Role of PE firms

PE firms perform a number of roles in the investee company. They can be majorly classified as follows:

·       Source of Capital

The main role of PE firm in any investee organization is to provide capital which may not be available through other sources. They help to recapitalise the company for future expansions. They also provide access to new channels of funding. Many a times a PE company is ready to invest in a company if it is already backed by another PE firm. For example, Vriti Infocom raised $5 million in series-B funding led by JAFCO Asia along with a follow-on investment from existing backer Intel Capital.

·       Strategic Support

Sometimes PE firm regard itself more as a strategic investor rather than a PE or a VC investor. In this role, the PE firm generally provides strategic inputs for growth and helps the company access new markets. It may also help the company in building a global outlook. They help find new acquisition targets or strategic partners for future expansion. A big company might invest in a smaller company which makes similar products or in a smaller company which will eventually become a client of the big company. This arrangement is beneficial for the smaller company as it allows the company to remain autonomous and in turn attract other investors. Larger companies also benefit because they carry less risk than an acquisition.For example, Intel Capital regards itself as a strategic investor and generally invests in technology related companies.

·       Operational Management

PE firms may also invest in a company to improve upon the management process and controls and thus better the efficiency of the company. They help the company to inculcate better corporate governance practices and new ways of management reporting.

·       Brand Building

Backing by a reputed PE firm helps in improving the quality perception of the company. This will help them in furthering their business prospects and help the company in acquiring new clients. It will also help the company to develop a network of contacts which can be utilized when need arises. A better brand will also help the company in attracting talent at senior management level as well as the entry levels.

By Prince Kumar (pgp01030@iiml.ac.in)

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STOCK PRICES JUGGLING IN 2011

There has been turmoil of sorts in the Indian stock market in the recent months. On 4^th of February, investors lost a mammoth Rs 1.2 trillion. We have tried to capture the reasons behind the convulsion in the points listed below.

Inflation: In January, inflation touched the dreaded double digit mark. The food inflation reached almost 14-15%. Investors were forced to pull out their money under such circumstances. Sensing this risk in Indian stock market, even FIIs started selling their holdings.

Increment in Interest rate: In February RBI increased BPLR (Benchmark Prime Lending Rate) by 50 basis points or 0.5%. As a result of this monetary policy by RBI, the sentiment among the investors turned negative which directly got reflected in the SENSEX.

Egyptian Crisis: India is rapidly becoming an important player in the global economy. So, the turmoil in Egyptian market hit the global economy as well as the Indian stock market. Restoration of stability in Egypt, as expected, led to a positive bearing on the SENSEX as well.

Financial Budget:  The Financial Budget was released by honorable finance minister, Mr. Pranab Mukherjee. There have been few issues discussed in recent budget. FII investment in corporate bonds will be raised to USD 40 billion. This helped attract world attention once again. Individual income tax exempt slab has been increased from ₨1.6 lacs to ₨1.8 lacs. As a result, a group of people will be able to save more and will be attracted to the high risk high return stock market. The SENSEX is expected to be positively affected owing to these incentives.

Japan Crisis: The recent tsunami and earthquake made Japan’s condition worst since WWII. As Japan is one of the main members of the global economy, this economic as well as social crisis in Japan has badly affected the world economy. Some companies like Toyota and Honda have been at receiving side.

Rise of SENSEX: But again, the downturn of SENSEX has been to a limited extent. The main reason behind this is the uncertainty of the Indian market. After downfall some people assumed a rise after this fall. So they started investing again. This resulted in sudden rise in market after mid February.

We hoped for a recovery after the budget. The Egyptian scenario showed some positive signs. Now, the over looming Japan crisis is shaping a slight negative trend. But the expectations are that the SENSEX will regain its pace and we will see the bull raging again.

