Mergers: Why Most Big Deals Don't Pay Off

A BusinessWeek analysis shows that 61% of buyers destroyed shareholder wealth 


The spring of 1998 was a fast and furious time for dealmakers. As stocks soared in one of the most exuberant phases of the decade's great bull market, multibillion-dollar mergers poured forth. Two and even three companies unveiled major deals in a single morning. At times, business in the ballrooms of New York's Waldorf-Astoria Hotel--a favorite spot for press conferences--was so brisk that as one CEO tangoed out, he risked colliding with the next one waltzing in.


These deals were solid undertakings--purchases of long-established companies with proven business models, tangible assets, and thousands of workers, unlike the ephemeral Internet affairs that came later. On Apr. 6, for example, Sanford I. "Sandy" Weill's Travelers Group announced a $70 billion merger with the banking behemoth then known as Citicorp, a deal so bold that it required Congress to repeal Depression-era laws about bank mergers. The next day, insurer Conseco Inc. (CNC ) announced it was paying $7.1 billion and a huge 86% premium to buy mobile-home lender Green Tree Financial. The following Monday morning, Bank One Corp. (ONE ) offered $28.8 billion for First Chicago NBD, and NationsBank bid $59.3 billion for BankAmerica Corp., as it was then called. Three weeks later, Germany's Daimler Benz snapped up Chrysler Corp. for $38.6 billion.

But an exclusive new study by BusinessWeek shows that fully 17 out of the 21 "winners" in the heady merger spring of 1998 were a bust for investors who owned their shares. If CEOs had kept their checkbooks under lock and key and simply matched the stock market performance of their industry peers, shareholders would have been far better off. For example, in the year after the Green Tree bid, Conseco shares lost 47% of their value. That's bad enough, but Conseco's relative performance was even worse. Shares of insurers in the Standard & Poor's 500-stock index rose 8% in the same time, meaning that Conseco lagged behind its peers by 55 percentage points--and that was before its stock spiraled down to 10 cents amid a debt restructuring, now under way. Daimler shareholders didn't fare much better: Their total returns underperformed S&P's index of auto stocks by 30%. Travelers shareholders were among the few who were in the money after a year, garnering returns that were a slim 2% better than other insurers.

Similar patterns appeared across the 302 major mergers from July 1, 1995, to Aug. 31, 2001, covered by our study, designed with Mark L. Sirower, head of the mergers-and-acquisitions practice of Boston Consulting Group (BCG). We used data from Standard & Poor's (like BusinessWeek, part of The McGraw-Hill Companies) and deal tracker Mergerstat. There was plenty to dig into. The M&A bonanza during those six years shattered record after record. It was five times greater than any previous M&A boom in U.S. economic history: In the three busiest years, 1998 to 2000, deals totaled nearly $4 trillion--more than in the preceding 30 years combined. And, of course, it included the biggest-ever merger: America Online Inc.'s $166 billion, all-stock bid for Time Warner Inc. in January, 2000.

Why were shareholders left with such a hangover after the binge? Primarily because the bidders paid too much. They were afflicted by what economists call the "winners' curse": So eager were they to snare a deal that the premium they paid gobbled up the merger's whole potential economic gain from the get-go. Meanwhile, sellers laughed all the way to the bank: They were suddenly offered 36% more than their shares were worth a week earlier.

Managers sometimes bought a pig in a poke--not fully understanding what they were getting. Often, they envisioned grand synergies that proved illusory or unworkable. They underestimated the costs and logistical nightmares of consolidating the operations of companies with very different cultures. They overestimated cost savings and failed to keep key employees aboard, sales forces selling, and customers happy. "Some companies fail to recognize that integrating acquisitions well is both an art and a science," says Jack Levy, co-chairman of M&A at Goldman, Sachs & Co.

While many managers are inept at picking winning deals, investors aren't. They have an uncanny knack of assessing quickly and accurately what impact a merger will have on a company's future cash flows and, thus, the value of its stock. That's why we used the stock market returns of buyers one year after their bids to measure whether a merger was successful. Many CEOs disagree with assessments of their performance by investors, but the market remains the most reliable measure. And while a year may seem cruelly brief for judging a merger, research by Sirower, author of The Synergy Trap, and Stephen F. O'Byrne, president of Shareholder Value Advisors Inc., has shown that the way prices move shortly after an acquisition is announced is a very good predictor of the buyer's operating performance over the next five years. "Knowledgeable investors can understand the economics of a deal in a minute," says Sirower.

To ensure that they were significant economically to the company, we focused on deals worth at least $500 million, eliminating any in which the buyer offered less than 15% of its market capitalization. The average buyer in our sample paid an amount equal to 47% of its own market value. We weeded out deals that were followed within a year by another significant acquisition by the same buyer. That's because it's nearly impossible to figure out the impact from one deal if another follows soon after. Besides, we suspected some companies were more interested in playing accounting games with serial acquisitions than in making deals likely to add real value to their businesses.

The main conclusions of our study:
-- Fully 61% of buyers destroyed their own shareholders' wealth. A year after their deals, the losers' average return was 25 percentage points below their industry peers'. The gains of the winning minority couldn't make up for the buyers' losses: The average return for all buyers was 4.3% below their peers and 9.2% below the S&P 500.

