Ambit - STRATEGY & ECONOMY - Theamatic - Err Group - The One Report That Changed India

STRATEGY &
ECONOMY
October 2013
The one report that changed India
Saurabh Mukherjea, CFA

saurabhmukherjea@ambitcapital.com
Tel: +91 99877 85848
Strategy & Economy
CONTENTS
Section 1: An eventful three years………………………………………………… 4
Section 2: The three business models of “connected” companies……………. 5
Section 3: The morning after……………………………………………………... 10
Section 4: Can India recover?.....................................................................14
Section 5: Investment opportunities............................................................ 22
Appendix 1: CAG’s 2G report.................................................................... 28
October 01, 2013 Ambit Capital Pvt. Ltd. Page 2

Strategy & Economy
THEMATIC October 01, 2013
The one report that changed India Recommendations

Bharti Airtel BUY
Three years since the Comptroller and Auditor General's (CAG) report
Ticker: BHARTI IN CMP: `319
on 2G spectrum allocation, India is a country transformed. Whilst most
of these transformations feel adverse at present (non-existent capex Upside: 21% Target price: `384
growth, rising stress in the banking system, and political confusion), the Mcap (US$bn): 20.3 6M ADV (US$mn): 24.5
catharsis triggered by the CAG’s report is for the better as it has
retarded the rise of ‘connected’ companies. Idea BUY
We argue in this note that over the next two years as policy paralysis Ticker: IDEA IN CMP: `168
ebbs away, some of the better managed large companies that have Upside: 8% Target price: `181
suffered over the past three years will make a comeback. We reiterate Mcap (US$bn): 8.9 6M ADV (US$mn): 13.5
our BUYs on Bharti, Idea, IDFC and L&T.
An eventful three years, especially for ‘connected’ companies (page 4) L&T BUY
The publication of the CAG's report on 2G spectrum allocation in November Ticker: LT IN CMP: `789
2010 changed the way Indian works. In particular, whilst a lot of finger pointing Upside: 41% Target price: `1,113
is taking place at present as to who is to blame for the slowdown, our index of Mcap (US$bn): 11.7 6M ADV (US$mn): 41.0
the 75 most ‘connected’ companies has underperformed the BSE500 by 60%
since the publication of the 2G report.
IDFC BUY
The three business models of ‘connected’ companies (page 5) Ticker: IDFC IN CMP: `88
Upside: 90% Target price: `167
Starting in the mid-1990s, a few (then) small road contractors figured out how
to game the public contracts system to perfection. As India became more Mcap (US$bn): 2.1 6M ADV (US$mn): 19.3
prosperous, these contractors became very large, very fast using a mix of the
following business models: (1) the ‘traditional’ contractor model; (2) the
‘resource grab’ model; and (3) the ‘capital grab’ model.
The unravelling of the three business models (page 10)

The CAG’s reports, Supreme Court verdicts and RTI-fuelled media exposés
stymied the three models once civil servants stopped signing off on files and
politicians sought shelter behind committees. Production of natural resources
either stagnated (coal) or fell sharply (iron ore, gas) and this hit downstream
sectors (steel, power). Capex growth fell from 14% in FY11 to 0.2% in 1QFY14.
Banks’ stressed assets ballooned from 3.5% (FY08) to 9% (FY13).
The long, hard road to recovery (page 14)

Whilst the outlook for the banking sector continues to be bleak due to loans
given to either inexperienced or corrupt promoters, the outlines of a new
regulatory construct for the Power & Infra sectors are emerging. In the new
world, the execution risk for infra contracts will stay with the Government and
the RoE for such contracts will be barely above the cost of capital. Regulatory
behaviour in the Telecom sector is also normalising. Just as importantly, Indian
society is for the first time being able to hold its politicians accountable.
BUY before the market discounts specific election outcomes (page 22)
Bharti is the listed telco best placed to benefit from consolidation in India given
its higher ARPU footprint and hence lower susceptibility to negative elasticity in
a rising tariffs scenario. Idea too will benefit from the greater pricing power
which comes from consolidation. It also stands from the expected pick-up in
data revenues. L&T’s FY13 and 1QFY14 order booking growth of 25% not only Analyst Details
displays its rising competitive strength (vis-à-vis its weaker peers) in the core Saurabh Mukherjea, CFA
business but more importantly provides strong visibility on revenues. IDFC is the saurabhmukherjea@ambitcapital.com
lender most positively exposed to the recent developments in the Power, Infra Tel: +91 99877 85848
and Telecom sectors.
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Strategy & Economy
Section 1: An eventful three years

“…one of the most important lessons we can learn from an examination of economic
life is that a nation’s well-being as well as its ability to compete is conditioned by a
single, pervasive cultural characteristic: the level of trust inherent in the society.”
- Francis Fukuyuma in ‘Trust: The Social Virtues and the Creation of
Prosperity’ (1995)
All of us have become habituated to seeing the Indian Government constitute an
enquiry or set up a commission whenever a scandal surfaces or a calamity befalls the
nation. The reports published by these bodies are greeted with as much excitement as
the weather report. The publication of the Comptroller and Auditor General's (CAG)
report on 2G spectrum allocation in November 2010 changed all of that.
Three years hence, with the economy weakened, with corporate India humbled, with
bureaucrats terrified of signing off on almost anything, we can safely say that the
CAG’s 2G report marks a watershed moment in India’s development.
In this note we take stock of what has happened in the intervening three years to:
 ‘connected’ companies and their ability to do business in India (Section 2);
 the lenders and investors who financed these connected companies (Section 3);
and
 civil servants and regulators who have to deal with and monitor these companies
(Sections 2-4).
Clearly, a lot of hand wringing and finger pointing is happening at present as to who The last three years have been an
is to blame for the current state of affairs. However, with our ‘Connected’ Companies unqualified positive for those who
Index (an index of the 75 most-connected companies in India) underperforming the want to see a cleaner India
BSE500 by 50% since the publication of the 2G report, the last three years have been
an unqualified positive for those who want to see a cleaner India.
However, have the events of the past three years created fresh investment
opportunities especially amongst the companies that were dragged into the quagmire
of bureaucratic paralysis and political inaction? In Section 5 we answer this question
in the affirmative.
Exhibit 1: The brutal underperformance of ‘connected’ companies
120
100
80
60
40
20
Sep-10
May-11
Sep-11
May-12
Sep-12
May-13
Sep-13
Jan-11
Jan-12
Jan-13
Ambit Connected Cos Index BSE 500
Source: Ambit Capital

Strategy & Economy
Section 2: The three business models of

‘connected’ companies
“In Mexico, Carlos Slim did not make his money by innovation…His major coup was the
acquisition of Telmex, the Mexican telecommunications monopoly that was
privatised…in 1990. The government announced its intention to sell 51% of the voting
stock (20.4% of total stock) in the company in September 1989 and received bids in
November 1990. Even though Slim did not put in the highest bid, a consortium led by
his Group Corso won the auction. Instead of paying for the shares right away, Slim
managed to delay payment, using the dividends of Telmex itself to pay for the stock.
What was once a public monopoly now became Slim’s monopoly and it was hugely
profitable.”
– Daron Acemoglu and James Robinson in “Why Nations Fail: The Origins of
Power, Prosperity and Poverty” (2012)
As is evident from the above quote, it is not unusual for emerging markets to be
characterised by ‘rent-seeking’ practices perpetrated by aggressive corporates
working in cahoots with the authorities.
Looking back at the Power and Infra sector’s performance over the past decade, with
Three different types of
the benefit of hindsight we can state that whilst some companies were (and remain)
misguided business models in the
genuinely in the business of providing infra to the public (in return for a fair return on
sector
their capital), a number of these companies entered the sector with specific goals
which at that time seemed realistic to them but ultimately turned out to be misguided.
We see broadly three different types of misguided business models in the sector—the
‘traditional’ contractor model, the ‘resource grab’ model and the ‘capital grab’ model.
(1) The ‘traditional’ contractor model
This model, which is almost as old as independent India, entails bidding for a public
works or infra contract at a low rate which other bidders/contractors cannot match
and then, once the contract is given, maximising the upside by either asking the
Government for more funds or by imposing levies on the public.
Starting in the mid-1990s, as the Indian government stepped up its programme of
Starting in the mid-1990s…a new
building roads between its major cities (and peaking with the NDA Government’s turn
generation of contractors became
of the century ‘Golden Quadrilateral’ road building programme), a new generation of
very large, very fast on the back
contractors became very large, very fast on the back on large road construction
on large road construction
contracts. Unfortunately, in the absence of a public audit on how much these road
contracts
contracts overshot their original budgets, it is hard to quantify the extent of financial
gain to these contractors.
However, thanks to the audit reports available on CAG’s website (http://cag.gov.in/),
it is possible to assess the ubiquity of this traditional contractor model.
Example 1 - CAG report on the Implementation of the Public Private
Partnership (for) Indira Gandhi International Airport, Delhi (also called DIAL):
DIAL is a joint venture consortium of the GMR Group (54%), Airports Authority of India
(26%), and Fraport AG & Eraman Malaysia (10% each). GMR is the lead member of
the consortium. In January 2006, the consortium was awarded the concession to
operate, manage and develop the IGI Airport following a competitive bidding process.
DIAL entered into an Operations, Management and Development Agreement (OMDA)
on 4 April 2006 with the Airports Authority of India (AAI). The initial term of the
concession is for 30 years extendable for another 30 years. Besides upgrading the
existing terminals, DIAL commissioned a new runway at IGI Airport on 25 September
2008. It also inaugurated the new domestic departure terminal 1D on 26 February
2009. Now we quote from the CAG report on DIAL:
“As per the Business Plan the original project cost approved by DIAL and communicated
to AAI to 18 January 2008 was INR 8975 crore [US$1.5bn]. …The final project cost
adopted by the Airports Economic Regulatory Authority (AERA) for arriving at the
Regulatory Asset Base (RAB) was INR 12502.86 crore [US$2.1bn]…i.e. 43.25% higher
than the original project cost…

