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HDFC BANK

A Project Report Submitted by Abhishek Agrawal

SUMMER PROJECT REPORT

“INDUSTRY & PORTFOLIO RESEARCH”

PROJECT FOR

HDFC BANK
BY

Abhishek Agrawal
WELINGKAR INSTITUTE OF MANAGEMENT DEVELOPMENT AND RESEARCH

UNDER THE GUIDANCE OF

Mr. Benjamin Frank
Sr. Vice president – Wholesale Credit & Market Risk

PROJECT DURATION

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MAY-JUNE 2008
CERTIFICATE

This is to certify that Abhishek Agrawal, a student of Welingkar Institute of Management, Mumbai has successfully completed his Summer Internship at HDFC Bank, under my guidance and supervision and submitted this report as a part of it. This report meets the requisite standards and expectations from the company’s side and has not been reproduced from any other report, book or monograph.

Mr. Benjamin Frank Sr. Vice President – Wholesale Credit & Market Risk

Mr. Sumit Kakkar Vice President & Head – Emerging Corporate Credit Risk

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Acknowledgement

Any accomplishment requires the effort of many people and this is not an exception. The collaboration and assistance of many people are involved in producing such a report. At the end of this report, I would like to take this opportunity to thank all those people who have helped in the successful completion of this training program. First and foremost I would like to thank Mr. Benjamin Frank, Sr. Vice President – Wholesale Credit & Market Risk, to provide me with an opportunity to undergo training in the company. I have learnt a lot from him and definitely the project would not have been a success without his support and guidance. He has been of help in more ways than one by being a constant motivating force. I would like to express my deepest & sincere thanks to Mr. Sumit Kakkar, Vice President & Head – Emerging Corporate Credit Risk. He not only provided me with the industry knowledge, but also gave me proper directions to effectively and efficiently complete the project. A special word of gratitude and appreciation is also due to Mrs. Farida Daruwala, Assistant Vice President – Wholesale Credit & Market Risk, for helping me gain an in-depth knowledge about the Industry and for her constant attention and overwhelming support. A vote of thanks to all the staff members at HDFC Bank for providing their timely support and insights for enhancing my learning and making my summer internship experience a memorable one.

Abhishek Agrawal

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Table of Contents

Topic Acknowledgement HDFC Bank at a glance Executive Summary Introduction Objective Scope Research Methodology Limitations of the project report Tea industry - a Snapshot Classification of Tea Industry Segmentation Marketing of Tea Factors influencing Tea Prices Cost elements Manufacturing Process Value Chain Some Facts about the Tea Industry Import trends Area under cultivation Industry Characteristics Competiotion Key success factors Demand determinants Export demands Supply determinants Growth drivers of the pachaged tea segment Government Regulations Government schemes for Tea Industry Key Financial Indicators Player market shares (Domestic branded Tea market) Performance Highlights Outlook Coal Industry - Snapshot Types of coal Industry Structure

Page No. 4 8 12 14 14 14 15 15 16 16 17 17 17 18 18 19 19 20 20 20 20 21 21 21 21 21 21 22 22 22 23 23 24 24 25

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Evolution of Coal Coal Mining Open-cast Mining Undergroung Mining Some facts about the Coal Industry Industry Characteristics Legal provisions on royalty E-auctions Logistics Growth Opportunities Coal Washing Coal consumption in Power sector Coal Exploration Policies and Regulations Environmental Issues Pricing Key Financial Indicators Performance Highlights Outlook ITeS Industry - Snapshot ITeS sector in a nutshell Positive factors affecting ITeS sector Negative factors affecting ITeS sector AT Kearney Scores for top 10 off-shoring destinations Different segments where domestic ITeS industry has forayed into Important factors required to sustain competitiveness Competitve advantage under threat The future plan of action - Domestic market Latest trends in IteS space New opportunities to explore Factors that differentiate TOP ranked companies with lower rung companies Ranking of the TOP 15 ITeS companies in India as on (2006 - 07) Film Financing by Banks - A Report Industry Overview Recent State of Industry Commercial movies Animated movies Industry Segments Production Distribution Exhibition Value Chain Business Model

25 26 26 26 27 27 28 28 28 29 29 29 29 30 30 31 31 32 32 33 33 33 33 34 34 35 35 35 35 36 36 37 38 38 38 38 38 39 39 39 39 40 41

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How does the Industry make money Producer Distributor Exhibitor Risk associated with Film Financing Risk Mitigation factors FDI :- International funds Factors affecting the film Industry adversely Where does a bank fit into the picture? Process of film financing - by a bank Important factors considered by a bank Mode of finance Cost heads Steps followed by a bank for financing a film Major risk associated with the film (from a bank's perspective) How is risk mitigated Other leading bank's Process What does Production house expect from Banks? Models of Film financing Upfront guarantee model Box-office model Production house's procedure Financial strength of the production house Revenue generation from a movie Conclusion References Annexure 1 : RBI Guidelines for Film Financing by Banks Annexure 2 : Manufacturing Process (Tea Industry)

42 42 42 42 42 43 43 43 43 44 44 44 44 45 45 45 46 46 47 47 47 47 47 47 48 49 50 52

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HDFC Bank at a glance

The Housing Development Finance Corporation Limited (HDFC) was amongst the first to receive an 'in principle' approval from the Reserve Bank of India (RBI) to set up a bank in the private sector, as part of the RBI's liberalisation of the Indian Banking Industry in 1994. The bank was incorporated in August 1994 in the name of 'HDFC Bank Limited', with its registered office in Mumbai, India. HDFC Bank commenced operations as a Scheduled Commercial Bank in January 1995.
Promoter

HDFC is India's premier housing finance company and enjoys an impeccable track record in India as well as in international markets. Since its inception in 1977, the Corporation has maintained a consistent and healthy growth in its operations to remain the market leader in mortgages. Its outstanding loan portfolio covers well over a million dwelling units. HDFC has developed significant expertise in retail mortgage loans to different market segments and also has a large corporate client base for its housing related credit facilities. With its experience in the financial markets, a strong market reputation, large shareholder base and unique consumer franchise, HDFC was ideally positioned to promote a bank in the Indian environment.
Business focus

HDFC Bank's mission is to be a World-Class Indian Bank. The objective is to build sound customer franchises across distinct businesses so as to be the preferred provider of banking services for target retail and wholesale customer segments, and to achieve healthy growth in profitability, consistent with the bank's risk appetite. The bank is committed to maintain the highest level of ethical standards, professional integrity, corporate governance and regulatory compliance. HDFC Bank's business philosophy is based on four core values Operational Excellence, Customer Focus, Product Leadership and People.
Capital structure

The authorised capital of HDFC Bank is Rs.450 crore (Rs.4.5 billion). The paid-up capital is Rs. 354.43 crore (as on 31. March 08). The HDFC Group holds 23.26% of the bank's

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equity and about 21.61% of the equity is held by the ADS Depository (in respect of the bank's American Depository Shares (ADS) Issue). Roughly 31.3% of the equity is held by Foreign Institutional Investors (FIIs) and the bank has about 190,000 shareholders. The shares are listed on the The Stock Exchange, Mumbai and the National Stock Exchange. The bank's American Depository Shares are listed on the New York Stock Exchange (NYSE) under the symbol "HDB".
Distribution network

HDFC Bank is headquartered in Mumbai. The Bank at present has an enviable network of over 761 branches spread over 327 cities across India. All branches are linked on an online real-time basis. Customers in over 120 locations are also serviced through Telephone Banking. The Bank's expansion plans take into account the need to have a presence in all major industrial and commercial centres where its corporate customers are located as well as the need to build a strong retail customer base for both deposits and loan products. Being a clearing/settlement bank to various leading stock exchanges, the Bank has branches in the centres where the NSE/BSE have a strong and active member base. The Bank also has a network of about over 1977 networked ATMs across these cities. Moreover, HDFC Bank's ATM network can be accessed by all domestic and international Visa/MasterCard, Visa Electron/Maestro, Plus/Cirrus and American Express Credit/Charge cardholders.
Management

Mr. Jagdish Capoor took over as the bank's Chairman in July 2001. Prior to this, Mr. Capoor was a Deputy Governor of the Reserve Bank of India. The Managing Director, Mr. Aditya Puri, has been a professional banker for over 25 years, and before joining HDFC Bank in 1994 was heading Citibank's operations in Malaysia. The Bank's Board of Directors is composed of eminent individuals with a wealth of experience in public policy, administration, industry and commercial banking. Senior executives representing HDFC are also on the Board. Senior banking professionals with substantial experience in India and abroad head various businesses and functions and report to the Managing Director. Given the professional expertise of the management team and the overall focus on recruiting and retaining the best talent in the industry, the bank believes that its people are a significant competitive strength.
Technology

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HDFC Bank operates in a highly automated environment in terms of information technology and communication systems. All the bank's branches have online connectivity, which enables the bank to offer speedy funds transfer facilities to its customers. Multibranch access is also provided to retail customers through the branch network and Automated Teller Machines (ATMs). The Bank has prioritised its engagement in technology and the internet as one of its key goals and has already made significant progress in webenabling its core businesses. In each of its businesses, the Bank has succeeded in leveraging its market position, expertise and technology to create a competitive advantage and build market share.
Businesses

