Thursday, December 31, 2015

Sugar Heads for First Gain in Five Years as El Nino Ends Surplus

After four bitter years, sugar mills can look forward to sweeter prospects in 2016.
Prices have rebounded 50 percent since reaching a seven-year low in August. Raw-sugar futures traded in New York are heading for a 4.6 percent gain for the year, their first annual advance since 2010. The market has finally swung to a supply deficit after years of surpluses. And the commodity will keep rising through the first quarter of next year, according to the average of 18 traders and analysts surveyed by Bloomberg News.
While strong Asian demand is helping, the revival in sugar’s fortunes can be attributed largely to one factor: El Nino. The weather pattern has cut the sucrose content in the sugar cane grown in Brazil, the biggest supplier, as well as yields in India and Thailand.
“The fundamental story supports prices at higher levels,” said Donald Selkin, chief market strategist at National Securities Corp. in New York, who helps manage about $3 billion of investments including commodities. “The market has anticipated the deficit and demand is increasing in developing countries.”
Raw sugar for March delivery added 0.3 percent to 15.19 cents a pound on ICE Futures U.S. in New York on Thursday. Prices may rise as high as 16.3 cents by the end of the first quarter, according to the average estimate. Three of those polled expect prices to fall by March 31while the rest expect the sweetener to rally further.

Indian Exports

Global output will fall 4.3 percent to 178.9 million metric tons in the 2015-16 season, which runs from October to September in most countries, trailing demand by as much as 8.2 million tons, according to trader Czarnikow Group Ltd. A shortfall is expected for the season after that, according to researcher Platts Kingsman SA and the London-based International Sugar Organization. The last time the sugar market had two straight deficits was in 2010.
Of course, sugar’s rally could still be derailed, not least by the possibility of increased shipments from India where the government is pushing mills to make mandatory exports of as much as 4 million tons. And further pressure on the real would help Brazilian commodity exporters in foreign markets.
“The Fed’s rate liftoff would put upward pressure on the dollar and downward pressure on commodity-market currencies,” said Sameer Samana, a St. Louis-based strategist for Wells Fargo Investment Institute, which oversees $1.7 trillion of investments. “The Brazilian situation is still very fluid, there’s still a lot of uncertainty. It’s hard to say that the real is out of the woods. ”
Jacyr Costa Filho, director of sugar producer Tereos Internacional SA, knows only too well the challenges posed by El Nino. The company’s Guarani unit, Brazil’s third-biggest cane miller, expects to crush 19.7 million tons of the plant in 2015-16, down from 20.2 million in the previous season. The decline is mostly because unusually heavy rain cut the cane’s sugar content, spurring Guarani to stop harvesting early and leave untouched 400,000 tons of cane. “It wasn’t worth the cost of processing,” Costa said by telephone.
Of the cane that has been harvested, Brazilian mills are using more to make ethanol after domestic demand for the biofuel jumped. Most cars in Brazil can run on gasoline or ethanol, and many consumers have switched to the latter after the government raised tax on the former this year. Ethanol also represents the quickest way for processors to monetize higher commodity prices after several years of struggle.

Ethanol Choice

“As the ethanol goes out the mill’s door, the money is credited to the account, which is not true for sugar,” said Fabio Venturelli, chief executive officer of Brazilian sugar and ethanol producer Sao Martinho SA. His company’s shares have surged along with the sugar price since September. “For those producers in need of cash, there’s no doubt they will choose to produce ethanol.”
Sugar production is also expected to shrink in China, to the lowest in a decade. TheEuropean Union will reap the smallest crop since 1971, according to forecaster F.O. Licht GmbH.
“There are upside risks to sugar over the long term.” said James Govan, a London-based fund manager at Baring Asset Management. “We could be in a period of multi-year deficits in sugar.”

RasGas, Petronet Revise LNG Contract to Lower Indian Prices

Qatar’s RasGas Co. agreed to cut the price of gas it supplies to Petronet LNG Ltd. by almost half from Friday under an existing 25-year contract with India’s biggest gas importer.
Under the revised terms, Petronet will pay RasGas $6 to $7 per million British thermal units, compared with about $13 earlier, India’s Oil Minister Dharmendra Pradhan told reporters in New Delhi on Thursday. A penalty for taking less-than-contracted volumes this year amounting to about 120 billion rupees ($1.8 billion) on Petronet has been waived by the Qatari company, he said.
The new pricing formula is linked to an oil index that reflects prevailing oil prices, the companies said. Brent, the benchmark for half of the world’s crude trading, has plunged 36 percent in the past year owing to a supply glut.
Quantities not taken by Petronet this year will need to be bought during the remaining term of the contract, the two companies said in a joint statement. New Delhi-based Petronet has taken about two-thirds of its contracted quantity from RasGas this year as gas users, including power plants and fertilizer makers, switched to cheaper supplies bought on the spot market.
Petronet agreed to purchase an additional 1 million metric tons of liquefied natural gas annually from RasGas through the remainder of the 25-year contract, ending in 2028, it said in a statement. This is in addition to the existing contract to purchase 7.5 million tons annually.

Annual Savings

The revised terms will lead to annual savings of 40 billion rupees, which will benefit gas consumers, Pradhan said. 
Petronet jumped 3.4 percent to 255.95 rupees, its highest close, in Mumbai. State-run GAIL India Ltd., its biggest customer, advanced 1.9 percent.
The pricing deal may stoke similar demands from other buyers, including Korea Gas Corp. and CNOOC Ltd., Credit Suisse Group AG said in a report dated Dec. 9.