-- The buyers lost largely because they paid too much, transferring wealth to the sellers' shareholders. From the week before the deals to the week after, sellers collected a hefty 19.3% extra return on their stock market value vs. their peers.

-- Bad deals don't get better on the whole if you wait longer to assess them. Among a 150-strong group of losing buyers whose purchases were not overshadowed by another deal in the second year, about four-fifths still showed negative returns after 24 months. About two-thirds of those showed no improvement at all.

-- Companies that paid for their acquisitions solely with stock--65% of the cases--showed the worst results. After a year, they lagged behind their peers by 8%. By contrast, those paying entirely cash gained 0.3%.

-- Investors' initial reactions were good predictors of subsequent price action. Of the bidders' stocks that traded down relative to their peers in the first week after their deals, 66% were still laggards a year later, by an average of 25%. The stocks that were up initially went on to score even bigger, turning a smallish 5.6% gain into a 31% leap a year later.

The worst deal of the lot by our reckoning was an Internet play. On Feb. 14, 2000, WebMD Corp., then known as Healtheon/WebMD (HLTH ), announced a bid to buy Medical Manager Corp. and a subsidiary, CareInsite Inc., for $3.2 billion in stock.

It was a veritable St. Valentine's Day Massacre. Forged at the peak of the Internet stock bubble, it burned shareholders of both seller and buyer. The 48% premium quickly evaporated. And, a year on, the company limped 152% behind its health-care peers as doctors and insurers balked at using WebMD's services. Roger C. Holstein, a member of WebMD's office of the president, says: "We were a health-care company with an Internet valuation. It makes for a difficult comparison."

By contrast, the no-nonsense purchase of office-supply company Corporate Express Inc. by Amsterdam-based business-supply giant Buhrmann (BUH ) turned out to be a big winner. Everything about the deal was right. The Dutch company's $1 billion bid was in cash, a sure sign of management's confidence in the acquisition. It paid a below-average premium of 24% for a company whose stock had been falling. And since Buhrmann already owned a major U.S. business in the field, BT Office Products International, the deal was a great consolidation play. The market liked the deal from the start, with Buhrmann's stock rising 20%. A year later it was up 110%, while rivals' stocks fell 19%.

Despite their patchy record, CEOs are still compulsive dealmakers. Indeed, after a brief lull, their appetites will likely quicken when they see prices of other companies falling faster than their own. This year, about 5,400 deals worth $346 billion were announced through Sept. 30, according to Mergerstat. Even though that's way behind 1999's record $1.4 trillion, it could match the 1996 score of $470 billion.

Still, individual investors can draw some useful pointers from our study. Their best strategy is usually to sell as soon as they see a pair of CEOs approaching a podium. If they're lucky enough to own stock in the target company, they're likely to get the lion's share of the gains--within the first week. The buyer's shareholders do best three times out of five by selling. But if their stock rises in the first week, they might do better by holding on.

Our results come at a time when the public is demanding that corporate directors do a better job overseeing top management. They show that there has been no improvement in CEOs' dealmaking skills since 1995, when BusinessWeek's major survey of mergers in the early 1990s found that half were failures. Since then, an army of consultants and bankers has tried to help CEOs improve their success rate. But they've failed.

That's alarming, because the price of failure is rising sharply. Until this year, companies could bury their bad deals on their balance sheets as goodwill--basically the difference between what they paid and the value of the assets that they acquired. Goodwill was quietly expensed over a period as long as 40 years. No longer. As AOL Time Warner Inc. (AOL ) shareholders are painfully aware, companies now have to take a write-off straight away if the assets deteriorate in value. In April, AOL took a $54 billion charge, a record. Other painful big-ticket reminders of bad deals have followed.

Scrutiny of mergers is only going to become more intense. Under rules adopted by the Financial Accounting Standards Board last year, companies have to explain in more detail why they are making an acquisition. They have to tell what assets, including intangible ones, such as goodwill and patent rights, they are getting for their money.

Why did CEOs do so many deals in the six years we studied? The bull market was a big reason, of course. Executives were brimming with confidence and rich stocks. "Mergers are a valuation-driven phenomenon," says Robert W. Vishny, a professor at the University of Chicago Graduate School of Business who specializes in corporate financial behavior. Only the high and disparate stock valuations across companies in the market could fuel so many deals in so many industries at premium prices at the same time, he says. Of course, executives had to offer plausible strategic reasons to their shareholders for putting their companies through the wringer of a merger. The most common rationales for change were industry deregulation (such as in telecom and energy), the need for consolidation and productivity gains, and opportunities to expand into global markets. "The market doesn't always believe it, but you do your best to make a good synergy story," says Vishny.

In the late 1990s, growth stocks dominated the market and investors clamored for companies with rising earnings per share. One easy way to juice earnings was to buy other companies. A company with a high price-earnings ratio could easily juice its own short-run earnings by buying one with a low p-e--even if the purchase delivered poor returns in the long run. At the same time, big institutional investors favored companies with bigger stock market valuations so they could trade in and out in a hurry. So desperate CEOs began paying high premiums to snare any deal that would push up their earnings and market cap.

Meantime, the bull market handed CEOs a potent deal currency: highly valued stock. It's better than cash, because CEOs can print stock almost at will. But when they pay with paper, CEOs tend to get into riskier deals. Some executives even argued that high stock valuations were the market's way of telling them to buy. "Companies were focused on the signals they were getting from the market, and those signals were misleading," says one banker.

