For the third time in the Indian stock market history, small and medium enterprises (SMEs) now have a new platform to access funds from people other than friends and family in the Bombay Stock Exchange (BSE) SME exchange that completed its first initial public offer (IPO) in February.
On the face of it, this exchange should be a god-send for India’s 26 million SMEs who suffer a chronic problem accessing capital. So where India’s Big Two – the National Stock Exchange and BSE – stipulate a minimum paid-up capital of Rs 10 crore, companies with lower paid-up capital can raise as little as Rs 50 lakh on this new SME platform.
According to the Securities and Exchange Board of India (Sebi), the new platform has been formulated after a detailed study of best practices from across the world and feedback from market participants. It has also taken into account learning from past attempts. One was Over-the-counter Exchange of India (OTCEI), launched in 1990 with aim of becoming the Nasdaq of India; it introduced many concepts that were new to the Indian capital markets then such as screen-based nationwide trading, sponsorship of companies, market making and scripless trading. However, the 1992 scam and the bear market that followed killed the initiative.
BSE Indonext, launched by then Finance Minister P Chidambaram in 2007, was specially created to cater to SMEs listed on regional stock exchanges. Since regional stock exchanges were unable to attract trader attention for lack of advanced technology, BSE tried to give them a lease of life under the new platform. The companies listed on BSE IndoNext, however, did not attract much market participation either.
So how is the BSE SME different? The concept is similar to the OTCEI, but additional safeguards such as 100 per cent underwriting of offerings, easier compliance norms such as half-yearly reporting instead of quarterly for bigger firms, and the provision to migrate to the main board have been put in place.
Sebi has also waived listing conditions such as profitability for three years, approval of prospectus by Sebi and so on.
The SME exchange is off the blocks with BCB Finance, a Mumbai-based firm, launching its first IPO. A good start is important in a race but in the case of the SME exchange, there are no podium finishes; the prize is for breasting the tape. And the exchange needs a lot of running to do before it can get anywhere near the finish line.
Can we set the exchange a finish line? Let us use a simple formula. Estimates put the contribution of SMEs to the country’s gross domestic product at eight per cent. The big exchanges, which are considered barometers of India’s trillion-dollar economy, have a market capitalisation of around a trillion dollars.
Therefore, an SME exchange, which represents eight per cent of the economy, should have a market capitalisation of $80 billion or Rs 4 lakh crore. Assuming SME promoters will sell stocks worth 30 per cent of their companies in the exchange, we should see initial share sales of Rs 1.2 lakh crore.
Investment bankers say these companies won’t enjoy the same valuations as the big boys. So, let us assume that these stocks will be sold at a tenth of values commanded by big boys, say, Rs 12,000 crore.
Thus, the finish line for, say, the next three years will be when the SME exchange has helped raise Rs 12,000 crore — that is, Rs 4,000 crore every year from now. Going by the first IPO, where the company sold 30 per cent stock to raise close to Rs 9 crore, we will need 400-odd such small IPOs every year.
Is this asking for too much? Not when you look at the size of the SME universe. There are about 26 million small firms employing more than twice that number. They account for 45 per cent of the manufactured output and 40 per cent of India’s exports.
So the Promised Land is beckoning. The faithful are eager to get there. But what about the road? Er, sorry, what road? Right now, there is no road. It has to be paved with the intentions of the intermediaries.
That’s because the structure stipulated by the regulators relies less on the platform itself but more on market makers and merchant bankers.
Take, for one, the merchant banker. His role is much harder than for a bigger company. He has to ensure that the issue is underwritten fully and 15 per cent of the issue has to be underwritten by his own balance sheet.
Also, since the minimum ticket size is set at Rs 1 lakh, bankers have to sell it to savvier and wealthier investors. Convincing these investors about a relatively little-known company is a difficult and time-consuming task.
It is the responsibility of the merchant banker to appoint a stock broker as the market maker for the issue and, under the rules, such market making should be done for a period of three years. And the market maker’s engagement has to be deep: he will be required to provide a two-way quote for 75 per cent of the trading time in a day.
The rules say: “The minimum depth of the quote shall be Rs.1,00,000. However, the investors with holdings of value less than Rs 1,00,000 shall be allowed to offer their holding to the market maker in that scrip provided that he sells his entire holding in that scrip in one lot along with a declaration to the effect to the selling broker.” The market maker’s role, thus, is crucial because it gives investor an exit option.
Assuming that we get one merchant banker to handle five companies at a time, we will need 80 dedicated intermediaries to bring 400 IPOs to the SME exchange each year.
Do we have 80? The big guns, who are happy to talk endlessly about the importance of the platform, are not too keen because they feel the money is too little. Even if a banker charges five per cent of the money raised, which is usually the upper end of the fee for big public offers, he will get a princely Rs 50 lakh for managing an issue of Rs 10 crore. They would rather spend their resources running free services for government share sales and boost league table positions.
And the smaller merchant bankers are either scared to make the three-year commitment or have to charge exorbitantly to be viable. The market maker for the first IPO is charging Rs 75,000 a month. At one per cent of the money raised every year, it makes the equity expensive for the SME, say analysts.
Even assuming an SME does find interested players, there is a lack of clarity on operational issues such as what will happen if the entire floating stock ends up with the market maker or the opposite position, where he is left with no stock at all to deliver. Exchanges have made representations to the regulator on these issues.
If we are lucky, we will get eight intermediaries who are serious enough about the business and are willing to cut corners to make this bottom-of-the-pyramid opportunity in to a viable cash making business. That means 40 IPOs annually, not 400.
If this effort has to be taken seriously and escape the ignominy of being bundled in history with OTCEI and the Indonext platforms, then the powers that be have to get eight sets of low-cost intermediaries, 40 companies and an investment of Rs 400 crore on the table by March 1, 2013 alone. That is not asking for too much if you remember where we started this from. But anything less will be too small.