LIC IPO set to write capital market history

Potential investors in the IPO of Life Insurance Corporation of India (LIC), the state-run insurance giant, may face a big EV conundrum. No, it’s not about electric vehicles, which in any case are now the talk of the town. This is Embedded Value (EV), a financial metric that will play a crucial role in LIC’s valuation and its government IPO price in the coming days.

EV takes into account the adjusted net worth of the life insurer, including free surplus and capital, coupled with the present value of future earnings from in-force policies. It is now accepted practice to determine enterprise value – while taking an insurer to the public markets – as a multiple of EV.

With LIC’s IPO slated for next month – the government has maintained it does not see the Russian-Ukrainian dispute impacting the IPO plan – there is much talk in circles from analysts, as well as among retail investors, on what might be a reasonable price for the IPO, and whether the government will leave anything on the table for retail investors.

There is also this debate in the market, questioning the nearly six-fold jump in LIC’s EV from a level of ₹0.9 lakh crore as of March 31, 2021 to ₹5.4 lakh crore as of September 30, 2021, and trying to determine what explains this sharp rise in EV.

Has 100% state-owned LIC resorted to some new accounting trick to increase its EV, or is this a consequence of the calculated strategic decision to change its allocation policy surpluses between policyholders and shareholders?

There is no official word on the strategic intent behind the change in surplus distribution policy, except for the assertion from some quarters that this was done to be in line with private peers. and with the blessing of the Legislature (the LIC law was changed) and, therefore, no one needs to raise an eyebrow about it.

MTM of LIC’s equity portfolio

So, what really happened is that the large portion of the increase in EV in September 2021 can be attributed to the Marked to Market (MTM) of LIC’s equity portfolio. MTM is the process of adjusting the price of securities to the prevailing market value on a date. The increase in EV is due to the increase in shareholder participation in the non-participating funds to 100% and the transfer of a large part of the equity portfolio to the non-participating segment and the obtaining of MTM.

The story goes like this. Historically, LIC had only one large mutual fund called life fund, where fund surpluses were allocated at a ratio of 95% to policyholders and 5% to shareholders (Government of India). Now, before the IPO, the government changed the LIC law, so there could be two separate funds that could be created. The participating fund (for participating policies) and the non-participating fund of the existing single pool of funds, and the surpluses of the non-participating funds were attributed 100% to the shareholders.

As a result of changes to the surplus distribution policy, LIC will gradually pay out 10% of PAR surplus (with participating policies) and 100% of non-participating surplus to shareholders. This has seen the company report a new business value (NBV) of ₹4,170 crore in 2020-21, delivering a VNB margin of 9.9% and an improved Indian intrinsic value of ₹5.4 lakh crore in the first half of fiscal year 22.

Macquarie Research, which clearly wrote in a note that the interests of policyholders could have been compromised by the change in policy for distributing surpluses, pointed out that this could have some impact on returns and bonuses in the future that LIC could declare.

The aforementioned note indicates that it appears that MTM stock gains were used to shore up EV. He added that LIC’s EV saw a sharp increase to ₹5.4 million rupees, largely due to equity market gains, transfer of a large portion of the equity portfolio to a non-even segment and then of the market. Now, Macquarie Research also believes that a portion of these equity gains would have been allocated to meeting the solvency margin of ₹2-lakh crore, as stated in the draft red herring prospectus.

So whatever conclusions retail investors draw from the electric vehicle conundrum, it doesn’t seem to affect their appetite for the insurance giant’s upcoming IPO.

Nice balancing act

However, the government needs to strike the right balance, particularly on timing and pricing, in bringing the country’s largest life insurer to the public markets (stock exchanges) next month.

Despite geopolitical tensions and the resulting fall in the capital market, it would do well not to allow itself to be swayed by exogenous shocks and to ensure that it does not lower its ambitions when pricing the offer, say observers of the capital market and observers of the economy.

Srinath Sridharan, business adviser and independent market commentator, said LIC and its business are India-specific. “You don’t have to worry about its valuations, market instability, due to the Russia-Ukraine crisis. Although overall market sentiment may seem muted or the index may fall as this war breaks out , even a small sign of a ceasefire and a return to normalcy can boost capital markets again,” he said.

Pricing the issue will certainly be a tricky business as the government must choose between maximizing its divestment revenue and at the same time not disappointing millions of retail investors, who have been the foundation of the markets’ post-Covid strength. fellows in recent years. two years despite the all-out sale of the FII.

Of course, no one knows how long the ongoing conflict between Russia and Ukraine will last and continue to rattle global stock markets. However, the government is expected to remain unfazed about this in any way, hurting the valuations that LIC would command in exchanges after listing.

Good fundamentals

After all, given the good fundamentals and the global stature of LIC (among the best life insurers in the world) and the growth track of this insurance giant in the years to come, it is obvious that global institutional investors and nationals will turn out in droves and line up to take part in the mega IPO, which will be the largest ever in the country’s capital markets history.

Plus, they would be well aware that any show when sentiment is muted is an opportunity for bargain hunting in emerging markets.

The government aims to offload 5% of its stake through an offer to sell (OFS) and earn a windfall of at least ₹65,000 crore (at a company valuation of around ₹13 crore). The Draft Red Herring Prospectus (DRHP) was filed with SEBI on February 13. So any pricing around an enterprise value of around ₹13 crore would mean an EV multiple of 2.4 times, given that EV is ₹5.4 crore. This could translate to a price range of ₹ 2000-2100 for the bookbuilding offer.

The government should, in fact, sweeten the deal for retail investors in the IPO by announcing a reduction in the uncovered issue price to this category as well. The retail investor share will be allocated at least 9.4 crores of shares (35% of the net issue).

While institutional investors will swallow the issue at any price range between ₹ 2000-2100, it won’t be so attractive for retail investors to jump in easily, analysts say. Especially considering that more than 60% of Indian households have seen their income drop due to the pandemic effect in the past two years.

So a discount for retail investors (also uninsured) will be in place and hopefully the government will accept this, they added.

For now, at the DRHP stage, only policyholders will receive benefits, such as separate reservation of shares and a discount. Up to 10% of the issue size (31.63 million shares) is reserved for policyholders and 5% for employees. Thus, the net size of the issue (after offsetting the quota of policyholders and employees) will amount to 26.89 crores.

The government would also do well to heed SEBI’s requirement of further dilutions to 10% in two years and 25% in five years, and not disenchant retail investors with aggressive pricing, analysts say.

The other alternative – if it does not want to offer a discount to retail investors – is to consider an even lower EV multiple, say 1.9, which will give an enterprise value of ₹10 lakh crore and therefore , divestment proceeds of ₹50,000 crore.

So, effectively, the government will have to take a crucial call as to where in the 1.9-2.4 EV multiple range it will settle for the proposed IPO offering.

The IPO has the potential to write a glorious new chapter in the Indian capital market journey and add to India’s economic strength. The government will hopefully do a smart job of making this a reality while also making a significant sum as divestment revenue.

Published on

February 28, 2022