Of course, stock does have some big advantages. Unlike cash borrowed to make an acquisition, it doesn't have to be repaid. Besides, it reduces debt-to-equity ratios and conserves cash reserves. It also dilutes shareholders' interests--a real cost, but one that is often ignored. "Paying with stock is a strong signal that not only do you think your shares are overvalued but that you are not totally confident about the success of the deal," says Sirower.

Another telltale mark of fatal chutzpah was the premiums CEOs offered: an average of 36% above the seller's market price one week before the deal. With high premiums, buyers are destined to fail unless they can create a lot more value from the takeover than the stock market had recognized. "On a $1 billion deal [with a 30% premium and fees for lawyers and bankers], you're taking on $300 million of incremental costs," says Jack Prouty, principal at Step-Change Management LLC, an Annapolis (Md.) consulting firm. "Then you're going to have some critical members of your sales force walking out the door with key customers. You're going to get a dip in business and dig yourself a hole of another $50 million to $100 million."

Of course, companies blame post-merger blues on anything but the failings of their own managers. Consider Office Depot Inc.'s (ODP ) $2.9 billion stock deal for Viking Office Products Inc. in May, 1998. It paid a 42% premium. The market hated the deal and knocked Office Depot stock down 12% on the news. Over the next year, Office Depot underperformed other specialty retailing stocks by 55 percentage points. Investor relations chief Eileen Dunn says Office Depot had to pay up to get fast-growing Viking with its international and mail-order businesses, perfect launch pads for e-commerce, which the company wanted to enter. The problem, she adds, is that the regulators had months earlier scotched Office Depot's planned merger with Staples Inc.: Its real estate acquisition team, key to meeting its growth targets, had bolted in anticipation of the consolidation.

In a roaring bull market, paying the going rate leaves no margin for error. Clear Channel Communications Inc. (CCU ) got into a fix by pursuing the then-hot properties of rival radio station operator AMFM Inc. in October, 1999. The $17.3 billion price tag was a 41% premium. Over the following year, Clear Channel shares lost 31%, as advertising slowed, cultures clashed, and the AMFM stations needed more investment than planned. Meanwhile, media stocks in the S&P 500 rose 19%. Clear Channel spokeswoman Diane Warren says the price was fair. "The merger has been an outstanding acquisition," she says, and still holds "enormous upside potential." It made Clear Channel the largest radio operator in the nation--sheer size that has spawned lawsuits alleging anticompetitive behavior. The company calls the allegations "absurd."

Some deals just seem poorly thought out to begin with. Department store chain Dillard's Inc.'s (DDS ) May, 1998, acquisition of Mercantile Stores Co. for $2.9 billion in cash seemed a logical expansion from the South into Ohio and the Midwest. But the two retailers had dramatically different marketing strategies. Mercantile was well-known to its customers for its "Midnight Madness" sales; Dillard's was far more conservative and avoided promotions in favor of an everyday-low-pricing strategy. Dillard's overstocked the Mercantile stores as it switched strategies. Customers balked, forcing Dillard's to deeply discount the goods. Its shares lagged peers by 55 percentage points a year after the deal. "The acquisition set Dillard's back a couple of years," says analyst Robert F. Buchanan of A.G. Edwards Inc. "It gave them a prolonged case of indigestion." Dillard's did not return calls asking for comment.

Indigestion is a common post-merger malady. It afflicted Harmonic Inc. (HLIT ) after it bought the core of the former C-Cube Microsystems Inc. for $1.7 billion in October, 1999. Harmonic, whose stock had risen elevenfold within a year, wanted C-Cube's equipment to carry broadband delivery of the Internet by satellite. But several key execs left, sales growth collapsed, and so did Harmonic's stock, down 86% a year later, 99 percentage points below communications equipment stocks. CEO Anthony J. Ley says the stock fall reflects weaker demand from his customers, and that the merger was a successful and necessary step to diversify his products: "We're much more likely to be around for the long haul," he says. But Ley also says he's wary of M&A: "It's fraught with danger. It requires very little to screw up completely."

Acquisitions also go bad when buyers don't know exactly what they're getting. That happened even to savvy investor Warren E. Buffett. He announced his $21.7 billion deal to buy General Reinsurance Corp. for stock the afternoon of Jun. 19, 1998, right after Berkshire Hathaway Inc. (BRK ) shares closed at their all-time high. That gave him some margin for error, but not enough. He discovered ultimately that General Re had taken risks it couldn't evaluate and had underpriced much of its business. The market caught on early: By the time the deal closed six months later, Berkshire shares were down 25%. A year after the initial announcement, they were lagging insurance stocks in the S&P 500 by 19 percentage points. Later, Buffett apologized to his shareholders.

Of course, some deals that appear to be flops still leave shareholders better off than they would have been otherwise. Indeed, for a CEO whose business faces a disastrous decline, a deal may be a victory if it manages just to keep his company alive. "Because the market reacts to an acquisition negatively doesn't always mean it was a bad idea," says Chicago's Vishny. "The stock may have gone down worse if it hadn't been used to buy real assets." Consider chipmaker Advanced Micro Devices Inc.'s (AMD ) October, 1995, deal to buy competitor NexGen Inc. for $860 million. AMD's stock lost 37% in the next year, 63 percentage points worse than peers. But had AMD not acquired NexGen's computer-processing chip technology, it would have been unable to compete with Intel Corp. (INTC ) and go on to produce its successful Athlon rival to Intel's Pentium chips. "This was basically a Hail Mary play to stay in the game," says founder W.J. Sanders III, who made the deal. "Without it, we were out of the processing game forever. It was a good deal then, and I still think it is a good deal."