By – Arun Marik (pgp01014.iimrohtak@iiml.ac.in)

Abhishek Verma (pgp01006.iimrohtak@iiml.ac.in)

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PTC India Financial Services IPO (update)

The price band has been fixed at Rs. 26-28 per share for the IPO that will be open from 16th March to 18th March, 2011. The shares are to be offered through a 100% book building process.
The company is to raise Rs. 407-439 crore depending upon the issue price. The company proposes to come out with a fresh issue of 12.75 crore equity shares and an offer for sale of 2.92 crore equity shares by Macquarie India Holdings Ltd as the selling shareholder. The face value of the shares will be Rs. 10.
The company has decided to offer discount of Re 1 to the issue price to retail individual bidders, PFC Financial Services Chairman T N Thakur told reporters here.
The Book Running Lead Managers (BRLM) to the offer are Almondz Global Securities Limited, ICICI Securities Limited, JM Financial Consultants Private Limited and SBI Capital Markets Limited.
Registrar of the Issue: Karvy Computershare Private Limited Hyderabad.
By:
Vismaya Agarwal (pgp01049.iimrohtak@iiml.ac.in)

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PTC Financial Services IPO by mid-March

PTC India Financial Services (PFS), an arm of the state-run PTC India, has received a nod from market regulator SEBI for an initial public offering (IPO) and plan to come out with it by mid-March. This clearly shows that firms are still upbeat about investor appetite despite a weak run in the markets this year.

The company can raise between Rs. 500-800cr through the IPO but they have not yet set a target. Thakur said that the fundraising will depend on the book value of their shares, which currently stands at Rs. 15.21.

The funds are to be used for the company’s growing operations, as well as to improve their debt raising ability and credit ratings. "Once you do the IPO, for subsequent (fund) raises, you have a benchmark," said T N Thakur, Chairman and Managing Director, PTC.

"PFS is on a steep growth path and the growing power requirements in the country will help the company grow further," PFS Director Ashok Haldia said.

PTC has a 77% stake in PFS’s present equity capital of Rs 600cr and will have 60% holding post the IPO. GS Strategic Investments, a unit of Goldman Sachs and Macquarie India Holdings, a unit Macquarie Group Ltd, each hold 11.20% and will have 8.7% and 3.5% stakes in the company, respectively, post the issue. The issue will consist of 12.75cr fresh equity shares in the market.

Avendus Capital, SBI Capital Markets, JM Financial Services, ICICI Securities and Almondz Global Securities are the arrangers to the issue.

PFS posted a profit of Rs 254.52 million, on total income of Rs 534.90 million for fiscal 2010, according to the draft red herring prospectus it filed with the Securities and Exchange Board of India

PFS is promoted by PTC India as a special purpose investment vehicle to provide financial services to the entities in energy value chain, which includes investing in equity and extending debt to power projects in generation, transmission, distribution, fuel related infrastructure like gas pipelines, LNG terminals, ports, equipment manufacturers and EPC contractors, etc.

PFS also provides non-fund based financial services, adding value to Greenfield and Brownfield projects at various stages of growth and development.

By:-

Vismaya Agarwal (pgp01049.iimrohtak@iiml.ac.in)

Prashant Chourasia (pgp01028.iimrohtak@iiml.ac.in)

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Budget 2011-12 - Analysis

This budget has been presented when rising inflation worries are overshadowing Indian growth story. Inflation rate of more than 8% and food inflation in double digits has already brought the SENSEX to its 6 months low. Finance Minister had the daunting task of checking the inflation while also maintaining the growth momentum of the Indian economy. Since the budget announcement, BSE index has risen by more than 700 points. Is this the short term rhetoric of budget or indication of some fundamental changes? Here, we will discuss main highlights of the budget and their possible effects on future prospects of the Indian Industry.

Fiscal Deficit:

For FY12, the Government estimates the fiscal deficit to fall to 4.6% of GDP from 5.1% in FY11 (estimated) primarily, on account of increase in both direct and indirect taxes and moderate growth of 3.5% in Govt. expenditure due to reduction in subsidies and reining in of unplanned expenditure. This will be a very difficult task to accomplish considering the fact that fiscal deficit for FY11 would have been 6.3% of the GDP without the spectrum auction.

Reduction in Subsidies:

The Govt. estimates to reduce subsidy bill by 12.5% this fiscal year to tame the rising fiscal deficit. But, the budget has remained silent on the issue of how to reduce subsidies in the backdrop of record high prices of oil, food and fertilizers thus raising speculations of increase in fuel prices after the budget or after state assembly elections in May. With already soaring inflation of more than 8%, it will be a hard task to achieve both the targets of reduction in subsidy and bringing inflation low.

