Road Sector Way ahead....

Road Construction-Another Land Grab On The Way

The GOI's Surface Transport and Roads Minister claims India will build as much as 20 km of new roads per day over the next 5 year. If the Minister's past record is any evidence, then the Road Construction projects too will turn out to be no more than an exercise at land grab, this time by led by construction companies like L&T, NJCC, HCC and IVRCL.

Investors would need to remember that most of the SEZs created in the previous 5 year term of the previous government are either stalled or being de-notified. This means that the peasants who sold off their Agricultural land at fabulous price to the Builders mafia are now rich, but the Builders are poor. Or is it the Banks which funded these builders.

Next in line will be the construction companies. They have before them failed BOT projects like the Noida Toll Bridge, the Kotputli-Jaipur BOT, and the Delhi-Ambala BOTs to evaluate. It must be realised and soon enough that India is a nation built upon freebies-users are not prepared to pay for services.

India's highways minister said he plans "a quantum jump" in road building in the coming year and this month begins a world tour to try to revive foreign interest in investing in Indian infrastructure.

"This is a paradigm shift, not merely an increase in spending," Kamal Nath, minister of road transport and highways, said of his building plans.

India has been trying to make $500 billion in upgrades to its crumbling roads, ports and airports -- with about one-third of the investment coming from the private sector.

But the plans announced with great fanfare two years ago have fallen short of expectations, as foreign investors, weighed down by the financial crisis, have mostly stayed away.

When the National Highway Authority of India put out requests for proposals for 60 road projects at the end of last year, it received no bids on 38 projects.

Mr. Nath, India's commerce minister until the newly re-elected Congress party gave him the highway job in May, is setting out on a roadshow to Hong Kong, Singapore, the U.S. and Europe to sell highway construction in India as an investment opportunity.

ICICI Bank Ltd., India's largest private bank, is setting up the roadshow, Mr. Nath said. The government wants foreign investors to help fund infrastructure improvements in return for profits from tolls and other fees.

India's decrepit infrastructure threatens to hinder growth, even in an economy less affected than others by the financial crisis.

In his office Monday evening, just a few hours after Finance Minister Pranab Mukherjee announced a 23% increase in the country's highway budget -- lifting it to $4 billion -- Mr. Nath showed detailed plans for increasing the pace of road building. The plans, with timelines for land acquisition, bidding and building, envision the construction of 127 roads in the coming year, at a cost of 982 billion rupees (about $20 billion.)

This investment plan envisions funding from the government as well as Indian and overseas investors.

India has been building about two kilometers of roads a day. Mr. Nath says he has challenged his department to increase the pace to 20 kilometers a day. The goals represent such a large increase in building that his department "doesn't know what hit them," he said.

Tushar Poddar, an economist for Goldman Sachs in Mumbai, says India's infrastructure projects, including highways, remain too high risk with too low an expected return to be attractive to most foreign investors. Goldman Sachs is staying on the sidelines for now, he said.

"The investment opportunity is not great by any stretch of the imagination," he said. "It's got a long way to go."

Mr. Nath said foreign interest is high. "I see a huge amount of money coming in," he said. "India remains a good parking lot, a good investment destination."

Mr. Nath said in the recent past the problem has been timing. When foreign investors were announcing fund after fund focused on Indian infrastructure in 2007, the Indian government was still fine-tuning the terms of the public-private partnership agreement that would guide the projects, he said.

When these so-called concession agreements were finally ready last year, Mr. Nath said, the financial crisis had hit and foreign interest had diminished.

To draw more bidders, he says, he has changed the conflict-of-interest rules so that investors can hold a small interest in multiple groups competing for the same road projects as long as that interest is below 10%. Until now, investors who held more than a 1% interest in a project were barred from investing in other groups bidding for the same project.

The change will allow existing investors to bid on more projects, but won't solve the broader problem of many foreign investors remaining weighed down by the global financial crisis, says Supratim Sarkar, senior vice president and group head at SBI Capital Markets Ltd., the investment-banking subsidiary of the government-controlled State Bank of India.

"The European and U.S. investors have to first clean up their own books before they can invest here," Mr. Sarkar said.

The Economic Recovery: Fast, Slow or Neither?

