Should you subscribe to I'bulls Power IPO?

Indiabulls Power's initial public offer (IPO) has received an overwhelming response from the first day itself. The issue has been subscribed 7.2 times so far with the QIB (qualified institutional investors) portion being subscribed 13.3 times. The price band has been fixed at Rs 40-45 per equity share. The minimum bid lot is 150 equity shares and in multiples of 150 shares thereafter. The issue will close on October 15, 2009.

However, Bhargav Vuddhadev of Noble Group advises investors not to subscribe to Indiabulls Power issue. He cites uncertainty over the power purchase agreement for Amaravati Phase 1, doubts on commerciality of Bhaiyathan plant, value creation, and equity dilution as reasons.

SP Tulsian of sptulsian.com doesn't see the fair price for Indiabulls Power above Rs 40. He advises investors to subscribe at Rs 40. "Retail investors should be cautious."

Here is a verbatim transcript of the exclusive interview with Bhargav Vuddhadev and SP Tulsian on CNBC-TV18. Also see the accompanying video.

Q: From your assessment of the issue and its valuations do you think it’s an attractive one or you would rather pass?

Vuddhadev: We are recommending clients not to subscribe to Indiabulls Power mainly because of three reasons, (1) we anticipate equity dilution risk in the near-term because we do not think there would be any operational capacity until FY12 and hence there won’t be any internal accruals to meet the USD 12 billion equity requirement for the Bhaiyathan power project (2) there are uncertainties over power purchase agreements (PPA) for Amravati Phase-I and Nashik power project. Also, the pricing for the former is not known. The PPAs is still not signed and (3) there is little value creation that we see from the Bhaiyathan power project given that 65% of the capacity is sold at 81 paise per unit as against cash operating cost of 65 paise per unit. Because of these three reasons we are recommending clients not to subscribe for this initial public offering (IPO).

Q: What is your call on the Indiabulls Power IPO?

Tulsian: I do not think that the issuers or the merchant bankers have really leant the lessons. If we see the four issues which have hit the capital market in last maybe three months or so, 75% have disappointed the in the form of two power IPOs being Adani and National Hydroelectric Power Corporation (NHPC) and third Pipavav. Only the Oil India Ltd (OIL) has awarded shareholders.

If one compares Indiabulls Power with Adani Power, the latter has a capacity of 6,600 MW while Indiabulls Power has been talking of 6,600 MW. However, Indiabulls Power has only two power projects of 1,320 mw each, which means the real capacity or the serious creation is in respect to 2,640 MW.

If I go by the same parameters of Adani Power in terms of the marketcap, Rs 22,000 crore because financing pattern has been broadly on the lines of 70:30 which we have seen in case of Adani Power, same here in case of Indiabulls Power. I go by the marketcap parameters Rs 22,000 crore market cap has been given to Adani Power. So, 40% of that gives 8,800 crore. If I go by the total number of issue share, that gives me a valuation of Rs 43 per share.

Since the price band has been fixed at Rs 40-45, I don’t think there is any justification for the share price or the book to get discovered more than Rs 40. In the case of the retail category, we see that all of them go for the cut off and for some reason we have seen that the issue has subscribed by about 7.2 times on an overall basis. But entire contribution is coming from qualified institutional buyers (QIB) category.

In any situation, firstly there is no compulsion on part of the investors to go for the issue. If they opt to and make a strict comparison with Adani Power, the right price at which it should get discovered is Rs 40 since they have already fixed the price band of Rs 40-45 because otherwise there are all the chances of prospective investors making losses in the issue.

Q: How would you put or ascribe a valuation given the two points that you made about the PPA concerns and the pricing issues. Given cash flow expectations from FY12 to FY14, what is a fair value in your eyes?

Vuddhadev: We have done a discounted cash flow (DCF) valuation for all the three power projects Amravati phase-I, Nashik power project, and Bhaiyathan power project and our DCF valuation comes to approximately Rs 36 per share.

Q: What you have worked in by way of a merchant power capacity and a merchant power price per unit as well?

Vuddhadev: We are assuming a merchant power price per unit of roughly Rs 5 per unit starting FY13 and we are reducing that by 50 paise per unit every year until FY17. From FY17, we will have a constant merchant power price of roughly Rs 3 per unit.

Q: In terms of capacity and price for merchant power, how does it compare with Adani Power?

Tulsian: I don’t think one can take a price of more than Rs 3.50 for merchant power if you take the project completion time after FY12 which is happening in case of Indiabulls Power. When I compare that with Adani Power, the same thing has got factored in because you have the correct indication of Adani Power in the form of the share having listed and that’s the reason I have compared that with the market cap of the company and given 40% of that because you do not see any big jump happening in case of merchant power realisation from FY12 onwards.