Meeting with Students of IIT Mumbai

11 Aug 2007 Rakesh Jhunjhunwala

RARE Enterprises Insight I Intellect I

AGENDA

About Rakesh and RARE Enterprises Value Investing India and its opportunity Some thoughts for you…

RARE Enterprises Insight I Intellect I

OUR ETHOS
• • •
Prayer  God’s Grace, Elder’s Blessings Aim  To win all wars despite losing many a battle Motto  Where the head is held high, and the mind is without fear . . . Logo - R^RE Enterprises  Rare, Enterprises, Green, Compounding Baseline  Insight, Intellect, Integrity
RARE Enterprises Insight I Intellect I

• •

EVOLUTION

• • • •

Early days (1984-89) Learning curve (1990-1994) Defining time (2001-2005) Aspiration (2005 - . . . .)

RARE Enterprises Insight I Intellect I

EARLY DAYS (1984 -1989)
• • • • • • • •
Humble beginning – Rs 5000 Initial hurdles Self-belief Inspiration – healthy influences No pain, no gain Initial trades Capital protection Tax compliance and efficiency

RARE Enterprises Insight I Intellect I

PARADIGM SHIFT (1990 -1994)
• • • • • •
Inflexion point – Madhu Dandvate budget First market cycle experience – agony & ecstasy Shorting and pyramiding Prudent betting Ambitions cannot overshoot market opportunity Understanding the importance of liquidity

RARE Enterprises Insight I Intellect I

LEARNING CURVE (1995 -2000)
• • • • • •
Rudder-less period Introspection Importance of reading, experiencing and learning Participation in tech boom Private equity learning – the value of scale Value picks – PSU jackpot

RARE Enterprises Insight I Intellect I

DEFINING TIME (2001 – 2005)
• • • • • • • • •
Once in a lifetime opportunity – India and its equity markets Growth stories Concentrated and diversified portfolio Maturity Buy right, hold tight – exit in frenzies Meaningful stakes Value adding investor Organization building Resisting temptations

RARE Enterprises Insight I Intellect I

ASPIRATION: 2005 AND BEYOND

• • • • • • • • •

Institutionalization Perpetual view Other asset classes Other geographies Investor of choice Philanthropy De-leveraging Strategic thinker People, skill focused

RARE Enterprises Insight I Intellect I

RAKESH AS AN INDIVIDUAL
• • • • • • • • • •
Independent thinker Passion for equities. Measured risk taker A trader, an investor, a venture capitalist Not afraid to make mistakes, but affordable ones No religion, no emotion, no ego, no rules. But, means remain more important than the ends Accept with an open heart and mind that the only constant is change. The urge to learn is a journey, not a destination Magic of emotion-less leverage, with discipline Patience born out of conviction. Be greedy, but be long-term greedy – understanding the role of time His word is his bond, highest integrity Loves his independence
RARE Enterprises Insight I Intellect I

RARE ENTERPRISES TODAY

RARE Enterprises

Trading

Public Investments

Private Equity + Value Addition

Secondary Market

IPO / Pre-IPO

RARE Enterprises Insight I Intellect I

AGENDA

About Rakesh and RARE Enterprises Value Investing India and its opportunity Some thoughts for you…

RARE Enterprises Insight I Intellect I

OUR INVESTMENT APPROACH
What We Look For

• Attractive, addressable external opportunity • Sustainable competitive advantage • Scalability + operating leverage • Management quality + integrity • EVA positive over investment horizon

•Valuation:

divergence

Price – Value

RARE Enterprises Insight I Intellect I

INVESTMENT BELIEF

1 2

Realism a Conviction Rigidity a Taboo

3 4

Safety of Capital - a Religion Absolute Returns a Passion

RARE Enterprises Insight I Intellect I

AGENDA

About Rakesh and RARE Enterprises Value Investing India and its opportunity Some thoughts for you…

RARE Enterprises Insight I Intellect I

INDIA ON A STRONG GROWTH TRAJECTORY
“A moment comes, which comes but rarely in history, when we step out from the old to the new, when an age ends and when the soul of a nation, long suppressed, finds utterance.”
Growth enablers Growth solidifiers & accelerators Growth and Indian stock markets

