by Santosh Nair
The issue was just about subscribed on the last day at the lower end of the price band. In private, the merchant bankers would say that a powerful rival of the company had prevailed on many of the institutional investors to withdraw their bids.
Cairn Plc may have got the satisfaction of raising Rs 5,788 crore through the issue, but more embarrassment lay ahead. The issue had a floppy debut on the bourses in the second week of January, closing at a 14 per cent discount to the offer price of Rs 160.
The year 2007 would turn out to be the high noon of the IPO boom, as 100 companies together raised close to Rs 34,000 crore. With property prices shooting through the roof across the country, realty stocks were a big draw with investors. Little wonder, then, that nearly 43 per cent of all the money raised through IPOs that year was by realty companies.
The chartbuster public issue of the year was the K. P. Singh-promoted DLFs, which raised around Rs 9,200 crore. The company’s road to stock market listing was a long and bumpy one. Some of the potholes are said to have had been created by Singh’s rivals who did not want him to become too powerful.
Realty stocks were soaring to new highs, and ‘land banks’ was the buzzword as real estate firms touted the value of the land owned by them to pump up their valuations. In many cases, the land parcels they claimed to own did not have clear title deeds. Also, investors paid little attention to the execution capabilities of the company, its profit margins, the regulatory hurdles and other challenges in developing the land. An even bigger problem was the lack of transparency in the financial statements of the property firms, given that a lot of their dealings were in cash.
But how did all that matter as long as land prices and stock prices were rising by the day? When the bubble burst the following year, real estate stocks would bear the brunt of the selling fury. But that was still a few months away.
In March, SEBI issued a directive that real estate companies could get land banks valued only if a clear title deed existed. And while the rule was directed at real estate firms in general, DLF’s valuation did take a bit of a knock as its merchant bankers had been pitching the issue on the strength of the company’s land bank.
When DLF’s plans to go public started doing the rounds in 2006, talk was that the listing would make K. P. Singh the richest person in the country and pitch DLF among the top three companies in terms of market capitalization. When the issue finally got all the required clearances, the number of shares on offer as well as the issue price were less than what had been talked about in merchant banking circles.
The year 2007 was also the high-water mark for the Indian broking industry. In May, the Nirmal Jain-promoted India Infoline poached four senior executives from the French broking firm CLSA. The quartet of Bharat Parajia, H. Nemkumar, Anirudh Dange and Vasudev Jagannath were paid a sign-on bonus of Rs 11 crore each. Parajia and another CLSA colleague Abhijit Raha had become legends in the broking industry by propelling CLSA to the top of the broking league tables. CLSA managed to retain the top slot for a good many years, despite bigger and more established global investment banks snapping at its heels. This was a record sum in the broking industry, where sign-on bonuses had rarely topped Rs 1 crore earlier.
Not just the broking industry, but outsized pay packages appeared to be the flavour of the season across the corporate world, as companies were making massive profits. Just two days before India Infoline had disclosed the details of the compensation package for its new executive hires to the exchanges, Prime Minister Manmohan Singh had corporate India in a tizzy when, at a public function, he urged restraint on ‘excessive remuneration to promoters and senior executives’. India Inc countered Singh’s remarks, saying it was easy to target top corporate executives because their source of income was public knowledge. On the other hand, most politicians who were known to have huge sums of unaccounted money could safely conceal those from the public.
In the last four months of 2007, as the market continued its climb, three well-known brokerages – Motilal Oswal Securities, Religare Enterprises and Edelweiss Capital – issued IPOs. All the issues fetched overwhelming response, and the stocks got off to a flying start on listing. Shares of Motilal Oswal and Religare Enterprises more than doubled in under two months. Shares of Edelweiss Capital surged 83 per cent on listing day itself.
Lucky were the investors who cashed out soon, because after the market crash of January 2008, shares of broking firms would be available for a fraction of their dizzying highs and stay depressed for a long time. And for many years ahead, the main source of income for these firms would be their lending business and not stockbroking.
25
Margin of Error
With the unprecedented bull run, some dubious dealings too gained currency. Thanks to the fantastic run-up in share prices, there were now plenty of mini-operators with a net worth of between Rs 50 crore and Rs 100 crore. These ‘jockeys’, as they were known in market parlance, were in demand among small- and mid-cap company promoters looking to boost the valuations of their shares.
In addition, there were operators who could even double up as investment bankers for small companies wanting to go public. These operators would have shell accounts abroad masquerading as FIIs, which would subscribe to small-sized IPOs. These operators also provided dummy HNIs to subscribe to the non-institutional portion of the book. In the first week of the stock’s listing, volumes and prices would be driven up through circular trading and the shares then dumped on unsuspecting investors.
Many brokerages also allowed their clients to take up excessive leveraged positions through the NBFC margin-financing route. In a margin financed trade, an investor would put up part of the money required to buy a stock, while the lender would put up the rest. SEBI rules permitted brokers to finance clients only up to 50 per cent of the transaction value, and only in stipulated stocks, with the position to be disclosed on the websites of stock exchanges.
