Wednesday, March 26, 2014

Troubles for listed MNCs to increase in India

 
The recent fracas between and its minority shareholders has blown the lid off the tension that has been steadily building between minority shareholders and listed multinational corporations in India. This is despite the fact that many of the listed multinationals have delivered better financial performance as well as stock returns to shareholders. Compared to their Indian peers, multinationals have higher return ratios (return on capital and return on equity) because of their superior allocation of capital, management skills and higher dividend pay-outs. This is visible in the shareholder returns too. Listed multinationals in India have generated (compounded annual growth rate) of nearly 19 per cent over the last decade while the BSE 500 has returned about 13 per cent. In contrast, many Indian companies tend to hoard cash, which is either parked in low-yielding bank deposits (or fixed return instruments) or used for unrelated diversification, leading to lower return ratios and stock returns.

But, over the last few years, Indian subsidiaries of multinationals have also begun to contribute significantly to their parents' earnings. It is the rising size and scale of Indian operations (in their global portfolio), and partly the fact that parents' global operations are slowing down, that have led to a conflict of interest and simmering tensions between the promoters (the parent of the multinational) and the minority shareholders in India. In a bid to get a larger share of the profits, experts say, parents of Indian multinationals are resorting to questionable tactics. Maruti Suzuki is a case in point. As it expanded its business, Maruti's contribution to its Japanese parent, Suzuki, grew significantly. By setting up a parallel manufacturing plant in Gujarat, partly utilising Maruti's post-tax profits, Suzuki would have not only reduced the Indian arm to a marketing company but would have also eroded its profitability.

There are several other examples of the multinational parent's growing dependence on its Indian subsidiary. Emerging markets contribute 55 per cent of Unilever's profit and by 2020 this will increase to 75 per cent. Last year, Unilever guided for lower profits due to the slowdown in key emerging markets like India.
on 22 January 2013 announced its decision to increase royalty from 1.4 per cent of sales to 3.15 per cent in a phased manner between 2013 and 2018. Over two days the stock was down over 7 per cent, and remained under pressure till end-April when Unilever announced an open offer. On April 30, Unilever announced the offer at Rs 600 per share, which though 21 per cent higher than the then prevailing price, was only 14 per cent higher than the two-month average price before the royalty increase was announced. The market viewed this as controversial.

Brokerages too are taking note of the investor sentiment. Espirito Santo recently red-flagged the top five royalty payers-Maruti (which paid the highest royalty as a percentage of sales at 5.8 per cent in FY13) along with Hindustan Unilever,
, and ABB.

While the increase in royalty is one of the many ways to benefit the parent, larger institutional shareholders claim that multinationals also resort to merging unlisted subsidiaries, into listed ones, usually enabling the parent to raise its stake. Conversely, there are instances of transferring (profitable) divisions to the parent firm, and that too at low valuations. Siemens is one such example, say experts. The German parent bought a company owned by its listed Indian subsidiary at valuations that were way lower than valuations a few years back. Holcim's complex proposal involving two of its listed subsidiaries was also questioned by shareholders. The proposal was to sell Holcim's stake in ACC to Ambuja Cements for cash consideration of Rs 3,500 crore plus higher stake in Ambuja. By doing so, it would have got the cash as well as retained indirect control in ACC.

Mismatched interest

Most of these restructuring exercise by companies are driven by the intention to enrich the parent company, say experts. London-based Nick Paulson, co-head (emerging market equities), Espirito Santo Investment Bank, says: "The problem is inherent - the interest of multinational and minority shareholders aren't fully aligned. Some companies operate with global standards of transparency and accountability, but others suffer serious incentive misalignments."

Investors today are watchful of red flags like royalty increases, merger of wholly-owned subsidiaries into parent-owned entities to increase shareholding, poor disclosures and weak boards. Ambit Capital says, "With the increasingly hostile behaviour of several prominent multinationals vis-à-vis minority shareholders, and given the business strengths and superior capital allocation of multinationals in general, investors face a dilemma today." The brokerage has red-flagged some of these multinationals which have been accused of short-changing minority investors.

Fund managers and equity strategists believe that multinationals command higher valuations because they pay dividends, but it does not mean that their corporate governance standards are world-class. Amit Tandon, founder & managing director, Institutional Investor Advisory Services (IiAS), says, "As the Indian business has grown, it has attracted more attention. So the parent looks at how to benefit more tangibly from it by either taking cash or increasing stake at artificially low valuations. These last few years have also been difficult globally - hence, the tendency to move cash from the Indian balance sheet to global balance sheet to shore up the global P&L." It is for this reason that Ambit Capital says that while many multinationals are great companies, they might not be great stocks given the misalignment in their interests and that of minority shareholders.

This behaviour is unique to India in many ways as these entities are listed in India not out of commercial compulsions but because Indian laws mandate them to do so. Tandon says India might be one of the few markets where large multinationals have a listed entity outside of their home markets. It is for this reason that they behave differently and the minority shareholder is an unnecessary irritant. There are about 100 listed multinationals in India, either due to historical reasons or because of acquisitions they have made.

So far, most decisions taken by the boards of these listed multinationals have sailed through, despite opposition from the minority shareholders. But the new
2013, introduced recently, has been a big step forward for the minority shareholders. Under this Act, all related party transactions will need to be passed through a special resolution, which requires 75 per cent consent from the minority shareholders. Any decision on mergers, royalty and other similar transactions will also need to be passed through a special resolution where the multinational parent will not be allowed to vote.

This opens up the possibility of more litigation. As IiAS points out in a report, Have multinationals found a way around the delisting norms?, "Given the complexity of regulations and increased cost of compliance across various jurisdictions, multinationals generally prefer to remain listed only in their home markets. This is especially true in the Indian context where the Companies Act 2013 and SEBI corporate governance code (to be implemented soon) not only requires a larger set of disclosures and approvals, but also raise the risk of litigation through class action suits."

But, even as the tensions are rising between the two sets of shareholders, there is perhaps more waiting to unfold. Because of regulatory tightening, many companies may look at delisting their Indian arms. But even that will have its own set of challenges with questions being raised on the manner of arriving at the delisting price.
ROYALTY PAY-OUTS: WHAT THE COMPANIES ACT SAYS

While the Companies Act makes it difficult for related party transactions to go through without the approval of minority shareholders, experts await clarity on whether royalty pay-outs fall in the normal course of business or are a related party transaction.