HDFC Bank offers a wide range of commercial and transactional banking services and treasury products to wholesale and retail customers. The bank has three key business segments:
Wholesale Banking Services

The Bank's target market ranges from large, blue-chip manufacturing companies in the Indian corporate to small & mid-sized corporates and agri-based businesses. For these customers, the Bank provides a wide range of commercial and transactional banking services, including working capital finance, trade services, transactional services, cash management, etc. The bank is also a leading provider of structured solutions, which combine cash management services with vendor and distributor finance for facilitating superior supply chain management for its corporate customers. Based on its superior product delivery / service levels and strong customer orientation, the Bank has made significant inroads into the banking consortia of a number of leading Indian corporates including multinationals, companies from the domestic business houses and prime public sector companies. It is recognised as a leading provider of cash management and transactional banking solutions to corporate customers, mutual funds, stock exchange members and banks.
Retail Banking Services

The objective of the Retail Bank is to provide its target market customers a full range of financial products and banking services, giving the customer a one-stop window for all his/her banking requirements. The products are backed by world-class service and delivered to the customers through the growing branch network, as well as through alternative delivery channels like ATMs, Phone Banking, NetBanking and Mobile Banking. The HDFC Bank Preferred program for high net worth individuals, the HDFC Bank Plus and the Investment Advisory Services programs have been designed keeping in mind - 10 -

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needs of customers who seek distinct financial solutions, information and advice on various investment avenues. The Bank also has a wide array of retail loan products including Auto Loans, Loans against marketable securities, Personal Loans and Loans for Two-wheelers. It is also a leading provider of Depository Participant (DP) services for retail customers, providing customers the facility to hold their investments in electronic form.
Treasury

Within this business, the bank has three main product areas - Foreign Exchange and Derivatives, Local Currency Money Market & Debt Securities, and Equities. With the liberalisation of the financial markets in India, corporates need more sophisticated risk management information, advice and product structures. These and fine pricing on various treasury products are provided through the bank's Treasury team. To comply with statutory reserve requirements, the bank is required to hold 25% of its deposits in government securities. The Treasury business is responsible for managing the returns and market risk on this investment portfolio.
Credit Rating

The Bank has its deposit programs rated by two rating agencies - Credit Analysis & Research Limited (CARE) and Fitch Ratings India Private Limited. The Bank's Fixed Deposit programme has been rated 'CARE AAA (FD)' [Triple A] by CARE, which represents instruments considered to be "of the best quality, carrying negligible investment risk". CARE has also rated the bank's Certificate of Deposit (CD) programme "PR 1+" which represents "superior capacity for repayment of short term promissory obligations". Fitch Ratings India Pvt. Ltd. (100% subsidiary of Fitch Inc.) has assigned the "tAAA ( ind )" rating to the Bank's deposit programme, with the outlook on the rating as "stable". This rating indicates "highest credit quality" where "protection factors are very high".
Corporate Governance Rating

The bank was one of the first four companies, which subjected itself to a Corporate Governance and Value Creation (GVC) rating by the rating agency, The Credit Rating Information Services of India Limited (CRISIL). The rating provides an independent assessment of an entity's current performance and an expectation on its "balanced value creation and corporate governance practices" in future. The bank has been assigned a 'CRISIL GVC Level 1' rating which indicates that the bank's capability with respect to wealth creation for all its stakeholders while adopting sound corporate governance practices is the highest.

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Executive Summary

This report is divided into 4 parts. Each part in itself is a separate report for each of the 4 industries studied. The individual reports give a very brief but important outlook of the sector covered. The report covers those aspects of each industry that are of utmost importance for a credit analyst while analyzing a company in that particular sector. Each sector study was done keeping in mind the information required to make a decision regarding the credit approval/rejection by HDFC Bank. Such snapshot industry reports come handy when instead of reading a voluminous externally published report with lot of unrequited data, a comprehensive report with necessary and sufficient information is available, for quick reference. It not only saves time but gives a snapshot of the industry in a more readable format like graphs, charts and tables. Basically the report gives an understanding of the key factors and dynamics of the industry. The 4 industries covered are:
Tea industry

The report on Tea Industry gives a snapshot of the industry covering various aspects such as the existing and estimated production & consumption capacities, major companies in this sector, demand drivers, manufacturing process, value-chain, growth opportunities, industry characteristics, key success factors, performance highlights, government regulations and future outlook. The report also gives a brief analysis of other major countries involved in import and export of Tea all over the world. Lastly, a tabular representation of the important financial data of major companies in Tea Industry (listed on stock exchange or widely known) is shown.
Coal industry

Coal is one of the most important elements used to produce power, which in turn is of utmost importance to any developed or developing country. The report on Coal Industry can be of great use to a credit analyst trying to understand this business and get an overview of the various important aspects such as industry characteristics, demand and supply drivers, performance highlights, manufacturing process, environmental factors and major companies and countries dealing in this industry. At the end a financial analysis of various companies in Coal Sector in done and presented in a tabular format.
ITeS industry

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The report on ITeS sector involved the study of this sector with a view to find the positive and negative factors that have a direct or indirect impact on the companies in this industry. Both macro-economic as well as micro-economic factors were studied. The report analyzed various important aspects such as competitiveness, future plans, latest trends and growth opportunities for the ITeS industry. The report also gives India’s standing among other countries and what factors are affecting the standing year-on-year basis. Finally a list of top 15 companies in the sector was analyzed with a view to find out what differentiates them from their peers/competitors and thus helps them to remain at the top spot. Such analysis would help the companies at the bottom, to grow, and give a new perspective to anyone analyzing this sector.
Film Financing

This is an untapped and unorganized sector as far as banks are concerned. In 2001, RBI allowed private and public sector banks to provide finance for films. Till recently only a couple of banks ventured into this sector owing to the high risk involved in this sector. HDFC Bank had received quiet many proposals from production houses to do Film financing. Therefore, before getting ahead with such proposals, HDFC Bank required to do an initial level study about the Film Industry so as to understand the business model and the risk. Film financing report emphasizes on understanding the business model from the perspective of both, the Bank and the Production house.

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Introduction

Objective:

The objective of this report is to study and understand the 4 industries, in order to help the credit analyst get an overview about them. The report gives a very brief but important outlook of the each industry covered. Each sector study was done keeping in mind the factors that are of utmost importance for a credit analyst while analyzing a company in that particular sector, so as to make an assessment and a decision regarding the credit approval/rejection. Another objective was to cover a wide range of sectors. In order to accomplish this, one industry from manufacturing sector (Coal Industry), one from service sector (ITeS industry), one from agricultural sector (Tea Industry) and one from entertainment sector (Film Financing) were covered. Also, while others are organized sectors, Film financing is an untapped and unorganized sector, so there is no ready data or report available to understand it. A lot of primary research was done in order to accomplish and successfully complete this report. The 4 industries covered are: 1. 2. 3. 4. Tea industry Coal industry ITeS industry Film Financing

Scope:

Industry research is broader in scope and examines all aspects of a business environment. It asks questions about industry characteristics, growth drivers, demandsupply scenario, competitors, market structure, government regulations, economic trends, cost elements, performance highlights, outlook over near future, manufacturing process, technological advances, historical trend analysis and numerous other factors that make up the business environment. Sometimes the term refers more particularly to the financial analysis of companies, industries, or sectors. In this case, industry research and financial

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analysis is done to help the credit analyst in understanding the industry with necessary and sufficient information. The scope of this project was to study the 4 sectors and make a report to help the credit analyst understand the important aspects of the industry so as to make a decision regarding credit approval/rejection. The scope was limited to Bank’s perspective and does not in any way reflect on the overall characteristics of the sectors covered.
Research methodology:

1. 2.

industry reviews/ company reports Numerous articles from newspapers, trade journals, industry portals and magazines have been used to collect latest data and compile in a form most suited to get a quick understanding of each industry covered. Databases like Capitaline have been used to get the financial statistics about specific companies within each industry.

3.

Limitations of the project report:

1.

The HDFC specific data (Portfolio research part) has been removed from the report submitted to college in order to maintain confidentiality. In film financing, the secondary data is taken from reliable sources on Internet. For primary data, the study required to find the perspective of the bank. There are two banks which are highly involved in film financing, however only EXIM bank could be contacted; IDBI bank was not ready to reveal/share any information. For the companies studied in each sector, companies where randomly chosen from those listed on the stock exchanges or widely known in each sector.

2.

3.

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Tea Industry - Snapshot

No. of domestic manufacturers: Over 200

Production capacity (aggregate 2007) 1. Existing: Worldwide: 3300 million kg Domestic: 945 million kg 2. Estimated: 989 million kg 2009

Major domestic players: Hindustan Lever Ltd, Tata Tea Ltd, Mcleod Russel India Ltd., Goodricke group Ltd, Jayshree Tea & Ind Ltd, Apeejay tea, Gujarat Tea Processors and Packers (GTPP), Dhunseri Tea Industries Ltd.

