Biznews Aug 26 To Sep 1

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BIZ VOCAB Private Equity Firms Private equity is the equity capital that is made available to companies or investors, but not quoted on a stock market. The funds raised through private equity can be used to develop new products and technologies, to expand working capital, to make acquisitions, or to strengthen a company's balance sheet. However, the average individual investor will not have access to private equity because it requires a very large investment.

WEEKLY ECONOMIC INDICATORS WEEK ECONOMIC INDICATORS ENDING 31st AUGUST

WEEKLY CHANGE(%)

RUPEE/ USD

40.96

0.31

RUPEE/ €

55.96

0.017

SENSEX

15318

6.20

NIFTY

4464

6.54

OIL($)

$73.84/barrel 3.81

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NEWS SNIPPETS Indian Economy thunders on, GDP up 9.3% in Q1`08 The economy weathered interest rate shocks and higher inflation to grow a robust 9.3 per cent in the first quarter ended June 30 of the current financial year beating market expectations of 89.5%. In the official data released on August 31, quarterly GDP is estimated at Rs 7,231.32 billion during Q1 of 2007-08, as against Rs 6,613.35 billion in Q1 of 2006-07. •

Manufacturing, a key driver in four years of rapid GDP expansion, grew an annual 11.9 percent in the April-June quarter, slightly slower than 12.4 percent in the previous three months. Services grew at an annual pace of 10.6 percent. Agriculture, forestry & fishing sector which posted 3.8% growth in Q1`08, remarkably higher than 2.8% in the corresponding quarter, a year ago due to good monsoon. Additionally, electricity, gas & water supply sector zoomed at a pace of 8.3% compared with 5.8% in the same quarter of pervious year. Also, weekly wholesale price index-based inflation dropped to a 15-month low of 3.9 per cent for the week ended August 18, well below the central bank's medium projection of 5 per cent for the current year.

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Impact • • • •

The stock market extended its strong opening gains after the data, rising as much as 1.5 percent on the day. The rupee was strengthened slightly to 40.96 per dollar, while the benchmark 10year bond edged up 1 basis point to 7.92 percent. India is now a $1 trillion economy, and this has given it increasing muscle in world trade talks and seen it invited to meetings of the world's leading industrialised economies. The scorching pace has generated jobs but it has also put pressure on roads, ports and other infrastructure, and increased wage and price pressures.

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Private firms invest record $3.8 bn in India Global private equity firms, including Blackstone and Carlyle Group, have made an investment of USD 3.8 billion in 2007 so far in the country, up 50 per cent from the year-ago period. The record volume has been reached through 81 M&A deals. Carlyle Group is the leading "financial sponsor" in India with investment of USD 777 million via two deals, including acquisition of over six per cent stake in HDFC. It is followed by Dubai International Capital, which acquired a 2.87 per cent stake in ICICI Bank for USD 741 million, and Blackstone Group with USD 619 million inflow via eight deals. Blackstone Group, the world's leading private equity firm, has acquired stake in companies such as Intelenet Global Services, Punj Lloyd and Gokaldas Exports. The US-based Group has also decided to pump in USD 150 million to acquire a stake in Nagarjuna Construction Company.

Impact  •

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With right macro economic policies in place, India is able to attract high PE investments which in turn will lead to a virtuous cycle of further improvements in the economic and infrastructural environment. And to sustain its current economic boom, India will need US$475 billion for infrastructure development over the next five years. Thus the importance of such huge investments is itself explained. The future deals would be consummated quickly rather than being put on hold. Also, even though the number of deals would be less, they are going to be larger-ticket deals. There can be a sentimental impact, and investors may stop to think if they need to be more conservative. The private equity investment in India can be compared with China. o India, with its pitted roadways, tainted water and visible, widespread poverty, might not seem a safer bet. Yet those outward signs obscure solid underpinnings for economic growth, including a democratic government, a strong education system, widespread knowledge of English and a deep pool of expatriates experienced in Western businesses. o Comparatively, cheap labour and foreign direct investment have made China the world's manufacturing powerhouse under a government that has embraced Western-style capitalism. o China has provided spectacular private-equity returns in recent years, but the weaknesses in China's legal system and the possibility of political instability remain concerns for investors. o For long term investment , India’s "soft" attributes, such as a democratic government and a free press that is rooting out corruption, outweigh China's more impressive investments in "hard" infrastructure such ports, plants, and transportation systems. o For more information on the same topic, visit http://www.altassets.net/casefor/countries/2006/nz9498.php

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Firstsource buys US co MedAssist for $330m In the second-largest takeover of an overseas business process firm by an Indian company, Firstsource Solutions has announced the acquisition of US-based MedAssist for $330 million. This is the third acquisition for Firstsource in the US and its seventh in all. With revenues of $99 million in 2006, Louisville, Kentucky-based MedAssist is among the largest firms providing revenue cycle management services to the healthcare sector in the US. The deal values MedAssist at 12.5 times its 2007 operating profit. MedAssist’s revenues have been growing at 710% annually and its core earnings margins are higher than most US firms at 22-24%. The deal will be financed through a combination of internal cash accrual of $80 million and a five-year term loan of $275 million raised at 250-300 bps over the London Interbank Offered rate (LIBOR).

