Why am I not buying into the PFC FPO?

Or any FPO for that matter. But we’ll get to that later. First, the initial details on the PFC FPO.

PFC is offering more than 22.95 crore equity shares through the public offer at a price band of Rs 193-203/share. This includes a stake sale of around 57,388,335 shares by the government, which has 89% (will be 73.73% post-FPO) stake in the company, along with 15% fresh equity. The FPO shall open on May 10 and shall close on May 12 for QII (Qualified Institutional Investors/Institutions) bidders and on May 13, 2011 for other bidders (retail investors, like us). The company has fixed the price band at Rs 193 – Rs 203 per share. Retail investors will get 5% discount. The company intends to utilize the fresh issue proceeds for augmenting capital base to ensure compliance with requisite capital adequacy norms and for future capital requirements.

Thanks for the news update dude. We have seen this in Times of India too. But what does PFC do? And what the hell is a FPO?

PFC (Power Finance Corporation) is a leading financial institution in India focused on the power sector. It basically helps out initiatives in the Power sector by lending money. PFC’s product portfolio comprise of Project Term Loan, Equipment  Lease Financing,  Discounting of Bills, Short Term Loan, and Consultancy Services etc. for various Power projects in Generation, Transmission, and Distribution sector as well as for Renovation & Modernization of existing power projects. PFC also provides technical, advisory and consultancy services related activities through its subsidiary company namely PFC Consulting Limited.

PFC is the largest listed term-lending NBFC (Non-Banking Financial Institution) in the country, which is planning to raise around Rs. 5000 cr through this issue. After this FPO, it will land up as the fourth largest lender by networth, higher than Punjab National Bank (PNB).

It’s also been awarded the status of Infrastructure Financing Company (IFC), which will enable the company to raise funds through issue of tax-free infrastructure bonds.

What is a FPO then? Is this the same as IPO by another fancy name?

An FPO is a primary market issuance when companies issue further fresh equity (15% in this case) or when promoters dilute their stake in the company (like the Govt. diluting its stake in this case). These companies are already listed on the bourses. Similar to an initial public offering (IPO), FPOs have a price band fixed for the issue. Unlike the corporate actions (such as bonus, rights’ issue that are applicable only to the existing stake holders, etc), FPOs are open to all investors. The price band for an FPO depends on the market value of the existing company shares and the reason for raising funds.

So, why is PFC looking to raise new funds, apart from of course, ‘we need money to make more money’ reason?

Well, in this case, there is a logical reason. Or that’s what they claim.

Currently, NBFCs can lend only 25% of their networth to a single company or maximum 40% of its networth to a group of companies. This prevented PFC’s ability to fund larger power projects of, say, Reliance Power or Tata Power or to lend more to their parent groups, Reliance Group or the Tatas. Through this FPO, since networth will increase, PFC’s ability to lend to these groups will also increase and hence more revenues.

Sounds good man. Is there any downside at all in PFC? Growing power sector, increasing power needs, lot of companies setting up power projects – why not be a part of this growth?

PFC currently lends to these power generation companies and SEBs. We have covered the bottleneck in our power value line (SEBs) already here and I will not dwell further. On the power generation companies front, currently PFC is suffering from too much concentrated exposure, with 54% of their loan book made up by just 10 borrowers. The ground reality on almost all power projects is that these long-gestation projects have upset their lenders and their shareholders.

Instead of recounting PFC’s peers, competition and financial health, I will just point you to a more in-depth and a comprehensive financial review here.

Alright. Thanks for the details. Can we just get to why you will not invest in this PFC FPO or any FPO for that matter?

Let’s assume the FPO price is fixed at the upper band (which usually is the case) at Rs. 203/-. We, the retail investors get a 5% retail discount. Therefore, our effective price is Rs. 193/-. But today’s price in the market is Rs. 215/-. Excellent. So, I can subscribe to the FPO at 193/- and sell it on the market at Rs. 215/- and pocket a gain of 11.4% in a month or so. Fantastic. Where do I sign up?