Demand Analysis: 3. Existing: (2007) Domestic: 801 million kg Exports: 156 million kg 4. Estimated: (2009) Domestic: 849 million kg Exports: 180 million kg

Prominent Global Players (countries): China, Kenya, SriLanka, Bangladesh, Indonesia

Main Buyers: 5. Domestic: Individuals, Hotels, Corporate offices. Overseas Buyers: China, Russia, UK,

Related Sectors: Coffee industry

6.

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Japan, Pakistan, US

Classification of Tea:

Source: Crisil Research Industry Segmentation:

1. 2.

3.

4.

Planters Tea growers, who primarily sell their produce at auctions and to exporters. Planters-cum-traders (Integrated) Originally tea growers, who diversified into the packaged segment to insulate themselves from fluctuations in auction prices. They are present throughout the value chain, from estate operations, manufacture and processing of tea, blending to marketing and sale. Non-integrated players Players who do not own tea plantations. They purchase tea and then blend, pack and market it. Non-corporate Entities 1. Green leaf growers (GLGs) 2. Bought leaf factories (BLFs) Indian auctions Private sales outside auctions Direct exports - 17 -

Marketing of tea:

5. 6. 7.

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Auctions continue to be the biggest distribution channel. Auction offers the benefit of acting as a single-point mechanism for sourcing varieties of tea, thus helping both the producer and the buyer. It also allows the small growers, who cannot afford a distribution network, to sell their produce at a reasonable price. Auction services do not require a broker for determining the quality of tea, as auction centres have their own apparatus for tasting and blending. There are 7 auction centres, located at Guwahati, Siliguri, Kochi, Kolkata, Coonor, Coimbatore and Amritsar, with Guwahati being the world's largest CTC (crush, tear and curl) tea auction centre.
Factors influencing tea prices: Cost Elements:

Short Term Climatic conditions

Medium Term Acreage in major producing nations

Long Term Demographic changes in major consuming nations Changes in tea-drinker's preferences over time.

Economic downturn in any major consuming nation

Emergence of new producing nations, especially in the East African region. Yield and age of bushes

Emergence of other substitute beverages

Re plantation efforts undertaken by major producers. Changes in orthodox to CTC mix

Cost Factor

% of sales 40%

Description

Man Power Cost

It has increased from 31% in 1998 to 40% in 2007. The rise can be attributed to declining productivity levels and the impact of high social and fixed overhead element in the wage structure. Labour costs for the tea industry are subject to provisions of the Plantation Labour Act 1951.

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Raw Material 13%

Non-integrated players have a higher incidence of material cost. Material cost comprises tea bought at auctions (in addition to production) and green leaf purchases. For integrated players, the decision on quantum of auction purchases is a trade-off between prevailing auction prices and the cost of production on own plantations. Capital costs are limited to the initial investment in plantation land and setting up of a processing factory, besides the periodic expenditure on re plantation and pruning intended to maintain the yield and quality of produce. Despite the low interest rate scenario, financing costs in the tea industry have been rising steadily. Over the years, the interest coverage ratio has improved. It has increased over the years on account of the increasing prices of coal and fuel oil. In per kg terms, energy costs are high and work out to Rs 5-7 per kg, mainly because the industry is classified as a HT consumer, despite the relative simplicity of its processing operations. The effective rate of direct taxes (for integrated players) is high, because of the simultaneous levy under the Central Income Tax Act at 30 per cent (on 40 per cent of profits) and under the State Agricultural Tax Act at rates of 30 per cent and above (on the balance 60 per cent of profits). The ratio of selling costs is higher for major branded players such as Tata Tea Limited at almost 13-14 per cent of sales. Selling costs of players in the branded market are higher on account of expenses incurred by them on promotional activities.

Capital Investment

2-3%

Financing Cost

6-8%

Power & Fuel 10%

Taxes & Duties

30%

Selling Cost

7-8%

Manufacturing process:

The diagrammatic representation of the manufacturing process is shown in Annexure 2

Value-Chain:

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Source: Crisil Research Some Facts about the Tea Industry:

1. 2. 3. 4. 5. 6.

7.

8.

India is the world's largest consumer and second largest producer (China being first) of tea, and accounts for 28% of the global supply. Tea is a significant foreign exchange earner; hence it has a large share in India's exports. Tea production is mostly concentrated in North India. Major tea producing states are Assam, West Bengal, Tamil Nadu, Kerala, and Karnataka. Consumption is growing at 3% per annum. Exports for 2007(Jan-Dec) were 28.3 per cent lower at 156.7 million kg. The decline in exports were on account of the following: 1. Strong rupee appreciation that rose more than 12 percent in 2007. 2. Sharp drop in exports to Iraq, given the bad experience of several exporters who had found a problem of remittance against past exports. 3. Lower off take from Pakistan and Kenya. According to industry sources, on an average, the most productive age of the tea bush is 11-20 years. Productivity remains stable between 20 and 40 years of age, after which it starts declining. The current age profile of tea plantations suggests that about 36 per cent are below their peak yield. The emergence of Sri Lanka, Kenya and China as major competitors, the dismantling of the erstwhile USSR and uncompetitive pricing of Indian tea as a result of high costs and taxes viz-à-viz Kenya and China have been some of the key factors for the decline of India's Tea exports in the last few years.

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9.

10.

11.

The Monopolies Restrictive Trade Practices (MRTP) Act, which restricted the growth of large tea companies, was abolished in 1991. Moreover, the gradual decline in auction sales, following the growth in the consumption of packaged tea also resulted in greater consolidation in the industry. Import Trends: 1. India's tea imports are minimal, meant chiefly for re-export. 2. Tea was on the restricted items category of the negative list of imports till 1998. 3. Many government policies, combined with the oversupply situation has kept imports at low levels. Area under cultivation: 1. India has the second largest area under cultivation after China. 2. Government policies in the form of Land ceiling Act, 1956 and the national forest policy have affected growth in the area under cultivation. 3. Further the land policy of 1979 does not permit surplus land with the government to be transferred to the corporate sector for tea cultivation. 4. In 1994, around 7000 hectares were added, and again during 1998-2000 about 70,000 hectares were further added.

Industry Characteristics:

1.

2.

3. 4.

5. 6.

The tea industry is seasonal, with production and quality varying from month to month. Conditions conductive to the growth of tea are a combination of warm days, long hours of sunshine, high humidity and adequate rainfall. The industry is characterized by the presence of a large number of unorganized players. The leading 20 players account for only about 47 per cent of total domestic volumes. The balance is accounted for by integrated SMEs, BLFs, merchant exporters and regional retailers. This labour-intensive industry employs over 2 million workers directly and another 10 million indirectly. The Indian tea Industry is characterised by levy of multiple taxes. Tea companies are required to pay corporate tax on a certain percentage of their profits and the remaining profits are subject to state agricultural income tax. The domestic tea industry is highly regulated. Government policies influence the industry's key aspects right from the raw material to the end-product stage. Competition: 1. The tea industry faces competition from alternative beverages such as juices and cool drinks. 2. It also competes against coffee in traditional coffee drinking belts. 3. Tea board has been promoting tea as a health drink, and not just a refreshing beverage. The tea board has sanctioned a Rs.200-million advertising package for the purpose. 4. Competition from regional players.

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Key Success Factors:

1. 2.

3. 4.

5. 6. 7. 8.
1.

Demand Determinants: Population growth, Trends in per capita consumption, Export prospects. Export demands: 1. Being the largest producer, India is a major player in the export market, accounting for 14% of the world exports. 2. Exports have fallen on account of a shift in consumption pattern from CTC to orthodox as well as substitution of Indian tea with tea from lower cost producers such as Sri Lanka, Kenya and Indonesia. Supply Determinants: Age profile of bushes, Yield, Climatic and soil conditions, Area under cultivation. Growth drivers of the packaged tea segment: Rise in affordability, Quality consciousness, Player initiative to step up packaged tea sales, Relaxation of Tea Marketing Control Order (TMCO) provisions. Branding Value Addition Strong distribution network and retail outlets. Mechanization and automation of operations. Vertical expansion: Land rejuvenation and replanting activities.

Government Regulations:

1.

2.

3.

4.

Special Purpose Tea Fund (SPTF) This regulation was implemented for Re plantation and rejuvenation of age old bushes to improve their productivity and quality of tea. Tea Marketing Control Order In 1984, the Ministry of Commerce promulgated the Tea Marketing Control Order (TMCO), which mandated all tea producers to sell 75 per cent of their output through auction centres in India. The order was primarily issued to protect small tea growers from payment delays or defaults arising from private sales. The TMCO was revoked in December 2001 to allow unrestricted sales of tea outside the auction system, with an intention to improve prevailing prices of tea. The government re-formulated a new order, TMCO, in January 2003. Regulations pertaining to increasing area under cultivation The Central government has made it mandatory for manufacturers, growers and brokers of tea to obtain a Licence from the Tea Board prior to the commencement of business operations. Management or control of tea units by the Central government In this, the Central government has the right and power to take over the board (management) or control of a tea unit, or authorize any person(s) to take over control of a tea unit under a few circumstances.

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5.

6.

7.

