Do it yourself

In recent weeks, a lot of market participants and commentators have expressed concern about the rising household (retail) investors’ interest in the SME segment of the Indian stock market. It has been highlighted that most of the businesses being listed on this platform may not be genuine and/or sustainable. The regulators have also expressed apprehensions about the widespread manipulation in the prices of several SME stocks. A 400x oversubscription to the recent Rs120mn IPO of a motorcycle dealership in Delhi has provided further impetus to the discussions on this topic.

There are demands that the criteria for listing on SME segments must be tightened and there should be deeper scrutiny of the companies proposing to list on this segment. The regulator, SEBI, is considering these demands and intends to prescribe stricter rules for the SME listings.

In this context it is pertinent to note the following points.

1.    As part of the broader capital market reforms, which included abolition of capital controls and establishment of an autonomous market regulator (SEBI), the Over-the-Counter Exchange of India (OTCEI) was established in 1990. OTCEI was modeled after the NASDAQ trading platform of the US and meant to provide small and medium sized enterprises (SME) a fully automated national platform for raising risk capital.

A number of SME promoters used this platform to raise money in the 1990s. However, the experiment was considered a failure as the listing process lacked adequate scrutiny and ingenious promoters were able to raise money at unsustainable valuations. A majority of the companies that raised money on OTCEI vanished, inflicting substantial losses to the investors.

2.    In the mid-1990s there were 29 recognized stock exchanges in India. The 28 regional stock exchanges (RSEs) helped the local companies to raise risk capital. All these RSEs had floor base trading and physical settlement of securities. A majority of investors in these local companies were also from the same state or region. For example, a company listed only on the Madras Stock Exchange was more likely to have investors from Tamil Nadu as its shareholders, because investors from other regions usually did not have access to the Madras Stock Exchange.

With the advent of the National Stock Exchange (NSE) as a computer based national trading platform, things started to change from 1995 onwards. In a couple of years the Bombay Stock Exchange (BSE) also transformed itself into a computer based national trading platform. Over the next decade and a half, all the RSEs faded into oblivion. Most relevant companies migrated from these RSEs to these two national stock exchanges. But many smaller local companies, listed only on these RSEs, also perished along with them. Not all of those companies were fraudulent. Many of them were just not big enough to qualify for trading on national stock exchanges. Investors in those companies also suffered for a long period; until they made offers to buy back their shares.

The point to ponder over is “did the market participants – regulators, stock exchanges, brokers, investment bankers, investors, etc., - learn any lesson from the OTCEI and RSEs episodes?” To me, prima facie, it appears that the same drama is being played all over again at SME platform; and only the unscrupulous promoters and intermediaries have learnt their lessons from the past failures, and become even more smart.

I had an opportunity to meet a group of market participants and industry representatives at a corporate event this week. The discussions over lunch and tea revolved around the three broader topics – (a) State of equity markets; (b) Expectations for the final Union Budget for FY25; and (c) Corporate performance. Unsurprisingly no one was interested in discussing politics, geopolitics and the US Fed’s policy.

 I had an opportunity to e-meet the promoter of a decent sized enterprise yesterday. His company manufactures some auto parts mostly for replacement market. The business of this company had been doing extremely well for past more than a decade, before it hit a small bump last year. It recovered from the fumble in two quarters and was about to regain its pre Covid trajectory in 1QFY22. The intense second wave has however derailed the business from recovery path. The promoter now expects the business to normalize not before summer of 2022. Even for that he is not very confident. I have known this gentleman for past 17years. It was for the first time I found the gleam in his eyes missing. A driblet of sweat on the temple was also rather conspicuous.

He is not only worried about his business. The worries are in fact emanating from a variety of factors. For example,

·         Having lost couple of senior family members to Covid, the family is terribly shaken. They are insisting they the family migrates to a “better place” to live. He has faced this situation earlier also and was able to manage it well. But this time his resistance is weak. He is finding it hard to convince his US educated children to stay back and work for the betterment of the country.

·         His working capital requirements have increased materially, as many of his customers (mostly traders) have failed to pay in time. He is staring at significant losses from irrecoverable debts. His raw material cost has also increased and he is in no position to pass it on completely. Therefore, he has to cut production. He is contemplating retrenching at least 20% workers in two weeks.

·         He faces serious threat from the larger peers who mostly produce for OEMs. Some of them have already started servicing the replacement market due to slowdown in OEM demand.

·         Many of his workers are turning violent generally. Many of them have faced hardship in treating their family members. He finds that workers’ belief in system is materially diminished. Some of them have turned cynical and get easily provoked. Their chances of becoming non-compliant are far higher now.

·         He expects his bankers to soon downgrade his credit facilities, which will further raise his credit cost. Though he has the wherewithal to withstand tough conditions for next 3-4years, a prolonged phase of uncertainty could precipitate the fall.

This gentleman is quite convinced that any hopes of normalization in 2021 are terribly misplaced. He feels it will be at least 15-18 months process to normalization. From his workers he understands that unlike the first wave which spared the hinterlands, the impact of this second wave is deep and wide. It has seriously damaged socio-economic fabric of the country. Many households’ finances have been damaged structurally, pushing them into vicious cycle of debt and poverty.

He agrees that the pandemic has fully exposed the inadequacies of our social infrastructure and disaster management capabilities and significant improvements must be expected in next few years. Nonetheless, surviving these next few years could be quite challenging for a significant proportion of the population.