The Securities and Exchange Board of India (Sebi) has proposed a set of undemanding requirements for small- and -medium enterprises (SMEs) wanting to raise capital through a public issue. Restrictions on net tangible assets, net worth, minimum number of investors and a track record of profits have been completely relaxed. Such a market will not only provide small firms with access to capital as an alternative to private equity (PE), but could also help PE investors by providing them with an exit route.
But the flipside is that the proposed market for these SME stocks will be all but closed for the Indian retail investor. Entry into the market is restricted for investors with a minimum investment size of Rs5 lakh.
The fundamental thought behind the proposals seems to be: SMEs can’t access the markets under the weight of the current disclosure norms and the high cost of raising capital through the conventional initial public offering. So the alternative should be a platform devoid of these restrictions. But since this would mean higher risks from an investor’s point of view, small investors should be safeguarded.
Similar considerations have been behind the setting up of the Alternext market by Euronext or the Alternative Investment Market (AIM) by the London Stock Exchange. But at AIM, although small investors can’t participate during the capital raising stage (primary market), they can participate in secondary market trading. Sebi, however, has proposed that even in the secondary market for such stocks, the minimum trade size should be Rs5 lakh. Prithvi Haldea, managing director of Prime Database and a member of Sebi’s primary market advisory committee, points out that if retail participation is encouraged in the secondary market, merchant bankers and large investors who have initially bought SME shares will try and dump them on unsuspecting retail investors. According to him, since small firms entail higher risks, disclosure levels should actually be higher for retail investors to take informed decisions. But since a relaxation is necessary for SMEs to access the markets, it’s best that small investors are safeguarded.
While AIM has largely been a success, it has had its share of criticisms. It allowed the listing of Langbar International Ltd, which, it turned out, had none of the assets it declared at listing. Renowned US investor Wilbur Ross told Financial Times last year: “There is a risk when you have materially lower standards, that you’ll attract the wrong kinds of people.” One way to address that is to make institutions sponsor these companies and be responsible for their conduct. A similar arrangement exists on both AIM and Alternext. Retail investors could participate in this market through mutual funds floated for investing in firms listed on the SME exchange.
The problem is that a market without retail investors will be low on liquidity. The average trade size on the cash segment of the National Stock Exchange was only about Rs30,000 in the year till March, thanks to the thousands of small trades done by retail investors. With them missing, institutional and high net worth investors will have to enter with the knowledge that the secondary market for these stock holdings will not be very liquid. The question is whether they will do so—at present, institutional investors shun small-cap stocks for the simple reason that it’s not easy to buy significant amounts of them without affecting the price. The upshot: low volumes, which make these stocks susceptible to market manipulation. Lack of liquidity is a frequent complaint for stocks listed on AIM.
Alternext uses a hybrid market model, which combines order driven trading and market making—one reason why OTC Exchange of India (OTCEI), touted as an exchange for small companies, lost out was because of its compulsory market-making system. The other reason was lack of speculation. If the new SME exchange is to succeed, it must exorcise the ghost of OTCEI.
Capex plans of Ashok Leyland
Hinduja Group flagship Ashok Leyland Ltd is on a capital expenditure spree. On Monday, it announced aggregate investment in its joint ventures with Nissan Motor Co. will be around Rs2,300 crore, Rs400 crore more than their previous estimate. The company had said earlier that it has earmarked Rs3,000 crore as capital expenditure, which will raise its capacity by 100,000 vehicles by 2010— its capacity now is 84,000 vehicles. This will be funded through a mix of debt and internal accruals. Analysts say the management has guided for an investment of Rs1,500 crore in the current fiscal, while the capex in FY08 was Rs900 crore.
The problem is, interest payments are already eating into profit growth. In the March quarter, while earnings before interest, depreciation, tax and amortization were higher by 11.6%, profits after tax rose by just 4.7% compared with the year-ago period. Interest cost was Rs9.1 crore, far above the Rs1.9 crore a year ago. For the full fiscal, interest cost was Rs49.7 crore, against Rs5.3 crore the previous year. Of course, debt service coverage is comfortable, but the concern lies in the additional debt to be taken for its huge capex programme. With wholesale price inflation breaching the 8% mark, there’s a lot of uncertainty over interest rates as well as raw material costs.
Investors have little patience with large capex programmes, preferring to enter a stock when the benefits of the programme are about to be reaped. That’s why the stock, despite decent results, has underperformed the Bombay Stock Exchange’s auto index.
Bank stocks face pressure
The Bombay Stock Exchange’s Bankex has lost 12.5% in the past month and the State Bank of India (SBI) scrip 15.8%, much more than the Sensex’s 5% loss. The SBI stock has fallen to its lowest level this year after disclosures about mounting bad loans and, most recently, its decision to raise deposit rates, which will squeeze margins.
Other banking stocks are also getting hammered. Bank of Baroda, Indian Overseas Bank, Union Bank, Vijaya Bank and Syndicate are all within a whisker of their 2008 lows.
There are several reasons: the fear of a slowdown in credit growth, a higher cash reserve ratio (CRR), liabilities on mis-selling of derivatives and fourth quarter results that show many of them are under pressure, with net interest margins being squeezed and net interest income not growing.
But perhaps the biggest worry is that public sector banks won’t be allowed to raise interest rates on loans, much in the same way as steel, cement and oil companies have not been allowed to raise prices.
For the banking system as a whole, despite the economic slowdown, the credit-deposit ratio was at 72.86% on 9 May, higher than the 72.72% at the same time last year. For the fiscal year to 9 May, non-food bank credit contracted by Rs7,481 crore, against a contraction of Rs43,502 crore over the same period last year. Clearly, desperate oil firms are scrambling for funds. That tightness is reflected in the call money market, where rates have shot up, as the CRR hike drains liquidity.
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