Niveshak Nov14

Niveshak TH THE INVESTOR E INVESTOR VOLUME 7 ISSUE 11

Diesel UNCHAINED

Inside: Insights by Prof. Samir K Barua Ex-Director, IIM Ahmedabad

November 2014

FROM EDITOR’S DESK Niveshak Volume VII ISSUE XI November 2014 Faculty Chairman

Prof. P. Saravanan

THE TEAM Abhishek Bansal Akanksha Gupta Apoorva Sharma Bhawana Saraf Gaurav Bhardwaj Jatin Sethi Kocherlakota Tarun Maha Singh Gulati Mohit Gupta Mohnish Khiani Palash jain Prakhar Nagori Priyadarshi Agarwal Ramesh Jaiswal Rahul Bajaj Sandeep Sharma S C Chakravarthi V Vishal Khare

All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

Dear Niveshaks,

The month of November saw the GDP growth dropping to 5.3% in the second quarter as compared to 5.7% in the previous April-June quarter because of the poor performance of the manufacturing sector with a growth rate of mere 0.1%. The wholesale inflation has dropped to a five-year low of 1.77% driven by softening prices of fuel and food items and the retail inflation based on CPI eased to 5.52% at the end of October. The SENSEX has risen by about 36% so far this year touching an all-time high and the net investments by overseas investors has reached USD 16 billion so far this year. The Modi government continued taking some positive steps towards the growth of Indian economy. The union cabinet approved the proposal to amend the FDI policy in construction and real estate sector with the minimum capital requirement brought down to 5 million US dollars from 10 million US dollars. SEBI also revamped the ‘Prohibition of Insider Trading’ regulations with more stringent measures, aligning its norms with international practices. The PM visited Australia for the 9th G20 summit where the G20 leaders committed to put in place a mechanism for automatic exchange of tax information between member countries by 2017. PM Modi made his debut among the world’s most powerful people after being ranked 15th on the Forbes list. Government re-launched Kisan Vikas Patra that would help gullible investors to channelize their savings towards a trusted government scheme instead of some Ponzi schemes. Our Cover story for the month of November 2014 edition is on Diesel Deregulation which would familiarize the readers with the concept, its pros & cons, impact on the various sectors and further what could be done for the improvement of the various sectors. The article of the month covers the topic of Universal Banking and its future roadmap in India. On the other hand, FinGyaan covers ‘GDP’s origins, relevance & alternatives in today’s world, which would take us through the evolvement of GDP. FinSight section is an insight into the HP Split into two companies HP Inc. and HewlettPackard as well as discussing competitive scenario and growth opportunities of both. Also, the Editorial Team of Niveshak, is pleased to introduce to you our new team, which has been selected to carry on the legacy of Niveshak. They are: Abhishek, Bhawana, Maha, Palash, Prakhar, Rahul, Ramesh, Sandeep and Vishal. Please join us in welcoming them to team Niveshak. We are confident that the new team will not only meet but surpass your expectations in this and the coming editions. Keep supporting them the way you have been doing to us. We are introducing a new column in our magazine ‘FinLife’ which would be covering the aspects of Financial Decision Making. This section will replace the widely cherished column, FinPact. This month’s FinView hosted the interview of Prof. Samir K Barua, Ex-Director, Indian Institute of Management, Ahmedabad. The Classroom learning section covers the intricacies of ‘Green Shoe Option’. It provides an in-depth understanding about the concept and the reasons for the exercise of the same. We would like to thank our readers for their immense support and encouragement. You remain our prime motivation factor that keeps our spirits high and give us the vigour and vitality to keep working hard. Stay invested! Team Niveshak

Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

CONTENTS Cover Story Niveshak Times

04 The Month That Was

Article of the month

10 Universal Banking in India

FinGyaan 18 GDP’s origins, relevance and alternatives in today’s world

FinLife

Diesel Deregulation and Pricing Issues.

Finsight

26 Analysis of HP mitosis FINVIEW

Fundamental or Technical 29 Interview Of Ex-Director, Analysis: An Amalgamation of Indian Institute of Management, both the perspectives Ahmedabad

CLASSROOM

31 Green Shoe Option

The Month That Was

NIVESHAK

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The Niveshak Times Team NIVESHAK

IIM Shillong HDFC’s FII holdings cross 75% Emerging as one of the sought after stocks for foreign funds, mortgage giant HDFC has seen overseas investors raising their stake in the company to a record-high of nearly 78% during the quarter ended September 2014. The mortgage financier has also become the first listed Indian company among 30 Sensex firms to have over 75% shareholding by foreign institutional investors (FIIs). Cumulative FII holdings in the company rose to 77.85% in the July-September quarter this year, according to data from stock exchanges. Moreover, shareholding of overseas players or FIIs in HDFC has been steadily rising since September last year. The rise of overseas shareholding in the mortgage lender, one of the highest among the country’s 30 listed bluechip companies, coincides with overall bullishness shown by foreign entities in the Indian stock market. According to market experts, overseas investors have shown interest in HDFC because of the smart returns given by the company. In May 2012, HDFC’s board had approved raising FII limit in the company to 100%. Kotak – ING VYSYA bank merger; Kotak to enter general insurance business In an all stock amalgamation, ING Vysya Bank decided to merge with Kotak Mahindra Bank, creating the fourth largest private sector bank in the country. ING Vysya shareholders will receive 725 shares in Kotak for 1,000 shares of ING Vysya. “This exchange ratio indicates an implied price of Rs.790 for each ING Vysya share based on the average closing price of Kotak shares during one month to November 19, 2014, which is a 16 per cent premium to a like measure of ING Vysya market price,” it added. The proposed merger would result in issuance of approximately 15.2 per cent of the equity share capital of the merged Kotak. One of ING Vysya’s directors will be joining the Board of Directors of Kotak. ING Group, which owns 43 per cent in ING Vysya, has indicated that it supports the proposed transaction. ING Group will become the largest nonpromoter shareholder in combined Kotak. The amalgamation is subject to the approval of the shareholders of Kotak and ING Vysya respectively,

NOVEMBER 2014

Reserve Bank of India under the Banking Regulation Act, the Competition Commission of India and such other regulatory approvals as may be required. The last merger to happen in the private sector banking space was in 2010 when Bank of Rajasthan was acquired by ICICI Bank. Kotak also received approval from RBI to form a 100% subsidiary to enter general insurance industry, which is currently growing at Rs 77,000 crore premium per annum. Kerala and Goa first states to fully provide one bank account to every household Kerala and Goa have become the first states in the country to provide one basic bank account to every household, achieving the primary goal of the Pradhan Mantri Jan Dhan Yojana (PMJDY) in two-and-a-half months of its launch. The finance ministry on Friday said Kerala and Goa became 100% saturated states in terms of coverage of all households on November 11. In addition, the Union Territories of Chandigarh, Puducherry and Lakshadweep, and three districts of Gujarat — Porbandar, Mehasana and Gandhi Nagar — have also covered all households under PMJDY with at least one bank account, it said. Of the 80 million accounts opened under the scheme as on November 25, public sector banks have opened 64 million accounts, while regional rural banks and private sector banks have opened 13 million and two million accounts, respectively. Jaitley called for more active participation by private sector banks. In terms of deposits, only Rs 6,292 crore has been collected up to November 25, as 60 million accounts opened have zero balance. However, the growth has moderated after September 30. PMJDY, which was launched by Prime Minister Narendra Modi on August 15, seeks to cover 75 million un-banked households in the country in the first phase. It provides INR 5,000 overdraft facility for Aadhar-linked accounts and RuPay debit card, besides an INR 1 lakh accident insurance cover. The scheme also envisages channelling all benefits from the union, state and local governments to the beneficiaries’ accounts. Finance Minister Arun Jaitley revised the target for opening bank accounts under the Pradhan Mantri Jan Dhan Yojana from 75 million

