Reliance Power Limited (RPL) IPO: All about Brand Power

Fair price per share = Rs. 130
Brand power per share = Rs. 320
Price per share = Rs. 450

Most brand valuation methods are biased towards ‘sales generation’ potential of the brand. Lux brand is to be valued by the no of units of soaps that can be sold under the brand and the premium price it can command because of the brand.

Now there is “RELIANCE” brand. Unlike other brands it’s not about the no of units of product it can sell but no of shares it can sell and the price premium it can command. And then you need to be a financial wizard like Anil Ambani (ADA) to be able to actually convert brand power into cash. He has created an unprecedented buzz around the IPO. The whole power sector has been re-rated after his big ticket IPO announcement. He had played his cards amazingly well – from making the Investment Bankers (IB) to toe the line to grabbing headlines he has done everything right. The “Power On. India On” campaign is also neatly done. The advertisement has that ‘energy’ about it which generates excitement.

However, there is a problem. Although he shares the ownership of the ‘RELIANCE’ brand with his brother Mukesh Ambani (MDA) he alone is reaping benefits through RPL IPO. In fact bad performance of RPL IPO can seriously dent the valuation of RELIANCE brand and that would affect both the groups. MDA in his speech to employees on the occasion of father’s 75th Anniversary stated that the group has always believed in doing first and talking about it later and will maintain the same in future. It made me wonder whether he was hinting to the reverse strategy being followed by his brother in case of RPL IPO.

The most admirable part of ADA’s wizardry is how he made the IBs toe the line. Deep inside everybody knows that the issue is highly priced but nobody has the guts to speak up.

One of my investment banker (IB) friend remarked “I had never felt so ashamed of my profession like this time. None of the investment bankers have the guts to stand up and tell ADA that pricing is ridiculous. Everybody is hoping that somebody else will bell the cat”.

Another remarked “I always thought I understand the markets well and then something like this (RPL IPO) happens and I realize that markets are too irrational to understand”.

Another remarked “Since Reliance IPO announcement, Power sector prices are not marked to Earnings but to Vision!!”

The world of IBs, where people have the competence to see beyond the brand wrapper has been silenced by awe of ADA and greed of business / money.

But beyond the IB world there is a world of small investors who swear by the “RELIANCE” brand name. I am not sure if even half of them understand that ADA and MDA groups are two different groups now. They don’t understand the nuisances of valuation business. What they understand is that Reliance group has given mind blowing returns to its shareholders in past and expect it to do the same in future. For them RELIANCE is magic wand which turns to gold everything it touches. A RELIANCE IPO can really drive the whole market crazy. Already there is a mad rush to open new demat accounts as was in the case of Reliance Petroleum IPO. ADA mentioned in one of the press conference that if regulation had allowed he would have offered full 100% to retail investors. However, deep inside he knows that getting retail section over subscribed would be the biggest challenge considering the Rs. 100,000 cap per applications. Around 6 lakh applications (assuming historic avg. of Rs. 50,000 per application) would be required for retail section to get fully subscribed. There are around 1 crore dmat accounts in the country and many of those are in-active. Hence retail section is not expected to get over subscribed by more than 3-5 times in the best case scenario. With huge amount of international money waiting to flow into India getting other sections over subscribed would be easier and most probably would be done in minutes of issue opening.

ADA would require some real hard selling. But few will dare bet against him. I believe he knows the game well and will be able to get his issue subscribed. Great market is already quoting a premium of around Rs. 400. Period starting 15 January would be really exciting. I suggest small investors to keep an eye on the subscription figures on the NSE website and wait till the last day before applying.

Valuation

Present value of future cash flow (FCC) method gives a unbelievingly low valuation. I believe ADA’s valuation has been based on the thumb rule – 1 MW = 4 crores. Hence for proposed installed capacity of 28200 MW he is expecting a valuation of Rs. 1,15,000 Crores. Well for installed capacity that valuation might be ok but for proposed capacity??!! Major chuck of the projects would not start operating before 2013.
Valuation marked to vision!!