Strategy & Economy
It was noted in the audit that at the time of financial closure in January 2008 levy of
Development Fee [DF] was not contemplated. [However] Large part of the enhanced
project cost was subsequently recovered by DIAL from the passengers using the airport
through levy of DF….as per the original estimates the entire funding was to be through
equity, debt, security deposits and internal accruals. However, this was reduced to
72.68 per cent of the total fund requirements of the actual project cost. This financial
gap was mainly filled by levy of DF…OMDA did not envisage the funding of project cost
through levy of DF from passengers….the inability of the shareholders of DIAL to bring
in additional funds to the project through additional debt from financial institutions led
to levy of DF on passengers.”
[The text in the square brackets is from us. Everything else is directly taken from the
CAG report.]
Example 2 - The CAG’s Audit Report on the 19th Commonwealth Games, 2010:
Delhi hosted the Commonwealth Games three years ago. The games themselves were
a chaotic affair with a bridge in the main stadium collapsing days before the
commencement of the games and with thousands of used condoms clogging the
drains of the toilets in the Commonwealth Games village. The CAG’s audit report
which followed a year later reads almost like a textbook in how to take advantage of
the famous ‘soft budget constraint’:
“The modus operandi observed over the entire gamut of activities leading to the
conduct of the Games was: inexplicable delays in decision making, which put pressure
on timelines and thereby led to the creation of an artificial or consciously created sense
of urgency. Since the target date was immovable, such delays could only be overcome
by seeking, and liberally granting, waivers in laid down governmental procedures. In
doing so, contracting procedures became a very obvious casualty. Many contracts were
then entertained based on single bids, and in fact, some of them were even awarded on
nomination basis. Taking liberties with the governmental procedures of the
aforementioned kind led to elimination of competition. A conclusion from such action
which seems obvious is that this could indeed have been the intended objective!
Eliminating competition led to huge avoidable extra burden on the exchequer….
The IOA [Indian Olympic Association] bid of May 2003 estimated on an all-inclusive The IOA [Indian Olympic
cost of just INR 1200 crore [US$0.2bn]…By contrast, the overall budget estimate of Association] bid of May 2003
CWG-2010 for GOI [Government of India] and GNCTD [Government of National estimated on a cost of just
Capital Territory of Delhi]…as of October 2010 was INR 18,532 crore [US$3.1bn]…We [US$0.2b]…By contrast, the
found numerous upward revisions in GoI’s budget estimates from time to time. In overall budget estimate as of
particular, there were seven revisions from April 2007 and September 2010 at very October 2010 was INR 18,532
short intervals…” crore [US$3.1bn]
CAG report.]
(2) The ‘resource grab’ model
This model came of age in the noughties as the burst of prosperity enjoyed by India
combined with the country’s weak institutional structures allowed opportunistic
promoters to capture under-protected natural resources and then monetise them for
personal gain. Based again on the CAG’s audit reports two prime examples of such
behaviour appear to be the 2G spectrum allocation and the allocation of coal blocks.
Example 1 - Performance Audit Report on the Issue of Licenses and Allocation
of 2G Spectrum by the Department of Telecommunications (DoT): This
controversial but extraordinary report (extraordinary for the nature and scale of the
exposé), which was published in November 2010, has a riveting Executive Summary.
In Appendix 1 we have reproduced a sizeable portion of the Executive Summary of
this remarkable document. In the next paragraph we provide the key points made in
the CAG report which ultimately resulted in a January 2012 Supreme Court verdict
quashing all the 2G licences awarded in 2008.

Strategy & Economy
India is divided into 22 telecom zones, with 281 zonal licences. According to the
national telecom policy when an operator gets a licence allotted to it, some spectrum
is bundled along with it (without having to be auctioned). On 10 January 2008, 120
new second generation (2G) Unified Access Service (UAS) licences were given to
telecom companies at the 2001 spectrum price and on a first-come-first-serve (FCFS)
basis. It appears that while awarding these licences, the Department of Telecom (DoT)
violated a number of rules. Amongst other things, 85 out of the 122 licences were
issued to firms which did not satisfy the basic eligibility criteria set by the DoT. In fact,
several licences were issued to firms with no prior experience in the telecom sector or
to firms that had suppressed relevant facts.
In November 2007, the Prime Minister had written to the then Telecom minister
directing him to ensure the allotment of 2G spectrum in a transparent manner and to
ensure that the license fee was revised. The DoT seems to have chosen to ignore
these recommendations.
In the same month, the Ministry of Finance (MoF) wrote a letter to the DoT raising
concerns over the procedure adopted by it. Once again, the DoT seems to have
ignored the MoF’s concerns. On 24 September 2007, the DoT issued a press release
saying that applications for licences would be accepted only up to 1 October 2007.
Then, the next day (i.e. 25 September), the DoT proceeded to advance the cut-off date
to 25 September. This meant that applicants had ‘less than an hour’ to file their
applications.
This allocation of 2G licenses on a seemingly arbitrarily managed FCFS basis without This allocation of 2G licenses on
a proper auction presumably resulted in losses to the Exchequer. The question is “how a seemingly arbitrarily managed
big was the loss?” The CAG’s estimates a range from `58K cr [US$10bn] to `152K cr FCFS basis without a proper
[US$25bn]. auction presumably resulted in
(For the full CAG report on 2G spectrum allocation see: http://cag.gov.in/html/reports/civil/2010- losses to the Exchequer
11_19PA/exe-sum.pdf)
Example 2 - CAG report on the allocation of coal blocks: Whilst the CAG
delivered the 2G spectrum audit without a specific directive from the Government, the
CAG report on coal blocks seems to have been prompted by the relevant ministry.
Quoting directly from the CAG report which was published in August 2012:
“The concept of allocation of coal blocks through competitive bidding was first made
public on 28 June 2004 at an interactive meeting held with stake holders under the
Chairmanship of the Secretary (Coal). Following the meeting, a comprehensive note on
“Competitive Bidding for Coal Blocks” was submitted (16 July 2004) by the then
Secretary (Coal) before the Minister of State, Coal and Mines, highlighting that
“…since there is a substantial difference between price of coal supplied by Coal India Audit [i.e. CAG] has estimated
and coal produced through captive mining, there is a windfall gain to the person who financial gains to the tune of INR
is allotted a captive block….”. It was, therefore, felt necessary by MOC [Ministry of 1.86 lakh crore [around
Coal] to adopt a selection process which could be acceptable as demonstrably more US$30bn] likely to accrue to
transparent and objective. Auctioning of blocks was considered as one of the widely private coal block allotees
practised and acceptable selection process which was transparent and objective. The
note further indicated that the “….the bidding system will only tap part of the windfall
profit for the public purposes…”. Despite these facts, the GOI [Government of India]
is yet (February 2012) to finalise the modus operandi of competitive bidding…Delay in
introduction of the process of competitive bidding has rendered the existing process
beneficial to the private companies. Audit [i.e. CAG] has estimated financial gains to
the tune of INR 1.86 lakh crore [around US$30bn] likely to accrue to private coal
block allotees (based on average cost of production average sale price of Opencast
mines of CIL [Coal India Ltd] in the year 2010-11.”
[Note: the square brackets are ours. Everything else, including the bold font, is taken
from the CAG report on the Allocation of Coal Blocks.]
(Source: http://www.hindustantimes.com/Images/Popup/2012/8/Final_Ministry_Coal.pdf )

Strategy & Economy
(3) The ‘capital grab’ model

Starting from 2004 onwards, as first the banks and then the stockmarket got very They underbid to win small
excited about the whole Power & Infra ‘opportunity’, certain promoters realised that contracts for which they availed
regardless of whether they possessed the innate abilities to put together viable infra of debt funding from banks;
projects, they would be able to get funding for the same on a 70:30 debt:equity basis. those loans then formed the
As a result, they underbid to win small contracts for which they availed of debt equity for the next (larger) project
funding from banks. Those loans then formed the equity for the next (larger) project bid
bid which then gave the promoter access to an even larger bank loan. Combined with
some creative accounting (especially around AS-21, the accounting standard
pertaining to ‘consolidation’), these small contractors grew rapidly to show not only
large balance sheets but also large P&Ls (boosted by the construction work being
done for the projects won by the promoter). The easy access to debt and equity capital
combined with the ability of certain promoters to bring into play the two models
previously mentioned in this section meant that certain infra companies became very
large, very fast over the course of the noughties.
Exhibit 2: Equity raised by listed Power, Infra & Construction companies
350 30%
300 25%
250
20%
200
15%
150
10%
100
50 5%
0 0%
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
Total equity raised by power, infrastructure and construction listed on BSE (Rs bn)
As a % of total equity raised by BSE companies
Source: Ambit Capital. Note: This only includes equity raised at the listed entity level. If the subsidiary of a listed
entity raised equity, then that will not be captured here.
Exhibit 3: Loans outstanding in the Power, Infra, Construction and Telecoms sectors
9,000 120%
8,000
100%
7,000
6,000 80%
5,000
60%
4,000
3,000 40%
2,000
20%
1,000
- 0%
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
Loans outstanding (Rs bn)

YOY growth in Power, Infra, Const & Telecom loans outstanding
Source: Ambit Capital using RBI data

Strategy & Economy
Exhibit 4: The BSE Power Index’s relative performance
FY-06
FY-07
FY-08 BSE500 index
FY-09 BSE Power Index
FY-10
FY-11
FY-12
FY-13
-60% -30% 0% 30% 60% 90% 120%


