Royal Mail shares were not sold too cheaply
Suddenly everyone’s an expert on the stock market. Apparently it was obvious that Royal Mail shares were too cheap at the IPO price of 330p, and now Vince Cable has now called in Lord Myners to review the whole affair.
Some examples:
- On the news the other day a politician (who shall remain nameless) offering up the nugget of wisdom that the low price had “cost” the taxpayer hundreds of millions of pounds.
- A newspaper article which said the government had lost out on £750 million (equivalent to 34,000 NHS nurses apparently) by not pricing the IPO at 455p, the price of the shares at the end of their first day of trading.
Okay, so the share price went up by 38% on the first day of trading; that does look suspicious. But is it really evidence of an excessively low price?
I don’t think it is.
330p to 615p in 3 months, it must have been a fix
By mid-January the 330p IPO price was looking even more ridiculously cheap. The shares had climbed to 615p and looked odds-on to double in price within the first six months.
Surely the IPO price must have been too low if it almost doubled in a few short weeks?
If only it were that simple.
615p to 470p in 6 months, perhaps valuing companies isn’t as easy as everyone thinks
That 615p price lasted for just a fleeting moment. Today the shares are trading at about 470p, down almost 24% in six months.
So if 330p is obviously too low and now 615p seems to be obviously too high, what price should the IPO have been?
Valuing Royal Mail using its expected dividend yield
Unlike those who think it’s all so obvious, I don’t think there’s a clear answer, but I’ll take a stab at it anyway using the trusty old dividend yield as a starting point.
The full year dividend is generally expected to be around 21p and so the IPO price of 330p put the dividend yield at 6.4%. For context the FTSE 100 yield was 3.5%.
To price Royal Mail shares in line with the market yield the IPO price would have been 600p.
Clearly that’s a lot higher than 330p. But generally IPOs are launched with a 10% or so discount relative to a reasonable estimate of the expected market price.
This helps to ensure a “smooth getaway” for the IPO and in this case it would have put the IPO price at 540p and the yield at 3.9%.
That all seems very sensible but Royal Mail had just been through a restructuring, it didn’t exactly have a strong record of profitability and it had workforce relation issues. And as an IPO there was less transparency in its results compared to listed companies, so valuing it in line with the market would have actually over-valued it.
To price in that uncertainty a discount should be applied, but what discount?
In other words, are there any other companies out there that are broadly comparable in terms of size, potential and uncertainty, so that we can look at their valuation multiples and dividend yields and apply them to Royal Mail?
If Royal Mail was Tesco, 330p wouldn’t be cheap at all
I’ll use Tesco as the comparison company because it’s another large, well-known company surrounded by a fair degree of uncertainty. If you don’t like Tesco feel free to use any company you like.
Tesco currently has a dividend yield of 5.3%, well above the market average because investors are afraid of the impact of Lidl and Aldi on the established supermarket leaders.
Let’s assume that a 5.3% yield is reasonable for a well-established company which is under pressure; one where the dividend isn’t expected to be cut, but where there are problems to be resolved.
If Royal Mail had been launched with a dividend yield equal to Tesco’s at 5.3% then its IPO price would have been 396p. That’s less than the 455p it closed at on the first day and just 20% higher than the actual IPO price.
But don’t forget that 10% discount which is required for a smooth IPO. Apply that and we’d end up with an IPO price of 357p, just 8% above the actual IPO price.
Of course that’s an incredibly simplistic valuation, but I think it’s probably as robust as anything the investment banks came up with, and it shows that 330p wasn’t necessarily all that cheap; certainly not cheap enough to require a review by Lord Myners.
Instead what we have with the Royal Mail IPO “crisis” is a lot of political mileage being made out of something that, once you look into it, is almost completely un-noteworthy.
Disclosure: I own shares in Tesco and Tesco is a holding in the UKVI model portfolio.
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10 comments
Agree completely. Was a tad peeved when I got the minimum allocation. Still , if you'd have applied for over 10,000 shares you'd have got zip. Friends in Abu Dhabi got "x" million though. Most of the so called mate have been selling at the high.