Listed multinationals may have gotten away with some controversial decisions in the past, but the Companies Act (2013) gives more muscle to the minority shareholder. Section 188 of the Companies Act has made it mandatory for all related party transactions, other than those in the ordinary course of business, to be passed through a special resolution, requiring 75 per cent votes of the minority shareholder. All transactions between the company and a related party (be it royalty payment to the parent or M&A with other related parties) would have to be passed through a special resolution. In this special resolution the related party (which would be the promoter) will not be allowed to vote.

Historically, promoters or majority shareholders have often pushed through regulations to benefit themselves, at times even at the expense of the minority shareholder. The new Companies Act has now changed the regulatory landscape. While more clarity on royalty pay-outs is awaited, even if the payments are assumed to be in the normal course of business, they would have to be justified to the audit committee.

Yogesh Sharma, partner (assurance), Grant Thornton (an assurance, tax and advisory firm), says: "Section 188 gives additional protection to minority shareholders. Any transaction which is outside the course of regular business, like brand fees or management fees payments to majority shareholders (or to related parties), would require going through a special resolution. Further, all related party approvals will now be scrutinised by the audit committee, which comprises of a majority of independent directors."

Nick Paulson of Espirito Santo says the bill provides the enabling architecture for better corporate governance. "There are tighter restrictions on related party transactions, but the restrictions will not apply to those entered into in the 'ordinary course of business'. The definition of this needs clarifying, as it creates uncertainty on issues such as royalties."

QUESTIONABLE DECISIONS BY

TRANSFER OF PROFITABLE DIVISION AT THROWAWAY VALUATIONS

Siemens India in January 2009 approved divestment of its subsidiary Siemens Information Systems Ltd (SISL) to Siemens Corporate Finance, wholly-owned by Siemens AG, in a deal valued at Rs 490 crore. The subsidiary SISL had revenues of over Rs 990 crore and a net worth (book value) of Rs 360 crore, implying a valuation of 1.25 times of book value. In contrast, in May 2003, the parent company had picked up 25.2 per cent stake in the Indian subsidiary for about Rs 80 crore (SISL's networth stood at Rs 120 crore as on September 2003) or valuation of 2.75 times of book value even as the profitability of the subsidiary had deteriorated in the year preceding the divestment in 2003

ROYALTIES RISE DESPITE SLOWING SALES

The top 25 listed MNCs in India paid Rs 4,950 crore in FY13, a 23.8 per cent jump over the previous year, well in excess of both sales and profit growth. Maruti Suzuki continues to pay the highest royalty at 5.8 per cent of net sales. Others in the list are HUL, Nestle, Bosch and ABB

BUYBACK ANNOUNCEMENTS SOON AFTER ROYALTY INCREASE

Hindustan Unilever on January 22, 2013 announced its decision to increase royalty from 1.4 per cent of sales to 3.15 per cent in a phased manner between 2013 and 2018. On 30 April, Unilever announced the open offer at Rs 600 per share, which was 21 per cent higher than the then prevailing price, but only 14 per cent higher than the two month average price before the royalty increase was announced. The market viewed this as controversial

CASH REPATRIATION FROM SUBSIDIARY TO PARENT

Last year, Holcim announced a deal involving sales of its controlling stake in ACC to its other listed subsidiary, Ambuja Cements. While Holcim would have got Rs 3,500 crore in cash (and a higher stake of 61 per cent in Ambuja versus 50.6 per cent prior to the deal) besides retaining its control (indirectly through Ambuja) over ACC, Ambuja would have seen significant cash outflow and equity dilution. Although Ambuja was getting majority stake in ACC (hence, ACC's financials would reflect in its consolidated numbers), the combined stake of its minority shareholders would have fallen 20 per cent. Analysts say, a better way would have been to merge ACC and Ambuja, which would have helped retain cash within the listed companies as well as made the structure simpler

SEEKING TO DE-LIST

This month, AstraZeneca Pharmaceuticals AB of Sweden announced plans to delist its Indian arm, AstraZeneca Pharma India (AstraZeneca), a move minority shareholders are opposing. IiAS, a proxy advisory firm, while examining the issue, said one of the patterns emerging is oddly enough, the 'Offer for Sale (OFS)' route. To comply with the minimum 25 per cent public holding rule, last year many promoters did so through the OFS or IIP (institutional placement) route. AstraZeneca's parent held 90 per cent stake which it brought down through the OFS route. In less than a year, the parent has come out with delisting offer. Given the current rules, the delisting is easier if AstraZeneca's parent manages to get the shares held by institutional investors. IiAS says that retail investors have alleged that entities which participated in the OFS were acting in concert with the promoters and would sell the shares purchased through the OFS to the promoters. This would impact true price discovery while de-listing.
(Source: Business Standard)

Rural consumption to drive truck rentals

 
Truck rentals could rise further over the next couple of months owing to the movement of agricultural goods as well as general merchandise on the back of a spike in rural consumption. According to S P Singh of Indian Foundation of Transport Research and Training (), there could be an upward bias in rentals for April and May given the higher procurement prices and spending in smaller cities and rural centres. This could perk up industry activity a bit, he believes. While rentals have been stable and firm thus far in March, those had moved up six to eight per cent in January and three to four per cent in February.

Given the rise in diesel prices, the cost push has been one of the reasons for the increase. According to Singh, the lack of fleet expansion and retention of older trucks have meant lower competition in the freight rental business and a moderation of supply. Higher utilisation of existing fleet without the additional cost of a new truck or monthly instalment has meant an improvement in truck operators’ profitability.

The rise in rentals in the first two months of the year was also boosted by a surge in demand for agricultural produce, fruits and other food items given the fall in prices and also movement of general merchandise. Thus, while the 20-25 per cent jump in despatches of fruits, vegetables and food items from production centres has led to higher demand for trucks, the past three months have also seen a four to five per cent increase in cargo from the manufacturing sector.

According to Singh, the improvement seen in the first two months might not last long given that the cargo availability from the manufacturing sector has not seen consistent improvement. This is why truck owners are not very keen to expand their fleet despite high discounts as well as subvention on their equated monthly instalments.

