have been?

While the answer is quite obvious, the question largely remains whether it can be addressed. So, what was the obvious part! Just take a look at the weights of different stocks in the Nifty and the Sensex. In the top 10% of the weights - ONGC, Reliance, Bharti and TCS dominate the Nifty and Infosys, Reliance and ICICI Bank dominate the Sensex. Barring Reliance, we saw some phenominal returns in the rest of the stocks. Add the next 10%, and with just 6 stocks in the Sensex and 10 Stocks in the Nifty, you have covered 50% of the index. You do not have to invest in the rest 80% of the portfolio!! to replicate half the index.


Next is to look at the performance of these stocks. I have taken a period from 24 July to December 8, 2006. This is when we started seeing the amazing rally in the Index. The stocks that has contributed has been none other that the ones that represent just 20% of the index.The rest 80% of the companies just gave a return of approximately 16%. So the question arises as to whether having such a skewed sensex or nifty actually makes sense in the first place.If one has to compare his portfolio, this is surely not the best benchmark. I just have to add these stocks in my portfolio and make merry and if I do not then there it is end of the road for any fund manager. It is for this reason we see a similar portfolio. No fund manager wants to be left out from this race of out-performing the index.


I tried to build another Index - a Price Based Index as followed in NYSE. Simple to calculate but has certain deficiencies. The stock with the highest price will tend to play heavily on the movement of the index. However, it is good our index does not follow that method as the returns would have exceeded 40% (under certain assumptions). Well, the weighted price does look a lot better that this method.However, if one follows a value line price index of an equal amount of investment in every stock in the portfolio, the return falls substantially to 23%. This looks a lot better than 35% that we saw earlier.

But is this what we need to expect from an index? I firmly believe that this should not be so. With more and more money coming into the country, the fight will always be with this set of stocks which is going to drive the price even further leaving fundamentals out of the window. What I expect of an index would be to represent the overall movement of most stocks in the market. What do we do then? I believe the focus should start moving from BSE 50 or Nifty Fifty to a probably broader index. A BSE 100 or BSE 200 or Nifty Junior should be an ideal one to start with. As we see more liquidity and transparency in the other set of companies, we can start having a BSE 500 or Nifty 500 as an ideal benchmark. Surprisingly in fall that has happened over the past few days, my portfolio was rather safe than the way the index fell. Now, that is not smart investing but just that my portfolio has stocks that do not represent the top half of the index. Hence, I tend to perform when the index corrects!! Now that is what is called contrarion investing.

Capital Safety Fund - Surely !!

Mutual Fund industry is a 'funny' industry. The best part is the near cartel formation in the products delivered by most of these fund houses. Not that they are not coming with the right products. It is just that most of these funds raise money on schemes that are too similar to one another and launched within a span of few months each and then forgotten forever. How many of us talk of dividend yield or fund of funds anymore? We are still comfortable with Reliance Growth, Franklin India Prima etc etc, the ones that have withstood time and have held themselves high!

Capital 'Safety' looks to be the new buzzword in Mutual Funds. Interestingly I looked at the offers coming from one of the Mutual Funds. Below is one of the schemes that is currently in offer. The scheme allows investor an option to invest in a 3 year or a 5 year scheme. I have just taken the 3 year for discussion. The investment in equity is a maximum of 20%. I have taken a conservative estimate on the debt side at 7%. At a minimum exposure in the debt side at 80%, the profit earned in the form of interest for the investor is Rs. 18000 or it covers most of the equity exposure that the investor is taking on the equity side of a maximum of Rs. 20,000. If the investor has to lose money on the scheme, then the equity market has to lose 90% of its value or the sensex value. Whoa! that is one pessimistic view of the markets.

I do not understand having such a scheme in the first place. Even if debt funds give 12% in the three years of investment, that gives about Rs. 9600 in profits. Unless the equity markets fall about 50%, this fund will not lose money.

Even in 2001 crash of equity markets, it took 3 years for the equity markets to fall. No fund manager would be that foolish to keep his money in the equity markets. If a change happens from equity markets to debt markets, he is bound to earn more, with fall in interest rates, giving capital appreciation on his debt portfolio, and reducing his chances of losing money.

I would have liked funds that sticks its neck out and is willing to take the risk on behalf of the investor. These funds will not lose money unless he makes something drastic on both the markets that he has to lose money to his unit-holders. A serious let-down to me! I guess SEBI is not willing to experiment as these are fund houses with awesome track records.

Under Pressure - Movie Theatres

Last time I was in a theatre, I was impressed by the infrastructure or rather the movie experience trying to be offered by FAME Adlabs. While there is much to be desired in-terms of service levels as I found it difficult to get my choice of food to take it inside the show yet I was happy considering that it was close to a private show with no one in the theatre except my gang of friends!

I am currently in Indore and it was really difficult to watch a movie as they were hardly any good theatres to talk of. Well enter the consumer age and things have rapidly changed over the past year. Three big multiplexes has reached this place. FAME Adlabs, PVR Cinemas and Inox. With an average of 4-6 screens, these corporate theater companies can house close to 1200 people at any given point in time.

Given the nature of this business, where people do not want to watch movies in theatres twice or thrice as it was earlier, most of these theatres need to reach to the audience really fast. Enter the idea of more than the standard number of shows per day with odd hour shows. Even if this were not enough, multiple screens are being used to show the same movie. Something that was close to a taboo in earlier days.

A good friend of mine was looking at the availability of tickets for DON, a new movie of Shah Rukh Khan in Indore. The results that came out was astonishing. I have attached two clippets on the same below from two of the four important theaters in Indore that follow a similar business model. The number of shows/day that was shown by these theatres in the next few days exceed 30! At an average 250 seats/screen, this translates to 7500 a day and for a week this will be 90000. At a 85% utilization rate and a cost of Rs. 125/ ticket, Indore citizens are going to spend a crore on movie watching this week for DON ! Phew that is a lot for a movie. What are the plans for the second and third week or the next month? Who is there to watch this movie in such a big theater? If I were to add the cost of the eatables, parking for this movie, another Rs. 100-125 is going to go off most of them. Movies are getting expensive!


Movies has taken a new turn today. It is no more the number of days that makes a difference to the director. No more do you see movies harping on running for 100 days, 200 days etc. It is how much money do you make during the first week, how much did you lose over the previous week, marginal loss in ticket sales!

It is important that we look at new-age theatres in a new light because the business model for most of these companies has changed.

• Most of them are looking at first week sales quite closely. Quite evident from the number of shows shown.
• Movies are getting extremely short-lived. The theater companies can be blamed for this. In their primary interest of capturing most of the movie-goers to their screens, they are showing more shows leading to lesser number of days for a movie. For people like me who like watching after the initial euphoria dies down, I end up missing most of them as they are never there on screens at a later date.
• New initiatives like SMS Booking and Internet booking makes sense to most of us. While I do not know the risks faced by these companies, I see this model making some change as there is no need to stand in a line, the ticket is confirmed and no anxiety is associated with getting tickets.
• Companies are also looking at the food counter closely. I know Satyam in Chennai did outsource this section thus making it profitable for them. Today, we tend to take something during the first section of the movie too rather than having something during and after intermission.
  
• Pricing has changed for the tickets. They are getting extremely expensive. The reason primarily arises from the huge infrastructure and maintenance costs for these theatres.
  
• With most of them running empty during the week and the non-availability of good movies at all times, good movies is getting expensive and so does huge variation in movies during the weekends and weekdays.

Understanding the Industry for any valuation

• It is nice to see the business model changing, it is even better to see an active corporatisation in theater distribution. Corporatisation is making distribution system. Earlier we had theater owners with less than 3-4 screens. Now companies like Inox, PVR Cinemas and Adlabs are consolidating the screens around the country. Directors can start actively looking at negotiating with the screen owners rather than the old model of having the middlemen. The old system can't die this early with the penetration still low in the Tier 2-Tier 3 cities but there is a step towards this direction. Also, this increases the bargaining power for these companies for better revenue sharing.
  
• Business revenues has changed drastically. What was earlier a function of days with a standard set of shows for a movie has now changed to more than 5 shows a day/screen to multiple screens for the same movie. This makes modelling more difficult as a bad movie can just see audience vanish creating huge unutilized seat for a screen and this will lead to huge unrecoverable variable costs.
  
• Also, weekdays and weekend pricing will start seeing some changes. With unutilizated capacity, price cutting will get into the place between theatres making it even more difficult. As most of these companies are still expanding, revenues from existing theaters has still not stabilized.
  
• This business is getting a bit murkier for an investor because there is hardly much to distinguish between the theatres. I am yet to see loyalty to any of these theaters by the audience.
  
• Business revenues are coming not only from ticket sales but also from the food counter. On a average every customer spends on a coke and a popcorn for two people. This is a revenue of close to Rs. 50 and a margin of around 60%. This is a strong stream and one that should not be overlooked.
  

