"If you can tell me something else where the fundamentals are so attractive...I'd be happy to put my money there," said Jim Rogers, the famed investor and self-made billionaire in a recent interview. "But I don't know of any other place."
What's he talking about? Agricultural commodities like soybeans, wheat and corn.
We begin our analysis with some simple "big picture" truths. The world's population has more than doubled since 1950 - from about 2.5 billion to 6.7 billion. By 2050, there will be more than 9 billion people on the planet. Almost all of this growth will occur in the emerging markets like China and India. And their populations will all be doing one thing, for sure - eating.
Now, hang on. I know that is a banal insight by itself, but this story has more layers than a tiramisu. After population growth, he second layer is the mix of food eaten, which is important. These undeveloped economies are becoming wealthier. Predictably, as people everywhere have done and continue to do when they have a little more money in their pockets, they change their diets. They spend more on food. The average Chinese person spends 40 cents of every additional dollar earned on food. In India, it's about 70 cents of every additional dollar. What do they buy?
They buy more meat, more fruits and more vegetables. Their calorie intake rises. That's why the UN says we'll need to boost food production by 70% by 2050 - a big task, given increasing restraints on water and quality arable land.
How do we meet that demand? Here the plotlines start to thicken and things get interesting...
Let's look at soybeans specifically. China is the largest importer of soybeans and has been since 2000. China was once the largest exporter of soybeans, but flipped to a net importer in 1995. It may well be impossible for China to meet its demands for soybeans by producing more of its own. Passport Capital, an astute hedge fund, estimates that in order to grow enough soybeans to become self-sufficient, China would need to cultivate an area about the size of Nebraska.
That looks impossible against China's arable land base, which has been in decline since 1988 - this despite the fact that China subsidizes agriculture. Another reason is the low level of water resources in China. (See the nearby chart "Who Has Water... And Who Doesn't.") Soybeans require a lot of water - 1,500 tonnes of water for one tonne of soybeans.
This chart is telling. Who has lots of water? Brazil. So it is no surprise to discover that the increase in demand for soybeans from China has largely been met by increasing soybean acreage planted in Brazil. (Brazil is the second largest exporter of soybeans in the world, behind the US and ahead of Argentina and Paraguay.)
The easiest way for China to get around its water shortage is to import soybeans. By importing soybeans, Passport calculates that China is effectively importing 14% of its water needs.
It looks likes this trend will continue for quite some time. When you look across the world, arable land per person is in decline. (Arable land simply means land that can be used for farming; it doesn't mean that it is currently used for farming.) But one nation has more potential for converting arable land into producing farmland than anybody else, by a country mile. It's Brazil again.
Brazil has a large tropical savanna known as the cerrado. You can think of it as the world's arable land bank. It's an area of about 250 million acres - about as big an area as all of the arable land in the US. It gets plenty of rainfall and sunshine. The soil is very old and runs deep. But there is a problem: The soil is nutrient poor. You need to add a lot of potash and phosphate - two key nutrients - to grow soybeans there.
According to estimates by SLC Agricola and Morgan Stanley, the average new acre of farmland in the cerrado requires 14 times the amount of phosphate and three times the amount of potash of a typical American acre. This means that it is expensive to grow grains here. You need a high soybean price to make it worth the effort - and there is more to it than just adding the nutrients. There is road and rail access, for instance. Someone would have to build all that out, too.
So now we are in a position to connect some dots on this story. China's increasing population and affluence will drive its soybean imports. These imports will come mainly from Brazil. And Brazil, as it converts more arable land to producing farmland, will need a lot more potash and phosphate.
What is true of soybeans is also true of wheat and corn and rice and other agricultural commodities. All of them face the same challenges for water and land. All of them require lots of fertilizer.
I've not mentioned the biofuel component. But this is another big pull on demand for grains. The US alone aims to produce 15 billion gallons of ethanol by 2015. All over the world, biofuel demand now competes with "dinner plate" demand for supplies of grain.
This is not a gloom-and-doom scenario. It simply means that there is a lot of support for higher prices for agricultural commodities. Inventory levels still remain low worldwide. Grain prices are all well off their highs. After adjusting for inflation, many of them are as cheap as they've been in decades.
This is why Jim Rogers said he likes the agricultural commodities. I couldn't agree more.
I also mentioned how this idea was hard to kill. In the Great Depression, purchases for jewelry and clothing and the like fell by 50%. But purchases for food - even for meat - held steady. We've seen similar patterns in recent busts. In the Asian Crisis of 1998-2001, the demand for food held steady, even while other markets collapsed.
Put it all together and you have a great case for higher grain prices. You also have an environment that is very good for fertilizers - in particular, potash and phosphate.
Tuesday, December 8, 2009
Sunday, December 6, 2009
Myth of penetration rate in emerging markets
The fundamental flaw in viewing just these penetration rates is ironically the demographics--the linchpin of the whole emerging market argument......
Since time immemorial man has looked for the next big idea and there have been financers wanting to get on the next gravy train. Oftentimes in the investment community, a story will peddle. One that has come to be a mainstay is either cellphones in India, cars in Brazil or some other consumable widget in a developing economy, and how those are set to grow since the penetration rates are so low.
Glossy presentations comparing penetration rates between developing and developed countries, the promise of outsized returns against smiling pictures of basket weavers toting next generation cellphones—if you are an investor in emerging markets, you have seen these missals once too many.
While there is no denying that emerging markets do have a huge potential for growth, we have often questioned the myth of the low penetration rates and the case of the magic gross domestic product (GDP) number. The magic GDP number is a mainstay of investment folklore. The premise is that at a certain GDP per capita, there is sufficient wealth created for the penetration rates to increase at an explosive pace. However, when you resort to an elusive GDP per capita to peddle your growth story, you know that the low hanging fruit has been picked off.
The fundamental flaw in viewing just these penetration rates is ironically the demographics—the linchpin of the whole emerging market argument. While most of these glossy dossiers speak of demographics and the bourgeois, what they overlook are the wide ranging income gaps between the haves and the have nots in these countries.
Countries such as India, China and Brazil have a majority population that is rural and relies on the agricultural economy. Admittedly, urbanization is on the rise but as is not uncommon knowledge, the majority in these countries would be content with having two square meals a day. Migrating them to the 4G network or up selling them the next economical car is a quantum leap. Instead of just having a blanket large population and citing low penetration rates, it might be worthwhile to gauge these rates against affordability metrics and how those are progressing.
A classic case is the auto penetration rate in Turkey. On the face of it, the penetration rate is at 10%—much lower than most developed countries. The low penetration rate, declining interest rates and a burgeoning middle class make for a classic emerging market story. However, the debilitating tax structure in Turkey puts a car purchase out of reach for most, resulting in minuscule improvements in the penetration rates because of poor affordability.
The magic GDP per capita number also falls flat here as Turkey’s GDP per capita is substantially high—about three times India’s—and fails to explain the low penetration rates. Even if GDP per capita is high, it might just fuel income inequality and need not guarantee a dramatic improvement in penetration rates. The rich will move on to their nth car but the low income population might still have to worry where their second meal will come from.
While demographics is a key selling point for most emerging market stories, ironically it is also the Achilles heel. Income and wealth inequality is not uncommon to most non-communist countries, but wretched poverty is common only to developing countries and to these masses, economic growth has meant little.
A common case study is the comparison between two former British colonies: Singapore and Jamaica. Both these countries started at comparable GDP per capita when they attained sovereignty. Both countries were faced with uneducated populations and poverty. Jamaica focused on its demographic bulge, and resorted to agriculture and natural resources, while Singapore focused on services and strict population control. Singapore enriched its existing population while Jamaica is still urbanizing its rural population. Today Singapore’s GDP per capita is eight times Jamaica’s.
The promise that urbanization will one day touch everyone’s lives is in no way definite. The companies that want to stake claim to your capital may well have the next cutting edge product, but is their addressable market ready to absorb and justify the investment and capital burn? Somewhere among the shiny presentations, look closer and you might well find a hint of the greasy salesman peddling the next sure-fire investment.
Wednesday, September 23, 2009
successful investor skills
The No. 1 skill that a successful investor needs is patience. You need to let the game come to you. My steady-state modus operandi is to assume that I'm just a gentleman of leisure, and that I'm not in the investment business. If something looks so compelling that it screams out at me, saying "Buy me!!," I then do a drill-down. Otherwise, I'm just reading for reading's sake. So, I scan a few sources and usually can find something scream out at me a few times a year. These sources (in no particular order) are:
1. 52-Week Lows on the NYSE (published daily in The Wall Street Journal and weekly in Barron's)
2. Value Line (look at their various "bottoms lists" weekly)
3. Outstanding Investor Digest (www.oid.com)
4. Value Investor Insight (www.valueinvestorinsight.com)
5. Portfolio Reports (from the folks who put out OID)
6. The Wall Street Journal
7. Financial Times
8. Barron's
9. Forbes
10. Fortune
11. BusinessWeek
12. The Sunday New York Times
13. The Value Investors' Club (www.valueinvestorsclub.com)
14. Magic Formula (www.magicformulainvesting.com)
15. Guru Focus (www.gurufocus.com)
Between all of the above, I have historically found at least three to four good ideas every year. Sometimes I make a mistake, and a good idea turns out to be not so good.
