Al-Ahram Weekly Online   23 - 29 March 2006
Issue No. 787
Economy
 
Published in Cairo by AL-AHRAM established in 1875

Bubbles burst

Waleid Gamal Eldien* examines the causes, and fall out, of Black Tuesday's run on share prices

What is happening to the Egyptian stock market? The question has been asked repeatedly since stock market prices began to drop a month and a half ago. The CASE 30 index, which represents the top 30 listed companies in terms of liquidity and activity, fell 28 per to close at 5892.73 on 14 March -- Black Tuesday. On 1 February the index stood at 8139.96 points.

It was on 1 February that investors began to take their profits, a day ahead of the extraordinary general assembly meeting (EAGM) of EFG-Hermes which would decide on whether to go ahead with a private placement for the first tranche of its capital increase.

There are several factors that contributed to the massive fall in prices over such a short period of time. A correction in the market was inevitable following a huge surge in prices and the capital influx that followed three partial privatisations -- of Sidi Krir Petrochemicals (SIDPEC), Alexandria Mineral Oil Company (AMOC) and Telecom Egypt (TE) -- that successfully attracted small retail and much larger Gulf investors to the market. The response to Telecom Egypt's, coupled with some exciting news about other market participants, provoked a state of irrational exuberance.

Though financial experts and traders had anticipated the correction some investors panicked, linking the performance of the Egyptian securities market with those of both Saudi Arabia and the UAE, though no significant correlation exists between them. But inter-Arab capital flight isn't enough to cause a market melt down. With respect to relative pricing, Egyptian securities valuations are far more fairly priced than those of Saudi Arabia and the UAE, especially when the expected growth in companies' bottom lines is taken into account, and a vibrant economy expected to grow by six per cent.

So why did the stock markets of Saudi Arabia and the UAE crash? First, the UAE Securities Market had three gigantic IPOs running simultaneously, and after a two-year bubble cross the board a corrective movement was overdue. As Table 1 shows, average trailing P/E ratio, even after a six month decline in prices remains, 20.3 times. If prices remain relatively constant in 2006 P/E will decrease only slightly, following to 19.1 times, marginal and not attractive to the short-term speculative investors who dominate the GCC markets. The reasons for the collapse in Saudi Arabia's market are even simpler. It is the most expensive market in the region with respect to the average trailing P/E ratio, which stood at 42.6 times. Again, if prices remain relatively constant in 2006, the forward PE ratio will drop to only 38.6 times, again not so attractive to short-term speculative investors, and twice as high as its closest regional peer, the UAE. Saudi Arabia and the UAE do, however, enjoy exceptional economic growth which, together with new companies being listed in the market, could ensure returns over the next year at a more reasonable and relatively modest level compared to other regional markets.

In 2006 the profits of market participants in Egypt will grow dramatically, making CASE the third cheapest securities market in the region after Oman and Kuwait, with a forward PE ratio of 12.7 times if prices remain relatively constant, attracting local, regional and international investors. If the privatisation programme in Egypt continues as planned, it will become more attractive relative to other regional markets.

What augmented the situation, however, was mismanagement on the part of Egypt's stock market regulators which led to an intensification of the market correction causing Black Tuesday's crash. The fact that the boards of directors (BOD) of many companies were selling their stakes, held directly or indirectly, at high speed, and in some cases completely exiting by selling directly in the market, conflicts with market regulations. The sale of significant stakes held by BODs should be announced in the press and put out to tender to attract interested potential buyers.

The share price of the Sixth of October Development and Investment Company (SODIC) had skyrocketed to a record LE284.37 by 15 February, giving it a market capitalisation of LE4.5 billion, up from just LE122.4 million a year earlier though no major change had occurred in the company. Since its inception SODIC's performance has been rocky, its profits neither sustainable nor sufficient. The company has repeatedly announced merger plans, and repeatedly retracted them, leading to a fall in price to LE118.77 on 16 March. Regulators have now suspended trading in SODIC's shares, a step that should but have been taken much earlier to protect investors against manipulation in the absence of any transparency over financial statements and future plans and contracts.

Market liquidity had, moreover, been tight owing to a large number of rights issues and Misr Aluminum's IPO running almost simultaneously. To cover these, some LE11.3 billion ($1.97 billion) needed to be injected in the market within a very short time frame. Regulators should have ensured the market would not reach such a saturation point by staggering rights issues and IPOs. As a result, several rights issue were not covered and had to be re-opened while Misr Aluminum's IPO attracted little investor attention.

In the meantime the Capital Market Authority (CMA) had refused to allow the private placement -- tranche I of EFG-Hermes's capital increase -- to qualified investors, a move that was supposed to protect the preemptive rights of ordinary investors but in effect did the opposite. EFG-Hermes's rights issue/private placement became an undeclared form of IPO that led to a drain on liquidity. Furthermore, it contributed to the depreciation of the Egyptian pound, as subscriptions had to be made in US dollars.

Stock market regulators should also have stepped in earlier -- as soon as the market had fallen by 10 per cent -- to halt trading on Black Tuesday.

So what should investors do?

The market has approached the bottom with reference to fundamental technical analyses, and if things go smoothly with government attempts to rebalance the market then share prices can be expected to climb, albeit modestly. This rising trend would need to be supported by improved liquidity and positive financial statements for the first quarter of 2006 for the market to illustrate that it is attractive to long-term investors. Investors need to cool down: nobody likes to lose money, but investors have to become more reasonable about fluctuations in market prices. Entering and exiting the market frequently leads to investors incurring an extra layer of charges and contributes to their accumulated losses. Investors, euphoric when the market it is peaking, seem to become hysterical when the bubble bursts, hardly a healthy approach to investment.

* The writer is chief investment officer at Orion Holding headquartered in Dubai. He is also a part-time instructor of finance at the American University in Cairo (AUC) and can be contacted at wgamal@orionholding.com. The views expressed in this article are those of the author only and do not represent the views of any institution(s).

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