Bulls, Bears and Other Beasts Page 8

  10

  Not Black, but Grey

  By the end of my second month with Govindbhai – or GB, as he was popularly known – he had taken a liking to me. During trading hours, he was a taskmaster, a boss very hard to please. But once work for the day was done, he would become a different person. Sometimes he would chat with me and the other dealer Dilip and talk about his experiences on the stock exchange. They were fun as well as insightful, considering that GB had been in the market since 1975.

  ‘Have you ever given a thought as to how the grey market in IPOs came about?’ he asked us one evening as we were sipping tea.

  Both Dilip and I shook our heads.

  ‘It is one of the many consequences of the licence raj and quota raj that used to prevail in the 1970s and 80s. Demand invariably exceeded supply, resulting in a black market for just about everything. You could say that the grey market for IPOs was actually a black market where you could get extra shares if you were willing to pay a higher price for them.

  ‘There was another reason for the emergence of the grey market. Most issues in those days just about got subscribed. I am talking about the days when IPOs of MNCs had not yet made the share market popular. To ensure that their issues sold, promoters would create a premium on their shares to get investors interested. If an issue priced at Rs 10 was quoting for Rs 11 in the grey market, the public would naturally develop an interest in those shares. The operator willing to buy the shares for Rs 11 in the grey market was backed by the promoter or the investment banker to the issue. After the initial bids for a few thousand shares that helped set a price, market forces usually took over. If that did not happen, the operator would keep buying some more shares till sufficient interest was generated.’

  ‘In a way, the premium created by the promoter was a kind of promotional expense,’ I remarked.

  ‘Absolutely. And the grey market was quite active because of the staggered payment structure too. Investors subscribing to an IPO or rights issue had to pay 25 per cent at the time of application, 25 per cent on allotment and the balance 50 per cent when the company would call for it, which would usually be a month or two after listing.

  ‘Retail investors were usually assured of allotment of the full quantity they had applied for. So they could sell an equivalent quantity in the grey market at a premium and deliver the shares once they got allotment. In absolute terms, the gains may not have been huge since the premium itself was not very big. But if you converted the profits into annualized returns, it was as high as 40-50 per cent,’ GB said.

  Memorable among the many stories he told us was a funny one about the grey market, and another which illustrated how the public issue market functioned.

  ‘There used to be a frail chap called Kamani, who always sported a bowler cap. He was well known in market circles as the agent of operators who were active in the grey market. If ever you wanted to buy shares of IPOs in the grey market, Kamani was the man to go to. He always had a quote ready. I had just joined the stock market and was working with a broker named Shroff.

  ‘Once, Shroff was chatting to a friend on the pavement outside his office, and Kamani happened to be having tea across the road.

  ‘“This Kamani fellow, I tell you, he will sell you anything, even if he hasn’t heard the name of the company. Tell him you want to buy tetrapods (the concrete structures along Marine Drive that shield the wall of the promenade from the tides) and he will sell you that too,” Shroff told his friend.

  ‘The friend found this hard to believe, and so Shroff decided to prove it. He called Kamani over.

  ‘“Kamani, I want a quote for Tetrapod, which is coming out with an issue shortly,” Shroff told him confidently.

  ‘At this, Kamani took out his pocket diary which had the grey market rates. He flipped through a few pages, but did not find any company by the name of Tetrapod. In those days most of the shares were priced at Rs 10. So Kamani ventured a quote, even though he had no idea what the company was about.

  ‘“One rupee,” he told Shroff.

  ‘“Is that your best rate?” Shroff asked.

  ‘“Yes, Mr Shroff, I am sure you know that nobody offers better rates than I do,” he said.

  ‘“Of course I do, Kamani, I would like to buy 5,000 shares,” saying which Shroff shook hands on the deal and Kamani noted it in his diary.

  ‘Five days later, Kamani came to Shroff’s office one evening.

  ‘“Mr Shroff, is this Tetraford a joint venture with the Ford Company of the US?” he wanted to know.

