Will It Fire Up IPO Market? - GSPC

There are theories, and theories, but it’s not as if all of them work. Consider, for instance, the fact that any business in the world depends on two critical factors - demand and supply. If there is an excess of demand over supply then a business entity would make sense. Currently, India’s oil and gas sector seems to be in such a situation where demand is much higher than supply and the gap is only going to widen as we move ahead. Just to quantify, the demand and supply gap for crude oil in 2009-10 was around 99.72 MMT and is expected to catapult to more than 165 MMT by 2011-12. It is further expected to rise to 315.10 MMT by 2024-25. Similarly, in the case of natural gas, the demand and supply mismatch is to be in the region of 221 MMSCMD by 2024-25.

This indicates a good amount of opportunity for players in the oil and gas field. So does this demand and supply gap mean better returns for investors in the stock market? This crucial question arises in the wake of Gujarat State Petroleum Corporation (GSPC) planning to tap the primary market with 44.80 crore equity shares (FV Re 1) in June. Since this will be the largest IPO of 2010 (till date), it would definitely set the tone for the rest of the IPOs that would follow in the year 2010. Hence this attempt to understand the GSPC IPO.

But the question investors would like to pose is: if demand and supply should be the factors to consider for growth and capital appreciation, then isn’t there a huge demand and supply gap in the power sector too? Many power generation companies have tapped the primary market based on a similar theory and yet failed to provide capital appreciation to the investors. Just to cite a few examples, one of the biggest IPOs was that of Reliance Power which is still quoting below the offer price and so has been the case with NHPC and Indiabulls Power. Note too the fact that all the power sector related IPOs were from reputed groups and their issue sizes were also big enough to make an impact on the primary market.

Further, the past trend is not so exciting when it comes to large-sized IPOs, with many of them having failed to provide capital appreciation to investors. Our research team carried out a study of the large-sized IPOs with issue sizes of more than Rs 1,000 crore and which have tapped the market since 2007. Our finding suggests that there were 14 such IPOs (excluding Jaypee Infratech and SJVN that are not yet listed at the time of going to press and hence not included) and as high as nine are quoting below the offer price. In 2010, one large-sized IPO of DB Realty which tapped the market is also quoting below the offer price. History suggests that good or bad IPOs can change the sentiment of the market drastically and hence it’s very important to understand the GSPC IPO which would be in the region of Rs 3,500-4,000 crore. If GSPC can create wealth for the investors, it can fire up the IPO market. Let us understand the company first.[PAGE BREAK]

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Downstream To Upstream
GSPC was incorporated to do business in the downstream segment of energy for setting up plants for petrochemicals. But the company did nothing substantial in that segment to call for much attention. Sometime in 1992 it ventured into upstream business through ‘walk-in rights’ in the Hazira field located in south Gujarat near Surat. This was the company’s first step into the downstream segment. Today, it has six producing fields viz. Hazira, Ingoli, Tarapur, Unawa, Cambay and Palej.

In the meantime, GSPC also expanded its business operations through the setting up of subsidiaries and joint ventures (JVs). In fact, one of its subsidiaries, Gujarat State Petronet, also went public and now quoting at a premium of 240 per cent against its issue price of Rs 27. GSPC holds a 37.77 per cent stake in Gujarat State Petronet. Today, GSPC has six subsidiaries and four JV associates. A majority of its business operations are based in Gujarat but the company intends to expand the same beyond the state’s boundaries.

The company, at present, holds working interests in 60 onshore and offshore exploration and production (E&P) blocks covering a total of 2,57,810 sq kms. 49 of these blocks are located in India and 11 are located outside the country, with 3 blocks in Australia, 4 in Egypt, one in Indonesia and three in Yemen.

Deen Dayal Gas Drives It Ahead
Presently, the company’s net entitlement of proved and probable (2P) for gas is at 966.90 billion cubic ft and crude oil is at 21.68 million BOE. While the company has the above revenue streams along with subsidiaries, its primary asset is 80 per cent working interest in the KG block which includes the Deen Dayal field. Actually 98 per cent of its proved plus probable gas reserves and 84.4 of its proved plus probable oil reserves are located in Deen Dayal West (DDW). The Deen Dayal field is divided into various areas such as DD West Downthrown, DD East, DD North and DD West.

According to the company’s strategy, it will first develop the DDW field. The money that would be raised through the IPO would be partly used for development of the DDW field. Currently the company is executing a field development plan for DDW and aims to commence the commercial production of gas from June 2012. There is a requirement of five wells to start this operation. GSPC has already drilled four wells and will complete the fifth one before starting its production. DDW would be the first major success of GSPC that would drive revenues of GSPC in a significant way.[PAGE BREAK]

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Positive Factors
The gas found at DDW is of much better quality than that of other com-panies. In fact, the gas here is so good that one can extract LPG from the same. Given this, we expect the company to command a better premium on the bourses. “We have a richer quality of gas because ours is older gas and is also deeper by around 4-5 kms. Further, it is richer as it has high carbon elements like methane and propane,” explains Tapan Ray, Managing Director, GSPC. As per the company’s field development plan, it would be getting USD 5.7 per thousand standard cubic feet against the normal price of USD 4.2 BTU.

The DDW field is in the KG Basin which is the most happening place for the Indian energy sector. Reliance Industries and even Cairn Energy have made huge discoveries in the same field which improves the chances of success for GSPC. As mentioned earlier, the company has various other blocks in the DD field but as a strategy it is first developing the DDW. But there are other blocks like DD East, DD North, DD West Downthrown and DD Northeast BRU too where the FDP (field development plan) would be done in next few years.

