Intellectual Thoughts by Sanjay Panda !!!!!: 2006


Sunday, December 31, 2006

Agricultural reform

When the National Commission on Farmers (NCF) mooted the idea of putting agriculture on the Concurrent list of the Constitution so as to bring it under the direct control of the Centre, nobody expected the states to readily agree to this radical suggestion and that’s what happended during the meeting of state agriculture ministers who met in New Delhi last week to discuss the recommendations of the NCF. No party in power would want to give up control over policies and programmes that could influence the vast rural vote bank. But that does not mean that there is no merit in NCF’s proposal, which was aimed primarily at addressing the issue of multiplicity and dissimilarities in taxes and levies, marketing laws and curbs on goods movement in different states.

The present scenario is far from conducive for creating a single all-India market for agricultural produce, which is what has been suggested by the NCF in one of its preliminary reports. While getting agriculture onto the Concurrent list will not happen in the foreseeable future, it is good that the states have endorsed most of the other recommendations of the NCF which included, significantly, the point that a distinction should be made between minimum support prices (MSP) and the procurement prices at which the government buys grain for its buffer stocking operations and for feeding the public distribution system. This means that market intervention at the MSP should be only to prevent distress sales by farmers, while grain procurement for the public distribution system and the various welfare schemes (like food-for-work) should be on commercial terms. Had such an approach been adopted in the last rabi marketing season, wheat procurement would not have been so low as to necessitate 5.5 million tonnes of imports by the government, at heavy cost to the exchequer.

Equally noteworthy is the NCF’s recommendations regarding the conservation of soil and water resources, and its opposition to the allotment of prime agricultural land for the creation of special economic zones and other non-agricultural purposes. Any perceptible shrinkage of farm land would not be advisable, especially at a time when the overall farm productivity has tended to stagnate, for it would gravely impact growth in the agricultural sector. In fact, what is needed is reversal of the process of land degradation through a massive programme for the reclamation of degraded lands so as to bring them under crop cultivation or, else, under productive plantation or forest cover. The objective of most NCF recommendations is to improve livelihood and income opportunities for farmers so as to prevent them from falling into a debt trap, leading to extreme cases like suicides. The need for moving in this direction is borne out by the National Sample Survey finding that over 40 per cent of farmers want to give up farming because it does not yield an adequate income. The NCF has suggested creation of income-generating opportunities in villages through activities allied to agriculture, besides in the non-farm sector. Now that the formulation of a national policy for farmers has begun, on the basis of the recommendations of the NCF and the views of state governments, these issues should be kept in focus and emphasis must be laid on the farmers income & livelihood rather than the cheap vote bank politics which politicians are exploiting for last several decades.

Wednesday, December 27, 2006

Money - 7 good reasons to invest in SIP's

Fact No. 1: Over a long term horizon, equity investments have given returns which far exceed those from the debt based instruments. They are probably the only investment option, which can build large wealth.
Fact No. 2: In short term, equities exhibit very sharp volatilities, which many of us find difficult to stomach.

Fact No. 3: Equities carry lot of risk even to the extent of loosing ones entire corpus.

Fact No. 4: Investment in equities require one to be in constant touch with the market.

Fact No. 5: Equity investment requires a lot of research.

Fact No. 6: Buying good scrips require one to invest fairly large amounts.

Systematic Investing in a Mutual Fund is the answer to preventing the pitfalls of equity investment and still enjoying the high returns. And it makes all the more sense today when the stock markets are booming.

1)It's an expert's field – Let's leave it to them
Management of the fund by the professionals or experts is one of the key advantages of investing through a mutual fund. They regularly carry out extensive research - on the company, the industry and the economy – thus ensuring informed investment. Secondly, they regularly track the market. Thus for many of us who do not have the desired expertise and are too busy with our vocation to devote sufficient time and effort to investing in equity, mutual funds offer an attractive alternative.

2. Putting eggs in different baskets Another advantage of investing through mutual funds is that even with small amounts we are able to enjoy the benefits of diversification. Huge amounts would be required for an individual to achieve the desired diversification, which would not be possible for many of us. Diversification reduces the overall impact on the returns from a portfolio, on account of a loss in a particular company/sector.

3. It's all transparent & well regulated

The Mutual Fund industry is well regulated both by SEBI and AMFI. They have, over the years, introduced regulations, which ensure smooth and transparent functioning of the mutual funds industry. This makes it safer and convenient for investors to invest through the mutual funds.
4. Market timing becomes irrelevant One of the biggest difficulties in equity investing is WHEN to invest, apart from the other big question WHERE to invest. While, investing in a mutual fund solves the issue of 'where' to invest, SIP helps us to overcome the problem of 'when'. SIP is a disciplined investing irrespective of the state of the market. It thus makes the market timing totally irrelevant. And today when the markets are high, it may not be prudent to commit large sums at one go. With the next 2-3 years looking good from Indian Economy point of view, one can expect handsome returns thru' regular investing.
5. Does not strain our day-to-day finances Mutual Funds allow us to invest very small amounts (Rs 500 – Rs 1000) in SIP, as against larger one-time investment required, if we were to buy directly from the market. This makes investing easier as it does not strain our monthly finances. It, therefore, becomes an ideal investment option for a small-time investor, who would otherwise not be able to enjoy the benefits of investing in the equity market.
6. Reduces the average cost
In SIP we are investing a fixed amount regularly. Therefore, we end up buying more number of units when the markets are down and NAV is low and less number of units when the markets are up and the NAV is high. This is called rupee-cost averaging. Generally, we would stay away from buying when the markets are down. We generally tend to invest when the markets are rising. SIP works as a good discipline as it forces us to buy even when the markets are low, which actually is the best time to buy.
7. Helps to fulfill our dreams
The investments we make are ultimately for some objectives such as to buy a house, children's education, marriage etc. And many of them require a huge one-time investment. As it would usually not be possible raise such large amounts at short notice, we need to build the corpus over a longer period of time, through small but regular investments. This is what SIP is all about. Small investments, over a period of time, result in large wealth and help fulfill our dreams & aspirations.

Friday, December 15, 2006

Technology- Digital printing market in India

It’s a war out there to grab a share of the growing digital printing market in India. The printing and graphics industry is expected to turn a shade brighter in 2007-08. The Indian digital printing industry is projected to grow to $17 billion by 2010, from an estimated $11 billion in 2005 (as per print and packaging research organisation, Pira International). Gone are the vendors’ obsessions with niches where digital printers might be lucky enough to find a hundred thousand impressions per month. For that matter, a number of the digital print providers who pursued those niches are gone, too.
A buoyant industry estimates that between 2006 to 2015 digital printing products (world-over) will account for almost 30-35 per cent of the overall printing market. In 2005-06, the emphasis shifted from the niches for digital printing to sheer volumes as vendors ramped up shipments of new high-capacity digital colour presses with lower operating costs. The resulting explosion in volume was no surprise. “Digital colour printing is finally on the threshold for the explosive volume growth that monochrome digital printing experienced in the last decade.
In its endeavour to spread awareness about the digital printing industry, Xerox India along with Karnataka State Printers Association and the Government of Karnataka announced a joint tie-up for setting up the first-of-its kind print testing and training centre in Bangalore and has also set up a Xerox Innovation & Technology Excellence Centre with an investment of Rs 5 crore. Expecting growth for personalised print jobs, print-on-demand, shorter run lengths, Xerox and HP hope to tap verticals such as banking, telecom, insurance, retail, manufacturing and graphic arts. HP also intends to play an important role in all the e-governance projects defined by the government of India. Lexmark, on the other hand, is aiming for the Internet companies, BPOs and KPOs to fuel its growth. “With India being one of the world’s largest IT hot-beds, the demand for digital printing equipments is bound to escalate. With one third of digital work expected to be personalised by the end of 2006, personalisation and customisation are the two big trends where Xerox, HP, Lexmark and Canon hope to play a key role.
In an industry dominated by low-cost conventional printing technologies such as offset, flexography, and gravure, it is not surprising to note the demand for digital printing is shaping out to be highly elastic in nature. Applications like Web-to-print, variable data printing and short-run digital printing have been a hit among creatives and publishers, telecom and financial institutions. “Innovation from a product generation perspective would continue to be around the three vectors — cost of printing (a combination of equipment media and ink), image quality and speed.” HP has recently revealed a breakthrough technology, Edgeline, which, it claims will change the way enterprise customers look at printing. The penetration of digitised variable data printing is facilitated due to the need for regional or local messaging (in B and C class cities) either on the telephone bills, tax statements, and receipts that no offset printer can manage. Digital monochrome and colour printing together account for less than 3 per cent of the volume of publication and commercial printing in 2006 but is predicted to reach 25 per cent by 2010. Nevertheless, digital printing is not going to overpower the traditional industry anytime soon. However, the digital segment will soak up most of the growth across the total market. That sure is great news for those print providers who are going digital and is also a challenge for the rest to get moving.

