Some High Quality Stocks for investing Now: United Breweries, Rallis india, Concor, UFO Moviez, Tata Chemicals

As market is falling, there are some good high quality stocks which can be bought now for long term. So I am listing some of them. These are less risky and belong to reputed and quality management groups.

United Breweries: It is not now with Vijay mallya. Global Beer giant Heineken is the largest shareholders with around 42% shareholding with Mallya holding around 31%. But Heineken is trying hard to buy the holding from Mallya and be a Majority shareholder. Indian states are very confused. They want to demotivate people to drinking, so they impose high taxes on liquor to make it costly for a common man. Although that poor common man finds shelter under low quality toxic local liquor and sometimes pays with his life.

Same is the case for Beer, although it is having alcohol content of 5-10% but it is taxed even higher than Whiskies which has 70% alcohol content; Beers sometimes are taxed at 70-80% much more than other liquor. So people have no incentive in drinking Beer with low Alcohol, at high prices equivalent to other brown liquors like Whisky. So they prefer Whisky etc as it gives them more kick per buck. So even a normal IQ person can see whether our Government is motivating us to drink low alcohol Beer or High whisky. But our IAS administrators cannot see this.

So time may change in the future. In india, we prefer high alcohol drinks to beer in the ratio of 70:30, but it is reverse in western countries. We drink only 2 liter beer per head, which is around 60 in USA, even china is at 35 liter. Moreover Beer is a social drink in western world with no social stigma attached to it. But in india people drink alone secretly in their houses mostly. But this is changing fast.

UB is having Kingfisher Brand which is having 50% market share. So apart from very capable parent in the form of Heineken there are many other growth factors which can spur the beer industry in india and so UB. First is the rationalization of taxes. Also Government can allow sale of beer in retail shops like cold drinks keeping in view its low alcohol content. So at 860/- after the recent fall, it is a good long term safe buy.

Rallis India: Another gem from house of Tata. It belongs to pesticides and seeds. It is not growing for last few years due to challenging environment in india. But it is having world level technological expertise. Its seeds subsidiary, Metahelix, which it acquired in 2010 is a giant in the making due to its superior research capabilities. Rallis is a 1800 cr giant. But it is focusing on leaving chemical pesticide business and investing big for Plant growth nutrients, Organic composts, seeds, Micro Nutrients and contract manufacturing at its newly created Dahej Plant. Its non pesticide business’ share is now at 33% from 10% few years back. Metahelix was a loss making one with turnover of around some 30 cr, but now it is profitable and going to clock turnover of 400 cr this year.

Dahej plant is going to perform well after some time. CMP is 214/-

Tata Chemicals: Moving away from fertilizer business which is under strict government control, hence handicapped by pending subsidies and low return ratios. It is in talks with selling this for 6000 cr which will make it debt free. It is a great company with unmatched R&D capabilities in india..owner of Tata salt and Swatch water filter. It is focusing big in branded pulses ( I-Shakti ) and other branded products like nutraceuticals etc. Its I-shakti pulses are only of its kind in india as they are unpolished and pure, so they pack with them all the essential nutrients, there is no player in branded pulses in india, which can be a huge market. Tata Chemicals has roped in its agriculture giant Rallis to guide farmers regarding growing pulses. India still imports around 15000 cr of pulses, so if Tata can build scale and brand, this can be a bigger story than Tata Salt.

But its only drag was Fertlizer business, which was capital intensive and delay in getting subsidies which resulted in high debt. Its debt is 7000 cr and debtors are around 3400 cr , mainly due from Govt. also inspite of capital employed of 3000 cr in fertilizer business, its operating profits before int and tax are only 300 cr.

So when I bought it at 250/- two year ago, I was thinking Tata Chemicals will do something to its fertilizer business. Because it was not investing anything new in it, so I was thinking either it will demerge it and sell a stake in it or it will sell the entire business. Now after 1 and half years of wait, there is a news that it will be selling its fertilizer business for around 6000 cr, although replacement cost of this is around 10000 cr. So even if it can get 6000 cr, it will wipe out all debt and with all gains of interest cost saving and high cash available for its branded business, it can grow manifold from here. It is a great buy with dividend of 10/- CMP is 410. I am buying more of it from 435.

Concor: Indian giant in rail container transportation. Rail logistic is cheaper by half than road but still roads carries around 70% of freight traffic in india. Rail carries only bulk commodities like coal and steel etc. Small cargo require freight stations all over india which at present are not here. But Concor is having around 3000 cr in its balance sheet so it is investing huge in building ICD at strategic locations. It is investing big for dedicated Frieght Corridor project of Indian Govt where railway lines from Calcutta to Ludhiana and from Mumbai to New delhi will be operated only for freight trains with triple capacity and at average speed of 100 Km (now at 25). This will revolutionize Indian logistic sector.

It is having a cold chain subsidiary, FHEL, which is expanding big. Concor has also entered into Air cargo business. India still expend around 14% of its GDP on logistic as compared to 7% in developed world  mainly due to gross inefficiencies built into the system. GST will bring more commonsense into it.  I have invested in it at 600, then at 1300 and now at 1495….will be investing more in it. Only thing to see is the government’s plan to sell partial stake in it. CMP is 1430/-

UFO Moviez: it is having 54% market share of digital movie transmission in india. It distributes movies in digital format through satellites. Earlier distributors were used to sell analogue movie prints at 70000/- per movie print which was very costly and would cost around 3 cr extra to show the movie in 400 screens  in india. India is having around 14000 movie screens. Digital prints were also costly and there were logistic problems. So there were piracy problems also due to non showing of movies all over india and digital hard disks and analogue prints can be pirated easily. But there is no such problem with direct digital distribution through Satellite.

