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Sunday, September 28, 2008

Indian banks post Rs 410 cr MTM losses

The Indian banking sector saw a mark-to-market losses of around Rs 410 crore due to their investment in instruments of troubled US financial giants like Lehman Brothers and AIG, 75 per cent of which is accounted by ICICI Bank alone.

"In terms of MTM losses of the banking sector including private sector, stood at Rs 410 crore owing to financial crisis in some of financial institutions. Of this, ICICI Bank alone has MTM loss of about Rs 309 crore," a senior Finance Ministry official said in New Delhi.

MTM is based on the market value of underlying securities and keep varying. MTM is a notional loss but it would be reflected in the balance sheet.

Besides, some state-owned banks had exposure in the instruments of these troubled US financial institutions to the tune of Rs 234 crore.

"Exposure of a few public sector banks to credit-linked and floating rate notes of Lehman Brothers and other troubled institutions is about USD 52 million," he said.

In his first reaction after the collapse of Lehman Brothers and the bailout of the largest US insurer AIG, Finance Minister P Chidambaram had said India's financial institutions were on a sound foundation.

As far as PSU banks are concerned, in which the government is a majority owner, he had said they didn't have any ‘undue exposure’.

"In fact, many of them have no exposure at all. Whatever exposures they have are in accordance with RBI's prudential guidelines," he said, adding, ICICI Bank had some exposure which it has disclosed.

The London subsidiary of ICICI Bank had USD 80-million exposure in the senior bonds of Lehman Brothers.

ICICI Bank Joint Managing Director Chanda Kochhar had said the investment by the subsidiary constitutes less than one per cent of the total assets of the subsidiary and less than 0.1 per cent of the consolidated total assets of the ICICI Group.

On June 30, 2008, ICICI Bank and its subsidiaries had consolidated total assets of Rs 484,643 crore.

The Finance Minister had said while the country's banking system was reasonably insulated from the global crisis, the credit crunch could have some effect in India as well.

"If there is a credit crunch in the rest of the world, it will, to some extent, impact the credit availability in Indian market. RBI, day before yesterday, took steps to provide liquidity to the banks," he had said.

Simplex Infrastructures

Simplex Infrastructures is among the few pure contracting companies in the infrastructure space that has managed to move up the value chain in terms of higher profitability while at the same time preserving the status of being contractors only.

The company has put up a strong show at a time when most other construction players have slowed down in growth and has also stood the test of surging commodity prices reasonably well.

Investors can consider buying the stock of Simplex Infrastructures (Simplex) with an investment perspective of two-three years. At the current market price of Rs 415 the stock trades at 10 times its expected per share earnings for FY10.

The stock has traditionally traded at a high premium to the industry average and the Sensex. While it continues this trend, its present price earnings multiple (on historical earnings) is near its three-year low valuations as of 2005. This presents an opportunity to enter the stock.
Expanding capabilities

Starting off as a piling contractor, Simplex quickly expanded its capabilities into executing projects in urban and marine infrastructure, industrial structures, roads, railways and power. While a good number of contractors would have charted a similar path, what differentiates Simplex is its well-diversified revenue mix.

For instance, revenues in the quarter ended June were a mix of industrial (25 per cent), marine (10 per cent), buildings (15 per cent), bridges and urban infrastructure (12 per cent each) segments, with some contribution from piling works, roads and railways. Diversification on this scale could be the key reason for the company’s ability to maintain robust order inflows, bucking the slowdown in the industry.

Simplex has also been conscious of changing opportunities in the industry and shifted focus to those sectors that hold better prospects.

For instance, its current order book shows a bias towards power projects, building contracts, railways and bridges and industrial structures. Clearly, the company has a higher proportion in sectors that hold potential for higher margins and provide scope for scaling up. For instance, in the power space, the company plans to transition from being a civil structure provider to a balance-of-plant executor.

We expect the power and urban infrastructure segments to be the key drivers for earnings and profitability while industrial and building projects could bring in higher volumes.

The company’s attempt to diversify geographically has also met with success. From a contribution of 9 per cent to revenues from overseas operations in 2006, the share doubled in FY 2008.

Overseas revenues, arising predominantly from construction work in the West Asian countries, contributed a whopping 27 per cent to the June quarter sales. Interestingly, the company has been able to naturally hedge the foreign currency revenues to a large extent as it has been utilising the revenues generated for capex and working capital requirements in the same geographies.

