Bulls, Bears and Other Beasts

by Santosh Nair

On paper, a sub-account was meant to be a scheme managed by the FII for foreign individuals or foreign corporations wanting to invest in India. Sub-accounts could not invest directly in India; they had to do so through an FII registered with SEBI. There were also entities called overseas corporate bodies (OCBs), which were overseas corporations, partnership firms or trusts with non-resident Indian ownership of at least 60 per cent.

  At that time, disclosure requirements for sub-accounts and OCBs were pretty lax. As a result the identity of their actual owners was a mystery. In most cases, the owners were the promoters and operators controlling these vehicles, directing the FII on what to buy and sell. But the market had no idea about this. Routing purchases through sub-accounts and OCBs had an added advantage; it would improve sentiment for the stock because of the illusion that an FII was buying the stock.

  Quite a few companies indulged in what was known as ‘round-tripping’. This effectively consisted of promoters stealing money from their companies by fudging the account books and transferring the money overseas, either through hawala or through a seemingly legal but shady transaction. At times, money earned through dubious export/import transactions was directly credited in a foreign account. The promoter then gave this money to a friendly FII that usually managed a cluster of funds investing in various markets across the world.

  The FII would use one of the many sub-accounts managed by it to route the promoter’s money back into India. On paper, it would be the FII investing in particular stocks, but behind the scenes stood the promoter deciding which stocks the FII would invest his money in. News of an FII buying a stock would improve the perception of that stock in the market. But usually, when the FIIs bought shares of a particular company, the sellers were entities controlled by the promoters. I have mentioned earlier that many promoters held shares in benami accounts, which ordinary investors were ignorant about.

  Another way to bring the promoters’ illegal funds back to India was through a private placement of shares by their companies. This allowed the company to offer shares to investors of its choice. One of the investors ‘buying’ the shares in this private placement would be the FII with whom the promoter had parked his money.

  There were times when the scorching rise in share prices made many of us nervous. We would book profits, only to see share prices climb again. It did not require great intelligence to know that this kind of mad rise in stock prices could not go on indefinitely. But I was reminded of Warren Buffet’s oft-quoted saying: ‘Markets can remain irrational for longer than you can stay solvent.’ The bears were realizing this the costly way.

  October brought cheer to the market as the BJP-led NDA coalition returned to power with an improved tally of seats. The Sensex touched the psychological mark of 5,000 for the first time ever on 8 October, and the BSE governing board and other senior brokers celebrated it by floating balloons printed with the number 5,000 from the terrace of the BSE building. The picture appeared in a couple of financial dailies the following day, and some cynical brokers said this was a sure sign of the market having peaked. But this bull market was not going to end so easily.

  The price appreciation that year alone in many stocks, particularly those in which Ketan had an interest, was simply unbelievable. Pentafour, which was quoting at Rs 700 at the start of 1999, jumped to Rs 3,000 by the end of the year. The stock had risen nearly four-fold the previous year too. Zee shares climbed from around Rs 640 to nearly Rs 11,000, even after a near seven-fold rise the previous year. Somebody who had invested Rs 10,000 in Zee shares at the beginning of 1998 was now sitting on Rs 11 lakh! Global Telesystems shares rallied from Rs 74 to Rs 1,000 in a year, Himachal Futuristic Communications Limited (HFCL) from Rs 37 to Rs 700, Aftek Infosys from Rs 45 to over Rs 2,100, Ranbaxy from Rs 270 to nearly Rs 1,000 and Software Solutions from Rs 600 to Rs 2,200.

  ‘Radhakishan or Rakesh will never be able to take the prices of their favoured stocks to the dizzying levels that a Harshad or Ketan are capable of,’ GB remarked one evening, when we were discussing the trading styles of the top players.

  ‘Unlike Harshad and Ketan, RKD and Rakesh are not reckless. They know when to exit a stock as well as they know when to get into one. Also, Rakesh and RKD believe in the intrinsic worth of a stock and are convinced that no stock can sustain an artificial price beyond a point. That is not the case with Harshad and Ketan, who think that no price is too high for a stock, whatever its fundamentals,’ GB said.