A new system has been proposed to be implemented, under which direct cash subsidy will be given to the BPL (Below Poverty Line) families to buy fertilizers and cooking fuel. This will help in checking the alleged diversion of the kerosene for adulteration and LPG for commercial purposes. A committee headed by Nandan Nilekani has been formed to work out the modalities for this system. This step has been taken very positively by the market.

Direct Tax:

a.)    Exemption limit for the general category individual taxpayers has been enhanced from Rs. 160000 to Rs. 180000 giving tax relief of Rs. 2000 to all tax payers whose taxable income is more than Rs. 180000.

b.)    Reduced the qualifying age for senior citizens from 65 years to 60 years along with enhanced exemption limit from Rs. 240000 to Rs. 250000.

c.)    Created a new category of Very Senior Citizens (80 years and above), who are eligible for a higher exemption limit of Rs. 500000.

d.)    Rate of Minimum Alternative Tax (MAT) proposed to increase from 18% to 18.5% of book profits.

e.)    Proposed a lower rate of 15% tax on dividends received by an Indian company from its foreign subsidiary.

f.)     Proposed extension of Rs. 20000 exemption for investment in long-term infrastructure bonds by one more year.

Infrastructure Sector:

Growth of Infrastructure Sector is vital for the consistent growth of the Indian economy. And the budget has taken many steps, like 27% increase in the budget for infrastructure expenditure, extension of exemption for investment in Infrastructure bonds and increase in long term infrastructure bond limit for FIIs to encourage investments in Indian Infrastructure sector. But the implementation part of the infrastructure projects was neglected. There have been huge delays in awarding the infrastructure projects and later in land acquisition processes.  The government needs to consider the implementation part as well to bring major turnaround in this sector.

Agriculture:

Agriculture has been given adequate importance and loans at concessional interest rate of four per cent have been announced for farmers who pay their dues in time and the credit target for farm sector has been increased.

Liberalization of FDI:

Allowing the foreign money through Mutual Funds is a major step taken by Govt. and the market has whole heartedly welcomed it, as it will help in routing foreign money into Indian markets. However, the budget has been silent on the issue of liberalization of FDI in the retail and insurance sectors.

By:
      Amit Tayal (pgp01009.iimrohtak@iiml.ac.in)

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Private Equity

Private Equity refers to the equity capital that is not quoted on a public exchange. Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity.

Types of Private Equity

1)    Leveraged Buyout – LBO is an acquisition of a business using mostly debt and a small amount of equity. A company will secure the loan by using the collateral from the company they are looking to purchase. They use this loan to buyout all the outstanding shares of the company. In LBOs interest is paid like in conventional loans. The acquired company will have to make enough money to cover the risks associated with the loan. That’s why LBOs are considered more risky.

2)    Venture Capital – Funding for start-up companies considered to have strong growth prospects. Most venture capital is obtained from one or more VC firms, generally in an exchange for an equity stake and majority of the control. Funding is often provided in staged providing sufficient cash to reach the next milestone. VC firms may also provide management assistance and other services.

3)    Growth Capital – It’s a type of PE investment in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a significant acquisition without a change of control of the business.

4)    Distressed and Special situations – These are investments in equity or debt securities of financially stressed companies. They can either be:

a.     ‘Distressed to Control’ or ‘Loan to Own’ strategies

b.     Special situations or turnaround strategies.

5)    Mezzanine Capital – It is a preferred equity instrument that represents a claim on the company’s assets which is senior only to that of the common shares. It is used in Leveraged Buyouts in conjunction with other securities to fund the purchase price of the company being acquired. It is often a more expensive financing source than secured debt.

            By:  

                  Vivek Kumar (pgp01050.iimrohtak@iiml.ac.in)

                  Prince Kumar (pgp01030.iimrohtak@iiml.ac.in)

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Index Funds

Basic Concept

An Index Fund is a mutual fund which will match the performance of an index, for example, like Sensex or the Nifty. It is a passively managed fund. On the other hand, an actively managed fund seeks to outperform an Index, that is, deliver a performance better than that of the index.

The index fund basically does this by investing in the stocks of the index in percentage of their weights. For example, a fund which tracks the Sensex will invest in the 30 stocks of the Sensex in proportion to the weights of the stocks in the Sensex. Alternatively, if an index has say 100 stocks, the fund manager will select a sample of stocks of the index which will match the index returns. This is done by sampling techniques, historical data research etc.

Since the fund has to just mirror the index, there is no research or stock selection issue, hence the fund is known as a passive fund.

Market theory Behind

The reason why people believe that funds should be passively managed is the efficient market theory. As per this theory, the prices reflect information to the extent that the cost involved in collecting information on stocks is more than the profits from it. The hypothesis implies that fund managers and stock analysts are constantly looking for securities that may out-perform the market; and that this competition is so effective that any new information about the fortune of a company will rapidly be incorporated into stock prices. It is postulated therefore, that it is very difficult to tell ahead of time which stocks will out-perform the market.

Advantages

Low Cost: Since the funds are managed passively and most of the modelling for investing is done by computers, the fund costs are very less compared to actively managed funds. In India, it is around 1%.

Lower Turnover: Passively managed funds have lower turnover, meaning that there is less buying and selling of stocks since their portfolio composition doesn’t change a lot with time. This result in lower brokerage costs, capital gains tax etc.

Lesser Risk: Compared to actively managed Portfolios which invests in relatively fewer stocks an index fund invests in more stocks thus reducing risk. Also you are not exposed to the risk of fund manager performance. Fund manager’s under pressure to meet targets may take aggressive positions which results in losses.

Beating Markets is not easy: In the long run getting returns above that of the market is not easy due to the factors mentioned above. For example, in mature markets 80% of funds underperformed benchmark funds.

Exchanges act as Your Manager: In a passive management fund you effectively allow the exchange to act as the manager. The exchange change stocks in the index based on performance, state of economy sectoral factors etc. Since Exchanges are managed by some of the savviest investors you are utilizing their services for free.

Disadvantages

Tracking Error: Since a fund has to have cash to meet redemptions, there will be some underperformance or over performance with respect to the index. Also, due to factors like change in composition of index or due to change in weights of companies owing to mergers, the performance of index funds generally is around 1-2% lower than index funds globally.

No Outperformance: The Index Funds are limited to produce returns less than equal to the Index. While, returns above index have no possibility.

Distortion in Stock Prices: Stocks which leave the index are beaten down because of index funds selling and stocks entering rise due to buying by index funds. This distorts the prices of index funds above fair value due to liquidity.

Lack Of Market Efficiency in Emerging Markets: Emerging markets are generally less efficient than mature markets due to volatility associated, more information gap, less investment and research activity etc. Under this situation, active funds may be better.

The Indian Scenario

In India, the popularity of index funds is extremely low. For example, in 2009, of the total equity investments, less than 1% was in index funds. There are many reasons for it. Like, in India for most people who invest directly, it is a passion and they take it seriously. While in the category of those who prefer mutual funds, there is lack of knowledge of the benefits of Index funds. Also, since the margins are lower in Index funds, most mutual fund companies don’t promote it as much to investors. Lastly, India being an emerging market there is more opportunity for a fund manager to pick up hitherto unknown stocks and beat benchmarks.

 But despite all this, if you are an Investor with a sufficiently long term horizon of 20yrs and your risk appetite is low it makes better sense to invest in index funds. Because in the long run all the tax, broking cost and averaging out factor should favour passive funds. For Pension funds, Life Insurance companies and other long term funds, index funds are a better option. Also, the situation in India seems similar to that US in 1970s, when Index funds were launched in US and there was a lot of scepticism. Now, 25% of all equity investments are in index funds in the US. Similarly, the investments in India will and should increase.

There is a bright horizon for index funds in India and long term risk averse investors should go for it.

References

1. http://www.nseindia.com/content/indices/ind_indexfunds.htm
2. http://www.livemint.com/2008/07/27215336/Do-index-funds-make-sense.html
3. http://en.wikipedia.org/wiki/Index_fund

 By - A.D. Dheeraj (pgp01001.iimrohtak@iiml.ac.in)

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