While truck rentals are moving up, analysts are not too bullish about the commercial vehicle makers in the near-term. According to them, recovery in the commercial vehicle segment could still be two quarters away. Volumes for the commercial vehicle sector are expected to fall 20-22 per cent in FY14.

“We maintain our negative view on the trucking industry (medium and heavy commercial vehicle segment) for the next six months. However, we believe, volumes have bottomed out,” says Surjit Arora of Prabhudas Lilladher.

China’s struggle for a new economy

 
What are the prospects for the Chinese economy? Few, if any, economic questions can be more important. I have just attended this year’s China Development Forum in Beijing, which brings western business leaders and scholars together with senior Chinese policy makers and academics, with this question very much in my mind.
Outside China, pessimism has been growing about the ability of the colossus to sustain its rapid growth. Worriers are paying particular attention to excessive capacity, investment and debt. I share the view that making the transition to slower and more balanced growth is an extraordinarily hard challenge even by the standards of those China has already met. Yet betting against the success of Chinese policy makers has been a foolish wager. When a superb horse meets a new obstacle, the odds must be on the horse. But even the best horse may fall

Yang Weimin, a vice-minister in the government, laid out the country’s new “guidelines for comprehensively deepening reform” in an invaluable background paper. This notes several new conditions.
First, China is an upper-middle-income country, with gross domestic product per head of $6,700. It is now tackling the rarely achieved task of becoming an advanced economy.
Second, the international environment is less favourable than it used to be, partly because the high-income economies are so structurally weak and partly because the Chinese economy has become so much larger relative to all others.
Third, the economy has itself changed. The potential growth rate has fallen to 7-8 per cent, partly because of a shrinking labour force; excess capacity has become massive even by Chinese standards; financial risks have risen, driven by excessive local authority borrowing, housing bubbles and growth of shadow banking; the country is now more than 50 per cent urbanised but its cities suffer a range of ills, including pollution. Finally, the resource-intensive growth pattern is hitting limits, notably of water, which is not a directly tradeable commodity.
The “Decision on Major Issues Concerning Comprehensively Deepening Reforms” agreed last November is the response. It is the blueprint for the next round of reforms. It proposes, notably, substantial institutional and political reform, including a transformation of “imperative and administrative governance” to “governance by law”. The market is to play a “decisive” role in resource allocation. The government is, in turn, to be responsible for “macroeconomic regulation, market regulation, public service, social administration and environmental protection”. Westerners would recognise all that.
This implies changes in the role of state-owned enterprises. It also implies a shift from positive to negative lists of what new entrants are allowed to do: instead of needing approvals, businesses should be able to do whatever is not prohibited. This might prove revolutionary. Also important are proposed changes to the system of residence permits, which should allow 100m migrants to become permanent urban residents.
To most outsiders the language of official declarations is mind-numbing. Yet, having listened to Premier Li Keqiang and vice-premier Zhang Gaoli, I found all this at least analytically convincing. They clearly recognise the need for decisive action in response to the challenges faced. What they want to do also makes good sense both on economic and environmental fronts.
A background paper on medium-term economic prospects and a presentation by Stephen Roach, now at Yale, show that China has also made real progress in its transition towards a slower, less resource-intensive and more employment-intensive pattern of economic growth (see charts). While the services sector has a significantly smaller share in GDP than in almost all other economies, for the first time it became bigger than industry’s in 2013. Before 2008, a percentage point of growth produced fewer than 1m new urban jobs. Since then each point has produced an average of 1.4m jobs. Inflation has remained well under control and industrial profitability has held up despite slower growth.
In all, the economy seems to have been adjusting quite smoothly to the inevitable slowdown driven by a declining ability to exploit untapped resources, including labour.
Yet China also has a highly unbalanced economy whose most striking feature is the extraordinarily low share of consumption, public and private, and extraordinarily high share of investment (both close to half of GDP). Until last year, in which there was a small reversal, the rise in the investment share had been rapid and almost continuous since the start of the present century.
At present, private consumption is about 35 per cent of GDP, roughly half the share in the US. The extraordinary share of investment has driven growth. But it is also directly related to the growth of excess capacity and the rise in leverage. As the paper on medium-term prospects notes, the outstanding risks to economic performance do indeed lie in the related risks of financial panic, imploding property bubbles, high local government debt and excess capacity. The peril is that a rapid correction would cause a positive feedback loop and so a far sharper than expected economic slowdown.
In many important industries, output is already below 75 per cent of capacity. Yet China is far too large to export its way out of this. In the case of steel, for example, its annual capacity is 1bn tons and output 720m, 46 per cent of the global total. A significant slowdown in infrastructure and property investment would devastate capacity utilisation in steel. The same is true for cement. Bad debt would soar.
The big question now is whether the corrective forces in the economy could overwhelm the ability of the authorities to manage the needed adjustments smoothly.
Some might argue that a crash is precisely what is needed. The authorities will disagree and so, which matters not at all, do I. They also have many levers under their control. Nonetheless, the downside risks from financial stress and macroeconomic adjustment have been rising sharply. I plan to assess the scale of the risks and possible responses next week.

Indian start-ups tap into mobile payments technology

 
Good luck finding a local store or delivery person in India who accepts anything but cash. Even in a nation of 1.2bn, fewer than 1m retailers are set up to take a credit card.
A handful of Indian start-ups, aided by a growing number of global investors, are hoping to change that by rolling out types of mobile technology first popularised by Silicon Valley start-up Square, the payments company led by Twitter co-founder Jack Dorsey
 