Strategy & Economy
Section 3: The morning after

“What do you do with a set of elites whose self-delusions are now reaching
Shakespearean proportions? They are, literally, becoming shadowy figures chasing
shadows. How does one diagnose this condition?”
– Pratap Bhanu Mehta in the Indian Express (May 2012)
The havoc created by these three business models running aground has been
immense and along multiple dimensions.
Once the 2G crisis broke in October 2010, civil servants stopped signing off on files
Once the 2G crisis broke in
on issues ranging from Environmental Clearances to access to coal blocks and
October 2010, civil servants
Ministers sought the shelter of committees (‘GoMs’ (Group of Ministers) and EGoMs
stopped signing off on files …and
(Empowered Group of Ministers)). Gradually, the Power, Infra and Mining sectors
ministers sought the shelter of
slowed down (see the charts which follow in this section). The lenders to these sectors
committees
then proceeded to restructure the loans made to these sectors (total stressed assets for
Indian banks have risen from 4.7% of loans outstanding in FY09 to 17.4% in FY13).
Unsurprisingly, the PSU banks ended up carrying the bulk of the problematic loans
and were brutally derated from 1x book value three years ago to 0.5x now.
At present, loans to the Power, Infra, Construction, Aviation and Real Estate sector
account for 20% of the loans in the banking system. Even if one assumes that only
one-fifth of these loans will go sour, this still means that 40% of the shareholders’
equity in the banking system will be written off.
In parallel, thanks to petitions signed by the NGOs (see below), the Supreme Court
took a renewed interest in the Mining sector and declared a blanket ban on iron ore
mines in Karnataka and Goa. This resulted in the business models of local steel
manufacturers, with the exception of SAIL and Tata Steel which do not have mines in
Karnataka and Goa, becoming unviable.
 Karnataka: In 2009, Samaj Parivartana Samudaya, an NGO, filed a writ petition
(No: 562 of 2009) in the Supreme Court for the Karnataka state's inaction against
illegal mining, even after the Lokyukta report dated December 2008.
Exhibit 5: How the Supreme Court shut down iron ore mining in Karnataka
Date Developments of the case
SC directed Central Empowered Committee (CEC) to submit its report on illegal mining in
25-Feb-11
Karnataka.
29-Jul-11 SC imposed a blanket ban in Bellary district
5-Aug-11 SC allows NMDC to mine in Bellary district
26-Aug-11 SC extends mining ban to Timkur and Chitradurga districts
3-Sep-12 SC lifts ban from Category A mines
18-Apr-13 SC lifts ban in Category B mines and cancels leases in Category C mines
 Goa: In 2012, Goa Foundation, another NGO, filed a writ petition (No: 435 of
2012) in the Supreme Court for continued illegal mining in Goa.
Exhibit 6: How the Supreme Court shut down iron ore mining in Goa
Date Developments of the case
SC directed CEC to submit its report on illegal mining in Goa
5-Oct-12
SC imposed a blanket ban on mining and transportation of ore in Goa
7-Dec-12 CEC filed its interim report
17-Sep-13 SC hearings begin

Strategy & Economy
Exhibit 7: Quantification of the decline in iron ore production in India (mt)
250
213 213 219
207
200
167
144
150
100
45 36
50
0
FY08
FY09
FY10
FY11
FY12
FY13
1QFY13
1QFY14
Source: Indian Bureau of Mines, Ambit Capital research
Exhibit 8: Quantification of the decline in Coal India's production growth
8% 6.8%
7% 6.1% 6.4%
6% 5.4%
4.8%
5%
3.8%
4%
2.7%
3%
2% 1.0%
1% 0.0%
0%
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
YTDFY14
Source: Company, PIB, Ambit Capital research
CAG, in its 8 September 2011 report (on RIL's KG D6 block) was critical of the
Government’s oversight, particularly on high-value procurement decisions, and
sought an ‘in-depth review’ of ten contracts, including eight awarded to the Aker
Group by Reliance Industries (RIL) on a single-bid basis.
CAG also alleged that the Director General of Hydrocarbons (DGH) and the Ministry
of Petroleum & Natural Gas (MoPNG) are unequipped to oversee the execution of the
Production Sharing Contract (PSC). Hence, according to CAG, RIL was allowed to hold
on to 25% of KG D6 exploration acreage despite lack of rigs and RIL also started
Phase 3 exploration without ceding the earlier area.
CAG also alleged that RIL denied CAG access to records and accounts of the KG D6
block and disputed the scope of the CAG audit. Hence, MOPNG (in its 17 July 2012
press release) cited that CAG has recommended withholding of sanction to work plans
and budgets for KG D6 block until access to records is given to CAG. This delay in approvals has partly
contributed to the sharp fall in
This delay in approvals has partly contributed to the sharp fall in KG D6 gas
KG D6 gas production (down to
production (down to 14mmcmd currently from the peak of 60mmcmd and the original
14mmcmd currently from the
planned target of 89mmcmd). In turn, this drop in gas production has meant that
peak of 60mmcmd)
India’s gas power plants (which have installed capacity of 18GW) are currently
running on 26% plant load factors.

Strategy & Economy
Exhibit 9: KG D6 gas production on a declining trend (mmcmd)
60
50
40
30
20
10
0
1QFY10 1QFY11 1QFY12 1QFY13 1QFY14
Source: RIL, Ambit Capital research
As civil servants stopped expediting clearances for projects and as the mining industry
Capital formation in India slowed
decelerated rapidly, capital formation in India slowed down sharply, from 14% in
down sharply from 14% in FY11
FY11 to 0.2% in Q1 FY14. Whole segments of the economy, such as stockbrokers,
to 0.2% in 1QFY14
asset managers, newspapers, auto companies, real estate companies, which fed off
the capex boom, were left staring at overcapacity in their businesses.
Exhibit 10: The slowdown in capital formation in India
40% 30%
35% 25%
30% 20%
25%
15%
20%
10%
15%
10% 5%
5% 0%
0% -5%
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
GFCF (as a % of GDP) GFCF (change, YoY in %)
Having overseen the exuberant boom of FY05-09, the incumbent administration now
finds itself at the receiving end, as the worst excesses of the boom are unwound. As
projects unravel, as companies go into CDR (knowing that the bulk of the downside
risk would crystallise with PSU banks) and as the economic growth slides, the
incumbent administration continues to lose vital electoral ground in these crucial
months running up to a spate of state elections (in Madhya Pradesh, Chhattisgarh,
Delhi, and Rajasthan) and the General Election.
Finally, and most profoundly, this logjam raised fundamental questions about India’s
ability to deal with the pulls and pressures of rapid economic growth. Raghuram
Rajan, the then Chief Economic Advisor and now the RBI Governor, wrote on 30 April
2013:

Strategy & Economy
“…India probably was not fully prepared for its rapid growth in the years before the
global financial crisis. For example, new factories and mines require land. But land is
often held by small farmers or inhabited by tribal groups, who have neither clear and
clean title nor the information and capability to deal on equal terms with a developer or
corporate acquirer. Not surprisingly, farmers and tribal groups often felt exploited as
savvy buyers purchased their land for a pittance and resold it for a fortune. And the
compensation that poor farmers did receive did not go very far; having sold their
primary means of earning income, they then faced a steep rise in the local cost of living,
owing to development.
In short, strong growth tests economic institutions’ capacity to cope, and India’s were
found lacking. Its land titling was fragmented, the laws governing land acquisition were Strong growth tests economic
archaic, and the process of rezoning land for industrial use was non-transparent. institutions’ capacity to cope, and
India’s were found lacking
India is a vibrant democracy, and, as the economic system failed the poor and the
weak, the political system tried to compensate. Unlike in some other developing
economies, where the rights of farmers or tribals have never stood in the way of
development, in India, politicians and NGOs took up their cause. Land acquisition
became progressively more difficult.
A similar story played out elsewhere. For example, the government’s inability to allocate
resources such as mining rights or wireless spectrum in a transparent way led the courts
to intervene and demand change. And, as the bureaucracy got hauled before the
courts, it saw limited upside from taking decisions, despite the significant downside from
not acting. As the bureaucracy retreated from helping businesses navigate India’s
plethora of rules, the required permissions and clearances were no longer granted.
In sum, because India’s existing economic institutions could not cope with strong
growth, its political checks and balances started kicking in to prevent further damage,
and growth slowed”.
(Source: http://www.project-syndicate.org/commentary/the-democratic-roots-of-india-s-economic-
slowdown-by-raghuram-rajan#2Uv6j75yQ6LxfQEX.99 )

Strategy & Economy
Section 4: Can India recover?

“The rise of Brazil since the 1970s was not engineered by economists of international
institutions instructing Brazilian policymakers on how to design better policies or avoid
market failures. It was not achieved with injections of foreign aid. It was not the natural
outcome of modernisation. Rather, it was the consequence of diverse groups of people
courageously building inclusive institutions…the Brazilian transformation, like that of
England in the seventeenth century began with the creation of inclusive political
institutions.”
– Daron Acemoglu and James Robinson in “Why Nations Fail: The Origins of
Power, Prosperity and Poverty” (2012)
There is some hope for lenders…

As highlighted in multiple CAG reports, at issue is not just malfeasance on the part of At issue is not just malfeasance
politicians but also dishonesty on the part of the corporates: on the part of politicians but also
“Eighty five out of the 122 licenses issued in 2008 were found to be issued to dishonesty on the part of the
Companies which did not satisfy the basic eligibility conditions set by the DoT and had corporates
suppressed facts, disclosed incomplete information and submitted fictitious documents
for getting UAS licenses and thereby access to spectrum…” - From the CAG report on
2G spectrum allocations.
More recently, on 9 August 2013, Dr KC Chakrabarty, Deputy Governor of the RBI,
made a similar point in the context of banking sector NPAs and restructured assets:
“The Gross NPAs and restructured standard advances for the infrastructure sector,
together as a percentage of total advances to the sector, has increased considerably
from `. 121.90 bn (4.66%) as at the end of March 2009 to `.1369.70 bn (17.43%) as at
the end of March 2013. There is enough evidence to suggest that a substantial portion
of the rise in impaired assets in the sector is attributable to non-adherence to the basic
appraisal standards by the banks.”
Therefore, reflecting on the events in the Power & Infra of the last ten years, one
cannot but help draw a distinction between:
 Genuine misjudgements (eg. a genuine attempt by an inexperienced promoter
to build a viable private sector power utility) versus questionable attempts (eg. a
power plant being built by a promoter using second-hand Chinese equipment
knowing full well that the plant will never be viable but he will get rich by related
party contracts to build the sub-par plant); and
 Legal initiatives (eg. an attempt to build a power plant after winning the bid fair
and square) versus illegal initiatives (eg. mining in the Goa countryside without
the requisite permissions).
Exhibit 11: Classifying Power, Infra, Telecom & Mining projects
Zone of Recovery Poor recovery prospects

Genuine
Eg. Large scale thermal Eg. Iron ore mines in Goa

power utilities & Karnataka
Ethics
Questionable
Poor recovery prospects

Poor recovery prospects
Eg. Several second rung
Eg. Several 2G Licensees
power utilities
Legal Illegal
Legality
Source: Ambit Capital.