Some Analysts Predict a Sharp Rebound While Others Foresee Sluggish Growth; a Few Say another Slump Is Possible

The U.S. economy is pulling out of its deepest and longest recession since the Great Depression. Some economists expect a powerful recovery, others a sustained but muted one. Some even say it will be neither: a fleeting rebound quickly followed by a second slump.

For Americans beleaguered by almost two years of economic pain, the contours of the recovery will determine how many people linger without jobs, whether cutbacks to public services are restored and how quickly savings and investments gain value.

Economists trying to predict the shape of the recovery look for parallels in previous recessions. But the current downturn, which started in December 2007, has echoes from a multitude of economic slowdowns.

It featured the same kind of deep dive in economic output of the 1970s and 1980s recessions, which were followed by sharp rebounds. The credit shock from the latest downturn also recalls the milder credit headwinds of the early 1990s, which turned a relatively short recession into a slow multiyear recovery.

But what distinguishes this recession from most others before it is a severe credit contraction whose effects, some economists believe, are likely to linger for years.

Whatever the structure of the recovery, many consumers won't detect a change in their own circumstances. So many jobs have been lost that the unemployment rate will remain high when the economy begins to rebound. Large swaths of still-jobless Americans will have exhausted their severance payments and unemployment benefits, putting them under further strain even as the overall economy picks up again. And once consumers find new work, their depleted savings will leave them more vulnerable if they were to face another job loss in the next few years.

Some sectors of the economy -- and regions of the country -- are likely to recover earlier than others. The manufacturing and housing sectors, for instance, have contracted so deeply that they are likely to start recovering soon. But the troubled financial sector still is in the process of contracting as banks reshape their balance sheets, putting its recovery further down the road.

The U.S. economy is pulling out of its deepest and longest recession since the Great Depression, but the path of recovery remains uncertain. The turnaround could go one of three ways.

Facing a range of potential recovery scenarios, Americans are displaying everything from strong optimism to anxious caution. In recent months, investors have seemed hopeful about the prospects for a robust recovery, pushing stocks up more than 40% from their recession lows in March. Private-sector forecasters in the latest Wall Street Journal survey say the economy is starting to expand, but to expect slow to modest growth of between 2% and 3% next year. Most businesses remain hesitant, bracing for a painful year ahead.

After Steep Drop, a Sharp Rebound

The most common path for the economy after a severe contraction has been a huge rebound in economic activity. Employers usually slashed their payrolls and output so sharply to protect themselves, and consumers postponed so many major purchases during the worst of the downturn, that a return to growth came with a fierce expansion.

After the deep recessions of the 1970s and 1980s, business activity rebounded and within several months employers were rapidly rebuilding their payrolls. "You can't find a single deep recession that has been followed by a moderate recovery," said Dean Maki, chief U.S. economist at Barclays Capital. And most forecasters proved to be too pessimistic as prior deep recessions ended. "Very few people were looking for the kind of growth numbers that were actually printed," he said.

Economic Anxiety Keeps Growth Slow

The economy may bounce back, but plenty of barriers block the path to a sharp rebound. Trouble with spending and lending could potentially make the recovery a slog.

Consumer confidence is falling as job losses mount -- albeit at a slower pace than before -- and homeowners reshape their finances after severe declines in home values. Households are saving more than they have for most of this decade. That's suppressing consumer spending, the engine for 70% of economic output.

The credit shock is likely to impair the business and consumer sectors for years. Businesses are less likely to get easy loans as banks shrink their balance sheets. That's also true for homebuyers who are finding it harder to get new loans and would need to offer up larger down payments. And, as real estate prices have tumbled, existing homeowners can't borrow against the value of their homes as they once did.

The credit headwinds "will continue to hang over the economy for a long time," said Nigel Gault, chief U.S. economist at Global Insight.

"It is one reason not to expect a strong recovery coming from the consumer side. It doesn't mean consumer spending won't grow, but it won't be a big leader the way it has been in previous expansions."

So after a quick bounce, proponents of the slow-growth view say the economy is more likely to expand at a 1% to 2% rate over the next year -- well below the 4% to 5% that's necessary to heal the labor market after a deep downturn. Recessions caused by bursting bubbles like the recent housing collapse -- as opposed to sharp rate increases by the Federal Reserve to thwart inflation -- seem to be followed by jobless recoveries.

Businesses are finding ways to stretch their existing resources rather than expect a rebound.