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to 100 million by Jan 26, 2015. RBI new norms on ATM usage charges According to RBI’s new guidelines that came into force from 1st November 2014, bank customers in six metros – Delhi, Mumbai, Chennai, Kolkata, Hyderabad and Bangalore – are allowed to withdraw money and/or carry out non-financial transactions like mini-statements at ATMs of banks, where they hold saving/current accounts, free of charge only five times a month. Every transaction beyond this threshold will be charged Rs 20 per use. Besides, the number of free transactions at ATMs of non-home banks have been cut to three times a month from five times. The RBI, however, clarified that nothing precludes a bank from offering more than three free transactions at other bank ATMs to its account holders if it so desires. The cap in the number of free ATM transactions will not apply on small/no-frills or basic savings bank deposit account holders who will continue to enjoy five free transactions. The United Bank of India (UBI) on Wednesday decided to continue with five free ATM transactions per month (including non-financial ones) at other bank ATMs for all savings account holders in both metros and non-metros. HDFC Bank and Axis Bank will charge their own customers for more than five transactions at their Automated Teller Machines starting 1 December. Union Bank will charge own customers for more than eight transactions per month at its ATMs and more than five at other banks ATMs. Punjab National Bank (PNB) on Wednesday said it will continue giving free transactions to all saving bank account cardholders using PNB ATMs, irrespective of the number of transactions. RBI tightens norms for NBFCs In a bid to bring non-banking financial company (NBFC) norms in line with those of banks, the Reserve Bank of India (RBI) on Monday unleashed tighter rules for NBFCs. According to the new guidelines, NBFCs will require higher minimum capital, have less time to declare bad loans, and a board-approved fit and proper criteria for director appointments.

Owned Fund (NOF) requirement is at Rs 25 lakh. In a phased manner, the NBFCs would be required to raise it to Rs 1 crore by March 2016, and to further double it to Rs 2 crore by 2017 with an objective to mitigate risks in the sector. To harmonise the deposit acceptance regulations across all deposit-taking NBFCs (NBFCs-D) and move to a regime of only credit-rated NBFCs-D accessing public deposits, existing unrated asset finance companies (AFCs) have been asked to get themselves rated by March 31, 2016. “Those AFCs that do not get an investment grade rating by March 31, 2016, will not be allowed to renew existing or accept fresh deposits thereafter,” RBI noted. Ratan Tata invests in another e-commerce firm, Urban Ladder Tata Group’s Chairman Emeritus Ratan Tata has invested in online furniture company Urban Ladder, making it his second personal investment in an e-commerce firm after Snapdeal. However the amount and other details about this investment was not disclosed. This is Tata’s second investment in Indian e-commerce business, after a previous investment he made in online marketplace major Snapdeal earlier in August this year. The latest investment comes four months after Urban Ladder raised ‘Series B funding’ from Steadview Capital and existing investors SAIF Partners and Kalaari Capital. “Tata understands the furniture space very well, specially our focus on product design since he has a lot of knowledge of the subject. His inputs and guidance will be very valuable for us,” Urban Ladder CEO and Co-founder Ashish Goel said. Launched in July 2012, Urban Ladder was co-founded by Ashish Goel and Rajiv Srivatsa. It offers over 1,000 products across 25 categories in furniture such as wardrobes, beds, sofas, dining tables and coffee tables.

The new norms, which will be implemented in a phased manner, are made applicable for NBFCs that manage funds worth Rs 500 crore and for those that accept public deposits. The central bank will also start granting fresh NBFC licences. At present the Net

The Month That Was

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Article ofSnapshot the Month Market Cover Story

Market Snapshot

Source: www.bseindia.com www.nseindia.com

MARKET CAP (IN RS. CR) BSE Mkt. Cap

9865772.54 Source: www.bseindia.com

CURRENCY RATES INR / 1 USD INR / 1 Euro INR / 100 Jap. YEN INR / 1 Pound Sterling INR/ 1 SGD

LENDING / DEPOSIT RATES Base rate Deposit rate

10.00%-10.25% 8.00% - 9.05%

RESERVE RATIOS 61.8658 77.2147 52.56 97.2283 47.5785

CURRENCY MOVEMENTS

CRR SLR

4.00% 22.00%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

9.00% 8.00% 7.00%

Source: www.bseindia.com 23-Oct-2014 to 26-Nov-2014 Data as on 26-Nov-2014

NOVEMBER 2014

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BSE Index Sensex MIDCAP Smallcap AUTO BANKEX CD CG FMCG Healthcare IT METAL OIL&GAS POWER PSU REALTY TECK

Open

% change

26752.9 9592.09 10642.69 17883.04 18948.89 9863.16 15245.91 7341.74 13929.77 10101.5 11281.25 10641.84 2092.69 8079.62 1432.29 5671.73

28386.19 10119.95 11180.24 18787.14 20586.35 9630.87 16236.26 7696.85 14809.67 11094.24 11274.31 10874.72 2135.26 8228.54 1660.73 6125.31

6.11% 5.50% 5.05% 4.81% 8.64% -2.36% 6.50% 4.84% 6.32% 9.83% -0.06% 2.19% 2.03% 1.84% 15.95% 8.00%

% CHANGE

Article Market of Snapshot the Month Cover Story

Market Snapshot

Niveshak Investment Done Fund on 30/6/14 Utilities (4.55%)

Information Technology (17.10%)

HCL Tech.

Infosys

TCS

Wg: 5.91% Gain : 11.08%

Wg: 5.17% Gain : 34.30%

Wg: 6.02% Gain : 7.25%

FMCG (26.51%) Colgate HUL

Britannia Wg:5.26% Gain : 63.67%

Wg:7.13% Gain : 23.79%

NTPC Wg:4.55% Gain:0.14%

Telecom (5.23%)

Wg:7.17% Gain : 11.62%

ITC

Wg:6.95% Gain : 5.67%

Auto (16.52%) M&M Wg:6.64% Gain : 5.60%

Tata Motors Wg:4.77% Gain : 23.47%

Amara Raja Batt Wg:5.11% Gain : 4.04%

Titan Company Wg:5.07% Gain:-2.01%

Chemicals (7.47%)

(17.47%)

Lupin Wg:6.07% Gain : 41.18%

Wg: 5.23% Gain : 4.71%

Auto (5.07%)

Pharmaceuticals Dr Reddyâ&#x20AC;&#x2122;s Labs Wg:3.29% Gain:37.90%

Bharti Airtel.

Ipca Labs

Wg: 8.11% Gain :-7.71%

Asian Paints Wg:7.47% Gain:22.04%

Performance Evaluation

As on 28th November,2014

Performance of Niveshak Investment Fund since Inception

November Performance of Niveshak Investment Fund

104

145 140

103.5

135

103

130

102.5

125

102 101.5

120

101

115

100.5

110

100

105

99.5

100

Opening Portfolio Value : 10,00,000 Current Portfolio Value : 14,03,430.0 % Change in Portfolio Value : 40.34% Change in Sensex : 39.98%

26-Nov

17-Oct

27-Sep

07-Sep

18-Aug

29-Jul

09-Jul

Scaled Sensex

06-Nov

Scaled NIF

19-Jun

30-May

10-May

20-Apr

31-Mar

11-Mar

19-Feb

Dec-14

Nov-14

NIF

95 30-Jan

Sensex

Nov-14

Oct-14

Values Scaled to

Risk Measures: Standard Deviation : 12.79%(Sensex : 13.05%) Sharpe Ratio : 2.84 (Sensex : 2.76) Cash Remaining:2,66,673

Comments on NIFâ&#x20AC;&#x2122;s Performance & Way Ahead : Currently the return of NIF (40.34%) stands inline with the returns of Sensex at 39.98% owing to our investment strategy of sticking to value fundamentals in the time of volatility. This month the NIF portfolio witnessed a reshuffle in terms of value and composition. Cash from Liquid funds were invested in Long Term debt funds where we expect better capital gains whenever RBI cuts rates and Bond Yields fall. In terms of composition we have sold expensive stocks where we feel the valuation had fallen out of your comfort areas and these valuations didnâ&#x20AC;&#x2122;t justify their growth rates. We moved some money to stocks with good future potential and relatively comfortable valuations. We have chosen Titan due to our expectation of a rise in discretionary spend on jeweller items , Amara Raja , is expected to see good volume growth due to the duopoly market it operates in and a rise in volumes of cars sold in the country. The 3rd company is M&M, where we expect a revival in their tractor business. The current P/E of Sensex stands at 19.56. This is considered as overvalued. However, since we have invested in companies which are fundamentally strong, this will not impact us and so we have not changed our investment strategy. The connecting string in all our portfolio has been to lookout for maximizing returns by taking asleast-as-possible risk.