Thursday, December 14, 2006

Money- Why to worry on Hedge funds

Indian financial regulators get skittish when the word “hedge fund” is used. Recent announcements suggest some movement by Sebi and the ministry of finance in their favour, while the RBI continues to argue against. One source of fear of hedge funds is the notion that all hedge funds act in concert. However, the global hedge fund industry is highly competitive. Over $1 trillion is managed by more than 8,000 hedge funds, each of which fights to gain an edge over the others. Coordination between such a large number of adversarial entities is impossible. Though a herd mentality can set in, on any given day some hedge funds will buy and some hedge funds sell.

The customers of hedge funds are institutions and sophisticated individuals. They have the wherewithal to monitor hedge funds, and shift assets to the best return-to-risk ratio. They keep the hedge fund manager on his toes. Marketing gimmicks targeting retail investors can put money into the hands of an incompetent manager. Such gimmicks do not work in the hedge fund sector, which is meritocratic and performance-driven. Fearful third world regulators like the RBI harp on the LTCM episode of 1999. Just as one plane crash does not render all plane travel useless, the case for hedge funds is not invalidated by one problem. The recent demise of Amaranth—where losses bigger than LTCM took place—shows improving institutional structures. From a regulatory viewpoint, Amaranth was a pleasant episode. A few rich men lost money, while hedge funds as a whole continued to trade every day, making markets more efficient.
There are two alternative strategies for regulation. On the one hand is the US path, where the government is not involved in the relationship between the hedge fund and his customer. Alternatively, in the UK and in Scandinavia, there is some light-touch regulation. In either case, the activities of hedge funds in securities markets have to comply with all margin requirements, position limits, etc. In India, given the penchant for turning a whiff of regulation into an onerous licence-permit raj, the US route would be better. A US-style policy framework needs to be created, to support both foreign and domestic hedge funds. The international consensus today says that hedge funds engage in rational trades and supply liquidity. The smartest analytical financial economics, the best Ph.D.s, and the best computer technology for trading are now in the hands of hedge funds. India needs their risk-taking, their liquidity provision, their analytical minds, and their systems. Foreign hedge funds are useful since they would not get shaken by the ups and downs of the market in the way that local investors do. On the interest rate and currency markets, India has failed to build meaningful markets; the active and intelligent trading of hedge funds can induce a paradigm shift. On the equity market also, the volatility of May 2006 has given a drop in liquidity which has still not been erased. Monthly traded volumes in equity spot and derivatives markets have dropped sharply. The gutsy retail liquidity providers of India have been shaken by the volatility of May 2006. Globally diversified hedge funds are a useful source of liquidity provision in Indian financial markets.

BS-editorial

Sunday, December 10, 2006

Dollar- Uncle Sam's worry

Those who react to last week’s fall in the dollar’s exchange rate and predict that the US currency is set for a further dip, would be well advised to read some of the forecasts made a couple of years ago, when the dollar had suffered a similar decline. Currency experts, bankers and economists were predicting then that the dollar would drop to as low as $1.50 against the euro, even $1.80 and $2.20. None of that happened, the dollar recovered, and life went on as usual. Now there is another round of nervousness, with the dollar dipping noticeably last week and having fallen by about 15 per cent this calendar year (though by barely 2-3 per cent against the rupee).

Is the long-predicted decline of the dollar about to happen at last, or is this another false alarm? That there is reason for worry, if not alarm, is easy to see. US housing has dipped for seven months in a row, US manufacturing has dipped for the first time in two or three years, and if the Federal Reserve drops interest rates (after a five-month hiatus) to try and revive the economy, capital could flow out of the US and further weaken the currency. If the Asian economies that hold foreign currency reserves of between $1.5 trillion and $2 trillion, decide that the dollar is not a safe store of value and look for alternatives, that will put still more pressure on the currency. ( Iran has decided to Euro against USD, thought it’s a different question why???) If, on the other hand, the Fed leaves interest rates untouched (for it is also worried about continuing inflation), it could slow down the US economy even more—and add to problems from another direction.

Surveying the flurry of comment on the subject, the most noteworthy is what has been said by The Economist. In a leading article it argues that, contrary to popular opinion, US productivity levels have not been improving faster than European levels, and that it is Europe which has greater room for productivity improvement. If true, that would argue in favour of a further weakening of the dollar as it argues in favour of switching to the euro as the currency of choice. With the dollar already close to its all-time low against the euro, some new currency benchmarks might well be set in the coming weeks. The other point worth noting is that the dollar has not really gained much ground this year against either the yuan or the rupee. Trade with India is not significant for the US, but that with China is—and if the yuan does not appreciate, much of the gains to be achieved from a cheaper dollar (through a reduced trade deficit) get nullified. From India’s perspective, the economy’s undoubted gains in productivity should help the rupee climb against the dollar, but the continuing weaknesses in the physical and financial infrastructure prevent that from happening, and the Reserve Bank is left with the task of pursuing an otherwise illogical currency policy and continuing to accumulate foreign exchange reserves in order to make up for the failures of the reform programme. There is no gainsaying that the US needs to do quite a lot of course correction in order to tackle its twin deficits (fiscal and trade), but if the dollar does fall further, it will test the quality of response from the other major economies—which now include India. If they fail the test, then global growth will be the casualty

Saturday, December 9, 2006

Biocides- Making a killing

According to a new report by Kline & Company, Specialty Biocides 2004-2005, the West European market for speciality biocides is currently the second largest on a global basis behind that of the US. Valued at around €485 million for a volume of around 125,000 tonnes on a 100% active basis, the West European market will continue to exhibit only modest growth (averaging 2-3% overall) over the five years from 2004 to 2009. The US market, by contrast, is worth about €1,175 million, Japan's is worth €185 million and China's €92 million, though growing rapidly.
As Figure 1 shows, Western Europe's speciality biocides market is less driven by water treatment applications than the US market, and more by industrial preservation.

Figure 1 - Main global markets for speciality biocides

However, the latter is far more important in terms of relative market share in Japan and China than it is in either Western Europe or the US, where 'other' applications, notably wood preservation, leather tanning and household and industrial and institutional (HI&I) cleaning products, loom larger.The most significant driver for future biocide consumption in Western Europe is changes in legislation that is currently uncertain and difficult to predict. Such legislation includes the Biocidal Products Directive (BPD) and the potential reclassification of, and increased labelling burden for, selected biocidal actives.
Suppliers of speciality biocides have already invested significant time and resources into generating the data required for the BPD approval process. In many cases, this process has been slow and drawn-out because active ingredients for each application have been reviewed in a stepwise fashion.
Concurrently, companies from China and India have been flooding the market with generic products, driving prices down, further suppressing profitability and generally adding insult to injury for West European suppliers of biocidal actives. However, manufacturers with a smart BPD strategy and strong products could see a healthy long-term return on their investment.
The product and application mix in Western Europe differs in terms of volume and value. Organosulphur biocides, including isothiazolines, dithiocarbamates, pyrithiones and thiocyanates, lead on a value basis, with a 25% market share. Nitrogen-based products rank second with a 23% share; this category include quats, triazines, THPS, oxazolidines among many others (Figure 2).

Figure 2 - West European market for speciality biocides by product chemistry

Figure 3 - West European market for speciality biocides for industrial preservation by application

Looking at the market from an applications standpoint, industrial preservation ranks first, with a 35% share by value of the overall West European market for speciality biocides, excluding formulations. Figure 3 shows the market segmentation for industrial preservation by application
Three key drivers are impacting such industrial preservation applications as marine anti-foulants, paints and coatings, adhesives and sealants, synthetic latex polymers, metalworking fluids, plastics and resins and mineral slurries. These are:

* the BPD
* increased competition from generics suppliers in India and China
* the potential reclassification and/or increased labeling of formaldehyde-releasing biocides and carbendazim

To date, none of the industrial preservation applications has been reviewed under the BPD. However, small-volume biocidal actives that are unlikely to make it through the review process have already been dropped and huge uncertainty exists regarding the final outcome, because biocidal actives will be authorised by individual application. Manufacturers have evaluated the risks and rewards of supporting their actives.
Currently, actives that are not patent-protected, such as bronopol, CIT/MIT and BIT, continue to face increased pricing pressure from Asia On the completion of individual BPD application reviews, foreign generic competitors will not be able to import freely unless they register or cooperate with a current European supplier of the active. This means that traditional European suppliers of these actives will have a level of competitive protection.Overall, speciality biocide consumption in industrial preservation applications is forecast to grow at an average volume rate of 1.25%/year. Similar to other global regions, the bright spot in the Western European market is the plastics and resins end-use segment, particularly for silver-based biocides.

