Bulls, Bears and Other Beasts

by Santosh Nair

  SEBI tried to source the details from the Financial Services Commission of Mauritius where Mavi was registered. But the details provided by the FSC were not very different from what Mavi had given to SEBI. Ultimately, the Indian regulator had to back off.

  Interestingly, Mavi’s name had also figured in the probe into the 2G telecom spectrum scam. Mavi was one of the firms through which funds were routed from Switzerland by the scam-accused to buy stakes in a company that had been allotted telecom spectrum through an opaque procedure.

  38

  Dalal Street’s Finest All-rounder

  One September morning in 2011, I was glancing through the stock quotes page of a business daily when my attention was drawn to the stock price of VST (formerly Vazir Sultan Tobacco), which owns the Charminar brand of cigarettes, the third largest cigarette company in India.

  It had hit a record high of Rs 1,350 the previous day. I was immediately reminded of Radhakishan Damani and his failed bid for control of the company in 2001. I checked the stock exchange website to see if Radhakishan was still holding on to the roughly 26 per cent stake in VST he had accumulated over the years. Sure enough, he was, and that stake was now worth Rs 520 crore.

  That was an almost 15-fold return from the time Radhakishan first started accumulating the shares way back in 2000. Back then, the reclusive investor had stunned the market by making a hostile bid for cigarette maker VST, which had British American Tobacco (BAT) as its single largest shareholder with a 32 per cent stake. Through his investment arm Bright Star Investments, Radhakishan had accumulated a shade below 15 per cent in the company in the course of the previous year at an average price of Rs 88 per share. He was willing to pay Rs 112 per share for an additional 20 per cent in the company, at a Rs 26 premium to the market price of the stock on the day he announced the bid.

  Even Radhakishan’s closest associates were surprised by this act of aggression, which was completely at odds with his soft-spoken and reclusive nature. The offer document mentioned that the acquirer’s (Bright Star Investments’) sole intention was to increase its stake in the company. While Radhakishan may not have had any plans to run the company, his stake would have risen above that of BAT, had the open offer been successful.

  Market-watchers felt Radhakishan Damani must have bet on BAT not being able to retaliate with a counter offer, as the Foreign Investment Promotion Board had twice in the past struck down BAT’s application to increase its stake in VST. Strangely, it was ITC, through its investment arm Russell Credit, which jumped in with a counter-offer of Rs 115 per share. SEBI delayed clearing Bright Star’s offer, as R. K. Damani was being investigated for his alleged role in the bear cartel accused of triggering the stock market crash immediately after the Union Budget of 2001.

  And while ITC and BAT had sparred in the past and shared a far from harmonious relationship, BAT tacitly supported ITC’s offer. Also, ITC was buying VST shares from the open market. Like Bright Star, ITC too said it wanted to own a significant stake in the company and did not have any intention of gaining management control.

  A messy bidding war ensued, and it soon became evident that there were far too many obstacles, regulatory and cultural, for Radhakishan to be able to walk away with the much-coveted prize. Bright Star upped its offer price to Rs 118 per share, in response to which ITC increased its offer price to Rs 126 per share. Everybody expected Radhakishan to withdraw from the fray since he would not have been able to sustain a bidding war with a company of ITC’s financial muscle.

  Once again, Radhakishan surprised the market by raising the price and size of his bid to Rs 151 per share for 30 per cent of the company. Still, he failed to win over banks, insurance companies and financial institutions, which together held 22 per cent in the company.

  Finally, when Bright Star’s open offer did commence, VST advanced its book closure date by a day, just before the last date of the open offer. Bright Star and its investment banker ASK Raymond James cried foul, alleging that it was a deliberate move to thwart investors from buying VST shares from the open market and tendering them in the open offer.

  Through the open offer, Bright Star managed to increase its stake in VST to around 20 per cent (and by another 6 per cent over the next few years), but Radhakishan’s dream to own a controlling stake in VST remained just that, a dream. Some argue that there are enough stocks that have given better returns since then. That is a fair point. But here is what makes Radhakishan one of the best value investors in living memory: a back-of-the-envelope calculation shows that the acquisition cost of VST shares for Bright Star was sub-zero, considering the hefty dividend pay-outs over the last nine years. Between July 2002 and July 2011, Bright Star – the investment arm of Damani which held the VST shares – pocketed Rs 71.36 crore through annual dividends ranging between 45 per cent and 450 per cent. This was more than the Rs 63 crore Bright Star had shelled out over the years to buy 26 per cent in VST.

  I am not sure if Radhakishan got over his disappointment at being muscled out by the BAT-ITC combine. But if he were to keep his ego aside, Radhakishan had every reason to feel good about the deal. I wondered if Damani would have rolled up his sleeves and engaged himself in the day-to-day running of the tobacco firm had he got control of it.