Article of the Month Cover Story

NIVESHAK

Universal Banking in India Sainath Zunjurwada

SIMSREE Introduction The financial crisis of 2008 could well be epochal in the financial history of the world. Like every crisis that has gripped the world, it too threatened to derail the good work of decades, but unlike your run of the mill crisis, it exposed deep seated fault lines in the so called sophisticated financial systems of the world. The investment banking (IB) sector bore the brunt of the crisis, it was after all one of the biggest culprits. In the aftermath of the crisis, the IB sector was in tatters. Some of the biggest conglomerate banks in America had failed spectacularly (ironically, they had been bestowed the Too Big to Fail status). Standalone IBs hadnâ&#x20AC;&#x2122;t fared any better. Universal Banking There are two pure forms of banking-commercial and investment. A combination of these two, in different proportions gives rise to Universal Banking (UB). For the better part of the twentieth century, universal banking was disallowed in the USA due to the perceived conflict of interest between commercial and investment banking

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arms of the group. However, the world embraced UB underscoring the economies of scale and scope so derived. In the US itself, the ban was lifted in 1999. The USA accepted UB under the Financial Holding Company (FHC) structure. The Bank as the Holding Company (BHC) or parent bank with non-banking subsidiaries model was employed in countries like India. UBs were dominant even in the pre-2008 era, due to monopolistic competition. The standalone banks were obliterated in the 2008 crisis and only the universal banks now survive. Addressing the risks A flood of regulations came in, such as the Volcker Rule in the US, Vickers Commission in the UK and Liikanen report in Europe, aimed at insulating the important, necessary banking activities from the riskier, less important. The Volcker rule was strict and narrow in focus. It sought to ban proprietary trading by banks, while distinguishing it from market making activities on behalf of customers which were allowed. It proscribes the coexistence of such trading activities and banking in different

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the domestic industry. The IB industry is at a nascent stage in India. It is mostly limited to a few big banks which are themselves curtailed in their ability to expand IB activities. The banking sector in the country is of the UB type, with no significant presence of standalone IBs. The UB structure is of the BHC hue, where big banks lead the conglomerate. The banks themselves are the holding companies, with subsidiaries involved in the financial services, IB activities. The risk emanates from the balance sheets of these affiliates, as the losses of such would be go upstream to reflect in the consolidated books of the banks, posing a danger to them. The 2008 crisis was a wakeup call for the regulators in the West. RBI had foreseen these risks, and taken steps to prevent wide scale failure of banks. The first of such measures was the limits on equity investment by a bank in a subsidiary company; or a financial services company which is not a subsidiary. This limit for the subsidiaries was set at 10% of the bank’s paid up share capital and reserves, while that on the total investments made in all subsidiaries and non-subsidiaries (engaged in financial services) is 20%. However, this effectively inhibited the expansion of this industry. So, while the West came up with giant banking structures, Indian banks were nowhere in the picture. Standalone banks, which would come under the purview of the SEBI, were also largely absent from the Indian theatre.

The investment banking (IB) sector bore the brunt of the crisis, it was after all one of the biggest culprits. In the aftermath of the crisis, the IB sector was in tatters. Some of the biggest conglomerate banks in America had failed spectacularly. © FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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subsidiaries in the same group. However, it doesn’t constrain intra group funding. The Liikanen Report was broader in scope, but less strict. The proprietary trading and the market making activities (no distinction made between the two) were required to be in different subsidiaries if within the same group. Additional conditions were imposed such as self-sufficiency in capital and liquidity for the subsidiaries and intra group lending on market prices. The Vickers Commission proposed that the banks should ‘ring fence’ their retail banking services from the investment banking divisions. This was aimed at narrowing the activities encompassed within the protected entity. This protected entity was very narrowly defined as the retail, corporate banking and the strategies to hedge risks arising from such activities. This was to the exclusion of all underwriting, secondary market transactions. Like the Liikanen report, but unlike the Volcker rule, it allowed room for the coexistence of protected activities and others in the same group, albeit in separate subsidiaries. These recommendations are however stricter than the Liikanen ones in the sense that the intragroup lending norms are stringent and the very interaction of such protected entities with the wider financial sector is curtailed. India Story With this overview of the world regulations, let us devote some time to the IB sector in India, and what the events across the world entail for

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Interestingly, SEBI has no regulations in place for IBs. There was no demand for such services in an essentially underdeveloped economy, and hence the regulator (which was itself a novice in this field) felt no need to put up the necessary regulations. The need for IB was not really felt because of the largely embryonic capital markets in the country. The developing country is now on the fast track of development and is now seeing fast development of these sectors. The manacled and demonized capital markets are now taking roots. With this background, the need has never been more urgent to bring in reforms in the regulatory framework of the RBI or maybe even a complete overhaul of the system. SEBI rules have to be drafted from the scratch for standalone investment banks. Future Roadmap The first question that the RBI needs to answer is whether to continue with the BHC structure or to embrace the FHC one. The advantages of the latter are numerous. The first of which would be the unshackling of the IB industry,

as the capital constraints would no more be relevant. In the FHC model, a holding company has subsidiaries that undertake banking, non-banking operations. Hence, commercial banking divisions would be protected from the risks emanating from the riskier activities. The risks arising from the losses of subsidiary IBs would be borne by the FHC. The responsibility of infusing capital into the subsidiaries would also lie with the FHC and not the bank. Lastly, the FHC structure would be beneficial in the event of winding up, as the resolution of different entities would be easier. As a clear demarcation would exist between the different components of the group. In the past, liquidation of the parent bank usually meant the liquidation of the subsidiary also. With a stronger FHC structure, this wouldnâ&#x20AC;&#x2122;t be the case anymore. Regulatory oversight could also be more efficient. Various studies commissioned by the RBI indicate a strong shift of the revenue pool from the traditional banking to investment banking. The acceptance of the FHC model could see the IB industry rise manifold, as the equity investment limits in the IB subsidiaries should not be as restrictive as the existing regulations.

The first question that the RBI needs to answer is whether to continue with the BHC structure or to embrace the FHC one. The advantages of the latter are numerous. The first of which would be the unshackling of the IB industry, as the capital constraints would no more be relevant. Regulatory oversight could also be more efficient. NOVEMBER 2014

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Article of the Month Cover Story

Studies suggest that the IBs would grow 10 times by 2020. The lessons from the crises of 2008 will have to be inculcated. A comprehensive study of various enactments in Europe, America must be undertaken. Recommendations of the Volcker, Liikanen, Vickers committees, aimed at reducing risks, while not inhibiting growth should be implemented, suitably tweaked for Indian environs. A regime of differentiated banking licenses could be initiated. A license would be issued to an entity to undertake a specific, limited activity. Niche banking players could capitalize on their specialized knowledge. Clear prescriptions must be provided for in the event of banking failures such as closure, restructuring, M&A, bridge bank. The objective of this exercise would be to transfer activities deemed as too risky to different entities (banning them outright could be counterproductive). With public guarantees limited only to the commercial arm to prevent contagion. A global debate is going on on this issue. A robust system based on strong checks and balances should emerge in India, enabling the expansion of IBs in the country. Conclusion Investment banks are a novelty in India. Their growth has been stunted due to regulatory restrictions. Changing environs mean investment banking is going to grow tremendously in the coming years. Regulatory restrictions could be lifted. The deepening of capital, wholesale debt markets could see the explosion of investment

banking activities, as more and more corporates demand these services. India has the BHC framework in place, replacing it with the FHC model could be on the anvil. The future holds tremendous promise. However recent events suggest that it wonâ&#x20AC;&#x2122;t be as easy as a walk in the park. The financial crisis and the ensuing regulations must be studied and inculcated in the pursuance of liberalization policies in India.