These biocides are more environmentally friendly, protect the integrity of plastics, and offer surface antimicrobial protection. European sales of biocidal actives to the plastics and resins market are expected to grow by 4.5%/year from 2004 to 2009, with silver-based actives growing by 10%/year.
By contrast, consumption of speciality biocides overall will grow by only 1.25%/year and annual growth rates in other market sectors over that period will be 3.0% in synthetic latex polymers, 2.3% in adhesives and sealants, 2% in minerals and slurries, 1.7% in marine anti-foulants and 1.2% in paints and coatings. In metalworking fluids, consumption is forecast to decline by 0.35%/year.

Overall, the growth of organosulphur biocides is relatively flat, at 0.7%/year on a volume basis through to 2009. However, within this category, isothiazolinines and pyrithiones will exhibit above average volume growth, driven by the displacement of older chemistries. Thiocyanates will decline, due to legislation concerns.
Biocide formulations are an important aspect of the West European paints and coatings, synthetic latex polymers, and adhesives and sealants markets. Kline estimates the market for formulated biocides at more than €200 million, with paints and coatings accounting for more than half the market.
The competitive landscape in formulations is relatively fragmented, with Thor (which pioneered the business model), Lanxess, Rohm and Haas and Troy among the leaders. Many suppliers of straight biocidal actives to industrial preservation applications have adopted the formulations business model in order to extract more value from clients.
In most cases, biocidal actives firms have acquired formulations expertise. For example, Clariant acquired Bactria, ISP acquired both Biochemica Schwaben and Progiven and Troy acquired the biocides activities of the former Riedel-de Ha‘n.Overall, the supplier base for speciality biocides for all applications is highly fragmented both from a product and from an application standpoint. More than 30 companies are active. Kline estimates that the top five suppliers of biocidal actives (Arch Chemicals, BASF, Lanxess, Lonza and Rohm and Haas) combined account for only 34% of the market value.
However, selected product and applications are much more consolidated. For example, the top five suppliers of organosulphur biocides in Western Europe (Arch Chemicals, Clariant, Lanxess, Rohm and Haas and Thor) account for 87% of the market. From an application standpoint, water treatment is relatively fragmented, with the top five suppliers accounting for around 40% of the market on a value basis. In contrast, for industrial preservation, the top five suppliers account for 65% of the market.

Saturday, December 2, 2006

OIL PRICES - How vulnerable is India to high oil prices?

Higher global crude oil prices will adversely impact GDP growth rates, inflation, the fiscal deficit and the current account deficit, but the country's macroeconomic stability is unlikely to be threatened.

Rising oil prices since 1999, initially as a result of OPEC supply-management policies, and later due to geopolitical uncertainties, had driven the international crude oil prices to an unprecedented level. Though oil prices have fallen recently from their peak levels, a sudden spike, which could be caused as much by a disruption in oil supplies as by demand increases, cannot be ruled out. The geopolitical situation in west Asia may well change abruptly. Also, the International Energy Agency in its recent World Energy Outlook (2006) has stated that over 70 per cent of global primary energy demand in the future will come from developing countries, led by China and India. This means prices of oil and gas will have a crucial bearing on the prospects of these economies.

How much of a threat do high oil prices pose to the Indian economy? If we go by the performance over the last few years, then it is quite evident that high oil prices have had very little impact on the growth in the Indian economy. Is this indicative of the Indian economy’s resilience to withstand high oil prices? Perhaps, yes, so far. However, the prospect of the economy withstanding the impact of persistently high oil prices will depend how they behave in the future.

In order to test the vulnerability of the Indian economy to higher oil prices, we carried out a combination of statistical and simulation exercises to look at how different oil price outcomes (average price during the year) will impact the four macroeconomic indicators — growth rate, inflation rate, the fiscal deficit and the current account deficit. Taking a baseline scenario as an average annual price of $64 per barrel, we look at an optimistic scenario with $55 per barrel and pessimistic ones with $80 and $100 per barrel.

The statistical estimate of GDP with respect to the price of oil is a useful summary measure of the sensitivity of the economy to an increase in oil price. The estimates of the relationship between GDP and oil prices, however, depend to a degree on what oil price measure we use. Many studies simply use the international price of oil assuming full pass-through to the domestic economy — a method we know is not really applicable to the Indian economy. Therefore, in the four scenarios presented, we have not taken the international price of oil as such, but the pass-through of international oil prices to the domestic economy, which is reflected in the Wholesale Price Index (WPI) for mineral oil. Based on the mineral oil component of the WPI, we have estimated GDP growth under alternate oil price scenarios.

A hike in oil prices increases the production cost of goods and commodities as well as transportation costs. This increase in input costs is passed on to the consumers, who ultimately end up paying higher prices. In our exercise, we used elasticity measures to quantify the impact of higher oil prices on general WPI, and hence on inflation.

We have also simulated fiscal deficit scenarios using a model that takes into account the international oil prices and their impact on the government’s payment of subsidies, and tax collections through impacted GDP. The gap between international and domestic prices of cooking fuels is increasing due to stagnant domestic cooking fuel prices coupled with higher international oil prices. Therefore, it would adversely impact the government’s overall subsidy bill and hence the fiscal deficit. Beyond this, however, economic activity in general tends to slow down due to higher oil prices, and this will lead to a lower tax collection and hence a higher fiscal deficit. Thus, we see the fiscal deficit of the government impacted via two channels.

For a country like India, which is heavily dependent on imported oil, ceteris paribus, a substantial increase in the international crude oil price will also lead to an increase in the oil-import bill. However, the slowing down of GDP growth due to higher oil prices will have an offsetting impact on non-oil imports. Both these factors will determine the net effect on the current account balance. We have treated oil and non-oil imports separately to find out the impacts of higher international oil prices. For oil imports, an algebraic decomposition of oil import intensity of GDP has been made. Non-oil imports have been linked to the activity in the economy captured through impacted GDP following a change in international oil prices. These specifications allow us to generate potential current account scenarios.

Our analysis of the impact of high oil prices on the Indian economy reveals some interesting results. Under the most likely scenario (average basket price of around $64 per barrel during 2006-2007), our results show that GDP growth would be 8.3 per cent and inflation would be 5.0 per cent. The fiscal deficit as a percentage of GDP would settle at 3.9 per cent and the current account deficit is estimated to be around 1.0 per cent of potential GDP.

At the basket price of $55, the Indian economy is expected to experience GDP growth of 8.7 per cent. Our simulation shows that inflation would be around 4.2 per cent, and the fiscal deficit would become 3.9 per cent of the potential GDP. The current account deficit would come down to 0.2 per cent of India’s potential GDP.

If the price touches $80, GDP growth would drop to 7.8 per cent and the inflation would cross the 6.0 per cent mark. The fiscal deficit as a percentage of potential GDP would become 4.0 per cent. Thus, our analysis indicates that if the Indian basket touches $80/barrel, it is unlikely that the fiscal deficit target for 2006-2007 would be met. The current account deficit would rise to 2.6 per cent of potential GDP.

While $100/barrel now appears increasingly improbable, it does serve as a reasonable limiting case in the simulation exercise. Under this scenario, while the GDP growth would further shrink to 7.1 per cent, inflation would inch up to 7.7 per cent. The fiscal deficit/GDP ratio would further increase to 4.2 per cent due to both a reduction in tax revenues and the government’s additional expenditure to fund increase in subsidies. The current account deficit would bloat to 4.5 per cent of potential GDP. The significant deterioration in the current account deficit, combined with declining capital inflows because of slower growth, might push the economy to the brink of a balance of payments problem. But, as we have said, the probabilities are rather remote and within the bounds of realism, macroeconomic stability does not appear to be threatened by high or rising oil prices.

To sum up, higher global crude oil prices will adversely impact all parameters included in our analysis, but the economy appears remarkably resilient. On average, a $10/barrel price rise reduces GDP growth by around 35 basis points, increases inflation by 75 basis points and fiscal deficit/GDP and current account deficit/GDP ratio by around 7 and 97 basis points, respectively.

BS

Tuesday, November 28, 2006

Finance- Real economy & exchange rate

The Chinese experience shows the costs of under-valuation are a lot less than the benefits in terms of jobs.

In recent years, as China’s exports have grown rapidly, and the country is registering increasingly larger surpluses on the current account (an estimated $140 billion this year), it has faced a lot of pressure for a “more flexible” exchange rate regime. Instead of openly calling for an upvaluation of the currency, the politically correct euphemism is to use the term “more flexible exchange rate”.

After holding on to a steady yuan-dollar exchange rate for more than a decade, China has engineered a modest appreciation (5.4 per cent) over the last year and a half. China’s exchange rate policy is clearly rooted in the need to create manufacturing employment. China needs to create at least 25 million non-agricultural jobs a year, considering the number of new entrants in the job market, as also the vast immigration from rural to urban areas. Most of these would have to be in the manufacturing industry, and its global competitiveness is, therefore, of crucial importance. 

