Market isn’t God; LIC’s listing does not reveal its true value

Update: LIC share’s performance was positively underwhelming on debut. In the pre-trading session on Tuesday, May 17, it opened at Rs 872 on the National Stock Exchange (NSE), about 8 per cent below the issue price. In fact, at this price, even policyholders who were allotted shares at the cheapest price — Rs 889 apiece — would have incurred a loss. During the rest of trading today, the scrip’s price ranged between a low of Rs 875 and a high of Rs  918.95. Even at the highest price offered for the share, retail investors who bought the share at Rs  949 would have lost 3 per cent.

When markets closed on Tuesday, LIC’s market capitalisation, which was expected to be a little over Rs 6 lakh-crore on the eve of the listing, dropped to Rs 5.52 lakh-crore, a decline of 8 per cent.

As argued earlier, the biggest losers have been the government and the policyholders.

Also read: Grossly undervalued, LIC’s IPO is the most controversial ever

The Centre, which went ahead with the float despite the adverse market conditions, has clearly suffered a significant loss. But even more importantly, policyholders who were supposed to be compensated somewhat for the losses they have suffered because of the way their share of the surplus has been diverted to shareholders (the government and the new shareholders following the IPO), have nowhere to hide now.

This was published at 6.30 am on May 17, ahead of LIC’s listing: Will the LIC share “pop” significantly when it lists today (May 17) in the stock exchanges? Or, will it merely start close to its issue price? If it does “pop”, would it set off a badly needed “feel good” factor to the stock markets that have sagged in the last several weeks? Or, if it falls flat, would it then justify the controversial decision to price the share much lower than what was expected just weeks earlier? All these questions miss the point about not just “markets” as we understand them but about the intrinsic worth of India’s biggest life insurance company. 

The listing has been the subject of intense speculation since the conclusion of India’s biggest-ever IPO — and the most controversial ever — on May 9. In the days following the conclusion of the IPO there was speculation that the LIC share, which once commanded a premium in the grey market, was selling at a discount before the allotments were made, on May 12.

Opinion on the IPO has been sharply polarised. The more vocal and powerful protagonists, most significantly among them the government, have insisted that the pricing of the LIC share has been made “attractive” to investors. This, they claimed, justified the desperate push towards the IPO, despite adverse market conditions in India as well as overseas, In particular, they pointed out that the wide dispersal of the shares among retail investors augurs well for the market by enhancing its breadth.

 Gross undervaluation of the LIC share

Those critical of this stance claimed this was besides the point. Those critical of the very privatisation of LIC, not unexpectedly, opposed the  IPO. However, among the critics were also those who argued that the timing of the IPO was horribly wrong. In particular, they had urged the government to walk away from the deal because of adverse market conditions, and return at a more appropriate time when markets had recovered.

They also argued that the under-valuation would result in not just a gross undervaluation of the LIC but also in substantial losses to the government whose disinvestment drive has gone off the rails. At stake is the valuation of India’s biggest insurance company — also among the biggest in the world. The projected losses caused by the headlong rush to list LIC range from between Rs. 26,000 crore and almost Rs. 55,000 crore. 

Media reports over the past few days have speculated that the LIC share has changed hands in the grey market at a discount. Apparently, retail investors, who bid for the shares at the discounted price of Rs 904 apiece at the upper end of the IPO price band, were trading their allotted shares at a discount to other investors. Recall that only LIC policyholders were offered shares at an even cheaper price — Rs 889 per share at the upper end of the price band. According to market gossip, shares were changing hands at Rs 929 apiece, still a discount of Rs 20 over the issue price of Rs 949 per share, the upper bound fixed for all other investors, barring retail investors, LIC employees and policyholders. Market gossip speculated that the “premium” for the share had dropped from Rs 100 to Rs 20 just before the allotment; some reports even claimed that it had turned negative.

Risk aversion among investors

So, is the “market” a neutral, unbiased and fair valuer of the price of the LIC share, or for that matter, anything else? First, it is important to appreciate that the “market” for the LIC share now is unrecognisably different from the one that existed at the beginning of the year. In fact, it is almost as if they are two entirely different personas. Even before the war in Ukraine started, which is blamed for the turmoil in global markets, central banks across the world had already started recalibrating interest rates in response to the surge in inflationary pressures. As interest rates rose, or even threatened to rise as was explicitly stated in the case of the US Federal Reserve, they made stocks unattractive. 

