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March 16, 2000

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Devangshu Datta

'New economy' stocks

It's been over two years since the 'new economy' stocks divorced themselves from the rest of the Indian economy. Until very recently, however, media attention was focused almost exclusively on infotech scrips.

Entertainment and communication stocks were rarely mentioned in the same breath as software. New economy stocks like Zee Telefilms, Sri Adhikari Brothers, etc. were usually treated like high-flying singletons rather than as entertainment industry leaders. Communication scrips such as MTNL and VSNL were treated like any other brick and mortar industry.

The penny dropped when correlation studies showed that it wasn't only Indian software that was strongly influenced by the US Nasdaq. Entertainment and communications scrips were also more heavily oriented towards US bourses than towards the Sensex. In all three categories, a lot of the funding comes from overseas and so does a lot of the business.

Correlation coefficients (r-square) for the new economy scrips with the Nasdaq are close to 0.9. This is useful trading information because of the time-difference between the US and India of up to 12.5 hours. The lag allows an Indian trader to place orders after knowing exactly how the Nasdaq has behaved. If adjustments are made for settlement complications, book-closures, etc. in India, the trading pattern gets even tighter. A Nasdaq sellout or bull run will inevitably affect Indian new economy scrips.

A few months ago, market operators finally started talking about the ICE group -- a composite basket of infotech or IT, communications and entertainment stocks. Just a couple of the majors in the new economy were part of the 30 stocks Sensex, which is the bellwether index for the Bombay Stock Exchange. The Business Standard newspaper then created a new index to try and capture the moves of this market. This was launched on a base-date of November 1, 1999.

The creation of the new ICE Index presented quite a few unexpected difficulties. Some of the biggest players in these new segments weren't listed at all. So financial information about them was at a premium and valuations were also pretty notional. Many of them had the classic new economy pattern of fast growth, combined with a red bottomline. So conventional valuation methods wildly overpriced them.

The ICE Index has 30 components, of which as many as 12 companies are currently unlisted. Dot-coms, media, entertainment and software companies, with a few hi-tech private banks, telecom, ISP and hardware companies thrown, in dominate the index.

The index, as such, is calculated on normal methodology of appropriate weightages and it is re-balanced daily on a basis of relative market values.

There can be no quarrel about the outperformance of the listed 18 scrips at least. Between November 1, and March 10, they have beaten the market by huge margins. The ICE Index as a whole has gained 276 per cent, while the Sensex has gained 24 per cent.

If one decomposes the index to exclude the unquoted elements, while retaining the same methodology, the ICE Index would have gained approximately 262 per cent by moving from 100 points to 361.9 points, whereas the Sensex moved up by 24.14 per cent between the same period.

More specifically, the month of February saw an enormous spurt that was only terminated by the Budget. While the Sensex moved up 12.7 per cent in the first three weeks, the ICE moved up 66 per cent. You could use any other methodology you choose, and these stocks would still have outperformed by huge margins.

The biggest winner has been Wipro, which gained 538 per cent after adjusting for stock splits. But 12 of these 18 scrips have produced triple digit returns since November. Even amongst the relative laggards, only NIIT and Tata Infotech have under-performed the market Index. In the listed segment, IT stocks have done better than the others with a collective return of 329.8 per cent versus 157.23 per cent, respectively.

What I found really interesting was the attempt to value the unlisted companies. In some cases, there were benchmarks in the sense of angel and venture capital investors who had produced seed capital and taken stakes on the basis of page views and other traffic numbers. You also had claimed page views and other traffic numbers for several of the other dot-coms. TCS, of course, could be treated as just another very large software company, though it will remain an eternal mystery why the Tatas haven't gone public. At the least, they could have rewarded loyalists with stock options.

However, valuations can't remain static for a segment that displays such high volatility. A surrogate method of valuation was used to keep updating the notional value of the unlisted components. A mega-deal like IndiaWorld-Satyam Infoway then causes exponential gains to the entire index since every comparable dot-com gains in notional valuations. Partially, these valuations were also a matter of sophisticated coin-tossing since a lot of important financial data just isn't available. Some of it consisted of just polling a consortium of VCs on their perceptions of given company's market value.

As a result of this fuzzy exercise, the unlisted segment of the ICE Index is reckoned to have outperformed the listed segment by a significant factor. Since the gross valuation figure for the unquoted stocks is released on the website, we can calculate that it is reckoned to have increased almost exactly as much as the IT segment in valuation with a 329.8 per cent gain between November and March 10. So it has outperformed the combined listed segment.

Incidentally, the unlisted segment was supposedly out-performing the listed segment by an even wider margin until February 21. It was calculated at registering a gain of 425 per cent versus the listed segment's gain of 327 per cent. The post-Budget slump has affected valuations more -- not unexpected -- given the lack of a price-discovery and trading mechanism for these entities.

It may be expected that companies that list in the near future will again see a multiplication of share prices. With among others, on the verge of a Nasdaq listing, we could be at the start of another gold-rush.

I wonder whether the feeding frenzy will last until the Securities and Exchange Board of India or SEBI actually gets around to changing the three-year profitability norms for Indian initial public offerings or IPOs. At that, most of these companies will prefer Nasdaq listing anyhow.

So, unfortunately, there will be little room for the average Indian investor to get a slice of the action. The only direct method would be to start-up a dot-com and set the wheels spinning. Since McKinsey received some 4,500-odd proposals on its website, it appears that a lot of entrepreneurs are doing just that.

Devangshu Datta

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