May a thousand market structures bloom

In my commentary on SEBI’s proposal to change the regulations of Indian securities markets in order to allow new kinds of market structures, I had mentioned that SEBI should simply enable exchanges to apply whatever market structures they wanted to apply, and let market participants sort out, through competition and pricing, what makes most sense for them.

This way, different stock exchanges in India can pick and choose their favoured form of regulation, and the market (and market participants) can decide which form of regulation they prefer. So you might have the Bombay Stock Exchange (BSE) going with order randomisation, while the National Stock Exchange (NSE) might use batch auctions. And individual participants might migrate to the platform of their choice.

Now, Matt Levine, who has been commenting on market structures for a long time now, makes a similar case in his essay on the Chicago Stock Exchange’s newly introduced “speed bump”:

A thousand — or at least a dozen — market structures can bloom, each subtly optimized for a different type of trader. It’s an innovative and competitive market, in which each exchange can figure out what sorts of traders it wants to favor, and then optimize its speed bumps to cater to those traders.

Maybe I should now accuse Levine of “borrowing” my ideas without credit! 😛


Narendra Modi should short the Nifty

The common discourse is that businesses like Gujarat chief minister Narendra Modi, and that India’s economic growth would get back on track if he were to become PM following the elections this summer. For example, this view was articulated well by my Takshashila colleague V Anantha Nageswaran in an Op-Ed he wrote for Mint last Tuesday, where he spoke of a “binary outlook for India” – either economic growth under Modi or further populism and stagnation under a Third Front.

Based on this view being the consensus, one can expect that the Indian stock market would go up significantly in case of a Narendra Modi victory, and would tank in case the Modi (and/or his party BJP) ends up doing badly. So what should Modi do?

He should short the stock markets, and fast. He needs money to run his campaigns, and he might be taking funds from friends and well-wishers, who expect some kind of payback in kind if/when Modi becomes PM. The question, however, is how he will pay them back in case he fails to become PM!

He will not have the power to pay back in kind. There is only so much he will be able to do as the Chief Minister of Gujarat. And given that he has got a lot of fair weather friends over the last couple of years, some of them might be disappointed that he didn’t become PM, and will ask for immediate payment. So how does Modi service these debts?

A part of his campaign budget should go into shorting the Nifty – perhaps by means of buying puts (with a May expiry – not sure they’re traded yet). This way, in case of his victory, he will end up losing his premium, but he will be able to pay back his creditors in kind, since he will be PM. In case he loses? The markets will tank anyway, and he will end up making a packet on these puts, which can then be used to pay back his current well=wishers!

Easy, no?

Issuing in stages

I apologise for this morning’s post on IPOs. It was one of those posts I’d thought up in my head a long time ago, and got down to writing only today, because of which I wasn’t able to get the flow in writing.

So after I’d written that, I started thinking – so if IPO managers turn out to be devious/incompetent, like LinkedIn’s bankers have, how can a company really trust them to raise the amount of money they want? What is the guarantee that the banker will price the company at the appropriate price?

One way of doing that is to get the views of a larger section of people before the IPO price is set. How would you achieve that? By having a little IPO. Let me explain.

You want to raise money for expansion, or whatever, but you don’t need all the money now. However, you are also concerned about dilution of your stake, so would like to price the IPO appropriately. So why don’t you take advantage of the fact that you don’t need all the money now, and do it in stages?

You do a small IPO up front, with the sole purpose of getting listed on the country’s big exchanges. After that the discovery of the value of your company will fall into the hands of a larger set of people – all the stock market participants. And now that the market’s willingness to pay is established, you can do a follow on offer in due course of time, and raise the money you want.

However, I don’t know any company that has followed this route, so I don’t know if there’s any flaw with this plan. I know that if you do a small IPO you can’t get the big bankers to carry you, but knowing that some big bankers don’t really take care of you (for whatever reason) it’s not unreasonable to ditch them and go with smaller guys.

What do you think of this plan?

IPOs Revisited

I’ve commented earlier on this blog about investment bankers shafting companies that want to raise money from the market, by pricing the IPO too low. While a large share price appreciation on the day of listing might be “successful” from the point of view of the IPO investors, it’s anything but that from the point of view of the issuing companies.

