Indian Multinationals

This article was published in The October 2014 issue of the Global Analyst

We have all been very familiar with Multinational Companies (MNCs) like Nestle, ITC, Unilever, etc., who operate in several countries, including India. Normally MNC’s are bound by the strictures of the parent company in terms of business practices, corporate governance and other related issues. While they derive majority of their revenues in a parent location, the idea is to spread far and wide in as many markets as possible and claim market share. Hence, over a period of time revenues generated outside their mother territory may outstrip the rest of the world. A good example is that of the Las Vegas (U.S. based), Sands Corporation, which generates bulk of its revenues from outside the U.S., in Macau, though it is based in America and is considered an American stock. Another example is that of Techtronic Industries, which is based in Hong Kong, but derives bulk of its revenues from the U.S. through selling power tools via Home Depot.

From a fund management perspective, investing in MNCs that derive more and more revenues from emerging markets than home markets can mitigate political and currency risks that are normally associated with direct investments. According to one study, emerging market operations of MNCs have delivered significant revenue and profit growth compared to home markets. Almost all big multinationals, including Apple, BMW, Prada, etc., are now betting more on their emerging market exposure than home market exposure. Hence, it is not surprising to spot these big names in all emerging markets, including India.

Extending this analogy, it may be interesting to examine how many of the Indian companies have ventured outside India, the so-called Indian Multinationals (IMNCs)! Typically, these would be companies that generate a majority of their revenues outside India. We could identify 10 companies among the 30 companies represented in the Sensex. The top three names belong to the IT sector, which by the very nature of their business models, serve clients outside India. This explains the heavy dependence on offshore markets by the IT majors. Together, they also account for a significant share of the Sensex at 18%. It is also interesting to note names from Auto, Pharma, Petrochemicals and Steel. Although it is common sense to assume that IMNC’s would be predominantly be owned by Indian groups, in cases where foreign ownership is high, it fully explained by FII ownership, which are entities that generally have their interests of investment at the forefront. Barring a few (Tata Steel, and Hindalco) all others have enjoyed good performance in the stock market. 

Company	Business Sector	% Revenue outside India	3-year CAGR (Share price) %	% share in overall Market cap	FII Ownership % June 2014	Foreign Promoter % June 2014	Total Foreign Ownership% June 2014
Infosys	IT Services & Consulting	97	6	4	41.58		41.58
TCS	IT Services & Consulting	93	29	11	16.11		16.11
Wipro	IT Services & Consulting	89	14	3	9.40		9.40
TATA Motors	Auto & Truck Manufacturers	85	29	3	27.52		27.52
Dr Reddy	Generic & Specialty Pharmaceuticals	83	19	1	34.30		34.30
Hindalco	Aluminum	76	-1	1	26.91		26.91
Sun Pharma	Generic & Specialty Pharmaceuticals	76	42	4	22.51		22.51
TATA Steel	Iron & Steel	71	-4	1	18.43		18.43
RIL	Oil & Gas Refining and Marketing	68	4	7	18.61		18.61
Cipla	Generic & Specialty Pharmaceuticals	56	10	1	23.32	20.77	44.09 Source: BSE

How about ownership? Among the 30 companies in the Sensex (not necessarily a broad representation, but will suffice for the case), we can notice four companies with significant foreign ownership exceeding 50% that can consequently be technically defined as foreign companies. However, even here we need to differentiate between FII ownership (which may be subject to quick changes) and Promoter holdings (which is always very stable). In that sense, HDFC cannot be classified as a MNC even though its foreign ownership is more than 50%, since majority of that ownership is due to FII holdings. Hence, the list reduces to Hindustan Lever (part of Unilever group), Maruti Suzuki (part of Suzuki group) and Sesa Sterlite. In general, they mostly operate within Indian market space, as signified by the low % of revenue generated outside India, and tend to represent a sizeable share of the Sensex (measured in terms of market capitalization).

Company	Business Sector	% Revenue outside India	3-year CAGR (Share price)	% share in overall Market cap	FII Ownership%	Foreign Promoter %	Total Foreign Ownership %
					Jun-14	Jun-14	Jun-14
HUL	Household Products	2	23	3	14.58	67.24	81.82
Maruti Suzuki	Auto & Truck Manufacturers	10	29	2	22.36	56.21	78.57
HDFC	Consumer Lending	0	12	4	77.36		77.36
Sesa Sterlite	Iron & Steel	46	-1	2	17.97	54.94	72.91
	Source: BSE

While MNCs eye the lucrative Indian market apart from other markets, IMNCs eye the huge global markets apart from the Indian market. The trend of Emerging Multinationals (EMNCs) is not a new trend. China’s Huawei, Mexico’s Cemex, Russia’s Gazprom and Brazil’s Embraer are but few examples. While some of these EMNCs would have internationalized their national experience, MNCs would have nationalized their international experience like that of Hindustan Lever. Of course, there are pure play IMNCs, like the IT companies (TCS, Wipro, Infosys). 