Valuation of such business is extremely difficult and unless we see some clarity, of which 'time' is the best master, any approach would lead to extremely diverse pricing models for these companies. Once we see most of these companies stop expanding, one can start valuing these companies with better clarity!

Glenmark - PR activities

Hi,
This is something interesting that I am seeing as a good PR initiative for a company that is looking to come out of the woods when in trouble. There was a recent news on the company being alleged with anti-asthmatic drug that is choking people. The clarification of the drug effects is available at the company website or you can click on the link below

Glenmark Investor Relations

This was in the NSE website yesterday in corporate communication:

The shares of this company has fallen by more than 15% with this news. The stock movement is available at knowcharts.blogspot.com

The director has now come now to buy the shares of his company to possibly indicate that he is happy with the performance of the drug and is willing to increase stake in his own stock. While this idea is sincerely appreciable I would have preferred if they increased their purchases some more. This purchase by both the directors is less than 0.05% of their existing portfolio, Rs. 4.5 lakhs each. The directors have also taken sometime to respond with this initiative. But yet, I like this initiative better than investing heavily in an advertising campaign which is expensive and may result in similar results on a cost-effectiveness basis.

His indian market would not affected much as the patients hardly ever look at the manufacturer of a drug and his extensive sales network will ensure that the news of their version of the 'correct information' reaches all doctors instantly, thus reducing his downside.

Overall, good idea!!

DCB - Aggressively Priced

Well, an issue that throws more surprises than ever!

A company that has

• a criminal case pending on fraudulent deposits
• an increasing losses in its income statement and negative cash flows for the past three years
• huge write offs because of its poor portfolio
• to now give existing shareholders fresh equity at a lower cost, a discount of 63% over its previous issue which happened in February this year
• been bordering on Capital Adequacy Ratio (CAR) at 9% and is compulsory lending lower amounts to maintain this margin
• currently wants to create a niche in banking by being in selected cities only!! What is the use of it is beyond comprehension!

Issue Details

No of share : 7.15 crore shares
Issue Size : 157.3 crores on the lower side and 185.9 crores on the higher side.
Date of the IPO : September 29, 2006 - October 6, 2006
Price : Rs. 22- 26
Post Equity Issue Dilution : 48.43% will be the free float for this bank
Lead Runners : JM Morgan Stanley and ENAM Financial
Net NPA Details : Currently down from 4.5% to 4.05% in three months
Gross NPA : around 14% of advances


Objectives of the Issue and the mission of the bank

• To raise capital for funding and meeting their Capital Adequacy Ratio
• To focus on improving low cost funds through acquisition of CASA accounts
• To grow fee based income
• Build a based call center and enhance retail presence
• Focus on a few states and build a strong sales team

Company Overview

It was setup as a new private sector bank. The company has 72 branches. Of which 26 are located in Mumbai. It has presence in Maharashtra, Gujarat and Andhra Pradesh. AKFED are its in-principal promoters and not from India. They established this bank after two consolidation in the banking history of theirs. They have a significant stake of approximately 60% which they intend to reduce it to 30% by the end of this issue. The bank is predominantly an SME bank. They focus on customers with less than 10 crores of business. They have a fairly large aggressive retail division that is contributing to their bottomline.The management is something to cheer about. It is headed by some strong people today. Mr Vijay Kelkar is in their board too. Most of them are non-executive directors.


Positives

• While the company is saddled with NPA's, since 2003 the company has done well wrt to NPA's as it has reduced to .75% net. It has burdened itself with current net NPA's at 4.05% or 78 crores.
• A professional board with immense experience of Dr. Vijay Kelkar, Anuroop Singh from ANZ etc which will help the bank in strong regulatory mechanisms.
• Setting up a call center will enhance the delivery model for the bank as it will be cheaper to solve a customers problem and creates an alternate sales channel.
• Customers are in the mid segment and the possibility of charging higher prices is probable. Hence, given the focus on low cost deposits, this can translate to higher net spreads from the current 3%.
• The bank in view of poor performance has taken amends to reduce its losses. It has reduced salary, stationary, postage charges, directors and auditors fees.
• The bank has a strong tax-shield with its accumulated losses. It has around Rs.50 of losses currently. Profits on this can be adjusted for the same. At 30% tax rate, this will give the shareholder of Rs.16 as a tax protection. Assuming this comes in the next ten years in an incremental basis there is still about Rs.6 on NPV basis.

Negatives

• The branch network of the bank is extremely weak. Of the 72 branches that the bank has 26 are located in Mumbai. 51 branches are located in three states constituting risk in raising money. Also, these three states, Maharashtra, Andhra Pradesh and Gujarat has strong network of banks.
• The banks internal controls on group exposure is at risk. One group has an exposure to 38% of its total capital!
• The gross NPA that the bank has shown does not give much information. 3 of the five sectors are growing well. I do not have much information on the chemicals, dyes and for the engineering segment. While there is much potential in this segment, however, considering the fact that one does not know the financial of these companies, it would be unfair to comment on the same.
• Foreign Investors in this bank have an exposure upto 68% before this issue.
• Cost of funds is 5.73%. SBI is currently at 4.73%. Most of the banks are at these levels.
• The focus is only building branches, focusing on key areas for business banking.
• The SME segment has a lot of focus with ICICI, HDFC and all MNCs giving a lot of importance. Nationalised banks and others were always there in this segment.

Financials of the company
The banks networth is near collapsing with around 170-200 crores erosion year after year.
The bank has really a very poor performance and unless they have their plans in place, this bank is headed for disaster. Their P/L shows increasing losses from 2003. Before this, they had an average profits mainly because of their revaluation of their assets. Their core income has been constantly reducing (30% in 6 years) and income from investments has reduced by 50% in the same time. Most of the other income barring lease rentals has remained or marginally increased in the past 6 years. Its interest outgo has also seen a corresponding decrease. But the employee cost and lease rentals has shot up the roof by more than 50%-60% in the same time.
There is an increase in the other expenses to the tune of 200 crores on a year to year basis with little explanation.


Capital Structure
This is probably the first time that I am seeing that the cost of the promoters capital is more than the issue price. The promoters are locking their shares for a period of one year. Also, AKFED, which has a share of 58% will have to dilute to less than 10%. There was a RBI circulation on foreign holding on a bank in India till 2009. The promoteres holding after this IPO will fall to 30%.ESOPs have been provided but its largely ineffective till the price reaches Rs. 40 and not in the next two years.


Interesting Facts

• The bank has strong exposure with some select few companies. 5 industries, according to their classification has exposure of more than 30% of their funded exposure. Its top borrower has control of more than 19% of the capital. If I am to understand the banking laws, unless this is in infrastructure this just cant happen.
• The bank has a customer base of only 6 Lakhs of which 5.95 Lakhs are in the retail segment.
• There has been a sticker sent to all existing shareholders stating that the promoters will have their shares locked-in for a period of one year!
• The bank has gross NPA at 14%, no wonder it is loss making.
• The promoters company are not profit making and though it should not impact the bank, but such request for dividend declaration would be hard to resist.
• Changing auditors rarely happen in a company, but this bank has changed its auditors thrice in five years. How come?
• One can read the litigation section to have some pass-time in the entire section of the prospectus.

The pricing of this issue:

Comparing it on earnings would be unfair as the bank is loss making and only one quarter of profits is available. So I have taken the book value for comparison and have assumed the following. I have used a two stage relative valuation based on the book value for the company. The following are the key assumptions made

ROE: 14% for the future considering that it is a bank and the leverage is high
Cost of Equity at 12% (CAPM method : Risk Free at 7%, Beta: 1.1 Risk Premium : 5% will give 12.5% as cost of Equity)
Growth during the first 5 years will be 20% and the rest will be at 4%
Payout Ratio : 10% for the first five years and 40% from then onwards.
Based on the above assumptions the price to book value can be 1.02 times.

At the current bookprice of Rs.18, this will work out to Rs. 18.36, making it expensive by about 25%. However, if one adds the loss in the books and the benefits that it would derive out of it, this will translate to another Rs.6. giving a total of Rs.24 to the shareholder.


Summary:

I like the management as it is impressive. The bank may be a loss making company but they seem to be committed in improving it. The portfolio is straddled with poor assets which they seem to be determined to improve. The incremental NPA this year has been only 0.5% which is heartening to hear. I would be suspect of the profit that they are making today as they were clear on the coming IPO. The bank has a strong focus on a segment where the revenue generation is higher. Though the competition is heating up in this segment, I am still happy with the margins that can be charged. Given that the cost of borrowing is on the higher side, this is offset with a higher cost of lending. The bank has not lost on non-fee based income and has done well on that front. Given that these are non-funded incomes, the capital requirements would be lesser.

The issue has been fairly priced and if it does get subscribed to less than Rs. 22-23 it would be a good one. It is a good IPO and can be applied for the banks possible future performance.

