Tuesday, October 27, 2009

>Venture Capital and Private Equity Investment in India

The face of global PE and VC is changing dramatically in the last few years. 2006 has witnessed the inception of funds infringing the threshold of $10bn – i.e. Blackstone’s $15bn buyout fund and the venture of KKR (Kohlberg Kravis and Roberts) on listed markets.

At the same time the amounts raised by these funds are growing to unimagined limits (about $300bn in June according to Bloomberg) giving great focus and tremendous attention to these kinds of alternative investments.

Following such developments and the ever mounting pressure of this flattening and globalizing world, there is an increasing need for funds to diversify internationally.

The factors stimulating the drive to go global can be summarized in the following:

The need of funds to globalize is driven both by their requirement to mitigate their risk exposure by investing in different countries as well as to tap innovation, which is occurring around the globe.

Adding an increased international competition and the higher cost of building a company in mature markets, the quest for global cost-efficiencies will mark the rise of future PE and VC trends.

Funds increasingly need to look at India, China, Russia and Brazil to take advantage of the global outsourcing and off-shoring as well as to exploit these low-cost/high talent markets.

In a world of cross-pollination, cross-border and cross-sector influences the leading form of investment for global funds will be much like Multinational corporations through international collaboration. Global investors are forced to seek out local funds in emerging innovation hotbeds to help understand the chased market, addressing due diligence in the correct way and penetrate their large developing consumer markets.

As the VC and PE industries mature, experts are pointing to a growing divide between the performance of the top-tier players and that of their smaller players, and it goes without doubt that scale is a big contributor to over-performance.

A recent survey conducted by the Emerging Markets Private Equity association (EMPEA) states that 65% of interviewed managers declare a future increase in interest (compared to 45% in the same survey in 2004) to invest in emerging markets1. According to the National Venture Capital Association (NVCA), India is the second most attractive location, gathering the positive attention of 18% of the American fund managers.

Given these conditions, this research is meant to cover India as a possible investment target: starting from a portrayal of the current Private Equity situation in India; it shall cover the legal and tax angle of funds establishment, the macroeconomic situation and its likely impact in the short and long term.

Moreover it will contain a description of its most renowned investment targets: the information technology industry and the real estate sector.

Finally, it will benchmark the current performance analysis to China and Brazil and stress the advantages and disadvantages of India.Inc.



First exploration well in KG D9 dry; retain Underperform: The first exploration well in the KG D9 block of Reliance Industries (RIL) has been abandoned due to poor results. The KG D9 block is believed to be one of the most prospective exploration blocks of RIL. On the basis of just one dry well one cannot conclude that KG D9 would not see large reserve accretion. However, the dry well is a setback. Investors may less aggressively value exploration upside after the KG D9 dry well. Our PO includes exploration upside of Rs419 with KG D9 at Rs210 being 50% of it. RIL’s shares factor in even higher exploration upside of Rs679 in our view. We reiterate Underperform on RIL.

Disappointment in first well drilled in KG D9

Large reserves in D9 still possible but potential may be cut: Hardy Oil has indicated that it may revise reserve potential in KG D9 after the first dry well. Risked prospective gas resources in KG D9 were estimated at 10.8tcf in May 2009. The risked prospective resources in lower and Middle Miocene play targeted by first well were 8tch with that in the largest prospect (it may have been first drilled) being 1.65tcf. One dry well may mean nothing. Large reserves may still be found in KG D9. Note that even in RIL’s Kg D6 block, which has 3.6bn boe of 2p reserves and resources, 10 of the 28 wells drilled were dry. At least three more exploration wells are planned in KG D9. Earlier guidance was of nest well in 2H 2010E.

Less aggressive exploration upside after KG D9 dry well?: In our view, RIL’s stock currently prices in 11.6bn boe of reserves, which is 2.5x its 2P reserves of 4.7bn boe. Its shares factor in US$20.9bn (Rs679/share) of exploration upside, in our view (see Table 4). After the dry well in KG D9, investors may less aggressively value exploration upside in RIL.

To read the full report: RIL


RBI’s new draft proposal to streamline PLRs: The RBI has put out a draft proposal (for consideration) recommending that banks should create a “base rate” to substitute the PLR (prime lending rate) to ensure greater transparency in fixing of lending rates. The base rate would be benchmarked to a banks’ retail deposit costs adjusted for the impact of SLR and CRR, minimum overhead costs and average ROE. Further, banks’ would not be allowed to provide less than15% of loans “below the base rate”. Few categories of loans (like credit card receivables, loans to bank employees’ etc have been excluded).

