US Immigration Bill - impact on Indian IT industry

The Indian IT industry will be cautiously following the US immigration bill to be introduced this week by the US Senate, with the objective to provide for comprehensive immigration reform, increase visas for skilled workers; and beef up border security.

Passage of the bill could be a boon to high-tech companies like Intel Corp.  or Facebook Inc., who would be able to hire more highly skilled workers from abroad. But the US immigration bill is likely to impede the operations of the Indian IT services cos.

The IT services industry grew rapidly in the 1990s.  Due to the Y2K hype, businesses were apprehensive about their IT systems and so there was demand for IT service providers. Once the Y2K hype was over, the customers became conscious of their IT spending. Consequently, the suppliers had to hire overseas, particularly in India, and that paved way for the off-shoring trend that is currently seen.

Indian consulting firms like TCS and Wipro introduced off-shoring by charging lower prices per consultant. These firms basically enjoyed the labor arbitrage due to large number of consultants working in India enjoyed and competed in terms of pricing. Big IT consulting houses like IBM and Accenture had to hire IT professionals in India and charge similar prices per consultant. 

In order to maintain their cost advantage, besides deploying a large pool of offshore resources, the Indian IT services companies also paid lower wages to employees travelling to the U.S on H-1B or L-1 visas, as compared to equivalently skilled Americans. 

The proposed US Immigration bill proposes wage parity between guest workers in the U.S. and equivalently skilled Americans. As such the Indian outsourcing companies that have a large no of on-site employees on US work permits, will need to pay them higher salaries. This will negatively impact the cost advantage that the Indian IT services companies have enjoyed so far.

As per the proposed bill, the companies will have to pay a $10,000 fee per additional worker if the employer has 50 or more employees and more than 50 per cent of these workers are H-1B or L-1 employees without a green card petition pending. Domestic companies like TCS, Infosys and Wipro will have to pay USD 10,000 for each additional H-1B employee they would be hiring.

On the positive side, it will also enable 11 million workers in the US including 2.4 mill Indians to obtain American citizenship. Another proposal is to award residency to those who earn doctorates from U.S. universities in mathematics, engineering, science or technology.

Management of Indian IT services companies are concerned about the increase in compliance cost and higher turnaround times, which would fundamentally affect competitiveness and the margins of these companies.

As it will take a few more months for the bill to be implemented, the Indian government, and outsourcing industry will be closely following the debates. Meanwhile the Indian IT services companies may need to look at revamping their business models to remain competitive.

Markets - On the Roller Coaster

The excessive market euphoria that was apparent in the beginning of the month has faded and has given way to apprehensions for investors worldwide.

Even as the markets seemed to recover from the concerns over Cyprus bank run, tagging it a one off event, the news of political turmoil in Italy shook the European stock markets. Greece's ATHEX Composite was off 4.8%. US indexes opened in red today. This certainly signals nervousness and dampened sentiments of investors. The Asian markets will also be impacted negatively.

Bank deposits that were so far considered as safe investment options, no longer seem to be safe after the Cyprus government decided to levy taxes on deposits, in a bid to secure bailout package from the European Union. The banks have remained closed for about a week and are likely to reopen with the imposition of capital controls by Cypriot authorities. This will limit the ability of the customers to access and withdraw money for a certain period of time, and thus save the banks from bankruptcy. Either ways it is a no-win situation. A bailout deal will send the country into recession, encourage small investors to hoard cash, and prompt foreign depositors to shift to other investment bases.

The fear that banking crisis may spread over to other European countries has spooked the investors. Adding another element of uncertainty to Euro Zone, is the inability of Italian politicians so far, to put together a new coalition government since parliamentary elections in late February. All these factors put together may cause a decrease in the inflow of global funds arising from the loss of investor confidence in the Euro Zone.

In India too, the United Progressive Alliance (UPA) coalition government may find it difficult to sustain due to withdrawal of support from alliances, thus creating conditions for early elections. After DMK pulled out of the  last week, the Samajwadi party has threatened to withdraw support too. If the Foreign Institutional Investors perceive that the Indian government will not have with enough bandwidth to carry out the envisaged and much needed economic reforms this year, then India too will see a decrease in the inflow of FII funds, which provide liquidity to the market.

As the sentiments have turned pessimistic, global markets will look up to political stability and announcement of measures for risk / crisis management to continue with the further run. 

Global Markets - Riding high on sentiments

Worldwide markets are echoing bullish sentiments.

The US Dow Jones Industrial Average index has surpassed its 2007 high and continues to make new all-time highs. The Standard & Poor’s 500 Index too is trading at post-2007 highs. Asian & European markets are rallying too based on cues from the US market. Indian markets are recovering from February lows.