The ultimate could-have-been-worse case is AOL Time Warner. Measured as a media deal it was a bust. AOL shares lost 37% over a year relative to other media companies. But at the time, AOL was an Internet company. So, although its shares plummeted 49% in the year after the announcement, it was still in business when other Net stocks crashed and burned. In effect, AOL boss Stephen M. Case persuaded Time Warner CEO Gerald M. Levin to trade valuable media assets for bloated AOL stock. That may be cold comfort to AOL investors--and infuriating to Time Warner's, who could have sold in the first week and cashed in the 17% premium on their stock. A year later, Time Warner shares were 9% below what they had been a week before the bid. AOL Time Warner declined to comment.

Our findings point to the need for CEOs and directors considering deals to get them right--or let them pass without a second thought. "The best thing companies can do is make sure M&A is a tool used in corporate strategy," says Sirower. "Instead of reacting to deals that come along, companies should only make acquisitions they need for a specific purpose."

With their stocks limping, the market tumbling, and the economy faltering, buyers are less cocky about deals already. "Going forward, there will be heightened concern over what companies pay and whether the synergies are real," says Goldman's Levy. "Everyone is going to be more cautious." After what buyers put their shareholders through in the 1990s, it's about time. 


By David Henry
With Frederick F. Jespersen in New York

A better way to measure bank risk

One capital ratio tops others in foreshadowing distress—and it’s not the one that’s traditionally been regulated.

In response to the global banking crisis, regulators and policy makers worldwide have united behind efforts to increase financial institutions’ minimum capital requirements and to limit leverage, hoping to reduce the likelihood of future bank distress. As of this writing, the debate over proper capital requirements continues, with major implications for the industry and the economy—yet there have been few specifics on which ratios should be targeted or at what levels.
To shed some light on the discussions, we analyzed the global banking crisis of 2007 through 2009 to identify relationships that different types of capital and capital ratios have to bank distress. Our analysis is observational, based on historical data, and not a real-world experiment, which would have required randomly selected financial institutions to hold different capital levels to gauge their effects. As a result, the findings do not definitively establish how institutions might perform in the future if minimum capital ratios were changed, but we believe that the evidence we provide is a valuable input for current policy discussions.
We found that one capital ratio—the ratio of tangible common equity (TCE) to risk-weighted assets—outperforms all others as a predictor of future bank distress. We also found that requiring a minimum leverage ratio would not have offered any insights that couldn’t have been found by studying the right capital ratio. And, not surprising, we found that a higher bar on capital requirements, while reducing the likelihood of bank distress, comes at an increasing cost.

One capital ratio outperforms the rest

Among the various ratios, the one that offers the greatest clarity into the likelihood of bank distress actually measures TCE (the portion of equity that is neither preferred equity nor intangible assets) against risk-weighted assets, or RWA (Exhibit 1). TCE, like Tier 1 capital, can absorb losses because it offers banks the contractual flexibility either to eliminate repayments entirely or to defer them for extended periods of time. It can also absorb losses whether or not a bank remains a going concern. Moreover, our analysis found that the measures most commonly regulated currently—those based on the combined Tier 1 plus Tier 2 capital levels—are the least useful, in part because banks can seldom use Tier 2 capital to absorb a loss if they are to continue operating. For example, unrealized gains on securities may be unavailable in times of severe economic stress, and subordinated debt may trigger default if payments are deferred.

In addition, banks have successfully arbitraged capital ratios traditionally watched by regulators through the banks’ increasing use of non-common-equity instruments, such as cumulative preferred stock and trust-preferred securities, that qualify for treatment as Tier 1 capital but could be issued at lower cost than common equity. This practice weakens the ability of an institution to absorb losses and the ability of regulations to limit its riskiness.

Leverage ratios add little benefit

Our analysis also found that an additional leverage ratio would not have offered any insight into the likelihood of bank distress beyond that provided by the TCE/RWA ratio. The same number of banks are affected (and the same amount of distress avoided) whether or not limits are placed on leverage.
This finding does not prove that regulating leverage ratios is a bad idea. It does suggest, however, that the rationale must be based on other considerations. For example, leverage ratios might protect the liability side of the balance sheet against greater-than-expected haircuts on repurchase (or repo) financing, which could precipitate a systemic crisis. They also might help prevent future errors in risk weighting and regulatory arbitrage of risk weightings. But the use of leverage ratios has also arguably created an incentive for the growth of off-balance-sheet activities, which remove certain assets from the leverage ratio calculation and increase risk while circumventing additional capital requirements.

