Last few weeks the markets were rife with rumours that Warren Buffett would be taking a stake in Kotak Mahindra Bank. There is an interesting background to this story. The promoter of Kotak Bank, Mr. Uday Kotak is required to reduce his stake in the bank from 29% to 20% as per the RBI regulations. Recently, Kotak Bank had proposed to issue Participatory non-convertible Preference Shares (PNCPS) so as to dilute the stake of the promoter without really losing control. However, the proposal was struck down by RBI as not being a promoter dilution in spirit, although it may have been dilution in the letter of the law. While the matter has gone to the court, there is a sense of urgency in Uday Kotak finalizing the sale of stake to a non-promoter. But would Buffett be really interested in buying Indian stocks?
Buffett may want to diversify his predominantly US portfolio
If one were to look at the principal portfolio of Warren Buffett held through Berkshire Hathaway, it is predominantly in US stocks only. As per the last annual report of Berkshire Hathaway, are top 5 holdings consisting of Wells Fargo, Apple, Bank of America, Coca Cola and American Express are all American companies. Out of his top 20 holdings, there are just 2 companies from outside of the US and they are also in the developed markets. In fact, unlike John Templeton, Buffett has never been a great believer in the emerging market story. But some key points may have urged Buffett to consider diversifying his portfolio.
- His principal exposure to Apple has seen a price correction of nearly 25% from its peak. Ironically, Buffett has for long been a sceptic on the tech story and had given some of the great performers like Google, Amazon and Facebook a skip. Even his exposure to Apple was quite late in the day. He may want to make up for this portfolio concentration.
- Buffett has been expressing concerns about US market valuations for quite some time and he has been worried that the market has been driven by liquidity for just too long. With the recent inversion of the yield curve in the US, Buffett sees a distinct possibility of an economic slowdown which could impact his US portfolio.
- Buffett is not new to Indian markets and he already has a stake in Paytm, as part of his endeavour to diversify into the fast growing Fintech business in emerging markets. Kotak Bank being one of the most tech savvy banks in India, he may be looking at the bank as a possible acquisition candidate. So the case for Buffett to take a stake in Kotak Bank is definitely as it will be a natural progression to his earlier stake in Paytm.
It could be beneficial both ways
If one were to look at the investment strategy of Warren Buffett, it has been either predicated on deep value or on asset quality. For example, Buffett did pick up a stake in Goldman Sachs at very low valuations and make a killing on the stock. Similarly, during the peak of the sub-prime crisis, Buffett held his belief only on one bank which had the most indisputable asset quality. Wells Fargo was one of the few banks to escape the sub-prime crisis even as the likes of Citi, Goldman, Morgan Stanley and Bank of America faced the heat. From that perspective, Kotak Bank has been the one bank that has focused on being conservative, strong compliance and lending discipline. This is visible in its NPA levels. For Buffet, Kotak Bank not only offers a logical progression after his Paytm purchase but also gives him a foothold in a quality banking franchise. It is already the second most valued private bank in India.
The benefits to Kotak Bank too are manifold. Firstly, the entry of a marquee name like Buffett gives a stamp of quality and rigor to the bank. Secondly, it also addresses the big concern of the promoters over equity dilution. The worry was that a market dilution would lead to excess float in the market and depress the prices. With a name like Buffett coming in, not only would the sellers think twice but the liquidity will also remain locked considering Buffett’s very long term investment style. It also gives the Kotak group the requisite SOTP valuations to better monetize its group companies at a future date.
A word of caution, neither side has confirmed the deal; not even the discussions. But, as we have seen in similar cases in the past, there is always some fire behind smoke.