Preferential allotment is the latest stock market game (9 December 2001)  

Indian corporate managements have never had it so good. Over the last couple of years, with active support from politicians, regulators and the finance ministry, they have wrangled the freedom to increase or decrease at will, the capital of companies that they control.

Firstly, they have had the creeping acquisition limit hiked from two to five per cent so that the controlling families ward off any threat of a takeover, the funds for the acquisition being siphoned off from the company in innumerable ways. Secondly, they used the long bear phase to bulldoze the government into promulgating a hasty ordinance to allow companies to ‘temporarily’ buy back 10 per cent of the equity through a simple board resolution without bothering for shareholder approval through a special resolution. This ordinance was passed without so much as consulting investor groups because the government was in a hurry to boost market sentiment.

Ironically enough, even before the amendment bill was passed by Parliament last week, the market had not only declared a bull run but it was the same old K-10 stocks were shooting vertically with the same irrational exuberance. But guess what? The moment the market has turned bullish, company managements have lost all interest in reducing capital in order to boost prices or increase their holding through creeping acquisitions. Suddenly preferential allotment is the name of the latest stock market game.

Corporate announcements over the last two weeks indicate that companies are lining up in droves to issue fresh capital to that privileged group—the promoters or controlling shareholders and their friends and associates. With SEBI rules mandating that preferential offers should be at the average of the previous six months’ stock prices, the end of a long bear phase is an ideal opportunity for promoters to make a killing on price alone—as always at the cost of all other classes of shareholders. The strangest of companies have announced preferential offers to promoters, many of which were, until a few weeks ago, quoting near their 52-week lows. Another interesting fact is that most of them have suddenly attracted speculative interest and their prices have rallied rather too smartly in the last two weeks. This is just the beginning of a big market operation.

During the Ketan Parekh led bull run of 2000, most industrialists were deeply involved in speculation, by borrowing against their personal shareholding. Many of them still have their entire holding pledged with banks. Preferential allotments are more useful since they need just a 10 per cent down payment—the rest can always be squeezed out of the company by diverting funds or manipulating sales/purchases. With the market entering what seems like a bull phase, the new capital that they will allot themselves will serve at least two purposes.

First, the shares acquired cheap through preferential allotment can be pledged with banks either to release their earlier holdings which are not under lock-in and release fresh funds which will be used to further speculate in the market and cash in on the bull run. However, in the past, most bankers had permitted shares under lock-in to be pledged too. Preferential allotments would be truly useful for those industrialists who want to ‘rent a market operator’ to ramp up their stock price.

It is standard operating procedure (perfected over several scams since the early 1990s) to make available a large block of shares for the operator to churn. This block of shares has always come from the promoters’ holding. As the stock price goes up, obliging bankers are ever willing to provide increased funds minus their standard haircut. If the promoters are lucky, friendly fund-managers would pick up the stock and provide them an exit route and a hefty profit.

Many companies who were on Ketan Parekh’s list of favourites are rushing off to issue preferential shares, even before regulators, large institutional investors and mutual funds realise what is going on.

Look at the announcements in the last fortnight alone. On December 6, Sri Vasavi Industries announced plans to allot 8.5 million additional shares to promoters, their friends and relatives with December 29, as the record date. Aurobindo Pharma has decided to issue ‘further share, convertible debentures or such other instruments as the board sees fit’ on a private placement basis. TV 18 wants to allot additional shares to the promoters and their associates and for good measure increase the investment limit for foreign investors of various kinds.

On December 4, Mercator Lines decided to allot five lakh shares to the promoters (chairman Harish Mittal and Archana Mittal) on a preferential basis. Mascon Global is even better. Its shareholders have already approved (on December 3) the decision to permit a GDR/ADR/ECB issue of up to $150 million, a private placement of up to Rs 150 crore to promoters, directors and associates and a preferential allotment to ISC holdings (up to $6 million). Himachal Futuristic Communication, a core company in the Ketan Parekh portfolio, is making a preferential allotment of equity or warrants to promoters.

Global Telesystems (now called GTL) is luckier. It has approved a proposal to convert a huge number of Swiss Franc (60 million) dominated foreign currency convertible bonds into equity at a premium—if and when converted. Flex industries which under close scrutiny these days for trying to bribe top bureaucrats, has already allotted 10 million warrants to promoters and their associates at Rs 24 each.

Then there is Fortune Informatics, Ion Exchange, Vam Organics, Unisys Software & Holding Industries, LCC InfoTech, and Warner Multimedia, which are planning preferential issues. Soffia Software is not only planning a preferential allotment but also increasing authorised capital and is keeping its option open to issue GDR/ADRs. Silverline Technologies is issuing convertible warrants to Subra Investments a Mauritius based company which belongs to the promoters and plans a couple of overseas acquisitions. Ankur Agencies is planning a preferential allotment to NRIs against a swap of shares held by them in a US-based company called Solix Systems.

Barring a few exceptions, what I have to say holds good for most companies. The dominance of K-10 scrips and speculative software companies would surely not escape the regulator’s attention. The question is, will anyone object before it is too late?

Will shareholders—especially the institutional ones ask questions before it is too late? And will the regulators initiate an investigation only after the price ramping leads to the inevitable collapse? Investors may like to know that a litigation filed by Consumer Education and Research Centre, against the preferential allotment scam of the mid-1990s which caused losses of over Rs 5,000 crore to ordinary investors is still languishing in the courts.