reliance

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As a continuation to Part 1, the Reliance Power IPO was over-subscribed . There were 3 slices, retail investors, high networth individuals and qualified institutional buyers. All three were over-subscribed by more than 75 times.

In Indian IPOs, you need to send in a cheque for amount you’d like to buy at the IPO price. The company encashes the cheque and then if the issue is over-subscribed, there’s a lottery to see if you’re allotted any shares. Right now, with the intense enthusiasm for investing in IPOs, most issues are over-subscribed. You’re most likely to receive a small fraction of the shares you asked for. Typically, the company gets to sits on your money for about 3 weeks while they figure it out and issue you a full or partial refund.

Anil Ambani’s Reliance Power which was trying to raise $3 Billion, received checks worth $200 Billion! Considering that they might be able to get 5% interest, that works out to around $625 million! Note: all numbers are in US dollars not Indian Rupees. 1 USD = ~40 Rupees.

It is widely speculated that the stock will open about 70% higher when its listed. This will make Anil Ambani the richest man in India, maybe even the world. He’s currently worth about $45 Billion after his networth tripled last year due to the exuberant Indian stock market.

However, the Indian stock market dropped 10% last Monday and a further 20-30% on Tuesday. Its been extremely volatile this week with the markets opening higher and then trending down. Its been reported that a lot of investors in Reliance Power have issued stop-payments on their cheques. Anil Ambani’s networth has also dropped significantly due this correction. Since his companies stock prices are down 25%+, I’d assume that his networth took a $10 Billion hit! The bigger they are, the harder they fall!

This severe correction in the markets has wiped out a lot of investors, mainly the ones that were over-leveraged or those that were speculating in index futures.  A severe correction could happen in the US markets too. Now is a good time to trim back your margin and make sure you’re not over-leveraged.

I’m currently on a short trip to India. For the past 2-3 years, India’s economy has been booming. There is construction everywhere and they’re building new malls and apartment complexes like crazy.

Even though I’ve been living in the US for the past decade, before that I spent 12 years in India. There’s been so much development in my city that I can barely recognize some of the areas. The people have definitely become a lot more prosperous and their standard of living is on the rise too. Up until 10 years ago, there was 1 new car model introduced every 5-10 years. This year, there are 30 new car models slated to be released!

Along with the booming economy and growth in jobs and salaries, there’s also jump in asset prices. Real estate has become insanely expensive, having jumped 10 fold since 2000. The stock market has also increased substantially. The Bombay Stock Exchange Sensitive Index which is a weighted index of 30 stocks has doubled since February 2006. This rapid escalation has created an investing frenzy among average people in India and I think the market may be getting somewhat speculative.

Unlike the US, where non-accredited investors cannot invest in a stock’s Initial Public Offering (and other high-risk investments), in India anyone can invest in an IPO. Right now Anil Ambani, son of legendary industrialist Dhirubhai Ambani and the 6th richest man on earth, is raising $3 Billion via IPO for Reliance Power.

Based on his track record and networth of $45 Bilion, which comes mainly from his 35-50% holdings in his 4 public companies Reliance Communications, Reliance Capital, Reliance Natural Resources and Reliance Energy, that doesn’t really sound like a lot. However, the financial report of Reliance Power for the year ending on March 31st 2007 shows it had revenues of ~$562,000 and net revenue before taxes of ~$135,000. After taxes and carry forward losses, its net income was only $3,900!!!

In order to give it a market cap of over $3 Billion, the market is assuming there will be a tremendous amount of growth in the next few years. Considering that the money is ear-marked for buying the land and building energy plants, thats some serious growth that investors are banking on. I’m no accountant and I haven’t even fully read Benjamin Graham’s The Intelligent Investor, but that seems like a pretty lofty valuation.

You’d think that a company with few assets and little revenue would have a tough time raising the money. However, on the very first day is was over-subscribed by 10 times. The period of allotment for the IPO is about 3-4 days and its presumed that it will eventually be over-subscribed by 100 times!

Somehow, this reminds me of the excitement and speculation surrounding Enron in 1999! While Reliance Power probably wont go bankrupt due to fraudulent accounting, I really think the market is getting a little frothy. This doesn’t mean the stock won’t make initial investors money. It might. And the Indian stock market might go up 50% this year too. In fact, it might go up 20% a year for the next 10 years.

But paying such a high valuation for a stock with no earnings and no assets isn’t really investing, it’s mostly speculation. Speculation isn’t always bad. But you should know the difference and set you expectations (and allocation of risk capital) accordingly. Once of the best books about investment manias is Extraordinary Popular Delusions and the Madness of Crowds which was written over a 100 years ago.

Reliance Power’s valuation puts it in the same league as First Solar (FSLR). FSLR had revenues of $350 million and a net profit of $30 million last year. Yet, based on the hype surrounding solar stocks, its market cap went as high as $23 Billion. On Monday, its market cap was $18 Billion and I shorted it. Since then it’s dropped ~17%. Lets see how they both turn out.