Also producers and distributors can now release their movies in 5000 screens at a same time which increases their revenue manifold even if the movie is a flop. UFO installed its equipment for free to make cinema owners realize its benefits. It cost it around 15 lakh per screen so UFO accumulated debt in its books. But it receives fixed fee from cinema owners, along with In cinema advertising rights and per show charges. In cinema advertising is going to get bigger as viewers cannot go anywhere but to see the ad. It has also developed a local software to convert 2D cinema into 3D very cheaply which is also growing big.

Although big foreign media houses like Paramount, Fox and sony etc show their movies only in DCI enabled cinemas all over the world. DCI screens are very costly, around 30-40 lac per screen. Cinema owners can not let go this revenue source either as foreign movies do big business in india. But now the issue is resolved as these houses also can not afford to loose the rvenue from Non DCI screens in india which are big in numbers around 10000. So these Non DCI cinemas (called E-Cinema) are also showing their movies.

But UFO is having  all fronts covered, it has invested in Scrabble entertainment acquiring around 76% share which is having the rights of making cinemas DCI ready in india and Asia.

It is posed to strong growth in the future. With rising income, its debt is only going to come down. Its turnover now is 477 cr with NP at 50 cr. CMP is 552/- IPO was at 630 in Apr-15.

Other include Piramal Enterprises, Raymond, Tata Global, Jagran Prakshan, Biocon, Tata Communications, Tube Investments of India etc. I will write a short note on these shortly.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing)

Quantitative Easing: Can it make our stock market Uneasy?

An economist is a man who knows a hundred ways of making love but doesn’t know any women.

It is good to start something very serious in a funny note, especially when you are about to sail into dark waters of economics. Many times I have been asked to explain this Quantative easing (QE) thing and there is nothing easy about it. But now there are fears that after USA has ended QE and looking to raise interest rates which may result in fall of Indian stock market as FII’s will be leaving India for higher interest rates. Actually the reality is even i do not understand the real reason behind QE because what we hear in the public stands does not make any sense related to results achieved so far and common business sense. So let’s try this together…

Suppose there is 100 rupees in the market with Mr X, who exchanges it for Wheat from Y, Y exchanges the same for Clothes from Z and Z exchanges the same for Shoes from S. So total goods traded are 100 wheat+ 100 Clothes+ 100 shoes=300. But we were only having 100, so this 100 has done the work of 300, thrice of original money supplied. This 3 is the velocity of money I.e 300/100=3. So base money is never equal to total money gets supplied in an economy, but total money is equal to Base money M multiplied by Velocity V, S=MxV. Now we know money supply is never fixed, it depends on velocity or we can better say propensity to consume by the people. People are more confident so they will do more transactions which means more demand and so more GDP i.e Growth.

Many thinks that this Base money is created by central Banks (RBI or FED) in the form of currency notes or coins or bank credits either by purchasing Govt bonds or giving loans to commercial banks But this is not true at all. This money is just a small part of total money in the economy. In reality, most of the money is created by our Commercial Banks like HDFC, SBI etc. They create the money out of thin air. Commercial banks (we will take HDFC) provide loans to the corporate and general public. But we think that HDFC loans out money equal to its Deposits. If HDFC is having 100000 as deposit then it can loan only upto 100000. But the reality is far from this. Banks are required to keep only a part of their deposits in cash as statutory or necessary reserves (say 10%) they can loan out the balance. Because people are not coming to draw their total funds…they will only need a part of it. That is 10% and with this banks can meet the time cash demand of depositors.

So HDFC can now loan out 90000 out of 100000, keeping 10000 as reserves with RBI. So you think it is all over and no new money is created? No…it is just the start. Suppose Mr X gets the loan of 90000 and he pays  the same to Y for buying a machine. So now what will Y do with 90000/- ? Well, it will surely come into bank in the account of Y, so now bank is having another 90000 as deposit, and so it can loan out another 81000 of it. So Banks can play this game for 8-9 times and total loan amount will be around 7 lac to 8 lac. So with one lac banks can create 8 lac of money…so this is money out of thin air.

And if this money is invested in increasing production, then it is good but if it is invested in buying assets then it may lead to inflation. Like someone can take loan to produce more pulses (India is short of this) or he can buy a house. Pulses will surely lead to growth and it can actually lower inflation due to stoppage of costly imports but buying a house or a car can lead to high inflation if the loan is not supported by rising income or if the cost of loan is higher than rise in income level. And cheap loans can really make people to invest in assets rather than taking risks of production.

That was precisely what happened in USA in 2000. Loans were cheap so people just went on investing in real estate. This only inflated the prices as supply can not be increased as fast as compared to demand. This lead to speculators entering in the game with cheap money…and prices kept on rising. People were just taking loans for buying houses thinking they could sell these for high prices or could rent these for income. But around 2005, interest rates rose as a response to market forces and inflation risk.

This led to a fall in property prices and buying fell. This made speculators to sell houses cheaply to pay out the loans which further reduced the prices. More selling started and prices fell down…some people who could not sell their homes for profit defaulted on their loans. When banks tried to sell those houses, they were getting only a part of their loans…it led to panic selling by banks to cover the losses and hell broke .

This chaos spread to normal spending in the economy as people reduced their spending due to unemployment and insolvency. Banks stopped giving further loans to clean their balance sheet and USA fell into recession. People were focusing on repaying their loans first, so they curbed their excessive consumption. Many of young Americans went back to stay with their parents.

In normal circumstances, a central Bank (FED) can lower interest rates to make people spend more by taking loans cheaply. It is called Monetary policy. Our RBI is trying the opposite by keeping interest rates high as it wants to fight inflation. Fed also tried this by taking interest rates near Zero so that people could take cheap loans for consuming or investing which would give a flip to the economic activity and so as to employment levels. But this looks good only in theory, it never happens in reality. Or we can better say it can happen in an economy where people are saving in excess due to high interest rates (as in China) which is making many productive resources lay idle. Lower interest rates can force people to consume more. China is exactly doing the same by lowering its interest rates.