Hence, the undervalued yuan. Indeed, for many years, the yuan’s fall in real effective terms was even more than in nominal effective terms, because China has had lower inflation than the US for nine years! This is remarkable at a time of surpluses on current account and huge capital inflows (in theory, both generate inflation pressures), resulting into reserves accumulation of a trillion dollars. One advantage China has in sterilising the excess money supply is that domestic interest rates are lower than the dollar or euro interest rates: this means that there are financial gains to the central bank in sterilising the growth in money supply. China is not only keeping domestic inflation low but, as a low-cost manufacturer, is a major contributor to keeping global inflation low despite the very high commodity prices of recent years.

But there is also a major risk in the reserve accumulation. As argued earlier also earlier, given the huge deficit on current account in the US, the possibility of a sharp fall of the dollar can hardly be ruled out. Indeed, diversification of Chinese reserves into other currencies (as Russia, Switzerland, Italy and the UAE are already doing) could itself trigger such a fall: it is Chinese investments in the US treasury market that keep the dollar from falling and the yield curve flat to negative. On the other hand, should the yuan appreciate against the dollar, there would be huge paper losses for the central bank as dollar assets become worth less in yuan terms. Assuming that, currently, 70 per cent of the reserves are in dollar assets, even a 5 per cent yuan appreciation against the dollar would lead to a translation loss of something like 250 billion yuan! Clearly, the authorities are treading on delicate ground trying to balance the needs of the real economy with the possibility of large paper/financial losses if and when the yuan is forced to appreciate in dollar terms.

Arguably, the root cause of the large and increasing surpluses China is registering on the current account, is the savings-investment imbalance. Despite huge investments, the savings rate is so high, above 50 per cent of GDP, that the excess savings result into a surplus on the current account. Interestingly, the household sector savings in China as a percentage of GDP are actually less than in India — this, despite the fact that personal consumption in China per capita is only about 70 per cent higher than in India, while per capita incomes are 2.5 times as large. The real cause of excess savings is the corporate sector: the corporate sector’s savings amount to as much as 30 per cent of GDP, with retained earnings alone contributing two-thirds of that. One reason, it seems, is that Chinese companies do not distribute dividends. 

At the macro level, one way of reducing the excess savings and the politically sensitive surplus on current account, is to get the public sector companies to distribute dividends, and spend the money on needed social services like health care, higher old age pensions, and so on. Sooner or later, we should see some movement in this direction even as the yuan gradually appreciates. Incidentally, the non-deliverable forwards market is factoring a yuan rise of just about 3 per cent over the next 12 months.

One point on which we need to learn from China is the focus on the real, job-creating economy rather than philosophical arguments about market versus managed exchange rate, the cost of sterilisation, and so on. On the second issue, what we often seem to overlook is that the cost to the real economy of an appreciating currency (jobs uncreated or lost, business profitability, forgone GDP growth, and so on) can be far, far bigger than the financial cost of sterilisation. To be sure, these costs are not as easy to calculate as the cost of sterilisation — but are, nevertheless, as concrete and perhaps even more important.

Sunday, November 26, 2006

Bucking the trend- The reverse expansive outsourcing

It’s a paradox facing India’s outsourcing industry. Its low cost location is its raison d’etre. But to stay in the game, it also has to be where the customer is, often an expensive site in western Europe or the US. First, India’s IT services industry began to buy western companies. Now, India’s drug makers are following suit.

In the past year, three Indian companies — Nicholas Piramal, Dishman Pharmaceuticals and Chemicals, and Shasun — have acquired European contract research and manufacturing (CRAM) outfits. They conduct early stage research and development (R&D) of experimental drugs for large and emerging drugmakers, produce them in small amounts for clinical trials, and do contract manufacturing. The reasons for this are sound: Indian companies have found that Big Pharma is either wary of offshoring some key, patent-sensitive activities to India or lacks adequate incentive to do so. India accounts for barely 1-1.5 per cent of the global CRAM industry. “[Acquisitions] will give the Indian companies access to customers who may not have otherwise considered doing business with them,” says Edward Vawter, president, QD Information Services, a US-based consultancy firm.
The path is not without risk. Though the companies have not been bought at fantastic valuations, the acquisitions come with high labour and manufacturing costs. Managers and scientists are free to leave once their contracts expire. But this is just the beginning. “More Indian companies will be purchasing European companies,” predicts Harry Rathore, US-based vice-president (sales and business development) at leading European contract manufacturer Lonza. The players also say they are open to more deals. So, what is behind this appetite?

Big Pharma is outsourcing like never before. According to Frost & Sullivan, the global pharma outsourcing market is worth $37 billion and growing at almost 11 per cent. Cost and time pressures are forcing customers to turn to China and India. By one estimate, India’s annual labour costs are at $3,000 a head compared to over $50,000 in western Europe. This has no doubt put western incumbents on the backfoot. But even today, most of the outsourcing activity happens there. Fifty per cent of the contract manufacturing market is in North America and just 10 per cent is in Asia, with the balance in Europe. This will not change in a hurry. “While we are an important cog in the wheel, it is never going to be all India and China,” says Ajit Mahadevan, president (custom manufacturing) of the Rs 1,582-crore Nicholas Piramal. This is why Nicholas and its peers have decided to take the battle for market share to the West.

No doubt, India is very much on the radar of the bluest of blue chips. Big Pharma such as Pfizer, AstraZeneca and Eli Lilly have outsourced to India. But business is only trickling in. Take the case of early-stage R&D. “There are some things that will not happen in India for two decades,” claims Janmejay Vyas, managing director, Dishman. Vyas claims that innovators are not comfortable offshoring early stage R&D — developing and scaling up new chemical entities — to India. The country has an untested patent protection law and no data protection. This is partly why the Rs 277- crore Dishman stumped up $74.5 million (Rs 343 crore) to buy Carbogen and Amcis, two sought-after names in the western outsourcing space.

Carbogen synthesises bulk drugs —the key ingredients that lend a drug its potency — for innovators. This includes finding the best possible process to make a bulk drug with the least amount of impurities. It also produces these bulk drugs for human trials. This isn’t rocket science. Indian companies have the skills to do it. But Vyas claims that Big Pharma will very rarely, if ever, offshore this to India. At the bulk drug synthesis stage, a company’s research may not yet be protected with watertight patents. India and China, with their history of copying innovator drugs (legal until recently), are therefore suspect.

Vyas says Dishman’s experience proves this. In spite of landing its first customer in 2002, Dishman only gets contracts to work on intermediates, the building blocks of a bulk drug. This is safer from a customer’s point of view since without knowing what the intermediate goes into, there is little you can do with it. Vyas thinks Carbogen, which works on about 400 products a year, will help Dishman move up the value chain. The other reason is proximity to the innovator. Early-stage R&D requires continuous interaction between scientists. Also, at this stage the drug goes back and forth between the innovator and the outsourcing company several times. “A scientist on the west coast of the US is going to struggle to communicate with someone sitting in Chennai or Mumbai,” says Mahadevan. Last December, Nicholas acquired UK-based Avecia from some private equity investors. Avecia owns 100 per cent in Canada-based Torcan, which is also into early R&D, like Carbogen.

Companies are not just reacting to what they perceive as problems. They are also proactively cementing ties with the biggest outsourcers. Nicholas already had a contract for process development and scale-up of world No.1 Pfizer’s animal healthcare products. But by acquiring Pfizer’s factory in Morpeth, Scotland, Nicholas emerged as its largest supplier in dollar terms. (Pfizer has agreed to source from this factory for the next five years or so). This means Nicholas now sits in on key supplier discussions. “When there is talk of ways to use a new supplier strategically, we are in the process,” Mahadevan says. It was Chennai-based Rs 377-crore Shasun’s existing customers who recommended Rhodia Pharma Solutions, says its CEO and managing director N. Govindarajan. Shasun can now offer a broader range of services to them.

Customers aside, specific skills and technology are also attractions. The low-cost Chinese juggernaut is providing tough competition to Indian companies in the high-volume, low-value business. They need to quickly enter higher barrier-to-entry markets. Technology can make the difference where cost won’t. Amcis, the contract manufacturer that Dishman bought along with Carbogen, is a case in point. Its facilities are small but handle potent and highly toxic material used to make cancer and eyecare drugs, requiring high levels of safety and containment. Although their potency means they are administered in small quantities, their dollar value is far higher — anywhere from $10,000 to $100,000 per kg. Being highly-priced, these are profitable for innovators. Minor cost differences cannot motivate them to change suppliers. “The contribution of manpower cost in a $5,000 product is nothing. What logic says that if I save $10 on a $5,000 product, the customer will be interested?” asks Vyas. Similarly, with Rhodia, Sha sun got access to technologies that it had licensed from Harvard University and MIT to counter low-cost competition from India and China. Nicholas’ Avecia is abile to make toxic products and other high-value drugs such as hormones, and owns fermentation equipment to make drugs more efficiently.

