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NiveshakTHE INVESTOR VOLUME 3 ISSUE 11 November 2010 ! The Good, The Bad and The Ugly Q2 Results RALLYING STOCK MARKETS DUE THE IMPACT OF RISE IN CRUDE OIL PRICES to HOT MONEY INFLOWS PG.08 ON THE INDIAN ECONOMY pg.20
CONTENTSNiveshak Times Fingyaan04 The Month That Was 16 Mergers and Acquisitions in a Recession finsight Cover Story 19 Axis Enam Merger11 Q2 Results – The Good, the Bad and the Ugly! CLASSROOM 23 Arbitrage Article of the month 08 Rallying Stock Markets due to Hot Money InflowsPERSPECTIVE20 The Impact Of Rise In Crude Oil Prices On The Indian Economy FINLOUNGE 24 Crossword
www.iims-niveshak.com The Niveshak Times IRELAND TO SEEK EU-LED BAILOUT AS FINANCE MINISTER BRIAN LENIHAN WORKS TO AVERT BANK COLLAPSE TEAM NIVESHAK IIM, Shillong DOMESTIC BUSINESS erty loans above Rs. 75 lakhs, IDBI also increased its Power Grid FPO garners 14.88 times oversub- interest rate for same by 25 basis points. scription SEBI raises retail investor cap to Rs. 2 lakhs The FPO offer from Power Grid Corporation of SEBI has doubled the upper limit for retail in- India for its 84.17 crore shares in the price band vestment in public offers from Rs. 1 lakhs to Rs. of Rs. 85-90 per share attracted a 14.88 times over- 2 lakhs to encourage greater investor participation subscription of 1252.96 crore shares. The oversub- in share market through retail route. Now an inves- scription reflects the continuing investor enthusiasm tor applying for shares up to Rs. 2 lakhs in an IPO in stocks of state run entities which or FPO will be treated as retail investor which will was also evident during the big- make him/her eligible for 5% discount on subscrip- gest Indian IPO by Coal India Lim- tion’s face value. It is relatively easier to buy shares ited. This FPO, which is estimated through retail investment due to relatively lower to generate about Rs.7500 crore, share subscription by this category as compared to is a part of the government plan HNI and institutional investor community. The total to raise Rs. 40,000 crores in the shares at the disposal of retail investors shares in a current fiscal year through stake public offer has remained unchanged at 35% and the sale in state owned firms. After this FPO, the gov- corresponding allotments for HNI and institutionalThe MonTh ThaT Was ernment’s stake in Power Grid will come down from investors has also remain fixed at 15% and 50% re- 86.36% to 69.40%. spectively. RBI hikes interest rates by 25 basis points India and China ranked higher in IMF’s quo- To tame the rising inflation, RBI pushed up its ta interest rates by 25 basis points with repo and re- G-20‘s decision to increase the quota for emerg- verse repo rate being 6.25% and 5.25% respectively. ing economies by 6% in its meeting in South Korea Though the WPI based inflation fell down marginally has resulted in India and China being elevated to 8th from 8.62% in September to 8.58% in October, the and 3rd positions in quota status respectively. Now latter figure is still considered to be above “comfort India’s quota in this 187 nation body has increased level” by central bank, thus triggering its decision to from earlier 2.44% to 2.75% signaling its emergence continue with its trend of increasing lending rates. as a major player in It also tightened its norms on high value property new world econom- loans as it increased the risk weight on property ic order. Emerging loans exceeding Rs. 75 lakhs from 100% to 125% ir- economies contrib- respective of its LTV (Loan to Asset Value) which also ute about 47.5% to has been subjected to an upper limit of 80%. This world economy in is likely to increase the difficulty of access to these terms of PPP (Pur- loans as the banks are likely to reciprocate with a chasing Power Par- hike in lending rates for such loans. ity) whereas their IDBI goes for a rise in interest rates corresponding share in IMF prior to this decision stood at 39.5%. In view of policy rate hike by RBI, public sector bank IDBI pushed up its interest rates by 50 basis India and Malaysia sign a free trade pact for points. The benchmark prime lending rate has been next year raised by 25 basis points to 13.50% with effect from India and Malaysia finalized a Comprehensive 4th November. It also raised its retail term deposit Economic Co-operation Agreement, CECA that is like- rates by 10-50 basis points for its various maturity ly to increase annual bilateral trade to $15 billion by schemes. With RBI increasing risk weight for prop- year 2015. Malaysia exports electrical and electronic 4 NIVESHAK VOLUME 3 ISSUE 11 november 2010