Gayatri Projects Limited - Hands Down

IPO is back and it is a nice sight to see the number of companies rushing in to cash this opportunity before the stock market crashes. FIEM is currently running and Minar, GPL (this one), JHS and Hanung on the pipeline. So what is nice of this IPO. I saw the others and thought something on projects to be an interesting one as there could be something on infrastructure.

There are times when you wonder how some companies, that have done all the negative things can still raise money. This is one company that falls in that category.


Issue Details

No of Equity Shares : 29 Lakhs
Objective of the Issue : Videocon Aplliances and Videocon Industries are diluting their stake and there is a fresh issue of 10 Lakh shares
Employee Quota : Just 1 Lakh compared to the others that I have seen in percentage terms
Post Issue Dilution : 29% will be for public
Price : Rs. 275 -Rs. 295
Issue Size : Rs 79.75 crores to Rs. 85 crores
Dates : September 26-29, 2006
P/E : As of last years earnings it stands at 13-15 times


Overview of the Company

The company has been around for 16 years and has an experience in constucting over 600 kms of highways and 1113 kms of irrigation canals. It has a minor interest in building ports, airports, industrial works etc. It has experience in building dams (7 in total). It has a current book order of more than 1000 crores of which 40% constitute building of roads and irrigation completes the rest. Its joint ventures have a book size of Rs. 1350 crores with approximately 50% in road segment.


Objectives of the offer

The first objective of the company is to get a listing in BSE and it wants to giva an exit-option to its existing shareholders. The first part of the objective is something that is unique. This company is not in IT sector where the requirement for publicity is high. It is into key infrastructure projects and the financials, experience plays a higher degree of role than a brand name.The company is borrowing in excess of 28 crores of which 20 crores would go to fund an SPV and the rest is to retire its debt. It currently has debt in excess of 250 crores and I do not know how this small change of 8 crores will make any impact.


Understanding the Financials

• The company has close to 60% of its balance sheet in working capital. Of its current assets, 85% is locked in inventories, loans and advances and sundry debtors.
• The current D/E is close to 2.75
• Work Expenditure which contributes close to 80% of the cost has been reducing over the years, indicating some pricing power
• The company has had a strong cash flow from its operations last year. This is highly fluctuating for the company with negative CFO in 2003-04. The company has too much debt in its portfolio that is carrying with a higher cost.

Positives

• The company has recently got a working capital loan from a bank for Rs. 165 crores. As a bank has allowed this, the company's financial might be getting better with good projects on hand.
• Work Expenditure which contributes close to 80% of the cost has been reducing over the years, indicating some pricing power

Capital Structure

• Well, this issue will make the promoter richer by 62 times on the lower side. Apart from it, the company has been issuing shares to its promoters at face value. There has been no infusion of capital since 1994. However, the company has capitalized its reserves by giving bonuses to its existing shareholders. The plan for the IPO has been in place for the past year as the company gave a bonus last year.
• With this issue, Videocon will completely come out of the venture. 16% of the equity capital is held by IL&FS and 2i. This part of the equity capital is not sticky and they can sell their issue at any time of their choice.
• D/E is close to 2.75, an average running with its peers
  

Negatives

• Management is extremely poor and the details have been given on the risk section.
• Dividend policy of the company for one of its group companies is at a big doubt. The company was incurring losses from the start but the company declared dividend. I do not know from where did the money came from to declare the dividend.
• The company's debt book is simply stunning with average age of 10 years. The company does not look to be in a position to recover this money and it exceeds 100 crores.
• The company does not believe in maintaining its assets. No AMC has been taken on its assets and it has written that its assets in construction equipment etc as one of its key strengths!
• The company has given guarantees amounting to Rs.233 crores to its group companies.
• Interest Coverage Ratio is only 1.75 times, this is extremely low for a company that is heavily leveraged. Small changes in revenue can wipe out its profits.
• As its loans are secured, this can create a bottleneck in its operations. This ratio has been improving over the years, but still in a dangerous territory.
• The company is using the exit as a route to raise money too. The SPV has a cost of Rs. 20 crores and this issue is expected to give Rs. 27.5 crores for the company and the remaining money is used to retire its debt.

Risks

Management

• One of its groups companies has a criminal complaint for non-payment of a lease rental. Though it is for a small sum, it still raises some concern on the quality of management.
• Two of its companies have been suspended from trading for non-payment. The company paid the fees for re-listing last year. It looks like the company wanted to have a clean sheet before this IPO. Unfortunately, BSE is yet to give a clearance as these companies is yet to start commercial production.
• The litigation against the company is quite high at 80. Civil, Debt recovery tribunal and sales tax being the key ones. The total exposure in these cases is close to 90 crores. Group companies and the promoters have not been spared either.
• 11 of the 17 companies have negative networth.
• The company has been doing a lot of inter-firm transfers. A total of 250 crores have been reported in this section but then most of them are acceptable transactions

Interesting Facts

I do not know if this true. This security is for listing only in BSE and not in NSE. However, I got the prospectus from NSE. Videocon must not have been too happy with this venture. The investment has generated close to 16% p.a. since its investment in 1994 excluding dividends. With 16% of the capital held by FIs with no lock-in, this stock can open with some profit booking. However, the management has been so poor that I would not regret having missed this issue.The company has priced on relative earnings and the company has priced it on the lower side. However, consider the D/E of the company with its peers, it is still on the higher side and its RoNW is at best - average.


This stock is a pure exit strategy for Videocon and borrowing for the SPV. The company's financials are by no means strong. There are too many litigations indicating poor management. FIs can pull the price down at the open of this issue and as investor apart from the sector it is playing in, nothing else is close to being attractive.


Gayatri Projects - Hands down for this IPO

Research Reports - The Fun of reading it

I enjoy reading research reports. There have been instances in the past when research analysts post reviews that are opposite in nature for the same event. An example of this was with SBI when the results were posted for the third quarter. Two research agencies, extremely reputed gave exactly the same reasons, but had a final outcome that was diametrically opposite.

Here is another instance of another research company. As an amateur analyst myself, I know how difficult it is to estimate the cash flows for a company. The company in this case is OMAX Auto. There was a recent 'buy' order from this reputed research agency. I went on reading it and I found the section of financials interesting. The company had given an expectation of the following in the previous year.


Consider the same the next year in the following. The research predicted that the company would have a sales figure of Rs 662 crores while the actual sales for the company was only Rs 578 crores. This increase is only 9% when the projected rate was approximately 25%.
The reasons that were cited were as follows.

• Employee cost : This amounts to close to 5 crores
  
• Power cost : This contributes to 5% of the cost. It was about 17 crores last year and this year it is at 24 crores. Of this 10% was the natural growth of sales. Hence it was already incorporated in the financials. The increase was only 5 crores.
  
• Interest cost : This is a reason that is unacceptable as the capex plans was already given in the previous year and their model should have incorporated this high cost.
  
• The company has saved 2% of sales which amounts to 11.76 crores

If one adds all these that the company has mentioned, they should have still got the profit that they had predicted as the cost of savings from raw materials has been offset with the increased cost in salary and power. Yet, they missed the mark by a big margin. Why cheat the investor for something that the company is not able to deliver? The research report completely ignored the poor sales forecast that it did and blamed the entire game onto the management for ineffective performance. Now, this is unfair. How is the company at fault when your forecast was way off-mark.

The answer lies somewhere in an article that I read recently by Paragh Parekh. He was in our institute to give a guest lecture and I truly enjoyed the subject on "behavioral Finance" that he taught that day. However, coming to this issue, he mentioned that the research agencies have targets on the number of reports that they need to generate in a year! I was stumped to see it and now after reading this, I find it believable. I have no solutions to this issue. But then, I think the research house should

• show the research agency's previous call on this company
  
• give reasons for a downgrade for this company
• the number of times it has downgraded on the whole for all companies that it normally researches
• the frequency of such changes and the timing of such changes
  

Now, as a research agency, I can still escape by giving a reason of higher interest rates or higher risks or high beta that will be built in the CAPM to confuse the common reader. True, it can happen but atleast I do know that the company has some reasons for the change in such forecasts.

Speculation Rocks

I was surprised when I was reading this document from NSE on a derivative update. Read the section on stock futures. We simply beat the nearest exchange 'hands down'. We enjoy taking risks and especially in the futures segment and not in the options segment. 15th in stock options and 9th in index options. We rank 1st in stock futures and 3rd in index futures.

Index options where it is probably easier to speculate as the only risk that one takes is a systemic risk. NSE stands 9th in this section. We are probably more risk takers than the rest of the world or probably too much 'inside information' at play. If one reads the entire document, one sees that the retail participation is extremely high (more than 50%).

God! This is scary

DFIs Shrinking Spreads or Rising NPAs

Typewriters saw its end with the introduction of computers and so did the bicycles after motor vehicles. Is it time to see the slow death of financial mammoths called Development Financial Institutions (DFIs) and the rise of capital market and banks to replace them?