These deals are also about building scale. With Avecia and the Morpeth aquisition, Nicholas’ revenues from custom manufacturing jumped to Rs 920 crore from Rs 220 crore. Nicholas has laid claim to being among the top 10 contract manufacturing companies in the world. With Amcis, Dishman has added $100 million (Rs 460 crore) to its topline. Shasun has got business worth $72 million (Rs 331 crore) from Rhodia. The upshot of all this is that companies are converting fast to the view that to leapfrog a business is to buy it. Says Nimish Mehta, pharma analyst, Edelweiss Capital: “Companies have realised they have to run some part of their businesses outside India.”

But there are concerns. One is that of customers deserting. Often they have another source supplying the same product and could increase offtake from them. This concern has led the Indian acquirers to meet all key customers before they sign on the dotted line. Also, in some cases they have got an assurance from the seller that the customers will honour their contracts.

But losing customers is a business risk. It is not unique to acquisitions. It can happen to any CRAM company. The more pertinent question is: where does all this leave their famed cost advantage? How long can they offer viable solutions to customers with expensive manufacturing sites and high-cost labour? “In the short run, this works out very well but I doubt whether you can sustain it,” says Venkat Jasti, vice-chairman and CEO of Hyderabad-based Suven Life Sciences.

Jasti should know. In 2003, when India didn’t have a product patents law, Suven was the first Indian company in the outsourcing space to purchase a small US laboratory called Synthon Chiragenics that did research for innovators. Synthon did have some technology, but Jasti believed that its value lay in its location — in the innovators’ backyard and far from India. “It was about giving comfort to the customer,” he says. But by 2005, things changed. The same customers came back to Jasti asking for cost benefits from its Indian site. By December 2005, Jasti had closed the lab and moved the equipment to India. He admits it wasn’t difficult — the lab employed 18 people, was located in a hire-and-fire market, and did not have any manufacturing attached to it.

That is not the case with the latest acquisitions. They come with hundreds of workers employed in factories. Redundancies are tough and expensive. This is likely part of the reason why no acquirer is willing to discuss the migration of jobs to India. At least, not yet. “We did not buy these companies to shut them down, scoop up the insides and bring them home,” says Mahadevan. There is another good reason for this. Factories are continuously churning out drugs for their customers and a disruption in supply would prove fatal. Changing a manufacturing site requires regulatory clearance that takes at least a year.

The acquirers are, thus, going for the low-hanging fruit. Sweat the existing assets better and squeeze efficiencies out of the supply chain. The first thing that Dishman, Nicholas and Shasun have done is switch raw materials that the Europeans were buying from Europe and the US with Indian and Chinese supplies. Dishman’s Vyas points out that Amcis, for instance, couldn’t be bothered with tapping Asia for incremental savings for its high-value drugs. “But now, if I can save them this money, then why not?” he asks. The second thing is to increase capacity utilisation. Nicholas has done this by moving customers from one-year contracts to 3-5 year ones. Earlier, according to Mahadevan, customers were unwilling to do this since Avecia was seen to be struggling. But the sale to Nicholas has brought stability. This, and new contracts, have improved its capacity utilisation from 60 per cent to close to 90 per cent. Shasun expects to increase Rhodia’s ultilisation by 10 percentage points to 50 per cent for similar reasons.

More importantly, by fitting the large-scale Indian manufacturing back-end into the existing operations, the Indian outsourcers think they offer a proposition that’s hard for customers to ignore. Again, look at Carbogen and Amcis. An innovator works with Carbogen through the early stages of bulk drug synthesis until phase 2 of human trials (Carbogen makes the drug for the trials). By phase 3, the quantities required are much larger since these trials are conducted on large numbers. This is where Amcis — Carbogen’s sister company — a pure-play contract manufacturer, comes in. Since the project manager remains the same, the customer does not feel he is dealing with a different company.

But Vyas found that, thanks to its cost structure, Amcis would turn down any business below a particular value. The innovator had to look for another contractor. Enter Dishman. It can offer to make both phase 3 and launch quantitities of a drug synthesised at Carbogen in its facilities in Bavla, Gujarat. By then, patent protection around a product is sound and the economics makes sense. Importantly, it saves a precious two years of transferring technology from Carbogen to the innovator and from him to his contract manufacturer. Vyas says this one-stop solution lowers the total cost of bringing a drug to market for the innovator and increases Dishman’s revenues. He claims a bluechip customer who found Carbogen too expensive has now signed up, thanks to the India connection. Dishman also sees Amcis able to take on business that requires a far larger capacity — in terms of fermentors, for instance — than what Amcis can currently provide.

Companies would also like to move the production of mature drugs that have reached the end of their patent life into India while retaining the manufacturing of new patented drugs in the UK. Both Nicholas and Shasun want this. Shasun also wants to use the patented process-development technologies that it has aquired, back home. “You have to employ 20-30 chemists to keep trying these technologies. We can do that cost-effectively in India, and that would increase their viability,” Govindrajan says.

In the meantime, all three are marketing their Indian facilities to customers through the acquired companies. They claim that, through this marketing, existing customers are giving them more business and new ones are coming on board. “If you can fill up the plant there and you get a lot of value, including business, coming into India, then why would you want to shift?” asks Mahadevan. Nicholas’ near-term margins have been under pressure due to Avecia’s losses. But a turnaround is expected by the end of this fiscal. Shasun’s Govindarajan also expects Rhodia to post a profit this year.

Industry watchers warn that western Europe is losing the cost battle to India and China. The true test for the Indian acquirers, then, will come a few years down the line when customers start squeezing more out of them. Then these assets and people may harm, rather than help, their business. Getting custom, they may discover, was the simple part.

source -BW

Saturday, November 25, 2006

Strategy- BASF, The Chemical company

In German, it is called the Verbund. J├╝rgen Hambrecht, the chief executive of BASF, describes his company's sprawling complex of pipes, towers and storage tanks as the “ultimate business cluster”. Spread over ten square kilometres (four square miles), it is the biggest integrated chemical site in the world. At first glance, BASF's third-quarter results, out on November 2nd, did not look great. Profits plunged because of restructuring costs at Engelhard, an American producer of catalysts (as in catalytic converters) which BASF bought earlier this year. And, on the same day, BASF announced 2,000 job losses.

But the underlying trend at BASF is surprisingly healthy, given that it is an old-fashioned manufacturing company in a part of the world where heavy industry tends not to flourish these days. It more than doubled its profits between 2002 and 2005. One-off charges aside, its third-quarter results suggest the company is in line for a 20% increase in turnover this year to over €50 billion ($64 billion), with pre-tax profits up 11%. Although many industries are fleeing from Europe to less costly countries, the efficiencies of the Verbund show how a traditional business can remain highly competitive, even when it operates in an expensive place like Germany. The complex at Ludwigshafen, across the Rhine from Mannheim, comprises up to 250 individual chemical factories turning out 8,000 different products. These range from simple petroleum distillates to sophisticated nanomaterials—tiny particles which can be used to change the properties of plastics or other substances. BASF employs about 36,000 people in Ludwigshafen, where it also has its headquarters. Many travel around the site on red works bicycles, individually numbered.

range from simple petroleum distillates to sophisticated nanomaterials—tiny particles which can be used to change the properties of plastics or other substances. BASF employs about 36,000 people in Ludwigshafen, where it also has its headquarters. Many travel around the site on red works bicycles, individually numbered.

The site's legendary efficiency comes from extracting the last drop of value from every chemical reaction. It makes use of the numerous by-products from each process. At other places these are often sold or shipped from one factory to another for further processing. At the Verbund, what is left over from one process is used only a few hundred metres away to make something else. This saves BASF a fortune. Compared with having, say, 70 separate factories some 100km apart, BASF calculates its cluster enjoys annual savings of €300m ($380m) in logistics, €150m in energy and €50m in infrastructure.

For Mr Hambrecht, the Verbund represents a huge advantage in an industry in which competition is increasing, especially in Asia. So BASF is trying to replicate the benefits of its cluster, not only in other countries but also at the corporate level. Instead of splitting into lots of firms specialising in one chemical, as many giants have done, BASF is seeking to become an even bigger conglomerate.
Mr Hambrecht, who is 60, has spent half his working life at BASF, which was founded in 1865 as Badische Anilin- & Soda-Fabrik. Anilin was once important in making dyes; soda is used in glass, soaps and textiles. Today the company's products end up in goods ranging from cars to electrical goods, cosmetics, sports equipment and medical devices.

