“World on the Edge”

This is the cover page headline of the October 4th, 2008 issue of The Economist, showing a man looking down from the breaking edge of a cliff.

A few days ago, with some friends the conversation drifted from the state of politics to the state of markets and I commented that the Real Estate market is yet to see significant correction and painful times. The reaction from others was “that’s not possible; at best it would stay at the current levels”.

We moved to why we are where we are. My simple(istic?) answer – that excesses get countered with excesses – was met with more questions about: is India’s state because of the depreciating Rupee, where has the money gone really, etc. I confessed that am not equipped to answer on M1/M3/Money supplies anymore (and I wonder who is), but thought there are so many of us wondering why are we where we are?

Let us attempt some simple answers.

The Economist puts it well:

“….For almost a year the markets had worried about banks’ liquidity and solvency. After the bankruptcy of Lehman Brothers last month, amid confusion about whom the state would save and on what terms, they panicked. The markets for three-, six- and 12-month paper are shut, so banks must borrow even more oney overnight than usual.

“Banks used to borrow from each other at about 0.08 percentage points above official rates; on September 30th they paid more than four percentage points more. In one auction to get dollar funds overnight from the European Central Bank, banks were prepared to pay interest of 11%, five times the pre-crisis rate. Astonishingly, rates scaled these extremes even as the Federal Reserve promised $620 billion of extra funding.

“Bankers have always earned their crust by committing money for long periods and financing that with short-term deposits and borrowing. Today, that model has warped into self-parody: many of the banks’ assets are unsellable even as they have to return to the market each day to ask for lenders to vote on their survival. No wonder they are hoarding cash.

“This is why those politicians who set the interests of Main Street against those of Wall Street are so wrong. Sooner or later the money markets affect every business. Companies face higher interest charges and the fear that they may one day lose access to bank loans altogether. So they, too, hoard cash, cancelling acquisitions and investments, in order to pay down debt. Managers delay new products, leave factories unbuilt, pull the plug on loss-making divisions, and cut costs and jobs. Carmakers and other manufacturers will no longer extend credit and loans will become elusive and expensive. Consumers will suffer. Unemployment will rise. Even if the credit markets work well, the rich economies will slow as the asset-price bubble pops. If credit is choked off, that slowdown could turn into a deep recession…….”  (complete article here).

PVC’s view since July 2007 – yes no typo there, 2007 not 2008 – has been not very optimistic.

Key Issues (2006-2008):

• Stretched Valuations since early 2006 – New listings at 3 digit/high 2 digit multiples of 2/3 years future Earnings or Mega IPOs with Zero Revenues for the next 3-5 years!!
• Easy PIPE deals for PEs, very little money for Seed/Early Stage companies.
• Easy Deals kill “real innovation” and foster “financial innovations” (aka excesses).
• Unrealistic Real Estate pricing – creates and encourages overleveraging
• Spiraling Commodity Prices- from Oil to Ore, Coffee to Copper. Trading in Commodities Futures being more profitable than existing businesses for many. The same being true for Stock Market and Real Estate as well. New Markets for diversion (not diversification) from existing business focus.

Some Recommendations (2008-2009-?):

• Cash is King – Preserve/Get Cash, kill your burn rate.
• If you have lots of cash, go out and start looking for companies to acquire. Consolidation’s best times are actually when the markets take a major beating.
• Drop your IPO plans, there is no market.
• If you are selling your company, remember Recommendation No. 1 – Cash is King.
• Series B/C would be big challenge, prepare your company for a freeze on additional capital inflows.
• If you do not have a (profitable) business model yet, figure it out very soon or quit.

It is difficult to predict, but we believe its going to be a long winter, and we do sincerely hope that we are wrong…..