Lowering risk has a cost

While it is possible to lower a bank’s level of risk by increasing its TCE/RWA ratio, the trade-off is higher costs. Reducing the number of banks at risk through a higher capital base decreases the returns on equity (ROE) for the industry (Exhibit 2). For instance, a TCE/RWA ratio of 10 percent would have affected all of the banks that became distressed during the recent crisis but would have required an incremental $1.45 trillion in capital⁷ and reduced industry-wide average ROEs by an extraordinarily high 560 basis points. In addition to the impact on ROEs, increasing the required capital levels would likely have macroeconomic costs, including the effects of a short-term contraction in the availability of credit and the potential long-term effects of reduced lending levels, which result in lower GDP growth
One test for regulators is wisely balancing the incremental benefits of higher capital requirements against the costs that they impose on financial institutions, borrowers, and society more broadly. For example, our analysis indicates that requiring banks to hold a TCE/RWA ratio in the range of 6.5 to 7.5 percent would have affected 83 percent of banks that became distressed while requiring $540 billion in incremental capital and a decrease in ROE of 260 basis points.
In the effort to prevent future banking crises, regulators would do well to set minimum capital requirements by balancing the benefits of reduced distress with the costs that come from higher capital requirements.

 

Biggest bubble in history is growing every day

Real estate, stocks, credit. China sure has its share of bubbles. Oddly, little attention is paid to the biggest one of all. China’s currency 
reserves grew by more than the gross domestic product of Norway in 2009. Its $2.4 trillion of reserves is a bubble all its own, one growing before our eyes with nary a peep out of those searching for the next big one. The reserve bubble is actually an Asia-wide phenomenon. And we should stop viewing this monetary arms race as a source of strength. Here are three reasons why it’s fast becoming a bigger liability than policy makers say publicly.

One, it’s a massive and growing pyramid scheme. The issue has reached new levels of absurdity with traders buzzing about crisis-plagued Greece seeking a Chinese bailout. After all, if economies were for sale, China could use the $453 billion of reserves it amassed last year to buy Greece and Vietnam and have enough left over for Mongolia. Countries such as the US used to woo the Bill Gross’s of the world to buy their debt. Now, they are wooing governments. Gross, who runs the world’s biggest mutual fund at Pacific Investment Management, is still plenty important to officials in Washington. He’s just not as vital as the continued patronage of state asset managers in places like Beijing.

You have to wonder what folks at the International Monetary Fund are thinking these days. Their aid packages tend to come with messy requirements, such as ‘get your economy in order’. China’s are merely about scoring resources or geopolitical points. We have already seen China throw lifelines to Wall Street giants, including Morgan Stanley. Entire countries seem like the natural next step.

China’s huge arsenal of reserves is increasing its global influence. The trouble is, China is trapped in an arrangement of its own making. As China and other Asian nations buy more and more US treasuries, it becomes harder to unload them without causing huge capital losses. And so they keep adding to them. “This is a titanically large foreign-exchange trade,” says David Simmonds, London-based analyst at Royal Bank of Scotland Group. “It’s the biggest one history has ever seen and there’s nowhere for these reserves to go.”


China aims to diversify out of US treasuries into other assets and commodities. The question that governments are grappling with is which markets are deep enough to absorb China’s riches? Gold? Oil? Euro-area debt? The Madoff family’s next Ponzi scheme?

The challenge for China alone is like trying to park an Airbus A-380 super-jumbo in a Volkswagen. Like all pyramid schemes, there’s no easy end in sight and things could end badly. If the dollar collapses, panicked selling by central banks looking to limit losses would shake global markets more than the US credit crisis has.

Two, reserves are dead money. The wisdom of currency stockpiling came from the chaos of 1997. Speculators sensed authorities in Thailand were sitting on few reserves, and they were right. Their attack on the Thai baht set the stage for an Asian meltdown. Governments spent the 2000s determined not to repeat the mistake. 


Three, reserves add to overheating risks. When policy makers buy dollars, they need to sell local currency, increasing its availability and 
boosting the money supply. Next they sell bonds to mop up excess money in economies. It’s an imprecise science that often leads to accelerating inflation. The strategy works out to be an expensive one.

Asian economies have too much of a good thing on their hands. In July 2007, on the 10th anniversary of Thailand’s devaluation, Asian Development Bank president Haruhiko Kuroda said the accelerating accumulation of reserves was a major concern for the region. Too bad nobody listened to him.

These huge sums of money could be used to improve infrastructure, education, health care and reducing carbon emissions. Never before have we seen such a misallocation of such vast resources. Asia can do better with its money.

The stakes are rising fast. The risks in Asia are skewed firmly in the direction of inflation. The focus is now on central banks to see if they will pull liquidity out of economies with higher interest rates. More attention should be on how reserve management is working at odds with that goal.

Central banks face a difficult task. They must withdraw excess liquidity without devastating their economies and running afoul of politicians. Only now is Asia finding out how some of its economic-protection tactics are amplifying the challenge.

Asia has been holding down currencies to support exports for more than a decade. It’s silly to ignore the side effects of that strategy for the region’s economies.

Think about how Dubai shook the global economy, or how the mere hint that Chinese growth may dip below 8% inspires panic. These disappointments pale in comparison with the turbulence that may come from Asia’s biggest bubble popping.

