The secondary market ascribed a value of Rs84,140 crore to Reliance Power Ltd (Rel Power) on the first day of trading in the company’s shares. This means that Reliance Energy Ltd’s (REL) 45% stake in the company is worth Rs37,860 crore. In a rather strange coincidence, Reliance Energy ended the day with a lower market capitalization of Rs37,620 crore. Does that mean Reliance Energy has no value of its own?
Well, purists would say that one should apply a holding company discount of 20-30% to REL’s stake, which would put the value of its holding at between Rs26,500 crore and Rs30,300 crore. But include the value of net cash worth nearly Rs6,000 crore as on March 2007 on REL’s books, and one still ends up with the conclusion that the market has put negligible value on the company’s various businesses.
To start with, Reliance Energy still has the power generation, transmission and distribution business in Mumbai and New Delhi. It also has the engineering, procurement and construction business, which should get a lift based on the plans of various companies to put up power plants. Infrastructure projects such as the Mumbai Metro rail project should also aid growth.
But it’s probably incorrect to say that these businesses aren’t being given much value by the markets. As we had suggested in this column at the time of the initial public offering book building, it’s more likely that investors believe Rel Power’s value will come down over time, and this is what is already reflected in REL shares. If that’s the case, there seems to be a neat little arbitrage opportunity available—which is to buy Reliance Energy shares and sell Reliance Power in the futures market. Once both stocks converge to where they actually belong, arbitrageurs will earn the difference by which Rel Power is currently overvalued.
But if someone is really convinced that the whole power story is stretched, they could go short on both stocks in the futures segment.
HNIs lose some net worth
The business model surrounding initial public offering (IPO) investments took a thumping on Monday after the most hyped among them, Reliance Power Ltd, ended the day at a 17% discount to the issue price of Rs450. Retail investors lost a tad less, since they were allotted shares at Rs430.
But high net-worth investors (HNIs), who made a business model out of churning funds in and out of IPOs, lost much more. They apply using borrowed funds, the cost of which amounted to around Rs110 per share, assuming funds were borrowed at a rate of 15% for a period of 15 days, the typical lag between the time of application and the receipt of refunds. Although these investors had to put up only 25% of the subscription value upfront, shares were allotted in the ratio of one for every 160 applied, leading to a high interest cost on a per- share basis. The net result is a loss of as much as 33% of the net investment for leveraged investors, based on Monday’s closing price. Note that only 52 large investors in this category accounted for 99% of the total bids worth Rs19,595 crore, with average bids worth Rs374 crore. According to market sources, some investors had to unwind other holdings to make good their losses in the Reliance Power IPO trade.
Even with previous successful IPO listings, HNIs stood little chance of making money, since the oversubscription levels were usually high, and the high interest cost was spread over only a few shares that were finally allotted. Somehow, this set of investors kept coming back for more. The Reliance Power experience could perhaps bring some sobriety to this set of investors.
More banks take RBI cue, reduce interest rates
Banks are slowly heeding the admonition by the Reserve Bank of India (RBI) on interest rates. State Bank of India cut its prime lending rate by 25 basis points on Monday. Bank of India reduced its lending rate on housing loans by 25 basis points and on personal loans and credit to the auto sector by 250 basis points. The bond market rallied, pushing yields down to almost the levels they were at before the January monetary policy statement.
Yet, not many debt market analysts expect RBI to cut rates soon. Gaurav Kapur, senior economist at ABN Amro Bank, points out that inflation remains high, with the prices of manufactured goods rising due to capacity constraints and cost-push factors. Wheat prices too have soared. Add to that the fuel price hike and it’s unlikely RBI will do anything that could fan inflation.
The government doesn’t want inflation to get out of hand with elections so near, while it also wants to ensure that growth doesn’t slow too much. Fortunately, the December quarter bank results have been good. A Citigroup report says that net interest income growth for the sector has been 23% against the year-ago period. Together with strong growth in fees and other non-interest income, pre-provision profits (minus trading profits) have been higher by 33.6% y-o-y. That gives banks some leeway in reducing rates. Also, as on 25 January, deposit growth for all banks was up 29.5% y-o-y, against 23.5% at the same time last year. That, says Kapur, adds to the pressure on banks to increase their loan assets. That should be a source of comfort to the government.
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