Wednesday, January 09, 2008

Reliance Power - the most awaited IPO, indeed !!

Reliance Power opens for subscription on 15th Jan 2008. While the issue price is likely to be around Rs.450 (i.e. on the upper end of the price band), the grey market price is already quoting at a close to 80-100% premium. At that price, the stock will be valued at around Rs.1.8-2.0 lac crore, that for a company that generates 'zero' watt of power !! There are various articles on the issue floating in the market, here's a look at two of them:

Article 1 -

The much awaited Reliance Power IPO is opening on 15th January 08, with a net public issue of 22.80 crore equity shares, of Rs.10 each, in the band of Rs.405 to Rs.450 per share. Looking at the expected demand from HNI, QIB and Retail, it is a foregone conclusion that book would get discovered at Rs.450 per share.


We all know that QIB category is required to pay only 10% on application in an IPO, while, High Net Worth Investors (HNI) and Retail Category needs to pay the entire amount. This is a cause of dissatisfaction amongst the latter categories as it is not perceived to be a fair level playing and they resent the discrimination between the categories for the same stuff.

Reliance ADAG, has somewhat tried to ease this - firstly by offering a Rs.20 discount to retail category and secondly by asking only Rs.115 per share on application, from HNI and Retail Category. The effective cost to Retail Category would be Rs.430 per share, presuming that book would get discovered at Rs.450 per share.

HNIs generally make application in IPOs by availing IPO finance facilities offered by various investment bankers and stock brokers at an interest rate of 15% to 16% per annum. Due to this facility, (which is to the extent of 90% to 95% in IPO like Reliance Power), an investor is able to leverage it by 10 to 20 times. The duration of finance is generally for 16 to 20 days, during which, the whole process of IPO gets completed.

With only Rs.115 being asked on application, there is huge interest amongst HNIs to apply for the issue. Premium of Rs.370 in the grey market is added attraction as businessmen and traders are also finding it attractive to go for margin funding to earn a return of over 300% per annum, on one's own investment.

Let us try and understand how this works :

An investor wanting to apply for 1 lakh shares, needs Rs.115 lakhs as application money. With 5% margin to be provided by the applicant, he puts in Rs.6 lakhs while Rs.109 lakhs is financed by an NBFC at 16% per annum interest. Assuming fund remains blocked for 16 days, the funding would have an interest burden of Rs.75,000 on Rs.109 lakhs having availed. If HNI category gets subscribed by about 200 times, there would be an allotment of 500 shares. Taking grey market premium of Rs.370 per share, it would give a profit of Rs.1,85,000, which results into a net gain of about Rs.1,10,000 (after deducting interest costs of Rs.75,000), on own investment of Rs.6 lakhs. This results into a return of over 300% on annualized basis.

In HNI category, also called as Non-Institutional Category, 2.28 crore shares being 10% of net issue is reserved, while 30% being 6.84 crore shares are reserved for the Retail Category.

It is a broad consensus that HNI category is likely to get subscribed by about 200 times. If we go by issue size of 2.28 crore shares, in this category and with Rs.115 as application money, it would need Rs.262.20 crore for one time subscription and 200 times would need Rs.52,440 crores. Presuming that close to 95% of this would avail 95% funding, IPO financing from NBFC is estimated to be about Rs.47,300 crores.

Do the NBFCs have the required depth to provide this kind of funding ?

Leading investment bankers like JM, DSP, Kotak, Enam, Edelweiss, Motilal Oswal, Birla, Citibank, Religare have been financing this IPO and book of each of them is running between Rs.3,000 crores to Rs.5,000 crores. But due to huge demand for margin funding, many of them have already made allocations amongst their clients and have closed their books. Also, few of them are now charging interest of upto 20% per annum, against earlier rate of 15% to 16% annually, offered by some of them. Even allocation to each client has been put with a cap of about Rs.25 to Rs.40 crores, per client, on which margin money asked from them is just Rs.1.50 crores to Rs.2 crores.

Surprisingly, huge demand is seen coming from Doctors, Lawyers, Architects, Builders and other leading businessmen, who have never availed this facility earlier for any of the IPOs.

Why this sudden interest ? Strength of IPO or name of Anil Ambani ?

Even in Retail Category, an upfront premium of Rs.7,800 per application is offered by the grey market operator. This is for investors having Demat Account in their name and merely to lend their name for making applications. All the finances are arranged and provided by the broker/operator buying this application.

In this scheme, broker/operator would apply for 225 shares, (maximum permissible in this category), which has a bid value of Rs.96,750 (after considering Rs.20 discount on upper band of Rs.450). The market is expecting an allotment of 30 shares in this category and presuming grey market premium of Rs.370 per share plus Rs.20 discount of Retail investor, this translates into a profit of about Rs.11,700. Of this, Rs.7,800 is offered for lending the name, while Rs.3,900 remains with broker/operator as his share of profit for doing all these exercise.

In Retail Category, 6.84 crore shares being 30% is reserved. Presuming an allotment of 30 shares on 225 shares having applied, market expects subscription level of 7.5 times in this category. This level of subscription would need Rs.5,900 to Rs.6,000 crores. If subscription level exceeds beyond 7.50 times economics of broker/operator would go haywire. One section of market is expecting this category to get subscribed by about 10 to 11 times and hence, find it interesting to sell application at Rs.7,800 in advance.

Looking at the huge interest and response expected for the IPO, you need to agree that fundamentals need not be the sole factor for one to get attracted to an IPO.

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Article - 2

A right royal abuse of power by Udayan Mukherjee, HT 8th Jan. 2008

The most awaited event of the Indian primary market calendar is here. Reliance Power may have priced its IPO in the Rs 415-450 band but the active grey market price is Rs 900. This gives Reliance Power a potential listing market capitalisation of Rs 2,00,000 crore. With zero installed capacity today, expected generation capacity of 6,000 megawatts by 2011 and 26,000 MW by 2016. NTPC, in itself a richly valued stock, has an installed capacity of 27,000 MW and commands a similar market cap. The market has simply taken an eight year leap and priced it in the Reliance Power stock today. I find that staggering.

A look at the ratios look even more mind numbing. This IPO money is being raised to execute about 7,000 MW of capacity. That should be done by 2012. That year, if all goes perfectly, Reliance Power will have revenues of Rs 7,700 crore, EPS of under Rs 8 and a book value of Rs 70. At the listing price of Rs 900, the stock would be trading at a 2012 price-earning ratio of 110, a price to book value ratio of 13 and a market cap to sales ratio of 26. These are four-year forward ratios, remember. The ratios moderate somewhat for 2016 but by then much further dilution would have happened to finance the additional capacity so the market cap would balloon substantially.

This is madness. While many explanations abound on how such valuations could be justified, this is so similar to the 100-plus PEs the market gave freely to information technology stocks back in 2000. While all of us know how that story finally ended, we should also remember how long that madness continued. The power madness, too, will end, sector tailwind notwithstanding, but it may continue longer than we think it can before fizzling out. While it lasts, the most expensive stock in the sector will become the valuation benchmark and will pull the others into the clouds. Just remember the old adage: those who forget history are doomed to repeat it.