ÂŠ FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

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Diesel Deregulation & Pricing Issues

Prakhar Nagori & Palash Jain

IIM Shillong Introduction Over the past decade there has been a tremendous pressure on Indiaâ&#x20AC;&#x2122;s fiscal budget because of the huge subsidy bill. These subsidies majorly comprised of food and fuel subsidies. India is the fourth largest consumer of fuel and because itâ&#x20AC;&#x2122;s a developing country the demand keeps rising pushing the fuel subsidy bill higher and higher. The fuel subsidy has risen exponentially from 0.6% of GDP in 2004 to almost 2% in 2010. The subsidy on fuel was estimated at around INR 1.82 lakh crore for the last two financial years, that is, 2012-13 and 2013-14. According to some economists, the diesel subsidy has cost India around INR 3 lakh crore in the last five years. With the rupee depreciating drastically and increase in international crude oil prices, this bill was increasing in leaps and bounds

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and deregulation of fuel prices had become a necessity. However, this decision to deregulate the prices of fuel is not a recent one. The petrol and diesel prices were deregulated in 2002 by the Atal Bihari Vajpayee government. But when the government changed in 2004, this decision was overturned by the then petroleum minister, Mr. Mani Shankar Aiyar. As a consequence the fiscal deficit started shooting up. In 2010, the government of India then decided to deregulate the petrol prices to reduce the pressure it created on fiscal deficit, as a result of which the fuel subsidy bill started declining. In continuation to this policy, the government decided to deregulate the diesel prices which would reduce the fuel subsidy bill to 0.4% of GDP in 2014-15 as compared to 0.8% in 2013-14.

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price of crude oil in international markets. This gave us a boost in our fight against high inflation. Even though the impact was negligible on the consumer price index (CPI), it had a large impact on wholesale price index (WPI). This would give the RBI more flexibility in its monetary policy decision. It may also lead to rate cut in future which will increase investment and production. Another benefit of diesel deregulation was better management and reduction in corruption due to increase in transparency of pricing policy. Earlier, the government had a dual method of price determination. The diesel sold in retail form was subsidized whereas the diesel sold in bulk was deregulated. This created arbitrage opportunities for profit seekers leading to opacity and corruption in this area. Many small industries who used to buy diesel in bulk started buying it from retail outlets to save costs. However there is a flip side to this step. Since the prices will be directly linked to the market, this will lead to more vulnerability. The prices will fluctuate more causing more volatility. Earlier the prices were fixed by the government which gave the consumers price protection to some extent. With this decision there will be dissent amongst the population. Also, even though the price deregulation brought relief to the consumers in the form of reduction in prices, in the long run it will increase inflation to a great extent causing severe problems in the economy as the demand for diesel is relatively inelastic. This will have a far reaching impact in a country like India where still a lot of people lie below the poverty line. The fluctuation of diesel prices may also have a huge negative impact on industries which are directly dependant on it, like the automobile or the transport sector. Impact of Diesel Deregulation on OMCs Diesel deregulation comes as a great relief to OMCs as the prices being market linked, they won’t be bearing the burden of subsidy which previously due to delayed subsidy payments by government was quiet a cost to them. This will lead to lesser interest charges and better profit margins. The deregulation is not only beneficial with respect to reduction in gross under-recoveries but will also be a boon to private players who are back in the game as they were not able to sell in retail market, as they did not receive government’s support for selling diesel at

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What is deregulation? Freeing the prices i.e. removing the price control of government over a commodity is called its deregulation. Prices of fuels like diesel, kerosene and cooking gas were regulated till now, but diesel now is the latest entry in deregulated club who’s another member petrol was deregulated in June 2010. The diesel deregulation was firstly done in a partly manner initiated by the UPA government by increasing the diesel prices every month by 50 paisa. But now recently on the onsite of low crude oil prices, Government of India has taken a decision of full diesel deregulation. Thus, now the petrol as well as the diesel prices are totally dependent on supplydemand and international crude oil prices. What led the diesel deregulation happen? Diesel deregulation, as discussed above, is not a recent talk but also being implemented in a partial way by previous government and was amongst important agendas of the Modi government. The combination of state election being over as well as very low international crude oil prices could be said as major triggering point for this deregulation where it had a negative impact on prices, thus decreasing them by Rs. 3.37 (Ex-Delhi) and saving the government from major heat like the one when petrol was deregulated. Pros and cons of diesel deregulation Diesel deregulation is a positive step towards economic growth and expansion. The most important benefit that can be derived from it is the reduction in fuel subsidy. This will reduce our fiscal deficit and make our target of 3% fiscal deficit in the next three years at a striking distance. Since India is a developing economy this amount can be utilised in a more productive way elsewhere, especially in the area of infrastructure development which has become the need of the hour. Also, since the subsidies are withdrawn and the prices are linked to the market, eventually it may lead to increase in diesel prices in future which will not only encourage reduction in consumption but also boost our pathway towards sustainable sources of fuel thereby reducing our reliance on crude oil. When the price of crude reduces, it will reduce our import bill which will help our balance of payments and appreciation of our currency. It will also increase our foreign exchange reserves as the payment for crude oil is made in foreign currencies. We saw that the diesel prices had reduced when the prices were deregulated due to decline in

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discounted rates; thus increasing the competition amongst OMCs. A competitive market scenario will surely lead to process enhancement as well as product development which would be good for everyone, a revolution similar to the telecom revolution. Auto-Industry’s Take The auto-industry supported the diesel deregulation, quoting that things could now be planned in a better way by the industry with respect to capacity building as well as by the consumer with respect to his purchase decision. Banking Industry’s Take The banking industry is positive on the diesel deregulation front as it would benefit economy leading to a decline in inflation and thus interest rates which will lead to a low capital cost and an increased demand for loans. State’s Says Apparently the states are not much happy with this deregulation decision as decrease in the price of diesel would cost them tax revenue losses, thus impacting their budgeting and proposed expenditures. Way Forward: Pricing still remains an issue There is an exigent need for some transparency in the pricing of diesel and other petroleum products vis a vis the method followed by the oil companies. The concept of ‘under-recovery’ has to be given a relook and a better and more logical price mechanism has to be implemented so that the benefits of diesel deregulations is harvested even in the case of volatile and high crude prices. The concept of under recovery is very vague and unique in India, it is the difference between the desired selling price of the oil companies and the prevailing retail price

