Bulls, Bears and Other Beasts

by Santosh Nair

  And the ‘beauty’ of the stock market is that even in times of utter despair, there is never a dearth of optimists, value buyers or bargain hunters – whatever you may call them. A record total of 34.67 crore shares of Satyam were traded on both exchanges that day which showed there were many investors who felt the company could still make a comeback, despite the serious mess it was in.

  When I first saw the news flashed on television, I could not believe my eyes. Rarely do you have the promoter of a frontline company admitting to a fraud, that too a fraud on such a massive scale. My trader’s instinct quickly took over, and I short-sold as many shares as I could. But the price had begun to sink rapidly, even before I could hit the ‘enter’ key on my trading terminal. The severity of the slide stunned the market, and within minutes the stock had fallen to below Rs 100. I wondered if I should be doubling my position, but decided against it. I covered my position at Rs 90 and waited. Since there was no intra-day circuit filter on the stock, it continued its free fall, going all the way down to Rs 30 before closing at Rs 40 by the end of the day.

  Satyam’s troubles had started a few months earlier when the lenders with whom the promoters had pledged shares to raise money started offloading them. That Raju was pledging his shares to raise money was not common knowledge because SEBI rules did not require a company to disclose details about shares pledged by its promoters.

  By the end of September 2008, promoter-holding in the company had fallen to 8.6 per cent, leaving the company vulnerable to a takeover.

  Still, the stock managed to hold ground in October while the market as a whole was being battered by the yen carry-trade unwinding. But, unknown to shareholders, time was running out for Raju. There was a big hole in Satyam’s books because of the fictitious cash and bank balances in it. Raju had managed to outwit the auditors so far, but at some point he would have to reconcile the books. Besides, he had to keep paying real taxes even if the revenues were fake. And, since he had pledged shares to raise money, the stock price had to be maintained, or the lenders would start dumping his shares. To maintain the stock prices, the artificial growth in revenues had to be sustained.

  In a desperate measure to cover up the non-existent revenues, Raju proposed to the board that Satyam buy out the unlisted Maytas Properties (wholly owned by the Raju family) for Rs 6,240 crore, and pick up a 51 per cent stake in the listed Maytas Infra for Rs 1,440 crore.

  Institutional shareholders were outraged, thinking Satyam promoters were trying to profit at the expense of minority shareholders of the company. Raju realized that antagonizing his important shareholders would draw more attention to the company’s workings, and so dropped the plan.

  That mollified investors somewhat. Just as Raju managed to put out one fire, another broke out a few days later. Fox News reported that the World Bank had banned Satyam from doing business with it for eight years for allegedly bribing its officials to secure orders. The company vehemently denied it, but the World Bank confirmed the development, sending the stock crashing by over 13 per cent.

  Things were rapidly getting out of control for Raju. On 27 December, just two days before the scheduled board meeting to consider a share buyback proposal for the company, it was announced that the meeting was being deferred to 10 January as options other than a buyback were being considered. The company appointed DSP Merrill Lynch to advise it on ‘strategic options to enhance shareholder value’.

  DSP Merrill Lynch’s association with Satyam dated back to 1999 when it had been lead manager to the company’s ADR issue and adviser to subsidiary Satyam Infoway’s acquisition of Indiaworld for a jaw-dropping Rs 499 crore. The deal, as I have mentioned earlier, had raised many an eyebrow, and there had been whispers in market and corporate circles that the promoters had actually siphoned off the cash raised in the recent ADR issue through the extravagant acquisition.

  A week after its appointment as adviser to Satyam on ‘strategic options’, DSP Merrill issued a statement that it was terminating the assignment, saying the company was not forthcoming on some crucial disclosures.

  Even though its stock had nosedived, many in the market believed the government would intervene, directly or indirectly, to salvage Satyam, given the number of jobs – roughly 53,000 – at stake, and the fact that Lok Sabha elections were barely three months away and state elections due shortly after. A section of the market hoped industry rivals would be interested in buying out Satyam at some price or other, even if the full extent of the fraud was yet to be ascertained.

  Betting on this, many traders started loading up on the stock on Friday when markets resumed for trading after the holiday for Muharram on 8 January. I picked up a couple of lakh shares at around Rs 30, a couple of lakh at around Rs 25, and another couple of lakh at around Rs 20. The volume of trades was again heavy on Wednesday, but the stock price began to sink after a steady start. The latest rumour doing the rounds was that the government was unlikely to intervene and would let Satyam go under. On BSE, the stock price tumbled to Rs 11 and on NSE to Rs 7. I sold out my positions close to the lows of the day at a considerable loss. While initiating the trade, I had planned to hold on to the stock for a month or even longer, by which time there would be some clarity on whether the company would be salvaged. But the rapid descent in the stock price forced me to react as a trader would.

  Most traders I knew took a hit on their long positions in Satyam, having sold out in panic. I watched the Satyam screen out of curiosity for a while, though I had sold out my position. There was heavy buying at lower levels, and I suspected that the buyers knew something that the rest of the market did not. I became more certain of this as the stock price climbed to Rs 23 by the end of that day.