All this barely a week after the US sequestration set in on March 1, 2013!!

The bullish markets have revived positive sentiments and created excitement, but it also warrants cautiousness. In wake of the upsurge, the markets appear to be discounting all negative news and taking ahead the rally based on selective good news or on expectations of continued monetary easing by the respective Central Banks.

The US market has chosen to focus on and celebrate the news of drop in US jobless claims monthly average to a 5 yr low, while ignoring the data that US trade deficit has widened in January to $44 billion and the US year end productivity has dropped to 1.9%, the biggest decline since 2008. As per the Sequester, about $85 billion in spending reductions will automatically occur in US by the end of Fiscal Year 2013.

The UK market was up on hope of cut in interest rates by Bank of England (BOE). UK’s manufacturing sector has contracted and this posses a major challenge for UK’s economy. BOE left its key lending rate unchanged in March. The European stock markets fell marginally after the European Central Bank kept rates on hold as expected.

Bank of Japan too kept its policy unchanged and decided not to step up monetary stimulus. Nikkei has been trading strong.

In India, on 28th Feb, the Finance Minister had presented the annual budget, aimed at reducing the widening fiscal deficit by cutting down government expenditure, increasing revenue and promoting growth. The quarterly GDP growth figure has slipped to 4.5%, the lowest in a decade. The market crashed after the budget speech was delivered by the Finance Minister, but recovered in the 1st week of March, following global cues. The uptrend may remain intact if the global markets are up as the speculation build up around Reserve Bank of India cutting interest rates to spur growth.

The markets are climbing higher, raising the hope that maybe the worst is behind us. But the question is whether the new highs will hold and for how long, particularly when the rally seems to be based more on market optimism rather than fundamentals. 

Market Reaction to new CEO announcement

On 21st Nov, Indian generic drug maker Cipla Ltd. announced its plans to acquire South African firm  Cipla Medpro. Subsequent to the announcement that is likely to boost its prospects in Africa, and is expected to be accretive to earning, Cipla Ltd. shares rose by more than 3 % after the announcement and were trading at Rs 390 on NSE.

On 22nd Nov, Cipla Ltd announced the appointment of Mr. Subhanu Saxena as Chief Executive Officer. Mr. Saxena has rich work experience of over 25 years, in industries as varied as FMCG, consulting, banking and pharmaceuticals. Following the announcement of the appointment of new CEO, Cipla share fell down during the day while the NIFTY index showed a upward movement. Cipla share price clearly did not follow the pattern in sync with the movement of NIFTY. 

This weak movement of the share price on 22nd Nov could have something to do with the announcement of new CEO appointment. Generally some market reaction is expected around the announcement day of a CEO appointment. In considering CEO candidates, boards of directors and selection committees are almost always concerned about the market reaction on the company’s share price.

At times markets tend to react unfavourably to the announcement of a new CEO, as investors may anticipate some amount of uncertainty involved with the change in CEO. There are other instances when there have been positive abnormal returns around the announcement of an outside CEO appointment. In such cases, results suggest that new outsider CEO appointments can be considered as beneficial to investors because they bring in knowledge from other organizations and can objectively evaluate and challenge the current strategy of the company and incorporate new and fresh ideas

.

Though the initial market reaction is in anticipation of  the CEO’s likelihood of success, however a  latest research by HBR shows that there is no positive correlation between how a company’s stock fares upon the announcement of a new CEO and the share price over that CEO’s tenure so the initial market reaction should not be considered an indicator of the CEO's likely performance.

Irrespective of the initial market reaction, it will only be evident over a period of time how the new CEO steers the Cipla towards higher levels of growth and creates value for the shareholders.

Challenges facing India’s Infrastructure Sector – Part II

In my last post, I had written about the challenges faced by infrastructure sector in India. If we were to look into the reasons behind the challenges in India’s Infrastructure sector, we see that the problems can be broadly categorized into structural or procedural in nature.

Structural reasons:

1.    Faulty incentives: Government organizations as well as the concessionaire are wrongly incentivized while implementing the infrastructural projects. Government contracts are generally awarded on the basis of lowest price and this encourages private players to undercut each other in prices for winning the contracts, thus resulting in poor quality bids and shifts the focus from long term viability of the project to short term gains, while transferring the risk to debt owners or the tax-payers.

2.   Oligopoly of project proponents: Infrastructure projects require very high capital contribution and bank funding. Since India is still young in terms of numbers and complexity of infrastructure projects executed, at present we find only a handful of companies bidding and being awarded with projects in the country leading to a situation of “managed competition” where projects theoretically can be “distributed or shared”.