Strategy & Economy
Now, you can combine these two dimensions to create a 2x2 matrix. Unfortunately,
The only place lenders and
for investors and lenders, regardless of who comes to power in New Delhi after the
investors are likely to get positive
next elections, the only place they are likely to get a positive returns (and that too
returns (and that too below the
below the cost of their capital) is in the ‘Genuine, Legal’ quadrant. So, for example,
cost of their capital) is in the
projects like Tata Power’s Mundra UMPP and Adani Power’s Mundra project seem
‘Genuine, Legal’ quadrant
likely to give lenders their money back but the RoEs for these projects are likely to be
10% at best and that too if the state electricity regulator agrees to the Deepak Parekh
Committee’s recommendation of allowing these two projects to earn a 10% RoE (by
allowing them to increase tariffs by 15-20%).
In fact, as pointed out by Vinayak Chatterjee, the Chairman of Feedback Infra, a
prominent consultant to this sector and often a trenchant critic of government policies,
the Deepak Parekh Committee’s recommendations are likely to act as a guide for
many other similarly stuck projects. We now quote from Mr Chatterjee’s 24 September
opinion piece in the Business Standard:
“While these two projects have often been talked about in the same breath, there are
some basic differences between the two.
The Adani Power Project consists of two purchase commitments - one contracted for
with Gujarat and based on domestic coal, and the second contracted for with Haryana,
based on domestic and imported coal. In both cases, the fuel was to be procured by the
developer. The source was identified as domestic in the case of Gujarat while it was
identified as a mix of domestic and imported coal in the case of Haryana. While the
power purchase agreements (PPAs) for both the Gujarat and Haryana bid processes
provided flexibility to bidders to de-risk their proposal with appropriate indexation, the
bidder chose not to take advantage of the provision and provided a fixed tariff without
indexation (for fuel, inflation et al). After the PPAs, the developer chose to contract with
its own trading arm for the supply of imported coal. With changes in the law in
Indonesia adversely affecting the price of imported coal, the bidder sought
compensation for change in the "landed energy price" in the fixed energy charge to the
"actual landed energy price" now applicable in the market.
In the case of the Tata Power project, it was clearly based on imported coal, sourced
from an entity in Indonesia in which it had a stake. Having bid 57 per cent indexation at
a free-on-board (FOB) level, it took a nuanced view and sought compensation for
change in the FOB price of coal for only the 43 per cent "non-indexed" portion.
With both projects incurring substantive losses, both sets of promoters petitioned the
CERC took the bold step of
Central Electricity Regulatory Commission (CERC) on the issue. Cutting through the
accepting the fundamental
thicket of ideological debates on the appropriateness, or otherwise, of tinkering post-
premise of the two developers
facto with bid parameters, CERC took the bold step of accepting the fundamental
that their case for compensation
premise of the two developers that their case for compensation had prima facie merit
had prima facie merit and chose
and chose not to be bound by the purity of bid processes. To take matters forward,
not to be bound by the purity of
CERC constituted an independent committee under Deepak Parekh to recommend
bid processes
"compensatory tariff", with clearly defined guiding principles under which the
compensation had to be determined…
Some of the key implications and learnings [from the Deepak Parekh Committee’s
recommendations] are discussed below:
 The committee recommended that the developers be paid the actual fuel cost they
incurred. For Adani, this would include ocean freight, port charges, and insurance,
whereas in the case of Tatas, it would be compensated for the change in FOB price
for the "non-indexed" portion of coal. It appears that the recommendation is based
on a conceptually differential approach to the two projects.
 On the issue of adjustment of potential increased profits of mining subsidiaries, the
committee has recommended that the share of the mining profits be adjusted from
the compensation. With Adani having since gone for a contract with independent
fuel suppliers, this provision now does not apply to its project and hence it is not
liable to suffer any consequential reduction in compensatory tariff on this account.
In the case of Tatas since it holds a 30 per cent stake in the mining company, 30
per cent profit of the mining company would be adjusted.

Strategy & Economy
 On the issue of relief due to third party (merchant) sales, the committee has
recommended that the state utilities relinquish their rights over the energy
generated above the normative availability of 80 per cent for third-party sale, and
an equal sharing of revenue (over and above fuel cost) from the sale of such
energy. In a reading of the compensatory award principles, the linkage between
this added ability to generate more profits and its corresponding ability to reduce
future compensatory tariff is not clearly visible. Now, CERC and the procuring states
have to converge on these recommendations.
Overall, the entire exercise provides practical and useful case material for India going
forward using private capital as a bedrock for infrastructure development, providing
confidence to developers and investors and dealing with the attendant issues of bid
sanctity, public-private partnership renegotiation, and life-cycle viability of infra assets
and, most importantly, balancing conflicting demands.”
(Text in square brackets and underlined text is ours. The rest of the text is from
http://smartinvestor.business-standard.com/market/Econnews-200615-Econnewsdet-
Vinayak_Chatterjee_Compensatory_tariff_Untangling_the_knot.htm.)
…but that hope has to be tempered with the reality of extensive bad loans
However, whilst things are looking up in the ‘Genuine, Legal’ quadrant, in the other …in the other three quadrants it
three quadrants it is hard to see how investors and lenders can avoid further pain. If is hard to see how investors and
the project is illegal (eg. the multiple coal blocks that have been deallocated after lenders can avoid further pain
being named in the CAG report) then it will be hard for the banks to get their money
back. Even if the project is legal but the promoter has pilfered away the funds (debt
and equity) allocated to that project through overpriced construction contracts, the
banks and investors will struggle to get their money back.
Whilst the lenders have used the shelter of ‘restructuring’ so far to protect their
balance sheets from the adverse impacts of these troubled loans, this has merely, to
use a popular phrase, ‘kicked the can down the road’.
Exhibit 12: The relentless rise in stressed assets in the banking system
2008 2009 2010 2011 2012 2013
Restructured advances as a % of gross advances
SBI 1.1 2.2 4.9 4.6 4.8 3.0
PSU banks 1.3 3.5 5.3 4.4 6.9 7.1
Old private sector banks 1.2 3.2 3.7 3 3.5 3.8
New private sector banks 1.6 1.9 1.7 0.7 1.2 1.2
All scheduled commercial banks 1.2 2.8 4.5 3.7 5.1 5.7
Gross NPAs as a % of gross advances
SBI 2.6 2.5 2.7 3.4 4.6 4.8
PSU banks 2.1 1.7 2.0 2.1 2.8 3.2
Old private sector banks NA 2.4 2.3 1.9 1.8 2.0
New private sector banks NA 3.1 2.9 2.7 2.2 1.8
Stressed Assets as a % of gross advances
SBI 3.7 4.7 7.6 8 9.4 7.8
PSU banks 3.4 5.2 7.3 6.5 9.7 10.3
Old private sector banks - 5.6 6.0 4.9 5.3 5.8
New private sector banks - 5.0 4.6 3.4 3.4 3.0
Source: Ambit Capital using RBI data.
Hence, regardless of the General Elections next year, it is hard to see how Indian
banks will emerge from this crisis without a major write-down of their loan books
(followed by a recap). Whilst for the PSU banks this will be a major affair, even the
more prominent private sector lenders to the Power, Infra and Construction sectors
seem likely to have to take significant write-offs. [The top private sector banks ranked
in order of the % of their loan book in Power & Infra assets are: Axis 12.7%, ICICI
12.3%, Yes 12.2%, Federal 8.8%, Kotak 5.2%, IndusInd 4.5% and HDFC Bank 3.4%.]

Strategy & Economy
From 27.3% of the Sensex three months ago, the Bankex now accounts for only 22.9%
From 27.3% of the Sensex three
of the frontline index. We reckon it is safe to say that this ratio will move in only one
months ago, the Bankex now
direction: down. The fact that India’s largest bank, the State Bank of India (SBI), was
accounts for only 22.9% of the
downgraded to junk status by Moody’s (on 23 September 2013) is a harbinger of
frontline index.
things to come.
Rays of light in the Power and Infra sectors
If the fate of the banks is sealed does that mean that the fate of the Power, Infra and
Construction sectors are also sealed? Not necessarily.
Firstly, since March 2013, the Government of India and various regulatory authorities
such as CERC are making the right noises regarding the resolution of the logjam
between power generators, fuel suppliers and state electricity boards through increase
in power tariffs, Coal India’s fuel supply agreements for projects with PPAs, and pass
through of high-cost imported coal.
Secondly, it is becoming increasingly clear that India will create a new set of norms
It is becoming increasingly clear
under which the private sector invests in power plants, road, ports, etc will be put up
that India will create a new set of
for tender by the state but with:
norms for power plants, roads,
(a) the bulk of the execution risk staying with the state (so if, for example, the cost of ports, etc.
fuel goes up for a power utility, then this will be reflected in full in the final price
of power sold to the state electricity board); and
(b) the promised rate of return from these projects being marginally above the cost of
capital (as opposed to the 20-25% returns promised by the Power companies that
went public in 2009).
Draft regulatory frameworks along these lines are already emerging from the sectoral
regulators. For example,
 AERA, the airports regulator, is proposing that RoEs for any airport projects that
are now tendered be capped at 16%. If the airport operator generates RoEs above
16%, the upside will be shared with the Exchequer.
 CERC, the electricity regulator, is stating that Power Purchase Agreements signed
by state electricity boards (SEBs) should henceforth give a minimum RoE of 15.5%
for a base level of plant utilisation. If a utility company is able to generate higher
RoEs, say by running the plant at higher utilisation, it will be allowed to earn up to
something like 18%. Returns above 18% will be taken away by the Exchequer.
That said, it is unlikely that these frameworks will be finalised in the life of the current
administration. Hence, India’s Power, Infra and Construction companies will have to
wait for at least two years before they get to bid for contracts which would not
damage them further.
Positive regulatory change in the Telecom sector…at last
In the Telecom sector, after the CAG’s audit three years ago, the intense competition
The intense competition
unleashed by the now infamously unfair 2G spectrum allocations of 2008 is now
unleashed by the now infamously
abating thanks to: (a) the DoT’s insistence since the CAG exposé on seeking high
unfair 2G spectrum allocations of
prices for spectrum; and (b) the cancelling of the 2G licenses in January 2012.
2008 is now abating
Furthermore, the TRAI chairman’s recent statements (see the table below) in support
of 3G ICR agreements and lower spectrum pricing is the first definitive change in
attitude towards the industry after a long time. Moreover, the introduction of the
unified licensing regime (released in August 2013) and likely clarity over the M&A
policy (likely in October 2013) may help clarify longstanding grey areas in policy.
Exhibit 13: The new TRAI Chairman, Rahul Khullar, is making the right noises
“If you simply do not have enough 3G spectrum to give everybody throughout the country, then can we
actually carry on with this regime, where you will not make more spectrum available and yet proscribe
ICR?.”
“This knee-jerk response of ` 50 crore of fines multiplied by 22 circles... this is absurd.”
“The entire paradigm on spectrum pricing has to be revisited.”
“Trading of spectrum for some reason has been treated as a holy cow. Everybody is buying spectrum on
auction, why don’t you let them trade?”
Source: These quotes are from a speech made on 2 August 2013, Ambit Capital research

