IPOs - To do or Not to Do?

Our clients call us ‘boring’. And we love it.

We take a lot of effort to keep a long-term investment plan ‘boring’.

One of our major focuses is on keeping portfolio volatility and drawdown in check. We dissuade clients from investing in products that are ‘fancy’ and ‘in-fashion'.

One such ‘product’ we strongly recommend against is Initial Public Offering (IPO).

More so IPOs of Pubic Sector Undertakings and government-owned companies.

?Here are 3 reasons for this unpopular stance :?

1. Unrealistic Valuations: Most IPOs are bull-market events. Companies like to offload shares when investor sentiment is at its peak. Usually, at these times lofty valuations are overlooked.

Following are the largest 25 IPOs that have happened in India. Most of them happened in years where the equity?markets was in a bull phase - with average returns being higher than long-term trends.

?Source: Moneycontrol

2. Insignificant gains: IPOs are seen by many in India as a short-term profit-making opportunity.?

Retail & many high networth investors are lured by this ‘quick buck’ scheme. This results in significant oversubscription in most IPOs. As a result, the allotment ratios are so low that invariably the listing gains are near negligible.

Here is a back of the envelope calculation for retail and non-institutional (commonly referred to as HNI) categories:

HNIs usually borrow to invest in IPOs. The above example considers - 6% p.a. for 15 days.

If returns are 50% then the gains are Rs.16000/-. In about 40% of the IPOs, listing happens at a price less than IPO price as well. We don’t think this kind of gain justifies the effort and the risk involved.

3. Underperformance of PSU stocks: Public sector undertakings have not been wealth creators in Indian stock markets for long. Like any other segment, they have their short outperformance phases but in the long run, they have been perennial underperformers vis-à-vis NIFTY.?

Source: BSE

?BSE PSU was constituted in Feb 2004. As of Dec 2021, money invested in Nifty would be worth almost 5 times (5X) the value of the same investment had it been made in BSE PSU in Feb 2004.

BSE PSU Index has the likes of SBI, Coal India, SAIL, ONGC, BPCL, etc. in it.

One of the key reasons for this massive underperformance is the management quality of most PSUs. There have been many cases of government interferences and abrupt changes in top management dampening investor prospects.?

LIC IPO - THE MOTHER OF ALL IPOs?

The government of India is planning to sell a 5% stake in the Life Insurance Corporation of India (LIC) through an offer for sale next month.

As per the draft red-herring prospectus filed with SEBI, the sale will be valued using the Embedded Value (EV) approach. In life insurance companies, embedded value is the present value of all future profits (estimated by the actuaries) added to the net worth (shareholders’ equity) of the company. Once the EV is calculated, a multiple is assigned to calculate the value of the company.

As per the actuarial valuation done by Milliman Advisors, the EV for LIC is Rs 539,686 crore as of September 2021.?

The current market valuation of listed life insurance companies are as follows:

Source: Company balance sheets and market price as on 18/Feb/2022

The average Price to EV multiple of listed life insurers is 3.31x currently.

LIC being the largest in this market, it will command a premium. A multiple figure of 4-5 times is floating around in the market as we write this.?That will peg LIC’s value to be upwards of 1.34 Crore Crores.

5% of that is INR 67,500 crores to 108,000 crores approximately. Even at the lowest point this is 4 times larger than the largest ever IPO (Paytm) issue in India.?

More than anything else…

Our biggest concern with LIC is the possible interference by the government in LIC’s core business. The draft red-herring prospectus has clearly stated the same. An extract from DRHP says:

We skip IPOs as a matter of principle. The fact that a huge supply is coming into the market makes us even more uncomfortable.

If a company doing an IPO has the potential to be a multi bagger, listing gains of 0.5-1 time is irrelevant in the long run. Market will give enough time & opportunities to evaluate a stock post listing and invest in them, if warranted.

More on our other core principles and investment philosophies coming up. Stay tuned.

Will you apply for LIC IPO? If yes, tell us why??