Mr Hambrecht enthuses about “the industry of industries”. Indeed, chemicals seem to be in Germany's blood. The country accounts for a quarter of the chemical industry's sales in Europe and a similar share of employment there. Germany supplies more than 12% of world exports of chemicals, the biggest single share. And the German industry spends a higher proportion of its revenue on research and development than that of any other country.In many countries, chemical factories are hardly the subject of civic pride. They are in Germany. In September an “open day” attracted thousands of visitors. Frankfurters, in particular, are proud of the huge chemical complex straddling the river Main at Hoechst, west of the city. Though Hoechst, once the local chemical giant, was absorbed into sanofi-aventis of France in 1999, its Frankfurt site still churns out polymers, pigments and pharmaceuticals. The former Hoechst headquarters, a redbrick relic of the 1920s, is an admired piece of Bauhaus architecture. Yet few sites are as efficient as the Verbund. A recent study of Germany's chemical industry by A.T. Kearney, a consultancy, found that most other production centres had big gaps in their “value chain”: raw materials and by-products had to be shipped around, at extra cost. The reasons are often historical or political. A complex at Leuna in east Germany, for example, was cleaned up at huge expense after German unification. It has never achieved its potential, even though firms such as Dow Chemical, Linde, Total and BASF have operations there. Other sites are too small or are underused, but cannot be closed for political reasons. BASF has recently been adding to its product range in a big way. In March it bought Degussa Construction Chemicals, part of a German maker of specialty chemicals, for €2.7 billion; in May it spent $470m to buy America's Johnson Polymers and in June it paid $5 billion for Engelhard, the cause of the profits crash.

Asia starts producing

Although these European and American additions bolster its business, BASF cannot ignore developments elsewhere. Ever bigger petrochemical and other downstream production facilities are being built in the Middle East. And burgeoning demand in Asia, particularly in China, is resulting in more chemicals being produced locally. Moving into developing regions can have benefits beyond lower production costs. It can allow chemical companies to get closer to both suppliers of raw materials and more potential customers. It nearly always makes sense to produce bulky chemicals, such as washing powder, where they are sold, to keep transport costs low. This puts places like China, which is a long way from the big Western consumer markets, at a disadvantage in exporting some products. But there are plenty of others to be made. Anything that can be conveniently put into a container and shipped cheaply is likely eventually to be made in Asia's low-cost factories.

Hence even BASF is having to shed businesses in which it thinks it is no longer competitive. The next to go may be a factory in Minden, Germany, which among other things makes caffeine. The Chinese now offer caffeine, which is easy to ship, to firms such as Coca-Cola at a third of the price that European factories can. Nevertheless, demand in China is so great that it will be many years before the country becomes a net exporter of chemicals, Mr Hambrecht believes. Demand across Asia is strong. Around half of future worldwide demand for chemicals is expected to come from the region. BASF already has almost 19% of its turnover in Asia, up from just 9% in 1995.

As it expands overseas, BASF is trying to replicate the Verbund concept. It has built smaller versions of the cluster in Belgium, Texas, Louisiana, Malaysia and China. The foundations of its Chinese factory in Nanjing were laid in 2001. Last year petrochemical production began there in a joint venture with Sinopec, a Chinese oil company. Mr Hambrecht, who fought internal opposition to the investment, believes that such opportunities in Asia offer European chemical companies their only chance to grow faster than at home. Chemical companies can be highly vulnerable to changes in the price of raw materials. Here too BASF hopes to gain some protection from its cluster effect. As long ago as 1969 it bought Wintershall, an oil producer. It has proved to be a useful hedge against oil-price rises. BASF is now trying to secure its lines of supply from Russia by a joint project with Gazprom to build a gas pipeline across the Baltic. It also has a share in a west Siberian oilfield. BASF was mining coal until the late 1980s, and today even that might again make sense. The company's expansion into energy seems set to continue: it recently announced plans for a joint-venture biodiesel plant in Belgium, which will use rapeseed and other organic material to produce fuel. Indeed, oil and gas provided 40% of the group's profits in 2005.

Other giants in the chemical industry have spun off various divisions to narrow the spectrum of their business . For instance, Bayer, Germany's second-largest chemical firm, listed its specialty chemical division, Lanxess, as a separate company in January 2005. Although the trend in the industry is to put new labels on bits of the business, such as “life sciences”, which includes health and food, or “coatings”, which includes paint, BASF still brands itself as “The Chemical Company”. The one business it has quit is pharmaceuticals, accepting that there is little overlap between drugs and its other products.

The diversity of its operations makes BASF unpopular with some investors because it muddies their view of the firm as a “pure play” on chemicals. Mr Hambrecht is unrepentant. He argues that conglomerates are better overall long-term performers than specialists. Through diversity, he maintains, companies can weather poor performance in one or two of their divisions. The specialist can also be more vulnerable to disruptive technology and the sudden substitution of one material for another. This is a particular risk for the chemical industry in Germany, which is highly exposed to the car business. Almost 70% of the German industry's innovations, such as smarter or lighter materials, go into vehicles. But it is harder to apply the Verbund effect in the developing field of biotechnology. A big handicap for BASF is the German government. Despite vowing in its coalition agreement last year to clear the way for genome technology, the government has since dragged its feet. Bayer is developing genetically modified rice, rape and cotton, but in America not Germany. BASF has the majority of its biotech research in Europe and believes Germany to be an excellent place for genome activities. But, says Mr Hambrecht, the government's attitude risks driving it away.

The virtue of virtuality
Perhaps the biggest danger to the Verbund, and the conglomerate-building which it encourages, is that it could lack the flexibility to cope with rapid market changes. But a variation of the concept might overcome this. This is the “virtual” Verbund; a large chemical site where a number of independent companies could voluntarily work together to achieve the same economies of scale, but use different processes as market conditions change. A.T. Kearney suggests that something like this might be done at some of the chemical sites in Germany where production capacity is underused. A European Union project supported by seven big companies, including Siemens and Degussa, is trying to get the idea going by streamlining test-production. Called Impulse, the project aims to reduce the cost and time of research and development by miniaturising test equipment. This would primarily benefit smaller, more flexible companies. The political objective is to keep jobs and factories in Europe.

Perhaps such initiatives might one day steal away some of the Verbund's advantages. But not yet. For now Mr Hambrecht, whose contract with BASF runs until 2011, is confident in the future prospects of his firm. As he jogs through the vineyards near his Rhineland home in the early morning he can indulge in thinking up new things to make.

Friday, November 24, 2006

Consolidation time for OTC drug manufacturers


Since the days of the wandering snake-oil salesmen, the business of "over the counter" (OTC) medicines has lacked glamour. For one thing, the market for prescription pharmaceuticals is far bigger and more profitable than the $117 billion global market for OTC drugs. For another, the brightest researchers prefer to work on glamorous life-saving drugs rather than on mundane stuff like cold remedies. The head of research for an American OTC firm has been known to joke: "If the customer takes our syrup, his cold will go away in seven days; if he doesn't, it'll go away in a week."

Perhaps it is no surprise then that Pfizer, the world's biggest pharmaceutical firm, has let it be known that it is thinking of selling its OTC arm—which peddles, among other things, Listerine mouthwash, Rogain, an anti-baldness treatment, and Benadryl allergy pills. June 6th was the deadline for outsiders to bid for the division, which Goldman Sachs, an investment bank, reckons may fetch $10 billion-12 billion. Britain's GlaxoSmithKline and America's Johnson & Johnson (prescription-drugs firms with big OTC arms), as well as Reckitt Benckiser, a British household-products firm, and others are rumoured to have placed bids. Pfizer is expected to unveil a shortlist of bidders in a matter of weeks and—assuming the board decides not to float the division on the stockmarket—a final sale will probably take place this autumn.

But this week's reported bidding frenzy raises an awkward question. If outsiders find Pfizer's OTC division so desirable, why is the firm eager to get rid of it? Revenues at the consumer division are nothing to sneeze at: they made up $4 billion of the company's overall sales of roughly $51 billion last year. While its prescription-drug sales have stagnated, OTC sales grew 19% in 2004 and 10% last year; Goldman Sachs reckons the division had profit margins above 15% for the past two years. What is more, the OTC business is generally much less risky than the expensive and frustrating quest for the next breakthrough prescription drug. But that may be one reason why Pfizer is flogging its OTC division. Between 2005 and 2007, the firm is set to lose patents on drugs earning some $14 billion a year in revenues. Finding new drugs to replace them will cost many billions of dollars. During that same period, the firm also plans to launch perhaps ten new prescription drugs, which will also need lots of marketing money. Selling the consumer business will bring in much-needed cash and may focus managers' attention.