1. 52-Week Lows on the NYSE (published daily in The Wall Street Journal and weekly in Barron's)
2. Value Line (look at their various "bottoms lists" weekly)
3. Outstanding Investor Digest (www.oid.com)
4. Value Investor Insight (www.valueinvestorinsight.com)
5. Portfolio Reports (from the folks who put out OID)
6. The Wall Street Journal
7. Financial Times
8. Barron's
9. Forbes
10. Fortune
11. BusinessWeek
12. The Sunday New York Times
13. The Value Investors' Club (www.valueinvestorsclub.com)
14. Magic Formula (www.magicformulainvesting.com)
15. Guru Focus (www.gurufocus.com)
Between all of the above, I have historically found at least three to four good ideas every year. Sometimes I make a mistake, and a good idea turns out to be not so good.
Sunday, September 20, 2009
India as the new plutocracy
As India is on its way to becoming a plutocracy, what implications does it have for investors in India?
Beyond DCF: The Oxford Dictionary defines the word “Plutocracy” as a society governed by the wealthy. Accordingly, the “plutocracy” label is usually attached to countries such as present day Russia or to societies such as ancient Greece or the Republic of Venice in the 16th century. India is fast emerging as a heavyweight entrant of this club. Why do I say so and what implications does it have for investors? Let us focus on the “why” first.
Recently, the Asian Development Bank published a study (“India 2039 - an affluent society in one generation”) highlighting that that India has 50 billionaires who together control wealth equivalent to 20% of gross domestic product and 80% of stock market capitalisation. Concentration of immense wealth (and the power that goes with it) in the hands of a select few is one would think fairly commonsense criteria for entry into the plutocrats club.
Secondly, one of the features of the Indian stockmarket over the past four years has been the visibility and rising importance of realty, infrastructure and construction companies (loosely called “infrastructure” in this column). Infrastructure now constitutes nearly 20% of the BSE 500 by market cap, up from 13% five years ago. Whilst there are fundamentally sound reasons for this sector coming to fore, if there is one sector where politics and business works hand in glove to enrich each other, it is infrastructure. In our daily interactions with these companies and their financiers, we cannot but help notice how deeply embedded politicians and/or political power brokers have become in the Boardrooms of these companies.
Thirdly, there is the RIL-RNRL saga being played out in the full glare of the media. Leaving aside the vexed issue of which of the two companies is in the right, one cannot help being astonished by the sheer punch that each Ambani brother packs in the corridors of power in Delhi. Add to that the sheer size of two Ambani empires (the Reliance companies in totality account for 14% of the BSE 100’s market cap and nearly 6% of the Indian economy) and one can safely say that we are looking at not just two of the wealthiest people who have ever lived anywhere in the world but also two of the most powerful people in India.
So if India is on its way to becoming a plutocracy, what implications does it have for investors in India? The first and obvious implication is that to be a large and successful investor in the long run, you have to have strong political connections. As a contact of ours in the Infrastructure sector says “apart from experience, political connections matter a lot in winning small to large infrastructure/ construction projects”.
Beyond winning contracts, political connections also give you powerful informational advantages as is evident from the successful “political consultancy” business that a friend of mine runs in Delhi – he specialises in helping investors stay on top of the latest thinking in high places on subjects such as the 3G licenses, Governmental infrastructure subsidies, Governmental spending plans, etc.
Secondly, if politicians are as important for investment success in India as I am making them out to be, it stands to reason that rather than being satisfied by a base fee they will want a cut of investment returns. So investors’ “carry” or upside assumptions need to be revisited accordingly.
Thirdly, since most politicians’ careers fluctuate, unless investors are able to associate themselves with politicians from across the political spectrum, their investment returns too will fluctuate in line with the fortunes of their political contacts.
Finally, to the extent that what I have described above is already part of the status quo but is not reflected in your investment strategy, you might want to dig deeper into the ownership of the subsidiaries of listed Indian companies. You might then find some very powerful non-businessmen holding large stakes in the subsidiaries of listed entities. To understand the true value of the listed entity, you could then knock off from it value of the powerful non-businessman’s sizeable minority stake in the subsidiary. If you were the person holding the regulatory keys to the biggest infrastructure contracts, I don’t think you would be attaching any sort of discount to the value of your stake in those projects. Astonishingly that is what many analysts assume when they attach attractive valuations to such infrastructure companies with undisclosed investors at the subsidiary level. So much for the efficient market hypothesis.
Beyond DCF: The Oxford Dictionary defines the word “Plutocracy” as a society governed by the wealthy. Accordingly, the “plutocracy” label is usually attached to countries such as present day Russia or to societies such as ancient Greece or the Republic of Venice in the 16th century. India is fast emerging as a heavyweight entrant of this club. Why do I say so and what implications does it have for investors? Let us focus on the “why” first.
Recently, the Asian Development Bank published a study (“India 2039 - an affluent society in one generation”) highlighting that that India has 50 billionaires who together control wealth equivalent to 20% of gross domestic product and 80% of stock market capitalisation. Concentration of immense wealth (and the power that goes with it) in the hands of a select few is one would think fairly commonsense criteria for entry into the plutocrats club.
Secondly, one of the features of the Indian stockmarket over the past four years has been the visibility and rising importance of realty, infrastructure and construction companies (loosely called “infrastructure” in this column). Infrastructure now constitutes nearly 20% of the BSE 500 by market cap, up from 13% five years ago. Whilst there are fundamentally sound reasons for this sector coming to fore, if there is one sector where politics and business works hand in glove to enrich each other, it is infrastructure. In our daily interactions with these companies and their financiers, we cannot but help notice how deeply embedded politicians and/or political power brokers have become in the Boardrooms of these companies.
Thirdly, there is the RIL-RNRL saga being played out in the full glare of the media. Leaving aside the vexed issue of which of the two companies is in the right, one cannot help being astonished by the sheer punch that each Ambani brother packs in the corridors of power in Delhi. Add to that the sheer size of two Ambani empires (the Reliance companies in totality account for 14% of the BSE 100’s market cap and nearly 6% of the Indian economy) and one can safely say that we are looking at not just two of the wealthiest people who have ever lived anywhere in the world but also two of the most powerful people in India.
So if India is on its way to becoming a plutocracy, what implications does it have for investors in India? The first and obvious implication is that to be a large and successful investor in the long run, you have to have strong political connections. As a contact of ours in the Infrastructure sector says “apart from experience, political connections matter a lot in winning small to large infrastructure/ construction projects”.
Beyond winning contracts, political connections also give you powerful informational advantages as is evident from the successful “political consultancy” business that a friend of mine runs in Delhi – he specialises in helping investors stay on top of the latest thinking in high places on subjects such as the 3G licenses, Governmental infrastructure subsidies, Governmental spending plans, etc.
Secondly, if politicians are as important for investment success in India as I am making them out to be, it stands to reason that rather than being satisfied by a base fee they will want a cut of investment returns. So investors’ “carry” or upside assumptions need to be revisited accordingly.
Thirdly, since most politicians’ careers fluctuate, unless investors are able to associate themselves with politicians from across the political spectrum, their investment returns too will fluctuate in line with the fortunes of their political contacts.
Finally, to the extent that what I have described above is already part of the status quo but is not reflected in your investment strategy, you might want to dig deeper into the ownership of the subsidiaries of listed Indian companies. You might then find some very powerful non-businessmen holding large stakes in the subsidiaries of listed entities. To understand the true value of the listed entity, you could then knock off from it value of the powerful non-businessman’s sizeable minority stake in the subsidiary. If you were the person holding the regulatory keys to the biggest infrastructure contracts, I don’t think you would be attaching any sort of discount to the value of your stake in those projects. Astonishingly that is what many analysts assume when they attach attractive valuations to such infrastructure companies with undisclosed investors at the subsidiary level. So much for the efficient market hypothesis.
Will India produce a Google
India will see birth of new billion dollar companies who leverage technology rather than make an innovation themselves.
I am sitting at Changi Airport of Sngapore as I write this piece, having just spent a couple of very interesting days at a conference titled “Leapfrogging Technologies” run by a group called TTI Vanguard which has on its advisory board a few legends including Nicholas Negraponte, Alan Kay, Len Kleinrock, Gordon Bell etc.
I had the honor of presenting the realities of India, and the various challenges and opportunities that exist here. Much time was spent at that conference debating the definition of “leapfrogging technology”. It was very clear that the audience, consisting primarily of senior technology executives of large multinationals, were technology biased, in the traditional sense.