Strategy & Economy
More specifically, a few clear regulatory announcements appear to be positive for

incumbents:
 Recommendation of significantly lower spectrum reserve prices: The
Telecom Regulatory Authority of India (TRAI), on 9 August 2013, recommended a
significant reduction in the reserve prices for spectrum across major circles. This
included 32-70% lower reserve prices than the November 2012 auction prices for
metro and category-A circles. However, TRAI also recommended tightening of roll-
out norms and non-reservation of 900MHz spectrum for existing licensees that are
looking at renewals, in the interest of re-farming. Furthermore, other positives
such as exploration of the E-GSM band (and thereby no auctions in the 800MHz
band), lower spectrum usage charges and green light to spectrum trading have
emerged from TRAI's recommendations. If the recommendation for lower
spectrum reserve prices is accepted by the Government, then this would likely
boost Bharti’s and Idea's target price by 3% and 2%, respectively. More
importantly, along with the Unified license rules and expected ruling on mergers
and acquisitions, we consider these recommendations as a crucial step towards a
more benign and clearer regulatory environment.
 No abolishment of roaming charges: The National Telecom Policy implied a
‘home’ network for subscribers across India and the removal of roaming charges.
As the marginal cost of providing roaming is negligible, removal of roaming
charges has a direct EBITDA-level impact. Although the break-up of roaming
charges is not reported by operators, it is likely to be 4% of India mobile revenues.
In June 2013, TRAI rejected the proposal to abolish roaming charges and instead
lowered the caps on roaming charges which was revenue-neutral for operators.
 Punitive actions by the DoT: The operators have been imposed with multiple
fines for various minor and major digressions. These include the demand for the The proposal to allow TRAI penal
one-time excess spectrum fees, penalties for 3G ICR (`500mn per circle) and powers may signal less severe
spectrum usage charges. The proposal to allow TRAI penal powers may signal less punitive action
severe punitive action, since TRAI can fine a maximum of `100mn per major
transgression (which was `500mn for DoT).
These announcements are at long last being accompanied by consolidation in
revenue market share for the incumbents (Bharti, Idea and Vodafone). In the exhibit
below, the numbers in the blue box show revenue share (in bps) gained by all three
incumbents combined in FY13 (vs FY12). As can be seen, significant consolidation has
been seen across India, barring Rajasthan and UP East.
Exhibit 14: Consolidation across India likely to benefit incumbents
Source: TRAI, Ambit Capital research

Strategy & Economy
This too shall pass

Finally, coming to the most pressing issue – can the Indian government ever allocate
natural resources in a fair manner to the private sector rather than swinging from
unchecked corruption on the one extreme to frozen by fear on the other? Since the
raison d’etre of the ruling class is to focus on its self-interest, sceptics will say that rent
seeking by politicians and bureaucrats will continue regardless of which party wins the
next General Elections. However, there are grounds for hope:
 Greater transparency: Every year all civil servants have to disclose their assets
to the Government whereupon the Government can be forced to disclose this
information to the public under the RTI Act. Now, whilst the corrupt civil servant
can continue to hoard illegal assets, beyond a point it is becoming increasingly
hard for civil servants to illegally gratify themselves without getting caught.
 Competent leaders are getting re-elected: At the state level, the continued
Continued success over multiple
success over multiple electoral cycles of competent state chief ministers such as
electoral cycles of competent
Narendra Modi (state election wins in Gujarat in 2002, 2007 and 2012), Raman
state chief ministers
Singh (state election wins in Chhattisgarh in 2003, 2008 and frontrunner in the
2013 elections), Shivraj Chouhan (state election wins in Madhya Pradesh in 2003,
2008 and frontrunner in the 2013 elections), Nitish Kumar (state election wins in
Chhattisgarh in 2000, 2005 and 2010) and Shiela Dikshit (state election wins in
Delhi in 1998, 2003 and 2008) is giving substance to the notion that leaders who
deliver governance and growth stay in power for longer.
 Changing public mood: Around a third of Indian MPs and MLAs (Member of the
Legislative Assembly) have criminal convictions against their name. A good
example of how the alteration in the public mood is leading to a cleansing of the
political system is the Supreme Court’s July 2013 judgement preventing convicted
criminals from either continuing to be MPs or MLAs (prior to this verdict a sitting
legislator convicted by the courts could hold onto his seat and contest elections
while his appeal was pending; the July judgement said that upon conviction a
legislator is immediately disqualified).
Unfortunately, in August 2013, with support from across the political spectrum, The Supreme Court verdict
the incumbent administration drafted an ordinance seeking to negate the barring convicted criminals from
Supreme Court judgement. Thankfully in September, sensing the public mood, the continuing to be MPs or MLAs
incumbent administration dropped the draft ordinance; hence, the Supreme Court stands
verdict barring convicted criminals from continuing to be MPs or MLAs stands.
In the Foreword to Zia Mody’s book on the ten Supreme Court judgements which
changed India, Soli Sorabjee, the former Attorney-General of India, writes:
“The judiciary, at one time, was considered and projected to be the weakest branch
of the state because it possessed neither the power of the purse not the power of
the sword. That myth has been demolished and the best evidence of it is the set of
ten judgements analysed and discussed in this book…The Constitution, enacted in
1950, has been the cornerstone in India’s democracy. After its enactment it has
undergone several amendments. The Supreme Court is the ultimate interpreter of
the Constitution and, by its creative and innovative interpretation, has been the
protector of our constitutional rights and fundamental freedoms.” – From “The Ten
Judgements which Changed India” (Penguin/Shobha De Books, 2013)
 An economy which is not structurally damaged: Contrary to popular belief,
the Indian economy is not structurally damaged. As highlighted in our 27 August
2013 note (‘Four popular myths regarding India’)
“The key challenge facing India today (in line with other EMs) is a ‘cyclical’
economic downturn after a long period of above-trend growth. An objective
analysis by the IMF of India’s positioning on structural economic parameters
suggests that India has broadly maintained its positioning over the last six years
(Source: the World Bank’s Country Policy & Institutional Assessment - see Exhibit
below). The key variable that has changed vs the pre-CY07 era is that the global
business cycle has turned downwards, thereby affecting a host of Indian macro
variables even though the structural features of the Indian economy, for better and
for worse, remain intact.”

Strategy & Economy
Exhibit 15: According to the IMF, India has maintained CY05-07 position on key
structural economic parameters
5
CPIA Ranking (1=low to
4
3
2
6=high)
1
0
Fiscal policy Macro Policies for Property rightsTrade rating Transparency,
rating management social equity and rule- accountability,
rating based and corruption
governance in the public
rating sector rating
Average over 2005-07 2012
Source: IMF, Ambit Capital research. Note: Definitions regarding each rating are as follows:
(1) The fiscal policy rating assesses the short- and medium-term sustainability of fiscal policy (taking into account
monetary and exchange rate policy and the sustainability of the public debt) and its impact on growth.
(2) The macroeconomic management rating assesses the monetary, exchange rate, and aggregate demand
policy framework.
(3) The policies for social inclusion and equity cluster includes gender equality, equity of public resource
use, building human resources, social protection and labour, and policies and institutions for environmental
sustainability.
(4) The property rights and rule-based governance rating assesses the extent to which private economic activity is
facilitated by an effective legal system and rule-based governance structure in which property and contract rights
are reliably respected and enforced.
(5) The trade rating assesses how the policy framework fosters trade in goods.
(6) The transparency, accountability, and corruption in the public sector rating assesses the extent to which the
executive can be held accountable for its use of funds and for the results of its actions by the electorate and by the
legislature and judiciary, and the extent to which public employees within the executive are required to account for
administrative decisions, use of resources, and results obtained. The three main dimensions assessed here are the
accountability of the executive to oversight institutions and of public employees for their performance, access of
civil society to information on public affairs, and state capture by narrow vested interests.
Where are we going as a society?

All of this being said, we have heard some of the sharpest minds in India tell us over
the past year that something is fundamentally wrong with the country – that we are a
fractured, greedy and corrupt society, incapable of performing well on a sustainable
basis. Is that really true?
As Francis Fukuyuma explains in his 1995 book ‘Trust: The Social Virtues and the
Creation of Prosperity’, over the past century, we have seen countries as disparate as
 China, France, Italy and South Korea (he calls them ‘familistic’ societies i.e.
countries where people build their identity and their central allegiances around
their families as opposed to their countries);
 Japan and Germany (he sees these as countries where people build their
identities around society and hence the sense of social obligation is very strong);
and
 The USA (which sees itself as a very individualistic society but actually has in its
origins in a strong sense of society and community often built around religious
identity)
make the march to prosperity. Fukuyuma claims that the ‘familisitic’ societies have to
live with higher transaction costs than ‘high trust’ countries like Japan and Germany
(since in the familistic societies the state has to step in to create an elaborate set of
rules and regulations which will define contracts). However, we can see that this has
not stopped South Korea or France from creating successful companies and
economies to rival their neighbours, Japan and Germany, respectively.