But USA was different, people were already having high debt…debt to income ratio was very high. So low interest rates could not seduce people to take even more loan when there was already an environment of fear and low growth. Corporates were having spare capacity and high cash. So it did not worked at all. Public just never went for cheap loans. Instead they were paying back their loans. Banks were also reluctant to create more loans as they wanted to clean the earlier mess. As no new loans were getting created and old one was paid back…it was destroying money. Low interest rates could have made people with excess savings to spend more but instead many of them invested in foreign assets like stock markets for better returns. You cannot take people as dumb, who would throw their money just because it is not earning. They can look to Gold for parking.

So Fed tried something extraordinary. It went for Quantative easing which was meant for pumping more cheap money into the economy. People are thinking that by QE, Fed just put more money into the economy but how Fed did this…not many are aware of this. Actually Fed thought that if people are not taking loans…so let’s give them money.

Government treasury Bonds and other financial assets like bonds etc are bought by Pension funds, insurance companies and commercial Banks.  These Bonds have coupon rate of interest which is payable yearly. Like 10% for a 1000 Rs. Face value Bond for 3 or 10 years. It means by paying 1000 I’ll be getting 100 rs every year as interest. But these bonds are traded in secondary market also, so if interest rate falls to 5% in the economy (mostly bank rate on deposits), then the price of this Bond will rise to 2000 which will make interest of 100 exactly as 5%. So on this basis prices of bonds keep fluctuating.

So Under QE, what Fed did was buying these bonds from the market at very high rates so as to bring the effective yield on these to near zero which made institutions holding them to sell these to Fed. And what was the result, Banks got huge amount of deposits after Pension funds and Insurance companies sold their bonds and got huge amount of money from Fed. so banks were in the position to lend this money to the public cheaply and economy would perform. But in general pension funds are not going to keep their money idle at banks with zero interest rates so they would invest this in other avenues like stock market or real estate which would raise the wealth of the public holding these , so in result confidence would rise and so as spending. 

But the money , which are invested by fund houses into stock market etc will not leave banks at all as the same will anyway come back to banks in the form of deposit but from other source.

Also the money paid by Fed to commercial banks for their Bonds also increased the reserves of these banks with Fed and so banks used this for making more loans.

How banks Make Loans

But if Fed was really thinking like this then there is one very fundamental flaw in this model. I am not an economist but i dont think banking acts like this in real life.When someone approaches to bank for Loan, bank never checks if they are having adequate reserves or not. They just simply approve the loan and in the evening if they find they are short of reserves at RBI, then they can take short term loans (one day) from other Banks or even from RBI. So banks are never short of Reserves. Banking is always demand side economics where supply can be raised as per demand. Banks are never short of reserves but of capital. This is the way banks operate and they can create any amount of money if it is demanded by public by way of debt. So this debt is the primary source of our money supply and it may look very scary for a common man.

So just by having deposits and reserves at Fed can not result in more lending. If people do not want to take any loan and banks are reluctant to take risk then nothing will work. So it is only wishful thinking that more reserves and deposit will spur credit demand.

But nothing like this happened, Fed bought around $ 4 trillion under QE-1, 2 ,3 but 80% of this is still in Fed’s reserve held by Commercial banks. This amount was never lent to the public so it was never used for the purpose for which it had been created. Stock markets did rise in US but not Gold, not Oil and not any other commodity like copper, Zinc etc. if rise of stock markets is linked with QE than why the same is not true for commodity market.

Surprisingly Fed started paying Interest to Banks on their reserves with Fed which further prompted banks to not to lend this money to risky loans as they were happy earning .25% interest from Fed with no interest payments on deposits. Banks have earned a windfall from this interest in this period and banks’ balance sheets have never been in this good shape. This step is confusing us about the motive of Fed, whether it wants to lend or keep this money into reserves. If it was concerning with possible high inflation but inflation was already very low in USA!!

Why QE

This makes me think that Fed is actually helping Banks in coming out of the mess created in last decade with reckless lending. Fed may have bought many of the not so good or Junk bonds mainly related with real estate (I do not have any data for this, but need to check this one out). This step of Fed provided banks with much needed cash and capital (profit earned is part of capital). Stock prices of banks skyrocketed after this. This have also stopped the possible panic that could have crept in general public after the demise of Lehman Brothers, and people might have lost interest in banks and that would have created havoc in the USA Banking and economy. So this QE may not be looking like achieving what was planned but it may have prevented a disaster.

And by making all this noise, Fed is actually creating feel good factor. I am always of the view that most important factor that can bring growth in an economy is not Capital and technology but CONFIDENCE of general public in the system and government’s capability. And by paying interest on reserves Fed is purposefully keeping the money with itself as money belonging to those bonds is already in the economy. Fed may be looking to sell these bonds when USA looks like coming back on track to these banks. Because if that money is again absorbed in the economy then it will become very difficult for Fed to sell these bonds into the market as this will drop the prices of these bonds significantly and interest rates will skyrocket.

After this QE, USA has not experienced any material rise in GDP and employment rates. The small rise witnessed may not be due to QE alone. But there are views that it has prevented a complete failure. So this QE can either be failure of Fed or there is something more to the story. I am just guessing because I need to gather a whole set of data to testify this which currently I am not having.

