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The Azhar Syndrome
The Occasional that talks sense... most of the time
(March 12, 2009)

By: Le Grand Fromage Email: legrandfromage@fglobal.com
Sometimes we get what we wish for, and then we get the rest of our lives to repent. This is precisely what has happened to India. This country has craved a bull market since the day a few Gujus got together and formed the Bombay Stock Exchange under a tree (actually, that’s probably a charitable description. More likely, they formed it in a slum). Since then, this country has lived on in the hope that it will get a secular bull market, akin to what the US got between 1982 and 2000. And intermittently, it did get bull markets…short, sharp ones, that enriched no one but the brokers. But nothing ever got even close to the US bull market. All of us sell-side low lives sold the mythical India story to dumb foreigners through the ‘90s, gobbled up their dollars at Rs.31.37/$, got them to buy loads of rubbish that miraculously turned more illiquid than molasses come a mini-bear market so that the foreigners could never take back the dollars they had brought in. But the broad bull market never came. Then came the 2003-2007 bull run. And that ruined the country. This bull market inflated dumb promoters to God-like status. It made mediocre fund managers become stars. It made below-mediocre sell-siders become ace stock-identifiers. It made the fiscal deficit nearly go away, however illusorily. It made even lowly back office clerks become Bloomberg operators at JP Morgan’s outsourcing units, getting in a month what they were getting in a year, so tight was the market for Bloomberg operators. MBA graduates joined their first jobs, with the laser-like clarity that the first task they needed to get accomplished, was to shoot off their resumes to all the other wannabe securities firms planning IPOs. IIM graduates shamelessly played one company off another to get $250 k joining packages from Lehman and like firms. The MBA institutes dutifully instilled the virtues of greed and avarice in their wards. Not that they needed to do much, for their wards had been coached into these virtues from childhood by their middle-class parents from Phagwara, who had never driven anything better than a beat up Ambassador. “Puttar, jitney paise mile, kam hai. Yaad rakhna, tere baap ne bahut mehnat karke tujhe padhaya. Ab, jaakar phatte chak de”: would be the mom’s sage advice (Son, money is everything. Remember, your father worked really hard to put you through MBA. Now, go and grab the maximum you can get”). With such solid middle class values deeply ingrained, young MBA kids ran amuck. And this led to the crazy spectacle of the recruiter actually being a person who was getting less money than the recruitee. There was simply no fairness in the world back then. But fairness is back. IIM graduates are being hired in dozens by state-owned Union Bank of India. Serves the losers right. One only hopes they don’t turn Union Bank into Lehman.

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In the bull market, promoters dreamt up grandiose businesses. Did silly acquisitions. Bid for nonsensical projects. And then went and poached “talent” from competitors at salaries that made Wall Street compensation look distinctly Cleveland-ish. It was crazy, and just plain out of control. All that is over, and isn’t coming back for a while to come. Thank God for that. But it is hurting: the fact that one year you were in the Forbes 400 Richest List, and now, you will more likely make the List of 400 Most Indebted Promoters. As Darryl Hannah told Charlie Sheen in Wall Street “Bud, one day you’ll realize that it’s a whole lot worse to make money and then lose it all, than never having made it at all.” This line sums up India’s plight. If the bull market hadn’t happened, the Tatas wouldn’t have had Jaguar and Corus. The Ambanis wouldn’t have had organised retail or nation-wide broking. GMR, GVK wouldn’t have got the airports. The brokers would never have listed. The real estate companies would have never accumulated land banks in the Andaman & Nicobar Islands or some such God-forsaken place. Subhiksha would have never got Rs.750 crs of debt (who are the dumb bankers who gave this kind of money to a cash negative retailer with no hard assets?) The peons wouldn’t have become Bloomberg operators, and then gotten laid off. The MBA kids would have never joined Lehman. Low intelligence, high momentum hedge fund managers wouldn’t have got any assets worthy of mention. Vijay Mallya wouldn’t have got his airline (now that would have been a shame, for Kingfisher First is far and away the best Business/First Class in the world). And now that the high watermark of life has been set, almost anything else seems a huge failure now. A guy drawing $250k now gets an offer of $100k, heads out to commit suicide. In 2002, he would have been spraying Veuve-Clicquot on Marine Drive. This is precisely what The Azhar Syndrome is all about. Azhar is the kid from the slums in Slumdog Millionaire. He flew to LA for the Oscars, slept on clean sheets in an air-conditioned hotel room, for the first time (and possibly the last time)…came to his Bombay slum home…and moaned to the press “It is so hot here, and the mosquitoes…I can’t sleep”. He is finished. A few nights in a clean hotel room, and the guy can’t adjust back to the reality of his slum existence. And before LA happened, he was happily rolling in the mud all day, and sleeping soundly with mosquitoes and all, in precisely the same slum. Azhar enjoyed a 5 day bull market. And his life is ruined forever. India enjoyed a 5-year bull market. And a whole generation has been scarred for life. Before the bull market, a stock market that doubled in three years seemed miraculous. An economy that grew 5% seemed fabulous. A market cap that reached a billion dollars in ten years was a gift from God. A salary that rose 9% a year was stuff that dreams were made of. An AUM of $50 mln was enough to get the sell-side to send you the hottest escorts. Naah…we were all so much better off without the bull market. Just as Azhar was so much better without the Oscar trip. We would all have been as happy as pigs rolling in shit. We are all rolling in shit all right. Except that we aren’t happy. Which brings me to this whole Slumdog mania. (I find the name utterly insulting. The book on which it’s based was called ‘Q&A’!). I mean…this guy, Danny Boyle has rubbed the face of this country with…well, you know what. And this country is dancing in the streets, in the aisles, in the shit-pits, in the Parliament, in the election campaigns…The newspapers have been breathless, the 2

