RINL fiasco shows govt’s weak grip on equity valuations

The government’s much-touted renewed push on disinvestment has got off to a false start with the deferment of the Rashtriya Ispat Nigam Ltd (RINL) public offering. The reason: it found the price range suggested by merchant bankers to be too low. This is not the first time that the government has called off an issue because of pricing. But the reason given is new, that the offer was below the company’s book value.

add_main_imageIn this case, RINL’s book value as of 31 March was ₹ 22 and the government was offered a price range of ₹ 16-18 by merchant bankers, according to a Mint news report. At first, that view seems reasonable. But RINL’s financials and the valuations of other metal companies disclose that the merchant bankers had a point.

RINL’s consolidated earnings per share during 2011-12 were only ₹ 1, which translates to a price-to-earnings (P-E) multiple of 16-18 times at the suggested price range by the merchant bankers. Steel Authority of India Ltd (SAIL) which is a good proxy for RINL, trades at a P-E multiple of 10 times, making the proposed RINL valuation look very optimistic.NextMAds

What about the issue being priced below book value? SAIL’s book value as of 31 March is ₹ 96.50, and its share price is ₹ 85. So it is quite possible that a company’s share price can be below its book value. Of the 11 stocks in the BSE Metal index, five are trading below their respective book values. That is no reason to doubt a share’s valuation, which among other things, reflects the company’s current financial performance, health of its balance sheet and the outlook for the business.

Metal companies are facing a downturn in the commodity cycle, which has affected their performance and investor sentiment. Some of their net worth is also deployed in newly created assets or assets under construction, making it less productive. As their plants stabilize and utilization rates improve, that should change for the better.

Having started off on the wrong note, the government needs to be prepared for future issues. Pricing equity issues at a substantial discount to their fair value (or market price in the case of follow-on offers) is one way to ensure subscription. But if the government wants a so-called fair price, then it may have to wait for a time when investor appetite for equities becomes stronger, and the global business environment changes for the better, or if the company in question has a strong growth story to sell to investors.

Most public sector units, except banks, operate in industrial sectors and are suffering the consequences of slow gross domestic product growth. Unless growth stages a miraculous recovery, the government has little choice but to use attractive pricing as a tool to attract investors to its disinvestment process.