In other words, the way Silicon Valley might think of leapfrogging in true high tech fashion (megabits/sec to gigabits/sec; order of magnitude better or faster). But towards the end of the conference after looking at examples in India, Bangladesh and Philippines, many realised that leapfrogging often has as much to do with technology application, often with a local twist, as it does with technology development. Let me explain further.
Admittedly VCs (including myself) have been harsh with the Indian entrepreneurial community for not being innovative enough, not thinking big and thinking incremental rather than monumental. Call it an epiphany or just a delayed “wake up call”, I am changing my thought process.
Leapfrogging In Indian Context
In India and many other developing economies, at this stage, it’s quite honestly less about groundbreaking technology development (except perhaps the MNC R&D hubs), and much more about leveraging existing technology to significantly impact quality of life, and making a business of it.
And of course, the scale in terms of number lives impacted is potentially earth-shattering in India and other developing nations. Take mobile telephony, for example. That definitely represents leapfrogging, since legacy infrastructure didn’t really exist to adequately serve a country of over a billion people. Obviously the mobile phone, once affordable, has led to over 400M subscribers on its way to many hundreds of millions more.
There were innovations along the way with respect to distribution, business model, and generally getting the scale the telecommunication sector has achieved in India. Similarly, dish has gained traction where no landline infrastructure exists (I love seeing them on top of slums, for example); and surely wireless broadband will eventually break through where no optical fiber or copper has been buried underground.
At the conference, I also had a good chance to interact with several Chinese entrepreneurs and investors. After speaking with them, and also looking at the recent success stories that have come out of China, the point that hit me like a Dhoni chauka (for readers in the US, use a 2x4 as a metaphor) across the face was the fact that companies like Baidu, Sohu, Alibaba, Ctrip, Focusmedia are Chinese companies that became massive while focusing (at least initially) only on the Chinese market.
They could do it better than their US counterparts partly due to language and cultural understanding, some technology and I would argue partially due to national pride. Similarly if we look at India, companies are emerging and will continue to emerge in a broad range of categories targeting the Indian market.
Local Winners, Local Advantage
Let’s take travel, for example. Cleartrip and Makemytrip, not Expedia or Travelocity are recognised names. For online jobs, it’s Naukri, not Monster. In matrimonial, it’s shaadi or bharatmatrimony, not match.com. Even in local search, the number one name is not Google, but Just Dial, which, by the way, gained momentum not from the new media (online, mobile) but from the old one (plain old telephony).
Then there are completely “Greenfield” areas where India holds tremendous potential. In consumer media, one could argue that India currently does not have its Amazon, eBay or Craigslist (at least at any decent scale). The entire area of online and mobile commerce holds tremendous promise. There is no real e-commerce or m-commerce for hard goods (travel, matrimonial, movie tickets are early successes for obvious reasons), due to lack of both remote transacting capabilities in many cases (credit card penetration); logistics and distribution (reverse and forward logistics) and sheer trust for online or remote transactions.
But Amazon didn’t become today’s Amazon on day 1. It took years, just like it will take years in India. But whether it is broadband connectivity (mobile and fixed); credit card worthiness platform (a la FICO score in the US) or a reliable logistics infrastructure, opportunities exist for startups to truly have an impact in making the remote commerce dream become reality, and by doing so, create India’s own online giants.
Opportunities
There are significant opportunities wherever one looks – in healthcare, education, energy/power, water, transportation and list goes on and on. Let me delineate a couple. The area of healthcare provides phenomenal opportunity. Indian lifestyle (fried food, lack of exercise) as well as hereditary linkages mean that India is a time bomb waiting to explode when it comes to diseases like diabetes, hypertension, and heart disease.
Opportunity exists to create an HMO like infrastructure (without hopefully the juggernaut that has been created in the US) that truly ties insurance, pharmacies, and the medical community. On the energy/power front, there are 400M people in this country without access to electricity. That problem won’t be solved by extending the grid necessarily, but rather by generating distributed power (locally produced; locally used). By the way, DFJ and Cisco recently sponsored the first ever Global Business Plan competition in June of this year.
Scores of plans were submitted by entrepreneurs from around the world including China, Russia, Israel, all across Europe, Latin America and of course, the US. The winner was not some quantum leap technical innovation, but rather a small company called Husk Power, with its base in Bihar, India. Husk Power is using crop husk as feedstock for distributed power generation in villages with several pilot plants already up and running. Again, this is an example of using existing technology, with more of an Indian wrapper, to address a potentially multi-billion dollar market that will lead to successful companies here locally.
The entrepreneurial success stories of the next decade or two will come from companies that are at least mostly, if not exclusively targeting the local Indian market, and within large and growing Greenfield spaces, only some of which are mentioned above.
Bottom Of The Pyramid
Then there is the entire bottom of the pyramid piece with massive opportunity around the same sectors as previously mentioned (telecommunications, education, healthcare, water, power) but with its own set of challenges around distribution, payments etc., but those issues will be addressed over time creating several large companies in the process.
The question that was asked of me at the conference was “will India produce a Google?” My answer was a very convincing “yes and no”. If one is asking the question from a technology innovation bias, then the answer is “no”, at least not in the near future (IMHO). But if one is asking whether new billion dollar companies will be created in India that leverage technology, then the answer is an absolute “yes”. Whether that happens in the next four-five years, I don’t know, but will it happen over the next decade, absolutely.
Leapfrogging: Developed Vs Developing Nations
Coming back to the point of leapfrogging, in developing nations, I would argue leapfrogging comes often as a result of Greenfield opportunities like mobile phones leapfrogging fixed infrastructure, or wimax leapfrogging landline infrastructure, dish leapfrogging analog TV, essentially where the inertia of legacy infrastructure doesn’t exist. Leapfrogging in developed nations usually involves quantum leap in technology itself or getting a whole lot more out of existing infrastructure since that investment has to be recouped. While developed nations think about better, faster, cheaper the developing nations are simply thinking of “anything at all”.
I think innovation or leapfrogging has its spectrum. When a country has nothing, going to something at all is considered leapfrogging, usually having nothing to do with technology improvement or invention, but rather either process innovation or pure execution utilising existing solutions. The next phase most likely is indianising the product or process.
To give an example, one of DFJ’s portfolio companies is Attero, an electronic waste recycling startup based in Noida (near Delhi in Uttar Pradesh). They have licensed some parts of the process but rather than fully automating the system, they have used inexpensive but readily available and trainable labour to create a more cost-effective recycling process.
Only once the existing technology is saturated or close to it, does there come a necessity to innovate as a grassroots technology level. The key question is whether India will feel that necessity or desire (one could argue that Israel doesn’t need to invent - outside of defense perhaps - but has an intellectual capital and sheer desire to do so). Finally, there needs to be an ecosystem for entrepreneurs (specially for technology entrepreneurs that US VCs tend to be biased towards) that is just starting in India. Fear of failure and stigma attached to it still exists. There is a lack of seed capital in the country to really get startups off the ground. Some are doing their part, no doubt, but much more needs to be done.
Bottom line: India is a goldmine of opportunity for smart teams that can truly execute on vast spaces. I predict that those same large spaces will produce several billion dollar enterprise value companies over the next decade. There may not be leapfrogging technology that comes out of India in the near future for the world to adopt, but phenomenal sustainable success stories will be created in India (initially for the Indian market) that leverage technology in interesting ways, and execute flawlessly to create our own version of Google, Cisco and Apple.
I am sitting at Changi Airport of Sngapore as I write this piece, having just spent a couple of very interesting days at a conference titled “Leapfrogging Technologies” run by a group called TTI Vanguard which has on its advisory board a few legends including Nicholas Negraponte, Alan Kay, Len Kleinrock, Gordon Bell etc.
I had the honor of presenting the realities of India, and the various challenges and opportunities that exist here. Much time was spent at that conference debating the definition of “leapfrogging technology”. It was very clear that the audience, consisting primarily of senior technology executives of large multinationals, were technology biased, in the traditional sense.
In other words, the way Silicon Valley might think of leapfrogging in true high tech fashion (megabits/sec to gigabits/sec; order of magnitude better or faster). But towards the end of the conference after looking at examples in India, Bangladesh and Philippines, many realised that leapfrogging often has as much to do with technology application, often with a local twist, as it does with technology development. Let me explain further.
Admittedly VCs (including myself) have been harsh with the Indian entrepreneurial community for not being innovative enough, not thinking big and thinking incremental rather than monumental. Call it an epiphany or just a delayed “wake up call”, I am changing my thought process.
Leapfrogging In Indian Context
In India and many other developing economies, at this stage, it’s quite honestly less about groundbreaking technology development (except perhaps the MNC R&D hubs), and much more about leveraging existing technology to significantly impact quality of life, and making a business of it.