In my assessment, IMNCs will prosper immensely as they look at global markets as an opportunity set as opposed to just targeting the Indian landscape, alone. However, operationally it may be challenging to coordinate vast networked operations and generate the requisite profits. Also, they may have to manage political and currency risks in the process. Also, from a governance point of view, the IMNCs may not be able to take with them notable or worthy best practices while they compete in new markets, as India is still learning to draft governance codes and is not widely acclaimed for such metrics, currently. On the other hand, foreign MNCs may have a head start here in terms of corporate governance.

What about financial performance?

Indian MNC’s (IMNC’s) enjoy a strong revenue growth relative to MNC’s and emerging market MNC’s though there are exceptions like Tata Steel and Hindalco. The high volume low margin nature of these sectors (steel and aluminum) coupled with strong domestic competition in foreign countries can explain this struggle. IMNC’s also enjoy superior net profit margins which probably results in better RoE and RoA. Again Tata Steel and Hindalco trail the ranking with poor net profit margins leading to lower RoE and RoA. Surprisingly, Hindustan Lever (MNC) boasts of strong RoE and RoA. In terms of debt, IT and Pharma among IMNC’s seem to rely less on this source of capital (due to high operating cash flows probably) while manufacturing sector including Steel, authomobiles, and Pharma have high D/e ratios. MNC’s have low D/E excepting HDFC which is a bank.

IMNC's	Revenue, 5yr CAGR	Net Profit Margin, 5 yr avg	RoE (in %), 5yr avg	RoA (in %), 5yr avg	Debt/Equity (in %), 5yr avg
Infosys	23	24.3	27.1	22.6	0.00
TCS	31	22.8	41.2	30.3	0.50
Wipro	14	17.2	23.4	14.7	22.41
Tata Motors	35	6.0	42.3	7.6	221.29
Dr. Reddy	24	6.3	13.6	7.2	53.83
Sun Pharma	39	29.0	20.9	17.8	4.78
Cipla	19	16.9	17.2	13.1	6.87
Hindalco	7	4.1	11.3	3.3	134.09
TATA Steel	0	1.3	5.6	1.2	190.88
RIL	30	7.0	13.5	6.7	56.75
Multinational Companies (MNC's)
HUL	13	12.6	99.9	27.4	6.88
Maruti Suzuki	21	6.4	16.3	10.8	8.02
HDFC	22	21.8	22.6	2.3	541.68
Sesa Sterlite	91	43.1	25.9	10.7	39.06
Emerging Market (EMNC's)
Huawei	4	9.2	10.7	6.0	75.16
Haier	57	3.1	37.8	11.0	4.57
Gasprom	12	25.7	16.1	11.0	30.52
Embraer	4	5.5	10.6	3.6	73.71
Cemex	-4	-5.9	-7.2	-2.0	99.70
Source: Reuters

In summary, the old concept of MNCs is giving way to a new breed of IMNCs that could add more value to their shareholders by expanding afar the opportunity set, a move that by itself can diversify and reduce risk. However, they have to contend with serious challenges of understanding various geographies, the associated currencies, political and transaction risks. The sagas and travails of Tata Steel-Corus and Tata Motors- JLR acquisitions are still etched strongly in our memory!

Calibrating Regulations

This article was published in The August 2014 issue of The Gulf Magazine

Regulations and regulatory reforms are in vogue these days. The GCC has been witnessing a swathe of regulatory reforms in various sectors. How important is it to calibrate and balance reforms and regulations? This question has become hugely important in this setting.

Broadly speaking, regulations have the following characteristics:

1.     Counter-cyclical nature: We see that policy makers wake up only when there is a disaster in the making! The global financial crisis of 2008 is a great example, post which, a wave of regulations evolved that was mainly aimed at the financial sector. We hardly see regulators active when the going is good. This is actually counter intuitive. Strong regulations should be introduced when the going is good, so that the stakeholders have the energy and the time to pursue them effectively. Locking the stable after the horses have bolted away does not make good sense!

2.     Market Maturity: Regulations can be illustrated as distillations of wisdom gained from ongoing market experiments. Markets evolve over a period of time through multiple experiences and regulations are nothing but an accumulation of such experiences. The troughs and peaks as the markets waltz through time enable regulators to absorb lessons and implement relevant checks and balances as part of the continuous movement towards greater perfection.  In that sense, regulations are milestones that indicate the levels of market maturity.

  

3.     Investor Confidence: Properly introduced regulations and reforms can go much towards enhancing investor confidence. Lack of investor confidence primarily stems from a poor regulatory architecture. A case in point is the emerging and frontier markets, which in spite of its attractiveness, nevertheless suffers from poor investor confidence (especially foreign investors).

4.     Ease of Doing Business: Regulations can go a long way in easing the way business is conducted. If enacted poorly, regulations can also contribute to the opposite. It is generally considered a best practice to measure the effectiveness and success of a particular regulation based on how well it facilitates ease of doing business. Ease of doing business is generally talked about in the context of foreign investors. I feel it does apply in equal measure to local businessmen.