There is another way except for QE to spur growth. That is instead of giving money to fund houses and banks, Fed can simply give money to USA government by subscribing to their zero rate bonds. So USA Govt will now have the money and it can spend where it feel is necessary. It can also waive the taxes from citizens leaving more money with them and so more demand and goodwill factor. Government can invest this money in sectors which are deprived of investments like it can provide free loans to Shale Gas producers to reduce their cost of production. But only problem with this is that it will increase the already high Government debt to GDP ratio. It will also be very difficult to get the approval for it politically. But I feel this is a much better chance as government knows better than citizens where there is over supply and where is under investment.

Now coming to Indian stock market

There is widespread fear that as USA has ended its QE program and will be raising interest rates which will prompt USA investors leaving emerging markets and this will create panic in the stock markets of those countries. Now as we know not much of the QE money has left USA. After excluding Fed reserves, the most of the balance is invested in USA stock market and real estate. I feel that not much of QE (Cheap money) has come into Indian stock market. The money which in fact has come into Indian market may be savings of the general USA public which are hard hit by this zero interest rate policy. Savings of the life of so many of USA citizens have become worthless and are not earning anything in USA. This money was looking for profitable avenues and Indian stock market was one of them.

Even so this money was invested into Indian market when rupee was much stronger. So there will be a loss if they sell it due to rupee fall if this money is invested for short term. FII’s are generally in india for long term and they are here because they have faith in Indian story. Most of all, FII’s are just around 20% of total Indian stock market and this is not big. Indian domestic investors are much stronger and bigger now and they can absorb any such plight of FII’s. No McDonalds and KFC will leave india as they have faith in Indian story and they have invested for long term. Much of the FII money is invested in Indian Bonds which still provide more interest rate but may be with lower ratings.

Demand by USA may be fuelling growth in china now and in Japan in the past, but Indian story is built upon domestic demand and creation of adequate infrastructure. India just need cheap commodity prices which are here. Recent recorded Growth in USA failed to lift commodity prices. There are also fears that further lowering of oil prices may hit USA shale gas producers hard as they are incurring losses even at $ 50 for oil and this may result in low investments and employment.

RBI is having large reserves of dollars of around 400 billion which are more than sufficient to support the Indian rupee in case of selling by FII as they will demand  dollars in exchange of rupee. Also most of these fears have already been discounted for in the Indian market since last year. Also I do not think that rate increase in USA will be massive as this will severely hit any recovery made so far. This small increase will be more than offsetted by rupee fall which has already taken place and more of that will occur in case if FII’s are selling. Moreover there are high chances that USA will further delay its rate increase as economic data needs to be tested over long term to confirm whether it is sustainable or not.

So I feel India will be able to withstand any rise of interest rates in USA much better as we are in much better place.

What is the problem with Chinese Economy?

An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today. I don’t remember who said this but the more I remember what our economists are saying every time there is some change in Economic data…I find the above sadly true. They are the most confusing people.

Just see when Oil was high, they were saying india was in trouble as it would lead to costly imports due to rupee fall, high inflation then low growth, low growth to low employment and so more rupee devaluation. And now when oil is down to the brink, they are saying it is indicative of low global growth, low Chinese demand, low growth in oil producers which will lead to low demand for products by them so it may lead to global de growth including india due to low exports as low exports means low consumption by exporters in india so again degrowth.

When China was devaluating its Yuan for competing in exports to USA, USA was crying that it was making its people unemployed. Now when China has devalued it more after a prolonged period of stable Yuan, they are fearing that it is a sign of problems with Chinese growth and so it may hamper USA exports to china…and so USA and global stocks are falling.

Come on guys…please hang on…I mean please let people take breath.

Let’s see like a common man what is happening behind this complex game. Let us take China for making it real. China exports 1000 bucks goods and imports for 1500 bucks. So in order to pay for extra import of 500/- china needs to have currency acceptable to the other country which is Dollar. So china can borrow that 500 dollar for paying hoping that in the future it will pay with more exports. Or China can attract Foreign investors to invest money in China and by doing so it can use dollars brought in by FDI people to pay its net imports. Here the game is opposite, China is an export surplus economy, means it is having 500/- excess dollars with it after paying for imports. Now add to these 500/- the other 1000 dollars brought in by FDI people for making factories mainly for global exports as China makes goods cheap. All this is resulting china with huge dollar reserves (around $ 3 trillion now).

But there is one problem with this model. You are becoming reliant on others for your earnings and competing against fierce competitors. Any change in demand could be drastic for your economy where only exporters are becoming rich; labor is getting very low wage the only factor making your product cheap. So China forayed into other destination, Investments. It invested huge amounts in building infrastructure, real estate, bridges, Trains….all this at a gigantic scale. This provided employment to the people, more money as rising demand for labor raised the labor rates.

There is nothing wrong with it. It is the best policy for promoting innovation and growth.  Although Classical economists like Keynes were not in favor of investments or savings; they were the supporters of consumption. Do not save but consume as more consumption means more employment and more growth. I will come to this consumption theory later on as I am a firm non believer of this.

First let me explain some myths about china. First myth which is making us nervous all this time is that China is an export oriented economy so any global slowdown will kill Chinese economy with non availability of financial resources. Net exports are just around 5% of total Chinese GDP. Finding hard to believe. But this is true. Actually there are terms which confuse us to believe otherwise like Gross exports are around 30% of Chinese GDP. Ok this is also true…but we are comparing an Apple with a Mango. GDP is a value added thing, but gross exports mean total value of exports…so we are comparing gross with net. China exports mostly those goods which are manufactured with imported goods. Like China imports raw Granite from india and after cutting it, processing and polishing it exports it globally. So gross value of this may be 150 but after deducting raw granite imports of 100, net exports are just 50/- . 

So Chinese growth story is surprisingly internal. Also if we take into account the fact that some of the goods imported by china are not used for exporting but for domestic consumption/production, then the net share of exports will rise from 5% to 7-8%. I am just using this to show that we can use these figures anyway we want. But having knowledge of their working will help us in making decisions.

