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.