INSIGHT: Valuation matrix faults

Jagran Prakashan touched a high of Rs 392 on its first day of listing, a 22.5% premium to its issue price of Rs 320. But soon this changed and the stock traded below the issue price for most of Wednesday’s trading session.

The average price at which the stock was traded was Rs 289.5, about 10% lower than the issue price. The stock closed at a 15.5% discount to the issue price, or Rs 270 — the worst performance by a debutant stock in the past two years.

In fact, based on the performance of the stock on the listing day, it looks like Jagran would have done well to price its issue at Rs 270, the lower end of its price band.

The markets did not fall between the time of subscription and the time of listing. On the contrary, they rallied smartly since the Jagran IPO opened for subscription and even closed at an all-time high on Wednesday.

The negative reaction, however, gives the impression that the markets are increasingly wary about stocks with high valuations, especially since the markets are at record levels. Even after the drop in Jagran’s share price, it trades at 45 times annualised six month earnings till September 2005. In many ways, Jagran’s listing is a repeat of what happened with HT Media, which has underperformed the market owing to high valuations. Incidentally, HT Media still trades at levels that are 11% lower than its issue price.

The saving grace for investors who have held on to their shares is that Jagran’s earnings growth prospects look good.

Although growth in circulation revenues would most likely be lacklustre in the near future, advertising revenues are set to grow at a fast pace, since the company plans to increase the number of colour pages. Colour advertisements normally result in better profit margins. The company is also expected to save on newsprint costs, thanks to its alliance with Independent, which is a large buyer of newsprint globally.

While earnings growth prospects may look good, the fact that the stock’s valuation is as high as 45 times annualised earnings could mean that returns may not be exciting even going forward.

Premium’s the word

Ingersoll-Rand Company has offered to acquire the 26% it already owns in its Indian subsidiary, Ingersoll-Rand (India) Ltd. The price at which the parent company would buy out minority shareholders will be decided through the reverse book-building mechanism, with the floor price set at Rs 344.95. Sebi guidelines require the floor price to be the average price for 26 weeks preceding the date of public announcement, at the minimum. In Ingersoll’s case, the average price works out to Rs 344.95.

The stock price of the Indian subsidiary stood at Rs 372 when the announcement of the buyout was made, an 8% premium to the floor price. But that doesn’t matter since the floor price is just the minimum price at which the parent company has agreed to buy out minority shareholders. Past history shows that the price discovered by the reverse book-building is normally much higher than the floor price set by the acquiring company. Besides, in most of these cases, the acquiring company has agreed to pay the price discovered through the reverse book-building mechanism.

In Ingersoll’s case, minority shareholders would expect at least a 10-15% premium over the current market price. That would mean a price of about Rs 420. Also, it’s not that Ingersoll is already trading at a big premium to its peers and, therefore, does not warrant a higher exit price. The Indian subsidiary is currently valued at a trailing PE of 35 times, more or less in line with the valuation of competitor, Atlas Copco, which has a trailing PE of 35.5 times. What’s more, Ingersoll’s Indian subsidiary has been performing well lately — in the quarter ending December 2005, the company’s revenues rose 33%, while its net profit jumped 63.7%. The construction technologies division had revenues of Rs 54.85 crore last quarter, but this segment reported a loss of Rs 0.18 crore.

The air solutions segment generated revenues made up by reporting earnings of Rs 11.34 crore. With the company doing well in terms of earnings growth and since valuations are in line with peers, it’s imperative that the parent company would have to pay a premium over current prices.