During 2004, economic recovery picked up some steam and lead to an unexpectedly large increase in federal government receipts. A federal government budget deficit expected to approach $500 billion in 2004 has been revised downward to $375 billion. At same time goods continue to pour in from Asian nations, especially China. The U.S. current account deficit set a record at $166 billion during second quarter. Should current account numbers seen during second quarter be projected out for a full fiscal year, there is a $225 billion surplus of demand going into purchases of U.S. government securities. This demand is creating downward pressure on long term interest rates.

The last time a significant gap emerged between U.S. federal funding needs and international trade deficits was in 2000 at height of dot com boom. The circumstances are slightly different this time around, but some similarities certainly should emerge over coming months. In 2000 economic growth was peaking as Federal Reserve aggressively increased short term rates to rein in economy. Interest rate spreads at time were very narrow as a result of investors recognizing inflation was not an ongoing concern despite a robust economy. It would not be unsurprising to see interest rate spreads further narrow as Federal Reserve continues to push short term rates up. Higher short term rates should continue to be offset with a continuing demand for U.S. securities from foreign banks to keep long term lending rates near levels they currently are. Though, investors should be complacent about holding U.S. treasury securities should persistently high oil prices push inflation levels beyond comfortable levels.

Forecasting future interest rate moves can always be a tricky guess and long term implications are much tougher to predict. It is expected that U.S. government’s finances will improve over coming decade as economic expansion gains further strength. The Federal Reserve will undoubtedly continue to gradually push short term rates upward over course of next year baring a prolonged weak spot or an unwelcome bout of inflation. The foreign appetite for U.S. dollars to fill international trade gaps should continue to provide stimulus to bond prices.

With foreigners currently holding about 75% of U.S. government debt, over long term foreign banks will be forced to take more aggressive risks in order to hold down their monetary units or allow their currencies to gain in value against dollar. There are growing signs of concern for U.S. large economic unbalances by some Asian governments. U.S. treasury officials, who have been pushing China to revalue yuan higher, may be pleased if China increases yuan’s peg against dollar by 5-10% prior to end of this year as is being speculated by some. Should Chinese revaluate their currency, it would not be surprising if other Asian nations follow a similar path.

There are two basic types of PIPEs. A Traditional Pipe is sale of unregistered shares, usually common stock, preferred shares or convertible securities at a discount to prevailing market price of stock. A Structured PIPE is sale of unregistered stock at an adjustable share price; primary risk in doing a Structured PIPE is that it can create a toxic convertible. The PIPE investor can use his PIPE shares to sell short company’s stock. As Company’s share price falls, investor has right to more company shares. These shares are used to sell short more shares of company’s stock. As short selling process continues, company’s stock goes into a death spiral.

Startup companies, R&D projects and debt consolidation aren’t easily sold to an investor as a PIPE financing. Growth capital that allows company to increase sales and acquisition financing are wisest proposed use of funds when your company wants a PIPE underwriting.

Private Western Investors are unlikely to be active in management buyouts in India because of possible regulatory hitches. India has a huge market for Mergers and Acquisitions. There are numerous assets in many companies that should be accumulated by farsighted Indian companies. In India, there’s massive potential for consolidation and corporate growth. It’s an opportunity that would interest many Western money managers.

American PIPEs are a unique investment vehicle. They provide public companies with a quick channel to capital. The process to complete deal is much faster than a traditional secondary offering. It isn’t that difficult or expensive to become an American public company.

Any public company in India can easily determine Indian Venture Capital and Mutual Fund investment interest in doing PIPE underwriting for their company. If public company wants to access western capital, public company’s shares should trade in United States. There are two cost-effective strategies that that will allow their shares to trade in States. 1. The Indian Company can have their shares trade as ADRs (American Depository Receipts). The primary U.S. Bank creating ADRs is Bank of New York. 2. The Indian Company can list their shares on any U.S. Stock Market.

A private Indian company should determine both costs of going public in India and availability of Indian PIPE underwriting for their company, if they take their company public. The private company’s alternative would be to take their company public in U.S.

In United States, more credible Stock Market, greater costs of listing your shares on it. There are far more PIPE investors for a New York Stock Exchange Company than one that trades on Over-the-Counter Market. PIPE investors funding New York Stock Exchange Companies are willing to risk far more money than those working with Over-the-Counter public companies. So more money your company wants to raise in a PIPE financing, greater costs of listing your shares in United States.

What does it cost to list your company in America? A rough estimate for New York Stock Exchange would be five million U.S. Dollars. For Nasdaq, American Stock Exchange or a Regional Stock Exchange, a rough estimate would be two million U.S. Dollars. For Over-the-Counter Market, costs should be less than one hundred thousand U.S. Dollars.

The listing problem related to costs is time it takes to list your company in United States. A New York Stock Exchange listing can take several years. Listing on Nasdaq, American Stock Exchange, or a Regional Stock Exchange would take about eighteen months. To list your shares on Over-the-Counter Market should take less than six months.

Business relationships are built over time. Unless your company is among economic powerhouses of India, you are better served starting small and building relationships with Western investors. Develop a business plan that will grow your company into a regional powerhouse and use PIPEs to add to your balance sheet assets.

About William Cate: In 1981, he founded and has since been Managing Director of Beowulf Investments: [http://home.earthlink.net/~beowulfinvestments/ ]. He is author of Venture Capital Profits, which proposes use of PIPEs to build companies through a process of Mergers and Acquisitions.

Author’s Note: This article appears in early 2004 in an Indian newspaper.