by Santosh Nair
The smaller traders protested, since the Rs 25-odd lakh charged by NSE initially (the rates declined over a period of time) was too stiff for them, and put them at a disadvantage against foreign players for whom the amount was loose change. Local traders who played for very small spreads were hit the hardest. A software program would seize the best buy and sell quotes in the blink of an eye. Humans could never hope to match that speed. By the time a trader punched in an order after checking the prices on his screen, the software would have already snatched that trade away from him. Algos also had the ability to crowd out the smaller traders’ orders by generating a large number of orders within a fraction of a second. For the small trader, it was like standing in a queue to buy tickets for a movie, only to find that the number of people ahead of him had suddenly trebled. Even assuming you were assured of tickets, you would be unlikely to get the seats of your choice. Similarly, the day trader would end up paying five paise or even more buying a stock, and get five paise (or more) less when selling a stock, simply because the algo would beat him to the best buy and sell quotes.
For a retail investor buying a stock for a longer time horizon, a five-paise or ten-paise difference did not really matter. But for the day traders, this difference was good enough to shrink their profits considerably, or even make trading itself unprofitable. The smarter among the lot changed their trading strategies and hung on, hoping for better times ahead. Instead of looking to make Rs 50 each on 100 trades, they decided to take bigger risks and attempted to make Rs 200 each on fewer numbers of trades. For some, it paid off and they were able to stay in the game. For many others, it was time to look for some other profession.
But institutional investors had other reasons to be unhappy about. Slowly but steadily, some of the privileges they had been enjoying for a long time were being taken away. It had started a couple of years ago when SEBI had asked institutions to start paying upfront margins on their cash market transactions. Until then, only non-institutional players had to pay upfront margins on cash market trades, as regulators thought it unlikely that institutions would ever default on their obligations to the stock exchanges. But the events leading to the global financial crisis punctured the aura of invincibility around financial institutions. They were now seen as entities as likely to default as a small investor or an HNI.
In May 2010, SEBI ruled that institutions would have to pay the entire application money while bidding for IPOs. So far, they had had to pay only 10 per cent of the application money while retail investors and non-institutional investors had had to pay the entire amount. As they had to pay little money upfront, institutions would bid for huge quantities. This led to a situation where heavy bidding by institutions gave an exaggerated picture of the demand for primary market offers.
High institutional interest would set off a chain reaction, as retail and other investors viewed it as an endorsement of the company’s fundamentals, and felt encouraged to invest. This would also influence the listing price, which hinged on the demand for the stock during the issue process.
Understandably, both FIIs and merchant bankers were opposed to the move because it reduced their power to game the IPO process. However, SEBI refused to budge on the matter.
34
Garibi Hatao, the SKS Way
There were two blockbuster public issues in 2010. I did not participate in either, but enjoyed the intellectual debates over the IPOs of SKS Microfinance, the first of two microfinance companies to hit the market in August. The size of the issue was a little over Rs 1,650 crore, consisting of a fresh issue of shares for Rs 733 crore and sale by the existing investors of the rest of the shares.
Microfinance being a new concept for the stock market, there was a lot of excitement and hype about the issue. Few understood the business model. They only knew that MFIs loaned money to the financially weakest sections of society – the poorest of the poor – who had no access to banks and other traditional sources of funds.
SKS, founded by 41-year-old Indian American Vikram Akula, drew applause, awe, and also scathing criticism for its decision to go public. The sceptics included the Nobel Prize-winning economist and pioneer of microfinance in Bangladesh, Mohammed Yunus. His contention was that the IPO would send a wrong message – that there was money to be made off poor people. After all, microfinance firms generally charged interest rates of anywhere between 30 per cent and 50 per cent to compensate for a higher risk of default by its borrowers. If an MFI’s rate of loan defaults was low, it stood to make handsome returns on its investment. Supporters of the IPO were convinced that an IPO success for SKS would encourage many other microfinance firms to raise money from the stock market and scale up their operations. They said this would lead to more competition among microfinance firms and lower interest rates, thus freeing many poor borrowers from the clutches of usurious moneylenders.
The company claimed to be driven by the lofty ideal of helping the poor through credit even as it tried to revolutionize the MFI landscape in India and helped investors make money in the process. Many an investor must have likely believed there was nothing better than putting money in such an IPO, as it would be a shot at making good money while also supporting a noble cause. It was for the first time that investors were being served a potent cocktail of capitalism and altruism on Dalal Street, and everybody wanted a draught of it.
The pre-IPO investors in the company included big names like Quantum, managed by the legendary trader George Soros, and Catamaran Investments, promoted by Infosys founder N. R. Narayana Murthy.
What did not fetch as much publicity was the sale of shares held in the form of stock options by the SKS management ahead of the IPO. To me, the eagerness of a promoter to take money off the table is never a healthy sign. Founder Vikram Akula and CEO Suresh Gurumani sold a portion of their options, agreeing to lock in the rest for three years.