  But the meteoric rise in their share prices was not the only crazy feature of the new-economy companies. Barely a month after its NYSE listing, Satyam Computer’s subsidiary Sify paid an astounding $28 million (Rs 122 crore at that time) for a 24.5 per cent stake in Indiaworld Communications. Promoted by IIT graduate Rajesh Jain, Indiaworld owned thirteen websites, including khel.com, bawarchi.com, khoj. com and samachar.com. The deal included purchase of the remaining 75.5 per cent stake in Indiaworld for $75 million (Rs 325.4 crore), with Sify paying $12 million (Rs 51.3 crore) for the option of buying that stake.

  All this for a company with a turnover of Rs 1.3 crore and a net profit of Rs 25 lakh. The media and the market cheered the deal, but in private many suspected that the deal was just a front for siphoning out money from Sify. It was pointless to voice such doubts publicly. Loss-making Internet companies in the US were quoting at even more outrageous valuations, and there was nothing wrong in a profit-making company being bought for Rs 500 crore, argued many analysts.

  Financially, 1999 was the best year of my career. But on the personal front, I had to endure a huge loss. Bauji’s condition started worsening around September. Finally the end drew near, and the tests showed that now there was no delaying the Grim Reaper who had been repulsed for the last twelve months.

  I asked the doctor if Bauji’s last days would be painful.

  ‘Yes, they will be. The growth has completely taken over his lungs. He will cough his way to death, spitting blood,’ he said.

  When I heard the doctor’s verdict, I cursed myself. It would have been better if I had let Bauji die when he had just two weeks to live. I had spent money on prolonging his life, only to see him die a painful death. I really wished the growth in his brain had continued at its normal pace and granted him a painless exit. As I was lost in my thoughts that evening in office, Bina called, saying Bauji was acting strangely. He was not recognizing people and was indifferent to everybody around. The next day, I took him to the doctor for a check-up. The doctor said the growth in his brain had resumed, and that it was now a matter of days. Two days later, Bauji lapsed into a coma from which he never recovered.

  18

  Rumblings of Another Crash

  Even Ketan’s closest associates found it hard to keep track of his trading calls. He would be bullish on his favourite stocks but frequently book profits when prices rose, only to buy them back when prices fell. Every such profitable trade meant his average cost of acquisition would reduce further.

  ‘Most of his so-called investment bets are downright dubious, but when it comes to trading skills, he does not have an equal,’ GB had once remarked.

  Such was the speed with which he got in and out of positions that it left the market guessing. Also, Ketan traded through a vast network of brokers to confuse anyone trying to piggyback his bets. He could be buying through a group of Mumbai brokers and simultaneously selling an even bigger quantity through Calcutta brokers. Sometimes it was the other way round, his buy orders exceeding his sell orders.

  By itself, there was nothing surprising in this tactic, since operators sometimes had to create a trend contrary to the position they wanted to take. If they wanted to accumulate a big lot, they would first try to depress the price to be able to buy cheap. The trick was to push the price below a key level and panic day traders and retail investors into selling out. If the operators wanted to offload a big position, they would try to boost the price and generate demand by buying a small quantity. This time, the price had to be pushed above a key level to tempt
retail investors and day traders into buying.

  At times, the brokers with whom Ketan placed orders would try to profit from front-running his orders. A few would get away, but Ketan got to know about most of them and punished them severely. He came across as soft-spoken and down-to-earth, but could be pretty ruthless with people who tried to double-cross him.

  Monk told me of an episode when Ketan learnt that one of his brokers was cheating on him. That broker’s rival squealed on him to Ketan, who checked out the information to find, after a couple of deals with the suspect broker, that it was true. Two days later, Ketan gave him an order to buy a stock that had been rising the last few days. The broker bought a good-sized chunk for himself before executing the order. Minutes after he had placed the order, Ketan offloaded a big lot of that stock through his other associates. The broker suffered a huge loss and rushed to Ketan’s office pleading for help. A few other brokers too were chastened in a similar fashion. But despite Ketan’s efforts to keep his brokers under his thumb, there was always somebody or the other who would try to front-run him. There was no way he could control every single one of them.