Prime Database: Primary market activity to heat up even more in 2016

While 2015 was a record year for new companies getting listed, Prime Database, India’s premier database on the primary capital market, expects 2016 to be even more promising.
“Already at the beginning of the year, there are 20 companies holding SEBI approval wanting to raise Rs.7,315 crore and another 11 companies wanting to raise Rs. 5,445 crore awaiting SEBI approval. Many more filings are expected in the near future,” it said in a press release.
2015 saw a 76 per cent jump in capital raising of Rs. 68,608 crore compared to 2014 and the amount raised was at a five-year high. 2010 saw the highest capital raising at Rs. 97,746 crore.
The growth rate of 76 per cent could have been much higher if the government’s divestments were in line with targets set at the beginning of the year. The government scaled down its divestment target by 43 per cent to Rs. 39,500 crore compared to Rs. 69,500 crore in the Budget.
“While a good start was made with over Rs. 35,000 crore being raised in the first eight months, the balance four months of the year did not see a single divestment hitting the market,” Prime Database said.
Of the total amount of Rs. 68,608 crore, Rs. 13,862 crore was done through initial public offers, which was again at a five-year high. The rest was through offer-for-sale and qualified institutional placement.
A total of 21 mainboard IPOs collectively raised Rs. 13,602 crore, with the largest IPO by Interglobe Aviation. Of the 21 IPOs, 11 were backed by private equity or venture capital investment.
IPOs by small and medium enterprises continued to remain robust though the amount raised was almost the same as in 2015. “There were as many as 43 SME IPOs that collected Rs. 260 crore compared to the previous year’s 40 IPOs worth Rs. 267 crore.
While fund raising activity in mainboard IPOs was robust, not all issues shared the euphoria or huge investor interest. While the seven IPOs of VRL Logistics, Alkem Laboratories, Power Mech Projects, Dr.Lal Pathlabs, Syngene International, S.H.Kelkar and Inox Wind received a mega response with oversubscritption in the range of 14-53 times, two IPOs were oversubscribed by more than 3 times. The balance 12 IPOs were oversubscribed between one and three times.
Of the total amount of Rs. 68,608 crore, the amount raised through fresh capital was only Rs. 25,964 crore; the remaining Rs. 42,644 crore being through offers for sale.
Like IPOs, OFS also saw a seven-fold increase at Rs. 35,564 crore and formed 52 per cent of total amount raised in 2016, largely led by the government’s disinvestments in Coal India and Indian Oil Corporation. But QIPs, which are done by listed companies, saw a dip of 39 per cent.

Story behind falling solar power costs in India

The solar industry is entering a period of cost efficiency thanks to advances in technology and competitive bidding
In today’s solar market in India, almost every passing tender has promised to deliver cheaper electricity.
This is good news for the procuring utilities but it has got lenders worried on the sustainability of the projects and the security of their loans.
The project sponsors often find it hard to believe the tariffs quoted on a tender just lost, but soon appear prepared to match or better it in their next bid.
This year began with a winning tariff of around ₹7 (Punjab at ₹6.88 and UP at ₹7.02) per kWh and closed well below ₹5 (both solar parks in AP at ₹4.63) per kWh.
Since 2010, over 7500 MW of solar power projects have been tendered and the winning tariffs have fallen by 58 per cent. If we peer further back to the regulated era, winning quotes now are less than one-third of the 2009 solar feed-in tariff rates.
Cheap route

The source of these gains is well recognised in the industry, as arising from lower polysilicon costs due to economies of scale and the learning effect, akin to that in the semiconductor industry.

China, which supplies over 51 per cent of the solar modules we deploy, has largescale vertically integrated units manufacturing crystalline silicon (c-Si) modules supported by a rich ecosystem.
Recent studies suggest that the supply-chain benefit from these clusters is continuing to deliver gains resulting in cheaper modules.
In India, meantime, savings from tender of larger capacity projects, a competitive EPC market, locally driven pre-development activity, and increasingly, lower cost of the balance of system (comprising inverters, power control systems, cabling) has reduced project costs.
Project developers, in response to a tender, innovate on the layout, design components, procurement models, and take a position on future pricing, module efficiency, and other parameters, in a manner that helps further differentiate their bids.
In the coming months, new solar power procurement plans totalling about 4720 MW, which is slightly larger than the entire existing installed solar capacity, have been announced.
The key question in the minds of bidders is what further declines can be expected on project costs. An equally relevant question for the government is what makes or mars this trend.
Cost, benefit

To start with, narrowing of technology choices (c-Si now constitutes over 90 per cent of production) and sourcing (over two-thirds of global supply is from China or Taiwan) has made better deals possible.