  I had lost Rs 90 lakh in a single trade, but took solace in the fact that there were others who had fared more miserably. When the Satyam stock had plummeted on the board’s decision to buy stakes in the Maytas firms, Larsen & Toubro (L&T) had picked up a 3.95 per cent stake in the company at Rs 170 per share. At the end of the December quarter, L&T’s stake in Satyam was higher than the promoter’s holding, which had fallen to 3.6 per cent because of the sale of Raju and Co.’s pledged shares.

  After the fraud surfaced, the L&T top boss A. M. Naik said his company would not sell or buy any more shares of Satyam. Two weeks later, the company would pick up an additional 7.6 per cent at Rs 34.52 per share, lowering the average cost of its 12 per cent stake in Satyam to Rs 82 per share. The company had little choice; it appeared almost impossible that the stock price would ever go back to Rs 170. But there was a better chance of the company being able to recoup its investment at Rs 82 a share.

  Over the weekend it also became clear that the government would not abandon Satyam to its fate.

  The entire incident reinforced what I had always believed: that only the promoter really knows what is going on inside a company, no matter how intensely researched a company and its stock. Satyam’s low PE multiple was proof that the market did not fully trust its earnings. But analysts and fund managers could never put a finger on what exactly was wrong with the numbers.

  A careful study of the cash flows, debtor outstanding, tax payments and operating margins vis-à-vis key competitors does provide an indication of the soundness of the business. But what safeguard can an investor have against a promoter who manages to forge invoices and bank statements, show fake revenues and cash balances, get them certified by a careless or complicit (as may be the case) auditor and, on top of all this, pay real tax on fictitious income? Nothing.

  The Satyam episode had investors worried about more such frauds surfacing in the coming days and cast a shadow on the shares of second-line IT companies, which until then were doing fairly well in a turbulent market. If you cannot trust the numbers of a frontline company, how reliable can the numbers of smaller companies be?

  The scam also punched a hole in India’s claim to having the best corporate governance standards among emerging markets.

  30

  Bulls
Make a Comeback

  For all his market wisdom, Old Fox had begun to overplay his hand without realizing it. In 2009, the market started climbing mid-March onwards, slowly at first, then gathering speed. The common view was that the uptrend was unlikely to sustain. Whenever there is a trend reversal either up or down, players take a while to recognize it.

  When the Nifty and the Sensex had managed to top 3,000 and 10,000 respectively by the end of March, chartists and non-chartists alike were still looking for signs that the market had finally broken away from its fourteen-month-long downtrend.

  Initially, I was content with small profits, unsure if an upcycle was under way. As prices rose, I would book profits, then buy again if the stock continued to show strength. All this while, Old Fox continued to short-sell with all his might, convinced that the rally ‘had no legs to stand on’.

  An error even the most seasoned traders are prone to is to misjudge the point at which to start cutting down positions even as you are winning. Everybody is aware of the market truism that nobody can catch tops or bottoms except liars. The experienced trader knows he will not be able to exit his entire position at the peak price or start covering his short positions at the bottom price. If the trader is not careful, he finds himself like the soldier who gives hot pursuit to an enemy and, in doing so, unwittingly enters enemy territory

  Something similar happened to Old Fox this time. He kept selling even as the trend had changed from bearish to bullish, a shift that escaped his notice. A bear trader’s unseen foe is the long-term investor, just as a bull operator’s nemesis is the genuine seller.

  As the market had kept falling over a long period of time, traders who went long in the futures market kept incurring losses. So did the short-term investors who had bought shares hoping to cash out within a month or two for a decent profit. The presence of these two categories of investors in the market had now dwindled as continuous losses drove many of them away. In their place had begun to enter investors who were willing to buy and wait it out for a year or two, or even longer. They included HNIs, promoters buying through fronts, and sometimes even the contrarians among retail investors. None of these investors buy aggressively, so it is hard to detect their presence. The market sees this trend as ‘shares passing from weak hands to strong hands’. As a result of this buying, the floating stock in the market had slowly begun to decline. Most of the players who wanted to sell out had done so and the shares now rested with players who took a long-term view of their purchases. Not recognizing these subtle changes, the bears had unknowingly ventured into enemy territory through sheer overconfidence. Once prices started to climb, the rise would be sharp because of the absence of enough sellers to blunt it. And that would make it hard for the bears to cover their short positions without sending prices shooting up.

  That is exactly what happened with Old Fox, who failed to realize that his opponents had changed. He was spot on when he had predicted the previous year that the market had peaked out. But he misread the signals as the market reversed trend. By mid-April, the Nifty was sniffing at 3,500 and the Sensex had topped 11,200. The bears were taken by surprise. Partly, it was their frantic short-covering of positions that added fuel to the fire and pushed up share prices.

  Old Fox had to cover a part of his short positions at a loss as prices flared up. But to his credit, the Fox knew when he had been beaten and would not stick to a market view just to prove a point. He squared off his short positions and began building long positions quickly.

  My winning streak that had begun in January last year, continued. I steadily increased the size of my trades and watched the profits pour in.