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radio jockeys have been gushing, some brand consultants have even said that this will boost tourism, just as Lord of the Rings boosted tourism in New Zealand! Danny Boyle is lucky. If he had done an equivalent film about Singapore (on whatever soft underbelly Singapore has), he would have been behind bars, getting caned across his butt with sticks dipped in alcohol. But then…what does one do with this country that loves becoming the laughing stock of the world? Where a Cabinet Minister states that the movie shows how the slums are a beehive of entrepreneurial activity. Unbelievable. Of course, Slumdog was going to win the Oscars. Look, there is a formula that wins Oscars. You crack the formula, you win. Further, a triumphalist film like Lagaan could never have won the Oscars. Everybody knows why. Have I seen Slumdog? No. Why should I pay to watch something I can see for free?

Why are India’s Private Sector Bank Stocks tanking?
ICICI Bank has lost 45% in the past 60 days. Axis Bank is down 43%. HDFC Bank is down nearly 25%. What’s going on here? Well, what’s going on is that the market is getting really nervous about the quality of their loan books. Remember, Indian private sector banks have been on a tear last few years. Great asset growth. Great earnings growth. Precisely the kinds of things that make me lose sleep. I just hate fast growing banks. I operate with the simple-minded belief that any bank that does that comes to grief, sooner or later. Banking is arguably the dumbest business known to mankind, and a fast growing bank is the dumbest beast in the jungle. The only model of banking that makes sense to me is a small, focused, narrow footprint bank, where the CEO knows every borrower, runs a dull, boring business that trades at book value. Any other model will self-destruct at some point. Citigroup exemplifies this self-destruct model, having lived on the edge for over 20 years. It survived its last brush with bankruptcy thanks to Alwadeed, who must surely rank as an even worse investor than what Warren Buffet has lately become. Indian Private Sector Banks have grown on all fronts last five years (the same 5-year syndrome again!). But surely this breakneck growth must have given birth to some warts that will show up when the cycle turns down? For sure. First Global’s Banking Analysts highlighted this risk in a report “Banking: Food for Thought - How serious is the threat to the loan book of Indian private banks? (Sector downgrade)” dated November 28, 2008. The key points that were highlighted in that note (which also downgraded all the major Private Sector Banks like ICICI, Axis and HDFC Bank): “Exposure to real estate alone was 175% of Net Worth for ICICI Bank, 180% for Axis Bank and 88% for HDFC Bank…and this was after the serial fund-raisings by all of them..…plus there was significant exposure to other cyclicals like steel, textiles, et al. Unsecured loans were (and probably still are) are between 112-165% of tangible networth. Total Sensitive Sector exposure + Unsecured lending, of these banks is: 305% of Tangible Net Worth for ICICI Bank; Axis Bank has the same ratio at 316% of Tangible Net Worth; and HDFC Bank, 292% of Tangible Net Worth. Sensitive Sectors are Real Estate and related sectors + Capital Markets”. Mind you, this ratio excludes exposure to other troubled sectors like Gems & Jewellery, Textiles, Steel, etc. Do the math or just send us a mail for our November report. It does not make for pleasant reading, though, I must warn you. 3

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The above ratios are the key to understanding why we turned outright bearish on these names a while back. Looking at the above numbers, our take was that there was no way the lofty 2-4x Price/Book of these banks would last. Their book values will take some hits in the coming months, and that is precisely what the market is saying through its price action on these names. So don’t start getting carried away by the usual sell-side rubbish about how attractive these banks are at these P/BVs.

The Other Important thing to remember
When folks start talking about the security of the Indian banking system (and of course, it is fairly secure…so far), and how it weathered the ’98 Asian crisis so well, bear in mind one very important thing: back in ‘90s, there were virtually no Private Sector Banks of any size or consequence around: HDFC Bank was barely 2 years old at the time of the Asian crisis, Axis didn’t exist, ICICI Bank was still a development bank. It is since 2002-03, that Private Sector banking has become the dominant force in Indian Banking, on an incremental basis: their business has grown at CAGR of 34% last five years, vs 25% for the entire Indian Banking industry. And we all know Private Sector Banks take far higher risks than state-owned banks. This is precisely my worry about India’s banking situation: in the ‘90s, the state-owned banks ran relatively conservative banks. In this decade, the risk-meter has swung more to the right, what with the Private Sector Banks’ pressure of quarterly numbers, growth, and the desire to impress the Street. None of which, generally speaking, makes for sound banking practice.

The World According To CMIE
One of the most puzzling phenomena last 12 months has been the venerable Centre for Monitoring Indian Economy (CMIE)’s amazingly bullish forecasts about the Indian economy. Slowdown, what slowdown, has been Mr. Mahesh Vyas’ refrain all this while. India will grow 8.5-9% in FY09. All this talk of a slowdown is plain rubbish. But now, CMIE has outdone even the most Polyanna-ish forecast of Indian corporate profits. It now says that Indian Corporate profits will rise 75% or so in FY10, and margins will double. Talk about CMIE being on steroids or some other substance. I have no doubt whatsoever that CMIE’s Excel sheets have become all corrupted as all the good Excel operators now work as construction crane operators (that became one hot paying job in India, believe it or not), and the formulae being fed in have gotten crazily mixed up. Unfortunately, the only guys believing these forecasts are living in Lutyens’ Delhi, and nowhere else.

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