CASE STUDY ON IPO GRADING

In a situation where public issues are priced aggressively, retail investors often suffer the most due to lack of knowledge and research. In order to avoid this and restrict bogus listings , the SEBI has made it mandatory for all companies raising money through the equity route to get their IPOs graded by an independent credit rating agency.

IPO grading
IPO grading is a service aimed at facilitating the assessment of equity issues offered to the public. The grade assigned to any individual issue represents a relative assessment of the 'fundamentals' of that issue in relation to the universe of other listed equity securities in India. Such grading is assigned on a five-point scale and a higher score would indicate stronger fundamentals. The four credit rating agencies registered with Sebi will carry out the grading.

Grad ing Proc ess

T he empha sis of the IPO Gradi ng exerci se is on evalua ting the

prospects of the industry in which the company operates , the companys competitive strengths that would allow it to address the risks inherent in the business(es) and effectively capitalise on the opportunities available as well as the companys financial position. Due weightage is given to the issuer companys management strengths and weaknesses and issues , if any, from the corporate governance perspective. IPO Grading methodology examines the following key variables: Business and Competitive Position :: Industry prospects Typical factors which are assessed here includes the growth prospects of the industry, the extent of cyclicality, competitive intensity, vulnerability to technological changes and regulatory risks inherent in the business . :: Market position A companys market position is indicated by its ability to increase/ protect market share, command differential pricing and maintain margins at par with, or superior to its peers. Factors evaluated would include the sources of competitive advantages like brand equity, distribution network , proximity to key markets and technological superiority. :: Operating efficiency The emphasis here is on evaluating the factors which could give rise to operational efficiency, depending on the industry where the company is operating and typically includes areas like access to raw material sources, superior technology, favourable cost structure and so on. :: New Projects Risks and Prospects Key issues evaluated here are the companys ability to successfully execute the project that is being undertaken and the potential upside to the shareholders on completion and commissioning of the project. :: Financial Position and Prospects

Ability to generate sustained shareholders value as reflected by trends in profitability margins , EPS growth, Return on Capital Employed (RoCE) and Return on Net Worth (RoNW) are evaluated. Complementing this is an analysis of the companys ability to generate free cash flows in the long term . The capital structure of the company is evaluated from a perspective of balance between the cost of capital for shareholders and financial risks associated with higher leverage. :: Management Quality The assessment is designed to evaluate a companys management depth, the profile of its key operating personnel, the adequacy of the organisation structure and systems in place as well as the managements stated plans and policies towards earnings growth and shareholder returns. :: Corporate Governance practices While IPO grading is not intended to be a detailed evaluation of a companys corporate governance practices, broad issues like apparent quality of independent directors, quality of accounting policies and type of transactions with subsidiaries and associates is looked into. :: Compliance and Litigation History The IPO Grade assigned is the outcome of a detailed evaluation of each of the factors listed, and is a comment on the fundamentals of the company concerned and its growth prospects from a long -term perspective. The assessment involves combination of both quantitative factors as reflected in financial numbers, market shares etc as well as qualitative factors like risks associated with new projects, or the managements ability to deliver on the promises made.

Will grading help investors?

It will certainly help individual investors in judging the strength of the IPO in terms of the fundamentals of a company, which is one of the objectives of the exercise. Crisil managing director R. Ravimohan says: We grade an IPO on its financial strength, corporate governance, management quality accounting practices and financial risk. This will help investors decide whether the price at which the security is being offered is acceptable or not. IPO grading will enable retail investors take informed decisions.

The following table gives a list of some IPOs that have been graded by the credit rating agencies.

Company / Public Open Issue Name IL&FS Transportation Networks Limited United India Mahindra Holidays 23-Jun-09 & Resorts India Bank Of 23-Feb-10 11-Mar-10

Close

CRISIL ICRA

CARE

FITCH

15-Mar-10

Grade 4

Fitch IPO Grade 4

25-Feb-10

Grade 4

Grade 3 Fitch IPO Grade 4(ind)

26-Jun-09

Limited Oil India Limited Rural Electrification Corporation Ltd Vascon Limited Emaar MGF Land 01-Feb-08 Limited Tulsi Limited Cords Cable 21-Jan-08 24-Jan-08 Extrusions 01-Feb-08 05-Feb-08 06-Feb-08 Grade 4 Grade 3 Grade 3 18-Jan-08 23-Jan-08 Grade 2 Engineers 3/5 07-Sep-09 19-Feb-08 10-Sep-09 22-Feb-08 4/5 3/5

Industries Limited J.Kumar Infraprojects Limited Reliance Limited Power 15-Jan-08 18-Jan-08 4/5 Grade 4

CASE I- IPO OF MAHINDRA HOLIDAYS AND RESORTS INDIA LIMITED Fitch has assigned a grade of 4 (ind) out of a maximum of 5 (ind) to the proposed initial public offer of Mahindra Holidays & Resorts India Limited (MHRIL).