Post World War II, several countries nearly depleted with capital resources, struggling to develop their financial and labour capital, infrastructure. Banks with its limited expertise charged high premium for projects with large gestation periods could never meet the demands of these projects. This gave birth to special institutions called Development Financial Institutions (DFI) to act as a ‘gap-filler’ with the following mandate

• Providing medium and long-term assistance to business undertakings in the form of loans, underwriting and investment and fill the gap created by banks who confined to short term financing and selective investing and a poorly developed financial market
• Assisting new project ideas, undertaking feasibility studies, providing technical, financial and managerial assistance for the implementation of projects
  

Different countries have followed different objectives such as financing, promotion, building technical expertise for the functioning of DFI. Countries like Germany, Korea and Japan have transformed or devolved their DFIs after having attained the objective and with the better access to capital markets. India today is straddled with DFI under huge NPAs. This paper aims to establish that it is not only shrinking spreads and NPAs but more than that and the future of
DFI.

Looking back into its past

RBI was entrusted with the responsibility of building the success story of the DFI in our country. The Industrial Finance Corporation (IFCI) was the first special financial institution established in 1948 by an Act of the Parliament. This was followed with establishing State Financial Corporations (SFC) in 1951; currently there are 18 SFCs, ICICI in 1955, LIC in 1956, Agricultural Refinance Corporation (ARC), UTI and IDBI in 1964, RECL and HUDCO in 1969-70, 70, Industrial Reconstruction Corporation of India Ltd. (precursor of IIBI Ltd.) in 1971 and GIC in 1972. There are currently 52 institutions in this category.


Financial Health

The classification to understand the financial health for the DFI has been done in two broad areas: FIs are regulated and supervised by RBI and FIs that are not under the direct purview of the RBI. IFCI and IIBI which have been operating as providers of direct assistance are all in poor financial health while refinancing institutions such as NABARD, SIDBI, NHB, EXIM Bank, IDFC have done really well in maintaining strong financials year on year.

The most inefficient among DFIs are State established SFCs. In states like Orissa, Bihar, TN, W Bengal, Maharashtra, Haryana and Gujarat, these institutions have eroded their entire networth and have neither been able to raise fresh funds nor service their debt requirements. The causes for the same have been explained in detail below.


The causes of decline in the 90s

IDBI, ICICI and IFCI formed the triumvirate on which the country's project finance edifice rested. Of these, ICICI rapidly changed to face the challenges of the new competition while IDBI was forced to change when faced with huge losses. However, IFCI’s future is still undecided. A look into what caused their decline in the 90s will show the following reasons

Evolution of the Indian Banking System
The Indian Banking system is today well diversified with public, private and foreign banks competing for similar businesses. The expertise they have acquired to manage risks in extending finance to long term projects has reduced the need of DFI. The credit given by banks and DFIs as a percentage of GDP has increased from 3.9% in 1971-1992 to 4.3% in 1992-2000 .

Competition – A driving force for effective performance
UTI mutual fund today faces competition from more than 30 other mutual fund companies. LIC competes with Prudential ICICI, Tata AIG, Bajaj Allianz etc. In the long term financing, there has hardly been competition. Being monoliths, IFCI, IIBI and erstwhile IDBI had poor loan appraisal mechanisms, ineffective regulation leading to mismanagement.

Riding the Low Cost Advantage of banks
Banks enjoy the natural advantage of having easy access to lost cost funds, a primary contention for DFIs. With RBI removing the LTO option for raising funds, DFIs were forced to raise funds from the market. DFIs are forced to lend to projects at rates that could make the loan unfeasible for them to service its cost of borrowing. The average cost of borrowing for SBI in 1997 was 6.3%, whereas the cost of borrowing for IFCI was above 10%. While the cost has reduced to 4.5% for the current year, it still remains the same for IFCI.

Poor asset distribution leading to NPA’s
DFI had the following issues: High sector exposure , cyclical nature of business, limited checks with group and company, long term loans led to disproportionate asset distribution. SFCs, on the other hand had been extending term-loans to SSIs. They were burdened with high operational cost, poor assessing skills, and were extremely bureaucratic. It is estimated that they would require around 3600 crores of capital infusion to clean their balance sheet.

Indiscriminate disbursement of loans
IDBI disbursement was growing at a rate of 14 per cent, ICICI at 27%, and IFCI at 20% since 1992-93 when the industrial growth in the country has stagnated around 3.5 per cent to 4 per cent indicating poor appraisal mechanisms.

Development of the Indian Capital market
One of the primary objectives of DFI was to act as a ‘gap-filler’ in the capital market and help lending medium to long term loans. The resource mobilized in the capital market in the form of debt and equity as a percentage of GDP has increased from 0.6% in 1971-1992 to 1.7% in 1992-2000 .

Others
The Public Undertakings Committee found SFCs

• Not following stipulated guidelines while sanctioning loans
• Lack of constant monitoring leading to misuse of funds
• Poor collection mechanisms
• Corruption and heavy sectoral exposure
• Political Interference

International Outlook on DFI

Internationally, DFIs have had significant changes in their functioning over a period of time. There have been two distinct models followed:

• Anglo American: Market based which competed for resources
• Continental Europe and South East Asian Economies: Financial savings was diverted to these FIs for investment.

Of the four DFIs in Japan, one was restructured and the objectives realigned to meet social challenges and the rest went bankrupt and sold to private banks. Korea’s DFI has constant shifted to focus the requirements of its government. Singapore’s Development Bank of Singapore (DBS) now functions as a full fledged commercial bank.

Recommendations on the future of DFI

Given the importance of DFIs role in as a ‘gap-filler’, the following are the key recommendations and shall be discussed on the basis of classification

Refinancing Institutions
NHB, SIDBI and NABARD can continue their status as a DFI till the existence of DFIs. However, they need to act as regulators for the section they are re-financing.

Sector Specific/Specialized Institutions
No changes are required to specialized institutions such as LIC, UTI, and EXIM bank etc. as they are competitive players and strong regulators. TFCI, National Co-operative Development Corporation and National Dairy Development Board should be converted to a NBFC and will be easier as they are profitable too .

Medium to Long Term Lending Institutions

Barring IDFC, IFCI, IDFC have shown heavy losses. The following are the options that are available for a turn-around.

Create an SPV or transfer them to IFCIs ARC Having completed this, the DFIs can be converted to a bank or an NBFC for the following reasons

• DFIs need to be given access to markets to raise low cost loans
• DFIs can cause systemic failures by not servicing their debt to insurance companies, pension funds. Hence, active regulation and portfolio monitoring will be needed from RBI.
  
• By deepening our debt market the dependency for DFIs will reduce

Devolving the system of DFI:

Converting them to banks or partnering with an existing bank
The success of ICICI’s conversion to bank and the recent make-over of IDBI to a bank but with a DFI status, gives a strong case for converting the existing DFIs to a bank. However, converting to a bank is not fraught without risks.

Partnering or Converting to a bank: A discussion
Establishing a bank will require

• Replicating an existing bank with no assurance of access to low cost deposits
• Longer Time requirement
• Heavy investment in technology
• Statutory requirements to be met with your current portfolio

Given these conditions, it is advisable for institutions such as IFCI or IIBI to merge itself to another bank than converting to a bank . RBI should allow these banks to raise long term loans through issue of ‘Development Bonds’ to fund the projects the DFIs have expertise in.

Converting into an NBFC
It would be ideal to see most of these institutions as NBFCs than DFIs as they can be regulated by RBI.

• Regulations can be relaxed on CRAR for profit making NBFCs of DFI nature .
• Active securitization of loans to help deepen the market.
• Compulsory investment from pension funds, postal savings in the lines of Korea.
• Diversification into wholesale banking including term finance, working capital finance, cash management services, equity to projects. Others include exposure to sector, group and individual companies.
  

State Financial Institutions - A stronger dose

In spite of commendable performance from Delhi SFC, APSFC (NPA’s currently at 16%) significant restructuring is imperative. The following are some of the key recommendations for SFCs.

Short Term Solution
Consolidate the bad portfolios of all SFCs and transfer to an SPV that works like in IFCI

• IDBI and SIDBI can restructure their loan exposure or convert them to equity. There would be a requirement of infusing close to 3600 crores from most states.
• An effective VRS , requiring close to 230 crores will be needed to reduce employee overheads that contribute 15-50% to less than 1-3% .
• Appoint a professional non-executive chairman with banking and finance experience and boards with experienced professionals, implement managementinformation system, adopt standard accounting practices and the EDIFAR should be updated with the defaulters list.
• Cross-sell other products and increase fee businesses.
• Prudent norms on exposure limits, in lines of banks, to specific industries must be established. Diversification of portfolio will ensure reductionof risk during adverse times.
  

