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Stories written for Outlook
Money July 2003 |
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BSE wants a free float Sensex. Is it a sensible intent? July 2003 In a drastic move, the Bombay Stock Exchange (BSE) has decided to calculate its 30-stock Sensitive Index (Sensex) based on the free float capitalisation of the companies instead of their total market capitalisation as is applied currently. This will take effect from September 1. The management of any stock market index involves two things—setting out the criteria for selecting—and consequent reviewing—stocks into the index and calculating the index. In the selection of stocks, the BSE uses total (not free float) market capitalisation and liquidity as defined by trading volume (the NSE defines liquidity as the impact cost for its 50-stock Nifty index) as the deciding criteria. What is free float. When calculating Sensex and Nifty respectively the BSE and NSE use the market capitalisation weighted method wherein the index value each day reflects the sum total of the market capitalisation of all the index stocks in relation to a particular period. The market capitalisation of a stock on a given day is taken to be the share price multiplied by the total number of shares issued by the company which are in existence as on that day. But the new BSE move will involve it taking not the total number of shares but that proportion of the total which it thinks are under "free float" and multiplying that by the share. Free float is generally understood to be those shares which are likely to be traded. Shares held by promoters, their relatives and shareholders having a controlling interest are considered to be unlikely to be traded. These shares are therefore sought to be deducted from the total number of shares and the remaining shares are considered to be free float shares. The BSE will ask all index companies to provide it with data relating to various categories of shareholding every quarter. Its index committee will then at its discretion decide which shareholdings are to be considered as promoter or having controlling interest in the company. These will be deducted from the total. For instance, the BSE finds Hindustan Lever (HLL) shareholding to contain 51 per cent of promoter holding. The balance, that is 49 per cent, is then rounded off to the next figure of ten, that is, 50 per cent. Only 50 per cent of HLL's total number of shares will therefore be multiplied by the share price to arrive at a "free float" market capitalisation. A similar exercise will be carried out for each of the index stocks. The effect. The table given alongside shows the differences between a full market capitalisation based method and one based on free float. Different percentages have been assigned by BSE to each of the 30 Sensex stocks as "free float" proportions and the market capitalisation is based on that. It is seen that the BSE will be taking only half of Colgate's, Hero Honda's HLL's, Nestle's, MTNL's and State Bank of India's market capitalisation while calculating its Sensex from September 1 while only in the case of Housing Development Corporation and ICICI Bank the entire market capitalisation is retained. The total Sensex free float market capitalisation is also 65 per cent of the total Sensex entire market capitalisation. As a result, the weightages of the stocks change. Weightage of an index stock is the proportion of its market capitalisation (total or free float) to the sum total of market capitalisation of all the stock in that index. In the new free float methodology of BSE for its Sensex one sees the existing weightages of existing heavyweight stocks—HLL and Reliance—come down by 2.8 and 1.2 percentage points respectively, whereas that of Infosys go up by 1.7 percentage point. Is it better. It can not be said with certainty whether a free float methodology for an index is better as compared to the existing one. If one wants to get a feel of the overall market from the index then it is imperative that the size of the companies, as denoted by entire market capitalisation, is reflected in it. The free float method is based on getting only tradeable shares reflected. But the liquidity of an index is reliably determined by applying the impact cost methodology. It can not be beneficial then for an index to discreetly tamper with the market capitalisation of companies.
July 2003 The Sebi-appointed primary market advisory committee has submitted to Sebi a review report of public issue norms. The report recommends critical changes in the entry criteria for unlisted companies seeking to raise funds from investors through a public equity issue for the first time. At present, an unlisted company coming out with an initial public offer (IPO) has to have had in three out of five preceding years any profits and a minimum networth of Rs 1 crore. Failing to meeting these two requirements or if the capital sought to be raised is more than five times its networth, a company could still make an IPO through the book building route with the proviso of raising at least 60 per cent from qualified institutional investors (QIBs – defined by Sebi as including mutual funds and foreign institutional investors). The committee wants Sebi to replace the profit criteria with a requirement of minimum net tangible assets of Rs 3 crore in each of the preceding two years. Says Prithvi Haldea, chief of Praxis and Consulting Services, and a member of the Sebi committee: "Uptil 1999 we had a dividend criteria which was then replaced by profitability. At that time and now, I believed that profitability ought to get reflected in the price at which the issuer seeks to raise capital from the public, and should not serve as an entry barrier." The implication here is that as an investor you ought to have access to companies who may not be profitable at present but would have assets operating in its business which could translate into profits in coming years. And you would decide at what price you are comfortable in subscribing to such companies' shares. The committee thinks making the companies have net tangible assets (NTAs – defined as all assets other than intangible assets) would have a sufficient deterrence from potential fly-by-night operators to raise funds from public. Investors benefit by this change because having a minimum Rs 3 crore NTA requirement is certainly better than any marginal profit figure (of, say, even one rupee) as the entry criteria. Another major change sought by the Sebi committee is a bringing down of the QIBs' subscription requirement from 60 per cent to 40 per cent. In existing as well as the proposed norms the idea of a QIB commitment is to allow all companies not meeting the first criteria of profitability (existing) or NTAs (proposed) should still be allowed access to public—albeit only through the book building route where the final price is determined by participating investors as well as a condition of getting QIBs to collectively take a minimum stake in the issue. Says Haldea: "A professional fund manager would normally not commit funds in issues without having done adequate research on the company and the issuer company garnering funds from public would be perforce to attract a minimum level of commitment from the professional fund managers." However, Haldea felt that 60 per cent requirement was high enough to bring down the quantum of retail participation and so the proposed change to bring it down to 40 per cent. As an investor, however, it would be difficult to say with certainty which one serves your interests better—the need to have higher comfort level by way of a higher percentage of institutional commitment or the ability to have a larger share of the issue.
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