Control over prices and distribution In this, Central government has the power to control maximum or minimum prices, which may be charged by a grower, manufacturer or trader in tea in the domestic or export market. Tea (Distribution and Export) Control Order, 2005 In 2005, the Government of India introduced “Tea (Distribution and Export) Control Order, 2005.” which replaced the earlier “Tea (Distribution and Export) Control Order, 1957.” Quality control As a food product, tea is governed by the Prevention of Food Adulteration Act (PFA). Scheme to boost production of orthodox tea. Market expansion scheme Price sharing formula Quality up gradation and product diversification subsidy scheme. 100 per cent FDI in the plantation sector. Crash tea up gradation scheme. Plan allocations

Government Schemes for Tea Industry:

8. 9. 10. 11. 12. 13.

14. Key Financial Indicators: All figures in Rs. Crores Name

Net Sales PBDIT

Operating Margin 29% 8% 3% 2% 1% 5% 11%

PAT

TNW

TOL/TNW Current Ratio Ratio 0.39 0.9 0.48 1.02 1.07 0 0.68 0.52 0.45 1.16 1.17 2.03 2.43 0.66

Tata Tea* Mcleod Russel* Goodricke Russel* Jayshree Tea* Apeejay Tea* Gujarat Tea** Dhunseri Tea*

1054.47 604.42 236.5 239.41 92.56 205.78 65.98

386.92 117.33 20.19 19.98 8.89 16.74 14.34

306.57 47.47 7.73 5.63 .69 9.72 7.07

1521.86 544.47 69.06 134.34 64.31 45.3 71.84

*The data is for year ended March 2007 **For Gujarat Tea, the data is for year ended March 2005 Player Market Shares (Domestic branded tea market):

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Company Name Hindustan Unilever Tata Tea Wagh Bakri Duncans Goodricke Eveready Jayshree Dhunseri

% Share 32% 23% 5% 5% 2% 2% 1% 1%

Others (i.e.; local and regional players) 30%

Performance Highlights:

1. 2.

3.

4. 5.

6.

7.

Production in April 2008 increased by 22.4 per cent compared to April 2007 levels. North Indian tea production up to April (January-April) increased by 6.9 per cent to 96 million kg, while South Indian tea production, up to April 2008, increased by 18.9 per cent to 74 million kg. Exports up to April 2008 (January-April) increased by 3.3 percent to 55.1 million kg. For the month of April 2008, exports increased by 33.7 per cent to 11.9 million kg against the same period previous year, this was mainly due to higher demand from Pakistan. Average auction prices in May 2008 were Rs 78.25 per kg, 15.2 per cent higher (y-oy). To boost the domestic tea vending industry, the commerce ministry has increased the cap on export oriented units' (EoU) sale of instant tea in the domestic tariff area (DTA) from the existing 20 per cent of f.o.b value of exports to 30 per cent. In 2007-08, the average price per kg of tea was Rs 98.36, which was higher by Rs 4.59 as compared to 2006-07. However, the volume shipped dropped to 155.59 million kgs, which is 62.56 million kgs lower than the 2006-07 level. Consequently, overall earnings declined from Rs 2,045 crore to Rs 1,530 crore. Tea production declines in Kenya; increases in Sri Lanka.

Outlook:

1.

Production will increase marginally at a CAGR of 0.4 per cent over next 2 years. While average yield from tea plantations may improve, the area under tea would

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2.

decline marginally with the implementation of the Special Purpose Tea Fund (SPTF) scheme. This would result in stagnant production. Considering the growth in tea drinking population and per capita consumption, the demand for tea is expected to grow at a CAGR of 2.89 per cent over 2007-2011, which would tighten the demand-supply gap leading to price rise by a further 5-6 per cent in 2008.

Coal Industry - Snapshot

No. of domestic manufacturers: 45

Production in India Coking Coal

Major domestic players: South Eastern Coalfields Ltd (SECL), Northern Coalfields Ltd (NCL), Eastern Coalfields Ltd (ECL), Bharat Coking Coal Ltd (BCCL), Mahanadi Coalfields Ltd (MCL), Tata Steel, SAIL.

1. 2. 3.

Proved: 16541 Indicated : 13453 Inferred : 2102

Non-Coaking Coal 1. Proved : 79325 Indicated : 106316 Inferred : 35564

Prominent Global Players (country): Peabody Energy(US), Rio Tinto(US & Australia), China Shenhua Energy (China), Arch Coal (US).

2. 3.

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Main Buyers : Power Generation companies

Related Sectors: Power, Steel products, Steel intermediaries, Cement Industry

Types of Coal:

1.
1.

For commercial purposes, there are different grades of coking, semi-coking and noncoking coal. Coking coal is broadly categorized on the basis of ash content while non-coking coal is graded on the basis of useful heat value (UHV).

Source: Crisil Research Industry Structure:

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Source: Crisil Research Evolution of Coal

2.

3.

There are different types of coal, based on their heating value, ash-melting temperature, sulphur and other impurities, mechanical strength, and many other chemical and physical properties. There are four stages in coal formation — peat, lignite, bituminous and anthracite. The conditions to which the plant remains were subjected to when they were buried determines the type of coal. Thus, the greater the pressure and heat the plant remains were exposed to the higher the rank of coal. Higher-ranking coal is denser, contains less moisture and gases, and has a higher heat value than lower-ranking coal.

Source: Crisil Research Coal Mining:

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Broadly there are two ways to mine coal: 1. Open-cast/surface mining Open-cast mining is open from the top. In such mines, the whole portion of land is dug from the top until the coal seam is sighted. In such mining, the top-soil is cleared by removing overburden from the seam, and then blasting and removing the coal. The ratio of overburden excavated to the amount of coal removed is called the overburden ratio and the lower the ratio, the more productive the mine. There are several types of surface coal mines: 1. Area surface mines 2. Contour mining 3. Mountain-top removal mines 4. Underground mining In this type of mining, coal is found deep inside the earth. This depth can vary from a few metres to more than 1,000 metres. Here, a small portion of land is excavated until the coal seam is found. Such mines have to be developed deep inside the earth, which is very difficult. This also affects the productivity vis-à-vis open-cast production. When the coal seam is found, different techniques are applied to extract coal. In underground mining, there are two main methods of extracting coal: 1. Room-and-pillar (bord-and-pillar) 2. Long wall mining

Source: Crisil Research

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Some Facts about Coal Industry:

3. 4.

5. 6.

7. 8.

9. 10. 11.

12. 13.

14. Industry Characteristics:

The Indian coal industry is the fourth largest in terms of coal reserves and third largest in terms of coal production in the world. The world's proven reserve base can last up to 155 years at the current pace of production. Also, these reserves are distributed well across all continents — unlike oil, which is dominant in a few parts of the world. The total Coal reserves in India were 287 billion tonnes in 2007. Out of this, 255 billion tonnes was non-coking coal and rest was coking coal. Coal has become an irresistible option, owing to its abundance, its distribution, and its affordability and most of all due to the advances in clean coal technology. Moreover, the scarcity in oil and gas and their soaring prices favour coal, making it an important fossil fuel for fulfilling future energy requirements. Coal accounts for around 54 per cent of the country's total energy needs. Primary energy consumption in India has grown by 163.6 per cent in the last 2 decades, while coal production has grown by 151.9 per cent. The current estimated per capita primary energy consumption in India is about 362.5 kilogramme oil equivalent (kgoe) per year. China is the largest producer and consumer of coal in the world. Of the total energy consumption in India, around 55 per cent comes from of coal. India has huge coal reserves — 253 billion tonnes as on January 2006. Of this, proven reserves are estimated to be 96 billion tonnes. Indian coal deposits are spread over 27 major coalfields, which are mainly confined to the eastern and central parts of the country. India accounts for around 10 per cent of the total proven reserves in the world. Coking coal is mainly used in steel plants and foundries, while non-coking coal is used in power, cement, and other sectors. Reserves of coking coal are low in India. India currently has 45 non-coking coal washeries with total installed capacity of about 103 mt. Of these, seven are run by Coal India Ltd (CIL) and the rest are operated by the private sector. A coal washery gives a project IRR of about 14 per cent, and equity IRR of about 16.6 per cent. India's non-coking coal production was about 390.6 mt in 2006-07, of which total washed noncoking coal was only about 55 mt. Coal, gas and oil comprise the bulk of fossil fuels. Out of these, coal is widely used due to its availability and affordability. Coal is one of the world's most important sources of energy, and it is used to meet 40 per cent of the world's electricity needs. Categories of coal reserves: Under the current system of reporting, coal reserves are classified into three categories based on the level of investigation conducted on the resources — proven, probable, and inferred.

1.

2. 3. 4. 5. 6.

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7. 8. 9.

10.

11.

1.

2.

