Going public

GUEST COLUMN

Public shareholding at a quarter of a company's shares would increase retail investor participation.

The implementation of the proposal by the finance ministry to provide for a public shareholding of 25 per cent of each and every class of issued capital of a company, both initial and continuous, seeking listing on a stock exchange will address four key concerns of liquidity, volatility, resident individual investor (RII) participation and price manipulation.

Liquidity
While the most popular scrips get traded heavily, a majority of listed scrips either are thinly traded or not being traded at all, all because of low floating stocks.

In 2006-07, out of 7,561 scrips listed on the Bombay Stock Exchange (BSE), only 3,097 or 40.3 per cent of the listed scrips were traded. In December 2007, only 2,904 scrips were traded accounting for 37.7 per cent of the listed scrips.

With the National Stock Exchange listing mostly large cap companies, and trading on all the regional stock exchanges having ground to a halt, BSE is the only stock exchange today where mid cap and small cap stocks are being traded.

Volatility
Indian stock markets are among the most volatile in the world. During 2007, average daily volatility of Sensex and Nifty was 1.54 and 1.60 respectively as against 0.92 of Dow Jones, 1.10 of FTSE and 1.17 of Nikkei.

Comparing with emerging markets, excepting the volatility of IBOV of Brazil of 1.73, volatility of other markets viz, 1.20 of JALSA of South Africa, 1.04 of Malaysia and of 1.36 of Mexbol of Mexico were lower than that of Sensex and Nifty during the same period.

A major cause of volatility is the operations of foreign institutional investors (FIIs) who with over $70 billion net investment amounting to about 4 per cent of market capitalisation account for about 30 per cent of the floating stocks and 30 per cent of deliveries.

The overall fall in Sensex by 16.9 per cent from 20,728 on January 14 to 17,222 on January 24, 2008 was mainly due to net sales of Rs 12,735.5 crore by FIIs while mutual funds had a net investment of Rs 9.686.80 crore""in the cash segment.

RII participation
Despite the growth of the market several fold with market capitalisation of nearly $2 trillion, shareholding population has not grown. In fact, according to SEBI""NCAER Study, the number of equity investor households halved from 12.1 million in 1998-99 to 6.1 million in 200-01, representing just 3.7 per cent of Indian households.

As on March 2005, 20.1 million had invested in equities, debentures and mutual funds representing a meagre 2 per cent of the population. There are several companies where holding by RIIs are less than 10 per cent, and out of them a lot of them less than even 5 per cent.

As per the study, Indian public held in NSE as on June 30, 2007, 13.35 per cent out of which shares of RIIs may be 7 to 8 per cent or less.

Manipulation of prices
Indian stock markets are also subject to manipulation and rigging up of prices and creation of false market among others.

Prior to the abolition of wealth tax, it was common to hammer the prices of SME shares by interested parties to pay less tax. However, stock exchanges took no effective action, although they had ample powers to do so under their bye-laws.

Concerns answered
A major concern of corporate India is that large listed companies need not have a minimum public float of 25 per cent while the same can be applicable to small companies.

The answer for this is that companies, small or big, need to have the same percentage of float as wider issues of spreading the equity cult, reducing unequal distribution of wealth are concerned. Another concern of corporate India is that all companies may not need all the cash that would be raised by the public offer of 25 per cent.

Companies already listed can utilise the excess funds for expansion, diversification and modernisation and generate better returns to the shareholders. Problems of excess cash, barring a few companies, is more a mirage than reality.

Fears of market depression is exaggerated as offer of shares by large holders to meet the minimum 25 per cent float, does not in any way reduce the earnings per share.

How can one justify a company like MMTC with a market capitalisation of over Rs 1,20,000 crore and a turnover of over Rs 23,000 crore in FY 2007 currently trading at over Rs 20,000 having a public float of a meagre 0.67 per cent with government holding 99.33 per cent of the capital?

The following suggestions could raise equity participation by RIIs.

Minimum public offer
The minimum public offer and float may be raised from 25 per cent to 40 per cent with the power to SEBI to reduce up to 25 per cent in respect of companies with foreign equity participation, joint sector undertakings and government companies.

Share of RIIs
At present, share of resident individual shareholders (RIIs) is 30 per cent with 60 per cent being allotted to qualified institutional buyers (QIBs) and 10 per cent to non""institutional investors (NIIs).

In some cases RIIs get 35 per cent, QIBs 50 per cent and NIIs 15 per cent. RIIs must get at least 40 per cent with QIBs getting 45 per cent and NIIs 15 per cent respectively.

If initially there is an allotment of less than 40 per cent to RIIs, there can then be an interchange among the three groups and also vice-versa. Post listing, while QIBs and NIIs holdings may be reduced to 40 per cent and 15 per cent respectively, RIIs holdings may be permitted to be raised to 40 per cent.

Period for compliance
In case of a shortfall below 25 per cent at present, the company may be permitted to bring about the public shareholding to 25 per cent within a period of one year as against the proposed period of three months.

According to one estimate, 1,200 companies would be required to offer shares worth Rs 10 trillion as against the market capitalisation of about Rs 75 trillion i.e. about 13 per cent of market capitalisation. It is not as though this is a unique experiment.

New York Stock Exchange, London Stock Exchange and Hong Kong Stock Exchange have 25 per cent as the requirement both for initial and continuous listing while NASDAQ has 1.1 million publicly held shares for initial listing and 0.75 million publicly held shares for continuous listing.

Shares at discount
At present, on a voluntary basis, companies can offer a discount up to 10 per cent on the offer prices to RIIs. It is worth considering making the discount of say 5 per cent on a mandatory basis to RIIs.

Instead of having book-building method with a band of prices, it is better to have a fixed price, as not all RIIs understand phrases like option I, option II, cut off price among others. If that is not possible, after the completion of allotment to QIBs and NIIs through book-building, RIIs may be offered shares at a fixed price.

Implementation of the suggestions mentioned above will usher in the dawn of a new era for the RIIs. This year could well turn out to be the year of the individual shareholders.

The author is former executive director, Bombay Stock Exchange.