3.   High cost of funding : High cost of borrowing both from bank loans and bonds, has off late increased reliance of companies on ECB to reduce cost, which exposes the project to currency volatility, underestimates cost over the project period and increases the risk of correctly forecasting cost of borrowing subsequently when refinancing.

Procedural Reasons

4.    Under assessment of risks: The quality of data/ information on which key assumptions are based have a great role to play on the integrity of the project. Under assessment of risks due to faulty assumptions, allows the bidder to quote low price for end users charges, which after a while may not be sustainable as can be seen in the cases mentioned in my last article, leading to situations where the concessionaires attempt to re-negotiate contract, citing some excuse, often soon after being awarded the project. Government agencies with the responsibility of evaluating the bids, need to take a objective view of the nature and severity of risk involved. On solution could be that the Government agency entrusted with the implementation of the project could fix boundaries for various parameters including end user charges, so that bids are within band in which bidders compete on the basis of better understanding and forecasting of risks, efficient use of resources and quality of management, rather than reckless gambling.

5.   Reduction of promotor’s stake in risk and reward: As is the international practice, in project finance/ PPP projects, some of the consortium members and equity contributors are also providers of goods and services for execution of the project. Such companies always have some room to recover their investment through innovative pricings of sub-contracts much before the cash waterfall would allow payback to equity providers. If such a thing does happen, it leaves the founder companies with virtually no risk and creates ground for them to be opportunistic during subsequent bargaining for revision of prices.

6.   Delay in fixing accountability: The slow judicial system in the country causes delays in enforcing liabilities in case of mistakes committed by companies or when companies try to put themselves at an advantageous position vis a vis other stakeholders. Delays can cause erring parties to get away with playing around in the grey zones of the contractual agreement and passing on the burden to the end users and tax payers.

All these factors point to the need for a more favorable environment, with institutions, mechanisms and improved governance standards to bring in the required efficiencies for allowing PPP to evolve and mature. 

Related articles

• Plan panel to approach Cabinet with mechanism for PPP disputes (news.in.msn.com)
• Public Private Participation in India - Issues & Challenges

Public Private Participation in India - Issues & Challenges

Infrastructure development had been identified as a critical prerequisite for sustaining the growth momentum of the Indian economy. Given the huge infrastructure deficit that India is facing, government has increased the target for infrastructure outlay during the twelfth plan period (2012 - 2017) to one trillion dollars, about half of which is envisaged to come from the private sector, including an annual $30 billion in foreign direct investment (FDI) inflows. Attracting such astronomical sum of investments will require the government to create a conducive environment with robust institutions and improved governance standards to ensure consistency and predictability of returns for the investors and to mitigate the risks of financing. Ensuring improved governance standards has so far emerged as the main challenge in meeting the country’s infrastructure shortages.

The infrastructure projects, though significant for the economic development, are highly capital intensive, require investments with a long time frame and hence are fraught with uncertainty. So Public Private Participation (PPP) are being seen as an efficient way to bridge the country's infrastructure deficit, by engaging both the public and private sector and thereby distributing the associated risks.  PPP projects are basically implemented in Project Finance mode where the liabilities of the company are non-recourse. The projects are usually undertaken by a consortium of developers who execute the project and a consortium of lenders who provide debt. Such projects may require a number of rounds of financing during its life time. The greatest challenge in PPP projects is to understand the risks and adequately distribute and manage them to make it beneficial for all the key stakeholders involved in it.

A series of events bring out the flaws in execution of PPP projects in India.

1.  Independent Power Producers/ Ultra Mega Power Producers including those promoted by powerhouse like Tatas and ADAG have appealed for upward revision of power off take price much before the contracts are due for renewal. The steep increase in tax introduced by major coal exporters like Australia and Indonesia, have severely impacted the cost of operations of the power plants using imported coal. It is apparent that the project developers had failed to reasonably assess this risk at the time of submission of their proposals. 
2. There have been reports of violation of Concession agreements in toll road projects including few cases where the concession agreements were terminated. Many such cases have gone into litigation. In highway development, most of the disputes have arisen due to controversies in payment and collection of toll for finished projects and rolling of credit and interim payments as concessionaires missed completion deadlines in projects under execution. According to the National Highways Authority of India (NHAI), the Gurgaon Expressway Project, that was supposed to be the showcase for tolled highways in India has everything going wrong with it — corruption in toll collection, substandard construction and maintenance, chaotic traffic management and unsafe ride.
3. The Airports Economic Regulatory Authority (AERA) approved an increase of 346 per cent in airport charges by Delhi International Airport Limited (DIAL), to help them recover the cost of operating the airport. This has adversely impacted thousands of passengers and resulted in Delhi being the most expensive airport in the Asia-Pacific region. Both domestic as well as major international airlines operating out of India have challenged the steep increase in airport charges and dragged DIAL to court.  
4. Airport Metro Line in Delhi, used by over 15,000 commuters daily, was suspended after safety concerns of the elevated tracks were raised by Reliance Infrastructure-led consortium, which operates the line. As a public-private project, Delhi Metro Rail Corporation (DMRC) has built the civil structure on the Line and Reliance Infrastructure is responsible for operations and maintenance. There operations have been incurring losses; this has led to the speculation if financial losses are the reason for suspension of services. .

