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S. Vaidya Nathan

IF INVESTORS are still wary of equities in the 1990s, to blame are the excesses in the primary market in the 1990s. Of the thousands of IPOs (initial public offerings) and offers for sale made between 1994 and 1996, less than a hundred were from companies with track record. Even in this shortlist, only a few managed to complete planned projects and deliver value to investors. The rest just frittered the money away.

This should occasion no surprise as the primary market of the mid-1990s was merely used as a channel to move public funds into private hands. The Securities and Exchange Board of India (SEBI) was late to wake up to the excesses, but when it did, it improved the disclosure framework, tightened the prerequisites for an IPO, and towards the end of the decade, introduced book-building. This route brought to market quality, wealth-creating IPOs such as Hughes Software, i-flex solutions, Maruti, Bharti Tele-Ventures, TV Today and Divi's Labs, to name a few. Yet the corporate sector has still not fully lived down the consequences of the excesses of the mid-1990s.

Free-pricing abused

As controls over pricing of equity were abolished in 1992, prudence took a backseat as companies set about raising funds at fancy prices; the pricing was justified with helpful projections of profitability dished out even by ICICI, IDBI, IFCI, Kotak Mahindra and Enam Securities, leave alone the plethora of lesser-known investment banking outfits. The earnings projections were vastly out of tune with reality. There was no element of the risk of business cycle built into them; in many cases, it appeared as if the price had been fixed, and the revenue and earnings numbers generated to justify it.

That the IDBI's stock traded at the offer price for just a couple of days over an eight-year period and, subsequently, well below that price, tells the tale of abuse of free-pricing. Not surprisingly, this put investors off; they had patronised such IPOs in a big way as the first few offers in the free-pricing mode — of IFCI, Bank of Baroda, Infosys and Satyam Computer — delivered value. Corporate greed was penalised, as investor apathy ensured that between 1998 and 2001, the number of IPOs/offers for sale could be counted on the fingers of one hand.

A colossal misconception

This period was also witness to a popular notion that equity was the cheapest source of the funding, as the premium element was perceived as carrying no cost. What companies failed to recognise in this process — they were also encouraged by investment banks seeking more IPO opportunities — was that their capital cost could only be the same as the investor's expected rate return.

By assuming and assigning a zero-cost to the premium element, companies converted what is, inarguably, the most expensive source of finance to the cheapest one. This led to an overhang on equity across Corporate India, with funds being mobilised in the domestic and global markets through the issuance of global depository receipts. As this understanding of the cost was not clued to reality, it soon fell apart.

Capacity overhang

The primary market boom of the mid-1990s also ensured excess of a different kind: A fad for capacity creation across a range of commodities, with the possible exception of aluminium and copper. Cement and steel were good examples. Buoyed by high cement and steel prices, and expectations of consistent double-digit growth in demand that was attributed to liberalisation of the economy, several firms set up cement and steel capacities.

Binani Zinc, Sanghi Polesyter and the Rajan Raheja group and the DLF group (both cited backward integration to construction as the reason for their cement foray) set up large-sized cement units. Jindal Vijayanagar, Essar Steel, Bhushan Steel, Ispat Industries and Lloyds Steel completed the steel story. The effect of the overcapacity still exerts pressure on profitability. For instance, in cement, a better balance between demand and supply is expected only two years from now.

This binge effectively ensured that even in the small number of companies where projects were implemented — without exception marked by time and cost-overrun — investors have had nothing to show by way of wealth accretion. Only the IPOs of the past two-and-half years have changed that. If the ongoing bullish phase is used to perpetrate excesses, the consequences would not be any different. Corporate India needs to walk a different path now, both for its sake as well as in the interest of investors.

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