The script was supposed to run in this fashion: A cooling global economy leads to lower international oil prices, which pushes down local bond yields, boosts the stock market and pushes up the rupee. And as international oil prices started falling in the middle of July, rate-sensitive stocks initially rallied, long-term bond yields started falling in spite of a rate hike by the Reserve Bank of India (RBI) and the rupee started to strengthen against the dollar despite the US currency hardening against most other currencies. While bond yields are now well below where they were when RBI hiked rates and while the stock markets have bounced from their lows, the rupee has given up all its gains and fell below the 44 to the dollar mark on Tuesday.
Dealers say the initial gains in the rupee were the result not so much of lower international oil prices, but of RBI not buying oil bonds directly from the oil companies. The RBI decision to purchase oil bonds directly had earlier removed dollar demand from these companies from the forex market, leading to a rise in the rupee. With dollar demand back from oil companies, the rupee has been under pressure. But the other factor weighing on the rupee has been the relentless selling by foreign investors, both in the cash and the derivative markets. In other words, as long as capital outflows continue, the stock markets as well as the rupee will remain weak.
But why should bond yields and the rupee move in opposite directions? Bond dealers say that the buoyancy in the debt market too is due to technical reasons, such as the demand for statutory liquidity ratio bonds. A. Prasanna, economist with ICICI Securities, says that bond prices have risen due to a short squeeze and that higher government borrowing in the second half should support higher yields.
To cut a long story short, the lower oil price story hasn’t really worked according to the script so far. Part of the reason is that oil prices have been stuck in a range after falling sharply—when they were falling rapidly, bond and stock prices and the rupee had all rallied.
If oil prices resume their downward journey, we could well have another rally in all our markets. As Citi Investment Research’s Asia economist Yiping Huang put it in a recent report, “A month or two ago, we looked for differences in current account positions and inflation pressure to separate Asian currencies. That paradigm has changed. Deterioration of the global economy has become a key risk factor. Therefore, currencies of less open economies may perform relatively better. That was probably why the INR, IDR and PHP (Indian rupee, Indonesian rupiah and Philippine peso) performed better than the SGD, MYR and TWD (Singapore dollar, Malaysian ringgit and Taiwan dollar).
And such dichotomy may continue in coming months.” Citi’s 12-month forecast for the rupee is 42 to the dollar.
Market’s concerns about Infosys’ Axon acquisition
Most IT analysts are positive on Infosys Technologies Ltd’s proposed acquisition of UK’s Axon Group Plc. Still, the company’s shares fell 0.5% on a day when peers, such as Wipro Ltd and Satyam Computer Services Ltd, rose 2-3% after the rupee breached the 44-mark to a dollar.
What gives? Axon released its results for the first six months of 2008, which weren’t exciting. Revenues grew 28%, helped by acquisitions, but a higher share of revenues from the North American geography led to a drop in margins. Operating profit rose at a lower rate of 19%.
Propped up by acquisitions, the North American region accounted for nearly 60% of incremental revenues. But, the company’s margins here were just 4.5%, compared with as high as 20.8% in the Europe, Middle East and Africa (EMEA) region. But, revenue growth in the EMEA region was a tepid 12% during the first half period. There is a concern that Axon’s growth is happening in low-margin areas, and that could bring down overall margins in the future.
One of the main concerns of the market is that based on Axon’s estimated earnings before interest and tax for the year till December, the pre-tax yield on the invested capital of $753 million is less than 10%.
Infosys currently earns a pre-tax yield of 11-12% on its cash. Of course, the expectation is that Infosys will improve Axon’s margins through synergy benefits and the benefits of scale, and so over time the acquisition should make sense.
But, some investors are bothered about the low yield as well as the fact that margins were on the way down in the first half of this year.
Besides, Axon’s healthy cash position of $46.8 million at the end of December 2007 depleted to $35.5 million by the end of June, partly because of a large payment of about $19 million as deferred consideration for some of its acquisitions. Axon has to still fully pay for all its acquisitions, and so the net cash position may be lower than it seems.
Finally, some observers seem surprised at Infosys’ choice of Axon, which has grown through multiple acquisitions itself. Infosys has been cautious about acquisitions in the past, partly because of concerns about cultural integration of the acquired company’s employees.
In Axon’s case, there could be multiple layers of integration issues, what with Axon itself having acquired five companies in the past two years, complicating employee integration by Infosys.
On the positive side, Axon complements Infosys well in terms of the industries it services and its core competence. The fact that it itself has delivery centres in an emerging market (Malaysia), implies that it will buy into the offshoring culture easily.
An IT analyst points out that Infosys’ own consulting division hasn’t been aggressive in this regard. All told, the acquisition can be rightly judged only after a couple of years after Infosys completes the takeover.
Ironically by then, there may not be separate numbers available for Axon, as it’s likely to be merged with Infosys.
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