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Thursday, April 09, 2009

Spike in the ADR premium for Tata Motors

by Anmol Sethy, originally appeared in Financial Express on 6 April 2009.

ADRs (American Depository Receipts, equity of foreign firms trading on US Exchanges) of Indian IT companies like Infosys, Wipro and Satyam, have until recently traded at a consistent premium over local counterparts. The existence of these premiums has been the subject of active discussion amongst traders and arbitraguers. However, over the last six months, an unlikely candidate has beaten these IT companies at this game, and this candidate is Tata Motors. This has happened in spite of not-so-impressive operating performance by the firm. It has been mired in difficulties regarding the stumbling Nano, an undersubscribed rights issue, dipping car sales, questions over its Jaguar-Rover acquisition, and an overall gloomy economic scenario.

Company Premium before Oct 08 Premium after Oct 08 Change
Patni Computer Systems5.2097.72548
ICICI Bank8.619-0.607-107
Satyam Computer Services21.71222.9206
Infosys Technologies6.0532.166-64
HDFC Bank9.2924.294-54
Sterlite Industries0.122-1.403-1250
Dr. Reddy's Laboratories1.1360.009-99
Tata Communications-0.1710.394-330
Mahanagar Telephone Nigam8.0873.411-58
Tata Motors0.02133.103157533

Until Mid October, the ADR premium of Tata Motor was near zero (click on the graph below to see it more clearly). In fact, it sometimes dropped below zero -- i.e. the ADR was at a discount as compared to the local NSE/BSE stock. This kind of behavior is generally seen in stocks of firms from countries like Mexico, Brazil etc where there are no capital controls on conversion of local stocks to the ADR and vice versa.

However, in India, RBI regulations impose a peculiar capital control. Though there are no restrictions on how many ADRs can be converted into local stock, there is a restriction on the opposite conversion. Local shares can be converted to ADR only if the existing number of ADRs does not exceed the total ADRs issued by the firm through its primary and secondary offers. This restriction on outflow conversion generally induces an upward pressure on the premium, as the float available for trading in US Exchanges becomes restricted.

This explains a good part of the existing premium in IT firms. As the demand for ADRs far exceeds the supply, an ADR premium develops, which cannot be arbitraged away.

In such a scenario, the sustained existence of near-zero premiums for Tata Motors ever since its launch in September 2004 is intriguing. While IT is considered to be an Indian strength and something which India is recognised for, the same cannot be said about the automobile sector. An ADR investor sitting in US, who is often an individual and not a financial firm, will be influenced by what is talked about regularly in the news and around coffee tables. This lifts the premiums of these firms. Also see this slideshow on the subject.

To truly appreciate the power of this `buzz' in the US, consider the daily volume traded. Suppose a firm from developing world announces the launch of a new revolutionary product in coming days, This firm would start getting ample coverage everywhere in the media. The investor will suddenly sit up and notice. This will increase the activity of the ADR. This is what happened with Tata Motors. News about the Nano launch first came in on around March 18. Suddenly, the daily volume traded in ADR jumped two fold to 1449757 ADRs/day from the average of 693496 seen before this year. The same however cannot be said for the local stock. Consequently the premium has also jumped, even exceeding 50% on March 24 and 25.

Though this may explain the latest surge, the fascinating question is: What has changed since Oct 2008 to justify a persistently large premium? One can be the fact that the premiums are not only driven by the performance of the foreign company, they are also driven by how local companies are performing. If in the same sector, local companies are struggling, while the foreign company seems to be relatively better off, the foreign company stock will perform better. Investors who have a mandate of undertaking sector specific investments for the sake of diversification, investment policies, or sheer interest in that sector, would withdraw their capital from local firms and invest in the foreign firm. However, in its local market, where the foreign firm will be compared with its domestic competitors, no such activity would take place and the price gap would widen, raising the ADR premium.

This is probably what happened with Tata Motors. The Detroit Three, namely GM, Chrysler and Ford, have been in all sort of financial troubles, especially after the collapse of Lehman. Dwindling sales, imminent bankruptcy and government bailouts probably scared away investors interested in the automobile sector to other automobile stocks like Tata Motors. This factor was active only in the US and not in the Indian markets, because institutional investors who take interest in the automobile sector are probably not FIIs (who tend to be the firms who take interest in India). This was not a particularly rosy time for Tata Motors either, with a failed rights issue and a decline in car sales by near 20% in October compared with the previous year. But Tata Motors seems have fared better than the Detroit-3.


  1. After reading the initial part of the article i guessed it right. This hypothesis can easily be verified by doing a peer comparison with other auto or non-auto companies from countries with capital market restrictions similar to India and whose ADRs must be still doing good.

  2. Does it lead to a conclusion that conservative capital conrol policies pursued by RBI are actually much more beneficial for a country like India than the much touted free market economy with full convertibility. Is it also a pointer to the fact that the conservative policies having produced results must now be made more flexible to take advantage of changes in the global scenario and its impact on India.

  3. I would also look at the borrowing done for short sales of the ADR's. The explanation might be the exact opposite. During the October month most auto company stocks the world over were going down and due to the TATA purchase of Jaguar/land rover, the active hedge fund community could have gone short on the stock using the ADR route as it would be next to impossible to borrow the stock in India and short in India. These positions would now be getting unwound as the lenders of the stocks would be asking for the stock back!

  4. I don't agree. Shorting Tata Motors in India is very easy: just short the stock futures!

  5. Ajay and others, Do you know of a data source that gives discounts & premiums of Indian ADRs when compared to underlying Indian shares on a daily basis?
    Thanks in advance for your help!

  6. Shashi, you can use

  7. Why did the infosys premium wre so high intially but over the time decreased to the present 1%-5% level?
    Is there any historical data source of ADR premia and the 'headroom' ?


  8. Why did the infosys premium wre so high intially but over the time decreased to the present 1%-5% level?
    Is there any historical data source of ADR premia and the 'headroom' ?

    --- Infosys has issued ADRs at regular intervals, as the number of ADRs issued rise permium comes down.
    --- ADR premia one can easily calculate by using ADR and Stock price.

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