Investment Ideas

After the much talked about and discussed nuclear deal, got passed through the US senate and the NSG waiver for India that preceded it, it will take some time for the corporate world in India to gear up for the benefits that may be extracted out of this deal. Currently, the regulators do not allow fully owned private nuclear power plants, only companies with a 51% government stake are allowed to generate nuclear energy. In practice, this has boiled down to only Nuclear Power Corporation of India Limited (NPCIL). Two years ago, the 89.5% government-owned National Thermal Power Corporation (NTPC) had approached NPCIL with a proposal that it enter the nuclear generation arena. But the talks have not made much headway. In my opinion, since it is also a security issue, the government will keep the private sector away from this for at least some more time. Thus, there is not much in the shelf for Indian corporate who might get directly involved in nuclear power generation. However, there are many companies which could get benefitted due to demand from government nuclear generators like NPCIL for its upstream (reactor parts, boilers etc.) and downstream (Transmission and Distribution) requirements.

According to a "must read" article in India Knowledge@Wharton, the upstream companies will get benefitted due to the U.S. companies helping to set up these plants will be looking to work with Indian contractors. Some of the contenders include: Larsen & Toubro (L&T), Hindustan Construction Company (HCC) and Gammon India in civil construction; L&T in reactors; Bharat Heavy Engineering Ltd (BHEL) in boilers; KSB, Kirloskar Brothers, Mather & Platt, Jyoti Ltd. and Bharat Pumps in boiler feed pumps; Alpha Laval, GEI Hammon Pipes, Maharashtra Seamless and Ratnamani Metals in heat exchangers; Honeywell Automation in panels; and Rolta India in consulting and engineering services. Some industry watchers also include Walchandnagar Industries, Godrej & Boyce, Bharat Heavy Plates & Vessels, the Hyderabad-based MTAR (which produces assemblies and precision components for use in space and nuclear applications), and Crompton Greaves. The nuclear deal might also make way towards some privatization in defense deals in India. However, this also seems to take some time.

On the downstream side there exists huge opportunities as the transmission and distribution losses currently stands at around 40% in the country. According to an article in livemint, in the five years to March 2012, India plans to add more than 50%, or about 78,577MW, to its power generation capacity of 143,006MW. If this target is to be achieved there has to be more efficiency on the transmission and distribution side and the players in this field must get well equipped.

The capacity addition of 78,577MW, at current estimates, will require some Rs10.31 trillion in investment. According to the Union power ministry, a Rs4.51 trillion state funding shortfall is foreseen in this target. According to the Associated Chambers of Commerce and Industry in India (Assocham), the apex industrial body in India, the power sector will attract investment to the tune of about Rs 2 trillion after the nuclear deal. These two figures suggest that there is ample space and requirement of funding sources other than the debt. In short, just like the real estate PE's there is a huge scope of Power sector based PE funds. In the last six months, private equity and venture capital firms have invested $890 million, in 14 big and small energy deals, compared with four transactions worth $123 million a year earlier, according to local private equity tracker Venture Intelligence. Also, power is the next big sector where PE's are eyeing after the Real Estate boom.

With PE deals like 3i to invest in Adani Power valuing the Company at $10 billion, Ind-Bharat power stake on sale and many other initiatives like by PFC to set up a Private equity arm in consortia with other PE players to finance big and small power projects, this is just the beginning of the investments in the power hungry country. According to a blog , 40 Indian companies including Videocon group, Jindal power and Tata power, have already started negotiations with the government and their foreign counterparts for nuclear power generation even before the government opened the doors for private players in direct nuclear power generation. All this being said and discussed, it seems that the Indian Power Sector has a long way to go if Indian economy has to grow. The government is doing there part to the extent they can and the corporates are doing what they can, now the PE firms have to see what they want to do as the power demand and supply equation seems to be on the supply side for the next few decades and an IRR of 25-30% is not that hard to achieve on a time horizon of 5-6 years investment in the upstream and downstream companies. However, if somebody is really interested in getting into the core business of generation than I think PE funds have to increase their investment time horizon to 10-11 years. Also, as the time horizon will increase the IRR requirement will also increase with the increase in the risk so an IRR expectation of even 40-50% will be achievable in the big power generation projects. In short, this is high time that the sideline cash get invested in the long term high growth prospects (Indian Power Sector) rather than waiting for somewhat safer but very low or no growth prospects (or Say Western World).

Indian real estate market has been in a booming phase for quiet sometime. The macroeconomic picture of world including India is getting deteriorated. Recently, inflation in India touched 8.75% which is highest in 7 years. Interest rates are also rising in India and every now and then property exhibitions are organized by the reality developers in major metros. These are indications that the real estate prices which were booming for some time in India, will take a knock from here following the US housing market.