Some economists are of the view to reduce those domestic inputs also from exports which are used for manufacturing products for exports along with imported raw or intermediate products. Like for exporting shoes, china may be importing leather from india but they are using locally produced rubber soles. If export value of shoe is 150, cost of leather is 100 and sole is 20. They say that value added by export is 30, so net export is 30. But this is where I differ from them and this is the area which may be causing problems to Chinese now.

I feel that this extra sole is produced only for Export purpose. Had it not been used for export shoe, it would not have been produced at all. So this rubber sole also represents the export economy sector. It should not be counted as internal.  I am having no statistics with me for this but we can safely assume that this can take the net exports to 12-15% which is now taking the shape of something material.

Chinese exports are very different as they mostly use intermediate imports. This value addition thing is a great source of income for china. It is quite safer than countries like Brazil, Australia or Canada which are based on export of natural resources or commodities and any fall in the prices of these can create havoc in their economies. China is a value added exporter with so many other intermediary goods supplier countries as partners. Although it is also prone to competition but the sheer scale of its production capabilities make it a potent force.

But if there is a global slowdown and demand falls then there is a danger to it. But this danger is lesser than what we thought initially and this danger has nothing to do with any mistake by china. However it can make itself safer by building capacities for virtually recession free goods than discretionary goods.

Now to the investment part. Investment is always good but if it is deployed in productive resources. Like Chinese Govt can make an investment for making a temple in a poor unconnected village thinking that it will provide employment to the villagers. But is this investment fruitful? No. Now compare this to a situation if they build a road from village to city and a small warehouse for storing agriculture produce. It will result in lower wastages of products and quick supply of those to cities at high rates. It will make village grow.

Also there is always a marginal productivity limit to an investment. More investments after a certain level result in lower incremental production. And even more investments after that limit make that particular investment as wasted. Like making two parallel roads from village to city; one road is wastage of resources. China has really wasted enormous resources on building excessive infrastructure in chasing growth. But this is not the fallacy of Investment model but wrong or wasted investments.

By providing cheaper finances to real estate builders, it is sitting on a huge unsold inventory of real estate. So now as china has realized its mistakes, so it is not expanding that much on building excess roads, train tracks, houses, bridges etc. So demand for steel, cement, paint and oil has come down big time; making the supplier of these quiver. So prices of these commodities will come down more; but more demand by countries like India and Africa will give these some supports.

Although countries which have built substantial capacities for steel, cement etc on the basis of Chinese demand are themselves to blame. But again we are finding ourselves at the doors of economists of these countries who failed to understand the fallacy of wasted investment Chinese model. Here I remember india Power sector giant, Tata power who placed the lower bids for its 4000 MW mega power plant at Mundra, Gujarat on the basis of cheap Indonesian coal thinking prices would remain lower. But Indonesian Govt raised the prices of coal meant for export and it made Mundra plant Powerless. Kudos to these planners.  World over global Shipping lines went mad for acquiring more ships for fulfilling demand for huge Chinese  imports of raw material and they are crying for last 5-6 years.

So after starting correcting this investment cycle, China focused on another growth vertical, Consumption. Chinese people were saving in excess; around 25% of their earning, to meet their future plans for house, education etc as financing for these were very less. Bank rates were low due to Govt focus on promoting investment cycle. So that money was just getting wasted; plus consumption of goods by people were very low. Chinese consumption share in total GDP is just 35%, USA is at 71%. China is lower but USA is excess. Anything near 50% is good. Because unless people consume more, investments made will not bear fruit. But this is where there is huge confusion; what is the right consumption, there is a huge debate on this.

To best understand this debate of Investment or consumption for development, let’s take the case of an isolated individual on a deserted island just like Robinson Crusoe. So Crusoe on his deserted island can produce fish and fruits for his consumption. If production is easy then he can arrange for fish and fruits for 2-3 days on a single day. Since he can’t turn his excess produce into savings in the from of money by selling these to others. So his savings will be in the form of surplus time left with him of two days. Then he’ll have two options to use his savings (time), first he can indulge in consuming his surplus produce alongwith enjoying sightseeing of the island (Leisure) or can use spare time to harness his production skills by weaving baskets or nets for catching fish or trying to learn agriculture (Research) to produce fruits on his own or he can make clothes/shelter for himself or can produce (Fish and fruits) further more.

As we can see, consuming his excess produce will lead him to nowhere near to growth infact it will diminish his wealth. The time he spends on producing (accumulating more fruits and fishing) increases his wealth but the time he spends on improving his skills or tools (Like an Axe for cutting wood for shelter and fire) increases his wealth even more.

And if one more person joins him, then he can lend his saving (excess fruits and Fish) to him who in return will indulge in making tools for better and more production or for easy and safe life. So return for Crusoe for his saving that he lends to him will be in the form of tools for extra and easy production.

So as we can see that it is investment of savings not consumption into production and research that leads to increased productivity and development. When people save more, it leads to fall in the interest rate which motivates entrepreneurs to borrow to invest into productive resources.

Excess consumption only leads to inflation with high interest rates which further aggravate the situation because due to high consumption and less savings little money is left for investing into increasing production and recession bites.

Conclusion

So I feel this Chinese fall story is over reacted by market forces. In fact china is trying to achieve much comprehensive growth which is inclusive of Exports, Investments and consumption; and so it is doing what is good for it. This may cause some short term problems to commodities suppliers like Brazil, Australia but even they can adjust as mining does not require huge capital. For others there may be a short term war like we are seeing in Oil where nobody is retreating. This will eventually lead to the oust of the weaker.