  ‘Even I was amused that Kamani could offer a quote for a company whose very spelling he was not sure about.

  ‘“Yes, of course,” Shroff said, sounding serious.

  ‘“In that case, is there some prospectus available?” asked Kamani.

  ‘“Why, what happened??” Shroff asked in return.

  ‘“I told my clients about the company and there is strong demand for it. One of my clients said it could possibly be a JV with Ford. If that is the case, I want to quote a proper premium so that I don’t end up on the losing side,” he said.

  ‘Shroff promised to get the prospectus for him in a couple of days, and then two days later told him about the joke. Such was the booming grey market that some of the leading newspapers carried the grey market rates for the Tetraford issue alongside the regular stock quotations issued by the exchange,’ GB recalled.

  ‘This almost made the quotes appear as authentic as the official quotes for the regular market. The rates were diligently faxed to the newspaper offices by Kamani and his group. Worried that this could invite trouble from the government, BSE president Phiroze Jeejeebhoy called the grey market players to his office and warned them against providing quotes to the newspapers in the manner that they had.’

  GB’s other story was about a Delhi-based company called Milk Food Products, which was looking to raise money through a public issue.

  ‘The company had hired a top foreign bank to market the issue, but response to the issue was lukewarm. A senior official by the name of Ahuja at the foreign bank was a good friend of Shroff’s. He came over to discuss his predicament with Shroff.

  ‘Ahuja told Shroff about the company’s strengths and bemoaned the lack of interest in the issue.

  ‘“The company may be good, but the market is not confident about it,” Shroff told him.

  ‘“What is to be done for that?” Ahuja asked.

  ‘“I will tell you,” Shroff told him, calling out to me, “Just ask Kamani to come to my office and tell him there is a new issue I want to know his views on.” He then turned to Ahuja and said: “While I am talking to Kamani, you will not utter a single word.”

  ‘Ahuja agreed.

  ‘A few minutes later, I returned with Kamani in tow.

  ‘After some small talk, Shroff asked Kamani what he thought of the Milk Food Products issue.

  ‘“Kuch dum nahin hain issue mein. Firstly, you can never trust Delhi-based companies. Six months later, there will be no milk, no food and no products,” Kamani remarked casually.

  ‘I could see that Ahuja was trying hard to restrain himself from having a go at Kamani. But having given his word to Shroff, there was nothing he could do. After Kamani left, Shroff told Ahuja: “There is a perception problem. The only way you can fix it is by creating a buzz in the grey market. Unless you are able to do that, the issue is doomed.”

  ‘Ahuja agreed, and gave Shroff the mandate to buy as many shares of Milk Food from the grey market as he could. Shroff did that, and as a result the premium for Milk Food shares in the grey market shot up dramatically. Players who had short-sold the shares realized they could be in for trouble on the day of listing and tried to cover up their positions. This frantic buying only fired up the prices even more.

  ‘Staring at a huge loss, the gang of short-sellers approached the BSE president asking him to put a cap on the price of the stock on listing day. Since it was not possible to do that without being accused of bias, the pre
sident decided to do the next best thing. He called for a meeting with Shroff and a couple of other brokers to whom the short-sellers owed big money.

  ‘The president requested that Shroff and the issue manager reach a settlement with the bear syndicate. Shroff was a bit miffed since it would mean having to forgo a chunk of what he felt were his rightfully earned profits. He expressed his displeasure to the president, who in turn felt that matters of the exchange should be settled amicably among the members.

  ‘Shroff relented, as he did not want to hurt his long-standing relationship with the president, who was a highly respected figure of his time,’ GB said.

  Our evening conversations would sometimes stretch to over an hour. GB also told us how it was the success of share issues by MNCs that got retail investors interested in the stock market.