The coal demand is expected to increase at a CAGR of around 7.5 per cent during 2005-06 to 2011-12. Coal is a freely tradable commodity. As per the current import policy, coal can be freely imported (under Open General Licence - OGL) by consumers themselves as per their needs and by exercising their own commercial judgments. A 100 per cent FDI is allowed in the equity of an Indian subsidiary of a foreign company or in the equity of an Indian company. However, these companies are not allowed to sell coal to a third party, as it is only meant for captive uses. Legal provisions on royalty: According to section 9 (1) of the Mines and Minerals (Development & Regulation) Act, the holder of a mining lease is required to pay royalty in respect of any mineral removed or consumed from the leased area. The Central government is empowered to increase or reduce royalty rates, in respect of any mineral, by notification in the Official Gazette under section 9 (3) of the MMDR Act. However, it is not permitted to increase the rate of royalty in respect of any mineral more than once during a period of 3 years. The Act also does not mandate that royalty on coal should be revised after every 3 years. E-auction 1. E-auction was started by CIL and its subsidiaries to sell coal in the open market. Emarketing was introduced in order to bring about transparency in the sale of coal. 2. This initiative also gathered steam to put an end to coal black-marketing, which was quite widespread. E-marketing ensured that the premiums that were cornered by unscrupulous traders and bogus industries would accrue to coal companies instead, thus improving their profitability/viability. 3. Further, it covered those genuine non-linked consumers in the official chain of supply, who had no access to coal than at the black markets. 4. Under the bidding process, the company needing coal would have to submit an application and then bid for the same. The highest price bidder would get the coal. 5. However, e-auction has been discontinued following a Supreme Court order. A new scheme in place of e-auction is under formulation. In the meanwhile, an interim policy for sale of coal through e-booking has been introduced. Under the interim policy, any buyer can make an offer for purchase of coal but cannot bid for the price. Sale of coal takes place at a fixed price that is notified by the coal company in advance. The maximum quantity that can be booked cannot be more than one-third of the quantity offered for booking. 6. Based upon some guidelines, the new e-auction system has been introduced from December 2007. Logistics: Coal is produced in the eastern and central parts of India, while it is consumed nationwide. As coal is predominantly used in the power, cement

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and steel sectors, and as its consumption is distributed, it needs to be transported over long distances. Coal is transported using the rail, road and sea routes.
Growth Opportunities:

1.

2.

Coal washing: An imperative in India due to lower grade of coal Coal washing, technically called coal beneficiation, is a process by which the quality of raw coal is improved by reducing the ash content and the extraneous matter that gets extracted along with the mined coal. Although India has significant quantities of coal, its production at present is of lower grade as compared with other countries such as Australia and South Africa. This is reflected in its high ash and moisture content. Driven by a rising population, expanding economy and a quest for improved quality of life, the energy usage in India is expected to swell from the current level. This would ultimately lead to increased consumption of coal.

Coal consumption in Power Sector:

Primary energy consumption in India

Coal Exploration:

3.

Exploration of coal reserves in the country is carried out in two stages. In the first stage, the geological Survey of India (GSI) continuously undertakes regional exploration to locate potential coal-bearing areas. In order to supplement the efforts of regional exploration, GSI and the Mineral Exploration Corporation Limited (MECL) have been engaged for carrying out promotional regional exploration.

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4.

In the second stage, a detailed exploration is carried out. The CMPDIL — on its own, as well as through MECL, state governments and private agencies — carries out detailed exploration taking into account mine planning and exploitation of coal reserves to meet sector-wise demand. Detailed exploration in the command area of SCCL is carried out departmentally. Mines and Minerals (Development and Regulation) Act, 1957 The Act sets out regulations relating to acquisition of land, prospecting fees, royalties, and dead rent payable to the state government. Coal Mines (Nationalisation) Act, 1973 The Act was amended on May 27, 1976, and it terminated all the mining leases on coal held by the private lessees. This Act allowed captive mining by private companies engaged in the production of iron and steel. Sub-leasing to private parties was also allowed under the Act. Coal Mines (Nationalisation) Act, 2000 Coal mining is allowed in the public sector and for captive mining purposes. A bill — namely, the Coal Mines (Nationalisation) Amendment Bill, 2000 — has already been introduced in the Parliament to open up the coal sector to private investment. Colliery Control Order, 1945 In this Act, the Central government had the power to fix the prices. However, a few changes were made in a phased manner to deregulate the prices of coal based on their grades and colliery. Colliery Control Order, 2000 Colliery Control Order 2000 was notified with effect from January 1, 2000, in super cession of the Colliery Control Order, 1945. Under the Colliery Control Order, 2000, the Central government's authority to fix the prices of coal was abolished. Water Pollution The major reason for water pollution from coal mines is suspended solids carried over in the drainage system of the mine sump water and storm water drainage. In some coal mines, acidic water is also found in underground aquifers. Air Pollution It is mainly due to the fugitive emission of particulate matter and gases including methane, sulphur dioxide, and oxides of nitrogen. Mining operations like drilling; blasting; the heavy earth-moving machinery on haul roads; collection, transportation and handling of coal; and screening, sizing and segregation units are major sources of such emissions. Noise The main sources of noise are blasting, heavy earth-moving machines, drilling, and coal handling plants.

Policies and Regulations:

1.

2.

3.

4.

5.

Environmental issues:

6.

7.

8.

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9.

10.

Land Degradation A large number of waste-dumps appear in the coal-mining area, occupying huge areas of land. This diminishes the fertility of the soil and makes it unsuitable for agriculture. Solid Waste A major source of solid waste in a coal mine is the overburden. Segregation of the stones in the coal handling plants and the coal breeze also contribute to solid waste generation. In India, coal prices were regulated by CIL. These prices are governed and fixed by CIL in consultation with the Central government (Ministry of Coal). The domestic price adjustment is based on the inflation indices WPI (for all commodities) and CPI (for industrial workers). However, in the international market, the price is governed by demand-supply factors. The real change in price regulation came in when the government de-regulated the pricing of coal under Colliery Control Order, 2000. Under the Colliery Control Order, 2000, the Central government's authority to fix prices was abolished. Coal prices are not fixed on the basis of demand-supply. Prices are based on costing and a particular profit margin that is based on economic and social consideration. It includes the cost of land, cost of forestation, other capital costs (appropriately apportioned over the life of the project), and other operating costs. Coal prices are fixed by the respective coal companies and are revised periodically. Basic price is the price of the coal at the place of production — at the pithead (run of the mine). There are lot of adjustments to be made to this basic price to arrive at the actual cost of coal. The final customer price includes freight and other charges (royalty and sales tax). International prices: International prices are governed by demand-supply factors. In the international arena, prices of exporting countries like Australia, Indonesia and South Africa reflect the international prices. However, freight rates are also added to the total cost of coal.

Pricing:

11.

12.

13.

14.

15.

Key Financial Indicators: All figures in Rs. Crores Name FYE* Net Sales PBDIT Operating PAT Margin 2% 11% 17% 110.6 461.65 748.27 TNW TOL/TNW Ratio Current Ratio 0.33 1.04 0.85

Eastern Coalfields 2007 Western Coalfields 2004 Central Coalfields 2006

4583.53 261.38 4141.09 933.64 4474.45 1468.5

(-)2925.43 0 1745.98 1322.48 0.28 0.88

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Mahanadi Coalfields North Coalfields Bharat Coking Coalfields South Eastern Coalfields

2006

3201.77 1843.62

39%

1256.3

3504.74

0.06

1.64

2007 2005

4630.84 2550.58 2865.81 (-)737.55

30% -37%

1366.48

5560.35

0.18

2.92 0.16

(-)1046.61 (-)4926.02 0

2006

7070.83 1532.61

13%

952.03

3441.24

0.14

1

*FYE= Financial Year ended (As these are government run companies, their latest financial data is not available) Performance Highlights:

1.

2.

3.
4.

The role of captive coal mining in growth of power sector has gained prominence in recent times with an increasing number of captive coal blocks being allocated to this sector and power projects with associated coal blocks setting new benchmarks for tariffs through competitive bidding - for instance, the Sasan ultra-mega power project (UMPP). Though the potential for incremental coal production from captive coal mines is significant, several issues pertaining to project execution has led to dismal performance on this front. Hence, it is expected that 20 million tonnes (mt) of incremental coal production will take place from this route during the 11th plan period. Coal remains the most preferred and competitive fuel option for power units within 500 km radius. Captive coal could provide better returns to power producers and lower tariffs for consumers. From 2006-07 to 2011-12, the domestic production of coking coal is likely to grow at a CAGR of 1.67 per cent, while that of non-coking coal is expected to grow at 7.84 per cent. Also, in 2011-12, around 94 per cent of coal production in India would be of the non-coking variety. Coal requirement for the power utility will grow at a CAGR of around 10% during 2007-08 to 2011-12. High coking coal demand by the Indian steel industry and low reserve base has boosted the import of coking coals. Coking coal requirement in steel production is expected to touch over 85.34 Million Metric Tons in 2011-12. By 2011-12, there will be a requirement of an additional 100 mt of coal washing capacity. With each tonne of coal washing requiring about Rs 200 of capex, this represents an investment potential of about Rs 20 billion.

Outlook:

1.

2. 3. 4. 5.

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6.

The 12th plan period is likely to record much higher contribution to overall supply from the allocated blocks. The total coal production through captive route by the end of 2016-17 is estimated to be almost thrice of that at the end of the 11th plan period (2011-12).

ITeS Industry - Snapshot

ITeS sector in a nutshell

1. 2. 3. 4.