The regulatory filings of major tier-1 global suppliers suggest that they continue to enjoy a sizeable gross margin on module sales, ranging from 20 per cent to 62 per cent and averaging 38 per cent, and so have headroom to compete on price to maintain their plant utilisation and market share.
A more recent cost benefit has come, ironically, from cheaper primary energy, in particular, coal.
The upstream segment of polysilicon manufacture is highly energy intensive and even as the quantity of silicon used in modules has steadily reduced over the last decade as wafers got thin, lower energy costs still translate into cost savings.
The energy consumed in the entire production cycle, from refining of metallurgical grade (MG) Silicon to polysilicon and modules, and that used in manufacture of the Balance of System, when costed at power tariffs for energy intensive industries in China, comes to about 8.2 cents per Wp of module.
This is a sizeable part of module price (47 cents per Wp, 2015), and buyers must look to extract energy cost savings in their procurement negotiations, besides the anticipated drop of 1-2 cents per quarter.
The translation of global energy prices is less direct, but competition from imports and subdued local demand caused Chinese coal mines to drop prices, by some accounts, by 24 per cent over last year.
The government reduced wholesale electricity tariffs earlier this year and has proposed another that together cut power tariffs by about 5.3 per cent.
Lower oil prices cut transport costs, both seaborne and inland, especially for the heavier glass back-sheet.
The cost involved is small at around 2 cents per Wp, but the margins of success in a widely contested Indian solar bid are slimmer still.
In the recent National Solar Mission tender for Ghani, the gap between the winning bidder and the second placed was just 0.2 US cents/kWh, and the top 10 bidders were separated by barely 0.6 US cents/kWh.
A new dawn

India’s 100 GW plan is, by far, the most ambitious solar procurement programme globally, and the experience of the last five years has given it a well-drilled tender process; solar parks take out some of the development risk.

This has reduced the cost of participation for bidders, and several long-term players with interest to build a portfolio have emerged.
UDAY, a new government initiative to improve the performance of discoms and rebuild their creditworthiness, will encourage investors to pare risk margin in their target returns, and should attract global funds that have a lower threshold risk.
Local conditions are starting to have a more pronounced effect on tariffs as the hard costs have come down. The quality of the procurers’ balance sheet and payment record is now starkly reflected in the tariffs offered.
But other factors influence it too: State governments must provide a clear roadmap to permit advance procurement actions; regulators must permit transmission spend to minimise curtailment; and procurers must execute the PPAs on time and avoid the temptation to haggle prices after the bids are opened.
The global conditions are favourable and, from all indications, will continue to drive down costs. Market evidence suggests that solving local issues, such as the above-mentioned ones, are now a growing key to the success.
The next time we are surprised by a record low tariff in a solar auction, we can be certain that the tendering agency worked hard to achieve it.

Wednesday, December 30, 2015

Investor Behavior Has Entered A Zone Of Imprudence: Howard Marks, Oaktree Capital

Howard Marks, Chairman and founder of Oaktree Capital, warns that investor behavior has entered the zone of imprudence and thinks that China is the biggest threat for the US economy.
If you want to know from Howard Marks which stocks are going to do well next year, you’re going to be disappointed. The chairman of Oaktree Capital, one of the most successful investors on Wall Street, does not need to pretend that he can look into the future. Instead, he focusses on the things that are most important to investing for the long run: risk control, a good sense of market cycles and inspiration which, for example, he finds in the world of sports.
Mr. Marks, we’re at an interesting point in time. For the first time since the financial crisis the Federal Reserve has raised the interest rate. How does the world look like from your perspective at this historical moment?
We’re in a very strange market. Most people are doing a good job of thinking and the consensus is not necessarily wrong today. On one side, the world is a very uncertain place and I think the average investor understands that. Most people are sober and sensitive to all the uncertainty. You don’t see many people who are massively bullish. Nobody is saying stocks are going to the moon. Back in 1999 there was a book published with the title “Dow 36’000” predicting that the Dow Jones Industrial would almost triple. Well, that book is not being re-published today.

And on the other side?
Security prices are not low. I wouldn’t say high, but full. So people are thinking cautiously but they’re acting bullish and they’re behaving in a pro-risk fashion. While investor behavior hasn’t sunk to the depths seen just before the crisis, in many ways I feel it has entered the zone of imprudence.

How do you explain this juxtaposition?
The answer is that they are forced to be buyers by the central banks. The rate on money markets is close to zero and treasuries yield between one and two percent or even negative in Europe. Most investors can’t live with that. They have to move out the risk curve in order to try to get five, six or seven percent. That has induced or forced risky behavior. To me, this is the most important thing that’s been going on over the last few years, and it still is here at the end of 2015.
There are a lot of risks lurking out there: Monetary policy divergence between the US and Europe, a high degree of stress in the emerging markets and the specter of further terrorist attacks. What’s the most important risk for investors?
Academics say risk equals volatility and the nice thing about volatility is that it gives them a number they can manipulate and use in their formulas. But I don’t worry about volatility and I don’t think most investors are worried about volatility. We know prices will go up and down. But if something is going to be worth a lot more in the future than it is today we’re going to buy it regardless. So people don’t worry about volatility. What they worry about is the potential of losing money.

You wrote extensively about risk in one of your recent memos. What does risk mean to you?
Most people think that there is a positive relationship between risk and return: If you make riskier investments you can expect a higher return. That’s total nonsense! Because if riskier assets could be counted on for higher returns than they wouldn’t be riskier. The reality is that if you make riskier investments you have to perceive that there will be a higher return or else you have no motivation to make that investment. But it doesn’t have to happen: If you increase the riskiness of your investments the expected return rises. But at the same time the range of outcomes becomes greater and the bad outcomes become worse. That’s risk and that’s what people have to think about.

Where do you see potential for bad outcomes?
Investors are not doing what they want to do. They’re doing what they have to do. They are like “handcuff volunteers”. Today, if you want to make a decent return you have to take risks. And most people have been willing to do that. And because of that money has flown into high yield bonds and leveraged loans. For example, at one time there were ninety-five straight weeks of inflows into leveraged loans mutual funds.