Investor response to the IPO was overwhelming, though many felt the shares were expensive at Rs 985 each. The track record of the company and the sound quality of its loan book were good reasons for investors to believe that its business model was scalable and that the premium valuation was justified.
SKS shares had a decent debut on the exchanges, gaining nearly 18 per cent on opening and ending the day around 10 per cent above the issue price. Its listing day performance would have been better had it not been for the weakness in the market. Still, the stock had a good run over the next month, climbing to around Rs 1,400.
But come October, and problems began cropping up for SKS, beginning with the abrupt resignation of CEO Suresh Gurumani over differences with founder Akula. The stock had been drifting lower for the past few weeks, and the power struggle within the board now put the stock under further pressure. But an even heavier blow was to fall a few days later. A spate of suicides by borrowers in Andhra Pradesh stirred the state government into issuing an ordinance to curb the activities of MFIs in the state.
The well-publicized story was that too many MFIs had sprung up in Andhra, and that agents of these firms were talking the poor into borrowing money, whether they needed it or not. These borrowers would blow up the money and later had to deal with the strong-arm tactics of the loan agents-turned-recovery agents when they failed to repay. Some killed themselves.
There was a conspiracy theory too, that SKS’s growing presence had threatened the livelihood of many politicians who were thick with the moneylenders and had a vested interest in keeping the poor poor. The incidents of suicide were exaggerated to weaken the reputation of MFIs in the state. The developments hurt SKS very badly because Andhra was its biggest market in terms of its loan book. The company never recovered from that blow, and by the end of the year, the stock price was down to Rs 600, nearly 40 per cent below the IPO price.
So much for long-term investing, I thought, as I went through the chain of events. The one who had subscribed to the IPO and decided to sell out within a month would now look smarter than the one who was stilling holding the stock.
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bsp; Meanwhile, as the market rose, my own bank account continued to swell steadily. The uptrend till August had been steady, but in September, the market just took off. However, the enthusiasm and excitement of the last bull run was clearly missing. It was a small group of players, mostly FIIs, who were raking in the big money.
Still, retail investors got one fair shot at making some decent returns through the Coal India IPO. Investors across all categories bid for shares of India’s largest coal producer, as the issue price of Rs 245 was thought attractive. The company aimed to raise around Rs 15,200 crore through the IPO, but got bids in the region of Rs 2.3 lakh crore. The issue was oversubscribed 15 times. Strangely, institutional investors who were complaining about the new rule requiring them to pay the full application money were the most aggressive bidders. The institutional portion of the book was subscribed nearly 25 times, with Rs 1.73 lakh crore’s worth of bids coming in. The institutional book in the Reliance Power IPO had attracted Rs 1.89 lakh crore’s worth of bids, but there was a crucial difference. Institutions that bid in the Reliance Power IPO had to pay just 10 per cent on application while in the Coal India IPO they had to pay 100 per cent of the application amount.
This supported my long-standing theory that you did not really have to pamper institutional investors with favourable regulations. If they smell an opportunity to make money, they will definitely invest. The retail portion of the book was subscribed two times, again underscoring the fact that if the price was right, retail investors would be as keen as their institutional counterparts to invest.
None of the investors who put money in Coal India had any cause for disappointment. The stock opened at Rs 287, and ended the day at Rs 342, at a good 40 per cent premium to the issue price of Rs 245. The Sensex topped 21,000 after a gap of more than thirty-four months, but the rally seemed a hollow one to most of us. Corporate earnings growth had begun to lose steam, and none of the brokerages were adding staff, despite the boom in stock prices.
Conventional market wisdom has it that a blockbuster IPO usually signals the peak of a bull run. This was proved right in 2008 with Reliance Power’s public issue. It turned out to be true again with the Coal India IPO. I thought the success of the Coal India issue would boost sentiment and draw more investors to the market. Besides, there was no massive build-up of positions in the derivatives market, as was the case in 2008. To me, frenzied retail participation is one of the most reliable signs of a market correction. There was no sign of that either. Still, the market began to flag after the listing of Coal India shares.
35
The Iron Law of Averages
A loan-for-cash scam towards the end of November undermined market sentiment further. It involved Money Matters, a Mumbai-based NBFC, senior officials at LIC Housing Finance, LIC of India, and some public sector banks.
Money Matters had suddenly shot to fame over the last year or so. Its fast-talking and ambitious founder Rajesh Sharma had begun his career in the financial market from a hole-in-the-wall office at Fort in the late 1990s. A chartered accountant by profession, Sharma’s skill at finding buyers for large blocks of shares of mid- and small-sized companies was much in demand with corporations.
Sharma was well networked with important fund managers, which helped him put through some difficult deals. In 2001-02, he is said to have befriended a senior official at a retail broking house that, in a few years, would be counted among the top brokerages in the country. Talk was that this official convinced some of his high net worth clients to buy the shares that Sharma was looking to sell. That turned out to be a major break for Sharma, and from then on, the size of his deals kept getting bigger.