Rallying stock markets due to HOT money Inflows Akash Agarwal & Abhishek Dassani XLRI Jamshedpur Since January of this year, there in nearly $4.3 billion into the In- The Indian stock has been a surge in equity value dian markets in November and al- market has been on across almost all the emerging mar- most $28.64 billion since the start of the rise on account kets and India is no exception. Last this year. The domestic institutions of the “hot money” month, the Bombay Stock Exchange have been a net seller which has (BSE) Index (Sensex) closed at over helped in meeting the FII demands. inflows from the 20000 points, while National Stock ”Hot money” refers to funds FIIs. Currently, a lot Exchange’s index, the Nifty, closed at that are controlled by investors whoAoM of investments are over 6000. Sensex jumped over 15 per actively seek short-term returns happening in the cent since January, due to huge capi- (mostly FII’s). These investors scan tal inflows, making the Indian stock the market for short-term, high inter- emerging econo- market as one of the best performers. est rate investment opportunities and mies. While FIIs have move their money from one invest- Where did the capital inflows certain positive im- ment asset to another very quickly. come from? pacts on the econ- Usually, the capital inflows Higher FII inflows to India may omy, on the other be attributed to the unclear growth come from both the retail domestic prospects in the west (US has slowed hand they can also investors and the off shore investors down while Germany and UK are up- affect the economy in the form of foreign Institutional beat) and unchanged interest rates Investments (FII’s) and Foreign Di- in a negative man- rect Investments (FDI’s). This had signifying lower returns with the Fed- ner if they are in eral Reserve, European Central Bank been the case earlier during the mar- (ECB), Bank of England (BOE) keep- excess. ket rise of 2007 or before, but this ing rates unchanged. Funds seeking time it’s different. One of the major better returns moved to the Asian concerns that India is facing is that emerging markets and in particular, this ‘hot money’ is going into the India has received stock market rather than new proj- large por- ects and startup companies in the tion of form of long term fund- ing. the in- The investment in the vestment. stock market has more than doubled this year, Overall Impact of foreign direct invest- hot money inflows ment (FDI) into FIIs are usually India fell more not concerned about than 25 per- the issues of devel- cent, com- opment of the developing pared to the economies, whether or not this is same period ethical is another debate. Though a year earlier. there are obvious positive out- So far, FIIs comes for an economy due to the have poured incoming FIIs, these are also accom- So far, FIIs have poured in nearly $4.3 billion into the Indian markets in November and almost $28.64 billion since the start of this year 8 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
priving the country of the short term capital. For example, in 2008 India was growing at the rate of 9.2% but its growth fell to 6.7 percent, partly because the foreign investors took out bil- CROSSWORD SOLUTIONS lions of dollars from Indian stock and the bonds market. The decreased supply of capital severely OCTOBER 2010 hit the companies with large capital requirements. Thus, when the economy opens to the short term capital in the form of ‘hot mon- Across ey’ by the FII, the risk of the capital sud- denly moving out of the country increases. 