Long Term solution

Banks have gained expertise in analyzing risk and have slowly started to increase their presence with in all segments including micro-finance . Given this current scenario SFCs have outlived their utility and should be phased out within a definite time frame. However, changing to a bank in the long run would be difficult. The opportunity should be constantly monitored and converted to a bank or an NBFC that can absorb the SFCs without affecting its statutory requirements.

Conclusion

DFIs had been the cutting edge of the Indian financial system and enjoyed high credibility as a more than being a ‘gap-filler’ .Recent losses with IFCI, IIBI, SFCs has changed the scenario. However, barring these few DFIs, others such as NABARD, SIDBI, NHB, and IRFC have done exceedingly well. However, the need has come to address these losses and look at the future of these institutions.

The government of India cannot escape from its obligation to bail out the sick DFIs. As long as the present legal structure makes it difficult to force delinquent borrowers to pay up, DFIs may have no option but to look up to the government. It can be argued that the current problem of NPAs of DFIs is itself partly the result of the acts of omission and commission of the government. It goes without saying that the long term remedy to the DFIs’ problem lies in the
development of the debt market. Converting them to a bank, that have gained the expertise of strong loan appraisal mechanisms, cheaper source of credit, better collection systems and active monitoring of disbursals and regulatory check would be more appropriate for the future of DFIs. However, it should be at the discretion of the DFIs. Active securitization, allowing long term development bonds, diversification, sectoral caps will further benefit by removing systemic shocks. It is much more than a combination of shrinking spreads or rising NPA’s that gets addressed.

Fines and the sham of it

Here are some interesting articles and something that I always thought was unfair. Read them at your leisure time and it has very little relevance to what I am planning to discuss today-

• Merrill Lynch
• Canara Bank
• IPO Scam

For some of us, clicking and reading is even more difficult than reading it here. I just sent the link to show that they exist and it is no fabrication from my side. Hence, I shall give a brief on most of them. Merrill Lynch was asked to justify their trades that they advertise as there was a 'big' mismatch between them and NYSE. Canara Bank was imposed with a 5 lakh fine for not maintaining the statutory requirements and the IPO scam is well known to most of us.

I shall just take the case of Canara Bank as it is easy for me to put my point across. Its fine was not maintaining the fortnightly balances on its CRR and SLR requirements as 'somehow' some balances from its branches was unnoticed by the head office. Not that it is impossible considering the number of branches it has, but then I always amazed at the power of modern technology in tracking everything, including me. Yet, it happened. Was this intentional, don't know. There was no 'show-cause' notice given to the public. If I was to look at it differently, things show a really different picture.

What if I did it intentionally. Look at Canara Bank's balance sheet. This incident happened sometime this year. The closing balance sheet deposits was close to 116000 crores. The company has to maintain CRR and SLR requirements on this-5% and 25%. The bank was fined 5 Lakhs for this. A small math calculation reveals this - Assuming that the company had invested the money in AAA rated 10 year paper instead of holding it in cash and G-Secs. So the bank should have maintained 34800 in CRR and SLR. Had the bank invested in AAA rated paper and the differential was 3%, this will boil to 2.86 crores for a day. Assuming it takes 2 months for the decision to take place and the fine to be given to RBI and as a good company invest the same in call market that is earning 5% returns. The bank shall now get approximately 7 lakhs as further interest. Have not gone scot free in this transaction. What has the company lost in this? A little bit on the brand value. Well, this is a financial transaction and will get reported mostly in business papers in a small section of a relatively irrelevant side or page where there is nothing else to fill. The bank can explain different reasons and accept that it was a mistake beyond its control. But was it?

The point was never to give a bad picture. I have been with Canara Bank and in all probability this could have just been an accidental error from their side and never intentional. However, if I were to create such a scenario in front of you, is it right? RBI should have actually estimated the profit on this transaction and levied charges proportionate to it. Yet it levied a standard fine. Is the regulator right in his decision or just plain lazy to take note of it? Look at the Merrill Lynch and the IPO scam. The profit has already been taken and the goodwill for Merrill Lynch in terms of being the best broker has already been decided. The incremental business has been created. Will the fine that the regulator imposes reverse these transactions? I do not know. If I were to be unethical, I would happily do so albeit not regularly that I kill this cash cow opportunity.

But then, I can do it, can't I.


The point to be noted is that I am using these companies as an example to explain my thoughts. This is purely a thought process.

HOV Services - Skip it

HOV Services - Exceeds Expectations?

HOV Services is a holding company and offers its services in the Finance and Accounting segment with its 6 key subsidiaries. They being in three different segments - Accounts Receivable Management, Enterprise Management Tools and Services and the third Insurance and Tax Services.

Investment Objectives

Investment for this IPO is between 81 to 97 crores depending on the pricing of the IPO, constituting to 32.3% of public shareholding.
The key objectives include planned capital expenditure (approx 25%), redeeming the units issued by its subsidiary (approx 70%), and further acquisitions

Investment Positives

The company is floated by promoters who have extremely strong background. While they are not paid any compensation for their work, they get excellent sitting fees of a lakh/month. Having read the entire prospectus, I could only find one positive aspect of investing in thi

Investment Negatives

1. The revenue stream for the company is extremely risky, with most of its revenues coming from its top 10 clients and this figure has been increasing over the past three years. The revenues are contract based hence their pricing becomes an issue everytime the contract is up for renewal.
2. The companys key revenues is from outsourcing and hence there will always be pricing pressure unless there is significant value addition
3. The company has acquired other companies without having an independent valuation. This is dangerous as the company could end up buying companies at higher prices.
4. Damages in terms of litigation exceeds 35 Lakhs.
5. It is natural for most companies to give promoters shares at substantial discount. This company is no exception. The promoters enjoyed a fresh equity investment at the face value in January 2006. Surprisingly the same is now being offered at atleast 20 times the cost of this issue.
6. The company is increasingly moving into the sphere of merely a pure BPO, whereing its clients save on cost when compared to their country. The reason is found in the sales mix of the company's 3 distinct subsidiaries. The share of it branded product division, EMTS, has reduced from 99% in 2003 to 12% in 2006.
7. Also the company is increasingly looking at business in the two segments where there will be a price war with little differentiation to offer.
8. The company has been buying out comapanies to generate its growth strategy. However, these companies have been coming at a premium now being reflected in the goodwill at which they are purchased.
9. Two of its subsidiaries are under losses.
10. The company's cash flow is a extremely volatile for similar incomes too. Given the nature of income that one would see in any other company, the same is just not true for this.

Strange ones

• The company's capital structure, as usual, remains a mystery inside an enigma. Consider this-32 transactions in the last 6 months. A lot of internal transfers between companies, promoters, promoters' floated companies. The company forms companies for a specific period and transfers the stocks back to the promoters at the end of the period. The company has largely grown inorganically. There is so much confusion on the holding companies and internal transfers that after sometime, you wonder where this is all ending. This issue is anything but pure confusion on share holding. The maze of transactions can lead to false understanding of the company's promoters.
• The company has floated options worth 5lacs to its employees creating further dilution to the capital structure.
• The issue, inspite of being on the lower side, has solved the company to exit one of its promoters, if not undertake limited work of capital expenditure.

Conclusion

1. At a networth of just over 11 crores and a book value approximately Rs. 13, the issue price is at 15 times its book value, extreme price for a stock in the BPO segment.At EPs of 5.96, the P/E works out to 33 times wheras its peers like Allsec are on the upper tens.
2. One of the primary usage of the funds is to give the existing investors an exit route more than funding the business operations that will help the company to grow further.
3. To me, the entire reading was like more of understanding who is the final owner of the company, rather than the business and the future of the company.

Such complex IPO's is worth a skip and that would be my choice.

ACE Constructions - Go on

ACE-Action Construction Equipment Limited

It is quite interesting to note that the company has changed its name thrice in the past ten years. Though most of it have been more of a regulatory requirement than merely to change it for namesake. The last time it changed, I could not reason the need to change to singular (equipements to equipment)

Moving to the most important part,

• This issue is for 50-59 crores depending on the cut-off price of the offer
• The company is issuing 25% of its capital to the public. Post this issue the promoters control on the company is expected to reduce from 87% to 65%.
• Lead runners for the issue is Karvy and they are back after a long time

Reasons for the IPO

• Setting up a new unit
• ACE is plannning to use a part of this IPO in a joint venture with Tigieffe SRL, Italy, though nothing has materialized in-terms of confirmation of the venture. The prospectus says that Rs. 6.6 crores earmarked for this. Considering the nature of the amount, this looks like it is in the final stages.
• Acquisition/Investments which is unclear
• Working capital requirements
• Brand building
• Building a corporate office

The total cost for all the above is about 78 crores and will be funded with this offer by about 50-59 crores and the rest with internal accruals and debt.