Square and its rivals, including eBay’s PayPal unit, make credit card readers that plug into smartphones for use by small scale merchants from artisans to babysitters who often avoid the hassle of accepting cards.
Leading Indian start-ups such as Ezetap and Mswipe might not have Square’s heady valuationwhich was put at about $5bn in January – but their technology works in much the same way, while targeting the more basic phones that remain common in India and other emerging markets. Ezetap, already doing work in Kenya, is looking to expand into other markets in Africa and Asia where similar technological constraints exist.
International enthusiasm for the sector was underlined last week when American Express took a minority stake in Bangalore-based Ezetap, barely a month after the company raised $8m in its latest round of financing. Rival Mswipe completed its second round of funding last month.
The duo’s successes come at a time of heightened US interest in Indian mobile technology companies. In January, Facebook acquired a mobile analytics start-up based in Bangalore, while Google recently purchased Impermium, a small cybersecurity firm.
The interest in new ways to pay stems from India’s fast-rising middle class, who have access to bank accounts but still tend to use cash or cheques to pay for everything from telecom bills to home deliveries. Their accounts come with debit cards, which, because few local merchants accept them, are used mostly at ATMs.
“You would never hear of it in the US, but our cooking gas is delivered in cylinders, and there are networks of distributors where you have this guy coming in his little three-wheeler or cycle and will deliver a cylinder and pick up a payment – traditionally it’s cash,” says Manish Patel, founder of MSwipe.
But gaining users means overcoming a number of challenges, including developing dealer networks capable of reaching smaller retailers in India’s vast but highly fragmented market. Mswipe works with about 7,000 merchants in India and Sri Lanka, while Ezetap has 12,000 devices. The company is targeting 100,000 by the end of the year, according to co-founder Abhijit Bose. Square’s card reader, by contrast, is used by a few million people.
Among the current users of Mr Patel’s service are gas distributors in the cities of Mumbai and Hyderabad. India’s legions of small neighbourhood shopkeepers provide a potentially vast market in an economy where most transactions still involve cash, but reaching them is a “non-trivial task”, says Rishi Navani, managing director of Matrix Partners, one of MSwipe’s backers.
Payments companies are also making headway with India’s growing ecommerce companies, such as Flipkart.com – a site often known as the “Amazon of India” – whose customers also tend pay cash on delivery.
But Sanjay Swamy of Bangalore-based start-up incubator Angel Prime, which provided early stage funding for Ezetap, says mobile payments growth is just as likely to come from larger enterprises.
“In the US it is used by hairdressers or dog walkers,” he says. “But in India it is also large insurance or telecoms companies who are using it to come to your door and collect payments. They are much larger businesses, doing this for the first time.”
Growth in the sector could be helped by India’s central bank, which is set to adjust rules to encourage mobile money services such as Mpesa, operated by UK-based telecoms group Vodafone. Those services have taken off relatively slowly in India compared to their success in African countries such as Kenya and Tanzania.
Ezetap is hopeful that partnerships with Indian banks, in particular, will help it make a breakthrough, in part because the improved security offered by plastic means banks are encouraging their customers to accept it. “We benefited from a huge uptick in bank account creation,” Mr Bose says. Adds Mr Navani: “There’s a massive opportunity for a low cost infrastructure to be built.”

Sunday, March 23, 2014

Tech stocks: The naughty nineties return

 
WATCH the stockmarkets for long enough and the same old patterns seem to emerge. Whether experience brings wisdom, excessive cynicism or an ability to get fooled a different way the second time around is another matter. The FT has a nice piece (registration needed) on the hot tech stocks of today and the valuation methods used to justify their prices.
This blogger's reaction is nostalgia; as a dotcom cynic, I recall writing an FT article on the potential justification for the valuation of Freeserve near the peak of the bubble. (If you don't remember Freeserve, well that's the point.) The lesson one tends to learn from these incidents (and from the FT piece) is that there is always a way of justifying the current price if you torture the data hard enough; since the finance industry tends to have an interest in high share prices, such justifications usually appear.

Two problems are commonplace. The first is the assumption that the early mover will continue to dominate the market. Sometimes this happens but not always; Facebook was not the first social networking site. If a market is terribly exciting, then companies pile in; there were lots of car makers in the early 20th century and most went bust. Often investors hedge their bets and value several stocks on the basis that each might dominate the market, but this produces a valuation that, in aggregate, is bound to be wrong.
 
The second problem is the assumption of rapid growth for a long period and then the use of a high valuation for earnings at the end of the growth cycle. The laws of compounding mean that no company can grow at 15% forever; even managing it for a decade is very unusual. At the end of the growth period, the company will be mature and its price-earnings ratio will fall; as recently as 2004, Microsoft's p/e was 29, now it is 14.
Look at the ingenious valuation approach for Tesla in the FT article. By 2020, it is suggested that the company could be selling 500,000 cars a year, 20 times what it has sold to date.
At an 11 per cent operating margin (higher than what Ford and General Motors aim for) earnings per share could be $13. Applying a 30 times forward multiple, and then discounting back five years at a 15 per cent discount rate yields a stock price of about $200. This is about where Tesla shares were just before its recent earnings announcement. (Its shares are now $250).
So this approach assumes phenomenal sales growth and higher margins than its competitors, and then requires the company to trade on a premium multiple on the basis of fast growth in the 2020s. It is a lot to take on trust.
When it comes to Amazon, the article has one bullish projection that margins will rise from 1-2% to 10% by 2022, and then qualifies it with a "stress test" of 7% margins. Surely the stress test would be to assume unchanged margins. (This is not a criticism of the journalists concerned; they are just trying to show how the industry thinks.)
Back in the late 1990s, when one made these kind of objections, the accusation was that you didn't "get it", that you were trapped in old ways of thinking. But it is possible to recognise that technology can change the world without accepting that the big gains will come to investors; history suggests that consumers tend to receive most of the benefits in the form of lower prices.
(Source: The Economist)