4. Petrobras Conclusion It will not be wrong however, if we say that FIIs 5. CDOAoM have played a big role in the formation of capital in the country. Some academicians even say that 6. CBOT the overall liquidity in the capital market can be at- tributed to the hot money poured in the country by institutional investors. The surge in the rupee 7. Cairn due to steady flow of dollars in the country also has its own implications for the economy. However, on the downside there are some severe implications 9. Peter Lynch in terms of increased volatility in financial markets. This volatility significantly impacts the small local investors in these markets. If we look at the over- all trend in the stock market today, many Indians have become wary of the stock market. Individual Down investors, for instance, did not jump at the recent IPO of SKS Microfinance. The Coal India offering was 1. Revenue Recognition also subscribed only 2.1 X times by the retail in- vestors in contrast to the overall subscription of 15.3 times. In early 2008, however they clamored 2. Sarbox to buy public offerings such as Reliance Power. Another significant development that has 3. UTI AMC been observed is that the Indian markets are now no longer insulated from the world mar- kets due to the international flow of goods 4. Plowback and services and international flow of capital. 8. BVP “There can be fairly seri- ous risks associated with the escalating equity market if the hot money keeps pouring in India” - Eswar S Prasad, Professor of Economics,Cornell University10 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
based SUV maker, SsangYong Motor Co (SMC) can lever- ONGC’s Q2 net profit was up 5.87% YoY and age SMC’s strong R&D capabilities and global footprint. net sales were up 20.64% YoY, mainly due to in- Tata Motors Q2FY11 net sales were up 36% crease in crude oil sales volume by 11.3% and lower subsidies(Due to increase in retail price ofCover Story YoY led by strong performance from core busi- ness and significantly better performance from auto fuels, overall subsidies declined as a result Jaguar Land Rover. Luxury car demand remains ro- subsidy burden shared by the ONGC fell 45% QoQ bust particularly in China, Russia and the US. This to Rs 1480 crore). Gas business revenues improved was on the back of a strong response to the newly 41%. Other income almost doubled QoQ to Rs 906 launched Indigo Manza. The latest launch of Aria in crore, mainly on account of dividend income from the mid-premium UV segment is expected to fur- subsidiaries and higher interest income. Miscella- ther improve market share in this growing segment. neous also accounted for a large part of the rise. Maruti Suzuki for 2QFY2011 registered 27% OMCs: Post the deregulation of petrol prices yoy growth in net sales while net profit at 598cr re- in June 2010 and price increases in LPG/ kerosene, corded a 5% yoy jump. The production capacity has the three oil marketing companies (OMCs; IOC, BPCL been increased to 1.3mn units (from 1.2mn) through and HPCL) have delivered significant outperfor- de-bottlenecking exercise. The current production rate is 110,000units/month. In October’2010 with sales of 1, 18,908 units the company crossed the one-lakh mark in domestic sales for the first time. Company Revenue Net Profit EPS Hero Honda 4551.95 505.6 25.32 M&M 5434.36 758.49 13.36 Tata Motors 28782 2222.99 38.91 Maruti Suzuki 9147.27 598.24 20.71 Revenue and Net Profit in Rs. Crores mance (14-23%) against the Sensex since July 2010. Oil & Gas IOC net sales for Q2FY11 increased 26.8% Oil and gas industry in India is almost US$110 YoY due to higher crude prices and strong refin- billion and oil accounts for almost 44% of India’s ing margin of US$6.6/bbl compared with US$2.7/ primary energy consumption. Demand for oil and bbl for HPCL and US$2.8/bbl for BPCL. With com- gas is likely to increase from 186 million tonnes pensation of Rs. 7220 Crore from the govern- of oil equivalent (mmtoe) to 233 (mmtoe) in the ment its net profit stood at Rs. 5293.95 crore. year 2011-12. India is net importer of oil and its HPCL’s revenue increased 25.3% YoY dependence on imports is 80% which is likely to primarily due to higher subsidy pay out go up in near future which might also bring do- of Rs.2830 crore from the government. mestic oil price equivalent to international price. BPCL reported impressive earnings of RIL’s Q2 FY11 net profit was up 27.80 % YoY Rs.2142.22 crore supported by government subsidy largely driven by high operating rates and improved of Rs.2950 crore and forex gain of Rs. 300 crore. refining margins at US$ 7.9 per barrel as against US$ Company Revenue Net Profit EPS 6 per barrel in the corresponding period of the previ- RIL 57479 4923 15.05 ous year. Its net sales were up 22.69% (YoY) helped by higher gas output from its KG D6 block where it ONGC 18430 5388.77 25.19 aims to reach peak gas output of 80 million stan- IOC 77335.75 5293.95 21.8 dard cubic metres. Growth in the refining segment HPCL 30870.23 2089.61 61.71 was driven by the increase in throughput and high- BPCL 35434.77 2142.22 59.25 er oil prices. The company has struck three shale- Revenue and Net Profit in Rs. Crores gas joint ventures with US firms so far this year. With Chinese and Irish con- cerns along with US Federal Reserve’s QE2, it would be interesting to see how the economy unfolds in the coming months 12 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
