Pricing a follow-on public offering (FPO) should be easy since a market price is available. But a new book-building system is causing a lot of heartburn.
After getting negative feedback from the NTPC Ltd’s FPO, the Rural Electrification Corp. Ltd’s (REC) FPO allows qualified institutional buyers (QIBs) to alter the price or quantity of bids. That may allay one concern but marketing is also an issue.
FPOs by state-owned companies need to be marketed aggressively to investors compared to initial public offerings (IPOs).
In public sector unit IPOs, investor interest is high, but not so in FPOs where the novelty factor is missing. The Rural Electrification FPO will test whether the altered bidding mechanism really makes a difference. The government had fixed a base price of Rs203 for the issue, an 8% discount to Wednesday’s closing price but the market price fell to Rs205 before closing at Rs214, narrowing the discount to 5%.
REC’s business model is a sound one. The company originally financed rural power projects but now funds all power projects. Its mandate also includes financing allied activities such as coal mining and fuel linkages.
Typically, a sector-focused company is riskier compared with a general financier, as it is hostage to the ups and downs of the sector. But India’s power deficit situation is seeing large public and private sector investment. Companies such as REC are seeing smart annual growth in disbursements as a result.
At the floor price, the FPO will raise at least around Rs2,600 crore in fresh equity for REC and around Rs852 for the government which is selling part of its stake. REC will use the money to strengthen its capital base and raise more funds for project financing. Loan disbursements in fiscal 2009 were up 32% at Rs17,157 crore. As of September, its long-term debt to net worth ratio was 6.13 times. REC’s performance has been improving over the years, with its net interest margin improving to 4.5% in the first half of fiscal 2010, compared with 4.2% in 2009 and 3.8% in 2008. But its price-to-book value at three times is even higher than that of state-owned banks such as State Bank of India.
Investors keen on participating in power sector growth may find firms such as REC a good proxy though exposure to a bank or sector agnostic financial institution will reduce sectoral risk. Ultimately, the discount to the market price will decide if retail participation in the issue is healthy or not. The issue will lead to partial equity dilution which seems factored in, as its share price is down 18% in a month’s time. That reduces the chances of underperformance over a longer period, as its disbursement growth will benefit from the investments in the power sector. In the short term, however, the aftermath of the FPO process will prey on investor sentiment.
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