Thursday, March 20, 2014

As Investors Flee, Russia Inc. Is Feeling the Pain

 
Want to know how President Vladimir Putin’s showdown with the West is affecting Russian business? Ask retailer Detsky Mir.
Detsky Mir (Children’s World), which started as a Soviet-style department store across from KGB headquarters in Moscow, rode demand from a growing middle class over the past two decades to become a $1.1 billion-a-year company. It now has more than 200 stores selling children’s clothing and toys in dozens of Russian cities. Last fall it announced plans for an initial public offering on the London Stock Exchange early in 2014.
Then came Putin’s grab for Crimea, and now Detsky Mir has put the IPO on hold, according to a person with direct knowledge of the situation. “In these conditions [the company] will not do anything,” the person said.
Detsky Mir isn’t alone. Even as Europe and the U.S. have refrained from imposing all-out economic sanctions, Russian companies are suffering as investors flee the country. Canceled IPOs, suspended loan negotiations, plummeting share prices—all are part of an estimated $50 billion in private investment that has left Russia since Jan. 1, according to economist Neal Shearing of Capital Economics in London.
The Russian unit of German retailer Metro (MEO:GR) may scratch its planned London listing, as shares in Lenta (LNTA:LI), another Russian big-box chain, have slumped more than 17 percent since the stock’s Feb. 27 debut on the London exchange. The crisis also could derail some $8 billion in loans being sought by major Russian companies such as steelmaker Novolipetsk (NLMK:RM) and mobile operator VimpelCom (VIP). “Until the situation stabilizes, there will be fewer international banks willing to lend in Russia,” Dmitry Dudkin of investment bank UralSib Capital in Moscow told Bloomberg News earlier this month.
At the same time, these companies’ stocks are getting hammered. Shares of Novolipetsk, controlled by one of Russia’s richest men, Vladimir Lisin, are down more than 34 percent this year. VimpelCom, controlled by billionaire Mikhail Fridman, has dropped 32 percent. According to the Bloomberg Billionaires Index, Russia’s 19 richest people have lost $18.3 billion since the Crimea incursion began on Feb. 28.
Businesspeople “are very scared,” Alexander Lebedev, who owns the Moscow-based investment group National Reserve, tells Bloomberg News. “There could be margin calls, reserves might be drawn down, exchange rates may fall, and prices will rise.”
And yet, business leaders have remained almost entirely silent, as the Kremlin in recent years has tightened government control of the economy. “The business community is freaking out—they’re terrified,” says Ben Aris, the editor and publisher of Business New Europe in Moscow, an online journal covering business and finance in the former Soviet bloc.
Ordinary Russians also would be hurt by capital flight. If the outflow continues at its current pace, it will total $70 billion during the first quarter, some 3.2 percent of gross domestic product. “There is a real risk that this could push Russia into recession this year,” says Capital Economics’ Shearing. Adding to the pain, the ruble has plunged 22 percent over the past year—a blow to shoppers in a country where imported goods account for more than 40 percent of consumption.
Despite its oil, gas, and mineral riches, Russia has suffered for years from a dearth of private investment that could diversify its economy and cushion it against commodity-price fluctuations. Consumer-facing companies such as Detsky Mir, Lenta, and VimpelCom looked set to help remedy that problem. Instead, Russia now will suffer an “absolute decrease” in private investment, says Bernie Sucher, an American entrepreneur and investor who has worked in Moscow for more than 20 years. “This is going to be an enduring setback for the economy,” he predicts.
Some in Putin’s inner circle seem to think the government can step up public investment to compensate for the loss of private capital. But, Sucher says, that approach is doomed to fail. Russia has already lost ground on competitiveness as the Kremlin has played an increasing role in the economy, he says. “The state, no matter how rich it is, cannot make up for the quality, efficiency, and competitiveness of private capital.”
(Source: BusinessWeek)

Capital goods: product firms’ performance improves on exports

 
 
Capital goods firms making engineering products like ABB India Ltd, Cummins India Ltd, Voltas Ltd and Siemens Ltd are seeing a gradual improvement in revenue and profitability although state-run Bharat Heavy Electricals Ltd (Bhel) is struggling.
The trump card for the smaller firms is their presence in short-cycle orders with a greater emphasis on products and reasonable contribution from exports.
In addition to the Middle East, which was a strong export zone for Indian engineering products, new regions like Africa, South-East Asia and Latin America are panning out well for Indian exports.
An analysis of 38 firms in the power and industrial products sector showed growth in the December quarter revenue against the year-ago period, according to a Motilal Oswal Financial Services Ltd report. This is good news, particularly as the growth comes after a gap of six-eight quarters. Much of this is on account of exports while some credit goes to currency and base effect factors.
Within the capital goods industry, export opportunities have sprung up for switchgears, boilers, turbines, industrial machinery and diesel generator sets where Indian firms are very competitive.
The trend is also mirrored in data at the Centre for Monitoring Indian Economy—while exports from India have increased, imports have fallen, helping narrow the trade deficit. Exports are inching up on the heels of a gradual recovery in the global investment cycle. Global firms like Cummins and Siemens in recent investor conference calls have indicated optimism, especially about European markets.
However, the domestic capex cycle remains bleak with worsening liquidity and capacity utilization. Construction, mining, real estate, power, oil and gas and roads remain weak. Hence, big firms like Bhel, which have a high proportion of long-gestation projects, are in a quagmire on account of project delays, policy logjam and poor demand.
The difference in performance is also visible in the financials. While Bhel’s profitability has been sliding for several quarters, that of Voltas, ABB, Cummins and Siemens is showing stability. On the whole, however, the S&P BSE Capital Goods index has rallied since September on the hope the sector has hit the abyss and a recovery is in the offing.
That said, it will take several quarters for the whole sector to hit positive all-round growth momentum, which will depend on domestic economic recovery. However, the smaller firms mentioned above may get re-rated in the markets faster than the whole sector.

EMs may be under performing but the corporations emerging from them have a rosy outlook

 
 