With economy expected to grow robustly ics grew by 28%. This was boosted by acquisition of and good monsoons, it looks good for the bank- Derma Rx in May 2010. Rise in copra prices by 26% ing industry with credit growth bound to improve. attributed to 100bps reduction in EBITDA. Volume But, with RBI planning to give licence to NBFC’s growth has been good. So, due to rising costs, vol-Cover Story to open banks, competition will increase and de- ume growth may be prioritized over margin growth. celerate the pace of expansion. Also, focus on le- Moving onto Dabur, margins expanded by veraging branches, promotional activities to at- 29bps to 22.4% despite increased inflation and tax- tract customers will be the broad theme so as to ation. Hair care, its largest category grew at 5.8%. increase market share. Also, rising NPA’s will also Reduction in employee costs (% of sales) and ef- be a challenge, especially in retail and SME seg- ficient operations were main reasons for increase ment where loans are provided without adequate in margins. But, on the negative was 2nd succes- securities. RBI’s recent increase in Repo, Reverse sive quarter of de-growth in Shampoo business. Repo rates will influence the banks other income. ITC showed good performance in ciga- Company Revenue Net Profit EPS rettes despite hike in prices. For its FMCG space, margins have improved with person- SBI 19808.09 2501.37 39.39 al-care products and biscuits gaining stability. ICICI 6309.1 1236.27 10.91 Overall, high inflation will prevent companies HDFC 4810 912.14 19.8 from raising prices significantly in order to preserve Axis 3624.25 735.14 18.01 market share. But, good monsoons augur well for the Revenue and Net Profit in Rs. Crores FMCG sector. While competitive intensity will remain high, focus will be on cost and cash management. FMCG Talking of the FMCG sector, it was a mixed Company Revenue Net Profit EPS bag. It has been a story of declining margins due HUL 4764.67 566.12 2.59 to rising raw materials cost across the sector. MARICO 540 59.66 0.98 DABUR 800.5 126.18 0.72 ITC 5147.18 1246.74 1.63 Revenue and Net Profit in Rs. Crores Conclusion India Inc. is set forth for a good second half going by the Q2 numbers. But it remains to be seen if they can reduce the impact of higher input costs. Also, with increasing recruitment, salary costs will also tend to reduce margins.With selling pres- Hindustan Unilever Ltd. reported Q2FY11 sure seen in domestic markets due to Chinese and net profit of Rs. 566.12 crores versus Rs. Irish concerns, it will be interesting to see the impact 420 crores in Q2FY10 i.e. gain of 34.76% YoY. it will have on different sectors.Good demand was After adjustments, PAT stood at Rs.533.65 vs. seen in Auto and IT sectors, but 2G spectrum scam 499 crores i.e. a growth of 6.8%. All the three ma- will definitely impact telecom companies which are jor segments viz. soaps and detergents, personal already struggling due to competitive pressures. For products, and beverages showed growths of 6.3%, banking, second half of the year usually sees an in- 14.7% and 9.3% resp. But again, due to increasing crese in credit growth - which is good news. FMCG ad-spend the EBIT margins have slipped, by 190bp, space will continue to see rising product costs as the 330bp and 160bp respectively. Costs of basic raw companies will pass on the load to customers so as materials like palm oil, benzene have increased by to protect margins. Also, incresing participation by 46% and 100% resp. Company had to hike prices FMCG companies in international territories is some- in certain products so as to protect margins. Pre- thing to look forward to. With promising recruitment launch of brands like Rin, Lifebuoy did help to im- figures from Wipro, TCS and Infosys and good growth prove the bottom-line. It was 6th successive quarter guidance from HCL, IT is likely to take off. So, overall of double digit growth for personal care products. India Inc, looks set to continue their growth story and For Marico, there was a volume growth across tackle the competetive dynamics and international businesses with PAT growing 15% over Q2FY10. The pressures so that we continue to report many such main contributor was Parachute Coconut oil at 10%, success stories in the issues ahead. Saffola Oil at 18%. Revenues from Kaya Skin Clin- 14 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