But global economy is much more complex now as all the countries are interdependent, so complete fall of the other will also leave me alone in the game. USA, the global anchor, is in much better shape. India is also growing strong. One cannot ignore the power of demand of goods from people from china and India; they are a strong force of 2.6-2.7 billions.

This post is an attempt to understand the brief working of Chinese economy and the ways Chinese are trying to have inclusive all round growth. But there is another part of this story…the currency war…more on this later.

Market Fall-Every Fall is not a Water Fall

Market is falling as expected. But no need to panic...i was always negative on china growth story. China made a big mistake by focusing big on exports rather than focusing more on stable internal growth. It was never a good strategy to provide excessive loans to go overboard in building export capacities that too at the cost of internal stable growth. You can not sell your car by removing all the workers from factory by using robots because who will have the money to buy your car when most of people are unemployed. China becoming a global production factory was never a solution, neither for china nor for the world. Now as china’s cost dividend is falling…it is getting the bigger picture clear.

But i do not think we are going to see 2008 again. We are much better here, there are no assets bubble which can cause ripple effects and create havoc on banks....only exception is indian real estate...but it is mostly financed with black money so not much of worry to banks.

Buyers are here for real estate but they are not buying due to high rates...so prices will come down and inventory will be sold. it is quite unlike USA subprime where assets were overbought with loan money.

India is not a high exporter to china neither to world...our story is 70% internal. But this fall will prompt to make policy changes like GST. China meltdown will soften the commodity prices more which is just great for india. Oil is already at $ 45...it will fall even more...nothing more to say except that it is killed by substitution effect. 

But indian Govt's role is very crucial here...it needs big time to start up the policy engine to boost the investments because we will lose jobs due to shrinking export market. So there is a big need to stop the ripple effect of that by upping the investments inside india.

i think we are at near bottom for indian stocks...so wait for some stability then buy stocks...but remember...buy quality stocks only. Be rational and do not loose hope. India is in a much better situation.

Will follow with more updates soon.

Info Edge India ltd and Network 18 media & Investments Ltd: Valuation of E-commerce Ventures-Zomato-Part 2nd

For earlier post on this topic, Click Here

Our company BHEL is building a 500 MW power plant in MP. It is a small town of MP. Once our entire team was having a party when one of our Engineer remarked, "we are doing a Great work by building this power plant”. Although his intention was of common welfare but I just shared with them my view. I just asked what great “value” this power plant would bring in the life of the people. What they will do with this power? What Great? They will use fans, lights, AC’s, watch TV, movies, Laptops, Phones. Are these great? Whether these are “Valuable”?

I told him that he was living a life more lavish than Lord Krishna but “this lavish Life” is not valuable to the Lord. Bring a sword to the neck of a Managing Director or CMD, most will tremble with fear and fall on feet. But the Lord is the one who will smile at the face of the Death. Whether we assign any value to the fearlessness and bravery?  What PE ratio we will give to a company which is making people brave? So we realize that value is Subjective. Lord will assign great value to bravery and we are happy watching Lord in a TV Serial. But objective consideration is that a business should provide value to the society at large to attract decent Valuations.

So the game of valuations is just a play of getting the value added by a business. And we are on our quest to understand the value added by most of our e commerce startups and whether that value will sustain.

As we know that E-commerce ventures are valued in a different way like on the basis of numbers of users of the product/service or reviews generated if portal is a discovery platform. Although these valuation metrics look very unconvincing to a common man having firsthand knowledge of the investing world. But these are not out of the context. I have given a brief example of newspaper vendor of a small town in part-1 of this post. Let us delve further.

Dynamics of Normal Business

Take a normal car selling company which has sold 1000 cars. Now one new customer buys a car. Will it change anything for old customers? Will it bring future or more business for the company? NO. Same is the case for a Steel company. The components of these types of businesses are not linked with each other. Person A buying a new car means nothing to B already having the same car. C will not give any value to the fact that he should BUY X car as A and B are having the same. He may choose the X after his analysis but nothing is contributed by the fact that A and B are using the same.

Dynamics of E-commerce Ventures

Now watch a telephonic company (assume a single one in a city) having 10000 customers, if one new person subscribed to its services, it will change the equation for everyone. Old user may get benefited to increased network and Telephone Company’s business will become more valuable as new person and so many others now communicate with each other, resulting in much more incremental revenue for the company.

E-bay gets more sellers of products because it is having biggest numbers of buyers. Every new seller will make things better for existing buyers and new buyers will make things better for existing sellers. Although new buyers are not beneficial for existing buyers but for existing sellers, so value addition here is diagonal.

Now move to Microsoft windows, new users make it more valuable because application developers will make new applications based on windows platform since more users are having it on their PC's/Laptops. So Application developers have more chances of making money if they make their application softwares based on Windows.

Naukri.com works in the same way. More job seekers come to it as it is having one of the largest recruiters registered. More recruiters will join it as it is having biggest numbers of job seekers, so as advertisers. Naukri.com is in unique position as it is having three components of business process, Job seekers, Recruiters and Advertisers. It can monetize all of three although it is subsidizing Job seekers so as to get more from other Two.

                                                 Network Effect

So these businesses have one unique trait associated with them-Network Effect. They can benefit from network effect. Network effect emerges where one new user makes the business more valuable to existing users (either horizontal or vertical). Network effects are more profound and visible in E-commerce ventures although they were present earlier also. Like in Video Games, Video game developers will create games only for platforms that have a critical mass of players; because developers need a large enough customer base to recover their upfront programming costs. In turn, players favor platforms with a greater variety of games. 

Wikipedia is another example of Network effects where more entries are made in it as it is having more users and more users use it because it is having one of the largest entries.