How the poor spend wisely

How the poor spend wisely | Smooth operators | The Economist
Page 82, May 16, 2009 ... Even those with very little money have a sophisticated approach to finance. [...] Smooth operators
May 16th 2009
From The Economist print edition, page 82 Even those with very little money have a sophisticated approach to finance
PAYING interest on your savings will strike most people as odd. Yet some poor people in the developing world do just that. In West Africa, for example, some people pay roving susu collectors a fee amounting to a -40% annual interest rate for looking after their deposits. And the authors of a new book, Portfolios of the Poor, about the financial lives of people who earn less than $2 a day find that this sort of "pay-to-save" model is by no means unique to Africa. They encounter a similar phenomenon in India, where a female deposit collector called Jyothi looks after small savings for people in the slums of Vijayawada, at an effective yearly interest rate of -30%. Some of Jyothi's customers are among the 250 families in South Africa, India and Bangladesh whose financial transactions over a year were recorded to study how very poor people manage their resources. Given that these are so meagre, this might seem to be an unpromising line of inquiry. But as many of the subjects emphasised, controlling the flow of cash becomes all the more critical when income is not just low, but also unpredictable and irregular. These features are what economists like to call "consumption smoothing"--spreading spending out in a way that ensures that what you eat one day is not determined by what you have earned that day or the day before. The subjects used a combination of loans and savings to ensure that their lives were not, literally, hostage to fortune. Hardly anyone lived utterly hand-to-mouth. The research provides evidence of the sophistication with which poor people think about their finances. They are acutely aware, for example, of the importance of some psychological phenomena whose effects behavioural economists have only recently begun to explore. For instance, they purposefully seek out commitments to help ensure that they meet their saving goals. Many of the South African women in the study joined several monthly "savings clubs" in spite of having bank accounts. They found that the extra discipline the clubs provided was valuable in itself, because it compelled them to save no matter what. Some went further. The mother of a Bangladeshi man who found himself unable to stick to his monthly saving goal found she could make him save more by taking out a loan from a microfinance company. The shared obligation of having to pay the regular loan instalments meant he abandoned his spendthrift ways. The unbanked do not have access to such luxuries as standing orders, which richer people use to overcome the temptation to spend whatever they earn. And they are forced to pay for things that are free for most--which enables women like Jyothi to earn a crust by offering a safe store for small savings. But with some ingenuity, they use unorthodox financial instruments to create a more stable life than their erratic incomes would otherwise allow. 

Telecom sector : Free market or free fall?

Allowing consolidation would solve many problems facing the industry and ensure telecom companies develop a sustainable business model, says Rajiv K Luthra

AT MOST discussions on the growth story of India, it is the telecom industry that is cited often as an example. India is said to be the fastest-growing mobile market with close to 500 million subscribers, which is set to rise to 1 billion by 2014. Although addition of new subscribers is driving growth, India has the lowest average revenue per user (Arpu) in any major telecom market in the world. This, along with other factors, is leading to a financial crisis in the industry. While the country’s cellular base expanded by 50% to over 450 million users from 2008 to 2009, operators’ revenues rose a mere 10.7%.
The primary reason for this is apparent: there is a race to the bottom, caused by the presence of far too many operators. Telecom is staring down the abyss, and faces the prospect of rapidly turning from a sunrise sector to an unviable business proposition. In fact, operators — in response to a recent consultation paper floated by Trai on spectrum and mergers and acquisitions (M&A) policy — have stated that the current crowd of 12-13 players jostling for space is not sustainable. It is also true that the global experience in the telecom sector has shown that no more than five operators are sustainable in any major market.
Regulatory framework: In such a market scenario, the telecom industry faces a prospect of a wave of consolidation. However, the shackles placed on market forces by government regulations are preventing this from happening.
There are a number of restrictions on M&As in the telecom sector. Consolidation is not allowed for three years after the grant of a licence, and there is a lock-in period of three years for the promoters’ stake. The combined marketshare of a merged entity cannot exceed 40% in terms of both subscribers and revenues in any circle, and no consolidation will be allowed if it leaves less than four operators in a circle. Growth is further cramped as no operator can have more than one licence in a single circle, therefore, in practice, there can be no buyout within the same circle. Finally, there is a 10% crossholding limit for telecom operators within the same circle.
Earlier, the regulatory emphasis was on having a large number of players in the sector to foster growth and competition. This objective has been fulfilled, and given the present state of evolution of the industry, its continued growth requires modifications to the regulatory structure.
The case for consolidation: There is excessive fragmentation of spectrum in the country, with the average spectrum possessed by a GSM operator being just 5.7 Mhz, about a third of global average. This leads to wasteful capital expenditure by operators, and the only people benefiting from this situation are the equipment providers.
Most large markets, such as the US, Japan and Brazil, have a maximum of 4-5 operators. India, in contrast, currently has 14 mobile operators, resulting in duplication of infrastructure and waste of resources when about six operators per circle would be sufficient. The current telecom policy has lowered the entry barrier, while making it difficult to exit due to the three-year lock-in. Inefficient operators are forced to continue operations instead of merging to reach a size that makes commercial sense.
THE three-year lock-in for promoter stake was introduced as a knee-jerk reaction, to prevent windfall gains made possible by what some people consider faulty government policy. Former technocrats have openly admitted that the restrictive M&A policy is more a cover up of inefficient handling of the first wave of distribution of spectrum — by adopting a first-come-first-served policy and a narrow subscriber-based criteria. This is far too drastic a measure, and even a tax on windfall gains would be preferable to a clampdown on M&A activity.
The FDI policy also needs a relook, as an Indian partner at present needs to have a minimum stake of 26%, which would amount to about $5 billion. A fewIndian companies that are not already in telecom have that kind of resources, and the few who do, would be unwilling to commit such large sums without getting control of the business in exchange.
The restrictions on M&A pose other challenges as well. Foreign players bidding for 3G licences would have to separately acquire a telecom licence, that would not come bundled with 2G start-up spectrum. Currently, it is close to impossible to acquire fresh 2G spectrum given the large number of pending applications. Also, due to the M&A restrictions, successful 3G spectrum bidders cannot merge with an operator having 2G spectrum. This makes the entire 3G auction process very unattractive to foreign players, thus discouraging foreign investment.
Fears of consolidation in the sector leading to anti-competitive practices are unfounded. The forming of cartels is highly unlikely in a scenario where there would be at least six major operators. Further, the Trai has sweeping powers to determine tariffs and interconnection charges, allowing it to combat price-fixing. Further, a government operator in the sector can break a cartel. Finally, the Competition Commission of India (CCI) exists to prevent abuse of market dominance.
Outlook: Allowing consolidation would solve many of the problems highlighted here, a fact that has been recognised by the Trai in its ongoing process of amending the regulatory structure. However, policy makers must not lose sight of the prevailing environment that is abound with nervousness about the prospects for the telecom sector, amid increasingly-fierce price wars and sustainability concerns. Consolidation will result in synergies in the areas of infrastructure, human resources, spectrum and other areas. This can bring down costs, improve quality of services due to the availability of sufficient spectrum and increase investment. This would lead to a win-win situation for everyone involved, and ensure that the amazing growth story of Indian telecom remains on track.
(The author is founder and managing
partner of Luthra & Luthra Law Offices)

