Friday, March 5, 2010

>Lessons from the Greek crisis

The fiscal position in the euro zone overall compares favourably with the United States, the United Kingdom and Japan in terms of both the government deficit and debt ratios, and the area has adequate domestic savings, as demonstrated by its balanced external trade accounts. However, the slide in the public finances of a number of countries in the zone led by Greece (Chart 1) has caused a very sharp rise in sovereign debt yields (Chart 2). Portuguese and Spanish bonds have been affected by contagion. Under attack from the markets, Greece has been given explicit support by the European Union: “Euro area members will take determined and coordinated action if needed to safeguard stability in the Eurozone as a whole”. It was defence of the financial stability of the whole euro zone that was stressed in the 27 EU countries’ statement, but the message to the markets, together with support for the Greek government’s current efforts to clean up its public finances, was very clear.

Default is not an option. Default would lead to contagion, causing yields to rise, and to more intense measures to rebuild public finances which would be likely to push the euro zone back into recession. Banking systems, which have in the short term financed the purchase of government securities, would also be affected, not to mention the risk to liquidity that would be created by further downgrades of sovereign ratings (the ECB only accepted paper rated A- before the crisis, but has cut its requirement to BBB+, although it has announced its intention to return to the previous level at the beginning of 2011).

The technical details of any plan have not been disclosed, but would not be without legal and political difficulties (Coordinated bilateral assistance? Early payment of European funds? Bridging loans? Guarantees from national treasuries?). On 16 March, the Greek authorities will have to provide a detailed timetable of the planned measures for reducing the government deficit by 4 points of GDP in 2010, and by about 10 points by 2012, as laid out in the stability and convergence plan approved by the European Commission at the beginning of February. If it looked as if the 4 points of GDP deficit reduction target is not going to be met, additional measures would have to be taken, on terms set by the European Commission, which has felt it necessary to call on the technical skills of the IMF. These arrangements are unprecedented. Greece has now been placed under strict surveillance and any assistance (it should be borne in mind that the Greek authorities have not yet officially asked to be helped) is subject to conditions. What must be avoided is the appearance of a bail out, since this is prohibited by the Maastricht Treaty.

To read the full report: GREEK CRISIS


Financial Technologies (FT) operates the largest commodity (MCX) and currency exchange (MCX-SX) in India. The company has evolved from a technology provider for exchanges to an incubator of exchanges and provider of related services such as clearing, warehousing, collateral management, risk management and data needs of users through “ecosystem” ventures. Its in-house technology enables it to set up exchanges at a cost and time-to-market advantage compared with international exchanges. The company's current portfolio includes ten exchanges and six ecosystems across Asia and Africa, trading in assets such as commodities, currencies, energy and equity.

MCX, MCX-SX key value drivers: With initial investments of US$10m-50m, the company has incubated exchange successes across commodity (MCX) and currency (MCX-SX), which have [1] market leadership with market shares of 83% and 51% respectively, [2] monetization at entity valuations of about US$1b, and [3] provided the venture capital to incubate four new exchanges. We expect MCX and MCX-SX to contribute 41% to our target price for FT. The success of its new exchanges could provide upsides to our estimates.

Play on non-linearity across ventures: FT is a play on operating leverage with increased sales coming with increasing margins across all its ventures. Over FY09-12, we expect [1] EBITDA CAGR of 30% (v/s revenue CAGR of 12%) in the technology business, [2] EBITDA CAGR of 56% (v/s revenue CAGR of 33%) in MCX, [3]
PAT CAGR of 40% (v/s revenue CAGR of 24.5%) in NBHC.

Technology business – fuel for the fire: Brokerage solutions/ exchange solutions for setting up exchanges fuel FT’s ventures across asset categories. In brokerage solutions, the company has a leadership position with over 80% market share in India, with more than 480,000 active licenses of its flagship product ODIN and presence at even competing exchanges like NSE, BSE, NMCE and NCDEX. We expect the technology business to contribute 34% of its target price and expect it to continue to be the key differentiator in reducing time to market and capturing downstream revenue.

Initiate coverage with a Buy, target price of Rs1,822: We value the stock based on the SOTP valuation, valuing [1] core business at 13x FY12 earnings in line with mid-cap IT valuations, [2] MCX at 18x FY12 earnings, [3] MCX-SX at 1.1x strategic sales valuation, [4] NBHC at 13x FY12 earnings, and [5] other investments at 1.5x invested capital. We initiate coverage with a Buy and a target price of Rs1,822.

To read the full report: FINANCIAL TECHNOLOGIES

>IT SERVICES: Consulting and Outsourcing summary takeaways (GOLDMAN SACH)

A confluence of technology changes is helping boost a cyclical recovery. Although IT services is relatively mature, we find pockets of growth and secular prospects. Across our presenting companies various technology changes were cited as key drivers of growth including the increased convergence of marketing spending and technology integration, the evolution of the application environment and the adoption of cloud initiatives, platform and IP-based solutions enabled by SaaS delivery models.

Vertical commentary provides a view on distinct industry drivers. Moving beyond the technology drivers, we found various examples of industry specific issues in telco, health care, public services, and financial services driving demand.