Linkage between lending and deposit rates more visible: In our view, the proposed recommendations would force a strong linkage with deposit rates and enhance transparency in loan pricing and help reduce the proportion of sub-PLR (est. at 67% as per RBI) lending as PLRs had become redundant. Further, it should help remove the “stickiness” in loan rates when deposit rates are cut. It would, however, push up rates of many AAA rated borrowers that were getting loans at much below PLR, given the cap of 15% for loans “below base rate”.

Base rate to substitute PLR:
More transparency in pricing

NIM impact minimal post “base rate” (8.5-10%): We don’t expect bank margins’ to be materially impacted (assuming proposal is implemented) post re-alignment in rates in key sectors / low rate loans. The effective “base rate” is likely to be around 8.5-10% for many banks. While substantially below many banks’ current PLR, it is in sync with the prevailing rates. Moreover, banks lending rates will also price in the operating costs, credit risk premium and tenor premium. Hence, spreads could easily be +400bps over the base rate for many SME segments. No cap on spreads. Educational loan is a segment where banks’ lending rates may be lowered by 1.5-2%; but corporate loans at 7%. Export rate not impacted. Further, ‘floating rate loans’ (like mortgages) banks’ can use external benchmarks (besides base rate), if required.

Impact on earnings not significant: In our view, the proposals, if accepted, are likely to be implemented only by early CY10. Hence, impact on Fy10 earnings should be minimal – even if we see some shift in borrowers to mutual funds (near term). Impact on FY11 earnings too may be limited owing to limited impact on margins. Further, with credit picking up and rates bottoming out, the shift to other sources may get reduced and banks may actually get more leverage with borrowers enjoying very low rates!

To see the full report: BANKS


Performance in line with expectations; uptick seen across segments: Rolta’s Q1 results clearly indicate the improving traction across its three business segments. The engineering segment has seen stability with marginal revenue growth after two successive quarters of decline, while the GIS segment continued to deliver profitable growth. The GIS division posted top line growth of 7.2% Q-o- Q and EBITDA margin expansion of 280bps to 46.8%. Company level operating profit margin improved 200bps to 35.6% Q-o-Q driven by cost rationalisation and better utilisation. Rolta’s order accretion remained healthy with INR 4 bn worth of new orders, taking the company’s total order book to INR 16.6 bn (up 3% Q-o-Q). However, despite better profitability during the quarter (vis-à-vis our expectation) higher depreciation and tax rate dragged down the net profit in line with our expectation.

GIS business segment drives performance: The company, with its unique solutions, has created a strong niche in the GIS market. With leadership in the Indian defence geospatial market and high exposure to the government its GIS business has more than offset the impact of slowdown in the engineering segment. Further, as its Fusion solution has gone live, profitability of the segment has increased to 47% at the EBITDA level during the quarter. We expect this business segment to grow ahead of the company’s growth rate.

Revenue momentum picks up with better profitability

Equity raising could be in the offing: Rolta has passed an enabling resolution to raise funds up to USD 250 mn through instruments like ADRs/GDRs/FCCBs/QIPs/Warrants or private placements of any other form of securities convertible into equity shares. Though the company has indicated that it has no plans currently to raise equity, we understand it could be particularly targeted to deleverage the balance sheet (current net debt of ~INR 8 bn, i.e., USD 172 mn). Though an option, the company is not pursuing any acquisitions actively currently. In case of full USD 250 mn being raised, equity will be diluted by 28%.

Outlook and valuations: Growth momentum returning; maintain ‘BUY’: Past two quarters have seen sharp increase in Rolta’s order intake, the impact of which in terms of better growth rates will be seen in the P/L during forthcoming quarters. We maintain our estimate of revenue growth of 12% and EPS estimate of INR 16 for FY10. At CMP of INR 187, the stock is trading at P/E of 11.7x FY10E and 9.7x FY11E earnings. We maintain ‘BUY’ recommendation. On relative return basis, the stock is rated ‘Sector Outperformer’

To see the full report: ROLTA INDIA


Lower commodity prices aid margins; execution remains strong: Bharat Heavy Electricals’ (BHEL) Q2FY10 earnings, at INR 8.57 bn (up 39% Y-o- Y), were ahead of our estimates on better-than-expected execution (revenues 4% higher than estimates) and lower commodity costs. EBITDA margins improved 340bps Y-o-Y, to 18.3%, on lower material costs (56.4% in Q2FY10 vis-à-vis 58.4% in Q2FY09, a 200bps improvement). Q2 revenues were up 24% Y-o-Y, to INR 67.2 bn, propelled by a strong quarter for the power segment (revenues up 23% Y-o-Y).