Now, credit markets have become quite nervous. What goes through your mind when you look at the rising spreads on high yield bonds?
That’s a good thing. If you’re a buyer you would rather buy at a high risk premium than on a low one, everything else being equal. Maybe the onrush of money was too strong, maybe the attitudes were too optimistic. Now people are a little more worried, especially since they already had a little bad experience in Ukraine, in Greece and in China over the summer.

Then again, the consequences of a full blown crisis in high yield bonds could be severe.
The riskiest thing in the world is the belief that there is no risk. When people think there is no risk, they do risky things. By contrast, when people think there is risk than they behave in a safe manner and the world becomes a safer place. That’s why I welcome the recent developments. They remind us that today the risks are substantial and they should be undertaken only with considerable forethought. My dad used to tell the story of the gambler who went to the race track and said: “I hope I break even because I need the money.” The market is not an accommodating machine. It will not go where you want it to go just because you need it to go there. So if you’re talking about money that you can’t afford to lose then you can’t say: “Just give me the highest yield.”

Investors aren’t the only ones who behave riskily. The central banks themselves have placed venturous bets on unconventional policies like quantitative easing and negative interest rates. What’s the price we’re going to have to pay for that?
This is one of the factors that contributes to making the world a risky place today. In the United States, we had seven years of super low interest rates to try to stimulate. That has never happened before. What are the long term effects on the economy? What’s the effect on lending behavior? And, how will that go now that the Fed has started to raise rates? What will that do to the world? The answer is very simple: We don’t know. And anybody who thinks he knows is kidding himself.

Some kind of wild card is the steep fall in energy prices. Has oil reached a bottom now?
There is nothing intelligent to be said about the price of oil, as I wrote in a memo at the end of 2014. Oil prices have been controlled by OPEC (editor’s note: Organization of Petroleum Exporting Countries) for the last forty years. So clearly, the past doesn’t tell you anything about the free market price of oil. There are assets we feel we can value: stocks, bonds, companies and buildings. They all have in common that they deliver a stream of cash flows that can be valued through a proper discounting process. But how do you value an asset like a barrel of oil or an ounce of gold that doesn’t produce cash flow? You can’t!

Oil was one of the most important factors for the financial markets this year. What’s your outlook on the eve of a new year?
Everybody would like to know what’s going to happen a year from now. What the economy, interest rates, exchange rates, earnings and all that stuff is going to. But it’s very, very hard to know. My favorite quotation on this subject comes from the economist John Kenneth Galbraith: “We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know.”

So how should investors prepare themselves for the next year?
The most important thing to do is to assess not the future but the present. Awareness and understanding of cycles is an essential tool for investment survival. That’s why I always say: “We may never know where we’re going, but we’d better have a good idea where we are.”

Where are we today?
The point is, we had a crisis in 2007-2008. The central banks all moved to stimulate the economies to get them going. But all around the world economies are growing slowly: Europe, America, Japan – and China is slowing down. That’s what’s happening today. The last six years have been slow and most people believe that the next ten or even twenty years will be slow compared to the ‘eighties and the nineties. And I must say, I am pretty convinced that they’re right. I happen to believe that the nineties especially, but maybe also the eighties, were in many ways the best of times and are not going to be duplicated. So in my opinion we’re not going back to a high growth environment.

As a matter of fact, some people fear that the US economy could even fall into a recession.
There will always be cycles and that means there will always be a recession coming. But is it one year away or five? That’s the question! I think we’re going to limp along in a slow growth mode. There is always a possibility of some acceleration. But there is no boom so there is no need for a bust. Booms usually create overexpansion and when it turns out that it was excessive it turns into a bust. Today, I don’t see boom and I don’t see bust. So I don’t see anything that could cause a recession in the short term, at least not in 2016 – and I’m not characterized an optimist.

And how about further down the road?
I don’t think the world has to worry about the US. But it has to worry about China. So if you’re asking me when the US will have a recession then the question is how long will China go without a recession?

How come?
China has been going for the last twentyfive years with superior growth and without a recession. It’s not going to grow 25 years in double digits again. China is going to grow in single digits and it may have ups and downs. And if China has a recession, that’s very significant for the whole world. Looking at the statistics you might say China is not too important for the US. For instance, the percentage of the profits of the S&P 500 (SP500 2053.13 -0.38%) companies that comes from China is just 1%. But a recession in China would have significant effects on other countries we sell to. The US would not be untouched. So if you need a culprit for a future recession in the US then it’s likely China will contribute.

Another concern are weak earnings. Yet US companies are paying out dividends and buying back shares at a record pace. How healthy is that for Corporate America?
One of the worst things is when a business behaves in a short term way. When the management does things which are not desirable just to please shareholders, either to make the stock go up or to hold on to their jobs. I’m not saying that all buybacks and dividends are wrong. But stock prices are on the high side of fair. The Price/Earnings ratio on the S&P 500 today is 19, whereas the post war average is 16. So if I wouldn’t buy the stock as an investor, why should the company be buying it? Don’t they have better use for their money?

Obviously, there seems to be a lack of good ideas.
There is an interesting book called “The Outsiders” by William Thorndike. He follows the careers of eight outstanding CEOs like Henry Singleton of Teledyne, Katharine Graham of the Washington Post, John Malone of Liberty Media and Warren Buffett of Berkshire Hathaway (BRK.A 199259.5 -0.93%). They all were outsiders because they behaved differently from the crowd. For example, when an industry would go through an acquisition wave these CEOs would not participate. They would think: “Everybody else is buying and that’s driving up the price of companies so we shouldn’t buy.” They were called capital allocators and they treated cash as a valuable resource. And today, with the average stock on the expensive side, these CEOs wouldn’t be buying their stocks back.