"People are very frightened," As people don’t know what to expect in the coming months, years hence there is a sense of fear and apprehension among people and they are adopting a strategy of wait and watch.

The payroll is down to about 70 employees from 200 several years ago, and companies are not in a rush to hire more workers back. Instead, the firm is automating more of its operations, putting computers on every desk and squeezing more out of existing employees.

The productivity is way up, because the people who are left have to work harder,

With a strong focus on productivity -- remaining employees picking up the slack -- some companies are likely to avoid rehiring workers as long as possible, keeping the rest on the jobless rolls even longer.

A Brief Rebound, Then a New Slump

The economy is likely to see a natural boost in the coming months from a rebound in production. After that, it will get some help from the bulk of the fiscal stimulus program late this year and early next year.

But then what?

The slack in the economy is so large that consumers won't see meaningful raises for years, and they will have less borrowing power to drive their spending. So consumers could make some of the big purchases they have been postponing and then close their wallets to save more.

Businesses, after a frightening period, could remain cautious about ramping up after a severe downturn. State and local governments could continue to cut back as tax revenue plummets. And the troubles aren't over for the banking sector. Foreclosures are still shooting up as loans go bad.

Once the boost from the federal government diminishes, the economy could still be without a major driving force such as consumer spending or business investment to push it forward -- risking a return to its concretionary phase. After a brief six-month recession in 1980, the economy recovered but then relapsed within a year. Soaring inflation forced the Federal Reserve to raise interest rates to double-digit levels, pushing borrowing costs higher and spurring a painful and lengthy recession. The late 1940s and 1950s each saw recessions return just three years after the prior downturns ended. That is because businesses can bounce back from crises -- such as wars -- but then find that the recoveries aren't durable.

Today's fear is compounded by the heavy federal spending. Some economists worry high deficits will push interest rates -- and borrowing costs -- higher for consumers and businesses.

Hope we don't have a double-dip recession, but that's a possibility, so will all the money spent by all the central banks bring productive results or just result in a state of high inflation.

Take Over Regulations: Regulation 11 & Regulation 12 : Latest Amendment

Background of the amendment dated October 30, 2008

With the stock market tumbling and sinking, most of the investors started selling their stake in the company. However, due to the down fall in the stock market, the buyers are not available. On the other hand, there is one category of buyer who can really value the company even in the downfall market, i.e the promoters of the company which can be group into two classes. Those who are holding between 15%-55% shares and those who are holding above 55% shares in the company

The promoters who are holding between 15%-55% can acquire further 5% shares as creeping acquisition in terms of regulation 11(1) of the SEBI (SAST) Regulations, 1997. However, those promoters who are holding above 55% shares are restricted from buying the shares in terms of regulation 11(2) of the SEBI (SAST) Regulations, 1997. Therefore, to give an opportunity to those promoters to buy further shares and to stop further downfall in stock market, SEBI came out with an amendment on October 30, 2008, thereby, relaxing the provisions of regulation 11(2) of the SEBI (SAST) Regulations, 1997. The amendment was introduced by the SEBI with the objective of again infusing the Investor confidence and for strengthening the stock market which was going through the unpleasant phase at that point of time.

An Analysis of provisions of regulation 11(2) of SEBI (SAST) Regulations, 1997

Regulation 11(2) as existed before the amendment dated October 30, 2008 is stated below:

No acquirer, who together with persons acting in concert with him holds, fifty five percent. (55%) or more but less than seventy five per cent. (75%) of the shares or voting rights in a target company, shall acquire either by himself or through persons acting in concert with him any additional shares or voting rights therein, unless he makes a public announcement to acquire shares in accordance with these Regulations:

Provided that in a case where the target company had obtained listing of its shares by making an offer of at least ten per cent. (10%) of issue size to the public in terms of clause (b) of sub-rule (2) of rule 19 of the Securities Contracts (Regulation) Rules, 1957, or in terms of any relaxation granted from strict enforcement of the said rule, this sub-regulation shall apply as if for the words and figures ‘seventy five per cent. (75%)’, the words and figures ‘ninety per cent. (90%)’were substituted.