Facebook derives the benefits of Network effects. Now suppose there are thousands of social network platforms available and people are using them equally. So no platform will be valuable…it will not get any investment and business as it is lacking the scale and it will not grow at all. But it never happens in real life, people shift their platform to the one which is having largest users as through it they can connect with more of their friends and make new friends. Network effect comes into existence on its own. So in E-commerce ventures you will always see one or two players having the entire share divided between them. Although existing players cannot relax on Network effect as there are forces which can disrupt an existing network…more on these later.

So no doubt, E-commerce ventures are valued on the basis of number of users as these can bring into play the Network effects which can multiply the revenue in the future when they are done away with their user acquisition phase. E-commerce ventures will spend handfuls on user acquisition initially and when they have critical mass then they start monetizing the entire network. And it can really become very big.

Zomato is just trying to be in a place to harvest the benefits of Network effects. So it is growing at breathtaking speed. It has acquired companies all over the world from Italy, UK, Australia to USA. Latest one was Urbanspoon from USA. Although USA was not the reason for acquisition as Urbanspoon was not the biggest in USA but it was in Australia and Canada. Yelp is the biggest in USA and Zomato has to make itself more useful and relevant if it wants to compete with Yelp.

Yelp is valued around $ 2 billion (around 13000 cr) down from $ 4 billion a year ago, after the news of its sale by promoters spread out. It is having around 150 million users every month. However unlike Zomato whose content is self generated, content of Yelp is generated by users and it is not restricted to food alone. Its turnover is around 2500 crores with NP around 250 cr in 2014. So Zomato with its superior content has all the might to compete with Yelp.

Zomato is present in 22 countries now, 43 offices worldwide, with around 1100 staffers from 65 nationalities. So it should focus on growing its existing business and monetizing the content. After it has gained some muscle mass, it should think of competing with Yelp which would require huge resources.

Its promoter Deepinder Goyal is a proud Punjabi, belongs to Mukatsar about 50 Km away from my hometown Bathinda. Punjabis are fighters and aggressive by nature. And so one thing that makes Zomato a class apart from other Indian companies is its aggressive tone. I have never seen any Indian company which is so aggressive. It is shaping its global dreams with killing instincts. In 2014, Zomato spent between $1 and 3 million for acquisitions in the Czech Republic, Slovakia, Poland, Italy and Turkey, but the biggest catch was Urban Spoon, with operations in the US, Canada and Australia for $ 55 million. Zomato is clearly going for the kill to reap the benefits of network effects.

Zomato has everything which can make it relish the network effects. First is its unique set of high quality content which is very difficult for any rival to replicate in short time and this is also working as a huge entry barrier apart from network effects.

Zomat’s most critical content is not user generated but it is aggregated firsthand. While starting afresh in the new city, one person is assigned in each city to collect data about the restaurants and clubs around the city. So they meet the owners, take the pictures of menus, Location, Food and other relevant data which is feed into a questionnaire having around 50-60 variables.  There is a centralized team which processes and cross-checks the data to confirm the validity. The data is then processed to be put up on the website. There is a separate team for advertising, which sells the website to the restaurant owners and attracts them to advertise with Zomato. 95% of the revenues are earned from advertisements from the local restaurants, while the rest can be attributed to event ticketing and restaurant booking.

Users can post reviews after visiting a restaurants, but only after passing some strict criteria. Zomato has algorithm and other technical expertise in hand to filter out the fake reviews which further improve the credibility of reviews. Restaurants can place their ads on the page; ads are appeared relevant to the search made by a user on the basis of locality and choice of foods. Restaurant owners are given a Dashboard page to see the traffic coming to them from Zomato and revenue getting generated. They can track the number of calls being made through Zomato, they can check the number of map views they got, the number of menu views they got. They can actually take a lot of metrics.

Restaurants placing their ads on Zomato are a perfect example of Targeted advertising which is a dream for any marketer. It is something I feel will change the dynamics of advertising industry where only 5% of the ads reach to the targeted audience which is highly expensive.

After the acquisition of Urbanspoon, its restaurant coverage has increased from about 300000 restaurants to more than 1 million restaurants across the globe and traffic is around 80 million per month. 

It is covering around 500 cities across the globe. This number is going to rise at an astounding rate in the future and these are not small numbers either. 

So now Zomato can afford to monetize its content. Apart from advertising, Zomato is focusing big on Order booking , table reservation, Payments all from Zomato platform. It wants to be relevant from Place discovery to final payment to a user. It has even tied up with Uber in india where a user can book a taxi from Zomato platform to the restaurant. 

Zomato has already acquired NexTable a US based restaurant reservations and table management Platform which competes against the Priceline's Opentable and SeatMe from Yelp.

Consumers will be able to search for a place to eat, check out recommendations and reviews from others, and then book a table there. Zomato can make revenues both on advertising on the search platform, as well as by taking a cut on reservations that it successfully makes for those establishments.

With this, Zomato is becoming more like Naukri.com with multiple revenue generating model. NexTable has developed a technology that lets restaurants update their data on the platform from smartphones and tablets, which makes a lot of sense considering the mobile nature of many of these businesses.

Acquisition of MaplePOS-a Potential Game changer for Zomato In Food ordering Business

In apr-15, Zomato acquired MaplePOS. It is developed by Delhi based MapleGraph, MaplePos offers restaurants features such as menu and inventory management, and has a built-in payment solution to accept debit and credit card payments. It is the first product based acquisition by Zomato. Food ordering is a big business, of 100000 crores in india and 30 lac crore globally. So Zomato can integrate this with its Data set and can offer more B2B solutions to restaurants and this can provide a recurring source of revenue for transactions on the cloud based platform.

Zomato is offering this with new name Zomato Base with features like modules for menu, inventory, recipe and customer relationship management, data analytics, electronic receipts, offline transaction support, payment gateway integration and a stealth feature which Zomato claims will change the way restaurants go about their business. As it is moving into food ordering and reservation services so technology is a must for smooth handling of the transactions and high end user experience. MaplePOS provides just that.