At the same time, there were no clear guidelines on margin financing by NBFCs, which would at times lend up to 70 per cent of the transaction value. There were also no restrictions on the stocks that could be funded in this way, and the positions did not have to be disclosed on the stock exchange websites, since NBFCs were regulated by RBI and not SEBI. Ingenious brokers who figured this out provided margin funding to their clients through their NBFC arms.
The regulators finally woke up to the havoc this practice caused, but years later. In August 2014, the RBI would bar NBFCs from lending more than 50 per cent of the value of shares pledged to them, and restrict such lending to shares that fulfilled certain liquidity criteria.
26
An Assured-Return IPO?
Even as the bull market was gaining in strength with each passing day, it was hard to ignore the signs of trouble surfacing in the global markets intermittently. But the tide of liquidity washing up the shores of the Indian market was so strong that it had managed to temporarily suspend the law of gravity in share prices. Analysts were devising newer ways to justify the bizarre share valuations, which were now factoring earnings three to four years ahead. The engines of the economy were running at full power; tax collections were at a record high; and the profit and loss statements of companies were not in good health.
Going short turned out to be suicidal for the handful of traders who were convinced that fundamentals did not justify the high valuations and that stock prices had to correct. They were right in their assessment of valuations, but lost money trying to stand up to a crowd that was willing to pump in funds without any thought to fundamentals. Also, promoters of most of the mid-cap companies were dabbling in their own stocks, using money borrowed by pledging their own shares.
Over the years, I had developed my own set of indicators to warn me of impending danger in the market. One such indicator was the ease of making money. The easier it becomes to make money off shares, the closer you are to the day of reckoning. By now the point had come when all you had to do to make money was to show up in front of a t
rading terminal. Pick any stock at random and you would still be able to sell it 10 per cent higher the following day. To me, this was a sure sign that the bubble could burst any time.
But getting the timing right is the most difficult feat for any trader, no matter how experienced he is. Traders who tried to call the top in realty and infrastructure firms in recent months had taken a nasty licking. Many of them had even become converts, turning buyers in those very stocks they had shorted, in the hope of recouping their losses. This was similar to the trend seen in technology stocks during the dotcom boom of 2000.
I was reminded of a stock market adage: a bull market does not start till the last bull has given up hope and a bear market does not start till the last bear has given up hope. One could already see many bears throwing in the towel after repeated failures in their attempts to profit through short sales. In fact, bears never stood a chance in the face of the tidal wave of FII money. By mid-October, FIIs had ploughed in a record $18 billion into Indian equities for the year so far, lifting the Sensex above 20,000. The Fed’s decision to cut benchmark rates in the US by 100 basis points in two tranches from mid-August was one of the key factors fuelling money flows into emerging markets, including India.
In two months, the Sensex had risen 5,000 points, setting off alarm bells in the government and the regulatory bodies. Strong capital flows was a good thing, but excess of it spelt trouble as it would make the rupee too strong, and by extension, Indian exports uncompetitive. The torrent of dollars had already lifted the rupee to a record high of 39 to the greenback. This apart, the dollar deluge made the Indian market vulnerable to a sudden withdrawal of ‘hot money’, if FII outlook on the country changed for some reason.
Hedge funds had become hyperactive, and a big chunk of their money was coming through the participatory notes route. It worried the government and regulators that there was no saying who the actual investors behind the P-notes were. They could be politicians, Indian promoters, the underworld or even terrorists! The fact of the matter was that a good chunk of the P-notes were just a sophisticated form of benami investment.
To rein in the marauding FIIs, SEBI signalled its intent to clamp down on P-notes. In a discussion paper released on the evening of 16 October, the regulator proposed an immediate ban on fresh issue of P-notes that had derivatives as underlying assets. It also proposed that renewal of outstanding P-notes be disallowed, and the positions be unwound over the next eighteen months.
The proposals rattled foreign investors, mostly the variety that wanted to play the Indian market by remaining anonymous. And the market had, by now, become addicted to hot money. Even though the P-note restrictions had been aimed at moderating capital flows into the country, a short-term collapse in stock prices looked imminent as P-note holders went about liquidating their positions. This would undoubtedly have had a domino effect as players tried to offset losses in one set of stocks by selling others in which they were still sitting on paper profits.
Traders who were heavily long on the market got behind their desks the following morning expecting the worst. And their fears were proved right. Frontline indices crashed 10 per cent – the Sensex tanking 1,745 points – within minutes of the market opening, triggering a one-hour shutdown.
SEBI and the finance ministry immediately swung into damage control mode, trying to pacify jittery foreign investors. Finance Minister P. Chidambaram said the idea was not to ban P-notes but only to restrict the flow of money through this route. SEBI chief M. Damodaran said the regulator would try to simplify the process of registration for FIIs so that more of them could directly invest in India instead of in a roundabout manner. That assuaged investors briefly, but the selling spree resumed the following day. In three trading sessions since the discussion paper on P-notes was floated, the Sensex had plunged nearly 1,500 points.