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in the domestic market. This ‘desired’ price is calculated on tradeparity basis that takes into account the landed cost of imported fuel and the price at which it is exported by domestic refineries. Presently, the ratio is 80:20 in favour of landed cost. For example, if the price on the trade parity basis is Rs.100 per litre and the domestic selling price is Rs.80 per litre then the under recovery reflected in the accounts of these companies is Rs. 20. But, in India, companies are not directly importing the refined petroleum products instead majority of them have developed their own refineries and they are able to refine products such as petrol, cooking gas and kerosene from the imported crude. Given this situation, the landed cost of imports which includes items like freight, insurance, custom duties should not be considered for setting the domestic retail price. These factors magnify the extent of under recoveries that the oil companies report. Therefore, the landed cost of imports inclusive of above mentioned items and the liveable should not be considered for fixing the ‘desired selling price’. The only exception could be a point where the global crude prices surge to the abnormal levels and the prices are linked according to the crude prices. Instead of that, the below mentioned proposed cost plus method should be mandated by the government in order to protect the consumer interest and promote efficient competition in the sector. The oil companies harp on “under recoveries” and always nag about linking the domestic price with it. The reason being the landed cost which includes all the duties and liveable actually serves as a shield to protect their actual losses from the inefficiencies in their refineries and

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other operations. This protection is unnecessary and unfair to the domestic consumers. It is very apparent that the public oil companies are saddled with deployment of larger number of staffs and with inefficiency in operations resulting from duplication of works etc. By allowing to charge liveable through the selling prices and then consequently recovering it from the under recoveries reported, these companies pass on their inefficiency to consumers. Also, the global prices of crude and the retail prices of petrol and diesel do not move in tandem. The forces that drive the markets of these two products and that adds the costs of these two products are completely different, like any disruption in process of petrol refinery can change the price of petrol or if there is a maintenance shutdown of any refinery then costing factors change drastically for each product separately, and it is nowhere related to the fluctuation in the crude prices. Therefore by taking into account only the landed cost of refined fuels rather than crude oil, the oil companies may be forcing consumers to pay a higher price when there is really no supply problem within the country. The most ideal way to go for any company is to consider its own cost structure based on the efficiency of their refinery. The final market price then could be cost of the crude plus the refining and the margin of their profit. The deregulation of diesel would promote competition by allowing the private players like Reliance Industries, Essar and Shell to enter into the retail arena and thus a more systematized way of marking the price could be followed. As of now, the PSUs generally tie themselves akin to a cartel when it comes to the pricing of their retail petroleum products. Therefore the next item of improvement in the sector is to push

the oil companies to the arena of cost based pricing that truly reflects their cost structure. It could also cause a differentiation in the final retail price and therefore the consumer would have wider choices. The real fight would then reduce to improving the efficiency in buying crude and refineries.

ÂŠ FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

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& alternatives in

FinGyaan

GDP’s origins, relevance today’s world

Ashay S Dalvi

K.J Somaiya Institute of Management Studies Has GDP as a criterion to measure economy’s progress reached the end of its utility? Today GDP has become the most important measure of progress in macroeconomics and almost every country’s economic policies are designed keeping in mind the GDP targets. Even the debt, expenditure, tax collection etc. are measured as a percentage of GDP. The criticism of GDP started in 1970s due to stagflation in advanced economies and modern problems like increased commuting time or lower happiness levels which are not factored in measuring growth. It is criticized for multiple reasons: one that it doesn’t measure the value created by economic activity but measures only the economic output and second that it doesn’t take into account non-monetary costs like pollution, economic inequality or work life balance. There are also critics of GDP like economists Michael Green who have also

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proposed alternative methods to measure progress. His organisation created the Social Progress Index for non-economic indicators like medical care and higher education. The present day universal standard definition of GDP has certain assumptions about what to be counted and what not as an economic activity which has market price. Although in mass production economy the amount of goods produced such as steel, cars, machinery etc. can be measured but in today’s advanced economy there are very complicated adjustments made to take into account quality up-gradation of products like technology to measure GDP and as a Dallas Federal Reserve bank report in 1998 put it that GDP was a measure suitable for measuring mass production and falls short of measuring intangible products such as income through goodwill or patent benefits or innovation for

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that matter.

economic output.

Tracing origins of GDP:

Measuring National Income:

Basically the concept of measuring economy started in the 17th century by William Petty in England and Wales to ascertain a nation’s capacity to pay taxes & till 18th and 19th century, tax revenue and trade remained the sole objective. However, prior to this, the Arthashastra, written by Chanakya (350 – 283 B.C) for the Mauryan empire, had the genesis for the economic policy of the Mauryan empire. Since the 17th century, right from the industrialisation to the race for the domination of Europe during industrialisation which led to wars among the colonial powers, the countries needed to know the ability of people to pay taxes to finance wars. The need to measure the nation’s economy had risen during the economic depression after the First World War when Simon Kuznets, heading the National Economic Advisory Council, submitted a report in 1934 to US Congress which contained estimates of national economy that made a huge difference to policymaking. It measured the output of all different industries and amount consumed by individuals. Kuznets is hence credited for providing the rough frame work of what we today measure as national income or GDP. The Second World War made the latter more important. So the conventional GDP measure as we know today was developed by economists working under John Maynard Keynes in 1941 after the great depression which emphasised on

GDP theoretically can be viewed in three different ways. First is the production approach which adds the “value-added” at each stage of production, where value-added is the total sales subtracted by value of intermediate inputs into the production process. Second one is the expenditure approach adds up the value of purchases made by final users. The third one is the income approach sums the incomes generated by production. The international standard for calculating GDP is contained in the System of National Accounts 1993, compiled by the International Monetary Fund, the European Commission, the Organization for Economic Cooperation and Development, the United Nations, and the World Bank. Real GDP is calculated from nominal GDP by adjusting the inflation in commodities using price deflator. Alternatives to GDP:

The alternatives to measure growth in addition to GDP were UK’s Office for National Statistics (ONS) & Australian Bureau of Statistics. UK’s Office for National Statistics (ONS) measures economic well-being by an annual survey. However ONS’s data hasn’t changed much since 2012. Certain important things like friendship, sex, relationships enhance wellbeing but policy making is difficult for these things. Australian Bureau of Statistics includes indicators like income and jobs, quality of the natural and urban environment, work-life balance, health

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Figure 1: World GDP Change (YoY %)

&access to education. The only problem here is most of these figures are based on survey methodologies and not on quantifiable data which makes it unsuitable for designing macroeconomic policies around it. While Australian model incorporates indicators like health, education, environment, crime and social attachment, it is actually used in a developed nation where growth is not a priority as per capita income is high and demand is slowing down. There is also OECD’s System of Economic Environmental Accounts (SEEA) but this is also used in addition to GDP and not as an alternative. The most important alternative that has emerged in recent years is the genuine progress indicator. Comparatively GDP and GPI are like gross profit and net profit. GPI was developed by Centre for Sustainable Economy and the Institute for Policy Studies in America. Such kind of method would tell if we are enjoying the benefits of economic growth (higher GDP) at the cost of eating up tomorrow’s resources and that GDP is not sufficient for this and hence it needs to be modified or replaced. Criticism for GDP:

Diane Coyle in her book ‘GDP: A Brief but Affectionate History’ in which she has studied GDP from 1940 and analysed in depth its strengths and weaknesses and how it influences politics. She concludes from her book that GDP is a good measure for 20th century and not for 21st century. The author’s main contention is that it doesn’t judge anything apart from economic output. Michael Green another critic, who has launched his own Social Progressive

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Index at the Skoll World Forum 2013. The Social Progressive Index is in different context than what the author sees as a replacement for GDP to measure growth. So the criticism cited by Michael Green seems misconstrued and misinterpreted. Some of the other critics include Jaret Woodard, a partner at BCG, argued that a sustainable economy and not a growth oriented

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E: Parameter measuring “inequality aversion” if E=0 then society cares nothing for inequality To factor in economic welfare the paper suggests concept of Weitzman’s Net National Product (Weitzman, 1976 and 2003). It is defined as consumption plus net investment. It’s given by

Where C: Volume of Consumption Pi: Price of the ith investment good Pc: Price of consumption I: Gross investment D: Depreciation Such measures are considered by leading policy makers as important as they not only factor in important things in the economy apart from economic output but also are worldwide accepted. But difficulties in tinkering with the present framework of GDP makes it difficult to incorporate these measures. Also some other economic indicators like HDI (Human Development Index), Gini coefficient for measuring economic inequality gives a fair idea about the overall economic progress and its sustainability. But certainly an all-encompassing criteria to measure growth needs to be created.

