The grey market is offering a premium of 1-12 on the Power Grid Corp. of India Ltd’s IPO opening on Monday, in the price band of 44–52.

That’s a decent premium on the price and reflects the quality of the issue. Power Grid Corp. has a monopoly of the power transmission business and transmits almost half the power generated in the country. It has an excellent track record and also owns a telecom backbone. So why isn’t the grey market premium higher? That’s probably because it is in a business where the returns are regulated.

According to current rules, the company is assured a 14% return on equity. But, that’s a feature that also makes it a low-risk investment, ideally suited to be a defensive stock in one’s portfolio, since the major risks are all pass-through items for the company.

In addition, in a rapidly developing country like India, power transmission could actually be a very rapidly growing business. That’s because the government seems to be serious about doing something about the power deficit in the 11th Plan (2007-12), as seen from the bulging order books of the power equipment manufacturers.

Under the Plan, the capacity of the national grid is being increased from 14,100MW to 37,150MW.

Power Grid plans to spend Rs55,000 crore in the 11th Plan towards investment in transmission projects. The rapid acceleration in capacity creation is important because when returns are assured, one obvious way to increase profits is to increase capital expenditure (capex). The company has commissioned transmission assets worth Rs2,490 crore in the first quarter of fiscal 2008 and four more projects are likely to be completed this fiscal, which would drive earnings in the short term. As the assured return on equity kicks in only after completion of a project, it’s important to have projects being completed at regular intervals.

The icing on the cake will be provided by the company’s telecom backbone, which has started to make profits from the first quarter of fiscal 2008. The company has been providing bandwidth to all the telecommunications operators on its 19,000-km network, which connects more than 60 cities.

The issue is priced at 16.9 times diluted earnings per share for fiscal 2007 at the lower end of its price band and at 20 times earnings per share (EPS) at the higher end. The upper end of the band is the valuation that NTPC gets. But, while the issue isn’t cheap, institutional investors are likely to lap it up as yet another way to get exposure to India’s infrastructure story. For retail investors, the grey market premium says it all.

Buy gets tepid response

Sintex Industries Ltd’s Rs150 crore acquisition to strengthen its auto component business doesn’t seem to have excited the markets. Its stock price has risen by just 1.5% since the buyout of the automotive plastics division of Bright Brothers Ltd. The acquired business has revenue of around Rs150 crore and its earnings before interest, tax, depreciation and amortization (Ebitda) for financial year 2007-08 is expected to be Rs25 crore. So, the acquisition price seems reasonable at one time revenues and six times Ebitda.

Sintex shares have outperformed by a large margin since July on reports that the company is close to an acquisition. While the Nifty has risen by 4% since July, Sintex shares have jumped by 37.2%. Given the weight of high expectations, the Rs150 crore acquisition may not have excited the markets because it would add less than 10% to the company’s consolidated Ebitda in fiscal 2008. There would also be some amount of scepticism because Bright Brothers’ total market capitalization is less than Rs50 crore, and Sintex has paid Rs150 crore for just one of its three divisions. But, it’s important to note here that Sintex would just be acquiring the assets in the form of a slump-sale purchase, and would not be acquiring any of Bright Brothers’ liabilities or bad debts, which are the main reasons for its low market value. Sintex itself trades at an fiscal 2008 enterprise value/Ebitda multiple of 12.6 times, so the acquisition is at about half its own valuation.

What’s more, it gives it access to large clients such as Maruti Udyog Ltd, Hyundai Motor Co. and Tata Motors. The bottom line is that the company expects the acquisition to be earnings accretive. The markets would still be awaiting the announcement of a large acquisition in the US or Europe before the stock moves from current levels. The bigger gainer from the acquisition was Bright Brothers, for whom the inflow of Rs150 crore exceeds its entire market cap by three times.

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