Changing complexion

Three transformations that investors will have to prepare for as the market undergoes another evolution

By Mohan Sule
The way of doing business has gone a dramatic change since last May. Transparency and rule-based governance are the buzz words. Natural resources are being auctioned. There are no phone calls or chits from the PMO or extra-constitutional authorities to bank CEOs to grant loans to cronies. Company bosses and lobbyists no longer have to make frequent trips to New Delhi with suitcases to tweak policies to suit them. The transformation is welcome and is another pointer that India is slowly graduating to a demand-based market from a supply-controlled economy. Investors have to prepare for the next phase in the evolution, where a company’s value will be determined by cost-efficiency and competitive policies rather than due to the monopoly status acquired by bagging licences based on proximity to the policy makers. The rise and fall of Naveen Jindal’s JSP should be an apt illustration and so also the wealth creation by the Adanis through acquisitions. Instead of SBI, the group is scouting finance from Russian and Chinese banks for its Australian mining project. The earlier stages saw the scrapping of the Controller of Capital Issues, which was vested with powers to decide not only the entry but also the size and price of the offering. The opening up resulted in a flood of fixed-price issues from the established to the shady. To solve the problem of hefty premium, the power of deciding pricing has been transferred to the market through book building. Another difference is the motive of the IPOs. Initially, they were to raise funds for expansion. Now shares are listed to allow early stage incubators to exit. The issue of expensive offerings, thus, continues.

The next stage is crucial. It can either propel the stock market’s wealth or discharge the third shock. The first was the period when fishery and aqua culture growers and timeshare promoters ripped investors, followed by the bursting of the dot-com bubble blown by eyeballs. Two types of issues will dominate. The first, of course, will be from the infrastructure sectors as stalled projects spurt to life. The not-so-pleasant past experience with these companies in the frontline of benefiting or losing due to government’s wise or whimsical policies might prompt caution. The second lot will be emerging companies, predominantly from the services sector. This is natural. The share of the services sector in a developed economy overwhelms manufacturing and agriculture. Pinning down valuations will be difficult due to their unique business models. Investors grappled with a similar dilemma when fast-food chains and telephony- and web-based aggregators of information ranging from general to wannabe brides and grooms and jobs entered the market. Is the valuation expensive based on trailing 12 months or cheap discounting the enormous forward earning potential? Lately, theme parks have sought funds and going forward there could be those setting up digital platforms to exchange used goods, sell furniture or find suitable houses not to exclude e-supermarkets. Should the market compare them with tech companies? Many of them may not even have comparable brick-and-mortar peers. More than these wonders, perhaps below-the-radar back-office and last-mile services providers are likely to be the winners, just as our tech companies remained immune from the crash of Internet companies.

The second challenge for investors will be to spot when a generational change takes place. Usually, the recast of indices is a good guide to notice the shift. Despite the first-mover advantage, Nokia and Blackberry have lost market share to the disruptive Apple. Traditional business houses have been shaken to the core by the net revolution, which has flattened the globe. Not surprisingly, they are in the forefront of the campaign to discourage zero rate arrangements between Internet service providers and e-commerce companies. The worry is that an agile upstart can neutralize the high-entry barrier in the real world by diverting traffic to its site by tying up with an ISP. Investors are already in the midst of the third wave of change. As the government pulls out from the business of running businesses, monetary rather than fiscal policies are having a far greater impact on the market. The US Federal Reserve’s moves are closely monitored. China’s softening of interest rates created ripples and so also liquidity injection by the European Central Bank to pull the euro zone out of recession. The policies to control the flow and the cost of money will affect the health of the market more than the budget as tax rates become stable and the government runs a system without many shocks to attract investors. Just as the Fed chairman is the most powerful person in the world, the Reserve Bank of India governor will be the man to watch out for.

Clash of conventions

Is volatility good? Can you trust promoters pledging their shares? Do cash-rich companies need investors?

By Mohan Sule

Stocks have been volatile of late, rising and falling with the flow of news. A sudden development interrupts consecutive days of unilateral direction of the market. On some other occasions, equities plunge or surge with equal ferocity on alternate trading sessions or even intra day. Events influencing investing are not necessarily confined to India. Stalling of key bills in the Rajya Sabha pulls down the market and so also improvement in US jobs data, sparking fears of US Federal Reserve sticking to its course of hiking interest rates from June. Similarly, cut in lending rates by China’s central bank casts a gloom on worries that the move will increase consumption of commodities by the largest manufacturer in the world and thereby boost prices as well as on concerns that the issue of retrospective collection of minimum alternative tax will drag on in courts. Besides the softening of the position of Greece on payment of debt instalments, putting on block a couple more PSUs for stake-sale and reworking the urea subsidy mechanism to kick start fertilizer production induce optimism. In short, the market is jumping from one issue to another without letting the resolution of earlier problems to percolate. This is because valuations have raced so much ahead, taking for granted that the NDA government will be bombarding the economy by one reform after another. Earlier, the delay by parliament in approving increase in FDI in the insurance sector to 49% was painted as the ultimate reform on which the well being of the economy hinged. Now it appears that the passage of the amended Land Acquisition Bill is the final frontier for India to conquer.

It should be evident by now that the Narendra Modi government wants to take one step at a time, covering its tracks even if it means delays, so it cannot be accused of carrying out reforms at the behest of certain sections of industry or to appease some other segment. In the process, however, it is the retail investor who is left wondering if the market flux is here to stay or temporary. Yet, realization in emerging that volatility may not be bad after all. For every foreign institutional investor fed up with the dodgy interpretation of tax rules in India, there might be a mutual fund familiar with the grinding speed with which the bureaucracy functions but still believes in the India growth story. The wild fluctuations are more likely to be a clash of opposing views rather than a reflection of a shallow market. The correction and recovery ensure valuations do not enter bubble territory or a downturn. A secular trend is more dangerous as it exemplifies unwarranted pessimism or irrational exuberance. The severe market gyrations should lead to rethinking of the vanilla concept of bull and bear phases. The other is of pledging of shares by promoters, which triggers a reflex ` sell’ action by investors, conjecturing all sorts of dark scenarios ranging from extravagant lifestyle of the owners to mismanagement.

Not all companies operate in ever-green sectors such as FMCG, pharmaceuticals and tech. A developing country needs capital-intensive industries. These companies have lots of debt, low promoter holding and ongoing capital expenditure. Shares are mortgaged to fulfil promoters’ contribution or to buy more shares to retain controlling interest after equity dilution. Better a promoter who publicly pledges his shares and invites focus on his company than who liquidates his holding in trickles and dribbles while the going is good. An extreme view is that it is only a matter of time before such inefficient promoters are dislodged in favour of an agile management. Another traditional position is being threatened in the face-off between companies preferring to keep investors happy with liberal dividends and those that are undertaking expansion and diversification for capital appreciation. Investor activists demand cash-rich companies to go for buybacks or increase the dividend rate and, in the process, further boost their valuations. The problem is that the perceived tax-free status of dividends despite the dividend distribution tax attracts risk-averse investors to dividend-yielding scrips over taxable fixed deposits or growth stocks. The fear is that acquisitions will result in leveraging of the balance sheet and sometimes turn out to be bad fits. Capacity expansion can go horribly wrong if anticipated demand does not materialise or there is disruption in the market. Yet, dividend yield too varies depending on the mood of the market. Just as interest rates recede, premium on companies with generous payouts also shoots up in a bull run. So if equity investing is providing risk capital, why chase overvalued companies not in need of cash?