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one which is more significant. Robert Kennedy also is critical to the negative effects of GDP like producing arms and ammunition leading to increase in the GDP. Also in 2009, former French president Nicholas Sarkozy, while addressing French national statistics agency requested that the agency give greater consideration to factors such as quality of life and the environment. The recent criticism of GDP is mostly due to the fact that the effects of the industrial revolution are fading after 200 years in advanced economies. The Asian tiger economies post decolonization is also experiencing this phenomenon. However the emerging nations especially BRICS have yet to realize the fruits of a developed economy and hence place more importance on economic output rather than on wellbeing. Whether GDP is an appropriate measure can only the decided on per capita income levels and purchasing power parity (PPP) of the economy. However if different nations try and use different statistics for measuring growth, it might be difficult to comparatively analyse the global scenario which would create confusion. The solution to this is the inclusion of aspects from Kuznets theory to present day GDP so as to measure the wellbeing of people such as gains to well-being stemming from innovation, new medicines, and better smartphones which helps increase standard of living of people. Modifications and improvements in GDP measurement: The debate whether income inequality and government spending on arms and ammunition should be incorporated in GDP has been there for a long time even after World War II after which the people felt the government spending on weapons as a wasteful expenditure. There have been attempts made to factor in economic inequality and environmental damage inside GDP measurement. In research paper published in LSE Growth Commission by Nicholas Oulton, attempts have been made to factor in economic inequality by Atkinson’s index of inequality (1970)

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Fundamental or Technical Analysis: An Amalgamation of both the perspectives Rahul Bajaj

IIM Shillong â&#x20AC;&#x153;The best way to have a million is to start with two million and trade in the financial markets using technical analysis â&#x20AC;&#x153; A lot of negativity has been built over the years around technical trading, however this powerful tool when used in conjunction with fundamental analysis can help enhance the returns of any trader. Difference between the two perspectives is that the technical analyst uses statistics and assets traded volume and historical prices data to forecast the prices whereas the fundamental trader calculates the assets intrinsic value through current performance and future projections. Technical analysis relies on patterns, historical prices to repeat in the future whereas fundamental analysis relies that the expected company future performance to reflect in the prices. However it is possible that history and market behaviour do not repeat in the former, and market behaviour/sentiment not being in sync with the fundamentals in the latter. Traders who invest in assets with good fundamentals at the right time can help maximise the returns for investors. Let us look at both the perspectives and how they can be used together. Technical analysis is applicable to stocks, indices, commodities, futures or any tradable instrument where the price is influenced by the forces of supply and demand. Technical analysts use combination of the open, high, low, or close for a given security over a specific time frame. The time frame can be based on intraday (1-minute, 5-minutes, 10-minutes,

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15-minutes, 30-minutes or hourly), daily, weekly or monthly price data and last a few hours or many years. As it can be done across time frames, it is possible to find short-term as well as long-term trends using technical analysis. Line chart, Bar chart and Candlestick chart are three types of charts that are used by investors to study the chart patterns. Higher the number of technical traders in the market more linear will be the price movements in accordance with the principles of technical analysis. The basis of widely used algorithmic trading is technical analysis methods adopted in the system itself Volume is an important measure for a technical trader. It helps a technical trader analyse the intensity of the price movements. When the trend in an Index/industry/stock is bullish and the volume traded increases it implies that the prices are expected to further increase in the future trading sessions. Similarly bullish trend with decreasing volumes implies a bearish trend as the intensity of price rise is decreasing. Pivot points, resistance and support levels are tools which are quintessential part of any shortterm technical trader. For the selected equity from fundamental analysis, use of such tools can enable the analyst to enter at the bottom most price level. Pivot point is the point near which asset prices are expected to be most

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Figure 1: Head and Shoulders

volatile. A support level is a price level where the price tends to find support as it is going down. This means the price is more likely to “bounce” off this level rather than break through it. A resistance level is the opposite of a support level. It is where the price tends to find resistance as it is going up. This means the price is more likely to “bounce” off this level rather than break through it. However, once the price has passed this level, by an amount exceeding some noise, it is likely that it will continue rising until it finds another resistance level. Pivot Point for Current = High (previous period) + Low (previous period) + Close (previous period) Resistance 1 = (2 x Pivot Point) – Low (previous period) Support 1 = (2 x Pivot Point) – High (previous period) Resistance 2 = (Pivot Point – Support 1) + Resistance 1 Support 2 = Pivot Point – (Resistance 1 – Support 1) Resistance 3 = (Pivot Point – Support 2) + Resistance 2 Support 3 = Pivot Point – (Resistance 2 – Support 2) Various Chart patterns like Head and Shoulders, Cup and Handle, Double Tops and Bottom etc. are used to further analyse the trends in the prices. Based on the time frame of the charts (Hourly, Daily, monthly, Yearly) similar time

frame predictions are made, however charting is more suitable for short-term patterns. Head and Shoulders: It is the most popular and easy to find pattern in technical analysis. There are two versions of Head and Shoulders – Upward and Downward. It denotes trend reversal as the two shoulders and a head is formed. If the right shoulder is formed it denotes that the asset is expected to move against the last trend. When the right shoulder is below the head it is expected to break down further, otherwise when the right shoulder is above the head an upward trend is expected.

Figure 2: Cup and Handle

Cup and Handle: When a bullish trend takes a bearish breather forming a cup and a handle as can be seen in the diagram, the asset prices are expected to continue moving in an upward trend. Double Tops and Bottoms: It is another Trend reversal pattern where the increase/decrease

Figure 3: Double Tops and Bottoms

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Figure 4: Triangle Patterns

in the asset prices is halted at the resistance/ support level. In double top reversal pattern the asset prices attempt to break the resistance levels twice after which downward trend in price movement pushes the prices lower. Similarly in double bottom reversal pattern prices try to break down below the support level, however has sustained in those levels by buying seen at the support level. After the two bounce-offs the asset prices starts moving in an upward trend. Triangle Patterns: There are 3 types of triangular patterns which are commonly used in technical analysis. As a triangle pattern is formed the asset prices breakout into an increasing or decreasing trend. A symmetrical or an ascending triangle pattern is a bullish pattern and there is upward breakdown in such a scenario, however in a descending pattern breakdown bearish movement is asset prices is expected. Leading indicators are those created to proceed the price movements of a security giving predictive qualities. The leading indicators will create many buy and sell signals that make it better for choppy non-trending markets instead of trending markets where it is better to have less entry and exit points. The majority of leading indicators are oscillators. Oscillators is a technical analysis tool that is banded between two extreme values and built with the results from a trend indicator for discovering short-term

overbought or oversold conditions. As the value of the oscillator approaches the upper extreme value the asset is deemed to be overbought, and as it approaches the lower extreme it is deemed to be oversold. Lagging Indicators are those that follows price movements and has less predictive qualities. The usefulness of these indicators tends to be lower during non-trending periods but highly useful during trending periods. This is due to the fact that lagging indicators tend to focus more on the trend and produce fewer buy-andsell signals. This allows the trader to capture more of the trend instead of being forced out of their position based on the volatile nature of the leading indicators. Fundamental Analysis: It consists of the analysis of two factors: 1. Qualitative factors: Various aspects which look at measures of a company that cannot be stated numerically but are the key factors related to the business/commodity are analysed qualitatively. Companies with intellectual property and competitive advantage have higher chances of retaining profits and retaining market share. Similarly companies with good corporate governance trade at a premium as it results in higher transparency and protection to the shareholders objectives. Capable management and favourable regulation further boost the