Despite this gloom doom scenario for real estate, there has been continuous interest from investors for Real estate focused PE funds in India. According to an article published in livemint in May 2008, the PE firms that enter the Indian reality market expect a 20-25% Internal Rate of Return (IRR). However, similar kind of IRR opportunities are available in some of the Real estate pockets of US also which is an obvious preference over any emerging market due to lesser risk associated in terms of completion of the projects.

Although, the PE firms always lookout for early exit opportunities, the investment horizon has to be increased by real estate focused PE firms entering India. The valuations of Indian real estate companies have come down drastically. Major public companies which attracted PE investments, like Unitech, DLF, HDIL, are trading at their year lows. According to an article in ET, the IRR expectations for PE firms have increased off-late due to increased risk. For long term PE investors this seems to be right time to enter the market as many deals can be struck at more favorable terms. The deal time can also be taken adequately which was not the scene sometime back when the valuations were at peak and the deal closure cycles seemed to have become shorter from an average of three to six months to three to six weeks.

Thus, in my opinion this seems to be the right time to launch India focused real estate fund which can do fund raising in next 4-5 months and evaluate deals after that, as in next 4-5 month the valuations would be looking more attractive. Also, the funds can look for Private Investment in Public Equity (PIPE) deals as most of the listed Real Estate firms in India are currently trading at their year lows giving attractive valuations.

The current race by Indian telecom majors to gain access to African markets and establishing a global footprint seems to have gone reverse way. The talks that were started by Bharti on 6th May 2008 to acquire 51% stake in MTN mainly via debt. However, as the talks moved further, the deal started shaping up in the form of a Merger rather than an acquisition i.e. MTN and Bharti as combined entity instead of two different entities. Lastly, on 24th May 2008, Bharti called off the deal saying that MTN wanted Bharti to be a subsidiary of MTN i.e. MTN acquiring Bharti from what started with Bharti acquiring MTN.

The most interesting part is just two days after this deal was called off, Reliance Communications (RCOM) got into the 45 day EXCLUSIVE negotiations with MTN. Initially, when Bharti was in talks with MTN, RCOM categorically said that they are not interested in MTN as the valuations are pretty high. The talks started with the similar term sheet which the MTN board had presented in front of Bharti (Or was it RCOM which might have provided the term sheet which looked favorable to MTN management before 24th May 2008. Just a loose thought, as the gap between the new negotiations was just two days and RCOM got into exclusive talks which Bharti didn’t). The term sheet states that RCOM will be a subsidiary of MTN (Similar to what was offered to Bharti in the end).

Now, the talks are in a phase where MTN is offering 51 shares for 100 shares of RCOM which values either RCOM at $23 billion which is very low compared to $30 billion current market cap if we value MTN at $45 billion, or values MTN at $59 billion if the value of RCOM is considered to be $30 billion. MTN was vying for 200 Rand/Share compared to Bharti offer of 175 Rand/Share at the time of its talks with Bharti which valued it at $45 billion. Even if 200 Rand/share is MTN’s expectation, the value comes to be around $ 51 billion and thus the value of RCOM that MTN is negotiating comes out to be $26 billion (Significant downside from current market valuation of $30 billion). However, RCOM is trying for a swap of 66 MTN shares for 100 RCOM shares.

A new twist in the tale is entry of Mukesh Ambani claiming that Reliance Industries Limited (RIL) has the first right to refusal in case RCOM is sold off. So if this deal is also called off due to any of the reason, who’s next in line for MTN – Vodafone?

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Today an opportunity in Nifty 2011 Expiry 5000 Strike Put is available. You can write it at 1021 i.e. Cash inflow is Rs. 50,000 per lot and Cash outflow (Margin) is Rs. 50,000 only. Now, I would recommend to write 10 lots of this Put option at 1021. Thus, you will get a cash inflow of Rs. 500,000 on a cash outflow of Rs. 50,000. I assume that the market would not go below 4450 so keep around 10,000 per lot for cushioning the open position if the market goes to that level. i.e. for 10 lots you have to keep Rs. 100,000. These margin can be in the form of Securities also after a haircut.

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Today the Nifty June 2009 expiry, 4700 strike Put option is available for ready trade at 542 i.e. the cash inflow of approx Rs. 27,000 and the Cash outflow for marginwould be around Rs. 32000 as the market is trading at around 4660. Thus, for Rs. 5,000 you can open a position. Right now a buyer for 1000 shares or 20 lots is available at 542 as shown. So if you write 5 nifty put options, your outflow is Rs. 25,000 and the potential upside can be Rs. 135,000 (if u wait till June 2009). I would recommend to write 5 options and add another 5 if the market fall more tomorrow. So just keep some cushion of around Rs. 5,000 for current 5 lots or Rs. 25,000 if the market falls to 4600.