While the concerned parties do have a right to protect their interest, repeated disagreements and litigations point to basic faults in the way PPP is being implemented in the country. So one would obviously ask- why the project developing consortiums were unable to predict the turn of events and did not provide for it in their bids and why did the Government accept their overtly ambitious and faulty bids.

In the next section, we will further analyze the issues facing the infrastructure sector in India.

Related articles

• Plan panel to approach Cabinet with mechanism for PPP disputes (news.in.msn.com)
• Challenges facing India’s Infrastructure Sector – Part II

How far will the Jaguar leap - Corporate Turnaround

Tata Motor's acquisition of Jaguar Land Rover is one of the most discussed cases of a successful outbound acquisition by an Indian company. Owing to rise in JLR volumes, Tata Motors reported a 136% jump in the consolidated net profit for March, on 30^th May, 2012. However, immediately afterwards, Tata Motors shares fell by nearly 12% in a day, due to Quarter on Quarter dip in the EBITDA margin of JLR, which accounted for 90% of Tata Motors net profit.

Flashback to June 2008. Tata Motors had acquired two iconic British brands - Jaguar and Land Rover (JLR) from the US-based Ford Motors for US$ 2.3 billion. This was the biggest buy-out in the automobile space by an Indian company. Ford Motors Company (Ford) had acquired Jaguar from British Leyland Limited in 1989 for US$ 5 billion. After operating it for losses for few years, in June 2007, Ford had decided to divest the brands as a part of its restructuring strategy. Tata Motors was interested in acquiring JLR as it would reduce the company’s dependence on the Indian market and facilitate Tata Motor’s entry into the luxury segment. In addition to the US$ 2.3 billion it had spent on the acquisition, Tata Motors had to incur a huge capital expenditure as it planned to invest another US$ 1 billion in JLR.

JLR being a British powerhouse brand, people questioned how Britain could allow Jaguar to be sold first to Ford, and then to Tata. The deal was not very well perceived due to the Indian ownership and the fears of outsourcing of jobs, technology and the brand to India. Analysts feared that Tata had made a mistake. Morgan Stanley reported that JLR’s acquisition appeared negative for Tata Motors as it had increased the earnings volatility during the difficult economic conditions in the key markets of JLR including the US and Europe.

Flash forward to 2012. JLR, a business that was battling for survival three years ago, has reported record annual sales and a 35% increase in pre-tax profits to £1.5bn due to surging demand in China.

How did Tata Motors manage to achieve such a remarkable turnaround for JLR?

To begin with, cash management and cost management were identified as the key priorities. A three-tier model was developed with the help of Roland Berger Strategy Consultants. First, a short-term goal to manage liquidity with the assistance of KPMG was put in place. A cash management system was built to manage cash on an hour to hour basis. Then came a mid-term target to contain costs at various levels and the formation of 10-11 cross-functional teams. A number of management changes, including new heads at JLR, were made and the workforce was reduced. Finally, a long-term goal that runs until 2014 was drawn up, focusing on new models and refreshing the existing ones.

Tata had also acquired the IP and skills from JLR that enabled them to locate a substantial part of production and supply chain in South Asia. This helped in bringing down the cost of production. Tata Motors divested stakes in group companies to raise cash. The proceeds were channelled for innovation and product development. A separate IT ecosystem was set up for JLR. JLR was always considered to be top end high end luxury brand but Tata added new products like Evoque which made the brand image a bit soft and targeted towards urban people, while still keeping the luxury branding intact. This brand image change by Tata worked in favour of JLR, helping it not only to survive but also to become an international powerhouse once again.

Tata’s footprints in South East Asia helped JLR to diversify its geographic dependence from US and Western Europe. After the downturn of 2008-09, JLR made its first operating profit in the quarter ending September, 2009. The profits continued in 2010, with an increase in Ebitda of 50% q-o-q. In 2011, JLR posted record annual profits of more than £1bn.

For the next five years, Tata has annual investment plans of £1.5 billion for JLR to impart the brand with a sustainable competitive advantage. How far Tata Motors will make the Jaguar leap is yet to be seen.