Saturday, December 15, 2007

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?

Sunday, November 11, 2007

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.

Sunday, October 07, 2007

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?

Saturday, October 06, 2007

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.

Monday, September 24, 2007

Infosys - The Toyota Way

In the linked article Jitendra V. Singh, dean of Singapore's Nanyang Business School argues that Indian firms should use the rupee's strength to their advantage by adapting their business models in innovative ways, much as Japan's automakers did during the 1980s.

The article provides a good starting point for Indian IT industry to think ways to reduce their currency risk. The risk is inherent by the nature of business where predominantly revenue is in USD while costs are in INR. Ideal situation as also suggested in the article is to follow Japanese automakers when they shifted production of low margin products to US thereby reducing impact of currency appreciation. But in the Indian scenario the fundamentals are different. While Japanese did enjoy the low cost advantage but they also had very high productivity which enabled them to be highly competitive even when shifted manufacturing to US. The Indian IT industry is still far from matching US productivity let alone surpass it. Indian advantage is genuinely labor arbitrage which more than compensates low productivity and enables firms like Infy to earn margins close to 30%. But as the article speculates on an exchange rate close to INR 20 / USD this would kill the Indian advantage if productivity does not rise large enough and also fast enough. The fact with any arbitrage is that it remains only for a short while before markets become efficient and wipe it out.

The exchange rates are beyond control of Indian IT firms so what can they do to still stay competitive? Answer lies in productivity improvement. Apart from organic ways of doing it through training, companies like Infy should use their accumulated funds and make logical overseas acquisitions in the space of high end IT services. The integration of these companies and their practices back in India would be very important as it is here where the productivity gains are required. High end services would also enable to expand the margins thereby providing thicker cushions against USD fall. These overseas acquisitions will also help IT companies in having a more geographically balanced revenue-cost structure thereby providing a partial hedge.

So overall its not just the Toyota Way for Indian IT companies but they need to find a innovative solution to the rupee appreciation. How about a (Shinning) India providing large part of revenues to Infy in our very own rupee?

Sunday, September 16, 2007

Arun Gandhi on Tata Corus Deal

Arun Gandhi - the Tata Corus deal maker in an interview to Moneycontrol talked about the deal. Some of the highlights:

Deal Timing:
The timing of the deal was crucial as during that time the Russian companies were undergoing IPO and if the deal had been delayed then they would have also jumped in with their IPO collections thereby increasing the competitive pressures of the bid.

UK Takeover code:
The UK take over code governs the deal making process to ensure fair deal to the shareholders. The law requires regulations on the break fee and stake building which acts as defense against the competition. The break fee has to be less than 1% of the transaction value and also the company directors need to certify that the break fee is in interest of shareholders. The stake building is allowed upto 30% prior to announcement. Post announcement stake building is risky as the access to confidential information during due diligence may expose the bidder to criminal insider trading prosecution and also it does not get a right to vote in the bidding. The UK law also has a provision to prevent financial assistance - target company (only public companies) to let the bidder use its assets or guaranties to secure financing.

608 pence:
In the last round of bidding CSN topped up at 603 pence and Tata wrapped up the deal at 608 pence. The price was chosen at 5 pence higher as there was 6 weeks time to go after the auction date and the Corus share price would have included the time value of money thereby keeping the share price lower than 603 pence. CSN at this point might had created trouble as it could have bought as many shares as it could at a price less than or equal to its bid of 603. Tata hence had to keep the share price above 603 and hence a bid of 608.

Monday, August 27, 2007

Recession or Growth ?

source: The Fed

Former US Treasury Secretary Lawrence Summers fear of recession seems un-real to me. The US interest rates are rising not because of inflation but because of growth in the economy as reflected by rise in real interest rates. The growth implies greater investment opportunities while the savings are slightly less than usual due to consumer driven growth. This imbalance of demand vs supply of money is the root cause of rising interest rates. The fear of recession does not seem real to me.

India Inc and Global domination!

Are the days of cheap money for buyouts over?

The rising bond yields suggest so. Media reports or Blackstone's stock performance also suggests so. Does it means the end of Mergers and Acquisitions around the world and especially the much talked about India Inc' overseas acquisitions?

I do not think so.

Indian companies were not acquiring overseas companies because interest rates were low earlier. Predominantly all Indian acquisitions were strategic and growth oriented. They were either to acquire technology or to acquire market access and customers. Those fundamentals of India Inc are still very much intact and hence the intent to acquire is intact. The question of funding though important but is not ultimate decider. Indian companies have been borrowing large sums overseas to fund the acquisitions only because funds are cheaper there. The increased interest rates will increase cost of borrowing but will equally reduce the valuations. In that scenario the increased interest expenses should be more than compensated with reduced cost of asset overseas. The US stock markets are down by about 6% while interest rate is up by about 4%. Hence the overall impact is only towards the better liking of India Inc. Instead of slowing down global acquisitions it is rather a buying opportunity!

