Is divestment of stake by promoters a necessary evil?

It is quite unfortunate to see retail investors panic and offload the shares the moment the government or the promoters announce divestment or offer for sale. Historical evidences suggest that it is the growth prospects and the valuation parameters which determine the future course of wealth creation in those stocks, rather than such divestments. It is quite surprising to note that even those divestments or offer for sale which didn't involve expansion of overall equity capital also got punished.

For example, on the eve of divestment of shares in Engineers India, the stock price came down to 52-week low of Rs 139 in July 2013 and subsequently it recovered 36% post divestment within four months. Once again the same stock fell as low as Rs 142 on the eve of another divestment in February 2014. However, after this follow-on public offer, the stock price again moved up 133% from this bottom within five months. It is unfortunate to note that the overall paid-up capital of this company remained constant during these two periods of divestment.

One can understand the negative impact if such divestment leads to significant expansion of the overall paid-up capital as the same would dilute the earnings per share. However, divestment or offer for sale from the existing promoters' capital does not alter the earnings per share, and hence there is no need for any panic reaction by the investors. Of course, the traders may get some short-term profits for the immediate responses to such moves.

Such opportunity losses have happened not only in the shares of government-owned companies, but also in the stocks of multinational firms. The classic example was Styrolution ABS – on the eve of offer for sales, its share fell 20% within 10 trading days in May 2013 to as low as Rs 425 and the weakness in the stock continued for few more months post sale of shares. However, in the next two years and three months, the stock price more than doubled from this bottom.

Retail investors need to understand that divestment without expansion of the existing capital doesn't change the fundamentals of the stocks. Such major fall in share prices only makes them more attractive in terms of valuation parameters, if there is no change in the business prospects during that short span of time.

On the part of the government, it is time to realise that the phased-out divestments or divestment through "options" method would minimise the wealth erosion for the both the government and common shareholders.

(Stock names are mentioned here only for illustrative purposes and do not form part of any recommendations)

The writer is founder & managing director, Equinomics Research & Advisory Pvt Ltd