e-Nagar

This is another bit in my series of stock market basics (advanced readers please skip the post)

India is a booming economy and as the companies expand their operations, they need more and more of capital to fund it. Sometimes the company is able to raise these funds by issuing bonds, taking loans from Banks, internal cash flow etc. but often when the company is expanding exponentially its advisable to issue a fresh set of equity and raise funds by selling it. This could be done via Rights or via FPO.

FPO: Further public offering:
Its much like an IPO, but its an IPO of an already listing company.

Concerns of FPO:
Usually people accuse the promoters/management of a company raising money through FPO of diluting the equity and not rewarding the shareholders adequately.
But if the management is good, then the reality is just the opposite.
an FPO usually happens when the stock price is at all time high. So in reality the FPO induces a stickiness in the price. (People rarely like to book losses, esp in a good company.)
Secondly the funds raised only enables the company to continue its exponential growth and hence benefiting the stake holders (both post and pre-fpo)
Thirdly the very fact an outsider is ready to pay the price for the share is a display of the company’s strong fundamentals.
So an FPO is actually a good thing for the minority stock holders.

Rights Issue:
Its is almost like a FPO i.e.:
1. Fresh equity of an already listing company is raised.
2. The fresh equity is always at a discount from the prevailing market rate (except a rare case where the promoter issues rights share instead of warrants to raise his holding)

However the only difference is that:
1. in the rights issue, only the existing share holders are allowed to subscribe. So the shareholding pattern does not get significantly altered.
2. The allotment would be in proportion to the existing shareholding pattern on the record date. So one does not have to worry about over subscription and hence no/low allotment.
3. The FPO is usually at the prevailing rates (or at a 5% discount) so that the existing shareholder’s interests do not get hurt. But the rights issue is usually a significant discount from the prevailing market rate to encourage subscription and also enable the existing share holders to save taxes by booking paper losses.
4. This discount in prices leads to a significant fall in the share price of the company (post record date)… (but now since the investors have more shares, their wealth does not alter) And this fall gives room for booking of paper losses and getting tax shields.
5. But this introduces a downside. If a company issues a rights issue (at a significant discount) then the existing share holders have to invest in the company, else they will suffer a significant dilution of stakes and capital losses.

Usually the Rights issue is marginally under subscribed because some of the minority share holders are not able to submit their applications in time. There it is advised that who ever subscribes to the rights issue, should apply for slightly more than the guaranteed amounts and benefit from it.

PS: I have deliberately omitted all equations and charts. Please refer to investopedia for details.

Price Band: 405-450 (QIB) and 385-430 (Retail Investors)
Dates: 15th – 18 Jan
No of Shares: 28 million equity shares

Pros
1) Reliance has always proved to be a goldmine for the investors and in the long run, always delivered superior returns. Hence its definitely a buy.
2) Retail Investors will get shares alloted at a 20/- Discount (4.6%) as compared to QIB.
3) Retail investors have an option to pay only 115/- (about 1/4) of the application money upfront.
4) Gray market premium for every such application is 7800/- (per Lakh)
5) The company has 13 ongoing projects that the company is developing have a combined planned installed capacity of 28,200MW. (largest in the country)

So it would be advisable for retail investors to apply for 225 shares, which has a bid value of Rs.96,750 (and an upfront payment of 25875)

Concerns:
Livemint has analyzed the prospectus and raised some valid points.
The company has no trackrecord, no revenue generation operations as of now. Even if everything goes as per target, the first plant would be operational by December 2009, and the last of the proposed plant would be commissioned in 2016. So all the hype is based on the future performance and how efficiently Anil can implement the project. However the present track record does not seem very encouraging.
1) The 300MW Butibori project is already behind schedule and the government, while giving an earlier extension, had said it wouldn’t allow any further extensions.
2) The memorandum of understanding (MoU) for the 1,200MW Shahapur project expired last April.
3) The company has requested for an extension of the deadline for the submission of the project implementation schedule for the 3,960MW coal-fired Madhya Pradesh power project.

Contrarian Approach:
Fundamentals does not seem to be the only factor around this issue. Also, because of the sheer size of the issue and prevailing volatility, there is a slight chance that the issue might get less than 160,000 retail applications. In that event, Reliance Power will be oversubscribed less than 4 times and will have to issue partially paid shares. And for the first 30 days you will be amongst those fortunate few who will actually be holding tradable shares.
So watch out for this trend. If this seems to happen, then I would recommend you to pay not the min 115/- per share, but the full 430/-.
This strategy would really pay off if you have multiple accounts (through spouse/family). So you could apply for few partially paid shares and few fully paid shares and get the best of both the worlds.

No of shares: 20.8 million
Issue Date: 28th Nov – 3rd Dec
Price Band 12/-

This is a classic issue which tells us exactly what are the tell tale signs of a bad IPO.
1) The factory has been operational since 1991, and still its growth and performance has been below average. No wonder a share of face value 10/- is going for ipo at 12/- Last year was the first time the company made a profit >1cr.
2) The objective of the IPO is to raise about Rs 26.2 crore to part finance the proposed Rs 500 crore greenfield one million tonne integrated cement plant in Jharkhand. Can someone tell me from where is the rest 474 crore coming?
3) Promoters are offloading 49% stake in the company. They might as well sell it the entire company off, after all Cement industry is on boom and Ambuja Cement (sensex stock) and L & T cement (another blue chip) actually did that recently.

4) The company boasts that it has made a profit of 1.14 Crore (on a proposed market capitalization of 53cr resulting in an EPS of < Rs 1.) but you have to read its balance sheet to realize that this profit was partly because of a trading profit of over 4 crore. (Now this confuses me, should i categorize this company as a trading firm or as a manufacturing firm?)

