India's NMDC takes beating after follow-on prices at bottom

Shares in India's largest iron ore producer NMDC fell another 3.2% yesterday to extend their two-day loss to 8% after the company announced that the government sell-down last week had to be priced at the bottom of the offering range because of thin, and highly price sensitive, demand.

However, even with the sharp sell-off -- shares in the state-owned company have lost 20% of their value since the price range was first announced pre-opening on March 8 -- the share price is still holding above the final follow-on price.

At a price of Rs300 per share (retail accounts and company employees received a 5% discount), the government was able to raise about Rs99.29 billion ($2.18 billion). This is the largest of the three sell-downs by the Indian government since the beginning of the year, and according to Dealogic, the biggest Indian equity issue since State Bank of India's $4.3 billion rights issue in March 2008.

That said, the price had to be fixed at the bottom of the Rs300 to Rs350 price range and the total deal was just 1.25 times covered. The retail tranche, employee portion and the shares targeted at corporates/high-net-worth individuals were all undersubscribed.

According to bankers, the problem was not a lack of demand for the stock, but a perception that the offering price was too high. At the low end, the price range represented a 28% discount to the market price on the Bombay Stock Exchange before the range was set and a 21% discount versus the underlying share price the day before the three-day bookbuilding started on March 10. However, this was largely the result of the underlying shares being artificially high because of a small free-float -- only 1.6% of the company was listed before this transaction -- and a lack of institutional trading. The offering price was still at a pretty steep premium to the company's regional peers and not surprisingly this did not escape investors, especially not international investors.

The tranche targeted at qualified institutional buyers, which accounted for 50% of the public portion of the deal (before the reallocation to the tranches that weren't fully covered), was 2.28 times covered. But, of the total QIB order volume, only 2.2% came from foreign investors.

Instead, the deal was pretty much rescued by domestic financial institutions, especially the large insurance companies. And it is not too far-fetched to think that they may have been pushed by the government to submit orders, especially since many of these entities are state-owned. However, one banker argued that institutions that can take a six- to seven-year view with regard to their investments "will definitely make money" on NMDC, but if they need a return within the next year-and-a-half, the current valuations would have been too challenging.

On a trailing 12-month basis, the price range valued NMDC at a price-to-earnings multiple of about 34 to 40 times, according to a source. This compared with an average 23 times for its key comparables, which include BHP Billiton, Rio Tinto, Vale and India's Sesa Goa. And other metrics show the same thing -- NMDC was offered at an enterprise value-to-sales multiple of 17.3 to 20.1 times, while the comps are at around five times; and on an EV-to-Ebitda basis NMDC was offered at about 20.7 to 24 times, versus an average 13 times for the comps.

As noted by observers before the transaction as well, this was not an easy situation for the government. It would of course have wanted to raise as much money as possible to bring it closer to its asset sell-down targets, but more importantly it cannot be seen to hand these assets over to the private sector too cheaply compared to the underlying market price.

"If you try to price too low, you are going to get lambasted by the opposition in parliament saying that you are selling the family jewels really cheap. On the other hand, if the deal doesn't go too well, the opposition will still climb on you," said one source after the completion of the deal. "So, they had to walk a tightrope -- it had to look reasonable, sound reasonable versus the existing stock price and the deal had to get done."

The offering comprised 332.2 million shares, which were all secondary. The deal represented approximately 8.3% of the existing share capital and reduced the government's stake to 90% from 98.38%

Of the total, 1.7 million shares were reserved for NMDC employees, leaving 330.5 million shares for sale to the public. Aside from the 50% QIB portion, 35% of the public portion was offered to retail investors while the remaining 15% was set aside for non-institutional investors, primarily high-net-worth individuals.

As it were, though, both the retail tranche and the non-institutional tranche were just 0.2 times covered, which meant the excess shares were reallocated to QIB investors. The employee tranche was less than 0.07 times subscribed.

NMDC, which was formerly known as National Mineral Development Corporation, is India's largest producer of iron ore by volume in the past three years, and as such is a key beneficiary of the overall growth of the Indian economy. However, the government sell-down proved that investors are by no means willing to pay any price for a piece of that growth.

The deal was arranged by joint lead managers Citi, Edelweiss Capital, Kotak Mahindra, Morgan Stanley, Royal Bank of Scotland and UBS.