Schneider Electric has signed an agreement to acquire Bangalore-based Conzerv Systems

Unreal estate !

The survey published in this week's economist is pretty interesting. According to it, Mumbai is among the least buy to let yield rates city. It means that if someone is buying a property only to lease it.. then its a money loosing proposition given the high inflation and interest rates scenario.

But what about the returns when a sells the property?

The real return of any real estate world over is from the capital gains. Even in this list if we analyze the topper Cairo, the rank has no meaning... Just a look at the prevalent interest rate there which is at 12.12% for 3 month loan (Reference: economist - published 28th Aug 2008) suggest that the return would be therefore negative ! True it will be more negative for Mumbai, but the comparison is still not accurate.

An accurate comparison should not just compare buy to let yeilds but should also adjust it for prevalent home loan rate and also the price appreciation. Mumbai which is doing badly on yeild & interest rate (thanks to Indian inflation) will quickly climb rankings on the capital gains! This will hold inspite of recent softening of property rates.

Olympic & Entrepreneurship

How is Olympic medal tally related to the world order ?

Historic trend for UK, US & Former USSR in terms of number of medal won per capita GDP suggest interesting conclusions. Though there is a visible decline for all three, Former USSR shows sharpest. Countries like Jamaica establish the fact that there is no close relation between Olympic medal and the financial power of the country, but we need to look deeper into the events where countries win. Russia traditionally has had stronghold in gymnastics while countries like Jamaica win in atheletics, while US has traditionally been winning in all kinds of events... individual or team. The declining medal to per capita GDP ratio is perhaps another indicator of 'flat world' and changing world order. The relatively stable trend for UK seem to indicate relativly stable social fabric for UK. It has undergone changes, but not as revolutionary as US or Russia & old friends.

The earstwhile USSR was known for its socialist way of things and children were identified quite early and trained to win at olympics. The events they won it required such "disciplined" training. While Jamaican atheletes might not had such training facilities, but its rather the power in the genes.

In US, UK while it seems more of the individualism... people excel at event of their interest.. hence a wide range of success stories.

Even Indian medals at 2008 suggest individualism victory. All the medal winners are ones who had put on line their own money to achieve the feet. This entrepreneual turnaround will definitly lead India to more medals in future olympics as their is now a establish record of instant success and celebrity status on winning. A status which till now was enjoyed by only cricketers and filmstars. Now there is another avenue. Indian entrepreneurs will surely grab this opportunity in near future and Indian victory will not be limited to few events.. but in diverse events.

Indian Pharma: Rx Consolidation

Indian Pharma sector has been long under performing compared to various other sectors. This under performance is attributed to several reasons such as eroding margins in the US generic business, weakening dollar etc. The chart shows the beating Pharma stocks have taken on the NSE.

Indian pharma companies are very good at producing quality generic drugs with continuous improvement and are also amongst the lowest cost manufacturers in the world. These companies are very similar in their operations, business model and to a large extent in the skill sets too. This seems to me the predominant reason for current under performance as these companies are competing fiercely not only in domestic market but also in the export market. This high competition is largely responsible for reducing margins and conceding all the 'low cost' Indian advantage to the world. The competition in the world generic market is further heating up and smaller Indian companies cannot sustain for long unless they get strong backup from Indian market.
With many players around the world going after generics, the margins are ought to fall. Companies are doing cross border M&A to access newer markets and capabilities. But this phenomena is causing problems because all companies in a way are becoming similar. Even the name is 'generics' but there is a critical need among companies to differentiate and to build scale. Acquiring companies abroad will help Indian companies in accessing new markets and counter the weak dollar effect, but to deal with margin pressures lot of domestic 'big deals' would be required. Currently there are some 15+ companies supplying bulk drugs largely to US market and it makes a very good case for these companies to come together and benefit from economies of scale to efficiently manufacture while also efficiently maintain large R&D pipelines.

but why is it already not happening?

Almost all Indian pharma companies are family owned. Is this ownership structure impeding domestic M&A?

A similar situation can be soon expected in IT sector also when margins will start shrinking when Indian service providers start competing vigorously against one another. But will we see M&A sooner there for them being largely professional companies?

Economics 101 - Demand & Supply of Crude Oil

Experts say that the current oil price 'crisis' is a lot different from the other two which hit the world during 1970s and 1980s. The earlier crisis were result of formation of OPEC and Iran Iraq war which disrupted the supply and hence by the law of economics at a constant demand if supply decreases then the price increases.

