Perfect Storm in Primary Markets - Straight from the Hip by J Mulraj
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Investing in India - Straight from the Hip by J Mulraj
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11 FEBRUARY 2008

The fall in the secondary market has hit the primary, or IPO, market. Whilst IRB Infrastructure managed to get subscribed, two issues, Wockhardt Hospital, and, surprisingly, Emaar MGF, withdrew their offers.

There are several issues to be considered in the IPO debacle. In its attempt at providing information, regulator SEBI may, perhaps, have provided an information overflow. The Red Herring Prospectii are handed out when entering an analyst/broker/press meet, with just a few minutes to scan voluminous documents and ask intelligent questions.

The indicative prices of the issues are decided in one on one meetings with select qualified institutional buyers, who judge the valuation based largely on future prospects. Yet in public meetings with analysts/brokers/press future prospects are never discussed, on the ground that issuers are barred by SEBI from talking about anything not revealed in the prospectus. The retail investor thus has to go by assessments of valuation by the QIBs, who may perhaps have such access.

Retail investors use as an input the prices quoted in the gray, or illegal, pre market. Since it is, by definition, an illegal, hence non transparent, market, it is susceptible to manipulation. Perhaps it may not be a bad idea to make a premarket legal and transparent, allowing participants to trade through stockmarkets so that the prices are perhaps fairer.

Absurd gray market prices then creates an artificial demand, which gets consummated by the ease of financing. In fact, IPO financing is a very lucrative business for the investment bankers, some of which have banks. The financiers take 10% from investors and finance the rest, at rates which give them a good spread. This encourages a culture of flipping, i.e. selling the stock immediately on listing. In other words, investors in IPOs rely on non transparent information from the gray market, to apply for shares using borrowed funds, so as to make a quick buck on exit. This is a display of greed, with no sympathy for it should it fail to result in the anticipated gain.

Not only is it individual investors that flip but also, surprise surprise, many of the institutional ones. This is where the 'discretionary allotment' bit of the investment banker comes in. The lead managers quote absurdly low fees to manage the issue, sometimes even zero fees. Since they are not charities, they are making good elsewhere. One is through the IPO financing. The other is through discretionary allotment. This is used to strengthen relationship with their favourite clients. The allotment is supposedly made to long term investors; SEBI must obtain data to see how much of the discretionary allotted stock is actually flipped within, say, a month. It may then, perhaps, impose a 6 month lock in on such discretionary allotments if it so desires.

Several years ago there was a survey of Taiwan in the Economist. One doesn't know if it still holds, but then new companies were not allowed access to equity markets. They needed a 3 or 5 year track record to be entitled to list. In India we have new companies not only listing, but doing so at prices, based on estimates of future earnings (not available to individual investors) that are high. Perhaps we could look a model where some sort of past operational track record is available. In the US, there are several levels of listing, whether on bulletin boards, or on smaller exchanges and finally on the big boards.

But to think of denying access to equity without a 3 year track record, we then needs to develop a vibrant venture capital ecosystem so that new ideas get enough funding to flourish. It is the venture capital industry in the US that is actually one of the main success factors for the innovation that comes out of it. The venture capital industry must necessarily be in the private sector because the public sector has been made to afraid of failure. Bad investments come under auditing scrutiny, thereby enervating the risk taking ability of management. One out of ten projects succeeds in venture capital funding; nine fail. We need a culture that accepts such failure (provided it is not deliberate) and the public sector doesn't allow it.

Last week the BSE-Sensex fell 777 points to end at 17464. The biggest contributors to this fall were ICICI Bank, with 212 and Reliance with 127. The NSE-Nifty fell 187 points, to end at 5129.

This fall is akin to the diarrhoea consequent to overindulgent greed! India still remains a good story, though we have a bumpy ride in the months ahead. First we have the Union Budget end February, the last one of the present Government. It should be full of populist sops, tinkering around here and there.

Look at what the Finance Minister has done to investors. Whilst imposing the pill of STT (securities transaction tax), a big big money spinner for the Government, he coated it with tax exemptions to make it palatable. Short term (less than a year) capital gains would be taxed at 10% and long term would be exempt. Having got STT accepted, he then let loose his officers, who made an artificial dichotomy between investors and businessmen, taxing the latter at steeper rates. The distinction is completely arbitrary which, of course, is a ticket to dishonesty.

Ok, so if you want tax revenue Mr Chidambaram, collect it. But do so honestly and transparently. Why not have non subjective criteria? For example, if sold within 6 months, tax at 33%, between 6 months to a year, at 20% and over a year, at nothing. If you want to encourage honesty in your department, do that.

Or take the duplicity of dividend taxation. Dividend is taxed at the hands of the company paying it instead of in the hands of the recipient, making its collection easier. Now, on the plea that dividend income is tax free, the IT Department disallows expenses of investors (accountants, errand boys etc), even though, in fact, the tax has been paid.

Public governance by the Petroleum Ministry is no less appalling. The failure to raise prices of petrol and diesel is insane. It only encourages usage of private transport which, in turn, has huge environmental impact. Witness changing weather patterns. India is going to be one of the major contributors to global warming. The larger the pool of private vehicles we build up on our roads, the bigger will be the problem of how to tackle global warming as well as energy scarcity. We are simply subjugating our future to our near term electoral needs of appeasing a vote bank of car owners.

After the Feb budget we will have the Rajya Sabha elections in April and the Pay Commission report, which is also very likely to significantly enhance the pay of Government workers, burning a hole in the budget. Given the record of recent state elections, one needs to see if the Government will be able to have control of the Upper House or what would happen to major reform bills should it lose it.

Given all this, the next three months are likely to be choppy. The market will likely be in a trading zone moving sideways in a 3000 sensex band, for the next few months.

Have you read the latest Honest Truth by Ajit Dayal?

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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