And of course, the scale in terms of number lives impacted is potentially earth-shattering in India and other developing nations. Take mobile telephony, for example. That definitely represents leapfrogging, since legacy infrastructure didn’t really exist to adequately serve a country of over a billion people. Obviously the mobile phone, once affordable, has led to over 400M subscribers on its way to many hundreds of millions more.
There were innovations along the way with respect to distribution, business model, and generally getting the scale the telecommunication sector has achieved in India. Similarly, dish has gained traction where no landline infrastructure exists (I love seeing them on top of slums, for example); and surely wireless broadband will eventually break through where no optical fiber or copper has been buried underground.
At the conference, I also had a good chance to interact with several Chinese entrepreneurs and investors. After speaking with them, and also looking at the recent success stories that have come out of China, the point that hit me like a Dhoni chauka (for readers in the US, use a 2x4 as a metaphor) across the face was the fact that companies like Baidu, Sohu, Alibaba, Ctrip, Focusmedia are Chinese companies that became massive while focusing (at least initially) only on the Chinese market.
They could do it better than their US counterparts partly due to language and cultural understanding, some technology and I would argue partially due to national pride. Similarly if we look at India, companies are emerging and will continue to emerge in a broad range of categories targeting the Indian market.
Local Winners, Local Advantage
Let’s take travel, for example. Cleartrip and Makemytrip, not Expedia or Travelocity are recognised names. For online jobs, it’s Naukri, not Monster. In matrimonial, it’s shaadi or bharatmatrimony, not match.com. Even in local search, the number one name is not Google, but Just Dial, which, by the way, gained momentum not from the new media (online, mobile) but from the old one (plain old telephony).
Then there are completely “Greenfield” areas where India holds tremendous potential. In consumer media, one could argue that India currently does not have its Amazon, eBay or Craigslist (at least at any decent scale). The entire area of online and mobile commerce holds tremendous promise. There is no real e-commerce or m-commerce for hard goods (travel, matrimonial, movie tickets are early successes for obvious reasons), due to lack of both remote transacting capabilities in many cases (credit card penetration); logistics and distribution (reverse and forward logistics) and sheer trust for online or remote transactions.
But Amazon didn’t become today’s Amazon on day 1. It took years, just like it will take years in India. But whether it is broadband connectivity (mobile and fixed); credit card worthiness platform (a la FICO score in the US) or a reliable logistics infrastructure, opportunities exist for startups to truly have an impact in making the remote commerce dream become reality, and by doing so, create India’s own online giants.
Opportunities
There are significant opportunities wherever one looks – in healthcare, education, energy/power, water, transportation and list goes on and on. Let me delineate a couple. The area of healthcare provides phenomenal opportunity. Indian lifestyle (fried food, lack of exercise) as well as hereditary linkages mean that India is a time bomb waiting to explode when it comes to diseases like diabetes, hypertension, and heart disease.
Opportunity exists to create an HMO like infrastructure (without hopefully the juggernaut that has been created in the US) that truly ties insurance, pharmacies, and the medical community. On the energy/power front, there are 400M people in this country without access to electricity. That problem won’t be solved by extending the grid necessarily, but rather by generating distributed power (locally produced; locally used). By the way, DFJ and Cisco recently sponsored the first ever Global Business Plan competition in June of this year.
Scores of plans were submitted by entrepreneurs from around the world including China, Russia, Israel, all across Europe, Latin America and of course, the US. The winner was not some quantum leap technical innovation, but rather a small company called Husk Power, with its base in Bihar, India. Husk Power is using crop husk as feedstock for distributed power generation in villages with several pilot plants already up and running. Again, this is an example of using existing technology, with more of an Indian wrapper, to address a potentially multi-billion dollar market that will lead to successful companies here locally.
The entrepreneurial success stories of the next decade or two will come from companies that are at least mostly, if not exclusively targeting the local Indian market, and within large and growing Greenfield spaces, only some of which are mentioned above.
Bottom Of The Pyramid
Then there is the entire bottom of the pyramid piece with massive opportunity around the same sectors as previously mentioned (telecommunications, education, healthcare, water, power) but with its own set of challenges around distribution, payments etc., but those issues will be addressed over time creating several large companies in the process.
The question that was asked of me at the conference was “will India produce a Google?” My answer was a very convincing “yes and no”. If one is asking the question from a technology innovation bias, then the answer is “no”, at least not in the near future (IMHO). But if one is asking whether new billion dollar companies will be created in India that leverage technology, then the answer is an absolute “yes”. Whether that happens in the next four-five years, I don’t know, but will it happen over the next decade, absolutely.
Leapfrogging: Developed Vs Developing Nations
Coming back to the point of leapfrogging, in developing nations, I would argue leapfrogging comes often as a result of Greenfield opportunities like mobile phones leapfrogging fixed infrastructure, or wimax leapfrogging landline infrastructure, dish leapfrogging analog TV, essentially where the inertia of legacy infrastructure doesn’t exist. Leapfrogging in developed nations usually involves quantum leap in technology itself or getting a whole lot more out of existing infrastructure since that investment has to be recouped. While developed nations think about better, faster, cheaper the developing nations are simply thinking of “anything at all”.
I think innovation or leapfrogging has its spectrum. When a country has nothing, going to something at all is considered leapfrogging, usually having nothing to do with technology improvement or invention, but rather either process innovation or pure execution utilising existing solutions. The next phase most likely is indianising the product or process.
To give an example, one of DFJ’s portfolio companies is Attero, an electronic waste recycling startup based in Noida (near Delhi in Uttar Pradesh). They have licensed some parts of the process but rather than fully automating the system, they have used inexpensive but readily available and trainable labour to create a more cost-effective recycling process.
Only once the existing technology is saturated or close to it, does there come a necessity to innovate as a grassroots technology level. The key question is whether India will feel that necessity or desire (one could argue that Israel doesn’t need to invent - outside of defense perhaps - but has an intellectual capital and sheer desire to do so). Finally, there needs to be an ecosystem for entrepreneurs (specially for technology entrepreneurs that US VCs tend to be biased towards) that is just starting in India. Fear of failure and stigma attached to it still exists. There is a lack of seed capital in the country to really get startups off the ground. Some are doing their part, no doubt, but much more needs to be done.
Bottom line: India is a goldmine of opportunity for smart teams that can truly execute on vast spaces. I predict that those same large spaces will produce several billion dollar enterprise value companies over the next decade. There may not be leapfrogging technology that comes out of India in the near future for the world to adopt, but phenomenal sustainable success stories will be created in India (initially for the Indian market) that leverage technology in interesting ways, and execute flawlessly to create our own version of Google, Cisco and Apple.
Tuesday, February 24, 2009
Life HAND BOOK 2009
Health:
1. Drink plenty of water.
2. Eat breakfast like a king, lunch like a prince and dinner like a beggar.
3. Eat more foods that grow on trees and plants and eat less food that is manufactured in plants.
4. Live with the 3 E's -- Energy, Enthusiasm, and Empathy.
5. Make time to practice meditation, yoga, and prayer.
6. Play more games.
7. Read more books than you did in 2008.
8. Sit in silence for at least 10 minutes each day.
9. Sleep for 7 hours.
10. Take a 10-30 minutes walk every day.. And while you walk, smile.
Personality:
11. Don't compare your life to others'. You have no idea what their journey is all about.
12. Don't have negative thoughts or things you cannot control. Instead invest your energy in the positive present moment.
13. Don't over do. Keep your limits.
14. Don't take yourself so seriously. No one else does.
15. Don't waste your precious energy on gossip.
16. Dream more while you are awake.
17. Envy is a waste of time. You already have all you need..
18. Forget issues of the past. Don't remind your partner with his/her mistakes of the past. That will ruin your present happiness.
19. Life is too short to waste time hating anyone. Don't hate others.
20. Make peace with your past so it won't spoil the present.
21. No one is in charge of your happiness except you.
22. Realize that life is a school and you are here to learn. Problems are simply part of the curriculum that appear and fade away like algebra
class but the lessons you learn will last a lifetime.
23. Smile and laugh more.
24. You don't have to win every argument. Agree to disagree.
Society:
25. Call your family often.
26. Each day give something good to others.
27. Forgive everyone for everything.
28. Spend time with people over the age of 70 & under the age of 6 and observing pets(animals).
29. Try to make at least three people smile each day.
30. What other people think of you is none of your business.
31. Your job won't take care of you when you are sick. Your friends will. Stay in touch.
Life:
32. Do the right thing!
33. Get rid of anything that isn't useful, bea uti ful or joyful.
34. GOD heals everything.
35. However good or bad a situation is, it will change.
36. No matter how you feel, get up, dress up and show up.
37. The best is yet to come.
38. When you awake alive in the morning, thank GOD for it.
39. Your Inner most is always happy. So, be happy.
1. Drink plenty of water.
2. Eat breakfast like a king, lunch like a prince and dinner like a beggar.
3. Eat more foods that grow on trees and plants and eat less food that is manufactured in plants.
4. Live with the 3 E's -- Energy, Enthusiasm, and Empathy.
5. Make time to practice meditation, yoga, and prayer.
6. Play more games.
7. Read more books than you did in 2008.
8. Sit in silence for at least 10 minutes each day.
9. Sleep for 7 hours.
10. Take a 10-30 minutes walk every day.. And while you walk, smile.
Personality:
11. Don't compare your life to others'. You have no idea what their journey is all about.
12. Don't have negative thoughts or things you cannot control. Instead invest your energy in the positive present moment.