The Indian ITeS industry has predominantly been an export-oriented market. In FY 07, the Indian ITES-BPO segment grew by 33.5% per cent contributing $8.4 billion to the total software and services exports of $31.4 billion. India holds a 45-50 per cent share of the global off shoring market. The most significant competitive factors are service quality, price, reliability, breadth of services, data security, industry experience, scalability, technology capabilities, and disaster recovery capabilities. Customer care continues to be the largest segment in terms of revenue, followed by finance and administration. The Indian ITeS industry employed around 415,000 people in 2005-06, exhibiting a CAGR of 46 per cent over the last 6 years. According to NASSCOM, India's ITeS industry employed around 545,000 professionals in 2007E.

5. 6.

Positive Factors affecting ITeS sector

1. 2. 3. 4.

Increased IT adoption Language compatibility Availability of huge talent pool Low labor cost

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5. 6. 7. 8. 9. 10. 11.

Rising acceptability of outsourcing non-core activities Rapid infrastructure development Robust telecom infrastructure Favourable political environment Favourable tariff and tax regime Liberal foreign direct investment (FDI) regulations The Telecom Regulatory Authority of India (TRAI) has brought down the international private leased circuit (IPLC) tariffs, which are widely used in the ITeS industry.

Negative Factors affecting ITeS sector

12. 13. 14. 15. 16. 17. 18. 19.

Rupee appreciation High wage inflation Attrition Competition from emerging off shoring destinations (Philippines, China, Malaysia, Mexico, Brazil, Sri Lanka, Czech Republic and Russia) Limited negotiating ability with clients As 80% of the clients are from US and UK, India has a no near-shore disadvantage. Multilingual CRM services (other than English) The monotonous work, coupled with graveyard shift timings have resulted in high attrition rates, and growing recruiting and training costs.

AT Kearney Scores for top-10 off shoring locations

Country Rank India China Malaysia Thailand Brazil Indonesia Chile 1 2 3 4 5 6 7

2007 Score 6.9 6.6 6.1 6.0 5.9 5.9 5.8

2005 Score 6.9 6.2 6.1 5.7 5.5 5.5 5.6

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Philippines Bulgaria Mexico

8 9 10

5.8 5.8 5.7

5.9 5.3 5.3

Different segments where domestic ITeS industry has forayed into:

1.

Telecom

It is adding 7- 8 million mobile subscribers every month, constitutes close to 50 per cent of the domestic ITeS industry revenues. Growth in mobile subscriber base, which is expected to reach around 325 - 350 million in 2008-09, is likely to drive the growth in the telecom vertical. 2. BFSI

Outsourcing in the BFSI vertical refers to the customer relationship management (CRM), document processing, policy renewal and claims processing functions. Servicing of savings account and credit/debit card holders via CRM will generate sizeable revenues in the banking vertical. 3. 4. 5. 6. 7. Document processing Transaction processing (Finance, Administration and Accounting (F&A), Insurance etc) CRM Human Resource administration Credit & Debit cards

The credit card base is expected to reach around 350 - 375 million by 2008-09, growing at an annual rate of 20 - 25 per cent for the next 2 years. Meanwhile, debit cards are forecasted to reach a whopping 1.8 - 2 billion by 2008-09, registering a growth rate of 35 - 40 per cent.

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Important factors required to sustain competitiveness

8.

The pressure on availability of total talent pool is expected to stay. We have to factor the suitability of the talent pool, based on educational background and English language compatibility. While acquisitions were one way of being located nearer to the outsourcer, setting up delivery centres in foreign countries is the other approach being adopted by most Indian players. The need to increase association with educational institutions/colleges is in the selfinterest of the industry to sustain its long-term growth story. The proliferation of the Software Technology Park of India (STPI) scheme and the National Urban Renewal Mission (NURM) has been among the most successful measures for the development of the country's IT sector.

9.

10. 11.

Competitive advantage under threat 12. Indian players would face intense competition from other off shoring countries such as the Philippines, Eastern Europe, Latin America and China. Consequently, the ability of Indian players to pass on billing rate hikes might be a tough proposition.

13.

Currently, India enjoys a competitive edge over all other off shoring destinations, except China. There is a substantial difference in the wage costs between India and other destinations such as Malaysia, Latin America and Eastern Europe (nearly 1.92.0-times).

The future plan of action --- Domestic Market

ITeS players are to seriously consider foraying into the domestic market. Reasons: 1. Exports revenue has grown at a CAGR of 32 per cent for the past 3 years, while the domestic revenue grew by 58 per cent in the same period. This high rate of growth experienced by the domestic industry has only added to its potential attraction. Booming telecom, BFSI and hospitality industries are likely to boost domestic ITeS revenues. Externally, factors such as GDP growth, currency volatility, technology adoption and cost reduction are expected to be the key drivers of the domestic ITeS growth story.

2. 3.

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4.

The rupee, which has appreciated by over 9 per cent with respect to the dollar in the first quarter of this financial year alone, has been exerting tremendous pressure on exporters. By diversifying into the domestic market, ITeS players will be able to mitigate this exchange risk and give some kind of stability to their revenue model.

Latest trends in the ITeS space

1.

Onshore expansion by M&A activities in the US and other locations with several objectives, which include access to new markets beyond just toe-holds, with ready resources, clients and revenues; access to new skill sets or domain and process expertise in the target market; access to new technologies; and greater credibility with target clients. Service providers are now drifting to higher-end strategic processes. Service providers are diversifying their geographic bases by creating new infrastructure in Tier II cities, in order to leverage lower costs and lower attrition rates, as well as to gain access to a larger talent base.

2. 3.

New opportunities to explore

1.

The next growth story would be in the space of domain/business-related opportunities such as KPO (credit analysis, equity analysis etc), legal process outsourcing, data analytics etc. According to CRISIL Research estimates, such knowledge-related activities have the potential to increase manifold (nearly fivetimes), and are expected to grow at nearly 1.5-times the industry growth rate. Off-shoring Services like the various 'high end' knowledge-based processes such as financial services research support and analysis for equity/debt/derivatives markets; econometrics, data analytics and modelling; business/corporate research/competitive intelligence; legal services, animation and game development services; medical transcription and basic; shared back-office and administrative functions.

2. 3.

The factors that differentiate TOP ranked companies with other lower rung companies.

1.

Presence in locations worldwide provides the company with multilingual capabilities, access to a larger employee pool and "near-shoring" capabilities to take advantage of time zones. Been in the ITeS space for a long time (most TOP ranked companies date back to a decade). Almost all the TOP ranked companies are subsidiaries of well established BRANDS in their own domain.

2. 3.

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4. 5.

Domain knowledge, functional expertise, experience and superior technology. They provide a wide range of services like travel, banking, financial services, Top 15 3rd party ITeS-BPO firms in India Parent Company 1 Genpact GE

insurance, manufacturing, retail, logistics, utilities and professional services. 6. 7. 8. 9. 10. 11. 12. Business leaders are experienced outsourcing industry professionals from global companies. Attracting and retaining senior talent. Advanced job training and development. Most TOP ranked companies follow the principles of lean six sigma. Centers of excellence have been created to harvest and share the in-depth knowledge of each function. Strong local market understanding. Trust of the customer due to long-term relationship.

Ranking of the TOP ITeS companies in India as on (2006-07)

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2 3 4 5 6 7 8 9 10 11 12 13 14 15

WNS Global Services Transworks Information Services IBM-Daksh TCS BPO Wipro BPO First source Solutions HCL BPO Infosys BPO EXL Service Holdings Citigroup Global Services Aegis BPO Services HTMT Global Solutions 24/7 Customer Mphasis BPO

Warburg Pincus Aditya Birla Group IBM TCS Wipro ICICI Bank HCL Infosys Citigroup Hinduja Group -

Film Financing By Banks – A Report

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Industry Overview

1. 2.

3. 4. 5.

6.

7.

8.

Releasing more than 1,000 movies a year, India is the largest producer of films in the world. Media and Entertainment industry grows faster than the gross domestic product growth (GDP) due to the elasticity of income. Entertainment industry is growing faster than the IT sector. Film production was given `industry` status in 2000 and RBI allowed banks to lend to film production. On an average film budget is Rs.10-25 crore Entertainment Tax is around 60%, although it’s different for each state . Trade and service aspects are governed under the General Agreement on Tariff and Trade (GATT). Indian film industry makes movies that people want to watch, unlike studios in the UK and the US, where people make movies because they think they have a great idea. Today, Indian films are screened in over 100 countries and watched by nearly 4 billion people worldwide. Bollywood is one of India's best-known brands internationally. India has a National Film Development Corporation (NFDC) which finances some films. However, NFDC cannot be considered to play a central role in the film industry because it finances too few films which, too, are not of the type that has made the Indian film industry so vibrant.

Recent State of the Industry Commercial Movies

“Mere Baap Pehle Aap” starring Akshay Khanna and Paresh Rawal, was released on 13th June 2008. It has not been able to recover its money back. It was produced by “Shemaroo” at a total cost of Rs.22 Crore. Overseas distribution was sold at Rs.2 Crore. PVR bought the distribution rights at Rs.13.5 Crore and spent another Rs.2 Crore on promotion and marketing of the movie. With a commission of 20% on this expenditure, PVR would share the overflow of revenues with Shemaroo after earning Rs.18 Crore. Shemaroo also expects to earn another Rs. 10-12 Crore form selling satellite rights.
Animated Movies

Animated movies are the latest trend in Indian cinema, and are catching up real fast. Most animated movies are based on an Indian mythological character as the protagonist. “Ghatotkach” is a recently released animated movie which could not fare well at the Boxoffice. It was made at an estimated budget of Rs.12 Crore. PVR had given Rs.50 lakhs. It also expects to earn another Rs. 10-12 Crore from selling satellite rights.
Most movies released in first half of 2008 were FLOPS!