Those CEOs were also good at investing. What does it take to be successful in investing?
For me, the definition of a great investor is one who performs well in the good times and doesn’t get killed in the bad times. In other words: When the tide goes out he’s prepared because he has a margin of safety in his portfolio. It’s like in the world of sports: Pete Sampras for example, who is widely regarded as one of the greatest in tennis history wasn’t always an exciting player. His highlights were hard to distinguish from his low lights. But that means his worst moments were almost as good as his best moments. That would describe a terrific money manager: Consistent and not too much excitement, no big ups and downs – and that’s what we try to do at Oaktree Capital.

In your recent memo you worte about inspiration taken from the world of sports. What else can investors learn from top athletes?
If you want to be a superior player you have to have self confidence. The same is true for the superior investor. At some point you have to act boldly. You have to say: “This is my conviction” and you have to act on it. You can’t have five hundred different stocks and expect to have a great return because you’ll be diversified into mediocrity. Also, you have to think different from the crowd because if you think the same you act the same and you perform the same. That’s what I call second level thinking. A first level thinker says: “It’s a great company so I should buy the stock”. In contrast, the second level thinker says: “It’s a great company. But it’s not as great as everybody thinks so the price is too high and I should sell.”

In your memo you also refer to the baseball star Yogi Berra. He was famous for saying things like “It’s too crowded, nobody goes there anymore”. What kind of trades are too crowded in today’s markets?
Today, I don’t see any glaring exceptions. Of course, I see some asset classes that are somewhat more attractive than others. But I don’t see things that are dirt cheap or crazy high, except the possibility of social media stocks and technology IPOs. But other than that I don’t see anything glaringly wrong. I just think the whole world is priced for a better future than we have.

So what’s your strategy in this kind of market?
We are living in a low return world caused by the central banks pulling down the risk-free rate to zero. And yet, even though the returns are low, the risks are substantial. That’s why at Oaktree our mantra for the past four and half years has been “move forward but with caution.” The outlook today is not so bad and prices are not so high that they demand complete caution and defensiveness. But at the same time prices are not so low and the outlook is not so good that we should be aggressive. So our strategy is not maximum defensiveness, not aggressive. It’s somewhere in between, but with a significant emphasis on caution. And that means you have to select your investments carefully.

