Out of the ordinary IPOs

So, you have heard of the hill community being built on 25,000 acres near Pune, the weight-loss chain that the fat in form or mind flock to, or the Mumbai-based physical security services provider that protects film stars to jets. You have gathered from conversations at office and social hangouts that they make for booming businesses.

Quick question: If one of these companies were to come out with an initial public offer (IPO), would you buy its shares? Unsure? Get ready to be caught uncertain again and again in the coming months. For, several companies from varied backgrounds and industries in India will become the first of their ilk to list their shares on stock markets and none will have a listed peer to compare with.

Names to look out for: Lavasa Corporation, which bills itself as the first builder of a hill station in independent India; VLCC Healthcare, the first mover among slimming businesses that sees increasing custom in a prospering India; guarding and security firm, Topsgrup; SKS Microfinance and Share Microfin, both providers of small-ticket loans; funds manager UTI Asset Management Company (AMC); insurer Reliance Life Insurance; and a commodity exchange—MCX, short for Multi Commodity Exchange.

IPOs THAT WERE UNUSUAL WHEN THEY DEBUTED

INDUSTRY	COMPANY	OFFER DATE	ISSUE PRICE*	CURRENT PRICE**
Fast Food Chain	Jubilant Foodworks	Jan. ‘10	145	338
Mobile VAS	OnMobile	Jan. ‘08	440	395
Internet	Info Edge (India )	Oct. ‘06	320	871
Aviation	Jet Airways	Feb. ‘05	1,100	462
Phone Services	Bharti Airtel	Jan. ’02	45	310
*In Rs. **As on Mar. 26, ’10. Bharti’s face value has been reduced from Rs 10 to Rs 5 per share

To be sure, there are companies in similar or related businesses listed in markets outside India but a fundamental problem vexes: How do you value and sell a company that has no peer to benchmark it against locally, especially when some among them—like VLCC and Share Microfin— have uniquely Indian flavours to their business models?

One IPO—as such initial share sales are commonly referred to—five years ago, may hold out a lesson. Early in 2005, over half-a-dozen investment bankers hit the street to sell the country's first airline issue—Jet Airways. It was tough as there was no domestic benchmark and the shares were priced at a hefty Rs 1,100 each. "It was difficult to justify a price-earnings multiple of 25," says an investment banker involved with the sale.

But what did the trick for Jet Airways Chairman Naresh Goyal was a strong brand and a profitable record. "We often used to convince investors by benchmarking it with Singapore Airlines and Ryan Air," the banker recalls. Result: the 17.2 million shares that Jet Airways was selling got lapped up within five minutes of opening and the IPO closed with 16 times demand. (More later on how much a lemon that IPO eventually turned out to be.)

Vandana Luthra, Founder & Mentor, VLCC "In the coming years, we expect to be more than triple our current size, with a large international footprint, well beyond the seven countries that we are currently present in" Company: VLCC Industry: Weight Management Time frame for IPO: Not fixed Valuation: Rs 2,000-2,500 crore Global peers: Weight Watchers International Inc., Nutri Systems International Inc. Valuation source: Market

Likewise, for the current crop of issuers, too, there are international benchmarks. Banco Compartamos SA, a microfinance firm listed on the Mexico Stock Exchange, has a price-earnings ratio of 18 versus a 20-multiple for that bourse—indicating a lower interest in it vis-à-vis the rest of the companies listed there. Security firm G4S plc., listed on the London Stock Exchange, trades at 17 times earnings versus a 11 times ratio for the broader market. These are important cues for investors interested in the SKS Microfinance or Tops IPOs.

A second investment banker, who is advising one of the companies in the IPO race, says the best approach to valuing the new businesses could be in the textbook. "Our thumb rule for valuing such companies is fundamental analysis based on an estimate of earnings and cash flows, and a comparison with global peers, if there are any," he suggests. (All the investment bankers interviewed wanted their identities protected because of client relationships.)

Ramesh Iyer, Managing Director, Topsgrup "Our endeavour is to move from high volume, low margins to low volume, high margins by aggressive growth in high-end consultancy and training" Company: Topsgrup India Industry: Guarding & Security Systems Time frame for IPO: In the next 18 months Valuation: Rs 1,200-1,500 crore Global peers: Securitas AB, G4S plc. Valuation source: Market

That may, at best, be a good start with more sophisticated models coming into play. For example, at Reliance Life, which is awaiting guidelines from the country's insurance and stock markets regulator after weighing an IPO as early as summer of last year, there are two methods of valuations: New Business Achieved Profits (NBAP) and Embedded Value (EV).

In simple English, the NBAP model is a discounted value of future profits arising from new business written during a year, whereas the EV method denotes the present value of future profit streams of the entire book plus shareholder funds at the insurer. It's more like a book value method of valuing a business asset. Although globally EV is preferred to value insurance businesses, in markets with low penetration and high growth such as India, the bias will likely be towards NBAP multiples.