5) One should not forget that the profitability of the company is partly due to the scarcity of cement and high prices.. so consistency is not guaranteed, infact that company has a track record of making losses and has a meager revenue of 26 Crore.

6) The company has over 90 crore in debt (a sum equal to almost 4 years of revenue)…. i wonder if even the banks can give them one extra penny.

7) The company says the IPO is to enable its backward integration into clinker… but tell me why would you make 100s of cr of fresh investment in a raw material plant to save 1-2 pennies on your annual revenue of 20cr. This defies all logic and commercial prudence!

In short this issue is the fastest way to penury. BTW the reason for this post is that MoneyControl and several other yellow journalists have assigned 3 star rating to this issue and even ICICI has recommended people to apply.

Till about last month, I used to believe that one of the best ways to gauge the quality of an IPO (offered price, expected listing gains and future prospects) was to see the subscription pattern on the penultimate day.. good issues will see huge response from the QIB/FII/MF while bad ones would be shunned.
Also issues with good management would see good response from the employees and IPOs with good long term prospectus would receive bids from Non Institutional investors.

So my strategy in any IPO was
1) To do fundamental research about the future prospects.
2) read the broker’s advice.
3) see the market response.
if 2 out of these 3 parameters gave me a positive response, I would go ahead, (and since I a advice to a lot of my friends that means an investment of atleast 10L) else I would wait and watch for the next IPO to come. In the past 2 years, this time tested strategy has never failed me (except when I got pure unlucky and the issue was so much over subscribed that I got my full 1L refund)

However this strategy seems to be failing in recent days.
I felt CCCL (consolidated construction company ltd) was a good company to invest in, but most of the brokers seem to advise me against it (they cited the fact that it is aggressively priced, and the intentions of promoter is dubious… only recently he issued himself a large number of shares at a throw away price of 10/- per share… then the company pays its parent holding company a sum of 20 million INR p.a. for the royalty on the trade mark.. etc. etc.) also till the penultimate day, the issue was barely subscribed.
Since 2 of the 3 parameters were against me, I gave it a pass… just to realize that all the bids came on the last day… CCCL saw more bids then Koutons (which was a darling of the investors)

So clearly, I need to develop an alternate strategy…. what is your strategy for IPOs?

Issue opens: Sept 18, 2007
Issue closes: Sept 21, 2007
Issue Price: Rs 370-415 per equity share of Rs 10 each in lots of 15 shares
Issue Size: 3,524,439 equity shares of Rs 10 each (of a total capital base of 30,551,397 equity shares of Rs 10 each)

Strengths:
1) Koutons looks like an attractive company with over a 1000 company managed stores and 18 manufacturing units.
2) If I compare its pricing with Raymonds and other garment companies with COFO (company owned franchise operated) retail centers, the pricing looks attractive.
3) By designing, manufacturing, distribution and as well as sales under the same flagship, the company is able to cut a lot of costs.
4) Huge sales per store due to hefty discounts offered by the stores.

Weakness:
1) I doubt weather the COFO model can work in the long run. Opening up manufacturing as well as retail outlets needs huge capital investments and hence limits the company’s ability to expand fast, as well as react to the changing market scenario.
2) Its unlikely that the company will be able to distribute from the multibrand shops and malls. This shuts it off from a major business opportunity and capitalize on the retail revolution.
3) INVENTORY TROUBLE: against a sales of Rs 402.40 crore, the inventory stood at Rs 373.84 crore. That is a whooping 340 days of inventory. In garment/fashion industry, you cannot stock for 340 days… primarily because the kind of stock which is sold, depends on the season.
4) Low Brand Value: Kouton’s stores only stock their own brands and perennial 70% discounts have completely eroded its brand value. This will prevent the company to move up the value chain.

Analysis:
I am very skeptical about the Company owned retail model. Its primarily because it involves huge capital investments, inventory problems and limits the enterprise’s ability to survive a business cycles. The company has been growing at a rapid pace, and if you are bullish about retail industry, then this might be a good company to invest in. But I would try to be away from a company who maintains 340 days of inventory and pushes sales by offering 70% discounts all year round.

Date: 10th -13th Sept.
Price band: 44-52
No of shares: 573,932,895 equity shares
PE:
Issue Size: Rs 2984 crore.

Pros:
1) PGCIL (power grid corporation of India Ltd) is the country’s principal power transmission company and Mini-Ratna.

2) Since I believe the infrastructure esp. power is going to drive India’s second phase of development, this company is well poised to benefit from it. It owns and operates almost all of the nation’s interstate and inter-region transmission systems. (61,875 km of transmission line and 106 substations) Last year about 298 billion units were transmitted through their infrastructure (about 45% of the power generated).

3) This company has no competitors and even in the next 10-15 years, I do not foresee any other infrastructure company (indian or foreign) to pose a threat. This is primarily because Power grid has acquired a lot of land for the transmission lines at very low prices, and it would be very tough for another company to replicate their model.

4) PTC (power trading corporation) is soon going to start up a electricity trading board where states can sell and buy power at real time. All this power is going to go through the national power grid… So the company positioned to benefit from this is Power Grid Corporation.

5) The country is going for Mega (larger) power plants which satisfies the need of the region instead of having numerous power plants in individual cities. This creates a big business opportunity for Power Grid.

Cons:
1) Transmission lines have huge infrastructure and fixed costs. Along with the land value, an interstate power transmission lines often costs more than the power plant itself.

2) This a a government owned company (bureaucratic losses, red tape etc.) so it might take a couple of years for it to generate some real wealth for the investors.

In short over a 3-5 year horizon, this company should do wonders (just like NTPC), but in short term it might not generate sufficient wealth for the investors primarily because of its inefficient governmental legacy.