Also read: Why LIC IPO may not be as attractive as it’s made out to be

Such changes cause a shift even among financial asset classes. Once interest rates increase, they cause bond yields to increase as the price of existing bonds floating in the market falls. This arises from the logic that the yields of existing bonds are inversely related to three prices. Thus, as bonds become more attractive or competitive vis-à-vis stocks, the market reacts by shifting its focus. 

More importantly, the differentials in interest rates and the differentials in inflation rates across countries also caused foreign exchange rates to turn volatile. Both these factors are critical for investors, especially foreign investors. For instance, even though the official inflation rates in India are still lower than those in the US, this is not reflected in the steady depreciation of the rupee’s value vis-à-vis the dollar. Instead, the “market” appears to be discounting the official inflation rate in India and perhaps judges the Wholesale Price Index (WPI), currently running for several months at double-digit levels, to reflect a more accurate picture of the Indian currency’s worth.

A rise in interest rates in the US, for instance, affects stock markets across the world in two fundamental ways. First, the cost of money that can be invested in stocks increases, thereby reducing the attractiveness of stocks. Second, the differentials in exchange rates as well as the rates of inflation in India as well as elsewhere increase the risk associated with foreign portfolio investments. 

Quite apart from all this, the growing realisation that India stocks are highly overvalued, not justified by companies’ true earning potential, makes investors even more wary. They would prefer the comfort of their home markets for at least the time being. 

The humbug of the market’s omniscience

Investors would naturally then at least expect a higher risk premium to invest in emerging markets like India. For all these reasons, the recent, and ongoing, slide in the Indian stock markets is primarily driven by the risk-averse behaviour of foreign portfolio investors. That change, between the beginning of the year and now, is a huge change. 

And, that has a huge bearing on what we term as the “market” that we expect to provide an unbiased estimator of the worth of a particular stock like that of the LIC as it lists today. It is almost as if we expect the “market” to act as God, all-knowing and all-powerful.  

But the “market” we see today is one that is very different from the one we saw earlier in the year. Take the case of “anchor” investors who invested in the LIC stock before it opened for retail investors. In January, after roadshows conducted globally, it was expected that several of the big global investors would participate in the LIC IPO. Instead, foreign participation among the “anchors” in the IPO was practically absent. 

Significantly, Indian mutual funds acquired almost three-fourth of the 5.93 crore shares on offer to anchor investors. The dispersal of shares even among the anchors was also quite skewed — almost one-third of the shares allocated to Indian mutual fund anchors went to the arms of just two Indian entities — SBI and ICICI. Thus, the claim that the LIC float would lead to a wide dispersal of shares that would create depth in the market, appears to have been defeated.

A valuation far greater than Reliance Industries

In February, when the LIC filed its Draft Red Herring Prospectus (DRHP), the expectation was that the stature of the company justified a multiple of 3.5 to 4 of its embedded value of Rs 5.40 lakh-crore. Simple arithmetic would have shown that LIC’s market capitalisation would have been a whopping Rs 21.58 lakh-crore (market capitalisation is nothing but the market value of all the issued shares of a company). 

At this valuation, this would have catapulted LIC beyond Reliance Industries, the company with the highest market capitalisation in India. This valuation would have meant that Reliance Industries would have been cheaper by a little over one-fourth, when compared to LIC. The comparison with other stalwarts such as TCS would have been even more favourable for LIC.

If the “market” today condescends to value LIC at close to the issue price of Rs 949 per share, it would mean that LIC as a company would be valued at a mere Rs 6 lakh-crore, 72 per cent cheaper than what it was just eight weeks earlier. How can God have been so capricious as to “offer” two sets off wildly divergent prices in a matter of a few weeks?

Lasting damage caused by undervaluation

It is likely that lasting damage has been caused to LIC because of this gross undervaluation. The float, which was initially expected to result in the government offloading 5 per cent of its stake, has been reduced to 3.5 per cent. Given the listing regulations — and notwithstanding the fact that the government has already exerted pressure on market regulator Securities and Exchange Board of India (SEBI) to bend its listing requirements in the run-up to the IPO — this implies that the government has to return sooner than later to offload through a follow-on offer of shares.

There is a strong possibility that the valuation of the shares in the IPO would serve as a “benchmark” for subsequent floats. Even if the government were to turn more prudent and insist on a higher price, the “market” is unlikely to accept it. The grossly undervalued price of the LIC share, arising directly from the unconscionable use of a very low multiplication factor applied, would then be the original sin from which LIC cannot ever get redemption.