  ‘Under the FERA Act of 1974, MNCs were forced to reduce their stake to 40-74 per cent by offering shares to Indian investors. The companies that could prove they had special technology were required to dilute only 26 per cent of their stake; export-oriented firms had to dilute 49 per cent of their stake; and the rest, 60 per cent. Conservation of scarce foreign exchange and getting foreign companies to invest more in India were the main reasons for the Indira Gandhi government to initiate that proposal.

  ‘By the time of its implementation, the Janata Party had come to power. The companies that agreed to dilute their stake and get listed on the stock exchange could continue with their business in India while the rest had to pack up and leave the country. IBM and Coca-Cola were among those that chose to withdraw from India. The industries minister George Fernandes has been credited with having thrown both the companies out of India. But the truth is far simpler – the companies left of their own accord.

  ‘Being forced to dilute their holding was bad enough. Worse still, MNCs were not given the freedom to fix the price at which they could sell their shares to the Indian public. That was decided by the Controller of Capital Issues, based on a formula linked to their book value and earnings track record.

  ‘This led to the companies having to offer shares at prices far below what they were actually worth. The CCI rule, though a blessing for Indian shareholders, was hard on the companies, as share valuation is based on perception about future earnings and not the past performance of companies. In fact, nearly every share issue was offered to financial institutions and retail investors for a song. The MNCs’ loss was the gain of financial institutions and retail investors. I would go so far as to say that the share offerings helped strengthen institutions like UTI and LIC as they got the lion’s share of the issues. This helped them build a first-class portfolio of shares at bargain prices. How else would they have been able to build the portfolios they had?

  ‘There may be plenty of fundamentally sound companies. But you can’t make big money by investing in their shares unless you are able to buy them cheap. The equity cult in the country got a big boost in 1977 when Hindustan Lever and Reliance Industries brought out their IPOs within a few weeks of each other. Brokers doubted whether there was enough liquidity in the market to absorb both issues. To everyone’s surprise, both issues got a decent response. Those two issues alone would have caused a massive expansion of the shareholder base in the country.

  ‘Through the late 1970s and till the early 1980s, there was easy money to be made from public issues. Colgate, HLL, Castrol, Ciba, Ponds, Pfizer, Glaxo, Bata, Cadbury, Richardson Hindustan (now Procter & Gamble), numerous tea plantation companies and others gave handsome returns to investors who risked their money on the shares.

  ‘Gradually, word got around and more investors began to apply, resulting in issues getting oversubscribed. Once that started to happen, allotments were no longer assured. Still, investors applying for small lots got preference over those who applied for big lots. The offshoot of this was multiple applications by small investors, as this boosted their chances of getting an allotment. Every investor would make at least four to five applications in the names of his kith and kin in addition to his own, hoping at least one would hit the target.

  ‘Other than MNCs names, some quality Indian companies too came to the market in the 1980s. Hero Honda, TVS, Apollo Hospitals, and Dr Reddy’s were among the notable names.

  ‘A typical prospectus consisted of a full page in a broadsheet newspaper. Most of the details in the prospectus were statutory information. The small table on profit and loss was sketchy. I guess the volume of information was just right, but the quality of information was suspect. Companies could make any claim, and there was nobody to vet it.

  ‘Right now, people are worried about a possible bubble in the public issue market waiting to burst. If you ask me, what we are seeing right now is nothing compared with the mania old-timers like me have seen in the mid-1980s. There was a boom in leasing companies soon after Rajiv Gandhi came to power. Many sectors were partly opened up, and this led to a huge requirement for working capital. Since bank finance was limited and not all companies could go public, it was expected that leasing companies would fill that gap. That became a sort of self-fulfilling prophecy. Many leasing companies flocked to the market to raise capital. The sums raised were in the range of Rs 60 lakh to Rs 1 crore. The boom in leasing companies soon spread to other segments too. On 11 February 1986, there were 110 issues launched in a single day. I don’t think I will see anything like that in my lifetime again. A handful of issues gave good returns, but an overwhelming majority of them bombed.