Negatives for the Company

1. The company looks to have taken a few loans with severe restrictions for the shareholder. The covenants on its loan, though is normal, looks severe on the management to take decisions on undertaking new businesses or expand its set-up using debt.
2. Sales of the company has increased by approximately CAGR 95% however the expenditure has tagged along pretty well. Margins for the company was extremely thin except for the last two years, where the company had the ability to price it higher.
3. The company has increased its balance sheet size by about 13 times in the past two years,wheras the business has increased only by about 100% annually in the same time. The company has given 25% of its balance sheet in the form of loans and advances. This loan is largely unclear.
4. The company has declared dividend last year and it was the first in the last five years.

Interesting Issues

The company's promoters are extremely clear on their allotment of capital. They have constantly issued shares at face value barring the last few issues. The company conveniently capitalised its reserves into bonus shares in the year 2005. It is quite interesting for the company to have done it, as this will give the promoters access to the premium money it charged to outside shareholders from its previous arrangements. The effect was that the company pocketed a 25% CAGR return on their investment on that day. However, it was not the company's profits only that was capitalised but premium money. One of their promoters is Benett, Coleman & Co. They have bought the shares at 100 and it looks like there is a wait for this investor to encash his investment. The company is lenient to the directors, friends, relatives as to have given it at a lower price than the outsiders. The company has been extremely lenient with insiders and quite harsh on its outsiders.

The company's EPS is approximately 11.08. At 110, this has a P/E of about 10, which is on the lower side. The company's networth is 43 crores and the current IPO is for 50-59 crores.The book value of the share is Rs. 29 and this works at 3 times at current issue price.

The company has made strong cash from operations. The cash EPS from operations was approximately Rs. 15.

I like the company for the industry which is in and I would go for it if I had surplus funds. The investment will be needed for the long term. However, if there is any downturn in the industry, this should be the first stock to sell as it does not pricing power.

Shirdi Industries Ltd : Braving the sentiments with an IPO

After a long time am I seeing a company braving the current slide in the market with an IPO. The past few IPOs have been quite a disaster for companies. Air Deccan's take-off in this market has been quite unsuccessful as is the same when it launched its first flight. Hope it has a better flight journey in the days to come. The others like Vigneshwara Exports tried to lower the price like Air Deccan in the hope of increasing some buying interest. Well, it had to return its money at the end. Prime focus and Allcargo all have seen some erosion in prices. However, given these conditions, Shirdi Industries defying the market comes with an IPO.

These are my thoughts on this company....They are personal views and I do hope it is able to raise its money successfully.

• Size of the IPO 44-50 crores
• The issue will be open from the 29th of June to the 05th of July.
• The company was incorporated in 1993 and the company is planning the current issue for manufacturing MDF and particle boards, flooring, door skins, laminates and door and furniture components

About the Company
The company was incorporated in 93 and primarily dealt with trading of forward sell options. Later, the company started to import raw materials from south east Asia and sold it under the ASIS brand. The current issue deals with this segment to increase its capacity in the manufacturing segment.

• The company is in B2B and mainly uses its dealership to induce sales. Discount may hamper margins and also cash flow. The details on the cash flows has been dealt in the later section.
• Sales is limited to a few states. The IPO does not talk of strengthening the distribution set-up, which I think is crucial to develop business in the long run.
• Internal competition is mainly from local, un-organised sector. The plywood industry has seen a few closures due to unhygenic practices.
• China is the largest producer of this company's product of MDF. The growth of this segment by China is around 40% while India's production increased by 2%. In the hard board, India manufactures 10% of Chinese production. Hence, any entrants of Chinese products will lead to a price war. India manufactures 0.4% of Chinese production.

Balance Sheet and Profit and Loss

A look into the manufacturing division of the company is revealing some startling results. The company seems to have done well in this divison. The company sales has increased from 80 crores to around 1300 crores last year. If you see the improvement in bottom-line, this comes to around 30% net margins (the assumption is that trading sales has a margin of 10%, other incomes and consultancy at 100%)

• The ROE is around 11% as of last year. However, a significant portion of this ROE is from the manufacturing division. The ROE has improved from 2% to the current level
• The ROCE, a better indicator of the business is also at similar levels of approximately 10%. This margin has moved from 8.5% last year

Depreciation seems to have been understated. The company has added 52 crores of assets last year, a 5 time increase in assets. However, the depreciation provision has increased only 35%. This can be possible only if the company has made substantial acquisition in land.

The cash flows of the company has been varied and strictly nothing conclusive is coming out of it. While the company has achieved a strong cash flow for the current year, the cash flows was negative on three of the five years. Also, the increase for the current year has been mainly on account of increase in creditors and the company has consistently increased its debtors over the years.

Capital Structure

Again, yet another disappointing capital structure for the company. The promoters have acquired the shares at around Rs.11. The company has made an allotment to a foreign company at around Rs. 53.84. With the euro currently at around Rs. 58, and the issue price at around Rs. 69-78, this company has got an exit option with about 18% profit in a year. Infact, the lock in period on this investment by this foreign company has just come to an end for 85% of its investment. Anyway, given that the promoters have made an excellent deal in this company, at buying it extremely cheap, its now time for the public to understand if this pricing is correctly valued.

The current issue has some interesting facts:
The company needs Rs.127 crores for its funding requirements. Of the 127 the company has already tied in funds of approximately Rs.87 crores. The remaining 40 crores is coming from this IPO. At current issue price of Rs. 69 the company is expected to raise 44 crores, giving it a margin of Rs. 4 crores. Well, that is around 10% higher than the company requirements. Will we see a reduction of price due to poor market conditions?

Investment Positives
The only positive that I saw in this company was the strength of the new business. The new business seems to have strong earnings potential given the sector of housing is seeing strong growth. The company has a strong pricing power given the margins on the business.

Investment Negatives

• The company has not paid any dividends since 1998.
• Company has entered into various businesses such as in finance companies, reality, and biotech. The group companies, especially one of them Poona Pearl Biotek has shown a 16 times increase in losses last year
• Current networth is 38 crores and the company is raising close to 44-50 crores in this issue
• The issue is two and a half times the current book value of the share and the promoters have acquired the shares at half this price
• Legal Proceedings against the company's directors are a bit hazy. The promoters are being sued for acting on personal interests. Though the claims are on the lower side, it still raises doubt on the management.
• The current earnings is at Rs.2.4 and even at the lower end the pricing of the issue will be at 28 times its current earnings. As a relatively unknown brand for the public, I personally believe this to be on the higher side.

Others:

• Though the lead managers has fallen to Allianz Securities, Edelweiss Securities seems to have taken the onus of selling the issue to the market. 50% of the issue is being underwritten by this company.
• The MOA has a whole paragraph of more than 15 lines on IT and the scope of operations it can undertake. This comes as a surprise, as it is the first time that you will hear IT from the company. The sales figures, does not indicate any revenues from this stream
• The promoters group companies are a big question on sustainability. A host of companies, pretty closely held. Most of them are showing high variability in sales across years. While this is does not impact the company directly, however, a company that has not paid dividend in the past five years, and the promoters having a clutch of companies with high volatility in sales, does not ring the right bell.
• The salary earned by directors are unnecessarily confusing. The perks are close to 2.5 times the salary being earned. At first glance, it looks like the company is paying only Rs. 35000 for the promoters every month. However, once you add all the perks it increases to around 1.15 lakhs on the lower side.
• The company seems to be quite sure that the price change could be possible as it has marked this sentence in bold that the change shall by duly intimated to the exchanges.

Given the above information, I personally believe that this IPO can be passed and the investor rather have his money invested in the direct market. However, these are only my personal observations.

India - Arcelor and Mittal

Business Standard was covering an opinion poll today and the question was whether Arcelor Mittal combine will help India. He had given a yes/no as his options. Now, this was interesting and I was trying what it could be. Arcelor has no known presence in India. Mittal, atleast has given his word to invest in a 12 mln plant. However, his presence in India, considering he is an Indian, is pretty disappointing as he waited till last year to invest in India.

India currently produces around 1/3rd of the combine capacity of this merger. Around 35 odd million. The entire country! Arcelor produces more money than Mittal but the latter produces more steel. So what am I being an Indian going to get any benefit? The big guns of India with Tata, Sail, Jindal all produce steel and their exports aren't that great, compared to this giant combine. Tata produces one of the lowest cost steel in the world and Sail and Jindal seem to have done some decent work, inspite of being one being a PSU and the other was almost a sick company.

I am just not able to understand how this deal is going to affect India.

• Are we going to get better deal on prices?
• Is he going to manufacture something else that is on the higher end of the value chain in India, post this merger?
• Will he stop his plans in India, now that he is got some incremental capacity in his kitty (close to 10% of the world production) and also considering that we have a government that is unclear on its policies?

I would not be surprised if the third happens as the government enjoys giving a decision and taking it back. The airport contracts, the SEZ issues on land requirements etc...