The IPO pricing issue is in the news again now, with LinkedIn listing at close to 100% appreciation of its IPO price. The IPO was sold to investors at $45 a share, and within minutes of listing it was trading at close to $90. I haven’t really followed the trajectory of the stock after that, but assume it’s still closer to $90 than to $45.

Unlike in the Makemytrip case (maybe that got ignored since it’s an Indian company and not many commentators know about it), the LinkedIn IPO has got a lot of footage among both the mainstream media and the blogosphere. There have been views on both sides – that the i-banks shafted LinkedIn, and that this appreciation is only part of the price discovery mechanism, so it’s fair.

One of my favourite financial commentators Felix Salmon has written a rather large piece on this, in which he quotes some of the other prominent commentators also. After giving a summary of all the views, Salmon says that LinkedIn investors haven’t really lost out too much due to the way the IPO has been priced (I’ve reproduced a quote here but I’d encourage you to go read Salmon’s article in full):

But the fact is that if I own 1% of LinkedIn, and I just saw the company getting valued on the stock market at a valuation of $9 billion or so, then I’m just ecstatic that my stake is worth $90 million, and that I haven’t sold any shares below that level. The main interest that I have in an IPO like this is as a price-discovery mechanism, rather than as a cash-raising mechanism. As TED says, LinkedIn has no particular need for any cash at all, let alone $300 million; if it had an extra $200 million in the bank, earning some fraction of 1% per annum, that wouldn’t increase the value of my stake by any measurable amount, because it wouldn’t affect the share price at all.

Now, let us look at this in another way. Currently Salmon seems to be looking at it from the point of view of the client going up to the bank and saying “I want to sell 100,000 shares in my company. Sell it at the best price you can”. Intuitively, this is not how things are supposed to work. At least, if the client is sensible, he would rather go the bank and say “I want to raise 5 million dollars. Raise it by diluting my current shareholders by as little as possible”.

Now you can see why the existing shareholders can be shafted. Suppose I owned one share of LinkedIn, out of a total 100 shares outstanding. Suppose I wanted to raise 9000 rupees. The banker valued the current value at $4500, and thus priced the IPO at $45 a share, thus making me end up with 1/300 of the company.

However, in hindsight, we know that the broad market values the company at $90 a share, implying that before the IPO the company was worth $9000. If the banker had realized this, he would have sold only 100 fresh shares of the company, rather than 200. The balance sheet would have looked exactly the same as it does now, with the difference that I would have owned 1/200 of the company then, rather than 1/300 now!

1/200 and 1/300 seem like small numbers without much difference, but if you understand that the total value of LinkedIn is $9 billion (approx) and if you think about pre-IPO shareholders who held much larger stakes, you know who has been shafted.

I’m not passing a comment here on whether the bankers were devious or incompetent, but I guess in terms of clients wanting to give them future business, both are enough grounds for disqualification.

Short selling Indian Hotels

I’m writing this post in protest against people who have stupid ideas such as declaring “no blog day” in order to protest against “hatred and terror”. I’m sorry I don’t get the point. I dont’ see how this kind of thing is going to help. And I don’t know how anyone who cares will be bothered by this.And if you don’t like this post, you might want to take some tablets which can cure irony deficiency.

So yesterday morning, after the end of our usual morning meeting at work, I switched on Bloomberg as is my usual practice. After checking on the Nifty, I  opened another window and checked up on Indian Hotels (the Tata group company that owns the Taj chain, among others). The stock was down 15%. Ruthlessly hammered down. By short sellers.

While the Taj Mahal was burning, and our security forces out in full force in order to salvage it, you had ruthless short sellers and market operators who were trying to profit from it by shorting the stock. This smacks of disrespect and needs to be condemned using the strongest words. What the owners and managers of Indian Hotels now need is our support, and you have people who are doing exactly the opposite.

Strong steps need to be taken by the government to improve regulation of markets in order to stop capitalists and monopolists from taking advantage of other people’s troubles. One model we could adopt is what has been seen in the Karachi Stock Exchange, where stock prices are not allowed to go down. This is an excellent step, and can be used to prevent operators from making a fast buck out of someone else’s misery