“ India has a dynamism that has never been seen before” • Economist, Oct 2005
RARE Enterprises Insight I Intellect I

GROWTH ENABLERS
CULTURAL
Tolerance Educational base Skilled People Savings Oriented

POLITICAL
Democratic Secular Populous Welfare Consensus Judicial System

GROWTH ENABLERS
DEMOGRAPHIC S Young working population ECONOMIC S Entrepreneurial

Sub-continent 54% of population Vast natural resources <25 years old class well Nuclear power Vast domestic market developed Amongst largest economies Top 4 Middle classResilience (no boom-bust cycles) in the world Irrelevance of Geographies

GEOPOLITICAL

RARE Enterprises Insight I Intellect I

INDIA ON A STRONG GROWTH TRAJECTORY

Growth enablers

Growth solidifiers & accelerators

Growth and Indian stock markets

RARE Enterprises Insight I Intellect I

GROWTH SOLIDIFIERS AND ACCELERATORS
1.

A democratic growth process rather than an imposed one; a bi

3.

Resurrection of a dormant and vigorous entrepreneurial gene.

5. Strong improvement in India’s macroeconomic indicators, com

7. Strong improvement in corporate performance, powered throu 9. On-going reforms to have a multiplier effect 11.Examples

RARE Enterprises Insight I Intellect I

INDIA ON A STRONG GROWTH TRAJECTORY

Growth enablers

Growth solidifiers & accelerators

Growth and Indian stock markets

RARE Enterprises Insight I Intellect I

INDIA HAS ALL INGREDIENTS THAT MARKETS VALUE
• •
Efficient capital allocation Sustained Earnings expansion driven by growth and productivity  8%+ Real GDP growth + 4%+ Inflation = 12%+ Nominal GDP growth  Corporates to grow faster than Unorganised sector  Operating and Financial Leverage to kick-in  Hence, Corporate earnings to grow at 18%+

Favourable framework for equity investing  Rising savings, yet low equity ownership – Significant poten  Corporate Governance  Transparency  Effective Regulation  Electronic Trading  Dematerialisation  Tax Paradise for equity investing under the STT regime De-risked model. Good balance between domestic RARE Enterprises consumption and global outsourcing opportunities Insight I Intellect I

THE INVESTOR PERSPECTIVE: LONG TERM

USA

INDIA

Source: Bloomberg

RARE Enterprises Insight I Intellect I

WHAT COULD GO WRONG
• •
Slowdown in US economic growth Global economy tanks  Possible  Will have some adverse implications for India in the short-run  But will have favourable asset allocation outcome in the long-run Politicians mess up  However, decreasing influence in causing damage India loses relative competitiveness  Unlikely Real interest rates go up significantly  Unlikely

• • •

India’s growth and it’s equity returns can be delayed, not denied
RARE Enterprises Insight I Intellect I

US: CHEAP CREDIT FUELS ECONOMIC GROWTH
Quest for higher returns: use of financial engg from regular mortgages  CDOs, CLOs Low interest rates after dot com Collapse… from 4.5 to 1% in 8Q Enable loans to customers with poor credit rating – 15% of all loans in 2006 , $ 1.2 Trillion Demand for housing Consumptio n boom Rising home prices Investment Boom

GDP growth

Cheap credit

Poor housing credit shielded by innovative structures, rising home prices

Low interest rates led to US Economy Debt surging to 340% of GDP from 280% of GDP in 2000 and 175% in 1980 … thereby fueling an extra ordinary consumption and investment boom
Source: UBS RARE Enterprises Insight I Intellect I

US: VICIOUS CYCLE OF GDP GROWTH
Consumption Declines significantly

Jobs lost Unsold inventories @ 15 yr high, 1.7 M homes Investment in housing declines

Rise in credit standards to sub prime due to defaults

Increase in EMIs As interest rates reset upward

Housing Prices decline

GDP slows down

Default by sub prime

Inability to refinance

US Residential Consumption and Investment accounts for 20% of World GDP and 60% of US GDP
RARE Enterprises Insight I Intellect I

