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Correct Valuation is Must for the Success of LIC IPO

they are systematically removing hurdles and relaxing norms and have also announced that 10% of the IPO issue size would be r

Life Insurance Corporation of India, LIC (1), is the largest financial institution in India, with assets of more than 32 lakh crore INR. The Indian government is clearing decks to make its listing process smoother.

Currently, issuers with a post-issue market capitalization of four thousand crore INR needed to offer at least 10% of the post-issue capital to the public and achieve a minimum of 25% public holding within the next three years. However, SEBI, Securities and Exchange Board of India (2) has now stated that the issuer must offer 10 thousand crore INR and 5% of the total amount beyond 1 lakh crore INR. It means that the size would ultimately depend on the valuation.

The post-issue market capitalization is likely to be about 10 lakh crore INR if we make a conservative estimate. And once the embedded valuation is known, it can go up to 15 lakh crore INR.

According to the new SEBI rule, on a 10 lakh crore INR market capitalization yardstick, LIC would have to make an issue of 55 thousand crore INR, which is 10 thousand crore INR plus 5% of 9 lakh crore INR.

It means if the market capitalization is 15 lakh crore INR, the IPO size will turn 80 thousand crore INR. And if it is eight lakh crore INR, the IPO size would be 45 thousand crore INR. Regardless, the LIC IPO, Initial Public Offering, would be the largest to hit the country’s capital market (3).

SEBI Relaxes Public Issue Norms

On Wednesday, SEBI relaxed public issue norms to make it easier for the Indian government to sell the country’s largest insurer’s stakes via a mega IPO (4).

However, the company’s size is complicating the government’s plan to sell its stake. It is also worth highlighting that even a mere 10% stake in the state-run insurance firm is worth at least 1 trillion INR (5). According to three people, it is a tough amount for the market to absorb, according to three people who are directly aware of the matter.

The new SEBI minimum offer and public holding norms would give the government more time to comply with the rules. As per the new norms, the IPO size must be 10 thousand crore INR plus 5% of the total market capitalization amount beyond one trillion INR for very large firms.

According to the market regulators, companies with more than one trillion USD size would now need to achieve at least 10% public shareholding in two years and at least 25% within five years from the listing date.

It is also worth noting that LIC is currently undergoing an evaluation by actuarial companies, and it will be the biggest beneficiary of SEBI’s relaxation.

Nirmala Sitharaman (6), the finance minister, had proposed during the union budget on February 1 to amend the LIC act and bring LIC rules under the Companies Act. The more would ensure that the company would not face regulatory obstacles while launching its offering. Notably, India’s largest insurance company has assets worth over 34 trillion USD, of which the government holds about 95%.

The finance minister further added that the Centre would hold at least 75% in LIC for the initial five years post the IPO and subsequently hold at least 51% in the insurer at all times, even after five years of the proposed IPO.

The public listing of LIC has been a prolonged affair since it needs amending the LIC act (7). It also needed to change its accounting and audit policies, distribute surpluses and amend Sections 24, 28, and 37 of the act.

(Section 24 is about the way the corporation handle its corpus, Section 28 deals with the dividend distribution norms, and section 37 offers government guarantee on all its policies)

Currently, LIC pays 5% of the surplus to the government, while the remaining goes to its policyholders. In comparison, private insurance firms pay 10% of the surplus to their shareholders, and the rest go to policyholders.

‘Section 24 explains how a corporation shall have its fund and all receipts the corporation shall be credited thereto, and all corporation payments shall be made therefrom.’

LIC’s equity capital stands at 100 crores INR, which needed to be increased to sell even a 10% stake.

On February 1, the finance minister also proposed to increase the authorized share capital of LIC to 25 thousand crore INR. The Budget further proposed to structure LIC’s board following the Companies Act.

Moreover, as per the government, LIC may make a reservation of up to 10% of the issue size in favor of its life insurance policyholders as one of the reserved categories in the proposed offering (8).

Listing Formalities So Far

The market is expecting the LIC IPO in the third quarter of the new fiscal year. The economy is making a comeback, and the stock markets are on the rise.

The Indian government has announced up to 10% of the IPO issue size reservation for policyholders. It is worth highlighting that LIC currently services more than 30 crore policies across India (9) and expects a smooth sail for its IPO.

Apart from the equity markets’ strength, it can also benefit from the huge global liquidity in the financial markets and the constant strong inflow of overseas portfolio investments. A large LIC issue would need support from all investors, FPIs, HNIs, DIIs, and retail investors.

Notably, FPIs have invested a record net of 2,61,968 crore INR into Indian equities in the current financial year. Inflows are likely to keep up on account of additional stimulation in the US and other countries, most likely to be beneficial for the issue.