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Jodha Akbar, Halla Bol, Sarkar Raj were big budget movies with big star cast and made by most reputed producers and directors have also not fared well at the Box-office in the first half of 2008. This shows how risky the situation is. This is one of the most important factors to be considered by Banks.
Industry Segments

The Film Industry basically has three main segments:
Production

1.

2.

The production process involves the development of the idea and making of the film. People involved in this activity includes, scriptwriter, executive producer, coproducer, producer, production manager, production co-ordinator, production accountant, director, first/second assistant director, continuity supervisor, cinematographer, camera assistant, art director, location manager, sound recordist, lighting assistant etc. The producer is frequently the first person involved in a project by selecting and developing material, engaging the best crew for the project, supervising the production and post production processes, securing exhibition and managing the publicity and marketing. They are responsible for creating the team, the process and almost inevitably the environment that will allow a production to succeed to its best potential and is ultimately responsible to the financiers/investors for any problems, delays or overspending that occurs.

Distribution

A distributor will acquire the rights to a production for a certain territory/ies and then use a variety of strategies to get the best screening outcomes for a production. Distributors can be very large, and attached to major media corporations. They will often manage the distribution of a production in several territories. Smaller, independent distributors tend to focus on one or two local territories. The job of distributor is really only found in the film industry as other types of production tend to deal only with sales agents and broadcasters.
Exhibition

An exhibitor is the final link in the screen production chain. In television an exhibitor would be a broadcaster; in film, a cinema or series of cinemas, or perhaps a film festival. Video/DVD stores could be seen as a mix of distributor/exhibitor. In essence they are the venue that a production will finally show on. Like distributors, exhibitors can be very large companies affiliated to major broadcasting corporations, or much smaller independent local cinema owners or local television stations.
Value Chain

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Business Model

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How the industry makes money

Producer:

1. 2. 3. 4.

5.

Distributors give him a minimum guarantee fee before the movie in return for film rights in a territory within the country. Producers can recover up to 30 per cent of the cost of the film, pre-selling it to distributors. If the movie does well and the distributor recovers his money, any additional inflows get divided between the two. Another 25 per cent of the revenue comes from overseas rights, 20 per cent from satellite rights, 10 per cent from the emerging home video market, 10 per cent from music (which includes wireless and Internet downloads). If the producer owns the intellectual property rights and has not sold it off in perpetuity (generally, rights are given for five years), he could make money selling his library to a TV channel in the long term. And where does he get his money? From banks. He can borrow on the strength of his balance sheet. He can fund his films from IPOs. Or go to individual high net worth individuals or companies to put in money as equity. Or, of course raise money upfront from distributors, or through selling some of the rights early to finance the cost of the film. They offer a Minimum Guarantee (MG) fee to the producer to book a territory. And spend on print and publicity on which they take a 20 per cent commission. Any overflow of revenue after recovery of the MG fee and commission is divided between them and the producer. In the old system distributors paid a rental to the theatre, irrespective of whether the movie ran or not is rapidly becoming history. Under a new system revenue gets shared between theatre owners and distributors. Generally, in the first week of a release, the split is evenly 50:50, in the second week the producer gets 40 per cent and the exhibitors the rest, in the third week the producer makes 30 per cent and if the movie continues into the fourth week, he gets 25 per cent of the collections.

Distributor:

1. 2.

Exhibitor:

1.

2.

Risk associated with Film Financing

Mainly there are three risks: 1. Completion Risk 2. Marketing Risk 3. Cost Overruns
Risk Mitigation Factors

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1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Stringent selection criteria. Producers with satisfactory track record should only be considered. Track record of cast and crew is very important (a rating mechanism would go a long way). Banks take the money back before the release of the film, because the distributors pay upfront. Bank gives only 50% of the finance. Need proper agreements with stars and suppliers. Insurance should be done for all those who are participating in the venture. Completion insurance. Contract should be defined in writing and should be legally enforceable as well as assigned in favour of the lender. Transparency in production and distribution arrangements that should be honored. Indian films enjoy greater acceptance and across a wider geographical market. Music, satellite, theatrical distribution, rights to cable, oversees distribution, gaming rights, broadband rights and home video rights are the other ways of generating revenues apart from Box-office collections, which narrows the risk further. The corporatisation of the film industry has also attracted FDI into the film industry. Sony Pictures released its first Indian production Saawariya in 2007. Walt Disney has tied up with Yash Raj Films for the production of three animation movies. International co-productions with the likes of 20th Century Fox and Warner Bros are on the rise. Under automatic route up to 100 per cent FDI is permitted in film industry (i.e. film financing, production, distribution, exhibition, marketing and associated activities relating to film industry) subject to certain conditions. High entertainment tax is negative for the industry, as it increases the cost of watching movies in theatres for average audience. Rising cost of talent and distribution acquisition rights out pacing the revenueearning potential of films. Lack of quality content being produced. Piracy

FDI :- International funds

1. 2. 3. 4. 5.

Factors affecting the Film Industry adversely

1. 2. 3. 4.

Where does a Bank fit into the picture?

5.

6.

With the huge and increasing number of movies releasing each year, its apparent that the production houses and independent producers require more and more money. In 2001, RBI allowed Banks to provide funds for Film Financing. Although only the production part could be funded by banks and not the distribution part which is equally important these days.

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7.

8.

9.

10.

RBI norms cap the extent of exposure to the sector to 5 per cent and also prescribe stringent rules for lending. A brief outline of the instructions stated in RBI circular is present in Annexure 1. Banks, in recent years, have been extending support to the Indian film industry. IDBI is one of the largest players in this segment. EXIM Bank, too, is a big player, although loans are available only to films that can generate an international revenue stream. Earlier filmmakers were dependent on ‘independent financiers’ who lent at 25 -30 per cent interest. As for banks, lending against films is certainly more lucrative, with interest rates at about 10-14 per cent. Finance has been extended based on the rights of the film. Repayment of finance is done prior to the release of the film. So the exposure is only towards completion of the film.

To understand the process of film financing by a bank and to understand the business model from a bank's perspective, it was important to discuss it with those who have the relevant experience. Thus, leading Banks with exposure in film financing were contacted. However, many Banks refused to share any information. One bank with a sizable exposure in film financing were ready to provided their extended support and time to help us understand the Bank's role in film industry. Following is the discussion outcome with that bank
Process of Film Financing – by a bank Important factors considered by the Bank

1. 2. 3. 4.

Successful track record of the producer. The producer should have made profits on the films produced in the past 5 years. Project based funding. Only 40-50% of the film is financed by the Bank. As a company policy, bank have a limit of Rs.20-25 crore per film

Mode of finance

1.

Cash Flow financing

Cost Heads

2. 3. 4.

The maximum money is spent on the fees of the lead artists (50-60% of the total cost of film). Other cost include fee of director, cost of shooting, equipment, making sets etc. which would together constitute about 15-20 Crore. Marketing the movie after shooting, creating hype before release, etc. are other costs associated with films.

Steps followed by the Bank for financing a film

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1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17.

18.

The Producer comes to the Bank with implementation schedule, the star cast and Director at the time of proposal. If the Producer has a good track record then Completion guarantee is not required, but with a fairly new cast n crew, the Bank may insist on a completion guarantee. The funding decision is majorly based on the track record and credibility of the Producer (whether the Producer will be able to complete and sell the film). The Bank may look at how strong is the Balance Sheet of the Production house. The Bank may require a certificate from the Chartered Accountant. The Bank requires the insurance of all the Key persons involved with the project. The Bank may insist on collateral, again depending on the comfort level with the Producer. Once the funding decision is made, a TRA (Trust and Retention) Account is opened in a bank. The funds are disbursed to the Producer from the TRA Account. The Bank holds all the rights of the film. During the pre-production and production phase, the Bank keeps getting progress reports. The Bank may at times visit the sets and talk to producers. Bank also gets report from the processing Labs, which has the negatives of the film. Apart from this, the Bank gets monthly TRA Account reports. The Bank starts getting the revenue once the Shooting is complete. The funds are shared on a Pro-rata basis. Once the movie is near completion, the Producer sells it to the Distributors and thereby gets his money which he puts in the TRA Account. Once the Bank gets its money back, it gives permission to the Processing Lab and the Producer to release the Film. The Bank gets back its money, a month before the release of the movie.

Major risk associated with the film (from a bank’s perspective)

1. 2.

Whether the Producer will be able to complete the film or not. After completion, whether the Producer will be able to sell the film to the Distributors or not.

How is risk mitigated

1. 2. 3. 4.

The film cannot be released before the Bank gets its money back because the Processing Lab requires the permission of the Bank to release the negatives. Cost and schedule overruns are not funded by the Bank. In fact the producer does not even come to the Bank for such funding. Only 40-50% funding is given by the Bank. The recovery of money is not dependent on the revenues generated by the movie at the Box-office (i.e. whether the movie is Hit or Flop). The Bank would get back the money before the release of the film.