  There was still one major hurdle for the market to cross – the Lok Sabha elections. Political analysts and psephologists continued to predict a hung parliament, and there was no strong reason to believe otherwise. Media reports showed a general disenchantment with the ruling UPA, but the Opposition appeared to be in disarray, with no strong candidate to lead the charge.

  The results announced on 16 May, a Saturday, took the nation by surprise. The Congress had returned with an even stronger mandate, bagging 220-plus seats on its own. More importantly for the market, this time the Congress would not be at the mercy of the Left parties that had supported the UPA from outside for much of its previous tenure and had hobbled the government from pursuing major economic reforms.

  The market move on Monday stunned everybody. Within 30 seconds of start of trading, indices leapt to the upper end of the 10 per cent intra-day circuit filter, and trading was suspended for an hour, as per SEBI rules. When trading resumed, it took only another 60 seconds before the indices surged another 5 per cent, and trading was halted for the day. The Sensex rose a whopping 2,100 points to close at 14,284, and the Nifty gained 651 points to close at 4,323.

  It was the first time in the history of the Indian stock market that trading had to be halted because of indices hitting the upper end of the intra-day circuit filter. Life seemed to have come a full circle for the UPA government. Exactly five years ago, on 17 May, a tactless remark by CPI leader A. B. Bardhan soon after the UPA victory had sent the market crashing to the lower end of the circuit filter, suspending trading for the rest of the session.

  Both indices cooled off over the following week, but sentiment had improved considerably by then. FIIs bought shares for Rs 20,600 crore in the net in May alone, which was seen as a vote of confidence by global investors in the India story.

  The dramatic turnaround in sentiment and the recovery in share prices also caused heartburn in some quarters. On 14 May, DLF promoters sold a 9.9 per cent stake in the company to a clutch of institutional investors for Rs 3,860 crore, which worked out to Rs 232 per share. This was less than half its IPO price of Rs 525 less than two years ago. At the peak of the bull run, the stock had touched a high of Rs 1,200. That now seemed very long ago.

  The founders used the funds from the stake sale to buy out private equity firm DE Shaw’s stake in group company DLF Assets Limited and also to infuse fresh funds into it. This decision would turn out to be troublesome for the promoters just two trading sessions later.

  To be fair to the DLF promoters, they closed the deal ahead of the election results as there was a risk of the market mood souring in the event of a hung parliament. As share prices surged crazily in response to the unexpected UPA sweep, DLF’s shares price rocketed to Rs 323 on May 18, the first trading session after the election results. By October, the stock had climbed to Rs 475.

  By July, many companies decided that market conditions were ripe for another round of fund-raising through qualified institutional placements (QIPs), or sale of shares to institutional investors. For many companies there was little choice – they needed to raise money not to grow their business, but merely to stay in business. There was a floor price for this placement – the two-week average closing price of the stock – below which companies could not sell their shares. They were free to price their placements above the two-week average if they found takers for it. Many companies tried their usual tricks, like getting market operators to bump up the stock price just before bids were sought from interested buyers.

  But fund managers refused to fall for the trap; they could now afford to be choosy as they were flooded with offers from companies starved for capital. The two-week average price formula meant nothing to them if they had reason to believe that the stock had been rigged or that the formula was yielding a high price only because the market as a whole had moved up and not because of the value of the stock. They drove a hard bargain, and in many cases promoters had to wait for their stock prices to cool off a bit before fund managers agreed to subscribe to their issues.

  Knowing that promoters would eventually have to offer their shares at a discount to the market price, many fund managers dumped the shares they were already holding in the company, buying the same stock at a cheaper price through the QIP route. The tables had turned, and this time it was the fund managers profiting at the expense of the
promoters.

  31

  A Reality Check

  But the severe bear run that had lasted fourteen months had brought about some changes that were hard to reverse. For one, even as share prices had risen sharply in the last four months, many stocks were a long way off from their giddy peaks of January 2008.

  Second, the bear market had exposed the fragile business models of many companies, mostly those in the infrastructure and real estate sectors. Many of them would never regain the favour of institutional investors, even though bull operators would take a passing fancy to them once in a while.

  From the perspective of the brokerage firms, the days of juicy commissions and brisk business from retail investors and HNIs had ended for the time being.Many clients had lost huge sums of money or had seen their paper profits shrink to alarmingly low levels. Many of them would not return to the market in a hurry, and some would never again have the courage to. The ones who stayed back reduced the size of their trades, biding their time till they felt safe enough to stake bigger sums.

  The investors who had dabbled in stock and index futures, however, had been dealt the most devastating blow. The broking houses had led them to this. It was in the interest of the broking houses that clients traded in the more risky futures and not in the relatively safer options, the commissions on futures trades being several times higher than on options trades.

  In 2007-08, as the bull market was raging, index and stock futures accounted for 87 per cent of the total turnover in the derivatives segment. The following year, the turnover in the derivatives segment declined by nearly 15 per cent, and futures turnover accounted for 64 per cent of this reduced pie. The next year it would fall to around 33 per cent. In the following years, most brokerages would earn a substantial chunk of their revenues from their NBFC (lending) business rather than from stockbroking.