Sunday, August 26, 2007


Butterfly - not this colorful one found in nature but is found around the world's financial markets! ... It is a fixed income (bonds / swaps) basket trading strategy to profit from anomalies of the interest rate term structure. The arbitrage is based on the principal of mean reversion where market expects the term structure's curvature to oscillate around its historical average position. Traders predict the shape of term structure and make a bet on it.

A Butterfly trading strategy is designed to profit from a relative mis-pricing of securities of different maturities while protecting against market and curvature risk. For instance if a trader maintains a view that a particular bond ,say a 4 yr zero, is priced higher relative to other bonds, he could short this bond in the hope that it would become cheaper in the near future. However such a strategy would involve too much market risk. If the interest rates fall then an outright short position in a 4yr bond would lose money anyway even if the trader had been right and the bond did become cheap relative to other bonds.

One way in which the trader could protect the short position is by buying a nearby issue, say a 2yr zero. In this case if the interest rates fall then the loss on the short position would be covered by the corresponding long position in the 2yr bond and vice versa. Thus if the relative mis-pricing were to correct the trader would make money regardless of the direction of the market movement. In other words such a strategy protects the trader against parallel shifts in the term-structure.

However one possible problem with such a strategy arises for non-parallel shifts in term structure. If the yield curve flattens, the yield on the 4yr bond might fall while the 2yr remains unchanged. Thus in this case the trader would lose money on the short position while the long would remain unchanged, thus even if the relative mis-pricing were to correct the trader would lose money. To cover the slope (change) risk the trader might take a long position in another bond with duration higher then 4 yrs, say a 6yr zero. With this strategy in place if the term structure flattens then the trader would lose money on the 4yr bond, gain on the 6yr bond while the position in the 2yr bond remains unchanged. If the term structure becomes steeper the opposite would hold true .Thus if the relative mis-pricing of the 4yr bond were to correct here the trader would register a net gain irrespective of any change in the term structure. In other words the strategy becomes direction neutral.

Such a strategy involving three securities of different maturities is called a butterfly trading strategy. The security in the middle of the maturity range, in this case the 4yr bond, is called the body, while the other two securities are called the wings. As described above such a strategy is designed to profit from relative mis-pricing while protecting against the interest rate level and slope risk.

Saturday, August 25, 2007

Jaguar & Land Rover in Rs 1 lakh

Whats the Tata strategy?

One on end Tata is pushing for the highest end of Jaguar and Land Rover while on the another is the Tata's "bottom of the pyramid" much hyped Rs 1 Lakh car. Is Tata spreading itself too thin or there is some deliberate thought behind? Lets think about it...

1 Lakh car is primarily for India and other India like emerging economies. Its more about the scale economics and knock down costs by fully redesigning and probably redefining what we know now as a car. The whole supply chain has to improve efficiency by order of magnitudes if the output has to be a car. Also technologically the fuel efficiency of this cars has to be improved by leaps and bounds such that it is not just a cheap car like Mauti 800 (even cheaper) but is overall a "bottom of the pyramid" car with lower total monthly cost of ownership. It will need to have fuel efficiencies closer to a two wheeler to compete in the market where at the lower side two wheelers owners look for flexibility and costs while at the higher side maruti 800 owners look for convenience and also the cost. If Tata has to sell its cars then it has to marry the two segments. Put together a car which is low cost but also offer convenience and flexibility. It should not be a car competing against a 3 yr old Maruti 800 available in second hand market for prices closer to Rs 1 lakh. No fun there!

So do Mr. Tata have the technology for a car with fuel efficiencies more than 40 KM per liter?

If he does not... I doubt the success of 1 Lakh car.
If he do.. then I believe we should long tata motors stock as not only 1 lakh car but also the Land Rovers and the Jaguars are going to do very well!

Why Rover and Jaguar? The biggest problem with these money loosing highly aspirational brands is the "gas guzzler" nature embedded deep in the very design of these 'cars'. If the 1 lakh car fuel technology can be applied here.. then we have at our hands a premium car which is as fuel efficient as a normal car. It is then the aspiration brand value in these brands will kick in and Tata can have winning proposition at hand.

Wednesday, January 31, 2007

Think Again: India

Barbara Crossette advices US to stay clear of India in Foreign Policy

First of all thank you Barbara for making every Indian feel so proud for duping US (world's big daddy) into nuclear deal. Its really an honor when someone claims that India can con US. Indians usually believe that India is one nation which is historically conned by every Tom, Dick and Harry.