Vide notification dated October 30, 2008, SEBI has amended the provision of regulation 11(2) of the SEBI (SAST) Regulations, 1997 and allowed the acquisition of another 5% shares by shareholders who already hold 55% or more shares but less than 75% shares or voting rights of a Listed Company subject to the certain conditions. The provision of regulation 11(2) as existed today after the amendment dated October 30, 2008 is stated below:

No acquirer, who together with persons acting in concert with him holds, fifty five per cent (55%) or more but less than seventy five per cent (75%) of the shares or voting rights in a target company, shall acquire either by himself or through persons acting in concert with him any additional shares entitling him to exercise voting rights’ or voting rights therein, unless he makes a public announcement to acquire shares in accordance with these Regulations:

Provided that in a case where the target company had obtained listing of its shares of making an offer of at least ten per cent (10%) of issue size to the public in terms of clause (b) of sub-rule (2) of rule 19 of the Securities Contracts (Regulation) Rules, 1957, or in terms of any relaxation granted from strict enforcement of the said rule, this sub-regulation shall apply as if for the words and figures ‘seventy five per cent (75%)’, the words and figures ‘ninety per cent (90%)’ were substituted.

Provided further that such acquirer may, without making a public announcement under these Regulations, acquire, either by himself or through or with persons acting in concert with him, additional shares or voting rights entitling him upto five per cent.(5%) voting rights in the target company subject to the following:-

(i) the acquisition is made through open market purchase in normal segment on the stock exchange but not through bulk deal /block deal/ negotiated deal/ preferential allotment; or the increase in the Shareholding or voting rights of the acquirer is pursuant to a buy back of shares by the target company;

(ii) the post acquisition shareholding of the acquirer together with persons acting in concert with him shall not increase beyond seventy five per cent.(75%). ”

An analysis of the provision of regulation 11(2) before and after the amendment is detailed below

S. No.	Regulation No.	Before the amendment dated October 30, 2008				After the amendment dated October 30, 2008
		Limit	Acquisition	Mode of acquisition	Open offer	Limit	Acquisition	Mode of acquisition	Open offer
1	11(2)	55%-75%	Any %	Any Mode	Yes	55%-75%	Up to 5%	1.Only through Open market purchases in the normal segment &NOT through · Bulk Deal · Block Deal · Negotiated deal or · Through preferential allotment OR 2. Pursuant to the buy back by the Company.	No
						55%-75%	Beyond 5%	Only through Open market purchases in the normal segment & NOT through · Bulk Deal · Block Deal · Negotiated deal or · Through preferential allotment OR Pursuant to the buy back by the Company.	Yes
						55%-75%	Any %	Other than specified above	Yes

An analysis of the amendment as understood by the Corporate world before the clarification circular dated August 06, 2009

· As the amendment only prescribed that an acquirer who already holds 55% or more shares but less than 75% shares or voting rights in a company can acquire another 5% shares provided the conditions prescribed under the said sub regulation are complied with. Therefore, it is understood that the acquisition is allowed for every financial year in the same manner as creeping acquisition is allowed under regulation 11(1) of the SEBI (SAST) Regulations, 1997.

For example: If any acquirer is holding 56% shares, then he can acquire further 5% shares in each financial year as allowed in regulation 11(1) of the SEBI (SAST) Regulations, 1997

· Further, it is also understood that an acquirer who is currently holding 54% shares can further acquire 5% shares in terms of the second proviso to sub-regulation (2) of regulation 11.

· It is assumed that the maximum limit of 75% provides in the amendment would stand modified to 90% in case of companies which are required to maintain the minimum public shareholding of 10% in terms of the Listing Agreement.

For example: If the promoter shareholding in the company, which is allowed to maintain the maximum promoter shareholding at 90%, is 84%, then they can further acquire 5% shares in terms of second proviso to sub-regulation (2) of regulation 11.
Thus, it can be said that although the SEBI by amendment dated October 30, 2008, has opened the gate for the Investor who were earlier restricted in terms of regulation 11(2) of the SEBI (SAST) Regulations, 1997, however, the amendment has been subject to the multiple interpretation.
Therefore, taking into consideration the interpretative confusion among the corporate world, SEBI has issued a Clarification circular No. CFD/DCR/TO/Cir-01/2009/06/08 dated August 6, 2009 amplifying the provision of regulation 11(2) as contained in the amendment dated October 30, 2008.