CONCLUSIONS: WE ARE IN A TOUGH PERIOD FOR EQUITIES
US Economy has to slow down Aftermath of a 25 Yr bull market in the US will not be easy High degree of complacency as too much easy money has been made too quickly World equity markets are bound to get shaken

Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums. — Alan Greenspan, 26 August 2005
RARE Enterprises Insight I Intellect I

WORLD ECONOMY IMPLICATIONS
WORLD SLOWDOWN

INDIA +
• • • • •
Oil and other commodity prices to weaken Interest rates to soften Domestic consumption story Low external reliance India – the beneficiary

• • • • • •

Turmoil in debt markets Rising oil prices Rising interest rates Slowdown in overstretched US China slowdown? Global currency realignment

HOWEVER, THE NEXT India may benefit…but after an FEW MONTHS WILL intermittent transition BE TOUGH period.
RARE Enterprises Insight I Intellect I

SENSEX POSSIBILITIES
SENSEX VALUE = SENSEX EPS X SENSEX PE
EARNINGS

Sensex 2010 - Crystal Gazing
P/E 10X 15X 20X 25X -------Earnings CAGR till FY 2010------10% 15% 20% 10,249 12,243 14,515 15,373 18,365 21,773 20,497 24,486 29,030 25,622 30,608 36,288
PER

ase Sensex EPS of 700 in FY2007

RARE Enterprises Insight I Intellect I

AGENDA

About Rakesh and RARE Enterprises Value Investing & qualities of successful investors India and its opportunity Some thoughts for you…

RARE Enterprises Insight I Intellect I

AS YOU EMBARK ON PROMISING LIVES
• • • • • • •
Whatever you can do or dream you can, begin it. Boldness has genius, power and magic in it. Do something you love The means are as important as the end Aspire, but never envy Be paranoid of success – never take it for granted. Realize success can be temporary and transient Build a fighting spirit – take the bad with the good When you see a horizon, it seems so distant. When you reach that horizon, you will realize how many more horizons are within reach
RARE Enterprises Insight I Intellect I

Thank You

RARE Enterprises Insight I Intellect I

INDIA UTILIZES CAPITAL MORE EFFICIENTLY
China Avg. GDP Growth rate Domestic Investment as % of GDP FDI as % of GDP Total Investment as % of GDP Incremental capital output ratio 10.3% 39% 4% 43% 4.2 India 7.8% 30% 0.8% 30.8% 3.95

RARE Enterprises Insight I Intellect I

GROWTH DESPITE CYNICISM
“India is the cradle of the human race, the birthplace of human speech, the mother of history, the grandmother of legend, and the great grandmother of tradition. Our most valuable and most instructive materials in the history of man are treasured up in India”. Mark Twain Growth enablers Growth solidifiers & accelerators 9 -11 % future growth a reality Growth and Indian stock markets “Despite this; the skepticism of most Indians, who have inherited from the British a talent for cultivated cynicism, is most surprising” Chris Wood, CLSA

RARE Enterprises Insight I Intellect I

INDIA's PEOPLE - ITS STRONGEST ASSET
Based on IMD World Competitiveness Survey
A large pool of skilled people...
Availability of skilled labour, 2003

...with high end qualifications...
Availability of qualified engineers, 2003 India USA Russia Brazil Germany Mexico China 3.9 7.3 7.2 7.1 6.9 6.4 8.9

...and extremely cost efficient
Total compensation for manufacturing workers, 2002 Germany USA Brazil Mexico Russia China India 2.4 2.3 0.7 0.6 0.4 24.1 20.3

USA India Germany Russia Brazil Mexico China

7.3 7.2 7.1 6.2 5.5 5.3 4.3

Note: Survey results: 1=low; 10 = high Source: IMD world competitiveness Yearbook 2003

RARE Enterprises Insight I Intellect I

INDIA's PEOPLE - ITS STRONGEST ASSET
“This is the century of skill sets” – Peter Drucker

• • • • • • • •

There are 3.22 Million Indians in America. 38% of Doctors in America are Indians. 12% of Scientists in America are Indians. 36% of NASA employees are Indians. 34% of MICROSOFT employees are Indians. 28% of IBM employees are Indians. 17% of INTEL employees are Indians. 13% of XEROX employees are Indians
“23% of the Global workforce addition over the next five years will be from India” - Economist
RARE Enterprises Insight I Intellect I

FAVOURABLE DEMOGRAPHICS WILL AID CONSUMPTION LED GROWTH

RARE Enterprises Insight I Intellect I

CONSUMPTION: EXPANDING MIDDLE CLASS
India To Have 4th Largest Number Of House Holds Earning > US $5000
Number of households with income >US $5,000 p.a.