  Among all the market-men of his generation, Damani is the one I respect the most. I can think of many names on Dalal Street who are good at identifying potential multi-bagger stocks. But I cannot think of anybody else in the country who can identify a good business for investment and is also competent enough to run a business if it comes to that. Damani had already proved his entrepreneurial and managerial skills with the success of his retail chain D-Mart, which he built from scratch. A remarkable feat, considering the fierce competition from much bigger players in the sector. I knew somebody who had worked with Damani on setting up D-Mart. He told me that Damani was involved with every aspect of the venture, even personally doing the rounds of Crawford Market and Musafirkhana (in South Mumbai) for wares, scouting for variety and low prices. Damani’s investment philosophy was simple: no matter how great the business, you had to buy the company at the right price to be able to get good returns.

  He extended that philosophy to the running of D-Mart. He knew that customers would be looking for variety in his stores. But to build customer loyalty, he knew he would have to offer variety at a competitive price. After all, even the wealthiest of his customers loved a good deal, and they would certainly want their friends to know about the deals too. This approach paid off handsomely.

  That he owned the real estate on which stood his stores helped Damani in the following years to keep a lid on operating costs. He had bought the land when it was not too expensive.

  39

  FCCB

  The volatile market trend for much of 2011 and 2012 spelled trouble for many mid-cap companies, which had binged on capital at the peak of the 2007 bull run.

  These companies had raised funds through an instrument called the FCCB for capacity expansion, acquisitions, and part retirement of expensive debt. As the name suggested, the money would be raised in a foreign currency and repaid in the same currency.

  The market was awash with funds at that time. The golden rule about raising funds is that you must go for it when it is available, whether you need it or not.

  Promoters could have raised money by selling shares, since their stock prices were quite high. But they did not want to dilute their holdings in their companies as the stock market frenzy was expected to continue for a while.

  At the same time, promoters were wary of loading their balance sheets with too much debt.

  FCCBs turned out to be the answer to their prayer, as they promised the best of both worlds. FCCB or convertible, in market parlance, had features of debt as well of equity. As in the case of bonds, there was an interest charge and a fixed tenure. The key difference was that the interest would accumulate over the tenure of the bond and only had to be paid when the bonds matured. The bonds were usually of th
ree- and five-year tenures. There was a pre-decided conversion price at which the bondholders could convert the instruments into shares at maturity. The conversion price was at a 15-20 per cent premium to the current market price of the stock.

  For both the promoter and the bondholder, the preferred outcome would be the shares quoting at a premium to the conversion price when the FCCBs matured. The FCCB holder would convert the bonds into shares, and sell them in the open market and make a profit.

  While going in for the FCCBs, almost all promoters assumed that the debt would not have to be repaid as the stock price would be higher than the conversion price. Also, they thought the rupee would continue to strengthen against the dollar.

  Prior to announcing an FCCB issue, many promoters would join hands with market operators and jack up the stock price. This was to ensure a high conversion price (since it was at a 15-20 per cent premium to the prevailing market price at the time of the FCCB issue) and improve sentiment for the stock.

  It is hard to believe that the fund managers subscribing to the FCCB issues were not aware of what the promoters were up to. Strangely, no tough questions about the companies’ business models or stock valuations were asked.

  But the business fundamentals of many companies and the true nature of their promoters were exposed as a result of the meltdown of 2008. And the stock prices never really recovered from the bruising sell-off. Despite the market rallying in 2009 and 2010, the stock prices of these companies were unlikely to be anywhere near the conversion price at the time of the bonds maturing.

  For the first time, promoters had to think about repaying the FCCB holders as the bonds were unlikely to be converted into equity. So confident were the promoters that the bonds would never have to repaid that they did not think of making any provision for such an eventuality. By then, earnings had begun to come under pressure for a variety of reasons like high input costs and weakening demand. In quite a few cases, the companies did not have credible revenues or genuine cash flows to begin with. They were only good at inflating their stock prices by colluding with market operators. But that business model was broken. Companies would now have to refinance the FCCBs if they were to avert a default. In simple terms, they had to raise fresh money to pay off the existing debtors. Raising equity capital was out of the question, considering the battered stock prices; promoters would have to dilute much more of their stake than what they would have liked to.

  And then came the final blow in the form of a nasty surprise on the currency front. During the bull market of 2007, the rupee had been steadily firming up against the dollar, and it was widely expected that the trend would continue. But as India’s economic fundamentals weakened from 2011, the rupee started to weaken against the dollar, and fell by more than 20 per cent from the level seen in 2007. This spelt more trouble for the companies, as they now needed more rupees to repay the dollars.

  Of course, as a desperate measure, the companies could choose to default on their obligation. But that would mean never again being able to raise capital in the international market.

  Some companies offered to buy back the bonds from the holders. The deal suited the companies because the price of the bonds had fallen sharply on concerns about their repaying capacity.

  Other companies tried to negotiate with the bondholders to restructure the terms of the bonds, trying to get them to settle for a lower interest rate while offering to lower the conversion price of the stock to a level not too far from the current market price.

  A few companies that were struggling to convince their investors to restructure the terms of the bonds tried to play the old game of manipulating the stock price. The promoter of a mid-cap telecom firm, which had defaulted on its FCCB, took the help of a market operator to pull up the stock price so that its bondholders would agree to a revised deal.

