Monday, August 27, 2012

Destiny of IFCI : Will it again be a PSU

On 24th Aug, The Cabinet Ministers of India decided to convert Optionally Convertible Debentures of IFCI to the tune of Rs 923 Crores at PAR. Post conversion government will directly hold 55.57 % of IFCI and up to 68.31 % of IFCI if we take into account the stake of other PSU in IFCI. There was full disclosure in the annual reports of IFCI about the conversion at Par subject to SEBI guidelines on Takeover.

Ifci logo

We will also look at the background of IFCI,

The Industrial Finance Corporation of India (IFCI) was converted into a company incorporated under the Companies Act, 1956 on 31.3.1993. It was then decided that holding of Government controlled institutions in IFCI should be maintained above 51 percent.

In the wake of likely systemic impact of IFCI defaulting on its liabilities, in the year 2001, the Government infused Rs.400 crore as Tier-l capital of IFCI in the form of 20 year 9.75 percent unsecured Convertible Debentures. This was a cash neutral transaction.

Thereafter, in December 2002, the Government had approved a financial assistance of Rs.5220 crore to IFCI which was to be released over the period from 2003 to 2011-12. Out of the package of Rs.5220 crore, financial assistance of Rs.2932.31 crore (Rs.523 crore as loan in the form of OCDs and Rs.2409.31 crore as grants-in-aid) was released. In 2006-07 the company started making profit and it was decided to stop release of further assistance to IFCI. The OCD terms said that IFCI can repay OCD to government.

The equity holding of Public Sector-Banks / Financial Institutions / Insurance Companies remained over the threshold limit of 51 percent till March 2004. Thereafter dilution in the holding took place in 2005 and it came below 51 percent.


Committee of Secretaries was constituted, headed by the Finance Secretary and comprising of Secretaries from the Departments of Economic Affairs, Expenditure and Financial Services. The Committee, after due consideration and taking into account all the facts, has inter-alia recommended to convert the OCDs of Rs.400 crore and Rs.523 crore into equity at par and that the Government need not make an open offer to the shareholders of IFCI and instead take exemption from SEBI under Section 11(1) of the SEBI (Substantial Acquisition of shares and takeovers) Regulations, 2011. 

Let the understand the impact of this conversion :

a) IFCI will become a Public Sector Undertaking (PSU), which will come under the ambit of bureaucracy, which may lead to delay in decision making.
b) The Expected EPS of FY12 will fall from around Rs 8 to Rs 3.60.
c) The price of Equity shares before the conversion was around Rs 35/-, After the conversion keeping other things same and Increasing the capital and decreasing the debt by Rs 923 crores, The new value comes to Rs 21 /-. (Cost of Equity)

There is a direct diminution in the value of IFCI call for us to see it lens and raises the question of Bureaucracy against Minority Investors. There are several points to look into the conversion of OCD.

a) Can Government convert the OCD in Equity?  Yes It was in the terms when OCD of Rs 523 Crores were  issued, also the Prevailing Market Price at time of issue of OCD was below Par, We should also understand that IFCI has received grants to the tune of 2409 crores.
About the issue of OCD worth 400 crores , it was a cash neutral transaction to maintain Tier I capital of the company. Also IFCI has the right to Prepay these OCD, I am not too sure How can government convert it in shares, effectively values of that Rs 400 crores become much more because of conversion, whereas IFCI investment of Rs 400 Crores in GSec does not change.

b) Can IFCI challenge such conversion : I doubt about it, The conversion is as per agreements, but which may not be bad in law but it may be bad in  spirits ? It is an executive order by CCS, where Law and State Machinery are part of it.

c) What about Minority shareholders : Minority Shareholders stand to lose, because of conversion. There was a disclosure for conversion, along with that it was mentioned that the conversion will have to follow Takeover guidelines. As per the guidelines, The government will have to buy 26% shares from minority shareholders as per SEBI formula of offer Price. But Instead the government choose to take exemption from SEBI u/s 11(1).

As per section 11(1), The SEBI board can grant exemption from making an offer for acquiring shares under the regulation after recording the reasons in writing from acquirer and if it is in the interest of investors in securities and the securities market.

I fail to understand, how exemption is in interest of Investors or Market, It seems these section is invoked to not make open offer.

d) Can SEBI look in the Matter : NO and Yes. SEBI cannot stay the conversion as they are as per terms and condition of OCD, but YES SEBI can take a stand on Open offer, I don't know how can SEBI get convinced that such exemption is in the interest of the Investors and markets. These will be a case for SEBI , where its stand for Investor Protection may be compromised.