The grade indicates the above average fundamentals of the issue relative to other listed equity securities in India. IPO Details Mahindra Holidays & Resorts India Limited proposes an IPO of its 92,65,275 Rs 300 and its last traded price was Rs.563.25(As on 30th March 2010). Source: www.nse-india.com Company Details MHRIL was founded in 1996 as Mahindra Holidays & Resorts Private Limited, and was converted to a public limited company in 1998. MHRIL is an established player in the equity

shares of INR 10 each. The date of issue was from 23rd Jun 2009 to 26th Jun 2009. It was listed at

leisure hospitality segment, and provides holidays through vacation ownership memberships. The company has an integrated business model, and its activities include acquisition of

members, servicing of members and maintaining contact with them, identification of locations and land resorts, and developing and operating resorts. As of June 09, the company offers stays at 27 resorts, which include 11 owned and leased resorts. Promoters MHRIL is part of the Mahindra Group, and was promoted by Mahindra & Mahindra Limited and Mahindra Holdings and Finance Limited. Majority of the shareholding (93.6%) is held by Mahindra & Mahindra Limited (M&M). The company has a management team that is well qualifies and experienced in the industry. Financial Snapshot The financials of the company can be summarised from the following table. 16

There has been an increase in the EPS from Rs 10.3 in 2008 to Rs. 10.6 in 2009. The increased membership has resulted to the healthy profit margins over the last three years. However there is a fall in the EBIT because of the high customer acquisition cost. MHRIL has also seen improving returns on average capital employed reaching to 38% in FY09. Grading Rationale The grading assigned to Mahindra Holidays & Resorts India Limited (MHRIL) is

underpinned by the companys established presence in the leisure holidays business in India. The grading also factors in the strong promoter background and advantages of the

Club Mahindra brand that MHRIL has created for its flagship product offering. The business of MHRIL, which is aimed at the domestic urban market, has been supported by changing demographics, strong economic growth, and increasing disposable incomes

in India over the last three years. The domestic travel and tourism industry has also been boosted by the increasing investment in infrastructure, such as roads, and the penetration of low cost airlines. MHRIL has seen increasing revenue and improving EBIDTA margins over theee last

four years, and the member base for Club Mahindra has increased to 91,946 as of 31st March 2009. MHRIL is currently the largest player in the industry, with few resorts, and competitors. the efforts

The financial commitment required for creation of an inventory of

involved in brand building, has created a considerable entry barrier to MHRILs operating segment. Fitch expects the domestic economy to continue to grow, which will help MHRILs performance. As MHRILs business isss largely based on establishing direct contacts with

customers and considering that about 35% of new membeeer additions in FY09 came from referrals by exiiisting memebers, MHRILs ability to manage these relationships could be a key factir in revenue generation. The proceeds from MHRILs proposed issue are expected to be deployed in the construction of new resorts and expansion of existing ones, to provide a larger range of resorts, and hence a wider choice of holiday destinations to members.

CASE II: IPO OF OIL INDIA LIMITED CRISIL has assigned a CRISIL IPO Grade 4/5 to the proposed IPO of Oil India Ltd. Company background OIL, a Mini-Ratna Company, was set up with the objective of exploration and production (E&P) of crude oil including natural gas. It was incorporated as a private limited company on February 18, 1959 under the name Oil India Private Limited, pursuant to a promoters agreement dated January 14, 1958 between the President of India, Burmah Oil Company and Assam Oil Company. It became a deemed public limited company with effect from March 28, 1961. Issue details

The date of issue was from 07/09/2009 to 10/09/2009. It was listed at Rs.1050 and the last traded price was Rs. 1145.80 (as on 30 th March 2010). SHAREHOLDING PATTERN

OILs management is headed by the CMD, Mr N.M.Borah. He heads a well-experienced team of senior management and key management personnel who possess rich domain expertise and experience.OILs Board consists of 12 members- 6 independent directors, 2 governement nominees and 4 whole time directors. The independent directors appointed on the Board of the company have an excellent reputation in their respective fields. Financial performance snapshot

Source: CRISIL, company reports Between 2004-05 and 2008-09,the companys operting income rose at a CAGR of 17.3%. The company has posted an EPS of Rs. 101 in 2008-09, growth of 22 per cent over 200708. The companys return on capital employed (ROCE) and return on equity (ROE) in 2008-09 stood at 35% and 25 %. OIL has cash of Rs. 61 billion as on March 2009. Crisils Grading Summary

To arrive at the grade, 4/5, Crisil has considered the following parameters
y y y

Business prospects and financial performance Management capability Corporate governance CRISIL has assigned a CRISIL IPO Grade 4/5 to the proposed IPO of Oil India Ltd. the

grade indicatees that the fundamentals of the issue are above average relative to the other listed equity securities in India.however, this grade is not an opinion whether the the issue price is appropriate in relation to the issue fundamentals. The grading reflects OILs strong position in oil and gasE&P space in the north eastern region. It considers OILs advantage over its competitors in terms of low finding and lifting costs. Further OILs management has a strong undestanding of E&P activities in the on shore areas. It has good track in exploration of reserves, a focussed approach in building capability. Strong cash flows, healthy cash balance and very low gearing augurs well for OILs growth plans. As of March 2009, the company had a cash and cash equivalent of Rs. 61 billion.