In the current scenario, when there is no obvious supply crisis, experts claim that the price is increasing as a result of increasing demand. especially from China and India who are in-efficient users of oil (use more oil per $ of GDP) vis a vis US and other developed countries. These economies growing at roughly 10% a year use 3 times as much oil per $ of GDP as some of the developed countries use. In the light of this data it would be interesting to see this exhibit:

The world is at the crossroads today where the developing world GDP is almost equal to developed world. Assuming that developing world uses 3 times more oil than developed world for every $ of incremental GDP, so the current oil demand should increase by 17% (assuming the developed world grow at 4% while developing at 10% with constant oil efficiency). In a scenario of linear supply function, the price should hence increase by 17% but in reality it has jumped by more than 60% in last one year.

Clearly it is not just the demand which is at play here. What can be the plausible cause to explain the price rise?

• The supply may not be a linear function! The oil producers may be running very close to their existing operating limits and any significant increase in production will require huge investments and that too in geo-politically unstable regions.

This hypothesis may be partly correct in the intermediate to long term but looking at the short term it still does not make sense. The exhibit (from OPEC website) shows the OPEC capacity and in short term situation seems quite comfortable.

Another hypothesis can be increased geo-political risk premium. In the current world political environment in which nothing other than the US presidential elections seems to cause a major change in world order. Does this elections has anything to do with oil prices? May be... It would be interesting to listen to some of the conspiracy theorist for the Texas connection to this oil price increase! After all the invisible hand is also the part of demand and supply relationship!

To me, the situation seems to be a combination of these scenarios, the cause of the rise in oil price would be due to demand effect + premium for new investment + increased geo-political risk premium. about $15 (20%) largely due to China and India, and rest $25 as investment and risk premium.

If someone is worried about next generation seeing oil. Here is the good news. We still seem to have oil for thousands of years! The current demand is less than 100 million barrels a year while proven reserves are in excess of 1000 billion barrels. Though majority in regions of the world which may not be exactly peaceful to likening of our democratic uncle Sam.

IPO - The Dutch Way?

With the recent Power Grid Corporation of India's IPO jumping close to 100% on listing, the debate is intense on SEBI allowing Dutch auction method for launching IPO. Analysis of few recent IPOs (last 22 IPOs since June 2007) reveals that as much as Rs 4500 crore was left on the table - the difference between closing price on listing day and the IPO price . More than half of this amount can be attributed to Power Grid Corp. On an average this represent a value jump of about 17% which is very much a typical IPO discount to encourage investors overcome the information asymmetry. A closer analysis of top 50% among these IPOs reveal a whopping 75% value jump totaling to Rs 3600 crore. If we drop Power grid from this analysis then it reduces to 45% or little more than Rs 800 crore.

Whose money was it anyway and whom will the Dutch auction benefit?

In case of Power grid it was government's money (direct equity and also the future plans of power grid) which went into the pockets of large institutions.

Analyzing the largest 3 IPOs during the period (DLF, Omaxe and Power Grid) it was only Power Grid which was severely under priced. DLF and Omaxe went up only by 8.6% and 12.9%. So is it about the ability of underwriters to price the IPO or about the ability of management to understand intrinsic value of their own company?

Dutch auction is theoretically a ideal solution which Google tried with its IPO but it was largely unsuccessful in meeting its objectives. The primary reason was execution. Dutch auction put lot of emphasis on investors to accurately price the offer. With lack of credible information and valuation abilities, are investors in a position to invest wisely?

Sensex - 20/20 champion by year end!

Will SENSEX go Up or Down ??

If the current euphoria in India Inc is to continue, then I predict the Sensex to cross the 20K mark by the year end.

At the current bull run the BSE bellwether index is trading just a notch above its long term historical P/E average (current P/E of about 24 vis a vis average since 1991 being 21.65). Current P/E is largely a result of the bull run seen in the last 12 sessions. Market is still at a lot lower P/E than what it had seen during the downturn of Jan 2000. The market needs to be more than 21K today to reach that levels of P/E.

The Q2 earnings will start coming in soon and the expectation is that India Inc will grow again by a handsome figure in the north of 10%. So the current P/E ratio (and even the historic one) justifies 20K by the end of Q3.

Another interesting fact here is the Price to Book Value ratio. It is currently at its highest value in more than last 10 years. Is this a sign of worry? Traditionally price to book value was in good correlation with P/E but currently it looks somewhat overheated. But here my belief is that it is largly due to the run in real estate prices. For many companies the book value of these assets depicts the historic value but today the market values them much more. So unless real estate prices crash, which is unlikely for commercial property, the current market levels should be sustainable and very much bullish.