What’s Distorting Stock Prices At The Time Of Relisting
Arvind Fashions Ltd., the retailing arm carved out of the Lalbhai Group, relisted on stock exchanges at about Rs 590 apiece, and then surged the maximum 5 percent allowed in a day. An ideal trading debut—only, it wasn’t.
The listing price was about half the lowest expected price that BloombergQuint had calculated based on valuations forecast by analysts.
Spencer’s Retail Ltd., hived off from Sanjiv Goenka-controlled CESC Ltd., listed at Rs 225 apiece, much higher than estimates, on the first day of trading. But then it hit the 5 percent lower circuit for 10 straight sessions.
These are examples of exchanges’ price-discovery mechanism gone wrong.
Demergers and mergers are now at risk of price discovery at the time of call auction, said VR Narasimhan, former chief of regulations at the National Stock Exchange of India Ltd., the nation’s largest bourse.
A call auction is a special 45-minute pre-open session on the day of listing for companies that have completed initial public offerings or are looking to relist. Investors can buy or sell a stock at a specific price. The exchange then matches the order based on volume weighted average to arrive at the base price before the normal trading begins. The call auction continues till a price is discovered.
Then for 10 days, the stock remains in a trade-for-trade session with a 5 percent price circuit. What that means is the seller has to hold shares and the buyer has to take delivery for such trading.
As a process it’s fine but the problem is with liquidity on day one of trading, according to Ajay Saraf, executive director at ICICI Securities Ltd. The regulator should allow some trading of the float—the total number of shares available for trading—for arriving at the base price, he said.
Lack Of Institutional Participation
Relistings are usually part of restructuring efforts such as mergers or demergers to unlock value. Trading is initially suspended in the company and resumes after all regulatory approvals are received for the rejig and issuing new stock or swapping of shares. Once the shares are submitted for listing, exchanges hold pre-open call auctions. But lack of liquidity distorts the price.
Exchanges globally grapple with the issue. In developed markets, institutional investors are among buyers and sellers. Their absence causes the problem in India.
Lack of institutional participation led to mispricing in some of the recently re-listed companies, subjecting the price discovery process to mischief, said a senior executive at an exchange—he didn’t want to be identified as the matter involves regulatory decisions. Unless institutions don’t participate, price-discovery will continue to be handicapped for liquidity, he said. The regulator can look at limiting the price-discovery process of relisting to institutional investors, he said.
The BSE Ltd. and the NSE declined to comment.
Problem Unique To Relisting
The current mechanism stems from volatility and price movements on the first day of trading, especially in the case of initial public offerings when speculative trading spikes. The Securities and Exchange Board of India instituted the call-auction process in January 2012 for IPOs and re-listed scrips.
But it involves thin volumes–sometimes a couple of hundred shares decide the relisting price, BloombergQuint found. That defeats the very purpose of it.
If the company is part of the portfolio of qualified institutional investors like mutual funds, erroneous price discovery can lead to mark-to-market losses, increasing volatility in the subsequent trade-for-trade sessions.
And the problem is unique to relisting because a company depends entirely on call auctions for discovering the base price. In case of IPOs, road shows and meetings with institutional investors provide valuable feedback on valuation. This is further strengthened through investments by anchor investors and the qualified institutional placement during an IPO. The company also has a say in the pricing of the IPO, unlike in case of relistings.
The levels of price discovery that an IPO undergoes are missing in case of relistings, said a banker at a boutique investment bank. Merchant bankers should find the base price through road shows, he said.
According to Narasimhan, the regulator can correct the situation. “The exchange can rely on the valuation report —already approved by it, the NCLT and shareholders—shared at the time of seeking approval.” The merchant banker then can use the report to arrive at a base value, and the listing price can be at a discount or a premium to it, he said. In a nut shell, he said, merchant bankers should be allowed to provide valuation for stocks relisting on the exchange.
The problem, however, is the at least six-month gap between the restructuring and actual relisting, and the valuation of a company could change.
The merchant banker that calculates the value can also provide a price band or another banker can do it, said a second banker on the condition of anonymity since the regulator has framed rules for relisting. That, according to him, should take care of any change in valuation over time.