Impact  • • • • •

The buyout will give Firstsource a footprint on the hospital side of the healthcare business.  The news of the buyout sent the Firstsource share zooming. It gained nearly 10% to close at Rs 79.40 on the Bombay Stock Exchange on 29th August, day of announcement of merger. This would help the company further build on its expertise in the healthcare arena, which already accounts for nearly 14% of its total revenue. Inclusion of MedAssist is expected to boost its topline by about $50-55 million in FY08.  The deal appears to be on the expensive side given the valuation of about 3.3 times sales compared to going levels. For instance, Wipro had valued its latest acquisition of Infocrossing at about 2.5 times sales. 

Trai against cap on no. of players Trai’s direction to not impose any limit on the number of players in the already overcrowded GSM market, relax stringent M&A norms, and charge higher spectrum fees for both GSM and CDMA players would enhance more competition and mergers in the telecom industry. Apart from setting up a committee to frame a new spectrum allocation criteria, Trai has proposed increasing the spectrum fee in addition to recommending a one-time entry fee for allocation of spectrum beyond 10 Mhz for GSM operators and 5 Mhz for CDMA operators. This was in stark contrast to the intense pressure from India’s powerful GSM lobby who were demanding a cap on the number of operators, retention of the existing M&A norms, a ban of offering dual technology (CDMA and GSM) under the same licence and retention of the existing spectrum allocation norms.

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Impact •

With no limit on the number of players, more players would be willing to enter the profitable GSM market and hurt the already diminishing profit margins of the established players. This could spur a new round of M&A in the industry.

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It would also help a GSM player to introduce the CDMA technology under the same license and without any extra cost.

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New Delhi-based real estate development company Parsvnath Developers has submitted applications to the Department of Telecom for providing unified access services in 22 telecom circles across the country.

 

Government using Using Forex Reserves To Fund Infrastructure projects After months of hair-splitting, the government appears to have had its way: a portion of the country’s forex reserves ($5 billion) is to be given to the Special purpose vehicle (SPV) for infrastructure financing. The finance ministry has reportedly decided to ask the RBI to subscribe to bonds issued to the overseas arm of the Infrastructure Finance Company (IIFCL), the SPV set up for the purpose. The

proposal, first made by the finance minister in his Budget 2005-06 speech, had hit an impasse with the RBI raising objections on a number of grounds. But with the law ministry now giving its goahead from the legal angle, the RBI may find it hard to continue to resist.

Analysis    

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Let us look at the pros: We are not making the best use of our reserves. Also, we have more reserves than we need when measured by number of months of import cover. To maintain robust economic growth, we need to improve the infrastructure.

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Now the cons: However, it is not so much lack of funds that is holding up infrastructure development as lack of bankable projects. In which case, it’s loans eventually have to be written off, then it is essentially no different from financing through the budget deficit. On the other hand, bankable projects can get financed on their own strength.

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Thus, using forex reserves for infrastructure financing is only an accounting fudge, an offbudget deficit much like oil bonds.

           

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Railways to set up 1,000-mw power plant The Indian Railways is all set to establish a captive power plant of 1000 megawatts (MW) capacity at Nabinagar of Aurangabad district, Bihar. A new company -Bhartiya Rail Bijlee would be set up for the purpose. The total cost of the project is estimated to be Rs 5352.5 crore and will be designated a mega status and it is being undertaken in collaboration with NTPC. The project will have a debt equity ratio of 70:30, where NTPC’s equity participation would be Rs 118 crore or 74 per cent, and the Indian Railway’s share would be Rs 417 crore or 26 per cent approximately.

Impact •

In 2002 also railways had forayed into the electricity generation business in a bid to reduce costs.

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The move could save Rs 1,000 - 1,500 crore annually on electricity bills for Railways, as state electricity boards typically charge the Railways two to three times the rate charged by central generating agencies at that time.

RIL forays into container trains business Reliance Logistics Ltd, an arm of RIL, is diversifying into the business of running container trains and plans to buy railway wagons to serve the needs of its parent’s various businesses including retail and to also serve other companies. Reliance Industries is part of the consortium developing the logistics park at Rewas port for container trains. The all-weather port with a deep draught (usually a depth of more than 16m), located just 10km away from India’s busiest container port, the Jawaharlal Nehru Port in Mumbai, is being implemented in three phases with phase I costing approximately Rs 4,000 crore. The railway ministry has already conducted two rounds of bidding since 2005 in which 13 private operators, including the Anil Ambani-run Reliance Infrastructure Engineers Pvt. Ltd and two state-owned firms—Container Corporation of India Ltd (Concor) and Krishak Bharati Cooperative Ltd—have received licences to run container trains between various ports and inland locations in the country. However, RIL hasn’t applied for license till now but may go for it in the next round.