Strategy & Economy
For a country as adaptable and as familistic as India, it would be surprising if its

politicians, civil servants and promoters are not able to plot a course through the
current morass which has hit key sectors of the economy and where complex
contractual arrangements have fallen apart due to a mixture of corruption, greed,
inexperience and institutional failure. These problems are not unsolvable and the
rewards for those who can lead India through this morass will be very considerable -
they will get to oversee the next boom.
In fact, we would prefer to see the events of the last three years from an even more
positive perspective.
In their meticulously researched book, ‘Why Nations Fail’ (2012) James Robinson and
Countries which fail to create
Daron Acemoglu say that the countries which fail to create inclusive political and
inclusive political and social
social systems eventually fail to create inclusive economies. Ultimately, such societies
systems eventually fail to create
become dominated by a plutocracy and fail to generate sustained economic growth.
inclusive economies
Russia, predictably, and China, more interestingly, look poorly positioned, say these
two eminent economists from such a perspective.
Robinson’s and Acemoglu’s take on Brazil’s surge over the past 30 years has
considerable relevance for India:
“The formation of a broad coalition in Brazil as a result of coming together of diverse
social movements [churches, student organisations, professional organisations] and
organised labour has had a remarkable impact on the Brazilian economy. Since 1990
economic growth has been rapid with the proportion of the population in poverty falling
from 45% to 30% in 2006. Inequality, which rose rapidly under the military,… has fallen
sharply, particularly after the Workers’ Party took power, and there has been a huge
expansion of education, with the average years of schooling of the population
increasing from six in 1995 to eight 2008.” [The text inside square brackets is ours.]
As with Brazil, so with India, the question of ‘Can India become a more more inclusive
economy or will it stay an economy dominated by a narrow elite?’ will have a bearing
on the economy and, in turn, on the composition of the Sensex.
Social and political change leading to churn in the Sensex
Gaurav Mehta, our strategist, highlights that of the 30 companies that were in the
Of the 30 companies that were in
Sensex in 1992, only 12 made it to the 2002 Sensex, implying a 60% churn ratio (see
the Sensex in 1992, only 12
our 28 June 2012 Decadal changes in the Sensex for more details.). In effect, the end
made it to the 2002 Sensex
of the ‘license raj’ in 1991 resulted in a number of these once formidable textile
companies (Century Spinning, Bombay Dyeing) and industrial companies (Premier
Auto, Hind Motors) being washed away in the 1990s. The corresponding Sensex churn
ratio for the ten years to the 2012 Sensex was 53%. In more stable markets, like the
United States, the churn ratio is around 30%. Even in other large emerging markets
the churn ratio is only around 35%, suggesting that the Indian market’s 50-60% churn
is possibly driven by factors deeper than the usual ups and downs of business cycles.
The changes in Indian society and politics between 2010 and 2013—“the end of the
Half of the companies that are
old raj” according to one of our increasingly muscular regulators—are likely to
currently in the Sensex are likely
unleash a churn on a similar scale over the coming ten years. Promoters who have
to move out by 2023
become used to the ‘resource grab’ or ‘capital grab’ models, especially in sectors such
as Power, Infra, Construction, Natural Resources and Real Estate, have to rethink their
strategies. We estimate that half of the companies that are currently in the Sensex are
likely to move out by 2023. As political power fragments in India and as politicians
and civil servants refuse to play ball (or are afraid to play ball), the ‘connected’
companies’ competitive advantages should wither away.
However, if half of the current Sensex constituents are expected to churn out of the
Sensex by 2022, the question arises—where will the replacements come from? You
guessed it – the replacements should come from Ambit’s portfolio of ‘Good & Clean’
companies (see the latest 23 September 2013 Good & Clean portfolio) and
Tenbaggers (see the latest 14 January 2013 Tenbagger Portfolio).

Strategy & Economy
Section 5: Investment opportunities

“And all of the ghouls come out to play
And every demon wants his pound of flesh
But I like to keep some things to myself
I like to keep my issues drawn
It's always darkest before the dawn.”
- From the song ‘Shake it out’ by Florence and the Machine (2011)
So if we believe that India can heal and mend her errant ways, if we believe that the
Indian economy is not structurally damaged, what are the investment opportunities for
the believers? In this sector we focus on the three specific sectors which have been in
the eye of the storm unleashed by the CAG.
Power & Infra
It will be at least two years before the Power & Infra projects start being tendered in
Infra sector lead:
India using contractual structures which make commercial sense (see the previous Nitin Bhasin,
section). Conservative investors might say that until then there is really no point in nitinbhasin@ambitcapital.com
getting involved in the Indian Power & Infra space. Unfortunately, things are never Tel: +91 22 30433241
that simple in India.
A significant section of the corporate world seems to be aligned with the Opposition
at present. If, as is likely, the opinion polls in October suggest that the Opposition’s
lead over the incumbents is widening (see our election analysis note dated 20
September 2013 ‘More than just political theatre’) and if the BJP also does well in the
state elections in winter then the market will start discounting a Opposition victory in
in the stock prices of the Power & Infra companies even if order flow remains weak for
these companies.
So what are the large Power & Infra stocks to look at from the perspective of an
investor who wants to get involved in this sector?
Whilst we expect that positive political, and regulatory changes could yield results,
Only four large infrastructure
these changes would take at least two years to bear fruit. Thus, the execution issues
players - namely L&T, Adani
and financial performance of power and infrastructure players would further worsen
Group, GMR and Reliance
resulting in distressed sales of assets and forced consolidation in the industry. Note
Infrastructure – seem likely to
that several infra companies including large players could be forced to dilute equity
survive
owing to their weak balance sheets, low cash flow generation and low credit
availability. In our opinion, only four large infrastructure players - namely L&T, Adani
Group, GMR and Reliance Infrastructure – seem likely to survive the ongoing crisis
on account of:
 Ownership of large assets which are of national and economic importance,
 Political and bureaucratic entrenchment of these large players,
 Relatively larger balance sheet size, and
 Execution capability demonstrated in the last four years.
Furthermore, a few small private unlisted players with strong promoter support (such
as Tata Realty and Infrastructure Projects) should also survive the ongoing
consolidation of the industry. Out of the four major infra companies likely to survive,
we only cover L&T as it has a strong balance sheet and a credible management
L&T (Target price ` 1113, 41% upside): Whilst the Indian capex cycle recovery
(execution and order momentum) remains weak, L&T’s FY13 and 1QFY14 order
booking growth of 25% not only displays its rising competitive strength (vis-à-vis its
weaker peers) in the core business but more importantly provides strong visibility; a
positive change in the operating environment can lead to its order book turning into
revenues much faster than expectations. We expect stability in its operating metrics at
the present lower levels and control over capex/asset ambitions to improve cash
generation.

Strategy & Economy
 Indian infrastructure segment to provide momentum to revenues: The

Infrastructure segment (including Power T&D), accounts for 67% of the order book
and 70% of the recent quarter’s inflow for L&T. Overall, the company’s book-to-
bill is 2.7x, but the infrastructure segment’s book-to-bill ratio is 3.8x, signifying the
visibility and the rising dependence on this segment. The infrastructure segment,
which accounts for 42% of total revenues, recorded revenue growth of 23% YoY
and EBITDA margins of 11.8% in 1QFY14.
 Margins and working capital turnover have limited downside: After a step-
down in working capital turnover and EBITDA margins, we do not expect a
material downside to these operating metrics in FY15 as the shift in execution has
already incorporated these changes. Rising infrastructure revenues will bring back
margins and higher Middle Eastern revenues will improve working capital
turnover. We expect RoEs to rise from the mid-teens to high-teens by FY16.
 Conservative but credible embedded value of `290/share: We find minimal
risk to our embedded value calculation as nearly 60% of valuation emanates from
cash-generative subsidiaries; infrastructure assets account for 29% of the
embedded value.
Valuation – attractive: We find L&T’s present valuations extremely attractive at 10x
FY15 core EPS (excluding other income) of `53 (excluding embedded value of `290)
and expect a rerating with: (a) a minor recovery in the investment cycle, (b)
stabilisation of the operating metrics, and (c) pre-election discounting of specific
electoral outcomes.
Exhibit 16: L&T’s share price movement and cross-cycle Exhibit 17: L&T’s share price movement and cross-cycle
valuation range (12-month forward P/E) valuation range (12-month forward P/B)
2,000 2,000
1,800 5x
1,600 1,500
26x 4x
1,400
22x
1,200 3x
18x 1,000
1,000
800 2x
14x
600 500
400
200 0
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Sep-13
Sep-07
Sep-08
Sep-09
Sep-10
Sep-11
Sep-12
Sep-13
Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research
Telecom
Apart from the more benign regulatory environment highlighted in the previous Telecom sector lead:
section, our BUY stance on the Telecom sector is predicated on: Ankur Rudra, CFA,
ankurrudra@ambitcapital.com
 Improvement in RPMs: Bharti and Idea both surprised on the extent of voice
Tel: +91 22 30433211
realisation growth in 1QFY14 (4.5% QoQ each) due to the discount reduction
process which started in December 2012. Vodafone also reported a similar growth
in voice realisations (4.7% QoQ). Whilst we do not anticipate these to rise further
in 2QFY14, as operators gear down for a seasonally weak quarter, note that: (1)
further discount reduction (started in May-June 2013) is yet to be realised, and (2)
the incumbents may continue to cross-subsidise non-established circles.
“RPMs indicated by STPs have been on the rise since 3QFY13. Assuming a constant
proportion of subscribers on the STPs, the realised RPMs on the STPs may have
increased 23-26% over September 2012 and 10-11% over March 2013.
Furthermore, Idea has rationalised its base tariffs in 1QFY13, increasing starter-
pack tariffs in circles where it lagged.” - From our Telecom team’s 16 July 2013
note, ‘Frontiers to the fore’.

