Sucheta Dalal :A new theory to sustain the bull market
Sucheta Dalal

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A new theory to sustain the bull market  

Apr 24, 2006

When two prolific letter writers set aside social issues and fire off letters blaming the spiralling Sensex on excessive speculation and market manipulation, you know that the Sensex at 12,000 is causing more fear than joy. Peculiar to India, the booming capital market and rapid economic growth has again translated into a sharp rise in real estate and gold, which are traditional investment avenues of ordinary Indians.


This worries even those who do not invest in the capital market.


India is already the most expensive capital market in the world. But typically, expert opinion about the future is sharply divided. Foreign institutional investors (FIIs) are showing signs of withdrawal, especially as US interest rates firm up. However, as the Indian economy continues to grow, frontline companies keep delivering good results and the booming real estate market promises to provide new accelerators to stock prices, large research firms are hedging their bets and also formulating new theories to explain and justify these developments. Christopher Woods (Greed and Fear newsletter) of CLSA, a global investment and research firm says: “India remains a classic asset-inflation story where the present bull market is likely to culminate in extreme overvaluation with stocks re-rated on their land-holdings. There is now general recognition of the national property boom that is under way. The pending IPO of DLF will mark the formal confirmation that India has become a property-driven stock market.”


Woods’ theory articulated in his latest report is that blue-chip Indian companies “have substantial, albeit largely unrecognised, land or asset-play components to them.” This nice little theory is obviously gathering rapid momentum, since top brokerage firms are dangling property development carrots before privately held companies, with no listing plans as well.


Will “asset-based” valuation be the new slogan that is being concocted to keep the bullish momentum going? Is this yet another short-term bubble that will burst with the bull run? Many valuation theories look extremely plausible at the height of a monster bull run. Like the valuation of tulip bulbs in Amsterdam (17th century) or the replacement cost theory propagated by Harshad Mehta, or the even more bizarre valuation of dotcom companies based on a projection of ‘eyeballs’ that would be drawn to Internet websites. This one, too, will be backed by extensive number crunching.


When prices beginning to look unrealistic, one would actually do well to install a rear-view mirror and remember that the 1992 collapse led by Harshad Mehta and the 2000 one led by Ketan Parekh took down two banks each and the savings of several lakh investors. In between these two scams, the IPO (Initial Public Offerings) mania of 1993-94 killed the primary market for a decade, after hundreds of companies vanished with investors’ money. Real estate-based valuations do look more substantial than those based on eyeballs, but when apartments that scandalised Mumbai at rates of Rs 35,000 a sq ft in the last boom sell now at Rs 63,000 a sq ft (a deal was reportedly struck for an apartment at Nariman Point in South Mumbai, in an apartment block overlooking the sea), it only confirms the property bubble.


• Some are looking at the real estate boom to explain the rush on stocks

• But, the theory of asset-based valuation doesn’t quite add up

• Indian MFs may sell themselves on this and further pump a bubble


But CLSA cites different examples. Its pick of companies with large real estate assets are Infosys and State Bank of India (SBI). Un-fortunately, that sounds uncomfortably like a superficial foreign assessment.


Asset-based valuation may have some merit when one talks about the Godrej group or Bombay Dyeing, where listed companies may actually hold substantial chunks of land. Or, say, a former public sector monopoly like VSNL, where the Tatas struck a real estate gold mine by acquiring it. Centaur Hotels, which was shut down by the Sahara group after acquiring it for a song, is being developed to unlock the value of every square inch of prime real estate it owns opposite the Mumbai airport. But SBI or Infosys? Unlike the boxwalla companies that fell on bad times after the British left India, Infosys has never had access to really cheap land; instead, the land became valuable after Infosys attracted further development.


Indeed, every Indian public sector company, including SBI, has sprawling offices and vast tracts of real estate that were generously gifted by successive socialist regimes to these “temples of modern India.” But even after a decade and a half of economic liberalisation, it is unthinkable that this land-holding will be productively exploited without privatisation or disinvestment. Any such move will be hugely controversial.


The biggest contribution of an asset-valuation exercise by research firms would be to expose the extent to which land and office blocks of publicly listed companies are held by private investment firms controlled by the promoters and profitably leased by them. Most of these assets are funded by the listed companies and should rightfully belong to shareholders, not the promoters. What is worrying about the CLSA report is its assertion that “India’s domestic fund managers are, after protracted scepticism, beginning to sense the potential power of this asset-based investing.”


Already, domestic funds seem to be the biggest investors in last week’s rally that took the Sensex past 12,000, while FIIs were relatively unimpressed by secondary market developments. Will Indian Funds, sold on an asset-based investment theory, end up providing an exit to FIIs if there is a deep correction? If that happens, the mutual fund industry would have again lost an opportunity to gain long-term credibility among investors.


-- Sucheta Dalal