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Opinion •

This move by Reliance would hugely benefit its other subsidiaries as it would not have to now depend on Indian Railways for transferring goods. Besides being profitable in the long run, this would also increase its efficiency and reduce the time taken for transfer.

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Moreover, it would also help in its plans to set up Reliance retail stores throughout the country apart from generating income by serving other companies who are interested in tying up with RIL.

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Also, this sector is now perceived as an opportunity by many other companies which would result in a new round of bids to run container trains thus improving efficiency and ultimately benefitting the end consumer. 

WORTH A READ Appreciating Rupee Once the rupee traded at 47 or 48, the rupee now hovers at 40 to the dollar. It is the fastest appreciation of the Indian currency in three decades. This raises fundamental questions like: • • •

Is the rising rupee good or bad for India? What impact will it have on the global competitiveness of Indian firms? Should the RBI or the Finance ministry intervene?

We will try to answer these questions in this article but we must first look at the reasons for the sharp rise in rupee.

Rise of rupee Dollars are pouring into India. Net investments by foreign institutional investors (FIIs) were $10.16 billion during January-June 2007. This is more than the $8 billion recorded in the whole of 2006. The foreign direct investment (FDI) numbers are equally impressive. In 2006-07, FDI inflows touched $19.53 billion, a 153% increase over the previous year. This figure includes private equity and also $3.5 billion in reinvested earnings. The government is looking at a target of $30

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billion in 2007-08. Foreign exchange reserves stood at $229 billion on August 31. This is a far cry from $5.8 billion in the dire days of March 1991, when India had to sell its gold to stave off a default crisis. External commercial borrowings of Corporate India were $12.1 billion in April-December 2006, an increase of 33%. Remittances from Indian workers abroad principally in the Gulf -- rose 15% to $19.6 billion in the same period. NRI deposits, attracted by better interest rates, were also up 35% in 2006-07 to touch $3.8 billion. These foreign exchange inflows have pushed the exchange rate to around Rs 40 to the dollar. The rupee has risen nearly 10% against the dollar this year. It has appreciated more than 14% from a low of 47.04 in July 2006.

Impact on Indian IT industry and exporters The rise has affected the operating margins of Indian IT companies. Wipro reckons that its operating margins were lower by 2.4% in the first quarter because of the currency appreciation. More than the large companies like TCS, Infosys, Wipro, Satyam, it is the small medium enterprises (SME) that rely heavily on US market are bleeding. Garment exporters and auto part suppliers bank on the dollar appreciating routinely after signing a contract. Now it is the other way around. I think these companies will be affected more than IT companies. The Confederation of Indian Industry (CII) says that the worst hit are the textile and leather sectors. A survey by the Federation of Indian Chambers of Commerce & Industry (FICCI) says sectors such as automobiles, consumer durables, food and food processing, gems and jewelry, textiles, handicrafts, and metal and metal products will be particularly impacted. 65% of our exports come from the SME segment. There are 15 million workers in this sector. The SMEs have profit margins of barely 5-10%. If the rupee rises, as it has, their entire profit gets wiped out. Total exports are about 20-21% of GDP more than the entire agricultural sector. The scale of job losses that could take place in the SME sector will hurt the economy even more than inflation.

Role of Government The situation is a reflection mainly of the trilemma that governments face; you can only have two out of three things. If you want to have a stable currency, an independent monetary policy and capital account convertibility, you can't have all three. You have to give up one. The positive feeling about the Indian economy is bringing in a lot of capital. The only way India can absorb this capital is to let the exchange rate appreciate. Many people feel the appreciation has gone beyond what is reasonable. But this is a balancing act. What else can the Reserve Bank do? It can intervene to stabilize the nominal exchange rate, and that will generate some liquidity. It can stabilize the liquidity, but that will impact the exchange rate. Whatever it does, there will be some problem.

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In an effort to force down the rupee's value, the RBI bought 28.4 billion in dollars between January and May 2007 and release rupees in the market. The sloshing liquidity leads to inflation, which is not politically palatable either.

Verdict The strong rupee is good for Indian companies seeking to make acquisitions abroad. When your deals are worth billions, it makes a difference. Airlines benefit. It is now cheaper for Indians to travel to the U.S. This is also a great time for Indian companies to buy equipment and technology products from the U.S. Companies that buy components from the U.S. are in good shape. It is a lot cheaper for an Indian PC manufacturer to buy an Intel chip or a Motorola phone. Mobile phone operators benefit from the strong rupee. As the Indian economy grows, the rupee will grow stronger. You can't get the benefits of globalization without feeling the other effects. Indian companies may not be affected much if their international competitors' currencies have also appreciated. However, China has suppressed the value of yuan and this will affect the market sale of Indian companies in U.S. Strengthening of currency is part of economic development and India is no different. Sure, this will effect the SME exporters but the benefits cannot be ignored. These exporters should look for new geographies or try to move up the value chain to maintain their margins.