Tuesday, December 29, 2015

Amazon Invades India

In the blistering heat one recent afternoon, a crowd of people gathered down a narrow side street in Govandi, one of Asia’s poorest and most sprawling slums, on the eastern edge of Mumbai. Here, goats and cows jostle for space with nearly a million people amid the fetid, trash-strewn paths and crumbling buildings. Many have no toilet at home, and thousands make their living by scavenging in the nearby municipal dump. But on this particular day, the crowd of men jammed into a storefront in the side street had arrived to try their hand at something entirely new in their lives: online shopping. At the door, a man handed passersby leaflets explaining that the store owner’s laptop connected to hundreds of thousands of items that could be delivered to his establishment within a few days. “I bought a mobile phone,” says Ansari Jameel, 24, amazed at the swift transaction, as he emerged from the store, adding that he had scraped together the money from his job packing vegetables in a local street market. “The prices are good, and I find a lot of things I cannot find other places, like clothes, shoes, and watches.”
Jameel does not know it, but he has just become part of a crucial experiment for one of the giants of the tech world:  AMZN 1.87% . His surprise discovery of Internet commerce is like found treasure to Amazon—and in CEO Jeff Bezos’s estimation, a key part of his strategy for future growth.
The setting for these ambitions is modest, to say the least. But that hardly matters. Or so we discovered when Amazon agreed to let Fortune spend a week on the ground exploring its barely two-year-old operation in India—a journey that took us through four cities, from north to south, veering from razzmatazz glitz to grinding poverty, sometimes within a matter of hours. In pulling back the curtains, Amazon, one of the most private public companies in the world, revealed how it is racing to piece together an immensely complex puzzle—much of which it is having to build from scratch, at giant expense and with painstaking attention to the minutiae, as it tosses out assumptions that American customers have taken for granted for decades. In doing so, the company, an upstart here, has thrown itself into a knife fight with two privately owned and much more established Indian competitors—Flipkart Internet Pvt. and Snapdeal, owned by Jasper Infotech Pvt.—as well as a clutch of smaller Indian startups that are nipping at all of their heels.
It is a fight that Amazon is far from certain of winning, yet one it cannot afford to sit out. The company predicts that India will be its biggest market after the U.S. within a decade and that the Indian e-commerce market as a whole will ultimately be gigantic. “The size of opportunity is so large it will be measured in trillions, not billions—trillions of dollars, that is, not rupees,” says Diego Piacentini, Amazon’s senior vice president for international retail, who oversees operations in Asia and Europe and who is Amazon’s biggest shareholder after Bezos. Over lunch in New Delhi, Piacentini tells me he now spends more time, by far, in India than any other country in his portfolio, shuttling back and forth from Seattle; he jokes that his last two haircuts have been in India. He believes a big payoff from the India push is “unavoidable.” But it will not come cheap. “We know that in order to win in India we need to do things we have never done in any other country,” he says. “We need great people, a great platform, and honestly, a lot of money.”
It is not hard to see why the battle for India is this fierce, nor why Bezos, famously obsessed with analytics, would see it as essential for Amazon’s future. The numbers alone are dizzying. India’s population of 1.25 billion is four times as big as the U.S.’s and more than double Europe’s. And since the median age is 27—a full decade younger than Americans’—the trajectory will be steep. India will overtake China as the world’s most populous country in just seven years, according to the UN. It is now the world’s fastest-growing major economy, and the IMF projects 7.5% growth next year. The roads and railways might be creaking under the strain. Many laws governing business are a confounding tangle, including a law forbidding foreign companies from selling products directly to Indians. That law effectively renders Amazon India a platform for vendors—akin to its “fulfillment by Amazon” program in the U.S.—rather than the company so familiar to Americans, which buys wholesale items in bulk and sells them directly in a Brobdingnagian online store.
“The opportunity will be measured in trillions, not billions—trillions of dollars, that is, not rupees.”
Still, one factor makes India vastly more accessible to global tech companies than that other mega-nation, China: The language of business here is English. “You have a market that is rivaled by only the U.S. and China. And China is very difficult,” says Jayant Sinha, minister of state in India’s Finance Ministry, whose résumé seems tailor-made for his high-level post: He spent years as a partner at McKinsey & Co. in Boston and at the Silicon Valley investment firm Omidyar Network in Mumbai. On the wall of Sinha’s Finance Ministry office, in the grand British-era government buildings in New Delhi, hangs a portrait of the national hero Mahatma Gandhi, who led the 1940s independence struggle, preaching simple living—a far cry from the talk within these walls these days, which is all about investment opportunities and profit-making. For e-commerce, Sinha says that after the U.S., “India is the logical No. 2.”
One reason for India’s huge potential is that it starts from such a small base. Barely one-quarter of India’s population has access to the Internet at home, whether on a smartphone or computer, and only a small fraction of those have ever shopped online. For e-commerce, that means explosive room for growth. Morgan Stanley estimates that revenue could soar to $137 billion by 2020, more than 10 times the 2013 level of $11 billion. That is partly thanks to plummeting prices for smartphones (there are cut-rate deals online for Chinese models like OnePlus and Xiaomi), which about 350 million Indians now own. Google  GOOG 1.89%  and Facebook  FB 0.95%  are among those investing heavily in increasing Indians’ online access, having concluded that their future growth—like Amazon’s—depends on massively expanding the world’s Internet users from the current 1 billion or so.
“The mandate is wider than just selling some products online. We’re building a whole e-commerce ecosystem,” says Snapdeal co-founder and CEO Kunal Bahl, who launched his company at age 27, in 2010, after earning a management and technology degree at Wharton in Philadelphia. He returned home to New Delhi, he says, only because the U.S. refused him a work visa to stay—a spectacularly good twist of fate for the now-32-year-old Bahl, it turned out. His company, built in part with financing from Alibaba  BABA -1.88%  and SoftBank, is valued at an estimated $5 billion.
Bahl is not surprised by the sharp growth in India’s e-commerce. “We know the tectonic shift is already happening,” he says. “We just need to explain to the outside world that it is happening.”
Though indian entrepreneurs saw the shift coming, U.S. companies were slow to arrive. That gave local executives like Bahl a headstart, which Amazon, for one, is now struggling to overcome. In 2007, six years before Bezos launched Amazon India, Binny Bansal, a computer engineer from northern India, co-founded Flipkart with his childhood friend Sachin Bansal (no relation) when they were in their mid-twenties, after the two had worked in Bengaluru (a.k.a. Bangalore) as software engineers for … Amazon. They concluded that Indians would love an Amazon-style shopping site. Just like Bezos, they began by selling books online. Eight years on, Flipkart, valued at about $15 billion, is now India’s biggest e-commerce company, with 44% of the market—nearly triple Amazon’s 15%—and the two Bansals are each worth $1.3 billion. Tiger Global Management, Accel Partners, and South Africa’s Naspers are key investors. Binny Bansal says they plan to take the company public in the U.S. by 2019. When I ask him if Amazon is hampered by having begun years after Flipkart, he says, “Absolutely. When you start late, you have to crunch whatever others have done in eight or 10 years into two years. That is just messy and crazy.”
The craziness was on full display traveling around India in October, when Amazon, Flipkart, and Snapdeal—on perhaps their busiest shopping week of the year—launched a frenzied marketing blitz to kick off the season of Diwali, the Hindu festival of lights, when Indians engage in a massive spending spree. A forest of billboards, the majority for Amazon, sprang up on roadsides and bus stations, promising blowout sales on furniture, clothes, smartphones, and other items; Amazon even ran a lottery for customers with a prize of a gold brick. Eight-page jacket ads for the three companies wrapped newspapers. Within hours of its five-day sale ending, Amazon switched its billboards for new ones announcing another three-day sale just a week later. Flipkart, meanwhile, announced it had sold $100 million in items within the first 10 hours of its five-day sale.
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To an outsider’s eyes, Amazon’s ads seemed frenetic and breathless, maybe even a little desperate. But the strategy comes straight from Bezos. To head Amazon India, Bezos had picked Amit Agarwal, a Mumbai native who joined Amazon in Seattle in 1999 after graduating with a computer science degree from Stanford. Agarwal shadowed Bezos for two years as his technical adviser before heading to Bengaluru, in southern India, the closest thing the subcontinent has to a Silicon Valley. “I spent more time with Jeff than my wife,” he jokes over breakfast. Then in 2013, Agarwal and Piacentini met with Bezos in Seattle to present their detailed business plan for India. The boss was unimpressed, they say, regarding their ideas as too cautious and methodical, given Amazon’s late arrival in India. He believed they had to go in with guns blazing. “He challenged us to think like cowboys, not like computer scientists,” Agarwal says. “We needed to move very fast.”
Bezos had good reason to worry. He did not want a repeat of Amazon’s past mistakes—in China, that is. There, Amazon trails far behind Alibaba and other Chinese companies, with no sign of ever catching up. “China has been something of a debacle,” says Benjamin Schachter, Internet analyst for the Macquarie Group in New York City. Amazon has only about 1.1% of China’s market and is so overpowered by Chinese competitors that it finally launched a store on Alibaba’s Tmall platform last March. But what went wrong in China is a matter of dispute. Schachter says investors believe Amazon “has invested a ton of money that has not really paid off.”
Amazon sees things differently. “We should have spent way more in China. On everything,” says Piacentini, an Italian who ran Apple’s Europe operations before joining Amazon in 2000. “And that is why we are not shy in India.” He and Agarwal tell me Bezos has given them wide freedom to run India without his intervention, accepting that it could take years for the billions of dollars in investment to show returns. “His solicitations are never, ‘When will we make money?’ ” Piacentini says. “It’s always, ‘Are we investing enough?’ ”
To signal just how much money Amazon was prepared to plow into India, in September last year Bezos flew to Bengaluru in a visit filled with Bollywood-style bling, arriving one day after Flipkart had closed a $1 billion round of financing. He posed on an ornately painted delivery truck outside Amazon’s Bengaluru headquarters dressed in a white Indian wedding suit and handed a $2 billion mock check to Agarwal. The message was clear: He would spend whatever it took to win.
By some estimates the company is spending nearly $25 million a month in India already. “Investors are prepared to give Amazon leeway,” says Schachter. “But they don’t want to see a repeat of what happened in China.”
Whether unbridled investment alone is enough for Amazon to catch up to rivals and dominate in India remains far from a settled question, of course. And some of those competitors, indeed, don’t exactly sound nervous at the prospect. “We’ve also got deep pockets,” says Flipkart CEO Binny Bansal, who adds that he has no worries about staying on top. “This is the last big frontier of e-commerce left. Nobody wants to lose.”
I got a close-up look at Amazon’s no-holds-barred plan late one afternoon in the Janakpuri neighborhood in western New Delhi. Down a side alley sits a warehouse that serves as one of the 4,000 motorbike delivery centers in the country—the first such service in Amazon’s 20-year history. There was a frenzy of action inside as each bike rider filled a large black backpack with packages, grabbed a list of addresses, and raced out the door. Straddling on the back of one of the bikes, I clung to the sides as we weaved through rush-hour traffic, dodging cars and rickshaws, women in saris, and the occasional cow. Experts in their districts, the riders are essential to Amazon’s ability to make speedy deliveries, since the country has an arcane address system, patched together haphazardly over the decades, with many addresses containing descriptions reading something like “behind the mosque, across from the stadium.”
Amazon faces a far bigger logistical hurdle than addresses, however: getting paid. Barely 60% of Indians have bank accounts, and only a fraction of those have credit cards. So Amazon’s payment systems in India are drastically different from any the company has attempted before and involve the kind of hand-holding that would be unimaginable to U.S. customers. About half the customers pay cash only when their purchases are delivered. Amazon has partnered with thousands of small shop owners across the country to act as pickup points in exchange for receiving a small commission per package.
When we finished our deliveries by motorbike that October afternoon in Janakpuri, we dropped by a tiny convenience store in the neighborhood, where a few Amazon packages sat on shelves between the rice and cooking oil. Lokesh Maggo, 33, whose father runs the shop, says he calls customers when their Amazon packages arrive and then collects the cash to give to Amazon the next time they swing by. In the process, his own business has grown. “People come here and then buy other things they need,” he says.
For now, Amazon’s strategy is to persuade Indian stores to sell their products through the company, even if it currently costs Amazon more money than it makes on the transactions. That could be inevitable right now, since its U.S. revenue model—buying in huge bulk at wholesale prices, then selling retail online—is not an option in India, whose laws forbid foreign companies, Amazon included, from direct sales to Indians.
