A big premium for India

With two sons vociferously splitting their loyalties between Manchester United and Arsenal, Brijesh Koshal is willynilly kept abreast of the latest from the English Premier League. But more than 'the beautiful game', the Head (Investment Banking) of Daiwa Capital Markets keenly tracks the English soccer team valuations.

"With so much history behind them, Man U is worth every bit of the $1.8 billion they are valued at. The TV rights alone are worth $25 million, while the AIG deal for shirt logo is worth $50 million," he reckons. A cricket aficionado himself, Koshal contrasts this with the sky-high valuations of the new Indian Premier League (IPL) franchises and is not sure they are justified, saying: "The IPL teams are after all unknown quantities."

But the IPL is just an indicator of the times. Investors are increasingly shelling out top dollar for Indian assets across diverse sectors. While the buzz about the India growth story partly explains the trend, a slew of recent deals has raised eyebrows. The Piramal-Abbott deal is a prime example.

When Abbott Laboratories snapped up Belgian company Solvay earlier this year, it paid $6.2 billion for a $3 billion company—a multiple of two times. For buying just a part of Piramal, Abbott forked out almost nine times the division's revenues. Abbott had the balance sheet strength to take such a risk on board. Or take the auctions of the 3G spectrum that garnered more than Rs 67,000 crore for the Indian government.

Sandeep Ladda, Executive Director at PricewaterhouseCoopers, says that when the telecom industry in Malaysia and South Africa opened up their 3G services, only 10 per cent of the subscribers upgraded. "There are no killer applications (yet) in 3G. It is a worrying factor," Ladda adds. Such a scenario can spell bankruptcy for the companies that bought spectrum at the auctions. Already the telecom companies have piled up debt to buy the spectrum.

Bharti Airtel could raise up to Rs 10,000 crore, which will send the ratio of its net debt to operating income soaring to 3 in 2010-11, from a negative 0.08 in 2009-10. Reliance Communication, too, seems over-leveraged with an additional debt burden of around Rs 6,500 crore, taking its gross debts to Rs 31,700 crore. Sunil Mittal, Chairman, Bharti Airtel, conceded that the auction prices had gone "beyond reasonable levels".

Then, there is the second realty boom in Indian cities now, within two years of a spectre of a realty bust. Mumbai has already seen an almost billion-dollar land deal and plans for the tallest ever residential tower in the world. Subhankar Mitra, Assistant Vice President at Jones Lang LaSalle Meghraj, says the Wadala land, for which Lodha Developers will pay Rs 4,050 crore, will be profitable as the government has allowed them to build four times the area in floor space. He, however, is worried that this could set the tone for irrational exuberance in the future with bids for some other mill lands of NTC soaring.

Adds Sanjay Sakhuja, Managing Director of Ambit Corporate Finance: "The worry is that in New York, barely half an hour away from Manhattan, you can buy a five-bedroom house on an acre of land for $1 million. For that kind of money, you cannot even imagine a similar house in Mumbai in the halfhour range from the city centre." Now here's a look at the final arbiter on valuations—the equity markets. India commands a higher price-earnings (P-E) multiple than peers from other emerging markets.

The one-year forward P-E of Indian markets at 15.6 is much higher than that of Brazil (9.5) and even China (12). Indian technology and pharma companies are among the most expensive globally. A Dr Reddy's or a Sun Pharma outstrips global giants like Pfizer or Glaxo. Tech service providers Infosys Technologies and Wipro may be seeing slower business growth, but they have one-year forward multiples of over 20—almost twice the valuation of a rival like Accenture, which, too, has established a significant India presence.

So, are the valuations in India out of whack? Perhaps not. Explains Gaurav Khungar, Executive Director at KPMG: "While you may value a company or a deal at something, there is always a premium you are willing to pay which determines the transaction price and the two are different." For instance, Khungar explains that in pharmaceuticals in India, while the average valuation would be around 13-14 times of operating margins, transactions can take place at multiples of 24 or 25— as seen in the Abbott-Piramal deal.

India happens to be the second fastest-growing pharma market, which is also expected to double its size to $16 billion by 2015. Also, low-cost manufacturing capabilities are the key consideration towards entering emerging markets. Then, today cost of capital is a lot lower globally. Says Sakhuja: "Interest rates around the world are close to zero and global growth assumptions are low. If you use the discounted cash flow method for valuation, you have to discount the free cash flows of a business with the cost of capital. As cost of capital goes down, the valuation can go up sharply."

Simply, lower rates mean a lesser interest outgo for the company over time, freeing up cash flows for future growth initiatives. Srividya C.G., Partner at Grant Thornton India, points out that total value and volume of deals that have happened in India in 2010 reminds one of the flurry of activity in 2006-07 when several big-ticket deals like Tata-Corus and Hutch-Vodafone were announced. However, in January-May 2010, while foreign companies have acquired Indian companies spending $4.8 billion, Indian companies, too, have spent $17.6 billion to acquire overseas. It's a much stronger India that the West is buying into now.

Favourable demographics and rising per capita income have ensured a robust domestic consumption story. Raamdeo Agrawal, Joint Managing Director of brokerage Motilal Oswal Securities, says there are many pointers to show that the India story has taken a turn. "Our currency has been stable at around Rs 45 to a dollar for almost a decade. I cannot remember such a phase in the past. This means our labour and capital productivity has improved, or else we would have seen a huge current account deficit," he says.

And, ah yes, the stock market valuations. Here's another takeaway. The relative stability of the secondary markets in India for the last six months augurs well, say analysts. Vinod Sharma, Head (Private Broking and Wealth Management) at HDFC Securities, points out: "For the last 10 months, the markets have not gone anywhere. From that perspective, we are on safer ground, that despite higher earnings growth, the markets have remained where they are. The markets do not appear overheated." Indian blue chips may appear expensive, but the valuations are clearly driven by the promise of future growth.

The IPL, though, most analysts feel, is a reminder of over-the-top valuations. Sahara bid $377 million for the Pune franchise. Venugopal Dhoot, Chairman, Videocon, who lost the bid for the Pune and Kochi franchise, asserts that the steep valuations did not make business sense. Sahara, according to some estimates, with its ambitious bid may not break even for at least a decade.

There is, then, always the lurking danger of investors losing sight of the big picture.

— Additional reporting by Rajiv Bhuva