Welcome the SME exchange

I can’t wait for the SME exchange to arrive. I have at least 20 mandates from SMEs that form majority of my client list to raise capital in the region of Rs.5 crores - Rs.50 crores. During the crunch times like this, Banks are too cagey and they just act up. Local financiers are hawkish and money doesn’t flow exactly at remunerative costs.

SME exchanges can bridge the gap since it could bring together savvy public looking for portfolio diversification. SEBI has rightly set the minimum lot for investment at Rs.1 lakh so that investors with requisite savvy and having the optimal risk appetite only participates. I welcome it for yet another reason – it would give significantly higher visibility to future large cap contenders as could be multi-baggers as well in the short to medium term…

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Ranbaxy open offer is biased

So many conjectures and assumptions surrounding impending Ranbaxy open offer.

As it exists today, if you acquire 15% or more of a target company, you have to make a compulsory open offer to other investors of the company to buyout further 20% stake from them – the idea is to give those investors an exit option at the same price. But there’s a catch. While promoters can exit their entire stake, the rest of the shareholders can only exit partially – if the acquirer does not want to buyout the entire outstanding shareholders.

In the Daiichi-Sankyo acquisition of Ranbaxy, the promoters are exiting completely at a price of Rs.737/-per share for their 35% holding. Now Daiichi-Sankyo (acquirer) has to make an open offer for another 20% at or about the same price - which is at a significant premium (Rs.194 or 35.72%) to the closing price of Ranbaxy share at Rs.543/- yesterday. So if the remaining holders of [entire 65% non-promoters] tender their shares in the open offer, only 30.7% shares offered will be accepted resulting in a rejection rate of 70%.

However, the preferential issue would also play an important role as it would change the acceptance ratio. If the preferential issue is made before the open offer then the capital base would be enhanced, affecting the acceptance ratio. Open offer on current base of 373.2 million share (would) result in buyback of 74.63 million shares (30.7% acceptance) and in case of an expanded base 419.3 million (adding preferential issue of 46.26 million), it comes to 83.85 million shares (34.5% acceptance).

I imagine a "what-if" scenario. If I hold 100 shares of Ranbaxy and tender it in the open offer, only 30 shares will be accepted by Daiichi-Sankyo at Rs.737. I will be left holding the remaining 70 shares and exposing myself to vagaries of price action post open offer, which will certainly be, down. But the promoters would have made a neat exit with full premium in their pockets. How fair is that? Well, they may explain it as “control premium” – for having stuck with the company for over 75 years and having not entered or exited like ordinary investors. Still it rankles.

Why not make the acquirers make a minimum open offer to public, as far as possible, equal to the percentage of shareholding acquired from the promoters – which is 35% in this case? That would restore a semblance of fairness. [Of course subject to Listing Agreement post offer minimum public holding criteria]

To buy 100 shares today, I have to invest Rs.54,300 @ Rs.543 a share. If I tender all these shares, only 30 shares will be accepted at Rs.737, fetching me Rs.22,110. Since this is an off-market trade, I will take a short term capital gains tax knock of 30% (+ cess) on the gain (Rs.194 x 30 shares), netting me just Rs.20,306. So my net investment on the residual holding of 70 shares will be (Rs.54,300 – Rs.20,306) Rs.33,994 or Rs.485 per share. Post offer, if Ranbaxy stock price falls below Rs.485/-, the holder is incurring a net erosion in value.

Now Ranbaxy has an EPS of Rs.17.50 giving it a P/E multiple of 31 at its current price of Rs.543. Will it be sustainable post open offer in these harried times of oil price surge, global inflation and waning sentiment in our markets? When the public offer euphoria dies down, the stock will end up quoting at an average P/E of let’s say 17, the price of the Ranbaxy share will be around Rs.290/- leaving me to stare at an erosion of 47.65% in my Ranbaxy holding.

Now you know why Ranbaxy stock price is not going anywhere even after the news of its acquisition by Daiichi-Sankyo… It’s a play on capitalism again. Loaded in favor of promoters. Remember – rich getting richer…?

Readers, what do you think?

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[Update : Thanks to reader Ratan for correcting me on the STCG error in the original post, that now stands revised.]

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SEBI in a hurry. Did PMO ask for "status report"?

SEBI today unveiled the guidelines for real estate mutual funds (REMF). For SEBI it’s another feather in the cap. Or is it another job done?

THE FINE PRINT

 Real estate mutual fund schemes can only be close-ended, listed on recognized stock exchanges
 At least 35% investment in ready-to-use projects mandated
 Investment in real estate assets, securities (including mortgage backed securities) capped at 75% of the net assets of a scheme
 Caps to be imposed on investment in a single city, project, securities issued by sponsor or associate companies
 Fund houses need valuation by two valuers every 90 days from date of investment
 Mutual funds cannot transfer real estate assets between schemes
 Have to declare daily NAV

Some doubts still persist.

Does SEBI have the expertise necessary to regulate murky real estate sector? Talk of defective title deeds, dated survey / registry documents, arbitrary valuations, diverse stamp duty assessment norms etc. Investors should do well to approach it with care. I would say “avoid”. It only intends to provide liquidity to developers that have bought land at astronomical prices. Now future cash flow from executed projects depend on affordability of buyers.

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Then two valuers declaring valuation every 90 days. Is it possible in a RE fund? The underlying prices may not vary in that frequency at all. What could be the benchmarks? Who will supply data given that most deals are done on part cash, part cheque basis? Now wait a minute. Don't we clearly see seeds of subprime mess being sown here? Creating layers and layers of instruments that eventually masked the real borrower to the bondholder. Will there be a housing loan waiver like a farm loan waiver? Hope someone nips it in the bud before investors - that have little or no way to discover the ture value of the underlying - burn their ass.

Inflation recently crossed 7%. Global liquidity crisis is not yet completely off our back. Has PMO sought status report from SEBI to *save* the beleaguered sector? We live in times when ministers put in a “friendly word” to cabinet colleagues to “save” companies in trouble!

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PE gets a knock, SEBI has remorse

Well, there it is. PE deals decline sequentially. [ $3.3 billion mopped up through 97 deals in the March 2008 quarter were lower than 131 deals totaling $5 billion in the December 2007 quarter]. The report cites weak market conditions for the thaw. But there is another reason that it masks – PE portfolios are beginning to look “sinful” exposing callous fund management. The reversals have been dramatic. Recognizing old fashioned due diligence, PE firms are now all the more wary of churning out “weekly” term sheets. Seems they've realized it is not about blind betting on market sentiments, not just about investing other people’s money (OPM) ; it’s also about delivering superior returns. It’s clearly not about letting limited partners grieve!

SEBI on its part has done some self appraisal and has remorse. That's rare! For mere “custody” of draft documents and posting it on its website, apart from “occasional” (to-plug-its-own-mistakes) release of notifications and guidelines, it has been gouging the market players by way of fees. Most of its charges leveled against alleged scamsters have been annulled by High Courts – so much for its “fact-finding” skills! Way too much CYA type “disclosures” emerging from the woodwork. It had to seek atonement some day. So here comes a catharsis.

New funds emerge on the horizon – Saffron Asset Advisors, is planning to launch Rs 300 crore domestic real estate fund, which will invest in non FDI-compliant projects in the country. It manages the real estate investments of NYSE Euronext-listed Yatra Capital, is now planning to launch a bouquet of funds focusing on India.

Recently, New Delhi-based Red Fort Capital announced the launch of its second offshore fund, with a corpus of Rs 3200 crore, to invest in Indian real estate. Red Fort has also launched a Rs 1,000 crore domestic property fund. South Africa’s Old Mutual and Mumbai-based ICS have floated a Rs 2,000 crore property fund and Triangle India Real Estate Fund.

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Dance of the bands

SEBI lifts price bands for non-IPO listings here.

Currently, the stock exchanges impose a price band on first day of trading / resumption of trading post corporate actions like merger, de-merger, capital reduction, CDR / capital restructuring, revocation of suspension, direct listing on another exchange etc. Now SEBI feels that in such cases there is no need for price bands because they restrict normal price discovery.

This has been my pet peeve too. Why not open up price bands for IPO as well? SEBI has been mulling over this for quite some time. In a free market, nobody can wish away volatility and price discovery can only be a function of demand and supply. There could be scope for manipulation by some operators but their span of control is limited. Driving the stock prices up or down by artificial intervention of operators come at a high cost and associated risk. The best way is to let a few players suffer the carnage. Mostly these operators are funded by promoters of companies to see their net worth zoom on the listing day. When a few get scalded, caution will rule and normalcy shall prevail. Allow some casualties.

It also seeks to extinguish the perilous grey market for securities – regarded as one of the primary concerns of Mr.C.B.Bhave, the new SEBI chief as soon as he assumed office recently. He seems to be a fast cat, having already enabled short selling by acting out lending and borrowing mechanism. Now it’s time he pays attention to my no-band philosophy on IPO price discovery as well.

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Who is SEBI trying to protect? The small investor? Nobody is a saint. Everyone big or small, comes here because she is greedy. Regulation is welcome to the extent anarchy doesn't get a reception. Taking regulation too far by imposing price bands is meddling. Let the markets rule.

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"Sure as hell will charge a fee"

Here..... Sebi wants to regulate Art Funds now. Entrepreneurs turned neo-art aficionados have lately been getting funny ideas. Who knows? There is always the proverbial worm for the early bird.

So I read their disclaimers in IPO offer documents.

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Of SEBI: “SEBI only gives its observations on the offer documents and this does not constitute approval of either the issue or the offer document.”

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Of NSE: “It is to be distinctly understood that the permission given by NSE should not in any way be deemed or construed that the offer document has been cleared or approved by NSE nor does it certify the correctness or completeness of any of the contents of the offer document. The investors are advised to refer to the offer document for the full text of the disclaimer clause of the NSE.”

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Of the BSE: “It is to be distinctly understood that the permission given by Bombay Stock Exchange Limited should not in any way be deemed or construed that the Red Herring Prospectus has been cleared or approved by the Bombay Stock Exchange Limited nor does it certify the correctness or completeness of any of the contents of the Red Herring Prospectus. The investors are advised to refer to the Red Herring Prospectus for the full text of the disclaimer clause of the Bombay Stock Exchange Limited.”

I agree this is a practice followed by regulators / stock exchanges globally. All of them are spineless freaks that neither have the gall to own up nor wish to let go off their influence. They know that no process of due diligence can be 100% fool proof. In other words, they're sure of their propensity to goof up. Yet, they just want to be there because they are. Wonder what will they regulate in Art? Will they know a Leonardo Da Vinci from a pattern in the ceiling left by some regulatory muck hitting the fan? May be they’ll add a few more lines to their disclosure. Or better still – create an intermediary, that knows even less, (a la merchant banker) to blame everything on.... The more things change, more they're the same.

But sure as hell will charge that fee :)

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Corporate Governance...? Mr.Damodaran, you must be kidding...

Remember Swaraj Paul…? The raider that stalked companies like Escorts and DCM in 1983…? It has indeed been the first such event that shook up the staid Indian promoters from their slumber, made them review their marginal holdings and think up defenses including issue of warrants.

Now Lord Paul’s then broker, Harish Bhasin is back in the game. He has taken the CLB route, alleging that the promoters of DCM Shriram Industries Ltd. are issuing warrants to themselves at (Rs.52) steep discounts without offering them to other shareholders. Each warrant entitles the holder to buy 3 equity shares. The advantage for the promoters is that they can just remit 10% of the price of the warrants and pay the rest over 18 months. If they find the share prices have zoomed, they will happily subscribe to the warrants at the earlier discounted price. ( Scope for raising debt to pay the remaining 90% by pledging the warrants that are in-the-money is easy, especially in these ultra liquidity times.) If they don’t, they just let the offer lapse. Is this corporate governance, Mr.SEBI chief…?

Mr.Bhasin, eyeing the huge land bank the company has at various locations, have challenged this and has come up with an Open offer to other shareholders (at Rs.70/-). This had prompted DCM promoters to react by raising the warrant prices (to Rs.90/-) by 75% at once (and extending subscription period by another 18 months, of course), meaning their still exists tremendous upside to the stock’s intrinsic value. Here's HB's latest counter offer (at Rs.120/-). The game is heating up... Given the fact that sugar industry is facing a mix of bad fortunes (supply glut, state administered prices, cane costs are higher than market price of sugar etc.), the stock prices have slipped a lot and what best time to shore up and consolidate? They know, bad times don’t last forever and for sugar, it's lasted long enough…

Dear Mr.Damodaran, if you are serious about enforcing corporate governance, let SEBI focus on the warrants game. That’s where there’s no transparency. The promoters issue warrants after passing a resolution u/s 81(1A) of the Companies Act, 1956 (notice that year…good lord !) which is a farce. Hardly 1% of the shareholders (in numbers) attend AGM and even postal ballots, nobody bothers to mail in. That’s clearly not working. I have a suggestion. Make it compulsory for warrant holders to pay up 50% of the issue price of warrants upfront and shrink the overlay period from 18 months to just 3 months. This would let in only serious players to take this route and will not permit share price arbitrage game.

Dear shareholders, I’ve been telling you guys to buy sugar stocks, now. Sugar business is cyclical and it’s on the cheap now. Most of the sugar mills carry large swathes of land that could be sold / developed in the current real estate boom. From hereon, I can see only upside for sugar industry since all things that can get worse, already has.

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Warren Buffet said, when others are fearful, you be greedy. In sugar stocks, you've a good reason to be greedy. Buy it. Buy it all… It’s not lost on you, just yet… Why let only promoters or a takeover raiders to make a killing? It'll be too late once the raid is launched. Be there, before the event....Will ya...? (Full disclosure : I and my family hold KCP Sugar Industries shares).

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[Update : Reader Dnyanesh has sent this link to an excellent article by Anil Singhvi on corporate governance. Thanks Dnyanesh.... Hat Tip !]

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Do away with P Notes - Give us infrastructure

Has the recent crackdown by SEBI on P Notes issued by FIIs been effective? Will it yield the desired fruit – that of controlling copious flows of capital from unidentified or least regulated entities? Well, time will tell.

But RBI still has to deal with its daunting problem. The surging capital inflows continue to pose a policy challenge for the Reserve Bank of India (RBI), as it undertakes its mid-term policy review tomorrow, despite some measures taken to contain unregulated inflows. The central bank is unlikely to signal any easing of monetary policy with surplus liquidity in the system, as any lowering of interest rates at this point, could hold upside risks to inflation.

The Prime Minister's Economic Advisory Council had estimated that an increase in the forex reserves of the RBI of $26 billion in 2007-08 could be consistent with the current real growth of the economy, moderate monetary expansion ( 17.5 per cent) and a tolerable inflation rate (4 per cent). "In the current financial year up to early October 2007 itself, forex reserves have increased by over $50 billion and tackling this problem is the most crucial policy dilemma," S S Tarapore, former deputy governor, RBI has said.

I often wonder – why not RBI absorb the excess liquidity thro infrastructure bonds and divert the entire corpus exclusively to address India’s appalling infrastructure needs – better Airports, Ports, Dams, Roads and the like… Given the pathetic state of our infrastructure, no sum of money would be found to be `excessive.’ We pay humungous sums anyway by way of Airport tax, fuel surcharge, toll etc. Is it not time we expect something in return…?