Strategy & Economy
Realised RPMs are likely to continue to improve in 3Q-4QFY14 (strong quarters

for traffic growth). The increase in 1QFY14 reported by the listed incumbents
implied that nearly 10-12% of the realised STP RPM increase (of the 23-26% total)
has been absorbed (assuming the same proportion of subscribers use STPs). We
have factored in RPM growth of 6-7% YoY for Bharti and Idea.
Exhibit 18: Incumbents’ ARPU may rise Exhibit 19: Driven by growth in realisations
Idea Vharti Vodafone 8% QoQ RPM

ARPU (`) Idea Bharti Vodafone
6% growth(%)
300
4%
250 2%
200 0%
-2%
150
-4%
100 -6%
50 -8%
-10%
0
-12%
1QFY10
2QFY10
3QFY10
4QFY10
1QFY11
2QFY11
3QFY11
4QFY11
1QFY12
2QFY12
3QFY12
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
1QFY10
2QFY10
3QFY10
4QFY10
1QFY11
2QFY11
3QFY11
4QFY11
1QFY12
2QFY12
3QFY12
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
Source: Company, Ambit Capital research Source: Company, Ambit Capital research
 Data revenue momentum builds: Bharti and Idea reported data revenue
growth of 17-21% QoQ in 1QFY14 driven by consumption (minus 2-8% QoQ)
and penetration (7-18% QoQ). Given that 3G usage remains in the early stages
of the consumption curve, higher per capita data consumption is encouraging.
Due to sunk costs in spectrum and network build-outs, incremental growth in data
services is clearly likely to drive RoCE expansion (175/350bps in FY14/15) as we
move towards the middle of the data capex cycle.
 Positive operating leverage may boost profitability: The mobile businesses
of Bharti and Idea recorded significant EBITDA margin expansion in 1QFY14 (up
185bps QoQ and 350bps QoQ respectively). Benefits from operating leverage
and moderated subscriber acquisition costs (through lower churn vs a year ago)
have resulted in significant margin benefits for both incumbents. The sharp
expansion in EBITDA margins is likely to sustain given the relatively benign
competitive environment, our expectations of higher realisation growth, and (in
Bharti’s case) improvement in the Africa business.
Overall, just as consensus and our estimates underestimated the decline in industry
profitability from competition, regulatory pressures and delay in data consumption, we
may be underestimating the strength of the recovery in sector profits this time. We
highlight that all three of our arguments are changing for the better. Moreover, both
Bharti and Idea retain substantial operating leverage to disproportionately benefit
from the above trends. We are BUYers of both Bharti and Idea. Our target prices do
not factor in lower spectrum reserve prices yet.
Bharti (target price of `384, 21% upside): Bharti is amongst the few international
operators which are currently trading at a discount to their five-year average
valuations. Whilst the Africa business continues to drag Bharti down, the company is
better placed to benefit from consolidation in India given its higher ARPU footprint
and hence lower susceptibility to negative elasticity in a rising tariffs scenario.
Furthermore, ground-level changes in Africa, such as: (1) change in management with
a focus on local leadership, (2) regulatory upheavals which are likely to be challenger-
friendly in the longer term (although near term impact may be negative), and (3) pick
up in data and value-added services, all bode well for the company’s profitability.

Strategy & Economy
At 6.5x FY14E EV/EBITDA, Bharti looks relatively inexpensive as compared to Idea at

7.8x especially considering the benefits of consolidation that it may accrue as the
industry leader in India and that it is likely to be less susceptible to demand dilution in
an increasing tariff scenario. Bharti is amongst the few international operators which
are currently at a discount to their five-year average valuations. On consensus basis,
Bharti is currently trading at 6.5x, at a 14% discount to its five-year average consensus
valuations.
Exhibit 20: Bharti's share price movement and cross-cycle EV/EBITDA valuation
1,000 Average
Price EV/EBITDA 15x
800
12x
600
9x
400
6x
200
3x
0
-200
Jun-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
Apr-11
Aug-11
Jan-12
Jun-12
Nov-12
Mar-13
Aug-13
Source: Reuters, Ambit Capital research
Exhibit 21: Most global operators are currently trading at a premium
40% 33%
32% 32% 32%
28%
30%
20% 21%
18%
20% 14%
12%
0% 8%
10%
-14%
-11% -8%
0%
Maxis
Idea
AT&T
Vodacom
RCom
Orange
Vodafone
China Mobile
MTN
Axiata
Bharti
Singtel
Etisalat
China Unicom
Millicom
-10%
-20%
Source: Bloomberg, Reuters, Ambit Capital research
Idea (target price of `181, 7% upside): Idea is a pure play on three primary changes
in the Indian Telecom landscape: (a) Returning pricing power: Idea is leveraged
entirely to returning of bargaining power that is driving EBITDA improvements across
operators given its higher operating leverage amongst incumbents, (b) Data growth:
Idea's data growth fuelled by rapid adoption of 2G and 3G services has outstripped
peers thanks a confluence of falling handset prices, rationalising data tariffs and
consumer adoption of data services such as messaging and social networks, and (c)
Greater regulatory certainty: Idea benefits from falling spectrum reserve prices,
rationalisation of spectrum usage charges and a benign approach to regulations and
penalties in the new regulatory regime. Greater operational and financial leverage
increase Idea's earnings sensitivity to all these positive changes. Although Idea trades
at a one-year forward EV/EBITDA of 7.9x,12% above its five-year average of 7.1x,
headroom for EBITDA surprises and sector leading execution keep the shares
attractive. We are buyers with a target price of `181, 7% upside.

Strategy & Economy
Exhibit 22: Idea's share price movement and cross-cycle EV/EBITDA valuation
300 15x
Average 12x
Price EV/EBITDA
200 9x
6x
100
3x
0
Jun-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
Apr-11
Aug-11
Jan-12
Jun-12
Nov-12
Mar-13
Aug-13
Source: Reuters, Ambit Capital research
Lenders
Some lenders have done a better job than others in avoiding the worst of the dodgy Financial Services sector lead:
Power & Infra projects and then in aggressively provisioning for the impending loan Pankaj Agarwal, CFA,
losses. From this perspective, we believe that IDFC (Target Price `167, 90% upside) pankajagarwal@ambitcapital.com ,
ranks pretty high. +91 22 3043 3206
IDFC’s stock de-rating from 1.7x one-year forward in February P/B to 1.1x one-year
forward P/B makes the risk-reward favourable for investors (see the charts on the next
page). The company’s earnings growth is highly geared to the recent positive
developments in the power sector (such as coal price pooling, SEB debt restructuring
and PPA revisions). Moreover, an adequate provisioning cushion to absorb even an 8x
increase in NPAs means that the downside risk to earnings is limited. We reiterate our
BUY stance and highlight the following positive points for this NBFC which looks likely
to become a bank next year:
 Levered to reforms in power sector: IDFC’s loan growth has slowed down to
13% in YTD FY14 (vs 50% in FY11, 31% in FY12 and 16% in FY13) and guidance
on loan growth is muted at ~10% for FY14, given weak credit demand from the
power and infrastructure sector. However, if the Government’s proposed power
sector reforms (such as tariff revisions, coal price pooling, and discom debt
restructuring) pass through and if the overall capital investment in the economy
picks up, IDFC could surprise positively on loan growth.
 Provisioning buffer could absorb NPAs: Despite a difficult macro environment
and in spite of being exposed to financially distressed sectors like Power,
Transportation and Telecom, IDFC has managed its credit quality well over the
past two years. IDFC has gross NPAs of only 0.3% (of the loan book) and
restructured assets of ~1% arguably due to better asset selection as compared to
its peers (gross NPAs plus restructured assets are ~7% and ~27% of the loan
book of PFC and REC respectively). With extra provisions of `8.7bn (1.5% of
current loan book) sitting on the balance sheet, the company could absorb
additional NPAs of up to ~2.5-3.0% on the current book without increasing its
provisioning cost. As on June 2013, only ~2.9% of the company’s outstanding
approvals were for under-construction power projects, which do not have captive
fuel capacity and hence are at risk.

Strategy & Economy
Exhibit 23: IDFC’s share price movement and cross-cycle Exhibit 24: IDFC's share price movement and cross-cycle
valuation range (12-month forward P/E) valuation range (12-month forward P/B)
300 300
20x 2.8x
250 250
200 200 1.9x

14x
150 150
100 8x 100 1.0x
50 50
0 0
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
Jun-12
Jun-13
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Jun-06
Jun-07
Jun-08
Jun-09
Jun-10
Jun-11
Jun-12
Jun-13
Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research