1994 U.S. Japan Germany UK France Italy Brazil Mexico Korea Spain
Source: EIU Country Data

2004 U.S. Japan Germany UK France Italy China Russia Brazil Mexico
RARE Enterprises Insight I Intellect I

2008 U.S. China Japan India Germany Russia Brazil UK France Italy

INDIA: ECONOMIC RESILIENCE
Least Volatile Economic Growth
Maximum-Minimum GDP Growth Rate (1993-2005) % GDP growth
15 10 5 0 -5 -10 -15 India Taiwan S Korea Thailand Singapore Hongkong Malaysia

Source: EIU; World Bank; IMF; Literature review

RARE Enterprises Insight I Intellect I

IMPORTANCE OF A DEMOCRATIC GROWTH PROCESS
Importance of a democratic growth process • Allows dissent and debate of multiple views. Over time the best views prevail and allow capital to be used in a fair and just manner. Without dissent, there is crony capitalism. • Creates a culture, civic society more conducive to technology development • Enables innovation & productivity driven growth which is more stable as it is built on competencies and skills Non democratic societies can have a period of fast growth, but can never achieve long periods of stable , sustainable growth • Never have the opportunity to build the right cultures, enrich civil society, develop quality education, or promote the rule of law and globally competitive Democracy makes for populism, pandering and delays. business

But it also makes for long-term stability • Fareed Zakaria, Newsweek
RARE Enterprises Insight I Intellect I

INDIA’s GROWTH – A BIOLOGICAL EVOLUTION
Change has come about by a due process of churn of opinions and counter-opinions. • Change has not been thrust down India’s throat. • A Free Press has enabled and encouraged public debate. India has gone through its experimentation with socialism, pseudo-capitalism, to reluctant capitalism and is on its way to unabashed capitalism Change has sustained • Inspite of multiple coalition parties of different ideologies having access to power for varying periods of time “India will never be a tiger; it is an elephant that has • None of India’s economic metrics are ‘controlled’ or begun to lumber. But what the elephant loses in unsustainable speed, it makes up in stamina” • Gurcharan Das, author of India Unbound
RARE Enterprises Insight I Intellect I

GLOBAL OPINION LEADERS RECOGNIZE THE CHANGE

What is happening today is the birth of India as an independent society … colorful, open, vibrant and, above all, ready for change. India is diverging from its past, but also from most other countries in Asia. It is not a quiet, controlled, quasiauthoritarian country that is slowly opening up according to plans. It is a noisy democracy that has finally empowered its people economically. India’s growth is messy, chaotic and largely unplanned. It is not top-down but bottom-up. It is happening not because of the government, but largely despite it.

• Fareed Zakaria, Newsweek

An economic litmus test is not whether a country can attract a lot of FDI but whether it has a business environment that nurtures entrepreneurship, supports healthy competition and is relatively free of heavy-handed political intervention. In this regard, India has done a better job than China RARE Enterprises • Yasheng Huang, MITI Insight I Intellect

CONFIDENCE: INDIA INC. GOING GLOBAL
Overseas Acquisitions by India Inc ($ US Million)
100 20 100 00 80 00 60 00 40 00 20 00 0 20 02
Source: Literature Review

20 03

20 04

20 05

20 E 06

RARE Enterprises Insight I Intellect I

REFORMS TO HAVE A MULTIPLIER EFFECT
Financial sector Telecom Insurance Power Capital Market Confluence of Reforms Infrastructure Development Tariff reduction Competition Bill VAT / Indirect taxes Direct taxes

RARE Enterprises Insight I Intellect I

IN GOOD MACROECONOMIC SHAPE
1996 13.8% 8.1% 32 -1.7% 17 4.7 -8.6% 4.2% - 1.5% 4.1% 14 - 1.3% 158 2006 8.2% 4.8% 103 Indicator Interest rate on 5 yr G-sec paper Inflation (WPI) Exports ($ Bn) Current a/c deficit (% of GDP) Forex reserves ($ Bn) Forex reserves as months of imports Currency appreciation Fiscal deficit

Barring Fiscal Deficit
Source: Analyst reports, literature review

RARE Enterprises Insight I Intellect I

IMPRESSIVE TRANSFORMATION OF INDIA INC.

