Tata’s $1.6B Corus Writeoff – The Backstory

In 2007, Tata Steel of India bought British steel maker, the Corus Group, for $12B. This was nearly $3B more than what it offered initially (the reason for the extra? a bidding war). Recently though, it announced a $1.6B write down in connection with the acquisition.

So why did the write-down occur more than 6 years after the acquisition?

A plausible reason is that it did take Tata Steel this time to realize that the full forecasted cost-side synergies, market power synergies, or both, were not going to materialize.

But The Economist, citing data that shows that 5 years is the average time across the world between “error and admission”, argues that these lags are often a result of companies’ internal politics – in the sense that write-downs are seen as (tacit?) admissions of mistakes on the part of a CEO, the board, or other executives. 

Specific to the Tata case, it makes two interesting observations:

So what does Tata’s write-down signify? Ratan Tata, the patriarch of the Tata group, retired as chairman of Tata Steel on December 28th. Until he left it was probably impossible to recognise that Corus, his biggest deal, was a flop.

His successor, Cyrus Mistry, has several underperforming businesses to deal with. Yet Mr Mistry has opted for a small write-off. Corus, analysts estimate, is worth a third or less of the $13 billion Tata paid for it, meaning the impairment should be much bigger. So this is no cathartic moment, of the kind that Hewlett-Packard and Rio Tinto sought. Instead of admitting defeat Mr Mistry probably hopes to sell all or part of Corus, or allow it partially to default on its debts (which are ring-fenced and not guaranteed by the Tata group).

Too big a write-off might suggest he would accept a low price, or cede control of Corus to the banks. Tata’s goodwill charge, then, tells you that the firm is not yet ready to walk away from its European arm. Given that this arm is losing about a billion dollars a year of free cashflow, that could be an expensive decision.

“India Rising” – Aberration or Inevitable?

Over the last several years, while some parts of India have seen extensive development and life for the middle class in selected pockets has gotten largely better, hundreds of millions of Indians have been left behind.

And this manifests itself today as a slowdown in GDP growth (but note: that is a slowdown in the rate at which GDP is growing, not a decline in GDP itself).

Raghuram Rajan, a University of Chicago Finance Professor and the chief economic adviser in India’s finance ministry, writing on a website called Project-Syndicate, attributes this to multiple reasons.

First, India probably was not fully prepared for its rapid growth in the years before the global financial crisis. For example, new factories and mines require land. But land is often held by small farmers or inhabited by tribal groups, who have neither clear and clean title nor the information and capability to deal on equal terms with a developer or corporate acquirer. Not surprisingly, farmers and tribal groups often felt exploited as savvy buyers purchased their land for a pittance and resold it for a fortune. And the compensation that poor farmers did receive did not go very far; having sold their primary means of earning income, they then faced a steep rise in the local cost of living, owing to development.

In short, strong growth tests economic institutions’ capacity to cope, and India’s were found lacking. Its land titling was fragmented, the laws governing land acquisition were archaic, and the process of rezoning land for industrial use was non-
transparent.
 

The rest of the highly readable article discusses other reasons, and remedies. 

India’s Airlines – Major Changes Ahead

The UAE’s Etihad Airways just bought a (24%) stake in India’s mostly domestic Jet Airways – after foreign direct investment in the airline industry was relaxed by the Indian government last year.

While Jet Airways gets liquidity for growth and expansion, Etihad gets a nice foothold in India’s growing domestic market. On top of that, and equally importantly, this can help it offer convenient “one carrier” routes from major international hubs and destinations to and from India – something that can help it compete with Emirates, Qatar and probably even major European carriers with global networks such as Lufthansa.

In other words, more competition for Indian air travelers which may translate into lower fares and more convenience.

The one entity that may not be too happy about this though is Air India, India’s state-owned airline that has had various management and profitability issues over the years.

An interesting excerpt on this, from Knowledge@Wharton:

Air India’s leadership has already begun complaining about “unfair competition.” Others have sounded warning notes as well. “Instead of giving Air India the time it needs to consolidate as well as expand its network, [the Jet-Etihad deal] will only hasten its demise,” said former federal railway minister Dinesh Trivedi in a letter to the prime minister. In a previous article, Wharton management professor Saikat Chauhuri told Knowledge@Wharton that “external shocks” could derail the initial signs of a turnaround at Air India. “I have been a vociferous supporter of government backing for Air India,” he noted.

Critics, however, say that a turnaround at Air India is an oft-repeated story. “It is no longer credible,” says Jitender Bhargava, a former Air India executive director who is writing a book about the airline.

And the national carrier is likely to face even more competition soon. The Foreign Investment Promotion Board has already cleared a joint venture proposal between the Tata conglomerate and Kuala Lumpur-headquartered budget airline AirAsia. AirAsia would hold a 49% stake, Tata Sons 30% and Arun Bhatia of Telestra Tradeplace the remaining 21%. Bhatia runs Hindustan Aeronautics and is related by marriage to L.N. Mittal of ArcelorMittal.

But if foreign equity investments increase the profitability, and stability (ref: Kingfisher), of various private airlines in India, surely this is good news for not just travelers, but also Air India’s pilots and employees who now have other avenues of employment?

Which leaves a few assorted politicians who might bemoan the ultimate (and unavoidable?) demise of Air India. That’s OK, though. In this day and age, the Indian government has no business being in the airline business. 

What Ails Infosys?

Recently, Infosys, one of India’s IT outsourcing giants released some weak results. The stock took a massive hit. In contrast, TCS, another Indian IT outsourcing giant, released great results a couple of days later.