Not so soon. Let’s imagine you are an investor who bought PFC at Rs. 250/- before the FPO (and its price band) was announced. Your current price is Rs. 215/-. Why would you not sell all your shares at Rs. 215/- and subscribe to the FPO at a much more favorable price of Rs. 193/-? Of course you would. And imagine a number of investors acting in a similar manner. The prices will converge very rapidly to Rs. 193/- as the date of allotment approaches. There might a very short window where you can eke out a 5% gain, but then again, I wouldn’t bet on it.

(I had however tweeted about an arbitrage opportunity a couple of days back on this. You could have shorted Futures/Options on the PFC counter, and subscribed to the PFC FPO, making approx. a 7-9% risk-free gain. Currently, the same arbitrage is not available).

What about fundamentals? I am ok to hold it for a year or two.

Well, given how the power generation projects are being implemented and how SEBs are acting up, I would bet on a 5-10 year timeframe rather than just 1-2 years. With increasing interest rates, atleast for the next year or so, I am not really positive on how many people will pay back (and thereby increasing in NPAs, increase in provisioning for NPAs and hence lower profitability). In fact, look at the last couple of quarter results. Not too positive.

Ok, but then what have you got against FPOs?

I just dislike the philosophy of a FPO. Say what you may, but I just hate dilution. Diluting through rights and bonus issues is one thing (where the first offer is given to existing shareholders), this FPO thing is taking it to a whole new level. For example, for the same kind of earnings that PFC has earned, there would now be 15% more claimants than before, thereby diluting my EPS by 15%. My intrinsic value per share is so much lesser. (so, in this case, you have interest rate risk and dilution risk).

I have a whole another issue with the philosophy of a FPO. In an IPO for example, the issue price is determined through an extensive pre-issue marketing exercise. By comparison the issue price in FPOs is generally a tempting discount to the latest price of the stock in the secondary market. What’s prominently visible to investors is the discount and not the risks of dilution. Also, most of the money raised by FPOs has been through the book-building route. Book-building is a mechanism of price discovery. How can it be applied to listed stocks, which have continuing price benchmarks available in the form of their secondary market prices? It’s illogical (and borderline ridiculous) to discover the price of a stock in two markets simultaneously.

Thanks for the rant, but what does recent history in the Indian market tell us about FPOs?

FPOs that have got listed since 2009 have seen a massive drop in their share prices. The Sensex has risen more than 90 per cent since 2009. However, most FPOs that have been listed during this period have fallen quite a bit. Birla Shloka Edutech has dipped 67 per cent below its issue price since its listing. Shipping Corporation of India (<24 per cent), NTPC (<14 per cent), NMDC (<10 per cent) and Tata Steel (<2.5 per cent). The only FPOs which have given some sort of gain are that of Rural Electrification Corporation (9%)and Power Grid (13%).

So there. I am not subscribing to this FPO.

Disclosure: No position in any of the stocks mentioned above. In fact, bearish on all the power related stocks for now.

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  1. #1 by Parva Thakkar on May 25, 2011 - 11:00 PM

    A very nice article and good blogging! I was onto google for FPO and futures strategy search and landed here. I am going to come here again and again for other IPOs as well! 🙂

    I was interested to know your views on ONGC and SAIL. Do you see an arbitrage opportunity there by shorting Futures?

  2. #2 by kdaaku on May 28, 2011 - 11:45 AM

    @Parva – Thanks for writing in and your kind words.

    I am not too sure I’d be writing on too many IPO analysis, unless I find it very very interesting. This blog is geared towards value investing than anything else.

    I usually avoid Futures Parva (if nothing else, just to keep my emotions in check coz I have this habit to get carried away with F&O). And therefore, I have no comment to make on the arbitrage opportunity you mentioned. I haven’t researched the idea.

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