Implementation Skill & Feedstock Issue

And how many years it will take ADA to install 28200 MW capacity?! Reliance track record for in power sector has never been great. Check out history of Hirma power project in Orrisa and such other projects proposed in late 90s and early 2000s. Apart from captive power projects Reliance doesnot have a track record of building profitable power projects. 40% of the proposed capacity is dependent on Reliance Industries Limited (RIL) supplying gas from its KGD6 fields. The case is under major dispute and resolution cannot be expected soon. (The relations between MDA and ADA is like India-Pakistan now. Even after 60 years firing would continue at the borders and this gas agreement is one such border. After resolution, ADA would require at least three years to build the plant and other infrastructure like pipeline etc. And although I salute ADA for his Financial Wizardry, I still doubt his implementation skill (click to read my previous blog on his implementation skills).

Yes, Reliance is famous for its implementation skills. But which Reliance? – ADA or MDA? – it’s the MDA’s Reliance which has the implementation skill as its core-competence. Please don’t confuse between the two.

Secondly, I personally believe the future belongs to ‘green power’. Rather than betting on coal and gas for power, sources like Wind and Hydro power should be banked upon. Considering the spiraling oil prices the cost competitiveness of fossil fuel as feed stock in future is doubtful.

Verdict: Subscribe for Listing Gains. Re-enter at Rs. 325 – 350 range.

1. This issue is highly overvalued but RELIANCE brand and ADA’s financial wizardry will see it through.
2. ADA to protect his equity/ reputation in the market will make sure that at least during the first few days market price would be higher than issue price.
3. I would suggest retail investors to wait till last day before putting in money. Check the subscription figure on NSE website. Put in money only after retail section has been subscribed at least 1 time and issue over all has been subscribed 5 times. Remember FII’s can withdraw their money at the last moment, if subscription figures are below expectations as they did in Cairn India issue.
4. Apply under full price option. Dont go for part payment option. It would provide an opportunity to sell out at the time of listing itself. Otherwise would be stuck with the stock for more than a month.
5. Sell on listing, making as much listing gain as possible. At least free your capital.
6. If you are compulsive Reliance shareholder re-enter the stock at around Rs.325-350 range. I can bet it will touch that level atleast once between listing date and completion of installation of 28000 MW

Why DLF IPO is Doomed

The big bang DLF IPO is here again. The price band is Rs. 500 – 550 per share and is offering 17.5 crore shares for subscription. At the upper end of the price band the issue hopes to garner Rs. 9625 crores!!!

And again my prediction is that it won’t be successful. I don’t believe in the real estate valuations and that I have stated many times earlier here. Today I will not talk about valuations. I believe, The size of the IPO is enough to kill itself.

Analysts are wrongly comparing DLF IPO to RPL IPO. They are trying to sell the point that if Indian market can absorb RPL IPO it can also absorb DLF IPO.

Let me argue to the contrary.

First – DLF is no Reliance

Reliance has a 30 year track record of rewarding its shareholders and Dhirubhai Ambani is known as father of equity cult in India. RPL’s parent company had a shareholder base of 35 lakh shareholders (It’s a record; every 4th investor in stock market is a shareholder of Reliance). RPL IPO saw a mad rush for opening D-Mat accounts among non investors. DLF can’t even hope for anything similar to that. DLF is not even TCS, ONGC or ICICI bank.

Second – It’s a Myth that Reliance Petroleum raised 8100 Crores from market through IPO

Fact: RPL has reserved 90 crores shares for RIL of the total 135 crore shares on offer. Which means the net size of the IPO was only 45 crore shares or Rs. 2700 crores.

Third – Not enough retail investors

I believe, everyone one will agree that if Retail part of the issue is not subscribed fully there is negligible chances of upside when the issue lists.

Now let’s do some number crunching.

DLF IPO size is Rs. 9625 crores at the upper end of the price band and is offering 17.5 crores shares for subscription. Around 30% of the issue would be reserved for retail investor. As per the SEBI guideline retail investor can invest maximum Rs. 1 Lac per IPO. Hence if all applicants apply for maximum permission number of shares it would require around 3 lakh applications. Generally less than 1/3 of the applicants apply for maximum permission number of shares. In case of RPL issue it was around 32%. Going by the weighted average method it would require at least 6 lakh retail applications to fully subscribe the retail part of the issue.