None of the above questions gets me a conclusive answer, but yet the results from the other readers was overwhelming 'yes'. I wanted an answer that had the option like - 'I am ignorant and hence inconclusive'. One thing that hit me immediately is that we like Indians to perform well and we back them for no apparent reason. Sania Mirza, Indian cricket, Arun Jain, Bobby Jindal, Vinod Khosla, the many known in US and the even more unknowns who are successful in other countries. W e support them as if they are here to help us move out of this rut with their achievements, but rarely we see that happen. We just sit back and applaud and have an empty happiness. Again, its a feeling that they will come and help us, because they have achieved. We, as Indians, must support, after all, he is an Indian.

Am I missing something that the others seem to have seen and possibly in plain sight?

Should the RBI hike Interest Rates

For the past few days, I have been tormented with this problem if it makes sense for the RBI to raise interest rates. Here, I am not talking of repo or reverse repo rather the CRR. I was quite surprised to see the rates hiked without notice to anyone. It caught everyone off-guard. It's sometime nice to see the power of RBI. Completely, neutral to government pressures. Even surprised to see the markets to have rallied the next day as I thought it was not a positive information for the markets to discount. Well, the markets have not been always rational.

The Fed has been hiking its interest rates over the past few years and its now reaching a level where the markets are increasingly jittery. At 5.25% we are at a all time high. It is increasingly removing money from Asian markets, which was largely leveraged from these countries. Also I don't know if he will be able to control inflation with this hike. The brunt of the fuel hike will cause further damage to inflation. However this is supply driven and demand driven. Our consumption of amount of fuel has remained more or less constant across two years. This could be important as one will not be able to change his consumption pattern too much because of this hike. He may reduce it, but the extent will be relatively small. Given this scenario, should India hike its interest rates. I have some thoughts on it.

• Capital is increasingly required in most of the industrial sectors. Most companies have announced their plans to expand or currently in expansion. As we have a largely under-leveraged companies, they have been borrowing quite extensively from the markets or banks. So, it is going to affect their profitability. I however, doubt if these companies will curtail their investment decisions or defer them for sometime till they have some clarity. It is obvious that the world over interest rates are hardening, and hence makes sense for them to have their expansion plans at these rates, than later.
• To a certain extent, we are handicapped to world interest rates. I don't deny that. I feel this rate hike has taken the speculative money and will increasing pressurize good money that can be spent as FDI to move out and Reddy wanted to prevent that by giving hints in the air. As I do not know our ECB completely, apart from what keeps popping in ET, my guess is that we still are not in the area of concern.
  
• Being a capital hungry economy and the projects lined up in infrastructure being huge till 2012, the governor should be more interested in the areas of lending rather than the rate at which it is being lent. RBI forced banks to increase the provisioning for house loans, which in my sense was a good move as it changed plans for the banks to shift priorities
  
• Directive lending should be bought back in place to ensure money is sent to the right sector. Now, here I do not want them to invest in agriculture, coz this sector is hardly growing and increasingly the money does not seem to reach the end consumer. However, with the kind of efforts that is being put in by ITC, Reliance, Bharti, HLL, Godrej, I personally believe money can be used elsewhere.
• Money can be specifically spent on building effective roads, airports, sea-ports and railways.
• Money can be spent on power. Somehow, the pace can be improved. With lending made aggressive, this can be done
• Money needs to be spent in having clean water, education etc. as these will help the country in the long run

Given this picture, I don't think interest rate hike will affect us immediately but I hope he does not hike the core interest rates as it start creating the fear of building expectation of hiking interest rates, which an even more danger to the system.

SREI Infrastructure - A must buy

The reason for my posting some companies in my blogs is just to re-inforce myself if I was right in making a purchase of shares. After this crash, it makes sense for an investor to be a critic and understand if staying with the company makes sense. The recent fall in the share market has given tremendous opportunities for investors to look at his portfolio and make adjustments to them. Surely, the crash would have left most of us wounded with huge losses, but I believe this crash giving an ideal entry to companies that one missed in the previous rally. The rally gave hints of companies that have the potential to be better than the others, but have fallen as there no buyers and speculators have left them in the lurch. Ideal long term investors need to grab them and have the next round of gains.

I enjoy infrastructure based companies as it is not heavily dependent on outside economies. Most of these companies undertake projects for the development of our country. The only risk being whether such investments will yield the desired returns. Peter Lynch did well in the 80s investing in companies that focused on infrastructure. If I recall correctly, he did a 5 bagger in most of these companies. His reason was extremely simple. These companies do a big service to give the country the next level of growth. However, these companies will stop showing growth after the country has become a developed one simply because consumption can be easily monitored. You are not going to spend more on electricity just because you have more money. You probably will travel more-but the facilities that you need from the road, ports or in airports will become predictable and further investments into these areas would only enhance comfort marginally. Well, we are a long way off. We hardly have continuous power, decent roads to travel, excessively used airports created by the low fare airlines. So creating the opportunity for all companies in this sector to grow and grow much faster. I do not know if they would grow at a pace greater than the other sectors, but I am atleast confident on the government's commitment to improve basic necessities that is much needed for us. Hence this post and possibly more on these type of companies.

The main problem that I encountered in this sector is the investment that one needs to make. Companies that are in IT, Entertainment etc rely heavily on manpower. Unlike infrastructure, where companies consume massive capital, these sectors hardly have such requirement. Any deal with proper pricing can ensure reasonable amount of safety for the return of capital. Infrastructure based companies run a risk on this. They consume capital and you do not know if they will make money. The projects have a huge gestation period and have leveraged balance sheets. Small changes in interest rates is sufficient to make the project infeasible after a few years. I am bullish on the country and hence I believe that I am making the right sense of investing in these companies.

I shall be posting my views on a series of infrastructure based companies in the next few posts of mine, if I have sufficient time at my disposal. My objective is to try and make sense in the policies of these companies.

SREI Infrastructure could probably be one such company that falls in this segment. The company gave up its highs of around Rs. 80 from around a month back to the lows of Rs. 30 today. That is one mammoth fall for a company that is doing pretty well. A company with a slightly different objective. They are into lending and only to infrastructure based companies. I read their annual report, and a truly interesting one. Very colorful (the company is in a purple patch), loads of explanation of the core activities of the company, extensive information on the industry (it probably took half of the report, which is a good one). Currently trading at a PE of 7. Imagine. Why are people not investing then? The company at its peak was trading at about PE of 18. Capital and infrastructure based companies were literally murdered in this crash. Probably that is why it is trading at such levels.

Company is primarily involved in these segments

• Equipment financing
• Equipment leasing
• Infrastructure Project financing
• Projects that are based on renewable resources (extremely small but amplified in the report)

Company has some diversification, of which some looks unnecessary in

• Capital Markets-generated marginal revenues, not making operating profits mainly due to increase in debtors
• Forex Services-generated about 2 lakhs of profits, not generating operating profits
• Insurance-loss making division and again not making operating profits and is moving into securitisation and asset reconstruction. Has created a new company that has a general license to market all insurance in one window. Company seems to have made some heavy initial investment not in assets, as the only asset they have is a computer. Sustainability in this seems to have some attractiveness as there is some synergies in business, especially in the non-life insurance sector.
• Venture capital-looks promising but details of this company is a bit sketchy. The company is investing in infrastructure based companies in the SME segment. The profitability that the company has shown is impressive. The salary in the P/L gives an indication that there are not more than a few individuals, and that too in the lower rungs of the company
• Retail Financial Services-made some huge investments in infrastructure, but the segment is highly competitive with banks being the market leaders. It is difficult for the company to position itself unless some clear differentiation can be created by the company.

Investment Positives

• Paison Ki Nilami-reverse Auction - a concept of reverse auctioning on determining interest rates.
  
• Direct bulk purchase of equipments from companies like Tata, Ingresoll Rand and ensuring their availability to its clients at cheaper prices. This fends off competition especially from the banking sector as their cost of borrowing is significantly lower. However, they would not purchase assets for lending them as leases. This activity has to be done by these companies.
  
• Listed on the LSE-can be more transparent in its accounts
• Its presence across the finance vertical, its expertise in consultancy, its reach
• Good dividend yield at current levels. At 15% dividend declared last year, the yield is about 4-4.5%. We have seen the upside on this stock a few weeks back.
  
• The company has done well in terms of customising its receipts with the cash flows of its client and has done well on the NPA front. Its capital adequacy ratio is well above the prescribed limit of 12%.
  
• The company uses securitisation of its assets, buys from ARC's (can get at a decent price) to ensure lower costs are maintained.
• The sales growth in its key areas are well above 30% and with more infrastructure based projects in pipeline and a capital starved country, the company should be able to maintain these growth levels for a certain period of time.
  

Investment Negatives

• Heavily dependent on the condition of the economy and the pace at which government will announce its projects
  
• Road projects are sometimes not viable investments. Any hardening of the interest rates can affect the project
• Raising money for projects- Rating of the company is not attractive. It is at AA-, which is a comfortable 200 bps from a bank. This benefit will affect the company as competition from banks is bound to get fierce.
  