So what’s the problem with Infosys, assuming that both are fundamentally in the same business – IT labor arbitrage between the developed world and the developing world?

According to The Economist, 

Infosys’s central dilemma is that its prices are too high compared with its peers’, and hence its best-in-class margins are unsustainable. The firm has now admitted that it has struggled to balance the short-term preservation of profits with long-term growth. Its hesitance has put it in a sort of Catch-22. It is reluctant to have a push for growth for fear of diluting its margins. Yet the cloudier the outlook for sales becomes, the harder it is to control efficiently the costs of ramping up recruitment and investment, thereby cutting into the margins the firm was trying to preserve.

The firm now says it will stop letting profit-margin targets get in the way of winning contracts. 

In other words, it is willing to trade margins for volume. 

On the face of it, such a strategy makes sense. IT services have come to define commodotization. So with a large number of firms – both Indian, and India-based western ones – chasing the same clients and offering the same types of services, pricing power is obviously weakened and volume is the name of the game. 

So why did Infosys think that customers would pay it higher prices? Any Infosys readers care to comment?

Novartis, India, Patents and Gleevec

On the face of it, yesterday’s Indian Supreme Court decision denying Swiss pharma-giant Novartis patent protection for its’ leukemia drug, Glivec (“Gleevec” in the US), seems unfair.

Since intellectual property protection is generally a suggestion in the developing world, it seems like this is yet another example of countries in that part of the world not respecting IP rights of foreign (and western) countries.

Novartis, of course, is disappointed with the verdict.

According to a statement from Novartis, “The primary concern of this case was with India’s growing non-recognition of intellectual property rights that sustain research and development for innovative medicines.” And Ranjit Shahani, vice-chairman and managing director of Novartis India, told Indian newspaper The Hindu that “No global player has invested in R&D here, and it is unlikely to happen given the atmosphere. India is a developing country and needs to encourage innovation. The verdict is not very encouraging and shows that the ecosystem to encourage innovation does not exist here.”

Pharma industry groups in the US are also unhappy (NYT article by Gardiner Harris and Katie Thomas):

“It really is in our view another example of what I would characterize as a deteriorating innovation environment in India,” said Chip Davis, the executive vice president of advocacy at the Pharmaceutical Research and Manufacturers of America, the industry trade group. “The Indian government and the Indian courts have come down on the side that doesn’t recognize the value of innovation and the value of strong intellectual property, which we believe is essential.” 

Equally predictably, the other side and various “patient groups” across the world are happy with the decision.

So what is really going on and why did India’s Supreme Court rule the way it did?

(more…)

India – IT Outsourcing Was Great, But What’s Next?

IT Outsourcing in India is a jobs’ success story.

Around 3 million direct jobs and another 10 million secondary jobs and perhaps that many more tertiary jobs have been created, thanks to mostly Western companies wanting to cut down on costs by having skilled Indians do an increasing amount of work.

In the beginning, this outsourcing was limited to programming and call center work – stuff that could be done without having to be in front of a Western customer – business or consumer. Over time, technology got better, skills got better and confidence on both sides of the world increased. So now some of these 3 million jobs include writing copy for Reuters, doing research for finance firms and even animation work for some of Hollywood’s movies. 

But there are three problems. One, in some way, shape or form this is still outsourcing and at some point, all that can be outsourced will have been outsourced. Two, wages in India have been increasing nearly 30% year on year. Some estimate that labor cost arbitrage, which has been a key driver of outsourcing, will not be advantageous anymore by 2015. Three, other countries such as the Philippines, South America (Brazil and Mexico are in the same time zone as the US, as some have noted, and their English skills and their technical skills are getting better).

The solution, for India, or anyone else experiencing similar problems, is to depend less on outsourcing and more on using technology in-country in any number of ways, much like in the US.  

But that is easier said and done because of the problems India’s wannabe tech entrepreneurs face, as a longish article in The Economist highlights in its recent issue.

India’s entrepreneurs must overcome three problems.

The first is payments systems. Only about a fifth of Indians have debit or credit cards and those who do are scared of using them online. When they try the process is clunky—a quarter of attempts to pay on the Indian Railways site, probably India’s most frequently used, fail. The good news is that regulators are easing the rules for small transactions. Anish Williams quit HSBC to co-found Transerv, a firm that has just launched a pre-paid mobile wallet that can be bought from street vendors and downloaded onto phones. It piggybacks on the credit-card payments system and should make buying online easier. Firms like this could make a big difference.

The second bottleneck is capital. India’s e-commerce industry will need billions of dollars to grow. But local venture-capital firms struggle to write cheques of over $100m. Some fear that foreign investment in e-commerce may fall under the same rules as apply to bricks-and-mortar retailers such as Walmart. These let individual states ban activity.

The third impediment is India’s telecoms sector. Once celebrated, it is indebted, loss-making and fragmented. To blame are a price war, graft and licensing rules that prevent consolidation and roaming. The industry is cutting investment in networks at exactly the wrong time. There are multiple different spectrum and licence charges; big operators pay up to a third of their sales on such levies and on taxes. Telecoms firms are so fed up they refuse to participate in new spectrum auctions.

To add to that, in many parts of India, entrepreneurs (who will of course inevitably stumble on a regular basis as they try to succeed) is viewed with suspicion, at best and derision, at worst. Change may be coming, but slowly, especially in the middle classes that have long wanted “safe”, salaried jobs. 

If there are a few blockbuster successes, that may start to change though.