Now lets talk some facts and refute flawed reasoning:

“India and the United States are not natural allies”
Well Uncle Sam is not stupid to give away goodies to 'spoiled brat' India had there been not ulterior interests. Uncle Sam wants to have a world where China's power have a counter balance in the upcoming world order and who better to take China head on other than India. From point of view of India the deal is not bad because India indeed want to compete with China on every front. Thinking that India will give away the nuclear technology to Iran is very imaginative as India's interest with Iran is only oil. Giving away nukes in neighborhood means getting them back in worst way. We already have a rouge pakistan to take care of. Can't afford another. So the natural allies is indeed the demand of hour.

"India is not a responsible world power"
Thanks for recognizing Indian power but it would help to understand the situation from Indina perspective. Indian interference in South Asian politics is purely strategic in nature. India has so many enemies all around that it is not left with any choice but to proactively thwart any threat. It is similar to uncle Sam's approach on Iraq, Afghanistan, Vietnam and what not... Only difference is that we do it in our backyard while uncle Sam does it in others backyard. And you should not be surprised that on maximum occasions the guns rising against India are tagged 'Made in USA'

“India will not surpass China except for population”
Please refer to your very own Goldman Sachs updated BRIC report "Global Economics Paper No: 152 - India’s Rising Growth Potential" where it claims that India will surpass US by 2045. Are you still worried about China?

“India is not becoming a high-tech, middle-class nation”
Next time do not believe anyone if they crib that their job got Bangalored. Write in business magazines advising US corps to not worry about Indian consumers as there aren't many. Just google fastest growing economies and check for yourself how many your own compatriots are going crazy over Indian market.

“India is not a model of tolerance”
Step 1: Get a world map
Step 2: Check if it shows pakistan
Step 3: If answer to previous step is yes then your hypothesis is proved wrong!

We are not the one who are reconstructing Iraq or Afghanistan. On loss of some 3000 lives (that too had a good number of Indians) US goes to flatten out Afghanistan. India is a long sufferer of terrorism and loses many times more lives every year. US is not the only privileged to secure its countrymen.

Barbara, I know that you are upset by the nuclear deal but think hard and you will figure out that it helps US more than India. It is another step from stopping energy hungry India to reach out to Iran for its oil.

Think again!

Monday, January 08, 2007

India Poised!

A nice forward which came to me! Captures the spirit of India Poised.....


The ant works hard in the withering heat all summer long building his house and laying up supplies for the winter. The grasshopper thinks the ant's a fool and laughs & dances & plays the summer away. Come winter, the ant is warm and well fed. The grasshopper has no food or shelter so he dies out in the cold.


The ant works hard in the withering heat all summer long, building his house and laying up supplies for the winter. The grasshopper thinks the ant's a fool and laughs & dances & plays the summer away. Come winter, the shivering grasshopper calls a press conference and demands to know why the ant should be allowed to be warm and well fed while others are cold and

NDTV, BBC, CNN show up to provide pictures of the shivering grasshopper next to a video of the ant in his comfortable home with a table filled with food.

The World is stunned by the sharp contrast. How can this be that this poor grasshopper is allowed to suffer so?

Arundhati Roy stages a demonstration in front of the ant's house.

Medha Patkar goes on a fast alongwith other grasshoppers demanding that grasshoppers be relocated to warmer climates during winter.

Amnesty International and Koffi Annan criticizes the Indian Government for not upholding the fundamental rights of the grasshopper.

The Internet is flooded with online petitions seeking support to the grasshopper (many promising Heaven and Everlasting Peace for prompt support as against the wrath of God for non-compliance).

Opposition MP's stage a walkout.

Left parties call for "Bharat Bandh" in West Bengal and Kerala demanding a Judicial Enquiry.

CPM in Kerala immediately passes a law preventing Ants from working hard in the heat so as to bring about equality of poverty among ants and grasshoppers.

Lalu Prasad allocates one free coach to Grasshoppers on all Indian Railway Trains, aptly named as the 'Grasshopper Rath'.

Finally, the Judicial Committee drafts the Prevention of Terrorism Against Grasshoppers Act [POTAGA]", with effect from the beginning of the winter.

The ant is fined for failing to comply with POTAGA and, having nothing left to pay his retroactive taxes, his home is confiscated by the Government and handed over to the grasshopper in a ceremony covered by NDTV.

Arundhati Roy calls it "a triumph of justice". Lalu calls it 'Socialistic Justice'. CPM calls it the 'revolutionary resurgence of the downtrodden'

Koffi Annan invites the grasshopper to address the UN General Assembly.

Many years later...

The ant has since migrated to the US and set up a multi billion dollar company in silicon valley

100s of grasshoppers die of starvation somewhere in India...