  

5.     Global Perception and Brand Building: Regulations can also contribute to enhanced and improved global perception about a particular market. Preservation of investor rights, intellectual property, speed of legal trials, can be cited as some examples that lead to the strengthening of a particular location or city as a brand (e.g.,Singapore). Major decisions, including setting up of manufacturing units, are critically based on the strength of global perceptions.

In the context of the aforementioned characteristics or essential features of regulations, it is worth mapping the framework to the GCC environment. The below chart illustrates the number of reforms, sector wise in the GCC, since 2008. It is interesting to note that foreign investment is an area where there have been only subdued regulatory movements; while Banking and Financial Services has witnessed intense regulatory pronouncements. There can be reasons for this. Attracting inward foreign capital may not be an immediate priority for liquidity rich GCC states. However, FDI is just not about attracting capital, only. Foreign investment can also enhance the talent pool in the region, bring new technologies, and above all, improve investor confidence and upgrade global perception. On the contrary, Banking and Financial Services is a dominant and highly mature sector contributing to over 50% of the market capitalization in the respective stock markets of the GCC countries. In the absence of an active debt market and due to a paucity of long-term funding instruments, banks end up being the primary mover of the financial wheel. This explains the “over regulated” nature of this sector.

Indicative Number of Reforms in GCC (2008-2013)

Source: Markaz Research

So, what then makes regulations effective?

1.     Balance: Under regulation may inhibit the growth of a sector; while excessive regulations may increase the cost of doing business. Hence, the need to balance regulations carefully.

      2.     Oversight: Declaring a regulation is only the opening gambit, while the real challenge lies in the implementation on the ground. A case in point are the Capital Market Authorities across many GCC countries. While CMAs’ require a spate of documentation to be submitted by the companies, they may not have the commensurate infrastructure or technology to monitor all the submissions and take action where necessary.

      3.     KPI's: Regulations become effective only when regulators don’t limit their role to just policing and fining. The agenda of regulators should be more broad based and should include the development and growth of the sectors that they are regulating. If after a decade of regulations, a sector has failed to demonstrate growth and development, then the regulators should also share the blame!

      4.     Cost: Mindless regulations should be avoided as compliance cost is an important component with respect to economic efficiency. This is particularly true of “imported regulations”, which under the name of best practices, are whisked in with little consideration given to their applicability vis-à-vis local realities.

In summary, it can be said that there can be no doubt about the integral and important role that effective regulations have. The role that they play in the organized development of a market cannot be understated or deemphasized. However, calibrating regulations and achieving a fit balance is the need of the hour.

Global Aviation: The Hare’s and the lone Tortoise!

Sometimes, figures speak more than the words. Recently I perused with interest the global aviation traffic (top 50) which revealed several insights about the gap some emerging countries like India faces in the global aviation traffic market place.

The top 50 airports in the world shared by 23 countries ferried 2.3 billion passengers accounting for 50% of the global population during 2013. USA leads the pack in terms of total passenger traffic nearly thrice the size of its population and boast of the largest network of airports to support this traffic density. Nearly 814 million people travel every year through 17 airport network within USA with Hartsfield–Jackson Atlanta International Airport being the largest ferrying around 94 million passengers followed by O'Hare International Airport with about 66 million. In terms of global ranking, Beijing Capital International Airport is now second largest after Atlanta International Airport with about 83 million passengers. However, it is the combined strength that matters more here than individual airports. At 17 airports, USA is air miles ahead of all other countries with China accounting for 7 airports in the top 50.

Dubai tops the table from a density point of view (defined as total passengers that pass through its airport relative to its population). At 66 million passengers, it transports 30 times its tiny population. Singapore Netherlands and UK also follow this hub model where there is distinct lack of connect with local population and aviation travellers though not as pronounced as Dubai.

USA is a case of domestic demand triggering the growth while countries like Australia, Spain, Malaysia and Turkey relying probably on tourist traffic to populate its air traffic density.

How about the BRIC’s? Excepting China which made inroads in the traffic density, all other countries are laggards with India being a notable one. With a population exceeding a billion, India’s total air passengers numbered only 68 million, a measly 6% of its population compared with 25% for China, 257% for USA and 3000% for Dubai. Though two airports figure in the top 50, (Delhi and Mumbai), the gap is significant and noticeable. Poor airport infrastructure, lack of focus to develop the country as a tourist destination, security concerns, affordability, poor regulations and above all economic stagnation all contribute to this sorry state of affairs. The train travel is also heavily subsidized making the conversion very difficult. While the noise made by low cost airlines and the associated price wars is interesting and may give an impression that Indian aviation is probably full of activity, statistics show that we have raced to the bottom over time and have a huge catch up to do. While in this race of global aviation traffic, there are several hare’s (USA, China, Dubai, etc.), there is only one tortoise!