Analysis of the circular

· Minimum 55% shareholding:

The creeping acquisition is allowed only to the acquirer who together with the PACs with him holds 55% or more shares in the Target Company:

For example: Where an acquirer holding 53% shares wanted to acquire another 2% shares in the company, then he would be govern by the provision of regulation 11(1) of the SEBI (SAST) Regulations, 1997 and would be required to give the open offer. The creeping acquisition as prescribed under regulation 11(2) of the SEBI (SAST) Regulations, 1997 is allowed only to the acquirer who holds 55% or more shares in the company and not to the person whose existing holding is less than 55%.

· Not at par with regulation 11(1)

The creeping acquisition as allowed under second proviso to sub-regulation (2) of regulation 11is not at par with the creeping acquisition allowed under regulation 11(1) of the SEBI (SAST) Regulations, 1997.
The creeping acquisition as prescribed under regulation 11(1) is allowed in each financial year i.e. an acquirer who is holding 15% or more shares can go on acquiring the further shares upto 5% in each financial year till the time his holding does not reaches to 55%.
However, the creeping acquisition as prescribed under second proviso to sub-regulation (2) of regulation 11 is not allowed in each financial year.

· One time acquisition

Creeping acquisition as prescribed under second proviso to sub-regulation (2) of regulation 11 is a one time acquisition.
The creeping acquisition limit of 5% as prescribed under the said proviso is allowed once during the entire life time of the Target Company and can be made in one or more trenches without any restriction on the time frame.

For example: If an acquirer holding 57% shares have acquired further 2% shares in the financial year 2008-09 and another 3% shares in the financial year 2009-10, then he cannot acquire further shares in the coming years as the entire acquisition as allowed under the aforementioned proviso has been exploited.

· No netting off allowed

The limit of 5% shall be calculated by aggregating all the purchases without netting the sales;

For example: where an acquirer holding 56% shares have acquired further 4% shares in the company during the financial year 2008-09 and sold of 2% shares in the financial year 2009-10, then he can further acquired only 1% shares without making the public announcement regardless of the fact that he has sold of 2% shares in the financial year 2009-10

· Maximum 75% shareholding

Irrespective of the level of minimum public shareholding to be maintained in terms of clause 40A of the listing agreement, the total shareholding of the acquirer along with the PACs consequent to the creeping acquisition as allowed under second proviso to sub-regulation (2) of regulation 11 should not increased beyond 75%.

For Example: Where the promoter of a company, which is required to maintain a minimum public shareholding of 10% in terms of clause 40A of the Listing Agreement, are holding 85% shares, then they cannot acquire another 5% shares in terms of second proviso to sub-regulation (2) of regulation 11 without making the public announcement as the said proviso has restricted the maximum shareholding to 75% irrespective of the fact that the company is allowed to maintain the promoter shareholding at 90%.

A comparison of issues involved in the amendment dated October 30, 2008 and the clarification given by the SEBI in the clarification circular dated August 06, 2009 is given below:

Issues	Amendment dated October 30, 2008	Clarification circular dated August 06, 2009
Minimum shareholding	It is not clear whether the acquirer who is holding 54% shares in the company can acquire the further shares in terms of second proviso to sub-regulation (2) of regulation 11.	Now, it has been clarified that only an acquirer who is holding 55% or more shares can avail the benefit of the provision as inserted in regulation 11(2) by the amendment dated October 30, 2008.
Creeping acquisition of 5%	It is not clear whether the acquisition is allowed for every financial year or is allowed once for the entire life time of the Target Company.	The creeping acquisition of 5% is allowed once during the entire lifetime of the Target Company.
Maximum shareholding i.e. 75% or 90%	It has not been provided whether the maximum limit of 75% would stand modified to 90% in case of companies which are required to maintain a minimum of 10% public shareholding in terms of Listing Agreement.	It has been now clarified in the circular that the maximum shareholding of the acquirer cannot increased beyond 75% pursuant to the creeping acquisition allowed under second proviso to sub-regulation (2) of regulation 11 regardless of the minimum public shareholding required to be maintained in terms of the Listing Agreement.

Query: 1

Whether an acquirer, who is currently holding 57% shares in the company, can acquirer further shares by way of preferential allotment in terms of second proviso to sub-regulation (2) of regulation 11?