Yes, RPL IPO was oversubscribed by around 13.8 times. It meant that total money retail investors provided was Rs. 2980 cr. (16*13.8*45cr*30%). At 100% retail subscription, DLF is hoping to raise Rs. 2888 cr (9625*30%)!!!!

Fourth – Where is the upside?

Even if the IPO managed to escape through like the Cairn India IPO and manage to somehow show 100% subscription by retail investor’s what’s the point of investing? Retail investor would like to invest in an IPO only if he is hoping that the IPO would be oversubscribed many times over and hence would command premium in the secondary market on listing. As shown above it’s very difficult that the issue would be subscribed completely. Hence I don’t see any possible upside in the issue.

Fifth – bad marketing

The one year listing drama has done enough damage to the issue. It can’t command the same confidence it would have a year back. Secondly rumors like – Ambani brothers have joined hands to make sure that DLF IPO is not successful is doing no good for the IPO. I don’t buy the logic that Ambani brothers are interested in relative market cap of DLF with RIL market cap already 2.5 times and RelCom market Cap also more than that of proposed DLF market Capitalization. Such rumors can only harm the issue. Very few like to bet against the Ambani at least on the stock market. Again news of leading i-bank deserting the ship is not taken positively by the market.

Sixth (the most important) – Valuation

Boss, look at the top line and bottom line figures. Do you think public is idiot??

My recommendation to retail investors

Don’t even think of investing in this IPO. And those who are planning of investing in other companies in the secondary market in the next 10-15 days please hold on to your horses. Check out the fate of the DLF IPO & its impact and then enter the market.

Cairn India IPO – Fair price Rs. 120 per share

Cairn Energy (UK) is coming up with an IPO for its Indian assets as a separate company Cairn India Limited. The IPO price band is Rs. 160-Rs190 and the issue is open from December 11, 2006 to December 15, 2006.

Background: Cairn Energy is an oil exploration company which sells its explored blocks to production companies once it strikes oil. The company’s core competence is exploration (and has a very good track record in that) and has negligible experience in production.

Cairn energy as it has done with other explorations around the world was looking to sell off its Indian blocks after striking oil. However greed took them in. And the credit for that goes to Merrill Lynch. Merrill Lynch’s Oil and Gas expert Mr. Rahul Dhir made a presentation to them that rather than selling off the block to one of the oil companies, Cairn Energy would be better off spinning off the Indian assets into a separate company and coming out with an IPO in the Indian stock market. The valuation expected in IPO as presented by Merrill Lynch was more than twice what Cairn Energy was hoping to get by selling the block to Production Company. Although the Cairn energy top bosses were not convinced that Indian assets can command that kind of valuation they were done in by the greed. They offered Mr. Dhir of Merrill Lynch CEO designation for the Indian subsidiary and lucrative stock options in return of leading the IPO process.

Can you imagine an Investment Banker becoming CEO of a company in a highly technical business like that of oil exploration & production? That what ‘irrational exuberance’ can do to people. The mad gold rush at the Indian stock market is providing opportunity to I-Banks and promoters to fool small investors.

I had discussion with couple of analyst in top notch Investment banking firms who have come up with research reports on Cairn India IPO. Although both of them have written in their report that the IPO is slight overpriced privately they admit that is grossly overpriced. When I asked them why they are not mentioning that it’s grossly overvalued – their response was they can’t bet against the market. They admitted such is an appetite for new IPOs that a good stock is lapped up at any price irrespective of valuation. And ofcourse a company that has stuck oil cannot be a bad company. But the question is VALATION??