  By the end of 2011, a series of bad bets had left me shaken. It would be a while before I regained my confidence. I had reduced the size of my trades the last couple of months, but that was not helping much. Perhaps I was being a bit overcritical of myself. It was a tough year for almost everybody in the market, and few had made profits worth mentioning. But I suspected I was beginning to suffer a burnout. One way of fixing it would be to take a break from the market and not trade at least for a month, however strong the temptation. I decided to indulge in the small pleasures of life I had denied myself for so long and become a dispassionate observer of the market when there was time to spare. A month-long voluntary exile from the market, if you may call it that, might rejuvenate me. I was not certain if this self-medication would solve my problem, but then I had nothing to lose.

  I told Bina about my plan, and she was delighted. But she was a bit sceptical too.

  ‘I can’t imagine you staying away from the market for more than a week; by the eighth day you will be suffering withdrawal symptoms and dying to get behind the trading screen,’ she said with mock annoyance.

  ‘Not this time, my dear. If nothing else, I will stick to my plan just to prove you wrong,’ I said.

  ‘But I fear the allure of your mistress will easily outweigh your desire to prove the wife wrong,’ Bina persisted.

  ‘The mistress will have to wait for a month,’ I said.

  ‘Really? I will believe it only at the end of the month,’ Bina said, still not fully convinced.

  I had bought a plot of land at Murbad six months ago. I wanted to spend my weekends there and grow vegetables. The turbulence in the market had kept me busy and I never got around to doing it. I finally had time on my hands to pursue my dream.

  My morning walks had stopped after trading hours were advanced by an hour to 9 a.m. I used to work out on the treadmill, but that was no match to enjoying the pleasant morning air in the company of my friends in the housing society I lived in.

  I also realized I had not been in touch with many of my relatives for a while now. Thanks to Facebook, I had reconnected with some of my close school friends, but had not met up with them despite promising them I would. I wanted to learn a bit of basic cooking too. For that I could not have a better tutor than Bina. And, as she managed the house so well, I had never troubled myself with the academic and personal progress of my children. I would now get to know them better as a father. Then there were the many movies I had missed last year. And suddenly, it seemed a month would be too little for the plans I had drawn up.

  But even as I was busy with morning walks, movies, cooking and social calls, I kept track of the market. I got back to work in the first week of February 2012, fully refreshed from my month-long break.

  Even though the economy was showing signs of slowing and the government was unable to push through any major reforms, the market continued its climb. But not for long. The mood changed for the worse towards the end of February, but the IPO of commodity bourse Multi Commodity Exchange (MCX) got an overwhelming response. MCX was the first exchange in India to go public, and given its dominant position in the commodity space, investors were excited about the issue. The plus-Rs 650-crore issue, priced at Rs 1,032 a share, the upper end of the price band for bidding, was subscribed 54 times. Notably, the retail portion of the book was subscribed 24 times, validating the theory that there would always be takers for a quality issue irrespective of general market conditions.

  40

  The Heavy Hand of the State

  It rained bad news in March, beginning with ONGC’s botched offer for sale (OFS) through which the government hoped to sell a stake of 5 per cent to raise approximately Rs 12,700 crore. The issue had to be bailed out by LIC, which had to soak up almost 90 per cent of the shares on offer in the absence of demand from other institutional investors, particularly FIIs. The stock had witnessed a decent rise through January and February, leading many to believe that the issue would be a success. But it turned out that LIC had been buying the shares in the open market during that period, most likely to support the price ahead of the offer for sale. It had picked up 15.7 crore shares between 1 January and
8 February but did not disclose this to the exchanges till much later. However, FIIs would have known through their network of brokers that LIC was the buyer, and so refused to bite the bait during the OFS.

  It was very likely that LIC was trying to support the ONGC stock price at the behest of the government. Nothing else could explain why the insurer chose to delay disclosure of the purchases to the stock exchanges. The episode showed both the government and the regulator in a poor light. Would SEBI have overlooked a similar violation by some other institutional investor?

  Including the 37 crore shares of ONGC it picked up through the OFS, LIC had invested roughly Rs 15,000 crore in ONGC in less than three months. This was a substantial chunk of the insurer’s annual kitty for investment in the stock market. Many market veterans began to wonder if LIC too would go the US-64 way, given the manner in which the government was meddling in its investment decisions.

  The Union Budget in mid-March did little to cheer up the market. In fact, two proposals in the Budget made FIIs see red. One related to an amendment to the Income Tax Act allowing for taxing past transactions in which the underlying asset was in India, even if the firm controlling that asset was based abroad and the transaction had taken place outside India. The other was for the introduction of General Anti-Avoidance Rules (GAAR). GAAR empowered the Income Tax department to deny tax benefits to an FII if they had reason to believe that a transaction was carried out exclusively for the purpose of avoiding tax. Many FIIs had set up shell companies in Mauritius and were routing their investments into India through those companies, taking advantage of India’s tax treaty with Mauritius to avoid paying short-term capital gains tax.