As expected, the Reliance Power initial public offering (IPO) was oversubscribed within minutes of the opening of the book-building process on Tuesday. The only concern now for those applying for the issue would be to get an allotment of shares. The higher the oversubscription, the lower the chance of getting a reasonable number of shares allotted. But if an investor really believes in the Reliance Power story, there is a simple way out.
An investment in Reliance Energy Ltd, which will hold 45% of the company after the issue, could act as a convenient means to circumvent the whole IPO process, where firm allotment is far from guaranteed. What about Reliance Energy’s valuations? Do they already reflect the listing gains of 80-100% expected in Reliance Power?
Hardly. Reliance Energy had cash worth Rs258 per share after adjusting for its debt as of March. Its EPC (engineering, procurement and construction) was valued at Rs197 per share by Morgan Stanley in a late September report. If anything, the value of this business should have risen considerably since going by the number of power projects that have been announced by various players lately. The core power generation and distribution business in Mumbai and Delhi was valued at Rs480 per share.
Put together, Reliance Energy must have a valuation of Rs935 per share (Rs900 after accounting for the 3.5% dilution in the company equity last quarter post-foreign currency convertible bond (FCCB) conversion).
At the higher end of Reliance Power’s IPO price band, the company’s 45% stake post-listing is valued at Rs1,550 per share, even after applying a holding company discount of 20%. Along with the value of its own businesses and cash, this works to a value of Rs2,450 per share. Reliance Energy closed on Tuesday at Rs2,330 per share, which means buying Reliance Energy at current levels is better than getting firm allotment of Reliance Power shares at Rs450 per share. What’s interesting is that Reliance Energy shares don’t reflect the huge listing gains assumed by traders in the grey market.
This is significant simply because the secondary markets do a much better job of price discovery than the primary market and the secretive grey market. Why haven’t investors put their money on Reliance Energy and whittled away the arbitrage opportunity? Perhaps because they are assuming that the listing gains may only be temporary.
The December quarter results of Infrastructure Development Finance Co. Ltd (IDFC) have been impressive, with profit after tax rising 74%, compared with the year-ago period. More importantly, gross approvals for the first nine months of FY08 have shown a rise of 60%, with Rs6,260 crore worth of approvals during the third quarter, taking the total for the nine-month period to Rs14,853 crore. That’s not surprising in view of the almost insatiable demand in the infrastructure sector.
Return on assets (RoA) for the nine months to end-December has been 3.6%, the same as in the first six months of the year. But the contribution of net interest income to RoA has come down a tad (compared to the first six months), while the contribution of non-interest income has increased. And if capital gains and the income from SSKI (which didn’t exist in the year-ago period) are left out, profits before tax have grown 40%, rather than 100%. But then the IDFC management has always said that net interest income would trend downward. That is precisely why it has diversified into investments and into asset management and advisory services, apart from taking over broking firm SSKI. The 12-month rolling overall spread, at 2% over the January-December 2007 period, is the same as it was over October 2006-September 2007.
At a price of around Rs220, the IDFC stock has moved up almost 60% from its level at the end of September and is trading at more than four times FY09 book value, a higher valuation than several private sector banks. While the excellent results and the high RoA may justify the high multiple, it’s also likely that the rich valuation will limit the upside in the stock.
IBM and decoupling
Is International Business Machines Corp.’s (IBM) 24% earnings growth in the fourth quarter a sign that growth remains healthy outside the US and does it therefore buttress the case for funds to flow to emerging markets? At first glance, that’s what it looks like since, according to CEO Sam Palmisano, “The broad scope of IBM’s global business—led by strong operational performance in Asia, Europe, and emerging countries—drove these outstanding results.”
The problem is that a substantial part of that earnings boost has come from a weaker dollar. Of the 10% increase in revenues in the fourth quarter, as much as 4 percentage points are due to dollar depreciation. So it’s not just strong non-US economies that have boosted IBM’s sales.
Since many US frontline stocks are diversified internationally, IBM’s results should provide some support to the US market. But the flip side of the weak dollar is a strong euro and a sluggish Europe. Add to that the weakness in the UK and Japan and we’re still far from hearing the last word in the decoupling debate.
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