Not impressed.Gives privatisation a bad name frankly, and is something the LEFT always leap upon. The idea itself, to incentivise the employees is a great one.
They should have priced it at 400 and sold it all to the public instead of to their mates in the city, win win, oh except for their mates who wouldn't have made millions on it, all makes sense.
K
Well this wont help matters.
"TNT Express plummets 11% after profit warning weighing on Royal Mail."
Hearing working conditions are "allegedly" alot harsher these days, less opportunities for swift sly breaks. Employee morale suffering as a result of being expected to work harder for longer. The changing working practices are not going down well, with employees being expected to multi task...
CEO/management excessively overpaid as well imo.
Expect a strike in the not too distant future.
Disclosure. No position in RMG.
I'm with TMFMayn on this. I thought it was underpriced at the time - and said so. But it wasn't as underpriced as many people seem to think!
IIRC I thought the price should have been around 400p.
The problem with the float is that Cable took advice from advisers who were over-focused on domestic demand and who over-valued the relevance of domestic institutions as potential long-term core holders. The result was bad advice. I don't blame Cable for taking the advice he was given - but he should have examined their assumptions much more aggressively (and sought other opinions).
I also agree with Fangorn about the strike risk - though I thought this risk wasn't as great at the time as many thought (but then I knew personally the individual responsible at the company)
330p to 400p isn't a great difference, so either could have been reasonable. Certainly more reasonable than the 470p or so it hit on day one and the exceedingly optimistic 600p after that.
Interesting to see were getting back to almost 400p again now. Perhaps a dividend cut or two and my original premise will be vindicated!
330p was never reasonable - and Cable should have spotted that he was being legged over if he saw the shape of the book (which he would have been entitled to see). Low 400s....400-420p was the right mark.
Think the business is weaker than when it was floated though....
Quite agree with your comments UK Value.
All these people claiming RM was sold too cheap also seem to be completely discounting the impact of strike risk as well.
In fact I'd wager that many were completely shocked how high it traded within the first week or so. Personally expect it to fall back considerably - I see it's at 488 currently, which is some way off its high. One series of strikes and it'll drop fast.
The privatisations always have to succeed - hence pricing ensures they're relatively good value. They are never priced where there is a reasonable chance of failure, period.
How about this for a thought:
There are two kinds of price; the price that you can actually sell something for and the theoretically correct price, i.e. the discounted value of all future cash returns.
So, I think I would probably agree that Royal Mail was cheap relative to the price that could have been achieved on the day of the IPO. Some sort of game theory-based auction might help here if they want to maximise the IPO price without negatively impacting the other things like the ability of the investment banks to do other deals, etc.
Then there's the other price, the price that matches the company's intrinsic value of discounted future cash returns. This is really the 'cheap' that I'm talking about in the article and I'm still of the opinion that it wasn't and isn't obvious that 330p is too cheap, i.e. Royal Mail's discounted future cash flows could be worth less than 330p. I would not be the least bit surprised to see the shares at 330p five years from now, although of course they may also be at 700p, I just don't think it's obvious which is more likely.
I guess I realise that the politicians are probably talking about the achievable price rather than the theoretically correct price, but that's not always made very clear and you still have to consider the other side of the story which is what would have happened if it had been launched at 400p or 450p? Perhaps it would have flopped... we will never know.
http://www.fool.co.uk/investing/company-comment/2013/10/07/you-must-act-now-to-secure-this-6-yield/
John, it was obvious at the ipo. The surplus property angle in particular made the share a bargain. No hindsight here I am afraid.
Mayn
The pricing of an IPO is not really about what a business is worth, but what punters will pay for it at the time. Fundamental valuation is marketing, as a seller you should construct it by inventing a plausible story on top of the estimated punter price, not the other way round.
That's the investment bankers' job to price it so that all on offer gets sold, with a discount just large enough to prevent everyone dumping it on the first day as that harms the long term ability of the issuer to raise further funds (or seller to sell other things). While it's not easy to find the optimal price, I do think they have cocked up some here, as it was so much oversubscribed, which surely they should have had a hint about had they done their homework more thoroughly.