Answer:

The second proviso to sub-regulation (2) of regulation 11 allowed the further acquisition of 5% to an acquirer who is currently holding 55% or more but less than 75% shares provided that the acquisition is made through:

· open market purchase in normal segment on the stock exchange but not through bulk deal /

o block deal/

o negotiated deal/

o preferential allotment;

or

· the increase in the Shareholding or voting rights of the acquirer is pursuant to a buy back of shares by the target company;

Thus, in terms of the above mentioned provision, an acquirer who is already holding 57% shares cannot acquire further shares by way of preferential allotment in terms of second proviso to sub-regulation (2) of regulation 11. He can do so by making the public announcement in terms of regulation 11(2) of the SEBI (SAST) Regulations, 1997.

Query: 2

Whether an acquire, who along with PACs holds 54% shares in the company, can acquire another 5% shares in terms of second proviso to sub-regulation (2) of regulation 11?

The amendment as well as the clarification circular as issued by the SEBI has specifically provides that the creeping acquisition of 5% as prescribed under second proviso to sub-regulation (2) of regulation 11 is allowed to an acquirer who together with the PACs with him holds 55% or more but less than 75% shares of a company. Thus, where an acquirer holds 54% shares in the company, then he can acquire further 0.99% shares ( i.e. upto 54.99%) as creeping acquisition without making the public announcement in terms of regulation 11(1) of the SEBI (SAST) Regulations, 1997.

Query: 3

Whether the creeping acquisition limit of 5% as prescribed under second proviso to sub-regulation (2) of regulation 11 is allowed for each financial year or is an only one time acquisition?

Answer:

In accordance with the clarification given in the SEBI circular dated August 06, 2009, the creeping acquisition limit of 5% as prescribed under second proviso to sub-regulation (2) of regulation 11 is a onetime acquisition and allowed once in the entire life of the Target Company. However, the acquisition can be made in one or more trenches in any numbers of years.

Query: 4

Whether an acquirer, who already holding 56% shares in the company has further acquired 5% shares in terms of second proviso to sub-regulation (2) of regulation 11 during the financial year 2008-09 and sold of 2% during the year 2009-10, can acquired another 2% shares in terms of the aforesaid proviso.

Answer:

SEBI Circular has specifically mentioned that for calculating the limit of 5% as permitted under said proviso, aggregate of all the acquisition without netting of the sales is to be considered. Therefore, in this case, as the acquirer has already acquired 5% shares in the company, therefore, he cannot acquired further shares without making the public announcement regardless of the fact that he has sold of 2% shares in the financial year 2009-10.

Query: 5

Whether where an acquirer who along with the PACs holds 74% shares of a company can acquire another 5% shares in terms of second proviso to sub-regulation (2) of regulation 11?

Answer:

Second proviso to sub-regulation (2) of regulation 11 allowed the further acquisition of 5% by an acquirer who already holds 55% or more shares but less than 75% shares in a company subject to some conditions as prescribed therein. One of such condition is that the post acquisition shareholding of the acquirer together with persons acting in concert with him after such creeping acquisition shall not increase beyond seventy five per cent.(75%).
Therefore, an acquirer who along with the PACs with him already holds 74% shares can acquire further 0.99% shares (i.e. upto 74.99%) in terms of second proviso to sub-regulation (2) of regulation 11.

Query: 6

Whether, where the company is allowed to maintain the promoter shareholding at 90% (i.e. the company which are required to maintain a minimum public shareholding of 10 %*) in terms of clause 40A of the Listing Agreement, an acquirer can acquire the shares increasing his shareholding beyond 75%?

Answer:

In terms of clause 40A of the Listing Agreement, the company is required to maintain on a continuous basis, public shareholding of at least 25% of the total number of issued shares of a class or kind, for every such class or kind of its shares which are listed.

*However, where the number of outstanding listed shares of any class or kind of the companyare two crore or more and the market capitalization of such company in respect of shares of such class or kind is Rs. 1000 crores or more, the company is allowed to maintain, on a continuous basis, a minimum public shareholding of at least 10% of the total number of issued shares of such class or kind.

It is noteworthy to mention here is that the circular has expressly restricted the acquirer from increasing the shareholding beyond the limit of 75% pursuant to the creeping acquisition provided under second proviso to sub-regulation (2) of regulation 11 irrespective of the level of minimum public shareholding to be maintained in terms of clause of 40A of the Listing Agreement i.e regardless of whether the company is required to maintain minimum public shareholding at 10% or 75%, the shareholding of the acquirer pursuant to the creeping acquisition allowed in the amended regulation 11(2) cannot increase beyond the limit of 75%.

