‘Equity appetite of smaller companies has disappeared’

Raj Bhatt, vice chairman of Elara Capital, says sentiment is turning against investing in equity directly. He believes that the next wave will be convertibles, where investors can hedge against the volatility in the stock market

In an interview to Moneylife, Raj Bhatt, vice chairman and chief executive officer of Elara Capital, a London-based investment bank, discussed rampant price manipulation, the effectiveness of the regulator, major threats to the India growth story and the outlook for India. Excerpts from the interview:

Moneylife (ML): Your company helps Indian firms raise capital through Foreign Currency Convertible Bonds (FCCBs) and Global Depository Receipts (GDRs). What is the current appetite for these funds among Indian companies?

Raj Bhatt (RB):
Historically we have done many GDRs and convertibles (FCCBs) here. But for a long time now, we have not done GDRs since equity appetite among smaller companies has disappeared. We have recently done a convertible for Prakash Industries for $110 million in two tranches. We are currently doing a $150 million GDR for a company together with Goldman Sachs and Morgan Stanley. Equity appetite is not very good because of the volatility especially in the last six weeks. Sentiments are turning against investing in equity directly. That is why one is not seeing many QIPs (Qualified Institutional Placements). So, I think the next wave will be convertibles, where investors would like to hedge against the volatility in the stock market. We are looking to do quite a few convertibles (size more than $100 million) in 2011.

ML: The spate of price manipulation instances recently has indicated how some operators try to manipulate share prices before an FCCB or QIP issue. What due diligence does your company conduct?

We are very clear in our approach—we look at the company’s fundamentals and stock price. If we see a significant movement in stock price before placement, we don’t go ahead with the deal. We have to look at the valuation, the 52-week high and low and the volatility in the stock. For the convertibles which we are lining up for next year, we are studying the companies and only after careful consideration we will go through with them, because investors need to be protected.

ML: What needs to be done to clamp down on such activities?

First, I feel there has to be a code of conduct among the investment bankers. These days, some institutions can fleece investors just to make money. So we have to do more due diligence. The regulator has to be stricter with these companies. Some mechanics must be put in place for barring people who are involved in overt market manipulations. There is no other solution—investment bankers have to be careful that they don’t do such deals. If I see that the stock price of the company has gone up 3-4 times in a matter of three months before the deal happens, obviously there is something wrong with it and I shouldn’t be marketing the deal. Sometimes investors get carried away and they buy such stories. Therefore the regulator needs to keep an eye out for this.

ML: Do you feel that the regulator, the Securities and Exchange Board of India (SEBI) needs to play a more proactive role in market supervision? How does the Financial Services Authority (FSA) in the UK differ from SEBI in terms of regulatory supervision and enforcement?

I think the regulator is being quite proactive in this regard, but it is a question of mechanics—once you find something has happened, how do you ensure that doesn’t happen again? How do you punish people involved in this?
I think the FSA is slightly advanced in the financial advisory business because not everybody can give financial advice in the UK (or even the US). It is a regulated activity. In India, one can set up a shop tomorrow and start giving advice on investments. You don’t need a license here. In the UK, you will be put behind bars unless you are registered with the FSA and should be a fit and proper person to give advice. I think that is what SEBI should eventually introduce—the financial advisory business must be fully regulated. Then, you will not have many of these players who operate in the market. It will eliminate almost 90% of the players. I am sure at some stage, that change will come.

ML: Only a handful of traders account for a bulk of market activity in India. Where do India’s capital markets stand vis-à-vis western counterparts?

Even in global markets, the larger banks and institutions in the broking system do play an active role. But here there are some large broking houses which represent much more clients. There are too many players in the market; that is why you have high concentration towards the large houses, whereas in the West the market has consolidated.

ML: Do you think retail investors will be wary of the equity markets in the light of what has emerged of late?

Yes, they will be wary of participating in small- and mid-cap companies, because there is not much volatility in the large-caps. But people also tend to forget quickly. If these stocks double tomorrow, they will come back again. So it is a short-lived phenomenon where they will stay away, blame operators and manipulators, and once the markets improve, they will not hesitate to invest. But in the meantime, you will have more people investing in the large caps.

ML: What do you think is a bigger threat to the India story—internal issues or external risks?

Inflation is definitely a risk. The other risk is the ability of the Indian markets to absorb foreign capital, which is very limited. I think the government has to continue its divestment programme aggressively to attract foreign capital. If there is a delay here, there will not be much FII inflows. FIIs are very cautious—they are not going to buy at any price. They are only going to buy at the right price. For instance, so much of money came into Coal India. So if we do not create the opportunity to attract money, it won’t come. Then, of course, the government needs to maintain control of deficits and macro-level balances.

ML: How do you see the impact of QE2 on inflows into India? Do you believe Indian markets are over-exposed to FII flows?

I feel there is a very limited impact on the Indian markets, because Indian can’t attract more capital despite the liquidity in the Western markets. India does not get much capital from the global point of view. We have got around $28 billion in FII inflows in these 11 months, which is miniscule. China can attract $20 billion in one month. For a country of India’s size, we should be getting a lot more. While China is a maturing economy, India is in the early stages. The problem is not that the money isn’t available, it is that India simply cannot absorb it. Where will FIIs invest? The government has to create more room for capital to come in. So QE will not impact equity inflows much, but it will impact other things like commodities prices and exchange rates.