What went wrong in Dubai?

The boom years of the early 21st century were good for many people, but perhaps no one enjoyed them more than Sheikh Mohammed bin Rashid al Maktoum, the ruler of Dubai. Stripped to its essentials, Dubai is a sweltering strip of sand blessed with a natural harbour known as the creek, which has been an entrepot for merchants and smugglers for centuries. Building on his father's vision, Sheikh Mohammed turned Dubai into a 21st Century boomtown, luring western financiers and tourists with gleaming steel and glass towers, vast beaches, and green golf resorts.

Now Sheikh Mohammed is calling for a standstill on debt repayments at one of his most important companies, Dubai World, least temporarily rocking world markets and raising huge questions about the future of Dubai.

Dubai was always a momentum play. Unlike Saudi Arabia or Abu Dhabi, the hugely wealthy emirate to the West, Sheikh Mohammed had scant oil production to fuel his grandiose ideas. Instead he sold the world on his vision of Dubai as a hub for the Middle East, western Asia, and Africa, attracting investment from his wealthier neighbors—both Arabs and Iranians—and increasingly, from the West and Russia.

For a while, it worked. Western bankers fell over each other to book space in his Dubai International Financial Center, a handsome if somewhat over-the-top real estate project aimed at being the Wall Street of the Gulf. The cream of technology companies and media companies, from Cisco Systems (CSCO) to Microsoft (MSFT), set up shop in Dubai's Internet City. CEOs and politicians came to Dubai to pay court to the ruler, whom they treated like a sage.

Sheikh's subordinates competed rashly

Sheikh Mohammed patronized a corps of young technocrats, who worshiped "The Boss" and raced to enact his visions. He told them there was nothing they couldn't do if they put enough imagination and energy into it. When Mohammed Alabbar, the chairman of developer Emaar Properties, came to the Sheikh with a plan to build a skyscraper in what was becoming the new downtown of Dubai, the ruler urged him to build the tallest building in the world. That's exactly what Alabbar did; today the Bourj Dubai is nearly completed, soaring above an artificial lake that boasts an elaborate set of fountains that cost $250 million. For a relatively small place, Dubai has acquired an extraordinary collection of futuristic towers—some of them unfinished or empty. The cityscape looks like something out of Buck Rogers.

A man in a hurry, Sheikh Mohammed created rival building arms and investment managers and spurred them to compete with each other for land and capital. At one point he had at least three private-equity operations going at once under his aegis. These units invested heavily outside of Dubai at the top of the market, using borrowed money. Banks, too, bought into the Sheikh's vision, or at least wanted to be included in the charmed circle.

When the credit crunch came, Dubai was badly exposed to known debt of $80 billion to $90 billion, and possibly even more. The Sheikh and his lieutenants, who had seemed masters at selling Dubai to the world, suddenly seemed inept. That Dubai has a serious problem has been well known for more than a year. Little progress has been made to resolve it.

It almost seems as if the ruler and those around him are in denial, not wanting to acknowledge the extent of their troubles—even to themselves. Earlier this year the ruler appointed a frank-speaking young finance minister, Nasser al Shaikh, who tried to force some of Dubai's big companies to sort out their problems. He was promptly fired.

A mystery: Abu Dhabi's $10 billion

In another sign of stress earlier this month, Omar bin Sulaiman, the well-regarded governor of the financial center, was also ousted. Three of the Sheikh's closest advisors were removed from the board of the Investment Corp. of Dubai, which manages the government's stakes in some of the big companies such as Emirates Airline. These moves may have been designed to appease critics in Abu Dhabi and Dubai's own worried merchant community.

Worried backers of Dubai always assumed that Abu Dhabi would come to Sheikh Mohammed's rescue if he got into real trouble. That has been true to an extent. Earlier this year the central bank of the United Arab Emirates, which is mostly funded by Abu Dhabi, the wealthiest of the emirates, loaned Dubai $10 billion. What has happened to the money is something of a mystery.