Unanswered Questions

What is the applicability of the SEBI (SAST) Regulations, 1997 on the acquirer who has acquired 5% shares before March 31, 2009 and another 5% shares after March 31, 2009 in terms of the second proviso to sub-regulation (2) of regulation 11 on the assumption that the creeping acquisition as allowed under said regulation is for each financial year.

Thus, it is required that SEBI should come out with another clarification regarding the above unanswered question in a good faith for the benefit of those investors who have taken this action.

-Farzan Ghadially

Is the Indian Stock Market Overvalued?

Is the Indian stock market overvalued?

In May 2004, soon after the left parties botched up their best electoral performance, the stock market index collapsed 20% as fear gripped the market. However the fear subsequently proved futile, and the market then delivered one of its best performances for the next five years. The economy grew almost at 9% and corporate India recorded high profits and return on equity. In fact, the market moved up almost 4 fold before it fell due to the macro economic conditions globally.

To study the current state of the economy, if we were to examine the S&P CNX 500 companies, constituting 95% of the market’s total capitalization with a time horizon as far as possible, firms delivering financial services, and banks, should be excluded as their businesses naturally need to be assessed differently.

Hence, we are left with the remaining 230 firms, whose audited information is available for 16 years - from 1993 to 2008. The best way to judge their financial performance is to assess their return on equity capital, which is going to be the focus of our analysis, because it is a common parameter that can help judge and compare across various sectors and industries, irrespective of their diverse natures.

Simply put, Return on Equity (ROE) can be compared to the interest payments on a fixed deposit - with the equity capital being equivalent to the principal payment of the fixed deposit. Both are simply a return for committing capital over a long period of time.

ROE for the period mentioned above and with respect to the 230 non-BFSI companies, was around 18% for India, compared to that of the US which was around 13%.

In the last five years (2003-2008) ROE saw a jump of nearly 50% (over the 1993-2002 period), to 23%, providing a strong case for re-rating of the Indian stock markets. Hence to understand this re-rating, we need to first figure out whether the ROE is currently finding a new mean, or is only surfacing at a crest soon to fall.

To understand this, we shall break the total time period into two parts viz. 1993-2002 and 2003-2008.

Let’s first take a look at the three key drivers of ROE:

1. A higher net profit margin:

This can come from 4 factors:

a) Higher operating margin

b) Lower interest rate, hence interest rate changes

c) Lower depreciation charges and

d) Lower direct taxes

2. Higher Asset Turnover (Income/ Assets)

3. Lower Leveraging

An analysis of corporate India’s numbers shows that the phenomenal ROE expansion mentioned above was pushed by the improvement in its net profit margin, as well as its higher asset efficiency, even as the leverage declined. Details are as follows:

What lifted ROE

Particulars	1993-2002	2003-2008	Change
ROE (%)	15.4	22.8	48.05%
PAT/Sales (%)	6.3	8.5	34.92%
Asset Turnover (times)	1.2	1.6	33.33%
Leverage (Times)	2	7	-15.00%

What Helped Net Profits

Particulars	1993-2002	2003-2008	Change
Operating Margin	17.2	16.5	-4.07%
Interest/Sales	5	1.8	-64%
Depreciation/Sales	3.9	3.2	-17.95%
Income Tax/Sales	1.9	3	57.89%
PAT/Sales	6.3	8.4	33.33%

It can be observed that the major drivers of net profits during 2003-2008, were in the form of:

a) A fall in interest rates almost by 4-5%, and

b) Decrease in overall leveraging by 15%,

which both contributed to a sharp decline (64% decline) in absolute interest payments in value terms relative to sales. So beneficial was this drop in interest rates for corporate India, that it offset the substantial increase (57.9%) in tax payments as well as a slight fall in operational efficiency (4.07% decline,) to increase the overall PAT/ Sales ratio by almost 35%.

The asset turnover ratio during the second time period also showed an increase of 33.33% vis. a vis. the first time period, while the Depreciation/ Sales ratio showed the same movement (reduction) by a good 18%, and all these factors put together prompted an overall increase in ROE for the second time period by almost 50%.