Similarly, mutual funds have traditionally been valued based on a certain percentage of the asset under management (AUM). However, UTI AMC's Chairman and Managing Director U.K. Sinha, who will lead the first AMC listing in India, says the right way to value such a company is to use cash flows and the future earning capacity rather than the AUM method. It's not just India's explosive growth in most sectors that make the challenge of valuations tougher.

Rajgopal Nogia, President, Lavasa Corporation "We are creating a 365-day economy in Lavasa by having a mix of residential and commercial space" Company: Lavasa Corporation Industry: Hill Station Time frame for IPO: Between September 2010 and March 2011 Valuation: Rs 10,000-15,000 crore Global peers: None Valuation source: Market

Several of the first movers headed to the bourses, for one, have diversified revenue streams making valuations complex. Take Share Microfin. It makes money from remittances and insurance products in addition to its core lending business. "We are also getting into selling healthcare products," says M. Udaia Kumar, Founder & Managing Director of the microlender.

Factoring in commission income on sale of such products with interest income makes valuations different from, say, Banco Compartamos. UTI AMC, which runs one of the largest domestic mutual fund operations in India, earns revenues from portfolio management services, offshore schemes and even a venture capital arm. The contribution of such other businesses has gone up to 15 per cent in the last three years and the company is "aiming to take it over to 25 per cent," says Sinha. Guarding makes for 90 per cent of revenues for Tops, but the share of intelligence, electronic security, consultancy and training, emergency response service and cash management is gradually rising. "Our endeavour is to move up the value chain from high-volume-low-margin to lowvolume-high-margin by aggressive growth in high-end consultancy and training," says Ramesh Iyer, MD, Tops.

The story is the same at Lavasa, where bulk of revenues come today from selling residential and other commercial plots, but it has joint ventures with 15-20 per cent equity stakes with partners in hotels and schools or even revenue sharing deals with retail outlets. Rajgopal Nogia, President, says he doesn't rule out toll on some 250 km roads to be constructed or levies on electricity or water supply in future.

Rajgopal Nogia, President, Lavasa Corporation "We are creating a 365-day economy in Lavasa by having a mix of residential and commercial space" Company: Lavasa Corporation Industry: Hill Station Time frame for IPO: Between September 2010 and March 2011 Valuation: Rs 10,000-15,000 crore Global peers: None Valuation source: Market

Still, one validation could be private equity deals entered into by the company and the value at which such transactions were sealed in the past. In February 2006, the country's largest commodity exchange, MCX, placed 10 per cent with Fidelity International. Going by that, it would be valued at some Rs 2,100 crore four years ago. An equity sale by Rajasthan Royals to Bollywood actress Shilpa Shetty and businessman-husband Raj Kundra valued the cricket team at $140 million last February. Ditto for VLCC, which has CLSA Capital Partners as an investor, and Tops that counts mega-investor Rakesh Jhunjhunwala as a backer.

In fact, in many instances, the private equity backing is a big driver behind proposed IPOs because such an event allows an exit to these early investors. A share sale in Share Microfin will help Legatum Ventures, which invested $25 million for a 51 per cent stake in the lender in May 2007, make big gains on listing. So, too at SKS Microfinance that has backers such as Sequoia Capital, Sandstone Capital and Kismet Capital.

M. Udaia Kumar, Founder & MD, Share Microfin "A public listing strengthens capital adequacy, attracts professionals, lends credibility and also improves corporate governance practices in the company" Company: Share Microfin Ltd Industry: Microfinance Time frame for IPO: Not fixed Valuation: Rs 1,500-1,800 crore Global peers: Microbank Compartamos of Mexico and Grameen Bank of Bangladesh Valuation source: Market

The learning curve is equally challenging for the issuers themselves. Being a first mover in an industry, says Sandeep Ahuja, Managing Director at VLCC, "may be quite disconcerting because then you have to end up discovering for yourself what works and what doesn't in an industry". For instance, is the use of consumables such as massage oil optimal in the slimming clinics business or are there clever ways to cut costs? Or, dexterously managing complexity at Lavasa, whose President Nogia insists his task is to build an ecosystem like Windows, the software operating system, and applications around it. "The way Windows creates hardware readiness, we at Lavasa are readying basic infrastructure by laying roads, waterline, drainage, fibre optic cable...," he says, adding: "It is all about creating a 365-day economy."

Indeed, if the firms planning to break new ground in the IPO market are successful, it could be a trend that goes beyond beefing up capital, improving corporate governance, attracting best talent by offering stock options or creating currency for acquisitions in future. It could open new industries to a large population of investors like Hughes Telecom did in 1999 (bought out by the Tatas).

Among India's top 10 stocks by market capitalisation is Bharti Airtel, which listed three years later. Or, investors risk going the dud way that Jet Airways has. After an initial surge, the airline's shares have never recovered ground and languish today at around Rs 460—one-third of its initial value. Some extra diligence to assuage your uncertainty on the new IPOs may be good for your financial health, after all.