Zomato is going to launch this POS service globally within few months, so it will be a big game changer for it. Imagine a waiter tapping a menu card on a tablet that beeps an order into the front office machine that processes the order, deducts a payment against a credit card or prints out a bill.

The machine would be designed by Indian engineers but made in China. The plan is to help eateries run everything from customer intelligence to inventory management from an Android app and a matching machine.

I am yet to study the more updates and details regarding this, but will update as and whenever I get these.

It has already launched its food ordering application Zomato Order, which is a different application from Zomato restaurant discovery. It has kept it separate probably to unclutter the application and lightweight apps; although both are inter linked.

Online food ordering is going to be a bigger market, already Foodpanda and Tinyowl are expanding big. Dominos Pizza gets around 40% of its business through online ordering. Although Zomato is late in entering, but it is already having huge data base of restaurants and unmatchable sales force which go to every listed restaurant quarterly to take note of product updates. Integrating these restaurants into other schemas like food ordering and reservations are very easy and can be ramped up quickly.

So all in all, I feel it has passed the first phase of foundation and now ready to go ahead with monetization. How much it will generate is just a matter of time; nothing more.

Keeping alive the Network Effect-Being Relevant

Now we are at the most critical part. Survival. There is a belief in the investment circles that network effect is almost impossible to break. But there are some things which are relevant only in theory. Although they are still used in practical world by majority and most of the times this following by majority transforms something mediocre into outstanding…another case of network effect. Like valuation of companies and businesses by 10 year Discounted Cash Flow model. I always find it irrelevant. In today’s fast pace world, which is changing too fast; Relevancy whether technological or commercial is becoming more important than everything. Who can assess the cash flows of a business for 10 years with even 50% of certainty!!

These are just textbook models relevant mainly for theoretical and conceptual framework.

So network effects are somewhat overhyped in touting as a sole killing force in creating a giant E-commerce business. But that is not the case always. Burrp was the leader when Zomato was just a baby, today Burrp is nowhere. It vanished as it stopped being Relevant to the needs of users and competition.

Same thing happened with Orkut when Facebook untangled its huge web and emerged as the new standard in social networking. So then Facebook started to enjoy the Network Effects. And today in the wake of Twitter, Instagram and Linkedin, Facebook is trying hard to be Relevant to its users. Although Twitter and Instagram borrowed their concept from Facebook. Twitter “instant status” and Instagram “Photo Sharing”.

But there is more to the story of Orkut than Irrelevancy. In my view, Google underestimated the power of social networking and so it did not paid much attention to transform Orkut into something superior. Had orkut been the brainchild of someone like Mark Zuckerberg, it would have been alive. Then Orkut might have gone for IPO and would have raised funds for growth like Facebook Did.

According to the textbooks, eBay should own the Chinese market. In 2004 it acquired the largest local online-trading company, EachNet, which enjoyed an 85% market share at the time. EBay’s CEO, Meg Whitman, had witnessed the power of network effects in the company’s U.S. business and was confident to own the Chinese market too.

Things turned out rather differently. Taobao, a Chinese upstart owned by the Alibaba Group, completely displaced eBay within a few years.

When eBay first entered the Chinese market, e-commerce was in its infancy. At the time, technical equipment such as motherboards made up the bulk of online auction purchases, and EachNet, the company that eBay acquired, appealed mostly to technically sophisticated customers. Thanks to strong network effects, eBay’s platform became an increasingly attractive place to buy tech products.

Taobao’s Chinese executives recognized that the company couldn’t compete head-on with eBay in the existing market. So instead they focused on an emerging segment of online auction customers—people on the hunt for clothing and consumer products. Although eBay had a leading position in terms of overall market share, its share of the new segment—which would come to dominate e-commerce in China—was far less imposing. What’s more, eBay’s strong position with techies was no help at all in attracting fashion-focused customers, who were more interested in whether other fashionistas used the site.

Mistakenly assuming that the company had purchased its way to market leadership, eBay’s executives committed a series of strategic errors, ones they might have avoided if they had realized the threat Taobao actually presented. For example, eBay was slow to offer an integrated payment solution, and it insisted on charging customers significant transaction fees. Had its network advantage been real, the model would have made sense—the company with the strongest network effects can typically get away with higher charges (or lower quality). But eBay was not dominant in the emerging consumer market—the mutual attraction between fashionistas and techies was weak—and so its model didn’t fly. In 2006 eBay shut down its business in China. (HBR, Case Study-Apr-2014 Issue)

So network Effects alone cannot sustain the success, but there is no denying that if network effects are properly backed by Relevancy efforts than it becomes a potent force. Amazon is a testimony to this.

It is really getting lengthy here. I want to write more on the Disrupting potential of competition in network effect….but some other times.

I feel Zomato has its eyes wide open and is not sleeping on the cushion of Network Effect. In fact it is focusing big on its relevancy efforts.

So Info Edge should not be valued at present on the basis of valuation given to Zomato in the last funding round which valued it around 5000 cr. Zomato has just completed the investment phase so it is better to wait to realize its earning potential. If Zomato can reap what it has sown till date, it will be an Indian Giant in the making.

So now we have the conceptual framework of valuing E-commerce ventures. I wanted to cover and assess the strength of ventures like BookMyShow, Moneycontrol and Firstpost etc. These are all part of Network 18 media and investments which is now owned by Reliance Industries ltd. I never have the faith in any of the reliance group stocks whether it is belonging to Mukesh or Anil Ambani. I don't think that they can ever place shareholders ahead of their personal gains. So Reliance is the major negative for Network 18...that's why i am giving it a miss here and may be forever.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing)