Why the lure of short term delisting gains can be painful...

May 21, 2014

In this issue:
» Dismal hiring pattern in manufacturing sector
» Mr. Rajan seeks autonomy for PSU banks
» Remuneration trends in IT sector: Should investors be worried?
» Charles Plosser : Excess reserves pose threat to US economy!
» ...and more!

Time and again, there are incidences in the stock markets that open our eyes to the loopholes that can cost investors dearly. In a recent event, the stock of Transgene Biotek hit the upper and lowest circuit on the same day. Unfortunately, the regulator is yet to acknowledge chances of a foul play as alleged by the investors. But what specially caught our eye here is the complaint by shareholders that the company had in the past deliberately announced its delisting at a price 2.5 times more the prevailing share price. As reported in Moneylife, investors believe that the promoters did not have any intention to de-list the company, and the announcement was just a way to manipulate share prices.

Stocks is the ideal asset class for long term investment . However, there are times when investors find it difficult to resist the chance of making short term gains. One such event is delisting announcement. As often noticed, a mere rumour at times is enough to shoot stock prices up. The chances to make quick gains at times tempts investors into buying stock with the only intention to earn delisting gains. And in doing so they at times end up burning their fingers!

Delisting is an event when a publicly listed company permanently disallows its shares from being publicly traded. The reasons could be expansion, restructuring of operations, acquisition or promoters wanting to raise stake in the company. At times, delisting could be forced on the company by stock exchanges as a penalty for non compliance to listing rules.

In the normal delisting case, the firms initially offer a delisting price which is usually at a premium to the traded price on exchange. However, it is just an offer and it is the investors who quote the price. As of now, while the regulator has fixed a minimum price to delist, there is nothing in the norms about the maximum price. This leads to a lot of speculation in prices post a delisting announcement. Currently, delisting is done through the reverse book building (RBB) method. Under this method, the highest price at which the maximum number of shareholders places their bids becomes the offer price. That said, the final option to accept or reject this price rests with the firm. Further, as per delisting norms, a company has to buy the statutory minimum 90% for successful delisting.

All these norms or rather a lack of a proper norm results in unreasonable movement in stock prices. In a lot of cases, an actual delisting does not follow an announcement , finally leading to stock price crash. And this can be a rude shock for the investors betting on a company likely to delist.

So coming to the key question - Should investors chase a delisting candidate?

The answer is: Delisting should not be a reason to invest in a company. Investors need to keep in mind that delisting has in some cases been misused by management just to manipulate stock prices.

Infact, acknowledging the problem, SEBI has recently stated that it plans to overhaul the delisting process. The regulator has proposed to introduce broader price discovery mechanism, reduce the timeframe and restrict the trading of their shares during the last few days before the closure of the reverse book-building (RBB) process. However, even these moves may not ensure an efficient price discovery.

Keeping in mind the associated risks, we would recommend investors to stick to stock picking approach that is based on fundamentals and valuations. Irrespective of events like delisting, such an approach is likely to earn strong returns over the long term.

What changes do you think should be introduced to delisting process so as to avoid the chances of price manipulation? Let us know in the Equitymaster Club or share your comments below.

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 Chart of the day
Lack of job creation in the manufacturing sector was one amongst many allegations that were levelled against the UPA's regime. Analyzing the past track record reveals that UPA, indeed, fared poorly when it came to job creation. Sample this. Between 2004-2013, when the UPA was in power the job growth in the manufacturing sector stood at meager 2.87%. Hiring patterns at 28 top listed manufacturing companies were taken into consideration here. This was to ensure that sample was large, diverse and better represented the industry.

As can be seen in today's chart, healthcare industry registered the highest man power growth of 7.7%. However, hiring in sectors like cement and fertilizers declined. Nonetheless, there are two things which could have led to such dismal hiring growth. One is automation which reduces the requirement of labor. Second is the contractual nature of jobs which are offered by most companies these days. Since these laborers are not on the company's rolls their addition does not get reflected in the overall manpower count. However, there is no denying that indecisiveness in UPA led to a freeze in hiring in the last decade. It would be interesting to see if and when the new government is able to revive it.

Manufacturing sector lags behind in job creation

The voice against inefficiency of public sector banks is getting stronger by the day. And the central bank is at the forefront of those seeking autonomy for PSU banks. It was just a week earlier that we wrote about the recommendation of a RBI panel headed by veteran banker P J Nayak. The recommendation suggested that the government should bring down stake in PSU banks to below 50%. However more recently RBI chief Dr Rajan said that privatization of PSU banks was not absolutely necessary to make them autonomous. Instead the government should stop interfering in their day-today affairs.

More often than not the government has treated PSU banks as cash coffers. The lending rate decisions and priority sector loans are predominantly influenced by political agenda. Hence despite being regulated by the RBI, the PSU banks have to abide by the mandate of the Finance Ministry. To add to their woes, the top management of these banks are selected and transferred as per the government's will. The result being that there is very little continuity and long term planning. While the government continues to draw dollops of dividend from these banks, the interests of depositors and minority share holders are heavily compromised.

As per Mint, Dr Rajan is not in favor of forced merger of PSU banks. He, however, believes that voluntary mergers would go a long way in making the banks more efficient and strong. We believe that both autonomy and merger of smaller PSU banks could be the most critical steps that will win them investors' favour.

We all are well aware of the furore caused by a recent plan by MNC giant Coke to reward its employees disproportionately. In fact, even someone like Warren Buffett had to face a lot of heat for being a rather passive observer to the whole episode. We were reminded of this by a similar event that is being played out much closer to our homes. A leading daily reports how the salaries of the CEO and Chairman of Wipro Ltd have seen a substantial jump over the previous year despite the firm's performance being rather lacklustre.

Deserving special mention is the Chairman Premji's compensation which has more than doubled in FY14 over the previous year. The company's CEO has also seen his salary go up by more than 20% during the same period. Well, the development is rather baffling as Wipro has had a rather decent record in matters of corporate governance. However, it turns out that the other large IT companies aren't far behind either. As the article highlights, the salaries are high for these companies even on a global level. Is this a big enough cause for concern? Not immediately maybe but if the trend does persist then questions will certainly be asked.

That the US Fed has accumulated massive debt as a result of its loose monetary policies is a fact well known. So when Charles Plosser, the Philadelphia Fed President, made a statement that the US Fed is sitting on a ticking time bomb, we were hardly surprised. The ticking time bomb that Plosser is talking about is the excess reserves in the banking system. The Fed had created these reserves through the purchases of US Treasuries and mortgage backed securities. But these reserves are still sitting with banks and have not really been released. This is because the economic activity has been so weak that credit offtake has not really taken off. So, when the US economy does begin to recover, lending will increase and these reserves will be released. With more money into the system, the possibility of inflation rising cannot be ruled out. If that happens, the Fed might have to raise interest rates faster then what was envisaged. Higher rates in turn would once again thwart economic growth. So should the excess reserves be trimmed sooner or later? Both scenarios paint a grim picture and will probably boil down to what is lesser than the two evils. Either which way it is basically a problem of the Fed's doing or it will be interesting to see how it chooses to tackle the same.

There can be no doubt that India's gold demand has fallen over the last several months. The UPA government along with the RBI had put restrictions on gold imports to curb the current account deficit (CAD). The measures have had the desired effect. As per the World Gold Council (WGC), in the Jan-March quarter of 2014, Gold demand in India declined by 26% YoY to 190.3 tonnes and by 33% YoY in terms of value. While this may have helped to officially reduce the CAD, it has encouraged imports via illegal channels to satisfy the domestic demand.

Thankfully, now there is greater awareness than before regarding such undesirable practices. As per the WGC, with a pro-business government now in power, things could change for the better. The expectations are high that the short term curbs on imports will be removed by the NDA government. If this were to happen we can expect a pick-up in gold imports. This will also benefit the jewellery industry. The import restrictions had made the environment quite challenging for such firms in 2013. If the restrictions are removed these firms could see better days ahead.

The Indian stock markets, after opening weak, continued to slip in the negative territory. At the time of writing, the benchmark BSE-Sensex was down by 144 points (-0.6%). Most of the sectoral indices were trading in the red led by capital goods and banking stocks. Only IT and FMCG stocks were trading positive. Most of the Asian stock markets were trading weak with Taiwan and Japan being among major losers. However the Chinese index was trading strong. European markets opened the day on a mixed note.

 Today's investing mantra
"Owning stocks is like having children -- don't get involved with more than you can handle. " - Peter Lynch

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1 Responses to "Why the lure of short term delisting gains can be painful..."


May 22, 2014

Nice article. A real eye opener for those who look for quick gains on delisting announcement. Although this happens mainly in MNC stocks, the domestic promotors have found this new way to manipulate the share price, very attractive.
The companies should be made to deposit substantial amount with SEBI before they make delisting announcement. This will avoid delisting announcement just for the sake of manipulating the share price.

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