Pfizer may also reason that this is a particularly good time to sell an OTC company. The sector looks ripe for consolidation. Andy Tisman of IMS Health, a consultancy, points out that none of the leading OTC firms holds even a 5% share of the world market (see chart), and the top ten command less than a third. A merger wave began last year when Reckitt Benckiser paid £1.9 billion ($3.4 billion) for Boots Healthcare International (BHI), which owned popular brands like Nurofen and Clearasil. As that valued BHI at over 20 times earnings, Pfizer bosses took immediate notice.

Bigger OTC firms would be better placed to establish global brands and capitalise on growth in developing markets—especially China. Euromonitor International, a research outfit, estimates that while global OTC sales will grow at 3% per year from 2005 to 2010 (and sales in Japan and America at barely 2%), sales in China should soar by 9% a year over the same period.

At present Pfizer has only a weak presence in China's OTC market. It does, however, have a strong prescription-drug business there, but that has been hobbled by piracy and legal battles over intellectual property—until now. Just this month, a Chinese court upheld Pfizer's patent protection on Viagra, the firm's much-pirated prescription remedy for impotence. And although the Chinese customers' taste for the delights of Western OTC products like Listerine mouthwash remains to be proven, nobody doubts that the country has a gargantuan appetite for impotence remedies. If you doubt that, ask any of the few remaining rhinoceroses in Africa.

Sunday, November 19, 2006

Indian gaming Industry. Outlook

Indian gaming industry is estimated to be $30 million in 2005, according to Nasscom. By 2009, the Indian gaming development industry is expected to grow to $300 million, at a CAGR of 78 per cent.

The numbers, while impressive, hide an important fact. For close to a decade, gaming development in India has held immense promise. Unfortunately, it still continues to do so. In the same period, the IT services industry has grown at 32 per cent from $13 billion to $17.2 billion. In the past two years, the number of gaming development companies in India has gone from 14 to just 20. It is, in fact, one of the rare software-related areas where India has not yet been able to make a significant mark globally. Not for lack of trying, though.

Gaming companies like Indiagames, Mobile2Win and Dhruva Interactive have striven long and hard for success against huge odds: lack of a gaming culture and skilled professionals, low funds and some heart-rending near misses.

For instance, a chance meeting with gaming legend and Infogrames Studios (now Atari) co-founder Eric Mottet in December 1998 offered Rao, and Dhruva, an opportunity to make a mark on the global stage. Infogrames selected Dhruva to work on parts of the PC game version of the movie Mission: Impossible. For over a year, Dhruva worked on the project, but when the time came for its release in the market, Infogrames backed out. By that time it was gunning for the licence of Mission: Impossible II and the film’s promoters didn’t want to publicise the earlier movie.

Despite the disappointment, Dhruva did not falter but took the services path and ventured into product development.” Dhruva’s fortitude is symptomatic of the industry. Pitted against the might of the Americans, Koreans and several others, and the general apathy of the Indian authorities, the Indian gaming development community has only had its passion and will power to sustain it. And while it will still take a momentous effort to attain Nasscom’s projections, things are beginning to change on the ground. Slowly.

The prospects of the gaming industry in India has been bolstered by the entry of animation companies like DQ Entertainment, Animation Bridge, Paradox Studios, ColorChips, Toonz Animation and Ittina Studios.

Why animation companies like Toonz should enter gaming in a big way is not difficult to understand. For one, it is easy for them to tweak existing resources (employees with skills in animation development) to make capital of a new opportunity. For another, the industry is slated to grow at twice the pace of animation, both in India and globally .

For both animation and gaming companies, a major source of revenues is outsourced services. For instance, it takes $6 million-7 million to develop a PC game in the US, compared to just $0.5 million-3 million in India. There is also the matter of reducing development time. A PC or console game takes two years on an average to reach the beta stage.

It, therefore, made sense for game publishers to outsource development to low cost destinations. In 2000, companies like Microsoft, Electronic Arts, UBSoft, Konami, Activision and Take 2 Interactive outsourced select modules to small firms (with teams of just 15-30 developers) in countries like the Philippines, South Korea, Singapore, India, Taiwan and China. This lowered development costs and brought down production time to 18-19 months by leveraging on the global delivery model.

For the past two years, Indian companies have also been trying to move up to the next level by developing their own intellectual property. For instance, come early 2007 and console game Archie’s Riverdale Run will hit the market. Developed by India’s FXLabs Studios, the game would have undergone its entire development lifecycle — from concept creation to final testing — in India. DQ Entertainment has formed a joint venture with French studio Onyx Films to produce three animation feature films — Skyland, Night of the Child King and The Enchanted Boy —and develop games around them for $89.5 million. The first movie, Skyland, and its game version will hit the market in early 2008.

Then, the success of Hanuman (developed by Percept Pictures and Sahara India Group), India’s first local content animation blockbuster, has spurred gaming developers to explore the rich repertoire of Indian content. Bangalore-based Ittina Solutions is likely to launch titles for mobiles and PCs in the next couple of years. Mumbai-based Indiagames, Paradox Studios and Fantasy Labs are also betting high on local content development not just for mobiles but for PCs and console games.

As mobile mania in India keeps moving north (it is the world’s fastest growing telecom market), consumers have shown a surprisingly high propensity for value-added services like game downloads. Riding this momentum, mobile gaming is expected to constitute 70 per cent of the overall gaming market by 2009 (it’s at 53 per cent now), according to Nasscom. Gaming companies have already benefited. For instance, mobile gaming constitutes 60 per cent of DQ Entertainment’s gaming revenues, and 40 per cent of Dhruva’s.

In mobile gaming, local content has already made its appearance. Thiruvananthapuram-based Toonz Animation launched its flagship animation title Tenali Raman as a mobile game and licensed it to Tata Teleservices across the circles it is operating. Going further, the company intends to launch games titles like Geeth Mahabharat and Hanuman.

Mobile gaming is also seeing new players planning to display their wares. For instance, Virgin Animation & Comics India, a JV between filmmaker Shekhar Kapoor, self-help guru Deepak Chopra and Virgin’s Richard Branson, has firmed up plans to venture into mobile gaming. Sharad Devarajan, managing director of the firm, says, “Our first phase into gaming would be through the mobile platform by end-2006, followed by other access platforms. Mobile gaming may be growing fast, and may constitute a large chunk of the industry’s revenues, but the margins for developers are wafer thin. For instance, a premium mobile game can be downloaded for Rs 150, and a standard one, Rs 50 upwards. Margins for these games can be 20-25 per cent for game developers. Indian telecom operators like Reliance have even introduced price-per-session concept, where a game could be priced as low as Rs 2 and Rs 4 per session. On the other hand, games on PCs and consoles come at a minimum Rs 350 and Rs 600, respectively. Premium PC and console games could get you down by Rs 2,500 and Rs 3,500, respectively. And margins, at 40-60 per cent, are healthy. Says FXLabs’ Garcia, who was one of six professionals who started GameStudio at Microsoft: “PC and consoles are attractive markets over mobiles both in terms of margins and to experience the game’s liveliness.” But while margins are healthy, PC and console games are far more expensive to produce. So, it may take even more time before Indian companies make a mark.

If there’s one thing that can wreck the aspirations of this budding industry, it is a shortage of skilled people. The problem has been around for ages, but not much has been done about it. India has 4,000-odd game developers right now. The demand is for 10,000 professionals in animation and 2,000 in gaming. Governments in states like West Bengal have initiated training programmes, but they produce just about 100 professionals a year. In comparison, Korea has about 60 colleges dedicated to animation education and has a game academy producing 250 professionals a year. (In 2005, it had 25,000 professionals.)

Then, the Chinese government is expected to spend up to $240 million to finance domestic game development over the next three years, according to Piper Jaffray, an investment bank and institutional securities firm. There is no such commitment from its Indian counterpart. Some companies are trying to make the best of the situation by setting up in-house training divisions. They are also trying to work with state governments to design a curriculum for gaming development. For instance, Toonz-Webel Academy in Kolkata is an animation school set up by the West Bengal government with Toonz Animation. The National Institute of Design, Ahmedabad, is also slated to introduce a game development course. Still, these efforts are far short of what is needed to propel the industry into the global league.

This is not to say that there is no hope. There is, but it will take a concerted effort from all parties involved. Of course, Indian consumers can change things themselves. Their growing numbers will give gaming companies reason to smile.


Saturday, November 18, 2006

Pharma- The biogenerics opportunity

The 30-year-old biologicals industry is over $50 billion in size. At 15 per cent growth rate, it is also the fastest growing category of drugs in the global pharma market. Of course, conventional pharma, at $500 billion, is 10 times as big, but it is growing at about 8 per cent.

Today, biologicals present another opportunity for Indian pharma — in the form of biogenerics (also called biosimilars) or generic copies of biologicals.