ML: What is the risk of a pullout by FIIs from Indian markets?

: FIIs play a very important role, but there is no reason they will pull out the money because they believe in the India story for the medium-long term. If they do pull out, it will definitely affect the markets here.

ML: What is your sense regarding India Inc’s performance for the next few years? Which sectors do you feel will perform the best?

We feel that 15-20% returns are possible every year in Indian markets (barring the short-term blips), which is very attractive provided the rupee stays in a tight range. Within sectors, we are bullish on FMCG, power equipment and infrastructure. There is a question mark over the real estate sector where the prices are too high. A lot of money has also come into the power sector, but there is an issue whether pricing power will be sustained.

ML: In terms of valuations, where do Indian equity markets stand now? What is your medium-term outlook on the same?

The markets are fairly valued. Any price rise beyond 15%-20% has to be justified by earnings growth. If you have higher earnings growth then the valuations will look cheaper, otherwise it is evenly balanced. I think valuations will stay within a range of 18-20 times earnings, if earnings continue to grow at 20%. If earnings decline, then valuations will come down. We expect a marginal decline in earnings in the coming quarters.

ML: What is your view on the entire emerging markets phenomenon that seems to have gripped the West? What can possibly derail it, especially now that it is a consensus?

Basically, the savings rate in the US has gone up and there is more money available to invest. Western economies are not going to grow at high rates. They also have a demographics problem. Growth in India and China has proved that these economies have decoupled to some extent. These countries will continue to grow irrespective of lower growth in Western economies. Money will chase wherever the growth is.

I think the major problem globally is the trade imbalances in the US. Everybody is concerned about the huge trade deficit the US is running, funded by treasury being picked up by the Chinese and some other countries. They have to take some measures for correcting this imbalance—it won’t happen over 1-2 years, but perhaps over a decade. The US can’t just keeping pumping money into the system. This is the biggest threat to emerging markets. If the US dollar destabilises, it will destabilise other economies. Too much money supply may also lead to inflation and affect commodity prices. But I think the US has resilience and has the fundamentals and resources to bounce back. The QE measures are purely to counter the double-dip. They are trying their best to avoid recession, and it is working.


Essar Shipping shareholders approves demerger plan

Ruias-promoted Essar Shipping Ports and Logistics Ltd said its shareholders and creditors have given nod for demerger of the company’s shipping, logistics and oilfields business into a separate entity.

"... At the meeting, the equity shareholders, secured creditors and unsecured creditors of the company have unanimously approved the scheme (of demerger) under sections 391 to 394 of the Companies Act, 1956,” the company said in a filing to the Bombay Stock Exchange.

The shareholders approval was sought on 30 November as per the directive of the Gujarat High Court to convene meetings of equity shareholders, secured creditors and unsecured creditors of the company, the filing added.
In August this year, the company had announced plans to separate its shipping, logistics and oilfields business into a separate entity, Essar Shipping, while the existing entity was to be renamed as Essar Ports.

As per the proposed demerger scheme, Essar Shipping will issue one equity share for every three equity shares they hold in the existing company, while the promoters will continue to hold a 83.7% stake in the new companies.
On the demerger plan, Essar Shipping director (strategy) Vikas Saraf had said, “At the end, the shareholders will hold two shares in the existing company and one share in the new company.”

The debt of the present company—Essar Shipping Ports and Logistics—will also be transferred to the two companies based on their current standing. The company, however, did not disclose the total debt.


OTPC signs MoU with Dhaka to open new transport corridor

ONGC Tripura Power Co (OTPC), a unit of Oil and Natural Gas Corporation, has signed a memorandum of understanding (MoU) with Dhaka to open up a new transport corridor through Bangladesh for transporting heavy equipment for its power plant at Tripura.

Pursuant to this MoU, the Bangladesh authorities will for the first time allow the use of the Ashuganj port on the Meghna River and the connecting road network between Ashuganj-Sultanpur-Akhaura check post (around 48 km) for transportation of project equipment to the OTPC project at Palatana, in Tripura.

This will facilitate the transportation of two gas turbines, two steam turbines and about hundred ODC (over dimensional cargo) items required for the OTPC’s ambitious 726.6-MW combined cycle gas-based power plant at Palatana, Tripura.

Transporting the items through Bangladesh will enable OTPC to advance the commissioning deadline for the project by around seven to eight months, as it will obviate the need to transport the ODC items by land through a long, challenging and complex route traversing Karimganj, Manu-Ambassa mountainous tracts and large number of river crossings in Tripura.

ONGC has 50% stake in OTPC, while IL&FS has 26%. In addition, the government of Tripura has a 0.5% interest in OTPC. The rest is untied equity.

Post-commissioning, the project will help in monetising the gas discoveries made by ONGC in Tripura during the last two decades, which have remained underutilised thus far due to lack of appropriate customer demand.

Implementation of this power project would enable ONGC to increase its gas output in the state from the current level of 1.7 million cubic meters a day to over 5.5 mmscmd.

The first powertrain of the project, with a generation capacity of 363.3MW, is expected to be commissioned in the last quarter of the 2011 calendar year.


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