  Not long ago a recluse who took pains to stay away from the spotlight, Ketan slowly began shedding his reserve. He now seemed to delight in flaunting his success and connections, and could be regularly seen socializing with Bollywood moguls and stars. Great was the surprise when Ketan threw a grand New Year party at a beachside resort in Mandwa, a short boat ride from the Gateway of India, to welcome the new millennium. The guest list included rising IT czars, Bollywood celebrities, senior corporate treasury officials, fund managers and Ketan’s associates in the industry. For an industry that thrived on secrecy and discretion, Ketan’s brazen show of power upset many of the old-timers.

  ‘The guy is drawing the attention of the government and tax department on us; there will be trouble before long,’ one of GB’s friends said.

  ‘Not to mention the underworld,’ remarked another, ‘Saala, khud toh doobegaa hi, saath mein hum sab ko bhi duba dega (he will sink, and drag us down as well).’

  And if you are wondering whether I was invited, all I can say is I was yet to show up on Ketan’s radar. He would have known of me through Monk but did not think me important enough to meet with yet. That hurt my pride not a little, I must say.

  These hiccups apart, it was an exceptionally lucrative year for me. It was the same for most of the others in the market, except for the minority that kept short-selling technology shares to prove a point. The Sensex rose around 40 per cent during the year, even though most of the revered old-economy stocks struggled through the year. Two things worked against these stocks. One, their earnings growth was nowhere as high as that of their ICE counterparts. Two, many investors sold their blue chip holdings to buy more of the new-age stocks, convinced that market leadership had permanently changed.

  Intoxicated by the fantastic run in stocks, most players expected the coming year to be even better. The logic was that FIIs would allocate more money to India since it was among the best-performing markets globally.

  The new millennium dawned without any disaster arising from the Y2K bug in computer systems, as was widely feared. One would have expected the bulls to be a bit cautious after the 40 per cent rise in the Sensex the previous year. If anything, it only emboldened them to the point of recklessness.

  The index rose 375 points (7.5 per cent) in the very first trading session of the year. I was told that operators were buying stocks, confident that they would be able to shortly offload them to FIIs. GB’s friend was not mistaken about Ketan’s actions attracting the attention of the tax department. In the second week of January, income tax officials surveyed Ketan’s offices and found evidence of undisclosed income. Some of Ketan’s favourite stocks weakened briefly, as did the Sensex, but the rebound was quick.

  No adjective can sufficiently describe the bull market that raged from January to the second week of March that year. Even the word ‘madness’ cannot fully describe what we witnessed in those two and a half months. It was as though everybody in the market had taken leave of their senses all at once. I will let the stock prices speak for themselves. Infosys soared from Rs 14,500 to Rs 28,000, Satyam from Rs 2,200 to Rs 7,200, Wipro from Rs 2,600 to Rs 9,800, Global Telesystems from Rs 960 to Rs 3,550, Himachal Futuristics from Rs 677 to Rs 2,550, and DSQ Software from Rs 950 to Rs 2,700 (I am providing rough figures). Compared with these stocks, Zee was a modest performer, rising less than 50 per cent, to Rs 1,600 from Rs 1,100. But it must be remembered that Zee was now a paid-up share of Re 1, which meant it was worth Rs 16,000 for shareholders who had bought the paid-up stock of Rs 10.

  By now, the mania for ICE stocks in India was mirroring that on Nasdaq. The phenomenal rise in share prices made a mockery of the price targets that analysts would assign for these stocks. Twelve-month price targets would be achieved in two months, leaving analysts scratching their heads over how to justify the new prices. And, despite many stocks rising tenfold or even more in less than two years, most stockbroking firms were reluctant to rate them as ‘sells’, even though they were quoting at bizarre PE multiples. Of course, there were the odd ‘sell’ ratings, but minuscule compared with the ‘buy’ reports that broking firms were enthusiastically bandying around. Analysts then started justifying the high valuations on the basis of something called the price earnings growth (PEG) ratio, which is not as commonly used as the PE ratio. All it did was to help the valuations look slightly saner. I remember GB once remarking that when stocks became overvalued and people tried to justify it rather than admit they were expensive, it was time to book profits.