  ‘Public memory being short, caution was once again thrown to the winds when mini-steel and mini-cement companies started hitting the market to raise capital in the late 1980s. And now there is some new fad going on. This will keep happening every few years no matter what history has to show. This short-lived public memory is what has kept the stock market going all these years.’

  Our discussions with GB did put things in perspective, but one could really learn things only from first-hand experience.

  FII activity in the Indian market kept rising steadily. There were more foreign fund managers now staying at five-star hotels. They were inundated with calls and visits from brokers seeking business from them.

  Prakash was quite clued in about the gossip on Dalal Street, and would let me in on some of the lurid details.

  ‘Mr X is quite thick with some of the fund managers. Do you know why, Lala?’ he would ask me with a wicked smile. I had heard some stories too, and the cast in every story would usually be different even if the plot was the same.

  ‘Go ahead, Prakash, enlighten me,’ I would egg him on.

  ‘Well, Mr X goes to the fund managers armed with two lists: one has investment ideas and the other has the names of high-society call girls and B-grade actresses. No prizes for guessing which list helps clinch the business,’ Prakash would say with a chuckle.

  ‘But in all fairness,’ he continued, ‘Mr X is far more professional compared with Mr Y, who goes to meet fund managers with just one list.’ More laughter would follow.

  In 1993-94, around 770 companies raised over Rs 13,000 crore through IPOs. Investors were lapping up everything on offer, never mind the credentials of the promoters or the business models. There was one high-profile fiasco, though: Morgan Stanley’s maiden mutual fund scheme launch in India. The US-based investment bank was the first foreign player to start a mutual fund company in India. Its maiden offer in January 1994 was the Morgan Stanley Growth Fund, a fifteen-year close-ended equity scheme. Those who invested would have their money locked in the scheme till it matured fifteen years later. The units were priced at Rs 10 each, and retail investors thought this was no different from a regular IPO, which could double or even treble on listing. Few knew the difference between open-ended and close-ended schemes, and even fewer understood the concept of net asset value (NAV) and units. Soon there were long queues of eager investors to buy application forms to subscribe to the scheme.

  Morgan Stanley grandly announced that units would be allotted on a first-come-first-served ba
sis. Nobody asked it how the firm would be able to ascertain which investors had applied first when the application forms were going to be collected from all over the country. I guess even the fund would not have anticipated the kind of response it would get from ill-informed investors looking to make a fast buck.

  The fund had aimed to raise Rs 300 crore, but ended up raising Rs 1,000 crore.

  Unfortunately for all the enthusiastic investors, the Morgan Stanley fund ended up buying too many wrong stocks and at such terrible prices that when the first NAV was announced, unitholders were poorer by 10 per cent. Worse was their realization that they could not exit their investment for the next fifteen years. The mutual fund units could be traded on the stock exchange, however, but they were quoting lower than the fund’s NAV. That experience left a bad taste in the mouth, and for the next few years Indian investors would shudder at the very mention of the term ‘mutual fund’.

  In the meantime, FIIs were slowly warming up to Indian equities. In 1993-94, FIIs pumped in a little over Rs 5,000 crore into Indian equities, with nearly half of it coming through in the last fiscal quarter. Foreign fund managers finally seemed to have tasted blood on Dalal Street and were thirsting for more.

  This spelt a hugely profitable business for many brokers who had managed to build a rapport with the important players. In the beginning, many brokers profited at the expense of the foreign funds. I knew two street-smart dealers – broking firm employees who execute buy and sell orders – at two different, reputed broking firms, who were masters at this game.

  Their modus operandi was simple. FIIs dealt in large blocks of shares. These two dealers were expert at sourcing big blocks because of their connections in financial institutions. The shares would be bought cheap from the domestic institution by a broker fronting for the dealers. The dealers would then buy the shares for the FII client from this broker at an inflated price. The difference would usually be settled in cash between the dealers and the front broker. At times, these trades happened with the full knowledge of the officials at both the domestic institutions and the foreign fund houses, since they too got a share of the spoils.