Why does Reliance Power Ltd’s initial public offering (IPO) command a premium of 100% or so in the grey market?
Why are brokers paying good money to rent demat accounts or for buying up applications? What explains the huge appetite for the issue? It certainly isn’t the company’s track record, because it doesn’t have one. The prospectus points out, very bluntly: “We currently have no power plants in operation or other revenue-generating operations and we have no significant operating history from which you can evaluate our business and future prospects and viability. You should not evaluate our prospects and viability based on the performance of Reliance Energy Ltd (REL) or our other promoters.”
Does the attraction lie in having “one of the largest portfolios of power generation projects under development in India?” True, the 13 projects that the company is developing have a combined planned installed capacity of 28,200MW. But the first unit of the first project will be completed only by December next year and the dates for commissioning of the other projects extend all the way up to 2016. Isn’t implementation risk a concern?
The IPO grading report from Credit Rating and Information Services of India Ltd (Crisil) says the group has considerable experience in the sector, conceivably because REL operates projects having a total capacity of 941MW. So, perhaps timely implementation should not be an issue? Well, the prospectus points out that the 300MW Butibori project is already behind schedule and the government, while giving an earlier extension, had said it wouldn’t allow any further extensions. The memorandum of understanding (MoU) for the 1,200MW Shahapur project expired last April and the company has requested for an extension of the deadline for the submission of the project implementation schedule for the 3,960MW coal-fired Madhya Pradesh power project.
In addition, the funds raised in this IPO will be used to fund six projectstotalling 7060MW. The funding for the other projects could very well lead to further equity dilution. Fuel supply and offtake arrangements have not been tied up for all the projects, land is yet to be acquired for some of them and the environmental clearance for one of them is under litigation. In short, as Crisil pointed out while assigning a rating of 4/5 to the IPO, “RPower is planning to put up capacity, on a scale and within a time frame, never achieved in India before and therefore it is likely to face significant implementation challenges.” Crisil also says state electricity boards, to which Reliance Power will sell the power, are a credit risk, although the company does have an option to sell to third parties in case state electricity boards (SEBs) default. And finally, the rating agency points out that the return on several power projects will be subject to regulatory oversight and even on projects won through competitive bidding, returns “may not be substantially higher due to competition.”
Perhaps the valuation is cheap? There’s no point looking at the current price-earnings multiple, because all Reliance Power’s projects are in the future. If the grey market’s assumption of a listing price of around Rs1,000 is correct, Reliance Power’s market cap will be about the same as that of National Thermal Power Corp. (NTPC), which has a current capacity of 26,000MW of capacity, plans to increase it to 50,000 MW by fiscal 2012 and triple capacity by fiscal 2017. Having won a number of its projects through bids, there is the possibility that Reliance Power’s contracts may be more lucrative. But note that NTPC already has 26,000MW under its belt.
Interestingly, the NTPC stock has gone up substantially to catch up withReliance Power’s valuation and it now quotes at an inexplicably high price-book valuation of 4.1 times based on fiscal year 2008 estimates published by Bloomberg.
If valuations aren’t cheap, why is the grey market so enthusiastic? Simply put, prospective investors believe that the current euphoria for power stocks will last long enough for them to cash in.
Also, the fact that the project is being promoted by the Reliance Anil Dhirubhai Ambani Group is a source of much comfort. The company’s presentation emphasizes the fact that the group’s companies have substantially outperformed the Sensex, with value creation of $72 billion (Rs2.83 trillion) in the past two-and-a-half years. Investors in Reliance Power are betting on that trackrecord.
Tata’s small car
The last time Tata Motors Ltd introduced a “small car,” it came on the back of a massive underperformance of its shares. Analysts were concerned that the car project would be a drag on profitability and would substantially dilute the profit margins earned by the core commercial vehicles business. Of course, another reason for the underperformance was the drop in performance of the core business itself and start-up losses.
This time around, the markets don’t seem as perturbed about the company’s small car launch.
The stock had risen 4% from the previous day’s close at the time of the launch. It later corrected with the rest of the market.The markets itself are in a much more optimistic frame of mind but the company’s shares have underperformed despite the imminent purchase of Jaguar and Land Rover.
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