  Broking firms could not afford to antagonize the companies from whom they stood to earn fees for helping raise capital or acquire other companies. And the brokers’ institutional clients too wanted to buy the high-flying stocks so that their fund performance did not lag behind that of their competitors. Few brokers or fund managers had the conviction to stand apart from the crowd for fear of appearing ridiculously contrarian.

  Another danger was building on account of the laxity on the part of brokers in collecting margin money from their retail clients. With prices rising almost by the day, the clients’ outstanding positions would always show a credit. Many investors used this credit to buy more shares, prodded on by their brokers eager for more brokerage. The day of reckoning did not seem too far away now.

  On 11 February, the Sensex topped 6,000 for the first time ever, but closed below that psychological level. That was a Friday, and we celebrated the landmark over drinks at the Harbour Bar in Taj Mahal Palace overlooking the Gateway of India. There were about a dozen of us. After the third or fourth peg, everybody present agreed that the market was absurdly overvalued and that it was time to sell out.

  After we broke up, GB and I had a short stroll by the seaside. There was a slight nip in the air, even as winter was in retreat.

  ‘You know, Lala, every time people attend a funeral, they become philosophical and return home promising to become better human beings the following day onwards. But after a good night’s sleep they are back to being their usual selves,’ GB said. ‘I am sure the same goes for all those who tonight vowed to reduce their positions after a few pegs. If anything, they will buy more as prices rise.’

  The following Monday, the Sensex hit a new peak of 6,150 intra-day, but again closed below 6000. By now the bulls were delirious with excitement and buying stocks at whim, confident that the index would hit 7,000 by the end of the month. I was surprised to see some of the most level-headed fund managers I knew behaving like momentum traders, chasing stocks on their way up.

  One particular fund manager at a domestic fund house who, until a couple of months ago swore by Warren Buffet’s principles of value investing, suddenly turned hyper-bullish on new-economy stocks. At a press conference announcing a new fund, a journalist asked him what value he saw in Zee at around Rs 14,000 (unadjusted for stock split) a share.

  ‘People who go by the a
bsolute price of a stock and say that Zee is expensive do not understand the business of the company,’ the fund manager replied. He was lucky that nobody in the audience asked him to elaborate further.

  A week later, the Sensex topped 6,000 a third time, but again failed to close above that mark. Some technical analysts saw this as a sign that the market was on the verge of peaking out, if it hadn’t already. But nobody took much notice of the slackness in the Sensex. After all, technology stocks were reaching highs by the day. So long as there was money to be made, what difference did it make where the Sensex was?

  The Union Budget further fired up market sentiment. It raised the FII ceiling in listed Indian companies to 40 per cent from the earlier 30. Only a month ago, Indian companies had been allowed to raise funds through issue of American depository receipts (ADRs) and global depository receipts (GDRs) without prior government approval. ADRs and GDRs were the equivalent of shares, except that they were offered to investors in overseas markets. ADRs are listed on a US stock exchange (either Nasdaq or NYSE), and GDRs on the Luxembourg Stock Exchange.

  The government also allowed Indian companies to use up to 50 per cent of their ADR and GDR proceeds to acquire companies in overseas markets. In the coming months, a few companies would raise money through GDRs, and the promoters would siphon off the funds by acquiring dubious companies abroad. The modus operandi consisted of the Indian company buying a foreign firm with whose owner the Indian promoters already had an understanding. The Indian promoter would pay a certain amount for the acquisition, more than half of which would be returned by the foreign owner later.

  I am embarrassed to tell you what my paper wealth had grown to by the last week of February that year. All I will say is that it was substantial enough for me to have lost count of it.

  ‘Lala, has it occurred that you must have made more money than Shah Rukh Khan over the last one year?’ Monk remarked the day after the Budget, when a group of us had gathered at a restaurant. I mentally calculated my net worth, and was flattered to realize that Monk was right after all.