As of now It does not seem that SEBI will be able to stand for Investor Protection and its stand may be compromised.

What about the future: IFCI as an institution is regaining its dominance, but after the conversion  there are areas where clarity will emerge only in future
a) Decision making may become slow.
b) IPO of one of its subsidiaries will be delayed, reducing its valuation
c) The talks of inducting a strategic investor will be a thing of past
d) Its biggest blessing in disguise may be that they may get a banking licence , which is also in distant future.

The returns of IFCI minority shareholders in long run will vindicate government action for conversion of shares.

I welcome you critical comments and suggestions

Sunday, July 15, 2012

The MCX Equity Exchange : Can it make a mark ?

Yesterday, MCX got a permission to start an equity exchange, sounds good as it will add to product list which can be traded, but can we make a list of what may or may not happen after this development.

It makes me think that with a long history of being an oldest exchange, if BSE is struggling with volumes, how would new exchange garner volumes. BSE generates volumes in derivatives only because of LEIPS (Liquidity enhancement program), where the traders are compensated for the statutory cost else there is no volumes in derivatives exchange

Then how can MCX make its mark ?

a) MCX intends to replicate success of MCX commodities and to some extent Currencies in Equities, but we must know that i) MCX & NCDEX started trading at around the same time, when neither had lead nor volumes.ii) Today MCX has volumes but if we dissect the volumes, they are mostly speculative and only in Metals, where delivery in very miniscule, whereas NCDEX commands higher volumes in Agri Products and huge quantities are marked for deliveries. iii) There is miniscule institutional participation in MCX whereas Big Trading houses and Many MNC procure through NCDEX. 

In Equities , to garner volumes you need the participation of Retail Investors, Traders, Prop Desk and also Institutions, but if we look at the above instance Institutions don't trade on MCX. It needs to be seen, How can MCX get institutional investors on board.

b) The biggest advantage of MCX, is that it has trading software and the required domain expertise in creating a back-end of trading in place. Thanks to support of its parent Financial Technologies. ODIN software (A front-end software for trading) was the only player until before some time, but now there are many other software vendors, but its still the leader.

c) I am also concerned about the risk management and work ethics in MCX, They need to come out with strong risk Management and strict code of secrecy and work ethics of its employees.

What can MCX do to make a mark ?

I believe that MCX  will have to differentiate their products to attract more players and different breed of players.

a) The first and foremost is they should try with delivery based Stock futures and options : There is a strong demand for delivery based derivatives in Indian market, but NSE is reluctant to introduce this as there is a fear of loss in volumes and NSE trading structure for cash and derivatives segment is different as such that they cannot introduce deliver based derivatives, whereas IF MCX goes on lines of Clearing members and Trading Members for equity brokers also, they will be able to introduce delivery based derivatives.

Incidentally all institutions are for delivery based derivatives and this is an opportunity that MCX can grab, because if Big breed of Institutions trade in MCX, then others are there to follow.

The Basic rational is Institutions have to run VWAP on Expiration day to close their positions and they expect volumes for VWAP, which they get only in NSE as of now, but if the stock futures are delivery based, they need not worry about the delivery, but volumes will follow as stocks will be marked for delivery.

b) In the same manner , they can trade in American options instead of European option and institutions would be a  more comfortable in such trades and it will also create sophisticated arbitrages opportunities for complex trades, which they will love.

c) The biggest obstacle wold be INDEX, It will have to create its own INDEX to trade, but they have opportunity like they can also introduce trading in MSCI index and other such index, which are maintained by big institutions and tracked by foreign investors.

d) SEBI guidelines for Derivatives market  mandates the structure of Trading Member and Clearing Member, such structure in Equities will also help MCX to garner its long list of small brokers and avoid Risk Management issues.

MCX will also have to overcome some regulatory issues like :

a) SEBI may move to supreme court for a stay in ruling, further increasing the waiting period.
b) SAT has mandated to reduce their stake in MCX below 10% in 18 months, which will impact its valuations.

Looking forward, we can look at MCX equities exchange as an opportunity for different class of investors and to satisfy their investment needs.