The sustained improvement in RoE and the growth in profits has come despite significantly lower tariff protection, lower inflation and deferred tax accounting. Indian skills and Indian enterprise have now got a global level playing field, and a much superior platform than India Inc. has ever had before.
RARE Enterprises Insight I Intellect I

PRODUCTIVITY IMPROVEMENTS: ASSET TURNS

RARE Enterprises Insight I Intellect I

PRODUCTIVITY IMPROVEMENTS: MARGIN EXPANSION

RARE Enterprises Insight I Intellect I

STRONG BALANCE SHEETS

RARE Enterprises Insight I Intellect I

POTENTIAL TO ENHANCE EQUITY OWNERSHIP
Distribution of Financial Savings 10 0% 8% 0 6% 0 4% 0 2% 0 0 % FY9 1 Ca sh Govtsch m s e e FY9 6 FY0 1 Dp e osits Eq ity&d b n re u e e tu s
RARE Enterprises Insight I Intellect I

1 .4 7 %

8 % .9

5 % .1

1 % .1

4 % .9

1 .0 5 %

FY0 5

FY0 6

FY1 1

LifeIn ra ce su n

SAVINGS EXPLOSION AHEAD

Rs. Bn Re/$ Savings $ bn Equity $ bn HH Savings $ bn

FY05 44 206 5 175

FY06 44 241 8 202

FY07 44 281 12 232

FY08 44 328 18 268

FY09 44 383 24 308

FY10 44 445 33 355

FY11 44 518 44 408

FY12 44 602 57 470

RARE Enterprises Insight I Intellect I

EXAMPLES OF TRANSFORMATION
1. Deficit to surplus economy 3. Airlines industry 5. Mobile phones 7. Increases in tax to GDP ratio 9. Emergence of first generation entrepreneurs. Largest endowments by first generation entrepreneurs 11. Changing attitudes – wealth/profit no longer a dirty word

RARE Enterprises Insight I Intellect I

FUND FLOW FOR EQUITY MARKETS
Savings Composition USD Bn GDP Gross domestic savings Savings to GDP % Financial savings - % of GDP Savings in Equity/Deb/MF - % of Financial Savings
Fund flow for market USD Bn Sources of funds Domestic savings FII investment Total Uses of funds Domestic equity issues Secondary market Total 3.2 5.1 8.3 5.5 3.8 9.4 4.8 6.7 11.5 6.5 3.5 10.0 7.1 11.9 19.0 6.5 7.4 13.9 7.5 14.3 21.8 10.5 23.7 34.2 14.8 35.2 50.0 20.7 44.2 64.9 4.7 3.6 8.3 5.5 3.8 9.4 0.1 11.4 11.5 1.1 8.9 10.0 6.6 12.5 19.0 5.9 8.0 13.9 11.8 10.0 21.8 21.2 13.0 34.2 34.0 16.0 50.0 44.9 20.0 64.9 1994 1995 2004 2005 2006 2007 2008 2009 2010 2011

1994 274 62 22.5% 35 12.8% 4.7 13.5%

1995 323 80 24.8% 46 14.4% 5.5 11.9%

2004 601 174 28.9% 83 13.8% 0.1 0.1%

2005 694 202 29.1% 97 14.0% 1.1 1.1%

2006 798 235 29.5% 133 16.7% 6.5 4.9%

2007 904 271 30.0% 156 17.3% 5.9 3.8%

2008 1,026 315 30.7% 184 17.9% 11.8 6.4%

2009 1,163 365 31.4% 216 18.6% 21.2 9.8%

2010 1,319 425 32.2% 253 19.2% 34.0 13.4%

2011 1,496 494 33.0% 299 20.0% 44.9 15.0%

RARE Enterprises Insight I Intellect I

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