The Indian government has made The LIC Amendment Act a part of the Finance Bill. Thereby bringing the needed legislative amendment for the IPO launch.

Even though LIC is currently under the Insurance Regulatory and Development Authority supervision, the LIC Act 1956 governs it. It enables LIC to get a special dispensation in several areas, such as higher stakes in companies.

The DIPAM, Department of Investment and Public Asset Management, which oversees the government’s equity in public sector companies, has already selected Milliman Advisors, an actuarial firm, to ascertain LIC’s embedded value (10). Moreover, it has also appointed Deloitte and SBI Caps as pre-IPO transaction advisors.

LIC Performance Amid the Pandemic

The LIC’s composite market share in a number of policies and first-year premium was 67.82% and 70.57%, respectively, for September 2020.

Notably, LIC, a contrarian investor, has taken every available opportunity in the market and has invested more than 2,60,000 crore INR in debt as of September 2020 compared to 2,44,931 crore INR invested last year in the same period (11).

The corporation booked over 15 thousand crore INR profits in the capital market until September. It has also achieved over 25 thousand crore INR in the first year premium income in individual new business performance in the half-year against 24,867.70 crore INR in the same period of the past year.

The company has also settled over 82 lakh claims amounting to over 48 thousand crore INR (12).

Investors Attraction

It is worth mentioning that the pricing of the issue would hold the key towards the IPO success. It is especially true if we consider our experience with previous public issues of two general insurance companies listed in 2017; General Insurance Corporation of India Ltd and New India Assurance Co Ltd.

The General Insurance Corporation, which offered its shares at 912 INR, is now dropped down to 170 INR. Similarly, the New India Assurance IPO, which offered its shares in the range of 770 to 800 INR to its investors, is now quoting at about 164 INR (13).

Moreover, both companies had issued one bonus share for every share held by shareholders between June and July 2018. It means that if an investor got one share of GIC at 912 INR, he would be holding two shares, one allotment and another bonus of 170 INR each. It means he would be sitting on a loss of 62% over his investment in the GIC IPO.

Even though the issue would help the government raise much-needed capital to fund its planned expenditure, investors would have to analyze it carefully before making any investment.

However, according to market experts, the issue has a huge growth potential considering LIC’s sheer size. They believe that the entire first year of a premium of more than 1.75 lakh crore INR in the financial year ended in March 2020, it’s more than 22.5 lakh individuals agent network, and its real estate assets country is a drawn in itself (14).

Industry insiders say that if its 22 lakh agents even sell one additional policy a year, it would add huge volume. Moreover, LIC is the country’s biggest institutional investor with a huge investment portfolio that can generate big investment returns.

Srinath Sridharan, an independent markets commentator (15), stated that incoming investors would benefit from its size and scale dominance during the listing. Even a marginal pre-employee business productivity improvement every year for the upcoming few years could bring much more significant business volumes than the actual size of some mid-sized insurance companies. As an owner wanting to realize better gains, the Indian government would surely structure the governance to reflect the respect it deserves as a large life insurance firm across the globe.

Moreover, while LIC would have a corporate structure and independent director, it would continue to have the sovereign guarantee, which would offer comfort to FPIs and other investors.

However, it also has its own concerns. According to a financial services sector analyst with a leading brokerage, bringing efficiency across LIC’s large number of agents is a big task. The insurer would also have to ensure that it doesn’t lose its market share to private players in a big way.

Experts believe that as the government is looking for a high valuation, investors should carefully analyze the issue price before subscribing.

Challenges and Concerns

While the proposed LIC IPO is dubbed as the mother of all IPOs in the country, it may not be a smooth sail. It faces several challenges, including stiff opposition from employees, concerns over its asset quality, investor appetite, governance, and regulatory compliance issues.

The Indian government plans to launch the LIC IPO in the second half of the financial year 2021 and dilute not more than 10% of its largest insurer.

Experts believe that IPO pricing could be a challenge. The issue would crowd out the secondary market investments as other investors would have to reallocate their portfolios to buy LIC pieces.

The market already witnessed the jitters in other insurance companies’ stock prices amid the LIC listing news. Notably, the biggest IPO to hit the Indian market was Coal India, which clocked more than 15 thousand crore INR a decade ago (16).

Moreover, there is a cloud over the LIC asset quality that could wary investors.

It is worth highlighting that a major chunk of the insurer’s assets is in Indian government securities, including state government and central government papers, whose composition is unknown.