Emerging market economies have experienced hard times of late. In India, FY13 GDP growth was the slowest in 10 years and the rupee hit a record low against the US dollar. Many foreign companies are retracting their investments and leaving the government struggling to turn back the tide. Other EM giants Brazil and China have also come under the spotlight as national growth rates plateaued and fell throughout the first quarter of 2014.
However, despite turbulent times in their home markets, the outlook for EM corporations is rosy.
A report by McKinsey Global Institute Projects suggests EM firms are likely to account for 40-50 per cent of the Fortune Global 500 by 2025, or double today’s share. So, while we have seen an EM slowdown throughout 2013, emerging-market multinationals (EMNCs) have evaded the recession woes that hamper their developed-market counterparts, catching Triad multinationals off-guard and wrestling market share from them as they overtake in the areas of innovation and branding.
Born from complex, heterogeneous markets where volatility has typically been the norm, EMNCs have weathered instability and financial stress to bounce back repeatedly. Having pushed onto the world stage they are set – regardless of economic climates in their home markets – to use their unique position and cultures to succeed on a global scale. I believe there are four key strategic paths that underpintheir success.
The Cost Leaders
Price competitiveness becomes more important than ever as consumers tighten their spending. It is here that EMNCs possess a distinct advantage, having always catered to cost-conscious customers. While EM companies have long pursued low labour-cost advantages, the Cost Leader strategy is original for its emphasis on process innovation to dramatically reduce costs and make operations scalable.
India’s IT companies such as Tata Consultancy Services epitomise this strategy. TCS and other Indian players like Infosys and Wipro developed a global delivery model for IT services – a novel service delivery platform that has enabled them to not only leverage lower-cost talent in India but also bypass the need for work visas to operate in international markets, an increasingly difficult proposition. This makes their operations rapidly scalable. Importantly, the global delivery model has dramatically improved the ability of companies like TCS to deliver projects on time and on budget – key metrics on which IT service providers are judged. As a result, TCS has seen its share price grow 10-fold in the last five years, while global peers IBM and Accenture have barely managed to double their own share prices.
The Knowledge Leveragers
Not all EMNCs choose to target established markets. These Knowledge Leveragers instead tap existing resources and knowledge of local consumers to build branded businesses in fellow EMs with untapped growth opportunities. Through desirable products and maintaining lower production-line costs, EMNCs succeed where established MNCs do not and cannot competitively engage.
Indian automobile and farm equipment manufacturer Mahindra & Mahindra, which enjoys 50 per cent market share for UV and SUV sales in India and 70 per cent of the country’s tractor market, employs this strategy. It takes its understanding of less affluent customers and uncertain operating environments to promote key models in other EMs and their lower-end segments. Although the downturn in the automotive industry worldwide has affected its business, Mahindra & Mahindra remains poised to take advantage of established trust and brand recognition to defend its turf and grow, notwithstanding the potential arrival of new competitors.
The Niche Customisers
EMNCs are known for challenging paradigms set by Triad MNCs and turning common practices on their head.
Brazilian cosmetics maker Natura did this by revolutionising traditional distribution channels in France, where it launched in 2005. It opted for a direct-to-consumer approach traditionally seen as ‘down market’ among French consumers. Not wanting to compromise its premium positioning, Natura learned that direct-to-consumer distribution was only perceived poorly due to low-calibre sales representatives, and recruited staff more representative of its target customers.
Maximising its flexibility and resilience to uncertainty, the Niche Customiser approach allowed Natura to adapt its business model to intelligently leverage limited resources and secure wider reach than would have been possible by simply opening a capital-intensive flagship store.
The Global Brand Builders
It is one thing to develop brand recognition in untapped emerging markets, but the most-compelling successes lie with EMNCs that have flourished after entering developed markets, targeting lower-end consumers within value-for-money segments overlooked by incumbent MNCs. These EMNCs have the flexibility to invest heavily in R&D and innovation to establish products that meet the specific demands of a niche market sector – and use this market share as a springboard to eventually outgrow their western counterparts.
Founded in 1991, China’s Mindray invested heavily in R&D from the outset to build its capability in producing mid-level technology –medical diagnostic products of global quality – at a significantly lower cost through clever product and process innovation. In its initial efforts in the US, it was able to become a supplier of ODM (original design manufacturer) medical diagnostic equipment to New Jersey-based Datascope, the world’s first monitoring device producer. In 2008, Mindray acquired Datascope’s patient monitoring business, to leverage its distribution infrastructure in the US and western Europe and build its business and brand in developed markets. Its efforts have been successful, with global revenues growing by 72 per cent between December 2010 and December 2013. More than 20 per cent of its international revenues today come from developed markets.
The bravery of these companies in re-writing traditional rules has paid dividends. The strategies laid out here are the foundation on which EMNCs survive and thrive in the face of financial setbacks at home, operating effectively on a global scale and outmanoeuvring legacy competitors. These four strategies leverage the low-cost advantage of EMNCs and have transformed many EM firms into global players. In fact, describing them as ‘emerging’ contradicts the fact that many of us use their products on a daily basis.
I am left wondering what the global marketplace will look like beyond 2025. Will today’s legacy MNCs even exist? I advise the western world not to write off EM corporations in a sweep of the hand towards slowing EM economies. For these companies, slowdown is just fuel to the fire in their long-fought battle to outride adversity.

Digital disruption: Six consumer trends and what businesses need to do now

 
Consumer behavior is rapidly changing, with “digital” activities growing rapidly in every sphere (see text box below). In the US, 48 percent of all the video viewed is now either “time-shifted” (using DVRs or video on demand) or “device-shifted” (from television sets to laptops, tablets, or mobile phones). Music is even more digital, with just over two-thirds of usage from streaming services, MP3 files, and satellite radio, leaving traditional AM/ terrestrial FM radio with a mere 32 percent share. On the communications front, mobile phones have overtaken landline voice, even among consumers aged 55 to 64. These changes in user behavior have and will continue to disrupt existing industry value chains and economics, creating many opportunities and risks for stakeholders.

Six “digi-shifting” trends

McKinsey’s research with and among leaders in the telecoms, media, and technology (TMT) sector tracks the cross-platform and cross-device behaviors of tens of thousands of consumers each year in both developed and emerging markets around the globe. Findings from the fifth and most recent year of research highlight six major ongoing consumer trends that are further compelling this shift to digital and reshaping TMT and related industries.
Achieving real and measurable returns on social networking marketing efforts will be a continuing challenge for players across the spectrum.
Device shift – from PCs to mobile/touch devices. Smartphones are fast becoming ubiquitous, with penetration of about 60 percent in the US. Just over 30 percent of US Internet-equipped households now have a tablet as well, and the rest of the developed world is close behind. Mobile phones and tablets now account for around 44 percent of all personal computing time, having nearly doubled since 2008. Most device manufacturers and their major retail partners are already experiencing the implications of this shift.
Communications shift – from voice to data and video. E-mail and telephonic voice have fallen from over 80 percent to about 60 percent of the telecoms “communications portfolio,” while time spent on social networks has doubled to take over a quarter of all user communications time. And when consumers do use their phones, only about 20 percent of the time is for talking (down from over 60 percent just five years ago). The majority is used for more data-centric activities such as streaming music, browsing Web sites, and playing games. Mobile carriers in particular face challenges in reorienting their business models to focus on data rather than voice minutes. The US market has many lessons for the rest of the world in this area.
Content shift – from bundled to fragmented. Thanks primarily to powerful search tools, the “long tail” of media and content (whether text, video, classifieds, products for sale, etc.) is accessible to anyone. Thus, some of the value in traditional “bundles” (newspapers, network TV stations, or big-box retailers) has been eroded. The way mobile phones are used illustrates this well. The number of apps installed (typically for a specific, single purpose) has doubled to over 30 per phone from 2008 to 2012. Spending on these apps is, however, highly fragmented, and growth potential remains very uncertain. Challenges abound for both content owners and marketers in reaching and engaging audiences that access such eclectic, fragmented media.