I welcome your critical comments and suggestions

Sunday, May 20, 2012

The Current State of Issue of Shares: Will it make or Break

Since last one year there were very few IPO in Indian Market, but there were many changes which has taken place in terms of Rules, Regulation and Guidelines by SEBI / FMO on public issues. We will discuss these laws and how it will impact investors, its sentiments and how it may impact price discovery process?

The Major changes in the guidelines are

Increase in application size of retail investors from Rs 1,00,000/- to Rs 2,00,000/- (already discussed in my previous blog) : As discussed in my previous blog it will reduce the returns on IPO market and may shy away investors. These has already taken place in market where there are no new issues and investors also do not have appetite and when good issue came in market the returns on investment in IPO was dismal (MCX). 

Finance minister has said that it will reduce the application time and it intend to do it by bringing in  IPO through stock exchanges: Finance Minister has gone on record to say that IPO process will be streamlined which will reduce application and allotment time and also it will streamline whole IPO process. They intend to do it by selling shares on Stock Exchange. In this process the investor will be expected to apply for shares on stock Exchange terminal using brokers, the allotment would be done as trade confirmation and shares will be credited in investor account using clearing house mechanism. So maybe by evening you will know your allotment and listing may happen in few days. Seems simple what will change?
a)       The issuer will save money on commission as they won’t be obliged to pay to brokers soliciting clients (There are many people who make a living on IPO forms, they will be heavily impacted and maybe the marketing of issue will be impacted)
b)      You will have to pay brokerage for applying through brokers.
c)       Now if you apply in shares you can apply it through ASBA (Wherein you can earn interest on that money till the date of allotment), but if you apply through broker you will have to give money to him in full and then only he will be eligible to apply on your behalf (It may happen that clients would be expected to pay before few days to avoid last minute rush) and will also put question on risk management of broker.
These may not impact much to investors apart from brokerage but these will be that way you apply in future.

New category of “Offer for sale” introduced by SEBI using Stock Exchange Platform: To bring IPO process under the ambit of stock exchange SEBI has created a new category of IPO “Offer for Sale” . In this category the promoters or Major stake holders can sell shares directly to investors.
The mode of application for these shares is same as discussed i.e. by putting bids through brokers, these offer is open only for one day and on listed top 100 stocks. So you know the allotment by 3.30 pm
What’s the difference in this category?
a)       We pay brokerage to apply for these shares, but we also may get allotment at discounted prices.
b)      The sellers would be promoters who want to reduce their holdings to meet SEBI guideline of Maximum 75% promoter holding by June 2013.
c)       The best part of this segment is the seller pays STT and can save capital gains tax.
d)      You can trade on those shares in 2 trading days.
There are successful, unsuccessful and controversial issue in this segment which includes ONGC flip flop.

New category of “Institutional Placement Programme” introduced by SEBI using Stock Exchange Platform : There is also a category like above but wherein only the Institutional Investors can apply. Other rules and guidelines are same as offer for sale but I have my reservation of this category. These can be misused by promoters to place their holdings with these Institutional investors maybe with some arrangement, which may be detrimental to interest of minority investors. I am sure SEBI can plug the holes in it.

SEBI law says any IPO with issue size of up to 25 crores would have pre opening session for price discovery and will be traded in T2T segment of 10 trading days post listing: SEBI say that all IPO below Rs 250 crores would be traded in T2T segment (Compulsory delivery, No Squaring off allowed) for first 10 trading days, Also on day of listing the stock will be in pre opening session for 1 hour for price discovery process.
Such steps were taken by SEBI to reduce huge volatility on the day of listing, but in turn it has taken the essence of trading from these stocks, Lets discuss what is happening?
a)       As there is no square off, traders keep away from these stocks.
b)      Because of that it reduces liquidity on the counter, it increase the cost of entry and exit.
c)       People apply in IPO is earn price appreciation on allotment but if traders move away, it reduces the probability of higher price (As there will be many investors who want to sell at the open and buyer may shy away knowing that or it may reduced its bid price)
d)      Because of these I believe listing gains would get capped and in short run its flavor.

SEBI law says any relisting and scheme of arrangement (Except for stocks in F&O segment) would have pre opening session for price discovery and will be traded in T2T segment of 10 trading days post listing: These stock will also trade in T2T segment which will hamper price discovery process in short run.
The above rules changes the way we trade in newly listed stocks and It will definitely impact the price discovery of these stocks on lower side,

But needless to say, that price discovery process and its impact on stock price will be there in short run but longer term performance of these stocks will only depends on its fundamentals.

I welcome your suggestion and comments.