LIC has 25,241 crore INR worth non-performing assets, of the total debt of 4,05,304 crore INR debt. Its sub-standard assets are valued at about 7,828.07 crore INR, and doubtful assets are worth 13,157.86 crore INR. In comparison, its total loss assets are 4,255.07 crore INR. The company has offered 18,195.73 crore INR towards non-performing assets, and the percentage of gross non-performing assets is 6.23%.

The big defaulters of LIC are the same as for banks like Deccan Chronicles, Essar Shipping, IL&FS, Gammon, Bhushan Power, Alok Industries, Videocon Industries, Amtrak Auto, Unitech, ABG Shipyard, GVK Power, and GTL. And LIC is not expecting to get much in many of these defaulting cases.

Scrutiny and Legacy Benefits

According to the Insurance Regulatory Development Authority guidelines, after listing, LIC would have to maintain a solvency margin of 150%. However, it would halt its role as the Indian government’s bailout guy.

It has had to bail out strained lenders such as IDBI Bank and PSU IPOs as the government financier. It had invested 21 thousand crore INR in IDBI Bank last year and bought an 8% stake in New India Assurance and General Insurance Corporation. It is worth noting that both companies are trading at 20% lower than their issue prices. However, all of these would change with the bourse tag.

LIC is a 60-year-old state-owned firm and is the largest insurer in the country. Distinctly, it controls more than 70% of the market share with 76.28% market share in a number of policies and 71% first-year premiums.

LIC’s net premium income for the financial year 2019 stood at 3.37 trillion INR, while its net income from investment stood at 2.22 trillion INR in the same year.

It is also worth mentioning that insurance stocks have been star performers. SBI Life was among four insurers that raised more than 1 billion USD in IPO in 2017 (17).

Plenty of Options Ahead for IPO Investors

Indian IPO investors received handsome awards in the past quarter with some spectacular listings. It has made investors flock to the primary marker as most recent issues receive astronomical subscription levels.

The taste of quick buck has now left IPO investors drooling over the potential of the proposed LIC IPO. The new year has already seen five IPO so far, including IRFC, Home First Finance, Stove Kraft, Indigo Paints, and Brookfield India REIT. Notably, these firms have cumulatively raised more than 11,175 crore INR.

More than eight issues are in the pipeline to make a market debut before the expiry regulatory clearance. The sentiment is further boosted with the economy opening up, improvement in high-frequency growth indicators, better corporate earnings, and optimism over the ongoing vaccination drive.

“The Budget focus on growth is likely to propel the CAPEX cycle. The equity markets will rise as a major beneficiary of the expansionary Budget and low-interest rates. The laggards of the past few years are gaining momentum.”

– Neeraj Chadwar, Quantitative Equity Research Head at Axis Securities (18).

In 2020, investors clocked an average of 42% listing gains compared to 20% in 2019 and 6% in 2018. Moreover, IPOS launched in 2020 were subscribed 75 times on average against 32 times in 2019.

Out of 13 IPO that made their debut in the market in 2020, nine were listed as premiums. Issues of Burger King, Happiest Minds, Route Mobile, Mrs. Bectors doubled investors’ money on a listing day. Apart from IRFC, four out of the five 2021 issues got listed as premium, with Indigo Paints leading the pack.

“Because of the coronavirus pandemic, several companies had to put their primary capital securing plans on hold. Many of the DRHPs were filed, but most issues didn’t see the day’s light. Now with the economy opening, primary market activity is back on track.” – Amishi Kapadia, Merchant Banking Executive Director, and Global Head, Yes Securities (19).

The recently issued IPOs have largely been a success story and have encouraged others to hit the market. They are also bringing in a niche and fresh business ideas to investors. There expectations that the Indian primary market would remain vibrant throughout the calendar.

“As the market is picking up pace, investors have significantly increased their risk appetite. And after a prolonged underperformance, midcaps and small caps are finally leading the rally,”

added Kapadia.

Final Note

Despite the hefty IPO season, only a handful of recent IPOs could hold their forts. Hence, investors should be wary of business growth and valuation.

Investors must assess an issue on different parameters before subscribing to an IPO. One must look at the business nature, its growth prospects, management integrity, the reasons for capital raise, and do the due diligence on the finance.

Retail investors should only put their money on quality issues as those with strong corporate governance standards, and growth potential would continue to do better.

Moreover, apart from LIC, a long list of firms are likely to aim to make the market debut in the upcoming year. It includes Zomato, Suryoday Small Finance Bank, National Stock Exchange, Studds Accessories, Kalyan Jewellers, ESAF Small Finance Bank, Annai Infra Developers, NCDEX, Bajaj Energy, Powerica, SAMHI Hotels, Grofers, TCIL, HDB Financial Services, among others (20).