But Sharma was a more active player in the opaque world of bonds, where he was known for his ability to find buyers for illiquid bonds. Sharma hit the big time in equity circles in 2007, when he managed to place large blocks of shares for Bank of Rajasthan and Deccan Aviation (which subsequently became Kingfisher Airlines) with institutional investors. Despite gaining acceptance in the more glamorous world of shares, Sharma appeared to be far more at ease in the debt market, which rarely made headlines.
Sharma’s business model had now evolved to the point where his firm was arranging loans for some of the top corporate houses in the country. In 2007-08, the company’s annual revenue was less than Rs 10 crore and net profit Rs 4.22 crore. By the first half of 2010-11, Money Matters had made a net profit of around Rs 75 crore on revenues of Rs 224 crore, sending its stock price soaring. The company’s scorching pace of growth made Sharma a force to reckon with in the financial services industry. Naturally, it also fostered jealousy and resentment among his rivals, most of whom had been left far behind in the race. One of them, an erstwhile business partner of Sharma’s, is said to have snitched about Sharma’s ‘business model’ to the investigating agencies. It turned out that Sharma was bribing officials at state-owned banks to get them to sanction loans to his clients, many of them real estate companies. In some of the cases, Sharma was able to get the banks to sanction loans to real estate companies in excess of what they were eligible for.
Sharma was arrested by the CBI, along with Ramachandran Nair, the CEO of LIC Housing Finance, and officials at LIC, Bank of India, Central Bank of India and Punjab National Bank. Barely a month before the scam was exposed, Money Matters had raised $100 million by placing shares for Rs 625 apiece with institutional investors, who included top names like Morgan Stanley, Wellington Asset Management, GMO and Fidelity. The stock, which was quoting below Rs 100 a year ago, surged to around Rs 700 by the time of the placement. A sevenfold rise in the stock price should have prompted potential investors to do some serious homework before buying into the issue. But that is the last thing most fund managers bother to do in a booming market.
I was tipped about the stock some months before all this, and managed to make a quick buck without staying invested for too long. My friend who had told me about the stock was confident that it would touch Rs 1,000 before the year ended. I would have hung on, but for the company deciding to offer shares to institutional investors. My experience has been that much of the action in a flavour-of-the-season stock happens before a share placement. I had almost doubled my initial investment in the stock and had no qualms about cashing out. Sharma’s arrest sent the stock into a nosedive, one from which it never recovered. Between 23 November and 31 December, the stock plunged from Rs 663 to Rs 130. Fund managers who had subscribed to the placement had no way of getting out, as trading in the stock would be frozen every day for lack of buyers. Over the next five months, the stock would tumble below Rs 50.
While I had made a decent profit, the regulatory glare in the wake of the scam worried me. My trade in Money Matters was not too big by my own standards but would easily figure among the sizeable trades in the stock over the last six months. I had not benefited from any insider information, and I was confident of being able to prove that. But having to disclose my trade sheets to the regulator and answer their numerous questions was something I always found distressful.
In December 2010, SEBI investigated four companies and found that their promoters had joined hands with market operator Sanjay Dangi and his associate firms to ramp up their stock prices ahead of their capital-raising through share placements to institutional investors. SEBI would later give a clean chit to most of the companies named in the report, but the promoters and market operators could no longer afford to defy the regulator with impunity.
I would have liked to end the year on a winning note, but that was not to be. To my annoyance, the loss happened in an IPO. I was never too keen on IPOs anyway but I invested because some relationships mattered more to me than money.
Even as the market was going nowhere, a company by the name of A2Z Maintenance decided to come out with an IPO. A2Z’s main business was installation of power distribution lines and substations. It was also into generating power from renewable energy sources, and managed solid waste for municipalities. But the company’s main calling car
d was a 21 per cent stake held by billionaire investor Rakesh Jhunjhunwala. He had bought the stake in 2006 for around Rs 20 crore, and now, with the company going public, planned to take some money off the table.
The success of the Coal India IPO had clearly showed that pricing mattered more than market conditions. Still, the A2Z management decided to push their luck, confident that Jhunjhunwala’s brand power would help command a hefty
premium, despite strong indications from fund managers that they would invest only if they felt the issue was priced reasonably. Now, the definition of what is ‘reasonable’ depends on the prevailing market sentiment. In a bull market, no price is too high, and in fact, investors seem to get a kick out of buying IPOs at inflated prices. But in an uncertain market, they fuss about operating ratios, earnings growth and business models.
A2Z wanted to raise Rs 675 crore through issue of fresh shares; and some of the existing investors – Rakesh included – were looking to sell a portion of their holdings in the IPO. The total size of the issue – newly issued shares and shares offered by existing investors – was around Rs 860 crore, at Rs 400 a share. At that price, Jhunjhunwala’s stake in the company was worth nearly Rs 500 crore – a return of 25 times for him in less than five years. He had offered 5 lakh shares in the IPO, enough to recoup his initial investment and still be left with plenty.