However, things turned around quicker than expected, as many FIIs that invest with a longer time horizon saw the correction as a good opportunity to buy into India. Typically, FII activity tends to taper off in December as most money managers head out on vacation. But this year, FIIs resumed their purchases with a vengeance in December, pumping in around a billion dollars, bringing their cumulative net purchases for the year to $17 billion – the highest ever in a single calendar year. The party in the stock market was on in full swing, even though there were telling signals that investors were beginning to lose their sense of proportion, and many companies their sense of propriety.
In addition to this FII interest, there was also the upcoming IPO of Reliance Power, the largest ever IPO in the history of the Indian stock market. The issue size was around Rs 11,500 crore, but looking at the demand in the grey market, the subscription would be many times that. Assuming the issue got subscribed ten times, over Rs 1 lakh crore would be sucked out from the market temporarily. The grey market for shares of Reliance Power was sizzling, and they were quoting at a premium of Rs 35 in November even before the price band for the issue was announced.
Lastly, there was the gigantic build-up of leveraged positions in the futures and options market. Worryingly, too many retail investors had got into a game meant for deep-pocketed players. To maximize commissions, brokers were encouraging their retail clients to recklessly build positions without any thought to the consequences if prices were to move sharply against them.
GB pointed out one more warning sign to me.
‘One sure sign of trouble is when businessmen and traders outside the stock market start heading here, convinced this is the place to make good money. In the right proportion, their investments are welcome, and even good for the market from a liquidity perspective. But the problem arises when they start ignoring their main business and start chasing easy money,’ he said.
Wherever I looked, the signs of a foolhardy euphoria were unmistakable. And yet, I was not sure if it was the right time to start going short on the market. The market kept climbing all through December, and both my trading positions and portfolio were turning in handsome returns. Yet, I was beginning to get uneasy. After topping 20,000 in late October, the Sensex was now moving in a narrow range, but many small- and mid-cap shares continued to make new highs every other day.
Even though I was wary of going short on the market, I began reducing my trading positions mid-December onwards. I then evaluated my portfolio, and decided to encash the stocks that had doubled over the last one year. These stocks were unlikely to rise at such a scorching pace in the near future. I had to curb my temptation to reinvest the profits; not an easy thing when you are surrounded by noise that the Sensex is going to touch 25,000 before the middle of next year. But I reminded myself that I was not getting any younger. A misstep at this stage of my career could set me back by a few years. I was no longer worried about going bankrupt, but recouping big losses would not be as easy as it was, say, five years ago. As I kept winding down my positions, I became more relaxed. Bina was happy too as I got home much earlier than before, and was able to spend time with her and the kids.
It had been yet another fantastic year for the market, the fifth in a row since the bull run began in 2003. True, there had been at least one sharp correction during the course of each of these years. There were phases when traders like me lost a packet, but the market had been kind enough to give us enough opportunities to get back into the game.
There was a New Year party planned at an influential market operator’s weekend home in Alibaug. I was not very keen on going, but GB insisted that I go with him.
‘Don’t be a sissy, Lala. Come, let’s have a good time. More importantly, listen to what some of the best people in the trade have to say about the market,’ he said.
‘If you say so, Govindbhai,’ I said. GB was one person I always found hard to turn down.
As I was driving down to Alibaug, a friend called to say that RBI had issued a circular permitting FIIs to short-sell equities. Short-selling by FIIs was nothing new. Even if the rules had forbidden it until now, many hedge funds were known
to have been borrowing shares held by foreign brokerage houses in P-note accounts, and selling them in the hope of buying them cheaper later on to return to the lender. The RBI circular would legitimize such short sales, going forward.
Also, there was a perfectly justifiable reason for RBI to allow FIIs to make short sales, as I saw it. The market was beginning to overheat because of the heavy purchases from both institutional and retail investors. Traders who had so far tried to short the market had been routed. The result was an absence of effective counterbalances in the market, should sentiment change for the worse. Perhaps by allowing FIIs to short-sell, RBI was trying to rectify the imbalance in the system. But whichever way I looked at it, the signs looked ominous.
I immediately called GB to inform him about the development.
‘Yes, I heard about it too . . . hard to say what impact it could have in the short term,’ GB said. ‘None, so far as I can see, as long as the overall trend remains bullish. But the day the trend reverses, rest assured that there will be slaughter. The bears are now armed; only, they will have to wait for a suitable opportunity to deploy the weapon for maximum impact.’
At the party, everybody was upbeat about the coming year. The seasoned hands knew a correction was in the offing. They had seen too many bull markets to believe that this party could go on indefinitely, even if they consoled themselves saying every bull market was different from the previous one. And the immortal line – ‘it’s different this time’ – seemed to ring true. The last time anybody present at the party had seen a bull run of such ferocity was during the peak of Harshad Mehta’s powers in 1992, when ACC had touched a dizzying Rs 10,000 per share, throwing every conventional method of valuation out of the window.