Figure 5: Qualitative Factors

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Figure 6: Quantitative Analysis

price of the equity. 2. Quantitative Analysis: Ratio analysis and valuation play a major role in fundamental analysis. The various ratio that are calculated is liquidity ratios, leverage ratios, activity ratios, profitability ratios, Valuation ratios. Valuation ratios such as P/E, P/BV, EPS (Earnings per share) and Sales per share are the most widely used ratios. Company valuations are done using Gordon growth model, Discounted Cash flow, Relative valuation and residual income method. Gordon growth model is used for determining the intrinsic value of a stock, based on a future series of dividends that grow at a constant rate. Given a dividend per share that is payable in one year, and the assumption that the dividend grows at a constant rate in perpetuity, the model solves for the present value of the infinite series of future dividends. Stock value = D/k-g Where D is the expected dividend one from now, k is the growth rate in dividend till perpetuity and k is required rate of return for equity investor. Discounted cash flow (DCF) analysis uses future free cash flow projections and discounts them (most often using the weighted average cost of capital) to arrive at a present value, which is used to evaluate the potential for investment. If the value arrived at through DCF analysis is higher than the current cost of the investment, the

opportunity may be a good one. Relative valuation is a business valuation method that compares a firm’s value to that of its competitors to determine the firm’s financial worth. Relative valuation models are an alternative to absolute value models, which try to determine a company’s intrinsic worth based on its estimated future free cash flows discounted to their present value. Like absolute value models, investors may use relative valuation models when determining whether a company’s stock is a good buy. Fundamental analysis mostly relies on the financial statements and the business model of the company whereas technical analysis is purely a function of price and traded volume of the asset based on the supply and demand. Fundamental analysis captures the profits, assets and future potential of the company whereas technical analysis focuses on the price movements and market behaviour. It is rightly said that fundamental analysis captures the rational side of traders whereas technical analysis captures the emotional side of the traders. Amalgamation of the two methods with minimum correlation will help us minimize the risks and maximise our returns. Would like to end with the last words “In fundamental analysis if you are good you will be right six out of ten times, but if you want to be right nine times you need to have a balance of both the perspectives”.

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Article of the Month Finsight Cover Story

Analysis of HP mitosis Sandeep G Y

IIM LUCKNOW

Introduction The business world in the US witnessed an interesting phenomenon in the last few months. Tech conglomerates like eBay and HP have split their companies citing reasons such as sharper focus required in the fast rising cloud computing and related services. A few experts received this phenomenon positively saying that these combined entities are plagued with ‘conglomerate discount’ and hence splitting into smaller independent chunks will make them nimble and agile enough to leapfrog in this competitive tech world. However, few others brushed this exercise as another attempt by the

top management to cover up their inefficiency in exploring the growth opportunities and also as a hurried response to the demands of the activist investors like Carl Icahn etc. HP Split: Meg Whitman’s Announcement On Oct 6 2014, Meg Whitman, the Chairman, President and Chief Executive Officer of HewlettPackard, announced that Hewlett Packard (HP) would split itself into two companies: One focused on PCs and Printers, to be called as HP Inc, and the other on corporate hardware, software and services, to be called as Hewlett Packard Enterprise. The split is going to be completed by the end of the next year. HP

Figure 1: Independent divisions of HP

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Figure 2: HP’s Recent acquisitions

investors would receive a tax free distribution of shares in the new company. This move marks a reversal for Meg Whitman, the former eBay boss who was roped in three years ago to turnaround the then ailing technology conglomerate. One of her first acts was to ditch the plan to shed the PC division laid out by her predecessor, Léo Apotheker, though she has since then left the option open for more radical actions to deal with HP’s problems. With growth stuttering in the last few years post the merger of HP with the then noted PC manufacturer, Compaq, and the onslaught of tablet computers leading to the shrinkage of revenue from PC division, Meg Whitman felt that this is the best time to divide the company to prepare the company for the next stage of growth. A glimpse of the financials of HP Based on last year’s revenues, both parts of HP would have ranked among the 50 largest US companies. HP’s PC and printer businesses produced revenues of $55.9bn in its last financial year, almost identical to the combined $55.7bn of its enterprise computing, services and software divisions. HP’s finances in FY2013: • Total revenue of $112.3 billion was down 7% year over year • Enterprise systems revenue of $28.2 billion fell 5% year over year • Its operating margin increased from 13.9% to 15.3% • Enterprise services revenue of $23.5 billion was down 8% year over year • Its operating margin fell from 6.9% to 2.9%

• Printing revenue of $23.9 billion fell 3% year over year • Its operating margins increases from 14.6% to 16.3% • Personal systems revenue of $32 billion fell 10% year over year • Its operating margin fell from 4.7% to 3.0% The last three quarters of 2014 are better but not exciting enough to match the turnaround efforts by the top management. Enterprise systems revenue was flat YOY at $20.5 billion and Printer revenue was down by 3% YOY at $17.2 billion. However, these divisions have higher margins at 15% and 18% respectively compared to the single-digit margins at other divisions of the company. HP has about $20 billion debt and $14 billion in cash and other investments. It is expected that debt would be transferred to HP Inc and make HP enterprise debt free, although the decision is yet to be finalized. Turnaround efforts The turnaround efforts at HP resulted in unsuccessful acquisitions notable among them was that of Autonomy, the UK’s largest software company by market capitalization. On Aug 28 2011, HP offered to buy Autonomy at 23x EBITDA valuing the company at $11 billion. However, within a year of acquisition, HP reported $5 billion write-down after being alerted by a whistle blower about the serious accounting improprieties at the software company. It resulted in a severe dent in the share price of HP as well as in the confidence of its investors. This ugly spat occupied the front pages of business dailies in that year.

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Figure 3: Market Share of Worldwide PC Shipments

Figure 4: Worldwide PC Shipments (in millions)

Is this split an acknowledgment of failure of oft-repeated synergy story? An emphatic No. Companies talk about synergies as the drivers behind mergers. Executives like to run big and expanding companies. Mergers are often driven by vainglorious attitudes of CEOs. Empirical studies state that 70% of the mergers are failures. When the companies split up, the top management often cites lack of growth as a reason. Lack of growth or divergent growth among the divisions of a company result in a discount called as ‘Conglomerate discount’ which has to be eliminated to keep the investors excited about the growth prospects of the company. According to Emilie R.Feldman, a management professor at Wharton, “Divestitures and spinoffs are the ugly stepchild of corporate strategy. They are viewed as acknowledgements of failures, bowing to pressure from investors and competitors. In reality, spinoffs can be used very proactively, as we are seeing in the HP case, to create value for shareholders and separate businesses that don’t belong together anymore.” So, a spin-off is not necessarily an admission that a mistake has been made. The prevalence of acquisition to spin-off only indicates that the promised synergies are rarely delivered. In the case of HP split, the move could allow the two divisions to focus on their core product offerings and go-to-market strategies that are decidedly different between consumer products and the enterprise. The move could signal renewed focus and commitment by HP with respect PCs and Printers, while allowing the Enterprise group more flexibility to react for its own needs as well.

Which division has more steam left? The Chinese major, Lenovo, has taken over HP as the company with the highest market share in the worldwide PC shipments. The worldwide PC shipment pie has stagnated at 75-85 million in the last two years. So, HP will have a hard time in improving the fortunes of its PC division, absent innovation in its value chain or the product itself. The printing business - HP’s most profitable division, accounting for a third of its profits – is a cash cow that has been helping the other divisions of the conglomerate. Its pre-tax profits have fallen by less than 7% compared to the other HP divisions where profits have fallen by half in the last three years. The low growth hardware business is likely to be valued at very low multiples compared to the enterprise division. This group may take most of its debt. The key investments would largely be organic to maintain the durability of the cash flow and the investors would be benefited largely by dividends. The caveat, of course, is the emerging PC shipment scenario in the near future. This leaves the other enterprise division debt free which may look for acquisitions. Targeted M&A was explicitly mentioned by Meg Whitman on the eve of the announcement of the split on Oct 6. Increased organic investments combined with targeted M&A are the way ahead for the enterprise division. The shareholders may be benefitted by share buybacks in this division as it gives leeway to the top management given the investment needs. Hence, in my opinion, the enterprise division is a better bet for investment given its healthy outlook, growth opportunities, and the competitive scenario in the software and cloud computing industry.