13. Don't over do. Keep your limits.
14. Don't take yourself so seriously. No one else does.
15. Don't waste your precious energy on gossip.
16. Dream more while you are awake.
17. Envy is a waste of time. You already have all you need..
18. Forget issues of the past. Don't remind your partner with his/her mistakes of the past. That will ruin your present happiness.
19. Life is too short to waste time hating anyone. Don't hate others.
20. Make peace with your past so it won't spoil the present.
21. No one is in charge of your happiness except you.
22. Realize that life is a school and you are here to learn. Problems are simply part of the curriculum that appear and fade away like algebra
class but the lessons you learn will last a lifetime.
23. Smile and laugh more.
24. You don't have to win every argument. Agree to disagree.
Society:
25. Call your family often.
26. Each day give something good to others.
27. Forgive everyone for everything.
28. Spend time with people over the age of 70 & under the age of 6 and observing pets(animals).
29. Try to make at least three people smile each day.
30. What other people think of you is none of your business.
31. Your job won't take care of you when you are sick. Your friends will. Stay in touch.
Life:
32. Do the right thing!
33. Get rid of anything that isn't useful, bea uti ful or joyful.
34. GOD heals everything.
35. However good or bad a situation is, it will change.
36. No matter how you feel, get up, dress up and show up.
37. The best is yet to come.
38. When you awake alive in the morning, thank GOD for it.
39. Your Inner most is always happy. So, be happy.
Thursday, February 19, 2009
What is school for?
Seems like a simple question, but given how much time and money we spend on it, it has a wide range of answers, many unexplored, some contradictory. I have a few thoughts about education, how we use it to market ourselves and compete, and I realized that without a common place to start, it's hard to figure out what to do.
So, a starter list. The purpose of school is to:
Become an informed citizen
Be able to read for pleasure
Be trained in the rudimentary skills necessary for employment
Do well on standardized tests
Homogenize society, at least a bit
Pasteurize out the dangerous ideas
Give kids something to do while parents work
Teach future citizens how to conform
Teach future consumers how to desire
Build a social fabric
Create leaders who help us compete on a world stage
Generate future scientists who will advance medicine and technology
Learn for the sake of learning
Help people become interesting and productive
Defang the proletariat
Establish a floor below which a typical person is unlikely to fall
Find and celebrate prodigies, geniuses and the gifted
Make sure kids learn to exercise, eat right and avoid common health problems
Teach future citizens to obey authority
Teach future employees to do the same
Increase appreciation for art and culture
Teach creativity and problem solving
Minimize public spelling mistakes
Increase emotional intelligence
Decrease crime by teaching civics and ethics
Increase understanding of a life well lived
Make sure the sports teams have enough players
If you have the email address of the school board or principals, perhaps you'll forward this list to them (and I hope you are in communication with them regardless, since it's a big chunk of your future and your taxes!). Should make an interesting starting point for a discussion.
So, a starter list. The purpose of school is to:
Become an informed citizen
Be able to read for pleasure
Be trained in the rudimentary skills necessary for employment
Do well on standardized tests
Homogenize society, at least a bit
Pasteurize out the dangerous ideas
Give kids something to do while parents work
Teach future citizens how to conform
Teach future consumers how to desire
Build a social fabric
Create leaders who help us compete on a world stage
Generate future scientists who will advance medicine and technology
Learn for the sake of learning
Help people become interesting and productive
Defang the proletariat
Establish a floor below which a typical person is unlikely to fall
Find and celebrate prodigies, geniuses and the gifted
Make sure kids learn to exercise, eat right and avoid common health problems
Teach future citizens to obey authority
Teach future employees to do the same
Increase appreciation for art and culture
Teach creativity and problem solving
Minimize public spelling mistakes
Increase emotional intelligence
Decrease crime by teaching civics and ethics
Increase understanding of a life well lived
Make sure the sports teams have enough players
If you have the email address of the school board or principals, perhaps you'll forward this list to them (and I hope you are in communication with them regardless, since it's a big chunk of your future and your taxes!). Should make an interesting starting point for a discussion.
Wednesday, February 18, 2009
Thursday, February 5, 2009
Sunday, January 25, 2009
EVA, SVA, and the Economy
Shareholder value analysis (SVA) is one of several nontraditional metrics being used in business today. SVA determines the financial value of a company by looking at the returns it gives its stockholders and is based on the view that the objective of company directors is to maximize the wealth of company stockholders.
Shareholder value is calculated by dividing the estimated total net value of a company based on its present and future cash flows by the value of its shares of stock. The resulting figure indicates the company’s value to stockholders.
The underlying principle of shareholder value is that a company adds value for its stockholders only when equity returns exceed equity costs. Once the amount of value has been calculated, targets for improvement can be set and shareholder value can be used as a measure for managing performance.
Before adopting shareholder value as a significant financial objective, you need to understand its implications and the best way for your business to approach it. It can be helpful to first plan the approach with professional advisers such as accountants or consultants who specialize in this area. A company’s value is calculated by subtracting the market value of any debts owed to the company from the total value of the business.
The total value of a business has three main components:
the present value of future cash flows during the planned period;
the residual value of future cash flows from a period beyond the planned period;
the weighted average cost of capital.
Total business value is calculated by adding present value of future cash flows to residual value of future cash flows and dividing it by the weighted average cost of capital.
If the result of this calculation is greater than one, then the company is worth more than the invested capital and added value is being created.
Future cash flows
Future cash flows are affected by growth, returns, and risk. According to Alfred Rappaport in Creating Shareholder Value, these factors can be explained by seven key value drivers that must be managed in order to maximize shareholder value:
sales growth rate
operating profit margin
income tax rate
working capital investment
fixed capital investment
cost of capital
value growth duration
Residual value of future cash flows
The residual value—the price at which a fixed asset is expected to be sold at the end of its useful life—is an important figure that represents cash flows arising after the normal planning period (usually five to ten years). It has been estimated that as much as two-thirds of the value of a business can be attributed to cash flows arising after this planning period. Viewed another way, only one-third of the value of a business results from cash flows arising during the normal planning period.
Weighted average cost of capital (WACC)
The WACC is the cost of equity added to the cost of debt. It represents the return a company needs to earn in order to justify the financial resources it uses. the WACC therefore expresses the opportunity cost of the assets in use. The WACC is entirely market-driven—if the assets cannot earn the required return, investors will withdraw their money from the business.
EVA(Economic Profit)
The Economic Value Added (EVA) is a measure of surplus value created on an investment.
It is a very powerful tool. The analysis is obviously a lot more complex.
This model works nicely in good times. But does it work today? What is it telling us?
I asked the following question:
Cost of Capital is part of the EVA equation. Given the credit crisis, how has this impacted EVA? Is cost of capital going up? If so, what does that mean in terms of where companies should invest then efforts? Or is it going down because the prime rate is so low? What does this mean that from a targeting perspective?
Here are the two responses:
Response #1: On the EVA question, theoretically the Cost of Capital is down given the prime. But actually it’s up given the credit markets — the Libor is a good proxy (the rate at which banks lend to each other). The B2B rates are even worse, hence all the talk about the credit markets freezing up. In terms of targeting Cost of Capital, that’s a tougher question. Most of the action in EVA around the Weighted Average Cost of Capital (WACC) is related to more or less leverage. So targeting it would mean more leverage and there’s not too many companies that want to go in this direction now. In fact, we may have determined a “ceiling” on how far you can push on that lever.
Response #2: From a mathematical perspective, marginal cost of capital is fairly low these days. The availability of capital, however, is the real issue. In the current market it is difficult to raise capital. Therefore if an enterprise can generate excess cash and can identify opportunities with good returns they should certainly invest. It is no different for an individual. Assuming that a major catastrophe is not looming on the horizon and assuming that one has available cash, this is the time to invest. I should hasten to add that the “classical” capital market theories upon which WACC and EVA are based are NOT, in my opinion, quite valid in a tumultuous market where risk free rates are almost zero and people are simply keeping cash “under the mattress.”
Interesting thoughts.
My follow up question is, “Assumiung WACC is up, what is the relative impact of cost reduction versus revenue growth on EVA?”