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A quick and clean surgery...?

He may not have gotten the coverage like a Chris Cox gets. But M.Damodaran, Chairman of SEBI is no less charismatic.

He stood his ground on restricting the use of participatory notes (P-notes) by foreign institutional investors, but made two important announcements.

The first is to allow proprietary sub-accounts of foreign institutional investors (FIIs) — i.e. sub-accounts that are formed to invest their own money — to issue P-notes provided they apply to register themselves with SEBI in the next 24 hours.

The second is to put registration of FIIs on the fast track. Addressing FII representatives from all over the world through a video conference, Damodaran, however, said the issue of offshore derivative instruments by other sub-accounts of FIIs will not be possible after the changes it proposed last week come into force.

Hope Damodran performed this surgery quick and clean, like he fixed the mess at UTI. Now will the market get back to its surge up north…?
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Cost of regulatory moodswings

Life’s a wave for all – has its highs and lows…SEBI is no exception.

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On occasions it’s on a regulatory Viagra and at others just as it has now, it goes flaccid. It’s the same with regulators everywhere.

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In the US Sarbanes-Oxley (SOX) is a poster child for a government act whose cures are worse than the disease. Given several ways to dodge its regulations, if one is intent on doing so, efforts to check will almost always fail. To ensure companies comply with the SOX regulations, the four large accounting firms that do almost all public company audits have raised their fees an average of 78 percent to 134 percent in 2004. Professor Ivy Xiying Zhang of the University of Rochester has calculated SOX has resulted in a cumulative loss of $1.4 trillion for the shareholders of public companies – that’s an average loss of about $460 for every US citizen.

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In India the regulatory cost will be borne by just about 5% of total population that has any exposure to stock markets. Now do your own math...

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The QIP deep dive

As early as January, 2006 a report by the SEBI-committee raised concern over the growing number of Indian listed companies tapping funds through the GDR/FCCB routes, on account of its time and cost effectiveness adversely impacting the depth of the domestic markets. While the number of follow-on public issues in domestic markets during 2001-02 to 2004-05 period rose from zero to six, the number of GDRs/FCCBs from listed Indian companies grew by three-fold from three to 42, the report had said.

On the basis of this report, SEBI came out with a solution in May, 2006 in the form of Qualified Institutional Placements or QIPs, which were significantly less cumbersome than IPO filings. As per the guidelines, issuers will have to allocate a minimum of 10 per cent of such placements to mutual funds. For each QIPs, there shall be at least two allottees for an issue size of up to Rs 250 crore and at least five allottees for an issue size in excess of Rs 250 crore. "Further, no single allottee shall be allotted in excess of 50 per cent of the issue size," the guidelines stipulated. The securities issued through QIPs will be equity shares or any securities other than warrants that could be converted into (or exchangeable) with equity shares, SEBI said in a circular.

The placements of these specified securities could be made only to Qualified Institutional Buyers (QIBs), while a minimum of 10 per cent in each such offer should be allotted to mutual funds, the regulator said. Promoters or those related to the issuers are barred from participating in such issues. Owing to these advantages, companies took to it happily.

But now since the market has been in a bearish mode for the past few weeks, the floor price stipulation (being the higher of the six-month weekly average or 15-day weekly average of the quoted prices) in the QIP guidelines have begun to adversely affect the issuances. The floor prices based on the SEBI formula are now higher than their current market prices. The floor price is again applicable from the date of the enabling resolution by the board. Of late, prospective issuers are finding their floor prices higher than their current prices. While SEBI doesn’t allow the QIP issuer the flexibility to revise the price downwards, investors wouldn’t be willing to come in at a price higher than the prevailing market price. Catch 22 of sorts.

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Will SEBI relax its floor price norms for QIPs or let it lose flavor ? Keep watching this space.

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