Strategy & Economy
Appendix 1: The CAG’s report on 2G

spectrum allocation
Shown below are extracts from the Executive Summary of the CAG’s
November 2010 report on 2G spectrum allocation.
“In January 2008, Department of Telecommunications [DOT] issued 120 new licences
for unified access services on the same day. These licences were issued at price which
had been discovered in 2001. Issuance of 120 licences in just one day and at a price
discovered in 2001 has drawn the attention of Media, Parliament and informed
members of the civil society…
In August 2003 TRAI had submitted a Report recommending a road map for allocation
of licences. This Report formed the basis for the UAS policy approved by the Council of
Ministers in October 2003. The implementation of UASL regime was to be carried out in
two phases with first phase of six months assigned for migration of already existing
Basic Service Operators (BSOs) and Cellular Mobile Service Operators (CMSOs) to the
new regime. The entry fee for migration of BSOs was determined as the fee equal to
what was paid by the fourth cellular operator introduced through multi-stage bidding
process in 2001. CMSOs were not required to pay any entry fee for migrating as they
had already entered the market through a bidding process and thus paid a market
determined price. The second phase was to start after the first phase in which a Unified
Licencing regime, with a nominal entry fee for the licence with the spectrum being
charged separately, was envisaged.
However, Audit examination reveals that the Department of Telecom did not implement
the licensing regime as approved by the Cabinet and implemented only the first phase
of the policy, overlooking the second phase. In the actual implementation, the interim
stage of implementation seems to have become the final destination. This appears to
have become the underlying factor, quite erroneously, to value the spectrum in 2008 at
2001 prices. An important objective of this policy decision to delink the prices of
spectrum from the issue of licence and devise an efficient allocation formula for
spectrum along with an appropriate price, remained unachieved. Ministry of Finance
was authorized by the Cabinet decision of 2003 to participate in the discussion for
efficient allocation of spectrum and price fixation but DOT decided not to associate the
Ministry of Finance….. The issue was never placed before Cabinet for a review….It was
noted in Audit that DoT managed to keep the issue of spectrum pricing outside the
purview of the GoM [Group of Ministers]…has also been revealed in the course of audit
that the Ministry of Finance, in November 2007, had questioned the sanctity of
continuing with the price determined way back in 2001 without any indexation or
current valuation. The Ministry had sought a review of the matter. This advice of the
Ministry of Finance was overlooked by the DoT…
The TRAI report of August 2007 had recommended 'no cap' on the number of licences in
any service area. Despite this recommendation of TRAI, the DoT issued a Press Release
on 24th September 2007 stating that applications for issue of licences would be
accepted only up to 1.10.2007. This action, in effect, conveyed fixation of an artificial
cap in the number of licenses to be awarded…To further compound the earlier decision,
of restricting consideration of applications received up to 1.10.2007, the DoT further
advanced this date to restrict issuance of Letters of Intent (LoIs) only to applications
received up to 25.09.2007…
The First Come First Served (FCFS) policy earlier internally adopted in DoT for allocation
of spectrum, was then extended for issue of new UAS licences. Under this policy, all
applications are registered in the Central Registry Section of DoT where date of receipt
and serial numbers are posted on it. Priority of applications is determined based on this
date of receipt in the Central Registry. In a communication dated 2nd November 2007,
the Hon'ble MoC&IT [Minister of Communication & IT] had even confirmed to the
Hon'ble Prime Minister that the processing of applications was to be on the FCFS basis.
However, audit found that DoT deviated even from the FCFS policy in letter and spirit.
The applications submitted between March 2006 and 25th September 2007 were issued

Strategy & Economy
the LoIs simultaneously on a single day, viz. 10th January 2008. A notice was issued
through a press release giving less than an hour to collect the same. This decision to
issue LoIs simultaneously to all applicants was taken at the level of the Minister. As per
the FCFS policy being followed those who were issued LoIs were given 15 days to fulfil
the conditions. This included submission of a Performance Bank Guarantee (PBG) and a
Financial Bank Guarantee (FBG). By changing the FCFS criteria, some licensees, who
could proactively anticipate such procedural changes were ready with the Demand
Drafts drawn on dates prior to the notification of cut-off date by DoT and could avail the
benefit of first right to allocation of spectrum, having jumped the queue…
Process followed by the DoT for verification of applications for UAS licences for
confirming their eligibility lacked due diligence, fairness and transparency leading to
grant of licences to applicants who were not eligible. Eighty five out of the 122 licenses
issued in 2008 were found to be issued to Companies which did not satisfy the basic
eligibility conditions set by the DoT and had suppressed facts, disclosed incomplete
information and submitted fictitious documents for getting UAS licenses and thereby
access to spectrum…
Many of the new UAS licensees of 2008 have been able to attract substantial amount of
Foreign Direct Investment (FDI). Value of a new company with no experience in the
Telecom sector can primarily be taken as that of the license and access to spectrum.
This would have been the prime consideration for foreign companies while infusing
large amount of capital in the form of equity in these companies shortly after award of
license. Based on this indicator, value of a pan India license works out between ` 7,758
crores [US$1.3bn] and ` 9,100 crores [US$1.5bn] as against ` 1,658 crores [US$0.3bn]
priced by DoT…”
CAG report, the one report that changed India.]
(Source: http://cag.gov.in/html/reports/civil/2010-11_19PA/exe-sum.pdf)

Strategy & Economy
Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 saurabhmukherjea@ambitcapital.com
Research
Analysts Industry Sectors Desk-Phone E-mail
Aadesh Mehta Banking / NBFCs (022) 30433239 aadeshmehta@ambitcapital.com
Achint Bhagat Cement / Infrastructure (022) 30433178 achintbhagat@ambitcapital.com
Ankur Rudra, CFA Technology / Telecom / Media (022) 30433211 ankurrudra@ambitcapital.com
Ashvin Shetty Automobile (022) 30433285 ashvinshetty@ambitcapital.com
Bhargav Buddhadev Power / Capital Goods (022) 30433252 bhargavbuddhadev@ambitcapital.com
Dayanand Mittal Oil & Gas (022) 30433202 dayanandmittal@ambitcapital.com
Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 gauravmehta@ambitcapital.com
Karan Khanna Strategy (022) 30433251 karankhanna@ambitcapital.com
Krishnan ASV Banking (022) 30433205 vkrishnan@ambitcapital.com
Nitin Bhasin E&C / Infrastructure / Cement (022) 30433241 nitinbhasin@ambitcapital.com
Nitin Jain Technology (022) 30433291 nitinjain@ambitcapital.com
Pankaj Agarwal, CFA NBFCs (022) 30433206 pankajagarwal@ambitcapital.com
Pratik Singhania Real Estate / Retail (022) 30433264 pratiksinghania@ambitcapital.com
Parita Ashar Metals & Mining (022) 30433223 paritaashar@ambitcapital.com
Rakshit Ranjan, CFA Consumer / Real Estate (022) 30433201 rakshitranjan@ambitcapital.com
Ravi Singh Banking / NBFCs (022) 30433181 ravisingh@ambitcapital.com
Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 ritikamankar@ambitcapital.com
Ritu Modi Healthcare (022) 30433292 ritumodi@ambitcapital.com
Shariq Merchant Consumer (022) 30433246 shariqmerchant@ambitcapital.com
Tanuj Mukhija, CFA E&C / Infrastructure (022) 30433203 tanujmukhija@ambitcapital.com
Utsav Mehta Telecom / Media (022) 30433209 utsavmehta@ambitcapital.com
Sales
Name Regions Desk-Phone E-mail
Deepak Sawhney India / Asia (022) 30433295 deepaksawhney@ambitcapital.com
Dharmen Shah India / Asia (022) 30433289 dharmenshah@ambitcapital.com
Dipti Mehta India / USA (022) 30433053 diptimehta@ambitcapital.com
Nityam Shah, CFA USA / Europe (022) 30433259 nityamshah@ambitcapital.com
Parees Purohit, CFA USA (022) 30433169 pareespurohit@ambitcapital.com
Praveena Pattabiraman India / Asia (022) 30433268 praveenapattabiraman@ambitcapital.com
Sarojini Ramachandran UK +44 (0) 20 7614 8374 sarojini@panmure.com
Production
Sajid Merchant Production (022) 30433247 sajidmerchant@ambitcapital.com
Joel Pereira Editor (022) 30433284 joelpereira@ambitcapital.com
E&C = Engineering & Construction

Strategy & Economy
Explanation of Investment Rating
Investment Rating Expected return

(over 12-month period from date of initial rating)
Buy >5%
Sell <5%
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STRATEGY &

The one report that changed India

Saurabh Mukherjea, CFA

Section 1: An eventful three years………………………………………………… 4

Section 2: The three business models of “connected” companies……………. 5

Section 3: The morning after……………………………………………………... 10

Section 4: Can India recover?.....................................................................14

Section 5: Investment opportunities............................................................ 22

Appendix 1: CAG’s 2G report.................................................................... 28

October 01, 2013 Ambit Capital Pvt. Ltd. Page 2

The one report that changed India Recommendations

The unravelling of the three business models (page 10)

The long, hard road to recovery (page 14)

Section 1: An eventful three years

Ambit Connected Cos Index BSE 500

Source: Ambit Capital

October 01, 2013 Ambit Capital Pvt. Ltd. Page 4

Section 2: The three business models of

October 01, 2013 Ambit Capital Pvt. Ltd. Page 5

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(3) The ‘capital grab’ model

Loans outstanding (Rs bn)

Source: Ambit Capital using RBI data

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Exhibit 4: The BSE Power Index’s relative performance

FY-08 BSE500 index

FY-09 BSE Power Index

-60% -30% 0% 30% 60% 90% 120%

October 01, 2013 Ambit Capital Pvt. Ltd. Page 9

Section 3: The morning after

October 01, 2013 Ambit Capital Pvt. Ltd. Page 10

Exhibit 7: Quantification of the decline in iron ore production in India (mt)

Exhibit 8: Quantification of the decline in Coal India's production growth

Source: Company, PIB, Ambit Capital research

October 01, 2013 Ambit Capital Pvt. Ltd. Page 11

Exhibit 9: KG D6 gas production on a declining trend (mmcmd)

Source: RIL, Ambit Capital research

GFCF (as a % of GDP) GFCF (change, YoY in %)

Source: Ambit Capital

October 01, 2013 Ambit Capital Pvt. Ltd. Page 12

October 01, 2013 Ambit Capital Pvt. Ltd. Page 13

Section 4: Can India recover?

There is some hope for lenders…

Zone of Recovery Poor recovery prospects

Eg. Large scale thermal Eg. Iron ore mines in Goa

Poor recovery prospects

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More specifically, a few clear regulatory announcements appear to be positive for

Source: TRAI, Ambit Capital research

October 01, 2013 Ambit Capital Pvt. Ltd. Page 18

This too shall pass

October 01, 2013 Ambit Capital Pvt. Ltd. Page 19

Average over 2005-07 2012

Where are we going as a society?

October 01, 2013 Ambit Capital Pvt. Ltd. Page 20

For a country as adaptable and as familistic as India, it would be surprising if its

October 01, 2013 Ambit Capital Pvt. Ltd. Page 21

Section 5: Investment opportunities

October 01, 2013 Ambit Capital Pvt. Ltd. Page 22