Is the government undervaluing LIC for its IPO?

The Initial Public Offering (IPO) of India’s largest life insurer LIC is finally here, albeit at a reduced size. The IPO is a pure offer for sale where the government is selling a 3.5% stake, down from its earlier plan to sell 5%.  

It plans to raise Rs 21,000 crore at the upper end of the price range of ₹902-949 per share. 

        

That will still overshadow Paytm’s Rs 18,300 crore issue. The IPO price values LIC at around Rs 6 trillion or 1.12 times its embedded value of Rs 5.4 trillion at the end of December. 

The embedded value is a measure of future cash flows in life insurance companies and a key financial metric for insurers.

When LIC filed the draft red herring prospectus (DRHP), experts had pegged its valuation at two to three times its embedded value, based on the valuation of its domestic private sector peers. However, market volatility due to the Russia-Ukraine war may have changed the dynamics. 

Listed private life insurance companies like HDFC Life, SBI Life and ICICI Prudential Life trade between 2.1 to 3.1 times their embedded value. The average market cap to EV ratio of the three is 2.6 times. If we apply the average multiple, LIC’s value would be Rs 14 trillion.  The IPO valuation is almost 60% below this level.

However, it is in line with the multiples commanded by global peers which are anywhere from 0.21 to 1.89.

Analysts highlighted that LIC had a lower Value of New Business (VNB) margin of 9.9% in FY21 compared with private players, who have VNB margins of 22-27% due to higher share of participation and group products.

Disinvestment secretary Tuhin Kanta Pandey justified the valuation and timing of the IPO at Wednesday’s press conference.

IPO is the first step of long-term value creation for shareholders, he says. The 3.5% is an optimal size in current market conditions, he said, adding that the valuation flows from optimised positioning, marketing strategy, accessing investors and market window. 

While the government said it has decided to go ahead with the IPO in May due to strong market demand and a "solid" anchor investor base, there also might be another reason. 

It has time till May 12 to launch the IPO without filing fresh papers with Sebi. If this window is missed, LIC would have to update the offer documents with the latest results and embedded value.

The government was previously criticised for under-pricing the October 2019 IPO of the Indian Railway Catering and Tourism Corporation, popularly known as IRCTC. At the top end of the price range, IRCTC fetched a market value of Rs 5,120 crore.  

The government divested around 12.5% of its stake in IRCTC during the IPO and sold another 20% in December 2020. Today IRCTC is valued at almost Rs 60,000 crore, an increase of 1070% since the IPO. Does the government risk a repetition of the IRCTC episode?

According to Ashish Gumashta, CEO, Julius Baer India, govt is eyeing price discovery for LIC and it can't think of a better defensive bet than this at this time. He believes this size will not disrupt the primary market, and the valuation leaves something on the table for investors. Market strength of LIC and private players vary. 

Another expert echoed similar  views. Deven Choksey, Managing Director, KR Choksey Investment Managers says the govt wants investors to come again for FPOs. He believes the valuation is sensible in current situation, but price to EV ratio could have risen to 2 if market conditions were right. 

The share price performance of India’s current IPO record holder also offers a lesson on what happens when an issue is overpriced. Shares of Paytm, which listed in November last year, are down 73% from their IPO price. 

Experts feel that the conservative valuation for LIC at this stage is a sensible approach by the government, which has to consider global and local market conditions, long-term return expectations of retail investors and the nature of LIC’s business compared to its private competitors, among other things. They say such attractive pricing will help an IPO of this size sail through easily even as the market remains choppy.