NOVEMBER 2014

Interview With Prof. Samir K Barua, Ex-Director, IIM Ahmedabad

How would the ‘Jan Dhan Yojana’ affect the Indian Banking System? Financial Inclusion is on the agenda of most emerging economies. In India, efforts at enhancing financial inclusion were begun by the previous government. However, the implementation was not at the scale planned by the current government. The major concern would be the number of accounts that are planned to be opened. By January 15, 2015 it is planned to open 150 million new accounts with an overdraft facility of INR 5000 for each account. While providing access to formal financial system is a laudable objective, indiscriminate opening of accounts does not result in true financial inclusion. A large percentage of accounts opened by banks under pressure from the government in the last several years are actually dormant accounts. The overdraft facility gets used up almost immediately and after that there are no transactions. That is not financial inclusion. The major step which the government needs to take is to encourage such account holders to become users of the banking system. The key step needed to ensure this would be through routing direct cash subsidies (food, energy) and other payments (NREGA) through these accounts. Only then the accounts would remain active and over a period of time the account holders would become truly integrated with the banking system. The other issue that needs to be addressed is the cost to banks of maintaining and servicing such accounts. It is estimated that banks incur a cost of Rs. 100 per month per account. If the accounts do not generate this amount of income, banks would be reluctant to provide requisite quality of service. This

issue needs to be addressed too for ensuring a voluntary buy-in from banks to the idea. The proposed Holcim/Lafarge merger will create the world’s largest cement producing firm. What are likely to be the issues the new entity would face from the proposed merger? According to you, what would be the likely impact of this merger on the aggregate market? Making a success of mergers, particularly involving large entities is always a challenge. The issues that are hard to deal with are the differences in the organization culture, management styles and processes. Since cement is not a commodity that is easy to transport, local prices often may be significantly different from global prices. Therefore in such situations regulators do become alert to the possibility of ‘unfair’ increase in prices due to greater concentration of capacity. Since cement is a basic commodity for infrastructure and housing, I would expect some action from the government and the regulators to ensure adequate competition in India. It is possible that regulators in India and some other countries too where these entities operate, may require them to divest some of their assets to ensure adequate competition. Recently we have seen a sharp drop in the price of Brent crude which even fell below $85 per barrel. One of the reasons that was attributed to this drop is weak global demand especially from Europe. Are there any other supply side or

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demand-side reasons that are affecting the global oil prices? Does shale gas have any role to play in this price debacle? Can we expect that the positive impact of reduced inflation will outweigh the negative impact of reduced exports due to weak global demand? There are multiple reasons for the decrease in the price of crude. US has now become selfsufficient in energy instead of being an importer. This is because US government took a decision to use domestic sources rather than depend on imports. Withdrawal of US demand from global markets has fueled reduction in price of crude. Another reason is currency exchange rates. Among the large developed economies, US appears to be the only economy that is doing well. It is growing at almost 3.5% while Europe and Japan are stagnating and China is slowing down. This has resulted in ‘flight to safety’ whereby savings from the rest of the world are flowing to the US. As a result, the US dollar has strengthened significantly (the US dollar index has risen to over 86 against other currencies). It has always been observed that strength of US dollar and crude oil prices are negatively correlated. This is so since crude prices are quoted in USD. Strengthening of USD implies higher prices in other currencies (for all other buyers). To maintain prices in other currencies so as to sustain demand, the producers are therefore required to cut price of crude in dollar. My assessment is that low crude prices may last for some time, may be another 3-4 quarters. But crude prices would rise after that above the levels we are witnessing today. Such low prices are not sustainable in the long term for the producers. India being heavily dependent on oil imports would benefit immensely from the low crude prices. On balance, I think the benefits from low crude prices out-weigh the negative impact on exports from slowing global economy. This is because India has a large domestic economy.

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In 2007 a high level committee on financial sector reforms was constituted under the chairmanship of Dr. Rajan. Proposal

NOVEMBER 2014

no. 22 says, “Regulatory actions should be subject to appeal to the Financial Sector Appellate Tribunal, which will be set up along the lines of, and subsume, the Securities Appellate Tribunal.” The recommendation asks for including even RBI under the ambit of unified Tribunal but in 2011 he opposed the same idea by saying that the same recommendation was ‘schizophrenic’ when Dr. Justice BN Srikrishna recommended it in FSLRC recommendations? What are your views? No regulatory body, be it SEBI, or RBI or IRDA would want to subject itself to monitoring. It is therefore not surprising that the view of RBI governor changed (if it indeed did as quoted in your question). There is need for an agency (other than courts of law) to hear appeals against the primary regulators’ decisions. If the legal system were more efficient then courts could have played this role. Unlike SEBI’s decisions that can be appealed against to SAT, there is no agency that can be approached against decisions of RBI. I think such a body is needed to deal with regulatory excesses and regulatory over-reach. Else, there could be an element of recklessness in the decisions of regulators.

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GREEN SHOE OPTION

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Saket hawelia IIM Shillong

But Sir, why would the company over allot the shares? Can you please explain how this option actually functions using an Sir, whenever we talk of the process of listing of shares, more often than not we end up discussing what underwriting of shares is. And an in-depth study of underwriting often leads us to Green Shoe Option. What exactly is a Green Shoe Option? Many a times, during the process of underwriting, there exists a clause that the underwriters are permitted to allot shares over and above what was intended to be allotted by the issuing Company. Legally, it can be referred to as the option given to the underwriters to ensure over allotment, in case there is an excess demand for the proposed issue. Green Shoe Option is usually exercised by the company in order to ensure a price stability and avoid the price fluctuations that may exist because of demand exceeding the supply. Sir, in that case why would the company give this option to the investment banker as an increased allotment of shares may lead to dilution of control? The entire objective of exercising the Green Shoe Option is to stabilise the pricing of the shares. So, when after the listing of the Company, the investors try to book their profit by selling the shares. As a result of this, there is an excessive supply of shares, leading to a sharp fall in the prices. I such a case, the Company shall intervene by exercising the Green Shoe Option and purchase the shares to create a “pseudo demand” leading to price stability.

example? Ok, let us assume that a Company ABC Ltd is planning to issue 200,000 shares. It exercises the Green House Option and actually issues 230,000 shares. It is important to note here that in this case, the Company does not really issue the “new shares” but provides the additional shares to the public by borrowing the same from the promoters of the company. Now, after the Company has been listed, it might so happen that the shares are being traded in the stock exchange at a price lower than the issue price. In such a case, the underwriter or the “stabilising agent” intervenes and starts purchasing the shares to put a halt on the falling share prices. The shares so bought are then handed over to the original owners or the promoters of the Company. Sir, what if the shares are not being traded at a price lower than the issue price? In that case, the company does not purchase the shares at all for the time being and waits for an appropriate time to enter the market. The concepts are pretty clear now, Sir. But one last question. Why is the Green Shoe Option so called? The name “Green Shoe” Option was coined in 1919, when Green Shoe Manufacturing Company, now known as the Stride Rite Corporation became the first company ever to exercise this option of over allotment. Thank you Sir. This explanation makes things very clear.

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WINNERS Article of the Month Prize - INR 1500/Sainath Zunjurwad SIMSREE Mumbai November FinQ Winners 1 st Prize - INR 1000/Swati Pamnani IIM Shillong

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