Shareholder value is calculated by dividing the estimated total net value of a company based on its present and future cash flows by the value of its shares of stock. The resulting figure indicates the company’s value to stockholders.
The underlying principle of shareholder value is that a company adds value for its stockholders only when equity returns exceed equity costs. Once the amount of value has been calculated, targets for improvement can be set and shareholder value can be used as a measure for managing performance.
Before adopting shareholder value as a significant financial objective, you need to understand its implications and the best way for your business to approach it. It can be helpful to first plan the approach with professional advisers such as accountants or consultants who specialize in this area. A company’s value is calculated by subtracting the market value of any debts owed to the company from the total value of the business.
The total value of a business has three main components:
the present value of future cash flows during the planned period;
the residual value of future cash flows from a period beyond the planned period;
the weighted average cost of capital.
Total business value is calculated by adding present value of future cash flows to residual value of future cash flows and dividing it by the weighted average cost of capital.
If the result of this calculation is greater than one, then the company is worth more than the invested capital and added value is being created.
Future cash flows
Future cash flows are affected by growth, returns, and risk. According to Alfred Rappaport in Creating Shareholder Value, these factors can be explained by seven key value drivers that must be managed in order to maximize shareholder value:
sales growth rate
operating profit margin
income tax rate
working capital investment
fixed capital investment
cost of capital
value growth duration
Residual value of future cash flows
The residual value—the price at which a fixed asset is expected to be sold at the end of its useful life—is an important figure that represents cash flows arising after the normal planning period (usually five to ten years). It has been estimated that as much as two-thirds of the value of a business can be attributed to cash flows arising after this planning period. Viewed another way, only one-third of the value of a business results from cash flows arising during the normal planning period.
Weighted average cost of capital (WACC)
The WACC is the cost of equity added to the cost of debt. It represents the return a company needs to earn in order to justify the financial resources it uses. the WACC therefore expresses the opportunity cost of the assets in use. The WACC is entirely market-driven—if the assets cannot earn the required return, investors will withdraw their money from the business.
EVA(Economic Profit)
The Economic Value Added (EVA) is a measure of surplus value created on an investment.
It is a very powerful tool. The analysis is obviously a lot more complex.
This model works nicely in good times. But does it work today? What is it telling us?
I asked the following question:
Cost of Capital is part of the EVA equation. Given the credit crisis, how has this impacted EVA? Is cost of capital going up? If so, what does that mean in terms of where companies should invest then efforts? Or is it going down because the prime rate is so low? What does this mean that from a targeting perspective?
Here are the two responses:
Response #1: On the EVA question, theoretically the Cost of Capital is down given the prime. But actually it’s up given the credit markets — the Libor is a good proxy (the rate at which banks lend to each other). The B2B rates are even worse, hence all the talk about the credit markets freezing up. In terms of targeting Cost of Capital, that’s a tougher question. Most of the action in EVA around the Weighted Average Cost of Capital (WACC) is related to more or less leverage. So targeting it would mean more leverage and there’s not too many companies that want to go in this direction now. In fact, we may have determined a “ceiling” on how far you can push on that lever.
Response #2: From a mathematical perspective, marginal cost of capital is fairly low these days. The availability of capital, however, is the real issue. In the current market it is difficult to raise capital. Therefore if an enterprise can generate excess cash and can identify opportunities with good returns they should certainly invest. It is no different for an individual. Assuming that a major catastrophe is not looming on the horizon and assuming that one has available cash, this is the time to invest. I should hasten to add that the “classical” capital market theories upon which WACC and EVA are based are NOT, in my opinion, quite valid in a tumultuous market where risk free rates are almost zero and people are simply keeping cash “under the mattress.”
Interesting thoughts.
My follow up question is, “Assumiung WACC is up, what is the relative impact of cost reduction versus revenue growth on EVA?”
Saturday, January 24, 2009
The U.S. Mega Bad Bank
Interesting article by Elizabeth MacDonald (Fox ).
Despite a full year of being in detox, the U.S. banking system is still lurching around in a hospital gown.
What is working, and what is not, and how will the incoming Administration deal with one of the worst economic crises to hit the world’s largest superpower since the Great Depression?
The markets need to clear, and clear out now, the bad assets acting like an anvil on bank balance sheets across the country, in order to stop this financial crisis–if we continue to prolong it with ad hoc government bailouts, we will soon look like our Pacific neighbor, Japan.
Forced mergers, forced shotgun weddings, forced liquidations, all must be on the table. Because all of the central bank’s liquidity and all of the Treasury’s bank capital injections can’t cure a bad bank asset.
“If Treasury gives a bank capital and the value of troubled assets keeps falling, it’s like throwing money down a hole–eventually the bank is going to need another capital injection,” says Michelle Girard, top economist at RBS Securities.
Bank executives wasted all of last year defending the status quo. From Bear Stearns’ Alan Schwartz to Washington Mutual’s Kerry Killinger to Lehman Bros.’ Richard Fuld to Merrill Lynch’s John Thain, all covered up with a multitude of spins the severe troubles on their books, leaving it to the press and to analysts to do that painspotting for the government. All of them are now gone from their companies.
And the government’s plans have careened so badly from pillar to post, you have to put a GPS system on the thought processes down in Washington, D.C. to keep track of what is going on.
Because following the government’s constant changes to its bailout plan is like trying to follow a mosquito in a tornado.
The latest idea: Now there is talk of a massive, US mega-bad bank, an outsized trash compactor, a gigantic dumpster much like the one Sweden launched in the early ‘90s to take on its country’s bad bank assets–which means we could be taxed like Sweden to pay for this entity.
A US Mega-Bad Bank that could get, say, $100 bn in TARP money, where it would then, ironically, lever that $100 bn up to $600 bn, with debt backed with FDIC guarantees, to start buying and taking off bank balance sheets $2.4 tn worth of rotting loans and securities issued for pie-in-the-sky projects like empty strip malls, condos and townhouses on swamplands.
Borrowings to cure borrowings in a government-distorted housing system steered by Fannie Mae and Freddie Mac, both built on borrowings backed by the US taxpayer.
Motion sickness?
Meanwhile, the Bernie Madoff Ponzi scandal is tying up the FBI’s efforts to catch the throng of scamsters engaging in white collar street crime, mortgage frauds, as well as other Ponzi scams and crooked hedge funds.
Because, sure enough, the SEC, it being an agency not populated with market cops but market crossing guards, doesn’t flush out frauds as they occur, neither do auditors–recessions do.
Where Are We Now?
Despite the fact that the US government is now providing insurance on $428 bn in bad assets from Bear Stearns, AIG, Citigroup, and Bank of America, despite the Federal Reserve morphing into the world’s largest junk investor as it has taken on $75 bn in bad assets from Bear and AIG, with more coming from Citigroup and Bank of America, despite the Fed nearly tripling its balance sheet, the economy still faces an estimated $2.4 tn in bad bank assets, now ticking time bombs.
The top four banks hold $1.4 tn in bad assets, out of a total of $2.4 tn of potential rotten eggs for the entire bank sector.
Because of these stinkers, some $2 tn in market value in the S&P financial sector has been lost since May of 2007, with Citigroup losing 10 times as much, analysts’ estimates show.
Each of the market values of Kraft Foods, UPS, Home Depot and PepsiCo surpass the market capitalizations of Citigroup and Bank of America-combined.
The Worst Two of All?
In the last week of trading, Bank of America has lost more in market cap than the $24 bn it spent buying Merrill Lynch itself. The $45 bn BofA got in government capital injections is now nearly twice its $25 bn market cap.
The government has had to invest twice in both Citigroup and Bank of America, as the two represent 40% of the assets in the sector, and are the two most levered up banks, from a tangible common equity perspective, says Goldman Sachs.
Citigroup, the world’s biggest financial supermarket, has hung its fire sale shingle on about a third of its balance sheet, $600 bn, selling anything not screwed to the walls. With a gun to its head, Citi sold Smith Barney, the only one of its main units to post a profit in the third quarter.
BofA is tenuously capitalized, says Friedman Billings Ramsey, going into 2009 with just $61.7 bn of pro forma tangible common equity supporting a colossal $2.4 tn of tangible assets.
What’s next?
Back to the Future
So it’s back to the future time, a revival of TARP 1.0, a United States Mega Bad Bank, is now under serious debate in Washington, to take on this Kryptonite. That would be a return to the initial incarnation of TARP, which would have held a Dutch auction for these assets.
The breakup of Citigroup could be a harbinger of what is to come.
As Fox Business first reported starting in November, Citigroup has split into Citicorp and Citi Holdings, with Citicorp a return to its roots as a deposit taking bank, and Citi Holdings housing its bad assets.
With this move, Citi may be positioning itself to unload a huge slug of the $895 bn in bad assets at Citi Holdings onto the US Mega Bad Bank.