Order backlog at INR 1.26 tn; intake slower in Q2: Q2 order intake at INR 80 bn, down 40% Y-o-Y might look disappointing but in our view too much should not be read into the same. in our view. Management remains confident of achieving its INR 500-550 bn target and closing a few pending private orders in H2FY10. Q2FY10 order backlog stood at INR 1.26 tn.

Lower commodity prices aid margin

Capacity expansion on track: Capacity expansion, to 15 GW, is expected to fully complete by December 2009- March 2010, while the second phase of capacity expansion (from 15 GW to 20 GW) has already commenced. The company expects to complete ordering for the second phase of capacity expansion by end of FY10, while the capacity expansion itself will be complete by December 2011.

NTPC bulk tendering in FY11 to determine competitive landscape: NTPC bulk tendering orders of 11x660 MW is likely to be finalised in FY11. As per the terms, BHEL is likely to get orders for six boilers sets and five turbine sets, provided it matches the L1 bid. We believe, the outcome is important as it will provide competitive insight. In our view, margins for BHEL could suffer during the initial phase of indigenisation (super critical) and aggressive bidding by new entrants like L&T.

Outlook and valuations: Introducing FY12; maintain ‘HOLD’: We are introducing our FY12 estimates, charting 33% CAGR revenue growth over FY10-12E, driven by lumpy delivery schedule in FY11 and FY12. Despite its steep valuation (P/E of 21x and 17.2x FY11E and FY12E, respectively) BHEL remains our preferred pick as in our view competitive intensity is likely to pick up in the Twelfth Plan. However, near-term upsides continue to be limited, in our view. We maintain ‘HOLD’ and ‘Sector underperformer’ on the stock.

To see the full report: BHEL


Policy rates likely to remain untouched: The Reserve Bank of India (RBI), on October 27, 2009, will go in for a half-yearly review of the Annual Monetary Policy announced in April. The October policy review is not expected to result in any change in key policy rates and reserve requirements—repo rate (4.75%), reverse repo rate (3.25%), and cash reserve ratio (CRR, 5%). Of keen interest will be any indication on the timing and manner of a likely ‘exit’ from the expansionary measures pursued by the central bank. We believe RBI will have to undertake some tightening measures in Q4FY10.

Economy shows resilience; growth sets in………….: For the bulk of H1FY09, monetary policies across emerging economies, including India, were fighting inflation and managing excess liquidity. H2FY09, on the other hand, shifted focus to reviving growth. Accordingly, accommodative policies and stimulus injections shielded economies from further upheavals and facilitated growth stabilisation. All along, the Indian economy showed much more robustness than most peers, with Q1FY10 clearly reflecting a return to the growth trajectory, strongly led by recovery in the industrial sector. Around this time, policy actions that yielded reasonably low interest rates extended the much required impetus to growth. The last quarter also witnessed concerted efforts by RBI and the government in moral suasion of banks to reduce interest rates and attend to the credit needs of industry, without compromising on quality. Sentiments were pumped when RBI, in its previous review, assigned an ‘upward bias’ to its 6% GDP growth projection for FY10.

Maintain accommodative policy rates; nurture incipient growth

………..but, inflation fuels concerns: While growth has bounced back, domestic conditions have gradually begun to warrant a need to revisit some of the expansionary policies adopted by the central bank during the past one year. Inflation expectation is one such concern that is gaining centre stage. With the headline inflation number being largely misleading at the moment, all eyes are fixed on other pressures that could further fuel inflation. RBI’s inclination of keeping a check over such expectations was clearly evident when it raised its March-end inflation projections for 2010, on the back of mounting pressures from food articles’ prices, in addition to tweaking its policy stance which is as follows:

• Managing liquidity actively so that government’s credit demand is met while also ensuring flow of credit to the private sector at viable rates.

• Keeping a vigil on the trends and signals of inflation and being prepared to respond quickly and effectively through policy adjustments.

• Maintaining a monetary and interest rate regime consistent with price stability and financial stability supportive of returning the economy to the high growth path.

To read the full report: RBI POLICY PREVIEW