European demand questions continue to linger. With Capgemini presenting at our conference we continued to field demand questions related to Europe. At this point, we know that Europe will trail the US by about 6-12 months given the lagging nature of its recovery. That said, the key leading indicators including major sequential trends in utilization, new head count additions, pipeline activity, offshore efforts, and pricing were pointing the right direction but would not convert to growth until 2H2010.

MNCs highlighted fully integrated model as a key differentiator. End-to-end capabilities are a requirement for winning large transformational contracts.

To read the full report: IT SERVICES

>India Financial Services Budget F2010 – Key Takeways

The Union Budget announced on Friday (Feb 26) was moderately positive for Indian banks/NBFCs: There were five key announcements from a banking industry perspective:
a) lower government borrowing program on a YoY basis;
b) government plans to infuse equity capital to the tune of US$ 3.5bn in SOE banks;
c) the RBI is considering giving fresh bank licenses;
d) extensions of farm loan waiver scheme by six months;
e) extension of the interest subvention scheme for low-cost housing financing by one year. We discuss these in greater detail in the following paragraphs.

1. Reduced tail risk from bond holding for SOE banks…but near term pressure likely to persist: The Central Government indicated that its net borrowing requirement will be Rs3,450 bn in F2011 – i.e. 13% lower than in F2010. We believe this helps reduce the tail risk of a very sharp rise in long bond yields. In the near term, there may be some pressure from the higher taxes on certain oil-related products (and consequent impact on inflation). But we expect the yield curve to start flattening, a positive for deposit-rich banks.

2. Capital infusion in state-owned banks: The government announced plans to infuse equity capital to the tune of Rs165 bn (US$3.5bn) in SOE banks so as to ensure they are able to attain a minimum 8% Tier I ratio
by Mar-11. This is a big pickup from the Rs19bn infused in F2009 and Rs12 bn in F2010. The government would fund Rs150bn out of the total Rs160bn using the loan secured from the World Bank for the purpose of capitalizing SOE banks.

Banks that would benefit from this would be those where the Tier I ratio is already weak and where government ownership is close to the minimum requirement of 51%. As can be seen in the Exhibit on the previous page, the banks that stand to benefit include IDBI Bank, Dena Bank, Vijaya Bank and Andhra Bank. Given the relatively large amount provided by the government, we believe that the other SOE banks will also receive equity for funding growth plans from the government.

3. RBI considering giving out fresh banking licenses: The Finance Minister indicated that the RBI is considering giving additional licenses to private sector players and NBFCs. As of now, there is no additional information with regards timeline or the criteria that RBI would use to give out licenses. This move
will be beneficial for NBFCs, since it could give them access to more stable deposit funding. Below we give a list of covered and non-covered names in this space.

To read the full report: INDIAN FINANCIAL SERVICES

>India Cement: Key Takeaways of Budget 2010 (MORGAN STANLEY)

We remain positive on the industry: We believe that demand/supply dynamics will remain favorable over the next few months, driven by strong demand momentum and our expectation of a modest increase in effective industry-wide capacity. We estimate that capacity utilization will inch higher, leading to increasing cement prices and potential earnings surprises. In our view, companies are in a position to pass on the impact of higher excise duty in the Budget, given current demand. We reiterate our Attractive industry view and OW ratings on Ultratech, Ambuja and ACC.

Key Budget highlights and likely impact:
• Increase in excise duty from 8% to 10%: This was in line with our and consensus expectations. Given the current demand/supply scenario, we believe companies will be able to pass this on. A couple of management comments in the press after the Budget (businessline) corroborate our view.

• Clean energy cess of Rs50/ton on both domestic and imported coal: This will have a marginal impact of around 50-60bps on EBITDA margins, if not passed on.

• These would be partly offset by a 250bps reduction in the surcharge on income tax, to 7.5%: This, in turn, leads to a lower overall tax rate of 33.2%, from 34% earlier.

Besides these, there are a few other highlights of the Budget that we believe are important for the industry.

Infrastructure focus – potential positive for demand: The government reiterated its focus on infrastructure
and rural development. Expenditure on initiatives that could result in increased cement consumption (see chart on page 2) has been raised relative to the previous year. While the impact of this is uncertain, in our view, it will provide an impetus for cement demand in the next 12 months. This makes us believe that our 10% demand growth assumption for F11e has upside risk.

Fuel price hike likely to lead to increased freight rates; likely to passed subject to demand-supply dynamics: In the Budget, the government restored a 5% import duty on crude oil, resulting in a per-liter increase of around Rs2-3 in petrol and diesel prices. As per general expectation, this is likely to be passed on by the transport companies. Given that freight comprises around 20-25% of total costs for cement companies, it would lead to an increase in total costs, resulting in some margin pressure if the companies did not pass it on. However, given our expectation of a balanced demand/supply environment over the next few months, we believe that the companies will be able to pass this on at least partially. Moreover, the impact is not likely to be seen before the Jun-10 quarter, in our view.

We believe that focus on infrastructure and rural employment bodes well for cement demand. The key policy changes are largely on expected lines and should broadly be margin-neutral in the near term, given our view that companies will pass on the impact of higher excise duty.

To read the full report: INDIA CEMENT