Who Will Oversee the US Mega Bad Bank?
Be mindful that the TARP program will be overseen by incoming Treasury Secretary Timothy Geithner, also the incoming boss of the IRS, who didn’t pay about $34,000 in self-employment taxes, who only paid his 2001 and 2002 self-employment taxes in November 2008 when he was tapped as nominee, and who wrongfully deducted as dependent care costs on his personal tax returns summer camp fees for his children.
Geithner is a former New York Federal Reserve official who oversaw the Bear Stearns bailout, the government’s Emily Litella moment, who is criticized for not doing enough in the interim to stop another primary dealer, Lehman Bros., from collapsing, who lives by his own tax rules as he makes up the bank bailout rules as he goes along.
An official who, with incoming Obama economic advisor Larry Summers–a self-made man who worships his own creator–will now oversee the rescue of the world’s biggest banking system.
Market Impact of the Mega Bad Bank
Would a mega trash compactor trigger a bank stampede, would banks then dump assets en masse onto the US taxpayer, and would doing so in turn potentially create fresh new values for this landfill, or marks, and thus more writedowns?
Would the US government then be forced to suspend mark-to-market accounting, a flawed bookkeeping methodology which even Enron used to inflate its profits, a methodology which has created colossal bank writedowns as it has forced banks to write down these assets as if they were selling them today in an iced-over market, even though many are not selling them?
The Problems with TARP
The TARP capital injections, in the form of stock purchases in troubled banks, have acted as blood thinner to existing shareholders, as the banks have had to issue more shares, diluting existing investors, explains economist Ed Yardeni.
There are more problems with the TAR-PIT.
The Treasury said it would give money only to healthy banks to jump-start lending. But at least two-thirds of the 314 banks who got TARP money were already in violation of federal regulatory guidelines for lending because they blew out their construction, development and commercial real estate loans, says bank analyst Richard Suttmeier.
And watch this. According to the Wall Street Journal OneUnited Bank in Boston received $12 mn in TARP money at the behest of Barney Frank, chairman of the House Financial Services Committee.
However, Suttmeier says that OneUnited’s commercial real estate loan exposure is 2,005 times federal regulatory guidelines for capital requirements. Two thousand and five times.
“The regulatory guideline is no more than 300% [of capital], and this ratio is the worst among all [of the] 8,384 FDIC insured financial institutions,” Suttmeier says, adding that “a bank in Alpharetta, Georgia had a heavier concentration, but [it has] already been seized by the FDIC.”
World’s Biggest Junk Investor: The Federal Reserve
Meanwhile, the central bank’s balance sheet has surpassed $2 tn, triple what it was a year and a half ago.
The Fed has taken on a mountain of potentially bad paper assets that, stacked, could reach to outerspace.
Among other things, the Fed $73 bn in assets from Bear Stearns and American International Group, warehousing them in off balance sheet vehicles much like Citigroup did and valuing them with the help of the credit rating agencies, who helped get us into this mess by rubberstamping as triple A all sorts of junk.
The Fed also has given massive guarantees of almost $300 bn to Citigroup and Bank of America.
What of all this monetary intervention? The Fed is now blowing out its balance sheet to fix a bursting credit bubble that the Fed helped create by keeping interest rates down too long. Inflation will be coming in the next five years.
Remember this quote: Business expansions never die of old age–they are routinely murdered by the Federal Reserve.
Why Aren’t Banks Lending?
Banks who have received $350 bn in TARP money are under attack for not lending enough money, notes economist Yardeni.
But actually, the banks are lending. However, they are lending almost exclusively to the Fed, Yardeni notes-or they are lending to panicked companies who are drawing down on existing credit lines. Yardeni says:
*As of January 14, depository institutions had $827.5 bn on deposit at the Federal Reserve Banks. That’s up $795.4bn since September 10, the week just before Lehman died. It is up $555.6bn since October 14, when the banks started to receive TARP money.
*On January 7, commercial banks had a record $1.1 tn in vault cash, cash items in process of collection, balances due from depository institutions, and balances due from Federal Reserve Banks.
*Since October 14, when TARP funds were first given as capital to nine major banks by the US Treasury, through January 7, cash held by banks rose $524.3bn, while loans and leases fell $148bn.
So, why aren’t they lending it? Would you want to lend money in a deepening recession, and who do you trust now to pay those loans back, says Yardeni.
All at a time when the banks have to roll over their own debt and pay interest on those liabilities, and when corporate borrowers are demanding cash to rollover their bonds, says Yardeni.
And when new accounting rules take effect later this year, banks will be force to put back onto their balance sheets hundreds of billions of dollars in assets and liabilities now warehoused in off balance sheet vehicles.
We are in a new year, 2009-can we expect more of the same that we saw in 2008?
The answer, unfortunately, is yes.
Thursday, January 22, 2009
Predictions for Global Economy in 2009
Neither I have a crystal ball nor parrots and cards, but I would like to make few predictions for the year 2009.After all life is all about predictions and speculations(pun intended). While 2008 has been a tough year, all signs point to 2009 being much worse. Here is what I see on the horizon for the upcoming year.
1) The stock market decline will accelerate in 2009, with the DJIA dipping below 6,000. Extreme volatility will engulf the markets with plenty of counter-trend rallies that will be fueled by speculators “calling the bottom,” only to find a new bottom the following month.
2) Unemployment will rise dramatically as “official” statistics reach towards 10% and true unemployment rises closer to 20%.
3) Real estate prices will continue to drop as rates reset and foreclosures increase across the country. Commercial real estate will finally follow residential, as price declines accelerate due to foreclosures on shopping malls, retail outlets, office buildings, etc.
4) Bailouts will continue, with more industries lining up for government rescue packages and both the financial and auto industries returning to the trough for more of their fix. This will lead to prediction #5.
5) Deflation will subdue and the first signs of hyperinflation will appear in the back half of 2009 as the trillions in bailout dollars begin to flow into the economy. The price declines that are a result of liquidation and de-leveraging, will give way to skyrocketing prices as politicians continue trying to print and borrow our way out of bad times. This will lead to prediction #6.
6) The dollar will resume its downtrend and make new lows during the first half of 2009. This will continue throughout the year with the dollar reaching into the low 60’s as the world loses confidence in the U.S. currency and the U.S. government’s ability to repay its debt.
7) Oil will rise from current lows and find a “fair price” somewhere in the $75 - $100 range, where it will float for much of the year. This will benefit alternative energy companies, although any gains will be muted by credit contraction and the overall market decline.
8) Agriculture prices will return to an uptrend as declining investment and unpredictable weather patterns lead to supply shortages amidst an ever-expanding population and increase in inflation.
9) Gold will make a new all-time (nominal) high reaching a price of $1,400 or more during 2009. A panicked flight to safety could push gold towards $2,000, although the central banks will dump gold on the market or make other attempts at suppressing the price advance.
10) All of the above will lead to increased crime and civil unrest with protests in the streets, bank runs and an increased police and military presence trying to bring stability to cities.
I wish that my predictions were a bit more uplifting, but we are truly in dire straits with conditions only continuing to worsen. The United States is essentially bankrupt and running on borrowed money and borrowed time. Many Americans will be facing severe financial hardship for the first time in their lives.
As for predictions about Indian Economy, still trying to figure it out.!!!!
1) The stock market decline will accelerate in 2009, with the DJIA dipping below 6,000. Extreme volatility will engulf the markets with plenty of counter-trend rallies that will be fueled by speculators “calling the bottom,” only to find a new bottom the following month.
2) Unemployment will rise dramatically as “official” statistics reach towards 10% and true unemployment rises closer to 20%.
3) Real estate prices will continue to drop as rates reset and foreclosures increase across the country. Commercial real estate will finally follow residential, as price declines accelerate due to foreclosures on shopping malls, retail outlets, office buildings, etc.
4) Bailouts will continue, with more industries lining up for government rescue packages and both the financial and auto industries returning to the trough for more of their fix. This will lead to prediction #5.
5) Deflation will subdue and the first signs of hyperinflation will appear in the back half of 2009 as the trillions in bailout dollars begin to flow into the economy. The price declines that are a result of liquidation and de-leveraging, will give way to skyrocketing prices as politicians continue trying to print and borrow our way out of bad times. This will lead to prediction #6.
6) The dollar will resume its downtrend and make new lows during the first half of 2009. This will continue throughout the year with the dollar reaching into the low 60’s as the world loses confidence in the U.S. currency and the U.S. government’s ability to repay its debt.
7) Oil will rise from current lows and find a “fair price” somewhere in the $75 - $100 range, where it will float for much of the year. This will benefit alternative energy companies, although any gains will be muted by credit contraction and the overall market decline.
8) Agriculture prices will return to an uptrend as declining investment and unpredictable weather patterns lead to supply shortages amidst an ever-expanding population and increase in inflation.