The above measures have ensured that the company’s order inflows remained robust. Simplex’s order book as of June 2008 stood at Rs 10,000 crore — a 56 per cent growth over a year ago.
Smart strategies

Simplex appears to be one of the few companies that has negotiated cost pass-through clauses that are in its favour. Close to 60 per cent of the company’s order book provides for a full pass-through of costs or requires the awarder of the contract to provide raw materials.

Of the remaining, 27 per cent orders are linked to indices where a large proportion of the cost hike is reimbursed. Orders with fixed price account for close to 15 per cent.

As the company has a practice of accepting short-term orders (with three-six months duration) such as piling works under fixed price contracts, this is unlikely to hit the overall margins. Among other companies only IVRCL has a similar favourable mix.

While the above could protect margins, the company may not see any significant improvement unless commodity prices remain stable.
Strong financials

Simplex’s revenue and earnings grew at a compounded annual rate of 41 per cent and 52 per cent, respectively, over the last three years. For the quarter ended June 2008, earnings, adjusted for extraordinary items, surged by 108 per cent. While operating profit margins witnessed an insignificant 50 basis point increase to 9.5 per cent, the company’s profit margins on domestic revenues took a dip, even as overseas margins remained high.

The management has stated that the dip is transitory in nature, owing to booking of mobilisation expenses on projects that are yet to contribute to revenues.

The cash position of the company also received a boost through qualified institutional placement in FY2008. Operating cash flows also turned positive on the back of an improvement in debtors’ turnover. Higher proportion of overseas revenue combined with increase in non-government clients could have led to the improvement. As a result of the above, Simplex managed to repay a part of its borrowings thus bringing the debt-equity ratio to comfortable levels and providing room for any fresh gearing.
New prospects

Simplex recently ventured into the onshore oil rig business. It leased out a recently acquired oil rig to Oil India for two years at a rental of $16,000 per day.

The company also hopes to let out three-four rigs by the end of this financial year. Such a business, although not fully related to its key business, would, nevertheless, provide a steady stream of income once the break-even is achieved in 2-2.5 years.

Similarly, in the real-estate space, the company’s gradual foray in the business without assuming responsibility for risk/cost of land (typically through joint ventures with a state Government) appears to hold potential. We, however, view this foray with caution at this juncture.

Tanla Solutions

The crisis in the global financial markets has taken a toll on several of the key banking, financial services and insurance clients of Indian IT majors. The top-tier companies may yet pull through, thanks to the breadth and depth of their service offerings and broad geographical diversity.

For most mid-tier companies, though, these are challenging times. Valuations for mid-tier IT players has plummeted, with most of them trading at single-digit price-earnings multiples on a forward basis. Even at these levels, the business risks associated with many of them are high.

In this scenario, players with niche offerings and catering to limited verticals or segments may chug along and deliver strong earnings over the medium to long term. Tanla Solutions, predominantly a network aggregator in the mobile value added services (MVAS) space, might be one such player. Investors with a two-year perspective may consider buying the shares of Tanla Solutions. At Rs 173, the stock trades at eight times its likely 2008-09 earnings. Tanla has no strict peers in the listed space.

An integrated play in the mobile billing and value added services catering largely to top mobile operators in the UK and Ireland, synergies from the acquisition of Openbit and an expanding domestic presence are key business drivers for Tanla. Content aggregators typically enable content from music companies, websites and entertainment companies to be made available in a downloadable format on mobile phones.

The company’s revenues have grown at a compounded annual rate of 173 per cent over the last three years to Rs 459.8 crore, while net profits have jumped 189 per cent to Rs 166.5 crore. The company has over the last several years been enjoying an EBITDA margin of over 50 per cent.
Integrated play

Tanla has end-to-end offerings in the mobile value added services segment, with network aggregation, product offerings and professional services. The company derives 78 per cent of its revenues from the network aggregation services. Its top clients are leading European mobile operators such as O2, Orange and Vodafone, all pan-European players, thus enabling Tanla to expand its footprint. These operators also have an average revenue per user (ARPU) of $35-45, of which non-voice revenues are $10-14.

In addition, the company also has its own products, such as content management systems, WAP Builder and Interactive TV. Although this segment contributes only 11 per cent of revenues, it enjoys 86.9 per cent of the EBITDA margins. Professional services are also delivered offshore by Tanla. Interestingly, most products are offered on a SaaS model, making the implementation cycle shorter and cheaper for clients and allowing for higher margins.
Openbit acquisition

Tanla Solutions’ acquisition of Openbit gives it a clear edge in terms of enhancing its offering in the on-device mobile payment segment. It could also help Tanla expand operations in new regions and create a sustainable revenue stream.