Amazon boasted in its earnings call with analysts in October that the number of Indian sellers on its site had increased 250% in a year. Left unsaid, however, was that recruiting them has required staff to help on almost every aspect of the sellers’ business. One afternoon we watched an Amazon team set up lights and cameras in a small furniture store in Bengaluru so they could photograph a few leather couches and upload them to the site. The store owner tells me he doubted he would sell a single item on Amazon, but decided he “might as well” post his high-end furniture on the site. It was, after all, free.
Much could still go wrong with Amazon’s strategy. The legal obstacles it faces are not ones that affect Indian competitors, including the country’s retail giant, the Tata Group. In February, Tata—late to the game—is launching its own e-commerce platform, effectively turning its thousands of retail stores into an Internet behemoth. Up in the colonial-era whitewashed Tata headquarters in Mumbai, the e-commerce team show me their plan, designed, they say, to put a serious dent in Amazon, Flipkart, and Snapdeal’s trade. “Indian growth is on a tear,” says K.R.S. Jamwal, executive director of Tata Industries. “People like to say the winners have already been chosen. I don’t agree. This is a 10-, 20-, 30-year journey.”
Beyond even its prodigious financial investment, though, Amazon is clearly going all in. Witness its practice of filling out tax forms for some sellers, letting the latter avoid one major bureaucratic headache that is a perennial gripe here; each of India’s 29 states has a separate tax code, making cross-country shipping a laborious process. Amazon will even pick up items from sellers and deliver them—something the company does only in India. Another practice unique to its subcontinent operations: Amazon takes telephone orders for goods from sellers across India, packs the products into bags with Amazon logos, and delivers them straight from the sellers’ stores on Amazon motorbikes. That’s a far cry from the Amazon Americans know—whose core business is built on shipping millions of items, including groceries, from its own warehouses rather than collecting them from outlets. But then that’s a model that would severely limit Amazon’s business in India, where mom-and-pop stores dominate.
For Indian businesses, to be sure, the partnership with Amazon is an unalloyed boon. Sales for local businesses rocketed eight- or 10-fold during the Diwali promotion in October (at least according to Amazon); the company also exports items like saris and handicrafts to 25 million Indians in the U.S. “This is a land of small shops, with people who have probably never accessed the Internet,” Agarwal says. “If you want fast, cheap delivery, you have to build the whole infrastructure yourself.”
The morning after zooming through Janakpuri by motorbike, I flew to Amazon’s biggest Indian warehouse, outside Hyderabad, 1,000 miles south of New Delhi. Set about a half-hour’s drive from the city’s glassy new airport, through fields and rice paddies, the 280,000-square-foot warehouse is capable of storing more than 2 million items—making it a relative piker compared with Amazon’s gargantuan hangars in the U.S. The Pampers diapers, Dr. Seuss books, math textbooks, Nikon cameras, and Ferrero Rocher chocolates stacked on the shelves represent perhaps something more precious to customers in India: the chance to buy merchandise they have never seen in their towns—including remote villages in the Himalayas and communities in Kerala reachable only by boat.
Propped against the walls of the warehouse are signs with the slogan that captures in a handful of words what is unfolding at hyperspeed around the workers in Hyderabad: “Transforming the way India sells, transforming the way India buys.”
To truly disrupt the shopping habits of 1 billion people, however, Amazon, Flipkart, and others will need drastic transformation of the country itself—change that can come, perhaps, only at the hands of government, not companies. There are signs that it is slowly happening (see “The Last BRIC Standing”). In 2014 Narendra Modi, a charismatic Hindu nationalist, came to power as Prime Minister partly on a sweeping “Digital India” campaign, promising to resuscitate the decrepit manufacturing industry, build highways and railroads, streamline arcane tax rules, create dozens of new cities with high-speed connectivity, and provide banking services to hundreds of millions of people.
Those are all things e-commerce badly needs, and Modi is promising big changes. Even for the few Indians with credit cards, online shopping is still “painful,” in Agarwal’s word, with obligatory two-step authentication and cumbersome interstate trading laws. Parliament is debating whether to introduce a national sales tax, and the government has launched a fund to finance venture capital, modeling it on Israel’s Yozma Fund, which has helped power the rocketing success of Israeli startups. After years of stagnation, Modi seemed like a godsend to Indian entrepreneurs. Little surprise, then, that during his September visit to Silicon Valley, where 15% of startups are founded by Indians, 18,000 people jammed the San Jose Convention Center to hear him speak.
But California is 8,000 miles—and a galaxy away—from India. “In South Mumbai or Bangalore it’s easy to feel you are in New York or Silicon Valley. We drink the same coffee, listen to the same music, watch the same TV,” says Sinha, the minister of state for Finance. “But step 10 or 20 yards outside that zone, and you are in India. We are a poor, developing country.”
No matter how much Modi transforms his nation, millions of Indians will continue shopping with cash for years to come, the roads will remain muddied and potholed, and thousands of factories will remain dysfunctional. Until now, Sinha says, tech companies have zeroed in on the “top 100 million”—hardly a small number, but a small fraction of Indians. But in creating cash payment systems and pickup points for customers and even allowing those with no Internet connection to shop on Amazon, the company has the possibility of reaching a customer base several times that size. “Amit [Agarwal] is Indian to the core. He totally gets India,” Sinha says. “He’s come in and reinvented Amazon’s model.”
For Amazon to succeed in India, it will have to straddle those two worlds: the wealthy few and the poor masses. If it does, it could have a shot at something else too: helping to create a new model for other emerging markets. If e-commerce takes off across India, the industry could replicate its model for India in other vast developing countries, such as Indonesia and Nigeria. Then, says Sinha, the tech industry would have two global centers: Silicon Valley and Bengaluru. “Just like the U.S. is the economic hub and innovation engine for the top 1 billion people on the planet, India is going to be the innovation hub for the next 5 or 6 billion people,” he says.
In the ramshackle slum of Govandi, where raw sewage clogs the gutters, Amazon’s storefront operation is one sign of how that new hub might look. Here, few people have ever logged on to a computer, and many do not yet have a smartphone. Instead, the store owner guides them through Amazon’s site, then writes down their order in pen in a ledger and takes the cash once Amazon delivers the item to the store, passing the money along to the company, minus a fee.
On a good day, more than 30 people purchase items in his store. It is a small start, but one Amazon believes will rise quickly. “What we do in India will affect Amazon’s future in a very, very big way,” Agarwal says. “If Jeff writes a book on Amazon, India will certainly be a chapter in it.” It will be some time before we know whether that chapter will be titled “Bezos’s Folly” or “The Billion-Customer Bounty.”