9) Gold will make a new all-time (nominal) high reaching a price of $1,400 or more during 2009. A panicked flight to safety could push gold towards $2,000, although the central banks will dump gold on the market or make other attempts at suppressing the price advance.
10) All of the above will lead to increased crime and civil unrest with protests in the streets, bank runs and an increased police and military presence trying to bring stability to cities.
I wish that my predictions were a bit more uplifting, but we are truly in dire straits with conditions only continuing to worsen. The United States is essentially bankrupt and running on borrowed money and borrowed time. Many Americans will be facing severe financial hardship for the first time in their lives.
As for predictions about Indian Economy, still trying to figure it out.!!!!
Monday, January 19, 2009
How to kill/catch a lion Weschool istyle
Now you guys must have read/spammed this joke a zillion number of times, but then once again adding a bit of flavor to this cliched one.. weschool ishtyle !!
How to Catch/Kill a Lion
Newton's Method: Let, the lion catch you. For every action there is an equal and opposite reaction. Implies you caught lion.
Einstein Method: Run in the direction opposite to that of the lion. Due to higher relative velocity, the lion will also run faster and will get tired soon. Now you can trap it easily.
Software Engineer Method: Catch a cat and claim that your testing has proven that its a Lion. If anyone comes back with issues tell that you will upgrade it to Lion.
Indian Police Method: Catch any animal and interrogate it & torture it to accept that its a lion .
Rajnikanth Method : Keep warning the lion that u may come and attack anytime. The lion will live in fear and die soon in fear itself.
Manirathnam Method (director): Make sure the lion does not get sun light and put the lion in a dark room with a single candle lighted. Keep murmuring something in its ears. The lion will be highly irritated and commit suicide.
Karan Johar Method (director): Send a lioness into the forest. Our lion and lioness fall in love with each other. Send another lioness in to the forest, followed by another lion. First lion loves the first lioness and the second lion loves the 2nd lioness. ut 2nd lioness loves both lions. Now send another lioness (third) into the forest. You don't understand right... ok....read it after 15 yrs, then also u wont!
Yash Chopra method (director): Take the lion to Australia or US.. and kill it in a good scenic location.Govinda method: Continuously dance before the lion for 5 or 6 days.
Menaka Gandhi method: Save the lion from a danger and feed him with some vegetables continuously.
George bush method: Link the lion with Osama bin laden and shoot him!
Finally .. the spice version
WeSchool Style : Get the lion to attend an innovation guest lecture and ask him to write a pre-read, then the 200 page summary on the thought process evolved , then form groups and write a detailed report and later again form another group and then write under a different topic on the same lecture and then once again form a different group to present a PPT;and if any two answers are same, punishment will be given in the form of another 6 hours innovation lecture.
All the answers should be different as it is meant to understand each individual's thought process which is different and to make it really lively link each of these works with credits worth a dime.
How to Catch/Kill a Lion
Newton's Method: Let, the lion catch you. For every action there is an equal and opposite reaction. Implies you caught lion.
Einstein Method: Run in the direction opposite to that of the lion. Due to higher relative velocity, the lion will also run faster and will get tired soon. Now you can trap it easily.
Software Engineer Method: Catch a cat and claim that your testing has proven that its a Lion. If anyone comes back with issues tell that you will upgrade it to Lion.
Indian Police Method: Catch any animal and interrogate it & torture it to accept that its a lion .
Rajnikanth Method : Keep warning the lion that u may come and attack anytime. The lion will live in fear and die soon in fear itself.
Manirathnam Method (director): Make sure the lion does not get sun light and put the lion in a dark room with a single candle lighted. Keep murmuring something in its ears. The lion will be highly irritated and commit suicide.
Karan Johar Method (director): Send a lioness into the forest. Our lion and lioness fall in love with each other. Send another lioness in to the forest, followed by another lion. First lion loves the first lioness and the second lion loves the 2nd lioness. ut 2nd lioness loves both lions. Now send another lioness (third) into the forest. You don't understand right... ok....read it after 15 yrs, then also u wont!
Yash Chopra method (director): Take the lion to Australia or US.. and kill it in a good scenic location.Govinda method: Continuously dance before the lion for 5 or 6 days.
Menaka Gandhi method: Save the lion from a danger and feed him with some vegetables continuously.
George bush method: Link the lion with Osama bin laden and shoot him!
Finally .. the spice version
WeSchool Style : Get the lion to attend an innovation guest lecture and ask him to write a pre-read, then the 200 page summary on the thought process evolved , then form groups and write a detailed report and later again form another group and then write under a different topic on the same lecture and then once again form a different group to present a PPT;and if any two answers are same, punishment will be given in the form of another 6 hours innovation lecture.
All the answers should be different as it is meant to understand each individual's thought process which is different and to make it really lively link each of these works with credits worth a dime.
FM with Sango..
A brief introduction ...Sandeep Gokhale joins JSW from the Vedanta Group where he was responsible for a host of key initiatives. During his thirteen-year tenure with the Vedanta Group, Mr. Gokhale held senior management positions and worked on several key initiatives. He conceptualised the roadmap for the Groups Rs. 6000 crore aluminium smelter complex in Orissa. Mr. Gokhale was also associated with the takeover of BALCO, Hindustan Zinc and other international mining assets during his tenure with the Vedanta Group.
Mr. Gokhale has done his post-graduation from the Jamnalal Bajaj Institute of Management Studies, Mumbai and is an Electrical Engineer from the Manipal Institute of Technology. . Currently he also takes classes for students across various institutes on subjects related to Finance; and is currently taking the subject FM for us :) Here was a person who took us 4 Straight hours of class with only a 15 mins break.... he took a abysmally low point in our day to the zeniths of F.A,C.A understandings.....(for some it was really hard to conc. with results being put up outside class notice board). Suddenly as if there was a magic charm I have started adoring P&L statements, Cash flows and all other financial instruments... The really wonderful aspect was that SanGo(as he is known :)) started with the theoretical part, and then took a tangential practical example (mostly from his Work-exp) and then went to the next tangent and then so on and so forth.. ultimately forming a perfectly round shape bringing us back to the initial understanding !! He gave us amazing insights into Taxation(thanks to real life PC example), depreciation and everything connected with them.. Did u know that the company has to file a min depreciation if in case they have to declare dividends ? And I really adored the practical example he gave of how the share prices of Tisco did a See-Saw, though the core competency of the group increased substantial.. and the only 2 cranes operating in Mumbai at this point of time are at the MIAL and Antilia (Mr.Mukesh Ambani's Mansion) .. Jai Ho ..Sango :)
Mr. Gokhale has done his post-graduation from the Jamnalal Bajaj Institute of Management Studies, Mumbai and is an Electrical Engineer from the Manipal Institute of Technology. . Currently he also takes classes for students across various institutes on subjects related to Finance; and is currently taking the subject FM for us :) Here was a person who took us 4 Straight hours of class with only a 15 mins break.... he took a abysmally low point in our day to the zeniths of F.A,C.A understandings.....(for some it was really hard to conc. with results being put up outside class notice board). Suddenly as if there was a magic charm I have started adoring P&L statements, Cash flows and all other financial instruments... The really wonderful aspect was that SanGo(as he is known :)) started with the theoretical part, and then took a tangential practical example (mostly from his Work-exp) and then went to the next tangent and then so on and so forth.. ultimately forming a perfectly round shape bringing us back to the initial understanding !! He gave us amazing insights into Taxation(thanks to real life PC example), depreciation and everything connected with them.. Did u know that the company has to file a min depreciation if in case they have to declare dividends ? And I really adored the practical example he gave of how the share prices of Tisco did a See-Saw, though the core competency of the group increased substantial.. and the only 2 cranes operating in Mumbai at this point of time are at the MIAL and Antilia (Mr.Mukesh Ambani's Mansion) .. Jai Ho ..Sango :)
Parkinson's law for an MBA
The Parkinson's law in IT states :
"Data expands to fill the space available for storage"the corollary in the life of any Typical MBA would be stated as :
"Idleness expands until it fills all time available"
While most of the out-side world would have been fantasizing about an MBA doing multiple roles with his single hand; solving case studies, attending CEO guest lectures, working on strategic assignments (I love everytime i use the word strategy), preparing Business plans, growth road-map for companies which have long bitten the bankruptcy dust... here is a lil bit of truth from my a typical MBAer.Unfortunately this is how it works for me :-
"Data expands to fill the space available for storage"the corollary in the life of any Typical MBA would be stated as :
"Idleness expands until it fills all time available"
While most of the out-side world would have been fantasizing about an MBA doing multiple roles with his single hand; solving case studies, attending CEO guest lectures, working on strategic assignments (I love everytime i use the word strategy), preparing Business plans, growth road-map for companies which have long bitten the bankruptcy dust... here is a lil bit of truth from my a typical MBAer.Unfortunately this is how it works for me :-
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