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5.

Even if the film doesn't recover all its money at the Box Office, Television rights and Oversees rights can be used to recover more revenues.

Other leading bank's Process

Although, it was not possible to discuss the film financing process with other banks with exposure in film financing, some information from reliable sources was collected. 1. 2. 3. 4. Film Financing portfolio is Project-oriented Advisory committee with representatives from various sections (people drawn from the industry – producers, distributors, actors and film critics) Film is treated as a project, financed on SPV basis. Money distribution 1. 45-50% max 2. 30% promoter's money 3. 20% other sources But Bank needed to be convinced about the remaining 50% to be from identifiable sources and should be satisfied with the financial close-up. This may not be true for all banks. Loans are given to individual producers on the basis of 1. how their films have fared in the past 2. project's strength 3. producer's financial capability 4. Track record of the completion of the films. Bank may insist on completion guarantee. Bank would have tied up with film processing laboratories to ensure that the release of the films would take place only on debt payments. Rates exceed the PLR by 1.5 to 2%. Funding only to production side and not to distribution and exhibition side of the value chain. Does not extend loan below Rs.4 crore and does not fund the entire project cost. But it does check the veracity of funds brought in by the producer or the film company. Loan above Rs.20 crore has to be backed by a completion guarantee. Insist on 1:1 debt equity ratio. Producers are required to repay the debt before the release of the movie, holding IPR rights may not be a safety net for loan recoveries. Complete cheque mode payment so that the accounting is transparent.

5.

6.

7. 8. 9. 10. 11. 12. 13. 14. 15.

What does Production house expect from Banks?

As banks are new in this business of film production, the next step involved finding out the business model from the people in the industry (producers and production houses). For this purpose, many leading Production houses were contacted for discussion. Although most of them refused to share any specific details, one of the leading production houses provided some useful information (although it wished to remain unnamed).

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Models of Film Financing

16.

17.

Upfront guarantee model In this model the producer sells the theatrical rights of the movie to the distributor for a minimum guarantee amount. This can take place at any stage in the movie making (pre shooting, during production, postproduction). For well-known producers, movie is sold even before the shooting starts. The distributor gives the money to the producer which is used to make the movie and once complete the distributor gets the rights to release it in the theatres. Box-Office model In this model the producers sell the movie to the distributor once the project is complete. The revenue generated at the Box-office is shared among the producer and distributor and exhibitor in a pre-defined fashion which changes every week after the release of the movie. The distributor's share increases and the producer's share decreases every week.

Production house’s procedure:

18. 19. 20.

21. 22. 23. 24.

They follow the upfront guarantee model. They make 3-6 movies at a time. A single movie takes anywhere between 3-6 months to complete. The money taken from distributors is not on a project basis (not for a specific movie). So the distributor gives money to the production house instead of, for a movie in particular. There can be changes in the actors and technicians at the initial stages. The schedule is also not fixed and whole process takes place in a haphazard manner. The production house does not have big assets to lease or give as security as demanded by a Bank while giving term loans or overdraft facility. The Balance sheet does not give a true picture of the financial strength of a production house (Different production houses use different accounting methods which may be misleading). The operational Cash Flow should be used to judge the financial position of the company. Box-office collections constitute only 40-45% of the total revenues generated as compared to 75-80%, 8 years ago. Satellite rights constitute 25-30% of the revenues. Satellite rights can be sold at any stage of the movie production, however the movie can be telecasted only after 4 months of its theatrical release. Oversees distribution is another major source of revenue. Music forms the least revenue generator among other things due to increased piracy of songs over the internet and MP3 format.

Financial Strength of the Production house:

Revenue generation from a movie.

25. 26.

27. 28.

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CONCLUSION

The report on 4 industries studied, gives a very important and quick know-how about the factors that are of utmost importance for a Bank to take a decision during credit assessment. HDFC Bank has a very stringent process of assessment and approval. Such snapshot industry reports come handy when instead of reading a voluminous externally published report with lot of unrequited data, a comprehensive report with necessary and sufficient information is available, for quick reference. It not only saves time but gives a snapshot of the industry in a more readable format like graphs, charts and tables. As a student, I have gained immense knowledge about the 4 industries covered. With a wide range of sectors covered, from manufacturing to service sector and from agriculture to entertainment. Coal Industry report helped me gain an insight about not just how Coal industry works but the whole dynamics of the manufacturing industry be it Cement, Aluminum or Steel. Similarly, ITeS sector study helped in understanding how things work in a services sector and what factors are important from their point of view and how it is different from the manufacturing industry. The whole perspective changes as there is no production process and customer satisfaction becomes a key objective. Tea industry report gives an overall picture of how an agri-based industry can provide a huge potential to grow, not only domestically but even globally by tea export. India ranks 2nd in terms of Tea production all over the world. Film Financing is an untapped sector, as far as Banks are concerned. Also, there is no readymade data available for Film Industry. A lot of primary research, including making of cold calls to arranging meetings and interviewing diverse people with varying perspectives about the same industry and combining all the information and putting it in a format that will hopefully help the Bank to venture into this vertical of Media and entertainment sector.

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REFERENCES

Newspaper articles Economic Times Business Line Research Data Industry Reports HDFC Bank's internal reports Websites http://www.ficci-frames.com/ http://www.myiris.com/ http://www.naukrihub.com/india/media/overview/sector-outlook/ http://www.thehindubusinessline.com/ http://www.rbi.org.in/ http://www.coalindia.nic.in/ http://www.financialexpress.com/news/ http://www.eximbankindia.com/ http://entertainment.indianetzone.com/films/ http://www.equitybulls.com/ http://www.screenindia.com/ http://entertainment.oneindia.in/bollywood/ Database Capitaline Company Annual Reports Apeejay Tea Jayshree Tea

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Annexure 1

RBI Guidelines
Entertainment Industry Bank Finance for Film Industry
The stance of Reserve Bank’s policy of bestowing operational freedom to banks in the matter of credit dispensation remains unchanged and that banks are free to take lending decisions based on their own experience and other relevant information without reference to Reserve Bank, keeping in view the spirit of the guidelines.
Guidelines for financing film production

1.

2.

3. 4.

5. 6.

Under the existing financing practices followed in the industry, the producers normally bring in about 25 per cent of the cost of production of a film and, the balance 75 per cent is met by way of advance payments from distributors and finance from private financiers. A peculiar feature of film production is that the producer recovers the entire cost of production of a film before / at the time of release of the film through sale of distribution rights to the distributors (normally distributors pay up to 40 per cent of the agreed amount when the film is under production and the balance at the time of the release of the film). Banks may obtain from the producers a detailed budget for each film, clearly indicating the entire cost estimates for the film and the means of financing the same. Ordinarily producers are required to bring in at least 25 per cent of the project cost as promoters' contribution. Producers are also required to tie up the advances from the distributors in the usual course as per usual practice (sales advances) to cover 35 per cent to 40 per cent of the budget. Banks may provide finance to such of the projects where the total cost of production of a film does not exceed Rs.10 crore. The disbursement of bank loan should ordinarily start only after utilizing the promoter’s contribution and advance payments from the distributors.

Security

1. 2. 3.

Banks may obtain the Laboratory Letter conveying rights on the negatives in favor of the lenders. The Music Audio/Video rights, CD/DVD/internet rights, Satellite Rights, Channel Rights, Export/International Rights, etc. should also be assigned to the banks to serve as main security along with the negative rights in the form of lab letter, through appropriate documentation.

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4. 5. 6. 7.

8.

First hypothecation charge on all the tangible movable assets under the project. Assignment of all agreements and Intellectual Property Rights (IPRs) in favour of the lenders. Lenders are to have right in negotiation of valuation of all IPRs. Collaterals, if necessary, may be obtained at the discretion of banks. A Trust & Retention Account (TRA) may be maintained for all capital as well as revenue inflows and outflows. Thus, receivables on sale of all IPRs may be credited to TRA. The modalities of TRA may be worked out on case-to-case basis to the satisfaction of the lenders. A No Objection Certificate (NOC) from all concerned parties for the TRA arrangement will be required. The lenders will have first charge on the TRA. Banks may look into the legal aspects of the laboratory letter, assignment of music, audio/video rights, etc.

Risk Factors

1.

2. 3.

To mitigate the production completion risk, it would be necessary fro banks to carefully appraise the projects having due regard to the track record of the producers as also the distributors. If necessary, banks may also engage industry specialists /consultants for evaluation of proposals. Insurance of risks, key personnel, etc. needs to be organised. Pending development of appropriate risk insurance products, the existing products such as equipment insurance, key personnel insurance, etc. could be availed of.

Changes in the Guidelines in 2002

1. 2.

The RBI withdraws the stipulation that banks should not finance projects where total cost of production of film exceeds Rs.10 crore. The Board of Directors of banks should fix an overall exposure limit to the industry and ensure that advances are distributed over a reasonable number of films so that the risk is adequately spread.

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Annexure 2
Manufacturing Process (Tea Industry):

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Source: Crisil Research

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