NMDC sets price range for $2.6 billion follow-on

The government's sell-down in the country's largest iron ore miner will boost the free-float to 10%, but valuation multiples suggest it could be a tough sell.

India's largest iron ore producer, NMDC, will start a three-day bookbuild today for a follow-on share sale that could raise up to Rs116.27 trillion ($2.6 billion). However, this is solely a sell-down by the government, meaning none of the proceeds will go to the company.

It is the third asset sale by the Indian company since the beginning of this year, and likely the last in the current fiscal year which ends on March 31. It is also the largest of the three, overshadowing the $1.8 billion sell-down in power producer NTPC and the $755 million sale of shares in financing company Rural Electrification Corp in February. Like NMDC, the NTPC deal comprised only secondary shares sold by the government, while 75% of the REC transaction was made up of new shares, leaving the government with only about $190 million of fresh funds.

Aside from the fact that the government got its money, the outcome of the NTPC transaction was disappointing as the number of participating investors was small with most of the deal ending up with one of India's large life insurance companies. In particular, the use of a so-called French auction to maximise the proceeds for the government fell flat as one buyer immediately pushed up the price to a level where it became unattractive for other investors. The effect was aggregated as the underlying share price fell through the price offered by that one buyer during the bookbuilding.

The French auction -- a system where the issuer sets a floor price rather than a price range and institutional investors can put in orders anywhere at or above that price -- worked better in the REC transaction as the underlying share price traded up during the offering period. According to market observers, investors were also more keen to buy this deal since most of the money would be used to support the future growth of the company, rather than to fill holes in the government's finances.

In light of the experiences so far, the government has decided not to use the French auction system for the NMDC deal, although that was the original plan. Instead, it has set a price range of Rs300 to Rs350.

The range, which was announced before the market opened yesterday, represents a 12.6% to 25.1% discount versus NMDC's closing price of Rs400.6 on the Mumbai stock exchange on Monday. The deep discount sparked a sell-off in the market yesterday that saw NMDC lose 6.2% to finish the session at Rs375.65, having been down as much as 8.9% at one point.

However, sources familiar with the company note that the underlying share price has been artificially high because of the small free-float -- only 1.6% of the company is listed -- and lack of institutional trading (the low delivery amounts each day suggest that most of the activity in the stock relates to day-trading whereby investors buy the shares in the morning and sell them again in the afternoon). And rather than being low, the price range does in fact look quite aggressive compared with the company's domestic and regional comps.

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

Consequently one can question whether even the discounted price range is attractive enough for institutional investors to get involved. However, in addition to the feedback received from institutional investors by the bookrunners, the government would obviously also have a picture of which domestic institutions might be interested in buying this stock and at what price. And given the need it has for the money, and the long list of other assets it is trying to sell, the government also cannot afford for the deal to fail, meaning it is unlikely to have set the price range higher than where it believes the market will be able to absorb the shares.

"The government is kind of between a rock and a hard place. They need to get these deals done and to go well, but they also cannot be seen to give things away below a certain valuation that they think is too cheap because there is so much more coming," noted one source.  

Given the small free-float at present and the large absolute size of this offering, it will effectively constitute a re-IPO of the company -- aside from the fact that the company will get no new money. However, the listing of more shares should make the stock more liquid and thus more attractive to institutional investors. That said, NMDC will remain firmly under government control. Following the sell-down, the government's stake is set to drop to 90% from 98.38%

The offering will comprise 332.2 million secondary shares, representing approximately 8.3% of the existing share capital. Of the total, 1.7 million shares will be reserved for NMDC employees, leaving 330.5 million shares for sale to the public.  

Of the public portion, 50% will be targeted at qualified institutional buyers, including foreign investors, 35% will be offered to retail investors and the remaining 15% to non-institutional investors, primarily high-net-worth individuals.

NMDC, which was formerly known as National Mineral Development Corporation, has proven and probable iron ore and mineral reserves of 1.36 billion metric tonnes. Most of this is high-grade with an iron content greater than 64%, which allows the company to charge higher fees; while at the same time the processing of the ore requires less work. It produced 28.5 million tonnes of iron ore in fiscal 2009, which ended in March last year.

As the country's largest producer of iron ore by volume in the past three years, NMDC is clearly a key beneficiary of the overall growth of the Indian economy. But the question remains whether the story is perceived to be exciting enough for investors to overlook the aggressive valuations. Another selling point is the sheer size of the deal.

According to the share sale prospectus, it is currently planning a number of capacity enhancing projects to meet the demand for iron ore from its customers. This will include the expansion of existing mines as well as the opening of new mines. Meanwhile, the company also has plans to get into value-added projects, such as steel production, and has signed a memorandum of understanding with the state government of Chhattisgarh to develop a steel plant with an annual capacity of 3 million tonnes. It also has plans for a second steel plant in Karnataka.

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

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