dig•i•tal adjective \'di-jə-təl\

We hear the word all the time, but what do we mean here by “digital”? In the consumer device and media context, digital refers to consumer-controlled electronic interactions or cross-platform usage rather than the specific technology layers behind a product and service.
Magazine publishers, for example, have been using digital page layout and printing techniques for decades, but we discuss “digital” in the context of how readers now are accessing those products through tablets and smartphones rather than on the printed page. Similarly, while cable broadcasters have long transmitted digital signals to digital set-top boxes, we now discuss “digital” in how consumers can watch unmanaged, Internet-based video on their main television sets from a variety of different providers.
In the consumer context, “digital” is shorthand for all things “non-traditional” that flow from online and mobile usage.
Social shift – from growth to monetization. Social networking represents almost a quarter of all Internet time (up 10 percentage points since 2008) and reaches over 75 percent of all Internet users. But for the first time, we have seen small declines in both total audience and levels of engagement in developed economies. This is a remarkably fast climb to maturity, given that major players like Facebook, LinkedIn, and Twitter have yet to celebrate their tenth birthdays. Facebook and LinkedIn now face the quarterly earning pressures of the public markets as well. At the same time, businesses of all shapes and sizes are actively trying to use social media as part of their marketing efforts. Achieving real and measurable returns on these efforts will be a continuing challenge for players across the TMT spectrum.
Video shift – from programmed to user-driven. Traditional live, linear television consumption remains relatively flat on an absolute basis, but has slipped on a relative basis. It now represents just 65 percent of all video viewing for US consumers on their television screens and 52 percent across all screens. Time-shifted DVR content – watching video on PCs and over-the-top Internet video services such as Netflix – makes up much of the balance. The increase in all varieties of time-, place-, and device-shifting video options will continue to pressure traditional advertising-supported business models for distributors, advertisers, and content owners in the value chain.
Retail shift – from channel to experience. Despite its tremendous growth and transformation of the retail landscape, e-commerce only accounts for about 5 percent of all retail sales. As connected mobile devices proliferate, their potential to transform the shopping experience (both in the store and online) is the next opportunity. About half of all smartphone owners now use their devices for retail research – and although only few today, significantly more consumers will soon be using smartphones and tablets to complete their transaction as well. The combination of mobile retail and true multichannel integration will have a transformative effect on the retail experience and ring in the era of Retail 3.0.

Industry takeaways

As these trends continue to shape the TMT landscape, players in this space will want to pay close attention to how this shift alters the value chain. Leaders would be well served to keep three key principles in mind as they evolve their digital strategies and business plans:
Averages hide incredible diversity in consumer behavior, necessitating microsegmentation. As has already been demonstrated numerous times, conducting a simple age-based segmentation provides high-level insight into the digital divide of different consumer needs and usage patterns. However, managers should take that segmentation several steps further to strengthen sales, operations, product development, and other key customer-facing business processes. Incorporating product- and brand-specific usage, spending, attitudes, and needs can make developing a far more nuanced segmentation possible. This highly segmented approach will be needed to win and maintain customer relationships.
Exhibit 1
The smallest customer segment may very well be the most valuable
The smallest customer segment may very well be the most valuable
Value is not equally distributed or accurately priced. According to the “80/20” rule, about 80 percent of value typically comes from around 20 percent of customers, regardless of business type. For TMT companies, this general truth can be even more extreme. In some cases (such as social gaming or digital news subscriptions), digitization has led to an even smaller share of the overall customer base driving nearly all of the revenue (Exhibit 1). Identifying these high-value users – whether on the Web site or in the store – will become a critical capability. For one digital publisher, very occasional visitors accounted for about 80 percent of the audience, but less than 10 percent of the total page views for advertisers. Understanding the detailed behavior of the remaining 20 percent of highintensity users enabled the company to successfully introduce a tiered-access subscription model while maintaining the overall size and breadth of the advertising audience. Digital marketing tools can also be immensely valuable in reaching these high-value customers with the right touch points. One mobile operator, for example, found that its highest-spending customers disproportionately used the e-commerce channel for both sales and service. The operator’s response was to build a set of targeted products and service offers specifically tailored to that segment. This not only lowered the company’s cost to serve, it improved satisfaction with those higher-value customers who used their preferred service channels.
Structural changes begin gradually – then they boomerang. Hemingway’s observation on how people go broke is as relevant today as it was right after the Great Crash. Short-term economic and industry factors often mask long-term structural problems that lead to gradual – and then very sudden – reversals. Consider that the newspaper industry enjoyed its most profitable decade in the late 1990s and early 2000s, even as online-only competitors for classified and display advertising grew in scale and market power. Similarly, the recording industry shipped a record number of CDs during the very dot-com boom that paved the way for digital music’s eventual takeover (Exhibit 2).
Exhibit 2
News and music are more popular than ever, but traditional modes of delivery are giving way to digital
News and music are more popular than ever, but traditional modes of delivery are giving way to digital
In hindsight, these reversals may seem obvious, even predestined. Yet in real time, understanding and acting on the probable contours of change requires reflection and deep insight into customer behaviors, industry dynamics, and feedback loops. For example: when lower customer volumes no longer support the fixed cost base required, providers often respond by increasing prices for the remaining customers, feeding a vicious cycle and accelerating the unraveling.

