What do you make of the corporate earnings numbers for 2009-10
Im comfortable with the growth in corporate profits. The IIP number, which has come in at 17%, mirrors the corporate performance. Indian companies are managing their capital very well. They face an environment that promises them 15% top line growth and most of them benefit from operating leverage. India is a price-sensitive market, so not all companies may have pricing power. Also, producers of commodities will be impacted because the global economy is still not out of the woods though there is a very low probability, just 10%, that the US will get into a double-dip recession. On Europe, our firm view is that its going to be positive but muted growth. However, the IMF is still talking about 4% growth of the world economy.
How do you read India Incs performance, going ahead
If you focus on companies that are catering to the domestic market, they will continue to do well. Telecom, of course, is a different story altogether, because theres been too much unhealthy competition and thats resulted in inefficient allocation of resources. So much so that some players are now servicing the marginal customers at prices below their marginal cost. Of course, I hold the view that were looking so good because we have underperformed in the past. In terms of solving some of our deep-rooted problems, the progress were making is slow. Im very optimistic in the short term but Im very cautious about medium to long term. I hope we undertake all the next generation reforms without delay.
Are you seeing a re-rating of the Indian market
Today the market is trading at around 16 times, but it wont trade at these levels continuously. Over a five-year period, it could trade at an average 16 times, with some overshoot and undershoot, depending on the global sentiment. India has already been re-rated in 2005 so we have seen some unusual returns for long-term investors who invested before 2005. Right now our PE (price to earnings) ratios fluctuate much like in any other developing market. I dont really see a reason for a re-rating of India just yet; I think the current multiples are taking care of our estimated growth rates. If we get about 9% growth in the next five years, we should be really happy. This will enable us a 15% top line growth, so we can really justify a forward PE ratio of 16 or 17 times.
Given that valuations are not cheap, how do you see action in the M&A and PE spaces
To me, telecom is ripe for consolidation due to economic necessity, and we can create value for there everyoneshareholders, the economy and the government. We cant sustain the consumer surplus that has been created due to excessive competition while on the margin there is a producer deficit. This was the cause of the Internet Bust as Internet companies created huge consumer surplus and huge producer deficit. However, Indian promoters are reluctant to sell for several reasons. First, every promoter is confident of growth and knows that his business could be worth three times as much in five years than it is worth today. So why should he sell Most promoters have children and want to hand over their businesses to them. Only those who get a great price will sell and the children can invest the money in more exciting businesses. Also, theres plenty of capital available for good companies. There are also CEOs who want to use PE not only for their capital but also for their expertise to move into the next orbit. In this respect, what venture capital did for the American economy, PE is starting to do for India.
The PE investment in Indian companies seems rather small compared with the opportunity.
Thats true. India is a great story for foreign investments. India can attract any amount of money but some of our regulations are not conducive to deals. We need to change our regulations and rely more on market mechanisms. Let me illustrate this for you. We would like to do structured transactions because there is a great deal of uncertainties about future outcomes and hence some differences between us and the promoters on the issue of valuation. The solution is a structured deal. But the latest regulations dont allow us to do structured deals.
If I want to give the promoter an earn out if he performs better than our expectations, then why should the authorities have any problem with that For instance, if he does well we could give him one per cent of his equity back, if he does better we could give more. The government of India has a Production Sharing Contract in oil & gas business that also means the same thing that as you have more oil you share more with the government. Similarly, GoI has a revenue share mechanism in the telecom sector Hence, the governments stand is totally inconsistent.
The lessons from the success of privatisation of Indias oil & gas and telecom sectors are loud and clear. When there is a lot of uncertainty regarding the future, both parties are served better through a structured contract depending on the future profit. GoI probably has not studied this impact of the policy on future PE investments. I can tell you with strong conviction that this is going to be very detrimental to PE investments in the future. We wouldnt have done four of the ten deals if this structuring wasnt available to us. I see a lot of policies like that which have no relevance today.
There is a need to look at the policies from a fresh perspective and from a cost-benefit analysis. Policies are often designed to contain a few unscrupulous players. But they end up hurting the majority of honest players and the country. Joseph Stiglitz earned his Nobel Laurate for his thesis that regulations help those against whom the regulation is intended. My experience in India is that regulations often hurt those who are meant to be protected by regulation.