Pepping up Efficiency:

Analyzing the increased asset turnover ratio, it is important to note how firms squeezed extra revenue from assets. Revenues themselves grew by 19%, and as inflation was relatively low between 2003 and 2008, most of this 19% increase would have come from volume growth rather than price increase. In other words, to have managed higher revenues, India Inc would have had to up production to support the volumes required for the 19% increase in revenues, which therefore translates into increasing capacity, and better inventory and receivables management. Which in turn proves that to have managed such an increase in the asset turnover ratio on the back of an increase in the asset base, was quite a feat performed commendably by corporate India between 2003 and 2008.

Let us take a look at the changes in the Asset Mix for these two time periods

Particulars	1993-2002	2003-2008	Change
Net Fixed Assets	62.10%	55.70%	-10.31%
Investments	10%	19.90%	99.00%
Net Current Assets	27.90%	24.40%	-12.54%

The lower Net Fixed Assets as well as Depreciation/ Sales Ratio, indicate that the firms added less capacity than earlier for generating the same or higher income. Further, Capital Work in Progress, which is a proxy for capacity addition, fell 9.6% in the second period, the period of rapid revenue.

Firms did a remarkable job in reducing the working capital needs arising out of inventory/receivables. Across the industry the firms reduced their inventory from 65 days to 46 days and receivables from 90 days to 50 days.

A good amount of retained capital was held as cash and investments. Corporate India’s cash holdings went up from 4.7% of total assets. Investments showed a bigger increase in the chunk of the asset mix pie, constituting about 20% of the total assets. A large part of this increase went to fund their group and associate companies, and hence may not be termed very liquid.

Higher retained earnings led to lower leverage, even as interest rates edged lower.

The net effect of these two was to substantially increase the ROE as Interest/ Sales dropped, and the increased profit margin and asset efficiency only added to the happy ending.

To cut a long story short, the ROE in a high GDP environment was boosted by reduced interest rates, practical amounts of leveraging, limited capacity additions, improved asset efficiency, and better working capital management.

Will Higher ROE Continue?

The biggest question that needs to be answered is whether the high ROE levels of 23% will continue or not. The GDP is poised to grow at a rate of 7-9%; however, firms this time around will have to add more capacity per rupee of revenue that they want to generate, due to the comparatively higher interest rates currently prevalent, that lead to an increase in the overall costs of capex and working capital.

With net fixed assets at 55% of total assets, and capacity additions limited in the recent years, capacities will have to be added as well as replaced. This cannot be funded by liquid assets. Hence corporate India will have to use fresh equity or debt to fund these projects, as the former will dampen the ROE more than the latter will, there is room for the latter as the overall debt equity ratio of India is a healthy 0.56, and hence the chances of India Inc raising debt are higher.

Expansions in sales will again put working capital under pressure as firms need to keep enough inventories and will have more receivables outstanding. Hence the overall asset turnover will be lower. After tax profit margins will also be reduced due to higher interest payments on the back of increased interest rates as well as the increase in debt funding predicted above. Increase in depreciation as a result of capex will also add to a reduction in the bottom line. Direct tax charges may come down but the net effect will be to reduce after tax or net profit margins.

This leaves us with the question as to whether operating margins will provide some sort of positive anchoring for future ROEs or not. However, historically, operating margins for India Inc have remained in a narrow band around 17% and have never improved consistently.

Based on the above analysis it appears that ROE for the Indian companies will head lower in the years immediately ahead of us.

However, the biggest wild card would be the interest rates. A substantial reduction in them in another year, and we may be looking at some respite for corporate India’s ROE.

Valuations of the Market

Let us run a simple experiment on valuations. Imagine corporate India converts its current equity to an equivalent number of Rs 100 bonds delivering 23% interest per year, which is the current ROE, for 10 years.

We follow the historic assumption that 68% of the profits are retained to add back to the principal each year and assume that these bonds are bought back at book value at the end of 10 years. Assuming the risk free rate of 7%, these bonds would be worth Rs 317 which translates into a price/book value of 3.17 for the S&P CNX 500, while the S&P CNX 500 had an actual p/b of 3.08 as on 3^rd July 2009.

Now repeat the same exercise based on India’s historical ROE of 18.2 per cent. The price drops to Rs 229, or a P/B at 2.29, against 3.06 currently.

The conclusion is that if Indian companies only manage to register the historical ROE — quite a likely scenario, investors are today over-paying for their stocks by a good margin. A rise in interest rates would only make the equation even less attractive.

- Farzan Ghadially

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