The company may be looking at developing the same in the near future and our reading is that it would consider DD East as the next one by 2015-16. As and when that happens, the company’s revenue potential would further shoot up. Our sources from the industry suggest that the potential from DDE could be higher than DDW. Moreover, the company has bid for NELP VIII and there are strong possibilities that it may be awarded these blocks considering that were very few other participants in this bidding process.

Government Support
GSPC has been promoted by the Government of Gujarat which, together with other state entities, will hold about 80 per cent stake in the company. The government holding acts as a cushion for the investors as there are no questions about the quality of management. “We benefit from a strong relationship with the Government of Gujarat and under its aegis we have undertaken various steps to expand and diversify our portfolio of businesses,” states Tapan Ray, CMD, GSPC. Even CRISIL has awarded a good rating of four out of five to the IPO. One of the factors considered by CRISIL while awarding this particular rating is the company’s strong and professional management bandwidth. Also, note that GSPC is having better financials with sales of Rs 5506 crore and net profit of Rs 375 crore unlike power companies tapping market.[PAGE BREAK]

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Institutional Investment Placement
Institutional investors are known as better judges of valuation of any company. As such, leading and good quality institutions such as SBI Capital, IFCI and IDBI Bank have invested in the pre-IPO placement of the company at a price of Rs 81 per share. This not only acts as a buffer but also provides a comfort level for retail investors. Further, total investments of Rs 989 crore have been made by other state-owned and group companies at similar price levels. In all, they would be holding a 7.73 per cent stake in the post-issue capital of the company.

Value Unlocking
Since GSPC has five unlisted subsidiaries we see a strong possibility that these subsidiaries would go for a public offering to unlock value for GSPC. But this may not happen immediately and we believe that it may happen by 2013. In fact, one of the subsidiaries is already listed and has created good wealth for its shareholders. GSPL tapped the primary market in 2006 at price of Rs 27 and is presently quoting at Rs 93, thereby yielding a gain of 244 per cent in just four years.

The Gujarat Factor
Our study on Gujarat-based PSU companies reveals that these are able to command better premium over their peer groups. GMDC, for instance, is commanding a P/E of 16.14x as against Sesa Goa’s 15.80x of FY10 earnings. Even GSPL is trading at a much higher P/E than Petronet LNG. Similar is the case with GACL which is in the business of alkalies.

Better Valuations
On the valuation front, the company seems to be well placed. Consider, for example, the fact that the EV/BOE for Cairn India is Rs 2,933 per BOE while for GSPC it is Rs 1,353. The enterprise value of Cairn India stands at Rs 59,049 crore and adding Rs 7,000 crore as capex, the total EV is Rs 66,049 crore. It has got reserves (P2) of 225 million BOE and hence the EV per BOE is arrived at Rs 2,933. [PAGE BREAK]

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In case of Oil India, with 974 million BOE of reserves, the EV per BOE is Rs 400 only. In the case of GSPC the total EV is Rs 26,655 crore and its reserves stand at 197 million BOE, which results in EV of Rs 1,353 per BOE. It is quite higher than Oil India but the best part is that we have not considered the valuations of GSPC’s subsidiary companies with huge assets that can create a much higher value for the company if the value unlocking is done in future.

A Few Concerns Too
As per FDP Plan, the company would be selling gas at a price of USD 5.7 per thousand standard cubic feet. This is much higher than the price set under the administered pricing mechanism (APM). Even in the RIL and RNRL gas dispute the price has been fixed at USD 4.2 BTU, this is lower than the company price. In other words, end users would prefer to buy the gas under the APM. This could impact the off-take of the company in case the user industry is able to source the same at the APM rate. But the industry is of the opinion that USD 4.2 BTU is not a feasible rate for new explorations to take place. Very recently R S Sharma, CMD, ONGC, has gone on record saying that the cost of producing natural gas has doubled in recent years and the price that the companies are getting is not even enough to meet the cost of production and the rate of interest on capital invested for the purpose.

Further, even though the company can lay claims to a better quality of gas, the fact remains that it lies under the sea at about 4,500-5,000 metres. Exploring deep blocks is a major challenge on the technical front. Also, DDW is in a tropical monsoon area that is subject to an average of one cyclone per year and experiences south-west as well as northeast monsoons.

Another development that can impact the industry is that as per recent article in the Wall Street Journal mentioned that over the past decade a wave of drilling around the world has uncovered giant supplies of natural gas in shale rock. According to some estimates, there is 1,000 trillion cubic feet recoverable in North America alone which may be enough to supply the US’ natural gas needs for the next 45 years. Even Europe may have nearly 200 trillion cubic feet of its own. The article also mentions the possibility of cost as low as USD 2 per million BTU. So if such discoveries happen, players like GSPC may not be able to compete with very low prices. But again, the study is in its nascent stages and hence it will be difficult to make any com-ment at this point.[PAGE BREAK]

Right Pricing Would Be The Key
Currently there is a high amount of volatility and uncertainty in the markets. So valuation holds the key for the company’s success in the primary market. In the past, we have seen that if the companies ask for higher valuation, investors tend to ‘cold shoulder’ the issue. So unless the company leaves enough on the table for the investors, the issue will not succeed and poor response from the investors would deter other public issues from tapping the market. We feel that some sort of a discount for the retail investors should be provided. As mentioned earlier, the company issued shares to the institutions at Rs 81 and in our opinion it should offer the shares in the same price range to revive the IPO market sentiment. We shall do an IPO analysis when the company announces its price band.