The company acquired an 85 per cent stake in Openbit in June, to be hiked to 100 per cent in two years, for $15.8 million. For June alone, the company declared Rs 7.4 crore in revenues, with an EBITDA of Rs 1.66 crore.

The acquisition holds several positives for Tanla. Openbit has strong tie-ups with players such Nokia and has its software products installed in 20 million Nokia phones. This deal can help Openbit extend its relationship with Nokia in countries such as China and India, where mobile subscribers are being added at 8 million a month.

This apart, on-device payment is a concept fast catching up in India, with several operators such as Reliance Communications and Bharti Airtel betting big on mobile commerce. Tanla is set to serve Indian operators and agreements with several players are on the anvil.

Openbit’s products may augment Tanla’s mobile applications offering in this regard. Openbit derives 60 per cent of its revenues from clients in Europe and 35 per cent from those in Asia-Pacific, both of which are high-growth regions for mobile payments.

While a bulk of the revenues will continue to flow in on a usage basis for features such as gaming and other entertainment-related downloads, Tanla could create a more sustainable revenue stream over the next couple of years, comprising set-up, upgrade and support revenues.
India Foray

Tanla has also started its India foray, with tie-ups with BSNL for a voice portal in all the circles. It also has agreements with Bharti Airtel for launching a voice product-M-Raga in two circles. Reliance Communication is also in a deal with Tanla for premium SMS delivery.

There are also agreements with content developing companies to deliver integrated offerings to domestic operators. But all these are at a nascent stage and it may be over the next two to three years that India will contribute substantially to revenues. With established players such as OnMobile, IMI Mobile and Bharti Telesoft to contend with, breaking into this market may be difficult.

In India the company may have to contend with tighter margin on VAS products as offtake is much lower than in the US and Europe. The company does not offer ringtone downloads or caller ringback tones, which may be a negative. Tanla may find competition from players such as IMI Mobile, which has just entered the UK, and Onmobile Global which has made acquisitions in France.

Bank of India

Investors can consider buying the Bank of India stock with at least a two-year horizon. Valuations are quite attractive, but the stock can be re-rated only when sentiment towards the banking sector improves on a rend reversal in interest rates.

At the current market price of Rs 275, the stock trades at 1.6 times its June 30, 2008 book value and 6.8 times its FY-08 earnings; 5.5 times FY-09 earnings.

Despite outperforming its peerls in the last three years, the stock trades at a discount to larger public sector banks, except Canara Bank .

Given that the broader markets might be volatile in the medium term investors can accumulate the stock during declines.

Bank of India is the sixth largest in terms of balance-sheet size and has superior profitability ratios, a diversified loan book, a de-risked bond portfolio, robust non-interest income and healthy levels of low-cost deposits. It created 50 SME centres and 20 retail hubs for focussed lending to these sectors.

The loan book, which has the ability to weather the current interest rate regime with relatively lower slippages, constitutes 13 per cent agriculture credit, 20 per cent retail credit, 21 per cent SME credit and 47 per cent corporate credit.

Bank of India’s balance-sheet and earnings have each grown at 18 per cent compounded annual growth rate (CAGR) in the last five years. The net NPA/advances have come down dramatically from 5.5 per cent to 0.5 per cent during the same period.

In the June quarter, a troubled period for most banks, Bank of India posted a 78 per cent growth in earnings thanks to strong growth in net interest income (25 per cent) and non-interest income (45 per cent), even as operating expenses remained flat.

The major boost to ‘other income’ came from forex transactions, commission, exchange and brokerage income and write-back of loans.

Trading profits remained flat due to underperformance of the capital markets. The bank’s cost:income ratio of 38.6 per cent is the lowest among the larger banks and shows good operating efficiency.

Advances grew by 37 per cent in the tough market conditions but at the cost of shrinking net interest margins (NIM).

The bank’s Indian operation’s NIM (3.3 per cent) is strong but the international operations pulled down the overall margins to 2.9 per cent. The NIM contracted as the bank’s cost of funds increased, even as yields remained flat on the back of a lending rate (PLR) cut of 25 basis points. Low-cost deposits form 34 per cent of the total, which is above the industry average, but does not give the bank an advantage vis-À-vis other banks (PNB, SBI, BOB).