Here’s how. In the last few years, new filings of conventional drugs have shrunk. So, there are fewer drugs to make copies of. Stricter regulations, higher failure in clinical trials, and longer time taken for approval of generics are other dampeners. Meanwhile, development of new biologicals has been on the rise. Besides, biologicals worth $14 billion are expected to go off patent by 2010. While insulin and erythropoietin are already off patent, products like interferon (Schering-Plough, Biogen) and granulocyte colony stimulating factor or G-CSF (Amgen) are scheduled to go off patent soon.

Even assuming a 50 per cent price erosion (since biopharmaceutical companies, creators of original biologicals, slash prices at the first sign of a biogeneric), it is a $7 billion-$9 billion opportunity for generic players. And, unlike in conventional pharma, Indian companies are on par with global ones to make good of this opportunity.

Roadblocks Galore

Cracking biogenerics is easier said than done, though. First, programming microbes to secrete a specific drug is much tougher than stringing together a group of chemicals to create a copy of a drug.This makes developing a biogeneric a more time-consuming affair (5-7 years) than a conventional drug (2-5 years). Also, controls over manufacturing conditions are far more stringent, leading to high investment.

But, perhaps, the biggest obstacle is that in lucrative markets like the US and EU, regulatory bodies (US FDA and EMEA or European Medicine Evaluation Agency, respectively) have not defined standard procedures for approving biogenerics, unlike conventional pharma generics. In a conventional pharma generic, provided you create the same molecule, and do a clinical trial to show that it works as well as the original, you are through.

In the case of biogenerics, biopharmaceutical companies contend that when the manufacturing process of a biological is changed, it may not be as effective or even similar. So, innovators’ data cannot be used to get regulatory approval. A biogeneric, thus, has to generate its own data through extensive clinical trials on far more patients before approval is given.

Fortunately for companies eyeing biogenerics, in 2005, EMEA defined a regulatory pathway for four biogeneric products — insulin, erythropoietin, human growth hormone (hGH) and G-CSF. The FDA, though, has approved only one — Sandoz’s Omnitrope (human growth hormone) — that, too, after prolonged litigation. But it has clarified that a standard regulatory pathway has not been defined for biogenerics.

All these factors have restricted pharma companies worldwide from getting into biogenerics. So, unlike the pharma space where western companies like Teva and Mylan had a headstart of more than a decade over Indian companies, in biogenerics all players are starting off on the same footing.

Revving Up Biogenerics in India

Mostly, Indian companies have preferred products that are relatively easier to make, like insulin or even erythropoietin. Few companies have chosen to tackle products like hGH and G-CSF, which are tougher to make but offer higher margins.

Things first started happening in the 1990s. First off the blocks was Dr. Reddy’s in 1994 (with a biologics department that was converted into a full-fledged division in 1999). It launched its first product, filgrastim (a G-CSF) in 2001, which was re-launched earlier this year in India and Brazil as Grafeel.

Then came Wockhardt in 1998. It launched its Hepatitis B vaccine in 2002, insulin in 2004 and erythropoietin in 2005. Also, in 2005, it created a separate division for biologicals R&D as well as manufacturing. They were followed by Biocon, which announced its plans for entering the market through insulin in 2002, and launched the product in 2005.

Strategy of Indian companies :

Dr. Reddy’s has chosen to focus on its areas of strength, oncology and related products, even in biologics. Brand building and marketing will be much easier because the products will move across the same channel. Wockhardt, on the other hand, is looking at products like insulin for India, developing countries as well as regulated markets. The strategy is to first enter the European market with products that have a defined pathway, and then look at the US once the pathway is clear.

And Biocon is initially targeting the biogeneric opportunity for its human insulin. The company is filing forapproval of its insulin in the regulated markets starting with Europe.Some companies, including Ranbaxy, are looking at taking biogeneric products developed by other companies and selling them in India and other less regulated markets. The idea is to take good products from small companies and use the bigger company’s marketing muscle to sell them. Some, of course, plan to eventually crack the US and European markets.

For instance, Concord Biotech, in Ahmedabad. Besides being the world’s only biogenerics company to manufacture all four immuno-suppressants, Concord also undertakes custom synthesis projects. In November 2005, Hyderabad-based Matrix Laboratories acquired majority stake in Concord. The products from Concord’s stable will be marketed in Europe through Docpharma (a generic company in Belgium that Matrix acquired last year) and then in the US.

Then, Ranbaxy has tied up with Hyderabad-based Zenotech Technologies to inlicense and market its products. Companies like Shreya Life Sciences, Intas, Cadila and Emcure also have well-defined marketing programmes. Shreya, which started as a distribution company in Russia and the CIS, is looking at products that can be imported and launched in India. Indus Biotherapeutics, a subsidiary of Intas, has developed human GCSF and recombinant erythropoietin for its parent. Cadila has launched Streptokinase under the brand name STPase. And Pune-based Emcure started by inlicensing biogenerics, and its current pipeline of products focuses on nephrology, oncology, cardiovascular diseases and gynaecology.

Brand Is The Key
Unlike generic pharma, in biopharmaceuticals, marketing is driven by brands simply because it is important for a company to establish that it has the capability to create a biogeneric successfully. Maximum value can be realised only from a finished formulation.” That’s because while raw material is cheap, the development process is long and expensive, making the final product almost as expensive as the innovators’. So, it makes sense to market under ones own brand name.

Aware that post approval, biogenerics will require extra promotion to sell in a new market, Indian companies are already setting up marketing front ends in Europe. Dr. Reddy’s plans to leverage its German acquisition, betapharm, to position its biogenerics in Germany and the UK. Others following suit include Ranbaxy in Germany, France, Belgium and Romania, and Wockhardt in the UK. Indian companies plan launches across the world. “India, rest of the world, Europe and the US, in that order. Wockhardt’s planned launch path is similar to Dr. Reddy’s.

so the race is on.



source BW

Acquisition & Merger - India's overseas acquisition spree

Indian companies are in an expansive, acquisitive mood. For example, Tata Steel, India's largest private-sector steelmaker, that it is on he process of acquiring Corus, a much larger Anglo-Dutch rival. If the deal came off, it would be worth several billion dollars, by far the largest foreign purchase ever made by an Indian firm. In the first three quarters of this year Indian companies announced 115 foreign acquisitions, with a total value of $7.4 billion, a huge increase on previous years, and almost as much as foreign firms have invested in Indian purchases.


The shopping spree spans industries from information technology (IT) and outsourcing to liquor. Wipro, for example, one of the country's big three IT firms, has this year acquired technology companies in Portugal, Finland and California. In pharmaceuticals Ranbaxy, an Indian maker of generic drugs, bought Ethimed of Belgium and Mundogen, the Spanish generics arm of GlaxoSmithKline. Bharat Forge, the world's second-biggest maker of forgings for engine and chassis components, based in the Indian city of Pune, has since 2004 bought six companies in four countries—Britain, Germany, Sweden and China. Suzlon, another Pune firm, which makes wind turbines, this year bought Hansen, a Belgian gearbox-maker. And United Breweries, a booze conglomerate from Bangalore, has made an unsolicited bid for Whyte & Mackay, a Scottish whisky distiller.

Behind this push overseas lies a combination of forces: a domestic boom; the availability of credit; a rush to achieve global scale; and a new self-confidence about Indian business's ability to add managerial value. India's economy is in its fourth successive year of growth at around 8%. In the first two quarters of this year GDP grew at rates of 9.3% and 8.9% respectively over the same periods in 2005.

With strong balance sheets, finance is not an obstacle. The stockmarket has been booming. Rupee interest rates, although they have been edging upwards for the past two years, are still, in real terms, at about half their levels of a decade ago. And, despite capital controls that place limits on external borrowings, India's big companies can raise huge amounts of money abroad. In August Reliance Petroleum raised the largest-ever syndicated loan for India, of $1.5 billion. Tata Steel is reported to have secured financing commitments of $6.5 billion for its putative bid for Corus.

Going global

That an Indian firm should even be contemplating borrowing so much for an acquisition shows how much corporate India has matured since 1991. That was when the government began to dismantle the “licence raj” of bureaucratic controls that had hobbled Indian business.


Tata Steel is emblematic of the successful parts of Indian manufacturing. It is known as the lowest-cost producer in the world. It is one of the firms that thrived in the more competitive marketplace that emerged in India after the 1991 reforms, and have since been able to take on the best in the world. What is noteworthy about many of them is that the root of their success is not India's obvious competitive advantage: its vast, low-cost labour force. In the IT and outsourcing industries, lower salaries for college graduates are an important reason behind Indian firms' rapid growth. But in manufacturing the stars tend to be experts in automated, capital-intensive production. Bosses who have flourished in such businesses in India, with its poor infrastructure and still-daunting regulatory environment, understandably feel confident that they have lessons to teach their new purchases in other countries. to be contd....