Mergers and Acquisitions in a Ankit Sinha IIM Bangalore Introduction firms, as well as external factors While M&A may Mergers and Acquisitions such as global economic environ- seem a natural (M&A) are an important activity for ment and government regulations. the growth of any organization. M&A The major positive effects can mode of expansion be increased market share and lower activity can have significant ramifi- in a booming econ- cations for the management as well cost of operations due to economies omy, the reasons as the investors. While this may of scale. The emerging company may for pursuing M&A seem a natural mode of expansion be more competitive, with improved in a booming economy, the reasons profitability and enhanced EPS. Also, activity in recession- for pursuing M&A activity in reces- there can be an increase in the indus- ary times may not be sionary times may not be apparent. try knowledge of the organizations. apparent as pursu- Pursuing deals in recession seems On the other hand, the con- ing deals in reces- risky and impractical. Credit markets cerned companies may face signifi- sion seems risky and and equity markets are depressed. cant legal expenses and takeover Historically, M&A’s have eroded costs, both tangible and intan- impractical. How- shareholder value rather than cre- gible. There can be potential de- ever, strategic M&As ating it. However, strategic M&As in valuation of equity and lowered in recession can add recession can add value leading to industry innovation. The merger value leading to sig- significant advantage for companies. of two large firms can also sup- press competition, and may lead nificant advantage Pros and Cons of M&A Activity to increased costs to customers. for companies. The pros and cons are primar- Whether a merger or an acqui- ily decided by taking into account sition is successful depends on how the short term and long term ef- the positive and negative effects fects of M&As. This depends on weigh against each other. This is internal factors like nature and highly subjective to individual M&As. strategic outlook of concerned Name Period Characteristics Outcome Sources of Financing Wave 1890s-1903 Horizontal Mergers Formation of Cash 1 Monopolies Wave 1910s-1929 Vertical Mergers Formation of EquityFinGyaan 2 Oligopolies Wave 1950s-1973 Conglomerate Growth through Equity 3 Mergers diversification Wave 1981-1989 Hostile Takeovers, Elimination of Debt Financed/ 4 Corporate Raiding inefficiencies Cash Paid Wave 1993-2001 Cross Borders Adjustment to Equity 5 Mergers globalization processes .. “Going downhill, everybody picks up speed.”-Business Proverb 16 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
Exhibit 4: Average acquirer excess return during various years Advantages of M&A in recession ers. Several strategies can help the companies to Contrary to the popular beliefs, M&A activ- successfully carry out M&A activity in recessions. ity in recessionary times can lead to significant Firstly, organizations should define a corporate benefits. Companies that are strategically and fi- strategy which is at the core of the company and nancially superior will find rare opportunities in allows it to invest with a clear thesis. Danaher Cor- recession to improve their competitive position. poration can be a suitable example in this regard. For buyers, strong companies with short term It engages in M&A to strengthen its base of real as- risk may be available cheaply. For sellers, reces- sets. It made 10 acquisitions in last downturn, in- sion provides opportunity for strategic divestures cluding Gilbarco. Gilbarco turned out to be the part and portfolio rebalancing. As seen from exhibit 4, of the third most profitable product line in 2008. Acquisitions completed during and right after the Secondly, companies should also buy and di- last recession (2001-02) generated almost triple vest frequently and consistently through cycles. the excess returns (“Excess returns” is defined as They should always keep in mind a list of po- shareholder returns from four weeks