• The other segments that the company is concentrating will give poor returns
• The company has a corpus of only 2200 crores
• There is a constant hint in the annual report that the company is not able to deliver its equipments on time due to non-availability. It seems to have mitigated thru bulk purchases.
• Interest Coverage ratio of less than 2 is a big risk in a rising interest rate scenario. The company's debt equity ratio is frightening given the fact that the company seems to borrow quite extensively (close to 6) and the borrowing mix is heavily tilted towards term loans from banks and financial institutions

Overall, the company has shown promise and the report that I spent reading for more than 3 hours was well spent. I truly believe the price of this stock to bounce back and show better appreciation in the years to come. More updates shall be posted when required.

Transfering Assets-Yet again is it fair?

Company	PRITISH NANDY COMMUNICATIONS LTD.
NSE Symbol	PNC
Announcement	Pritish Nandy Communications Ltd. has informed the Exchange that the Company has received a letter from Reliance Capital Asset Management Limited, a body corporate that pursuant to an inter-scheme transfer on June 05, 2006 from Reliance Growth Fund holding 9,00,000 Shares of the Company constituting 8.5985% of the paid up capital of the Company to Reliance Media & Entertainment Fund, there has been a change in shareholder, but the percentage holding by Reliance Mutual Fund i.e. 8.5985% remains unchanged.

The above mentioned was in the communications sections today. I found this piece interesting. It is a normal practice for mutual funds to shift assets from one scheme to another, so ideally this should not have created any panic to the investor. However, some interesting facts :-

• Sales of this company is extremely volatile. It was down from around 40 crores to 30 crores to back to 34-35 crores in the past three years.
• The share is trading at close to a year low. Has participated in the downside quite well
• Reliance Growth Fund is a flagship fund of the company and there is always pressure to perform constantly. The Media fund is less focussed than the hugely acclaimed Growth fund, creating pressure to perform.
• The Growth fund is completely transferring all its assets to the media fund. Total assets of the scheme : 2800 crores. Transferred money of this company : 3 crores. Not much to show any impact.
• Volumes are low in the market and this company is facing resistance at higher levels with huge 'sell' orders. Hence any share sold is further going to dampen sentiments on the stock
  

Yet the fund is doing it. Now what could be the reason? I just was thinking if this is the way wherein the fund is revamping its portfolio by transferring assets to other funds that are not that noticeable and can always be blaimed on markets of these companies specifically (one can say media companies, in general, have not performed) Just a wild guess.... but then I do not know. If it is so, then it is a disappointment from the fund house as the company is passing the buck of losers to these funds wherein the investors are forced to take the loss. Though the existing shareholders have not gained anything from this transaction, it gives the fund, the much needed liquidity to invest in stocks that have better potential to grow. It is similar to accepting the losses and taking fresh positions, but only this time it is at the cost of the other fund, infact their own fund.

All this could just be an imagination from my side, cynical of such a transfer. As mentioned previously, this happens most of the time in mutual funds. I just took this case to mention how this is applicable to save one's face in the worst of times.

Report on Annual Reports

The recent crash in the market has led to fewer IPO's reducing my workload. That was bound to happen. How long can we keep funding an unreasonable growth in the stock market. Someone's got to lose. Well, if not for anyone, I surely did. However, when I did ask a few of my friends if they lost money, I surely heard two reasons. I am there for the long term and this is a temporary correction long awaited and secondly, the long term story of the country is still intact. For the stock to move upwards, there should be a buyer who can find value once we reach back previous highs. I do not know who is that going to be. and as usual time will surely tell.

So what is exciting in these markets. My holidays gave me a huge list of annual reports to catch up on. I enjoy reading annual reports. It is like reading a prospectus. A lot of repitition making it complex and boring to read. If there is some regulation that requires repetition, then its high time the law some change. Endless repitition of the best performance and silently ignoring the important signs. As a shareholder, even if it means a single share, I get to read the important stuff of the company. It is true that the company incurs more cost to maintain a single shareholder, but then every shareholder has the right to be informed. This time around, till I see an IPO in the pipeline, I shall comment on the shareholders report and my observation on them.

I think it is important for every shareholder to read the annual reports. It probably gives insights to the company that one would have never thought of. For example on the recent budget proposal on ultra power projects. We get information that India is building 4-5 ultra power projects. One sees the shortfall in generation at about 75000 MVA. Now what do I understand by this. Can Reliance actually bid for this...does it have the competency to bid...no idea. Reading the reports, esp annual reports gives indication if the company has the capability to implement. Btw, for information the company only generated around 1000 MVA for the last financial year. The total generated in the country was 125 times his generation. Surprised, yeah so was I as Reliance always advertised as though it was the largest producer. It still is, but the scale is just not comparable. Public utility companies are far ahead in power generation. The annual report from the company was equally disappointing. There was no symbol of the newly formed ADAG symbol. Though I am not a big admirer of the symbol, yet it is a signature of the company and this was missing.

The report from Anil Ambani is always good to read. Somehow, though I do not know him personally, I like what he says. Comes out as a person who is truthfully and likes doing things within the constraints of the law, wherever applicable. The company actually has not done that well this year. The sales has been on the lower side. The company has reached its limits in capacity and incremental sales has to come from expansion. The company's foray in wind is disappointing and natural gas has had no buyers. No wonder he has not advertised this in his report. The company has revalued its assets. This could have been due to the de-merger between the two brothers. I hope this was the reason as I do not like companies revaluing assets upwards, esp. during boom markets, as they are not going to devalue once the market is down. The company has not charged the depreciation due to this upward revaluation on the profit and loss directly. They have used their reserves to make up the higher cost. This again is something unacceptable, revaluation is similar to having bought the asset that year. They should have charged it to the income statement directly without using the reserves. I understand the company has not done anything wrong, just that it is unfair to the shareholder. Next, on the company's general, distribution, administration expenses- the investment to the gratuity fund dropped dramatically. Could find no reason as the company had a slightly higher salary expenditure. The company should be completing its merger with Reliance Energy Ventures this year. Should this create an impact to the company? I do not have an answer as I am not clear of the shareholding pattern of the company. My ideal guess is that it would not have an impact but to be certain I need to know the shareholding pattern of the company and the extent of impact of this shell company.

Finally, I am definitely interested in this company for the following reasons. I am bullish on infrastructure based companies. Reliance energy has got approvals to build over 12500 MVA over the next few years. The investment should roughly be in the range of about 50000 crores. The company has reserves less than 10%. So, the company will be borrowing and given its credit rating, this should be easy. However, I will be concerned if dilution occurs due to FCCB, as they can demand steep discounts. I like the aggressiveness of the management. There is a definite hunger for success. The company has got Anil Ambani, and he too is like his brother in thinking big projects. The best of this team is that this is in a sector with huge opportunity of success. Growth will taper off in a decade but utility companies are as the name suggest- a requirement that can't be reduced.

The next one that I read was on Gail. I have been investing in this stock for a long while and I finally took the pains to read their annual report. Unlike the report by Reliance Energy, this was comparatively attractive to look at. This can be both negative or positive. Negative as the company is spending on something that is hardly read and positive as the company is proud. My take on this is that, the company ought to make it attractive as this is a PR material for the company and it is important for the company's management to be proud of its results. It does not have to be lavish yet a little bit of shades should do no harm. Coming to GAIL, the company is an ideal company with immense potential to grow. It is in the oil sector, yet the company makes investment on communication lines, which is irrelevant. You will see this getting disinvested or floated into a separate company soon. I am not happy with their investment. I do not see the synergies of business apart from the gosling that they are using for building them. It reminds me of a famous quote by Mark Twain- There are two times when a man must not speculate: One when he has money and the other when he does not. This looks like speculation with money to me. The company otherwise is making some good moves in investing in local bodies for distribution of CNG and LNG. The company still generates 70% of its revenues from its core sector of selling gas. Here is something funny. The company's vision is to ensure value is created to all stakeholders yet it takes pain to reiterate by giving importance again to environment and customers. My guess is that they do not believe these two as a part of their stakeholders. Its part time directors is a total disappointment. Two directors have attended just one of the 15, the best being 10 attended by another director. Wonder what value they add in that one meeting that they attend.

About 23 giving an PE of about 10. Ideal for a company with ROIC of over 27%. The company is suffering from the subsidy burden. It had to pick up a tab of about 1100 crores translating to about Rs. 13 per share. Well, one is helpless of the atrocities of government policies even if they are going to get something back in the form of Oil Bonds. Anyways, the company is in the right sector and the supplies that it is making to the power sector and for local consumption gives this company an ideal candidate for investment. It is still a govt defined pricing sector, and my faith of the current government is losing over the past few months. Yet I would like to invest in this company.