Few things that need to be highlighted which has not been properly highlighted:

1. The company has almost no experience in production. The company’s core competence is only exploration
2. The company rather than having a technical person as CEO has got an investment banker as CEO. Not only would it be de-motivating for operating personnel it would also hamper the operations. Expect change in management soon after the IPO.
3. The promoter is not interested in the production business. Expect no management support and possible stake sale in the near future.
4. MRPL or ONGC has not given any firm commitment regarding offtake of crude produced. Refinery plan at the well head has already been put into the dustbin. The quality of crude makes pipeline transportation difficult as the crude solidifies in the pipeline if the required temperature is not maintained. Hence transportation would be a costly issue and it need to be solved immediately so that pipeline infrastructure is ready at the time of start of production. Considering the situation right now, it seems that it would lead to delay in the project.
Comparable crude trades at a discount of Brent crude price. The discount rate is currently around 20%. In India only Essar and MRPL refinery apart from Reliance Refinery is capable of handling such crude. Considering the transportation problem, geographical location of plants and relative strength of players my bet is – Cairn would on its knees sell the crude to Reliance at a heavy discount. (This is if they don’t sell out of the project completely before the production starts).
5. ONGC has disputed the claim of Cairn India that they are not liable to pay the cess. ONGC has claimed that Cairn India would have to pay 70% 0f the cess as they hold 70% stake in the block.
6. Cairn Energy would not be using the proceeds from the IPO for capital investment. The money would flow out of India to the parent company and its shareholders.

How I-Banks fool us

“Chor – Chor mosere bhai”. This is the only explanation I have to explain why other I-Banks are not coming out with a negative report on Cairn IPO. Couple of points worth noting in the Macquarie report:
1. To reach at Enterprise Value / Reserve multiple of 12.5 they have divided the total market capitalization of international oil companies by reserves. However total market capitalization includes valuation due of refinery and marketing assets also which has been ignored. (Infact it’s a goal seek calculation. Just to justify the valuation of Rs. 160 – 190 this mistake has been committed knowingly). Real multiple should not be more than 6.5 as that of ONGC. If same multiple is used for Reliance oil & gas assets valuation, the oil and gas assets of Reliance alone should be valued at Rs. 1,35,000 crores!!!
2. Secondly, each such exploration contact has some government share (In this case it ranges between 20% and 50% depending on cost recovery). Valuation should be discounted by same percentage.

When you discuss the same with these I-Banks the only argument they have to defend their recommendations is not valuations but the fact that Petronas has taken 10% stake in pre-IPO placement @ Rs. 176.5 per share. For Petronas this might be a hedging option or a “getting your foot in strategy” to pre-empt any other bidder for the assets. Or there might be some fine print to the deal knowledge of which is not available in public domain.

Anyhow not going into too much detail, my conclusion is:

1. You will get an opportunity to buy Cairn India shares at a price around Rs. 120 atleast once between listing and start of production.
2. If you want to take an exposure in exploration business you would be better off buying Reliance Industries shares.
3. At IPO price the shareholder would not end up losing only under two conditions. Either oil prices sky rockets by atleast 30% or Cairn India strikes more oil.
4. Don’t be surprised if SEBI pulls them up or if IPO price is revised downwards

VOIP – Voice over Internet Protocol

This appears to be the next big thing to hit the telecom circuit and it may take many things (not exactly telecom now) by storm. As Sunil Mittal says Telecom is like the Pacman who keep growing eating other business. Well IP (Internet Protocol) is the thing that will help telecom eat few big-ticket businesses. One of this will be Cable TV business that may soon shift totally to telecom operators. Already IPTVs are in advanced stages of development & testing.
VOIP can kill the difference between local call & STD/ISD calls. It would again lead to ‘Talk Unlimited’ scenario. Currently Indian regulations donot facilitate VOIP but soon regulations will have to change. Indian telecom players are already betting on it. Tata’s latest acquisition – Teleglobe is interesting because Teleglobe has recently merged with itself ITXC – the world’s biggest carrier of VOIP minutes. Reliance is working closely with Microsoft on IPTV technology. Bandwidth (international undersea optic fiber cables) is already there. If policy changes in time India might lead the VOIP onslaught. I am on a look -out for an IP expert who can teach me fine points about the technology. Anybody??