Bank of India’s capital adequacy ratio (CAR) stands at 12.39 per cent, well above the RBI’s stipulated limit. The Government holds 64 per cent stake in the bank which is higher than most of the PSB peers. This gives the bank adequate room to raise capital to fund aggressive advances growth.

The bank made Rs 129 crore mark-to-market provision for available for sale (AFS) investments, but it may see some write-backs this quarter, on the softening of bond yields.

For AS-15 retirement benefit, the bank had provided Rs 70 crore for the current quarter (this provisioning will be recurring in all quarters for the next four years).

The bank has to provide for the employee wage revision. It has exposure to risky investments overseas which might lead to losses or higher provisioning.

The bank had also taken a hit of Rs 54.6 crore as the premium on held-to-maturity (HTM) bonds was amortised from interest income. Prudent risk management helped the bank to limit slippages in asset quality. The Gross NPA/advance has come down from 2.29 per cent to 1.64 per cent over the year. Net NPA/advance stands at 0.5 per cent. The provision coverage at 80 per cent will cushion the bank in adverse conditions.

The bank has one of the highest return on equity (28 per cent) and return on assets at 1.25 per cent, which places it among the better banks; the credit deposit ratio is also the highest among nationalised banks.

The bank has displayed robust growth in advances and earnings in a challenging environment. Though it may be hard to replicate the same growth rates going forward, healthy growth rates are still expected.

The management expects 20 per cent growth in advances this fiscal. Given the high corporate exposure, any sharp slowdown in the corporate capex cycle will be a key risk. An increase in PLR by 125 bps is likely to help the bank maintain its NIM at healthy levels in the coming quarters. A core earnings growth at about 19 per cent in FY-09 appears possible; trading profits and forex gains have the potential to boost growth rates further.

Going forward, the bank may have to choose between growth in advances and quality of assets. Low-cost deposits are hard to come by in the current scenario where the banks are wooing customers with higher rates.

As with other PSU banks, the bank is leveraging on its branch network by offering various third-party products such as mutual funds and insurance.

To boost its ‘other income’, the bank has entered loan syndication, increased fee structures across various products and entered into an insurance joint venture with Dai–Ichi. The bank intends to cover operating expenses with its non-interest income this fiscal.

Onmobile Global

Investors with a one-two year perspective can buy the shares of OnMobile Global, considering its strong focus in the domestic mobile value added services (VAS) market. An expanding product offering, increasing global footprint through well-chosen acquisitions, and a wide client base are other key positives. At Rs 485, the share trades at 28 times its likely 2008-09 earnings. That’s not cheap. But the stock is an attractive option considering its strong growth prospects on the back of domestic mobile operators continuing to add 8-9 million subscribers a month, operating profit margins of over 40 per cent, and absence of listed peers. The stock has retreated 35 per cent from its highs, under-performing the broader market in the fall.

OnMobile works with mobile operators for providing services such as caller ringback tones, ringtone downloads and IVR-based services. All leading mobile operators in the country such as BSNL, Bharti Airtel, RCom, Vodafone Essar and Idea Cellular feature on the client list. The revenue share for any VAS product is between 20-25 per cent of usage. With all these operators witnessing rapid subscribing additions and looking to augment non-voice revenues to stem the falling realisation, OnMobile appears well-placed to benefit from the opportunity.

Caller ringback tones and IVR-based solutions are set to dominate non-voice revenues hitherto dominated by messaging alone. A study by IMRB shows that VAS revenues for Indian operators are expected to grow at 70 per cent yearly to Rs 16,520 crore by 2010, with SMS revenues declining and other VAS products taking over. The IVR-based solutions cater to a rural audience, where a bulk of subscriber additions are happening, where cumbersome dialling of codes may be overcome by the local-language based prompts for their VAS requirements.

OnMobile recently acquired Telsima, a natural speech recognition software player that has capabilities in foreign and several Indian languages. This paves the way for additional license fee in addition to revenue share for OnMobile in addition to geographical expansion. The phone backup service acquired through Voxmobili in France offers a higher 25-35 per cent revenue share and already has several Indian operators interested. The company is also a content aggregator for contests, polls, and score updates run by Web sites, entertainment channels and publication houses. The rollout of 3G services by the middle of next year is another significant opportunity for OnMobile.

Possible vendor rationalisation by players such as BSNL and Bharti Airtel and competition from players such as IMI Mobile, Bharti Telesoft and Servion, are key risks to the business.