TMT’s winning digital strategy

With an understanding of the trends driving the changes in the TMT landscape and a sense of their wide-scale implications, company leaders can begin to shape their future strategies. Five strategic considerations in particular can enable them to capitalize on the shift instead of conducting business from behind the curve:
Stay close to users by investing in customer insight. Customer behavior is rapidly changing, demanding strong market intelligence and customer insight functions. Innovative teams should integrate emerging digital, social, and mobile tools into more traditional “voice of the customer” processes to effectively build feedback loops into key business functions, such as product development and sales. Never before has this been easier.
Build a competitive edge with deep analytic skills. As segments get smaller and more distinct, the need to use data to optimize product development and marketing will only grow. Leading players will test and measure just about everything, and big data systems will support and guide them.
A long-term value-creation agenda requires both attracting millennials and serving the older, larger customer base.
Make business models more robust to reflect consumer diversity. Focus and breadth are both needed. In other words, focus on the 20 percent (or 2 percent) that drives the economics and build diversity into business models to address the remaining 80 to 98 percent.
Ensure investments are clearly aligned with consumer shifts. Executives need to clearly communicate the “what” and the “why” of strategy and operations and tie this to current opportunities. But most companies will also need to make sure legacy platforms and businesses get the management attention they deserve.
Reward superb execution skills. A potential downside of big data and analytics is that the analysis goes on too long and the market opportunity evaporates or is seized by a competitor. To avoid this trap, top management’s focus needs to be on delivering the products and services that will serve and delight their customers – today and tomorrow. Looking at these behavior shifts and at the group that is leading the change, it is clear that for many big TMT players, an inability to connect with millennials will probably mean being out of business in ten years. At the same time, not being able to hold on to their older, larger base of customers means they will likely be out of luck a whole lot sooner than that. This is a very interesting marketing and sales challenge for agencies and marketing directors, but an existential challenge for top C-level executives and strategists with a long-term value creation agenda. The digital platform is growing rapidly in importance in the areas of communications, entertainment, and retail. Regardless of the industry, a nuanced understanding of customer preference and a business model aligned with these insights will be necessary for most organizations to prosper in an all-digital world. This is as true for those currently on top of their industries as for laggards. Both will also need to prepare for the generational, transformative changes in the market as maturing millennials replace retiring baby boomers as decision makers for household spending – and business investments for that matter.
(Source: McKinsey's Report)

Tata’s Cyrus Mistry plans $8 billion infrastructure push

 
Cyrus Mistry, chairman of India’s Tata group, is planning to spend at least $8 billion (around Rs.48,880 crore today) building roads, airports and housing, betting a stable administration after India’s coming elections will lead to a new wave of infrastructure development.
Mistry, 45, who took over as the group’s chairman in December 2012 after Ratan Tata’s two decades at the helm, is expanding at least three unlisted infrastructure companies within the $100 billion conglomerate, according to two people familiar with his plans. The businesses will get more attention after Mistry has overhauled operations at bigger, listed Tata companies including the auto and steel units.
The initiative from Tata, which control assets including Jaguar Land Rover and New York’s Pierre hotel, underscores the hope among Indian companies that infrastructure project approvals and spending will pick up when a new government is formed after elections ending in mid-May.
“Mistry looks at this sector as a phenomenal opportunity,” said U.R. Bhat, managing director of the India unit of UK-based Dalton Strategic Partnership LLP, which manages $2 billion globally. “It’s a natural extension of their capabilities. Tata has the financial muscle to bid for the biggest of the projects and dominate,” he said.
India needs to spend $2.2 trillion by 2030 on urban transportation, housing and office space to boost infrastructure ranked below that of Guatemala and Namibia by the World Economic Forum, McKinsey and Co. said in a 2010 study.
Triple order book
“From 2012 through 2017, India is likely to spend Rs.41 trillion ($668 billion) on infrastructure with almost half of it being provided by the private sector,” Siddhartha Roy, Tata Group’s chief economic adviser, told reporters in June.
Tata Housing Development Ltd, Tata Projects Ltd and Tata Realty and Infrastructure Ltd (TRIL), which builds information technology parks, malls and residential complexes, are among the infrastructure units that are aiming to more than triple their order books to Rs.70,000 crore in five years,” said Sarika Kapoor Chokshi, a Tata Sons Ltd spokeswoman in Mumbai.
TRIL plans to spend Rs.22,700 crore in the next five years building highways, airports, hotels and urban transportation, according to a presentation made by managing director Sanjay Ubale last June. Tata Housing is developing 26 projects across 10 Indian states.
Looking abroad
Mistry also is encouraging the units to seek contracts abroad, in particular in western Asia and southern and western Africa, according to one of the people familiar. Tata management expect infrastructure activity will expand in a year or two after a new Indian government spurs an economic rebound, the person said.
India’s growth slowed to 4.7% in the final three months of 2013, idling below 5% for the seventh consecutive quarter and denting the Congress party’s chances of extending its decade-long rule in national elections that start next month and conclude in mid-May.
Narendra Modi of the main opposition Bharatiya Janata Party (BJP) will have the best chance of leading the next government, polls indicate. Modi has run on his record of stronger-than-average growth in Gujarat, which he has led since 2001.
Developers are either not investing in or exiting highways projects citing the government’s inability to provide the required clearances in time, analysts at India Ratings and Research, the local unit of Fitch Ratings, said in an 11 March report. Following the completion of upcoming parliamentary elections, the sector is likely to gain renewed attention from policy makers, they said.
Construction background
Infrastructure interests Mistry the way designing cars fascinated his predecessor Ratan Tata, said one of the people familiar, pointing to his family’s 150 year experience in the construction sector. Mistry’s billionaire father and elder brother control the $2.5 billion Shapoorji Pallonji Group, a construction conglomerate that was started by Mistry’s great grandfather with an Englishman in 1865.
The infrastructure initiative is a component of Mistry’s strategy since becoming the Tata group chief. He also has sold assets, written down overvalued ones and restructured units.
“Ratan Tata had an aggressive strategy of leaving a global footprint,” said Shishir Bajpai, a Mumbai-based director at IIFL Wealth Management Ltd with $1.7 billion under management and advisory. “A few worked and a few didn’t. It makes sense to relook and redefine it. We have been buying shares of Tata companies over the past few months.”
As for infrastructure, Dalton Strategic’s Bhat said: “They are trying to find the next big opportunity and capture that.”
(Source: Bloomberg)