before to four tential targets. For example, Cintas maintains a weeks after the deal, compared to peers) of ac- pipeline of priority targets and cultivates strong quisitions made during the preceding boom years. relationships with them. Thus, it can often ap- According to Bob Filek, partner with PwC Transac- proach a target long before other acquirers. Cin- tion Services, “M&A activity in 2010 will be driv- tas has sustained its sales growth for 39 years. en by strategic buyers who have access to capi- Thirdly, companies should tailor merger in-FinGyaan tal and the strategic vision to capitalize on some tegration efforts to deal thesis and the sources of the best values we have seen in recent times.” of value. This can be accomplished by increased due diligence from the M&A team. Often, buyers Strategies for M&As during recession in the same industry overlook the details as they From the previous discussion, it can be in- believe that they know the industry. They con- ferred that M&A activity in recession can lead to duct cursory reviews of the target company and significant benefits, and separate the leaders from are often surprised to find out the actual valua- the laggards. Organizations that proceed carefully tions to be much cheaper than they anticipated. can generate significant returns for their sharehold- Companies that are strategi- cally and financially superior will find rare opportunities in recession to improve their competitive position. 18 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010
THE IMPACT OF RISE IN CRUDE OIL PRICES ON THE INDIAN ECONOMY AMITKUMAR RAJANI Welingkar Institute of Management, Mumbai INDIA’S CRUDE OIL REQUIRE- needs. The Energy Information Ad- Crude oil is one of MENTS ministration (EIA) expects India to the most essential become the 4th largest net importer India is emerging as an eco- commodity. A slight nomic powerhouse of the 21st cen- of oil in the world by 2025, behind fluctuation in crude tury & a large consumer of energy the United States, China, and Japan. oil prices can have resources. Despite the global finan- OIL UNDER-RECOVERIES both direct and cial crisis, India’s demand for energy The dependence on crude oil continues to rise. But India still faces indirect influence tremendous challenges in meeting imports is chronic for a developing country like India as the current re- on Indian economy, its energy requirements. In order source utilisation pattern does not and will continue to to sustain the rate of growth, In- contain alternatives to imported dia needs to develop a reliable pool affect, considering of energy resources which can be crude oil. Further, in a situation of the fact that India is unabated rise in oil prices the prob- tapped in the long run. lem tends to get compounded. 6th largest importerPerspective Government Owned Oil Market- of oil in the world. ing Companies (OMCs) in India sell petroleum products (excluding Pet- rol) at a subsidized rate. The losses incurred by these companies are called “Under Recoveries”. The Gov- ernment of India compensates the OMCs for these under recoveries ei- ther through cash payment or issue Oil meets about 24% of India’s of bonds. commercial energy requirements. In 2009, with a consumption of 3 mil- Under recoveries of OMCs for lion barrels per day, India was the FY 2008-09 were Rs. 1,03,292 Crores. 4th largest oil consumer in the world The Government issued oil bonds to after the United States, China, and the tune of Rs. 71,292 Crores whereas Japan. the remaining burden of Rs. 32,000 Crores was shared by Upstream Oil India’s proven reserves of Companies. crude oil and oil production have not witnessed any significant improve- ECONOMIC IMPACT OF RISE IN ment in the last few decades. As OIL PRICES a result, India largely relies on im- India’s huge dependence on ported crude oil to meet its energy Imported Crude Oil makes it vulner- requirements. able to the shocks & disruptions In 2009, India was the 6th larg- in the Global Oil Market. Any sharp est net importer of oil in the world, spike in oil prices in the global mar- importing nearly 2.1 million barrels ket results in an unfavorable eco- per day, or about 70 %, of its oil nomic situation in India. The reasons In 2009, with a consumption of 3 million barrels per day, India was the 4th largest oil consumer in the world after the United States, China, and Japan 20 NIVESHAK VOLUME 3 ISSUE 11 NOVEMBER 2010