This all came to a head on Nov. 25, when Dubai rocked world markets by announcing that it would seek a standstill on debt repayments of ports operator and real estate developer Dubai World, the most troubled of state-controlled Dubai Inc. companies. The timing was horrendous, coming on the eve of an Islamic holiday, as well as the U.S. Thanksgiving. Worried investors—who only recently had begun putting new money into Dubai on the presumption that the worst was over—scrambled for information. Little was forthcoming. Reporters raced around the city, chasing press conferences that were never held. In a bizarre statement on Nov. 26, Sheikh Ahmed bin Saeed Al Maktoum, a Dubai official, said: "The government is spearheading the restructuring of this commercial operation in the full knowledge of how the markets would react."

What prompted the Dubai leadership to behave this way? There has been much speculation that an increasingly sceptical Abu Dhabi had refused to come to Dubai's rescue. But Abu Dhabi appears to have been blindsided by the debt gambit. Only hours before, two Abu Dhabi banks agreed to subscribe to $5 billion in Dubai bonds. Dubai's conduct looks more likely to stem from a combination of lack of awareness and denial, which may well be making things worse than they need to be for Dubai and its ruler.

What happens now? Abu Dhabi will come under pressure to provide more help to avoid being tarnished by a meltdown next door. Sales of Dubai's overseas assets, such as New York clothier Barneys, may be accelerated to raise funds. Sheikh Mohammed will try to preserve his independence and dignity. But already—in what some interpret as a sign of Abu Dhabi's growing influence—Sheikh Khalifa, that nation's ruler, is now pictured with Sheikh Mohammed on a huge poster at a traffic circle in Dubai.

Source: economictimes.com

Bank of England Poised to Sustain Crisis Aid

Chief Mervyn King Seen Keeping Measures to Nudge Economy Into Growth, While Other Central Banks Weigh Paring Programs

The U.K.'s top central banker, Mervyn King, faces a tough call at a pivotal meeting this week: Whether to continue showering money on Britain's troubled economy while other countries consider dialing back emergency relief measures.

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Many signs suggest Mr. King and officials on the Bank of England's interest-rate policy committee will expand their sweeping bailout of the economy. Growth prospects are dimmer for Britain than nations such as France, Germany and the U.S. The British economy, heavily dependent on the financial-services industry and fueled by high levels of consumer debt, is seen by some as acutely vulnerable to the aftershocks of the global crisis.

A manufacturing survey out Monday raised hopes that Britain might finally see economic growth in the fourth quarter. But investors have been spooked recently by a third-quarter gross domestic product report that showed Britain still in a recession that dates back to early 2008.

To rescue the economy, the Bank of England has slashed interest rates to record lows and launched a program of buying government securities with freshly printed money. Critics say while these policies may have averted economic Armageddon, they come with huge costs; some worry that such money-pumping exercises, known by some as "quantitative easing," could spark an outbreak of inflation.

As the Bank of England weighs continuing extraordinary measures, other central banks are acting differently. The U.S. Federal Reserve, which also meets this week, recently completed a program of buying $300 billion of government bonds, though it is still buying mortgage-related debt. The European Central Bank is expected to keep interest rates on hold without introducing new measures.

"This is not an easy decision for the Bank of England," says Malcolm Barr, an economist at J.P. Morgan Chase in London. "Bank officials realize the global outlook is improving."

Mr. King's decision -- and its effects -- could determine how easily Britain emerges from its worst economic downturn since World War II, and provide a first crucial test of the U.K. central bank since it became independent from the government 12 years ago.

The Bank of England's Monetary Policy Committee will vote Thursday on whether to expand, halt, or pause its bond-buying program. So far, the bank, through quantitative easing, has bought £175 billion ($287.85 billion) of mostly government securities, or roughly 30% of the entire conventional government bond market.

Many economists expect the nine-member Monetary Policy Committee to keep interest rates at 0.5% and expand the eight-month-old program by £25 billion or £50 billion. The reason: The U.K. economy is still contracting. By contrast, France, Germany and Japan returned to growth in the second quarter. Early readings show the U.S. economy grew at an annualized pace of 3.5% last quarter.

"The GDP figure was a game-changer," says Simon Hayes, chief U.K. economist at Barclays Capital in London.

The BOE programs have had an effect and some data have shown signs of economic pickup. The benchmark 10-year U.K. government bond yield is 3.66%, down from 3.85% on Feb. 10, the day before Mr. King first suggested the bank would start buying government bonds. Quantitative easing also may be helping to stir U.K. stock and bond markets.

Many economists don't see Mr. King's efforts, including low short-term interest rates, having a significant effect on the economy yet, which is why the bank may do more.

The bank hoped that its efforts would boost the supply of credit to companies and households and increase spending. But data out last week show that a key measure of the money supply actually fell £14.6 billion in September from August.

Further extensions of quantitative easing run the risk of shaking investor confidence by underscoring the severity of Britain's economic challenges.

Many economists also note that the BOE efforts come against a deteriorating fiscal backdrop. The International Monetary Fund predicts the U.K. government's budget deficit could hit 13% of GDP in 2010. Such deficits are likely to lead to reduced public spending and higher taxes, which could crimp growth.