Case Study 1 - on Initial Public Offer (IPO)

BPO Limited is planning an IPO in the SME platform. Its present capital structure is as under :-

49 lakhs Equity Shares of Rs. 10/- each - Rs. 4.90 Crores

The company has not issued any security, other than stock options to employees

Its profits after tax for the last 3 years were as under :-

Year Ended 31.3.2016 Rs. 4 Crores

Year Ended 31.3.2017 Rs. 4.50 Crores

Year Ended 31.3.2018 Rs. 5.00 Crores

The company came out with an Employees Stock Option Plan on 1 st April, 2014.

On 1st January, 2018, employees exercised their stock options with respect to 1 lakh equity shares
There are no outstanding options as at 31.3.2018

The Net Worth of the Company as at 31.3.2018 was Rs. 12.00 Crores

Three listed companies have been identified as companies in the peer group for comparison. The
Merchant Banker lead managing the issue has advised that the IPO Pricing should be lower than the
best performing comparable company in the peer group by at least 10% in terms of Price Earnings
Ratio and not higher than its own EPS multiplied by lowest PE multiple among the peer group
companies for the Year Ended 31st March, 2018.

The following data is available with respect to the three companies in the peer group are given below
:-

Name of Current Earnings per Face Value Share Net

Company Market Share Rs. Capital Worth
Price YE 31.3.2018 Rs. Crores 31.3.2018
(CMP) 31.3.2018
APO Ltd 104.00 12 10 5.00 Crores 18.00
Crores
CPO Ltd 160.00 15 10 7.50 Crores 20.00
Crores
FPO Ltd 182.00 15 10 9.00 Crores 26.00
Crores

Answer the following questions

1. Which company has the highest Return on Net Worth (RONW) for YE 31.3.2018
a) APO Ltd b) BPO Ltd c) CPO Ltd d) FPO Ltd

2. The Basic Earnings per share for the Year Ended 31.3.2018 of BPO Limited was closest to
a) 10.50 b) 10.00 c) 11.00 d) 12.00

3. Which company has the highest Price to Earnings Ratio, presuming that in the case of BPO
Ltd, the issue price would be Rs. 120 ?
a) APO Ltd b) BPO Ltd c) FPO Ltd d) CPO Ltd
4. Which of the following statements is not necessarily true
a) The Basic and Diluted Earnings Per Share for the Year Ended 31.3.2018 for BPO Limited is
the same
b) The Basic and Diluted Earnings Per Share for the Years Ended 31.3.2017 and 31.3.2016 is
not the same.
c) CPO Ltd and FPO Ltd are equally profitable because it has the same Earnings per Share
d) Pricing in an IPO cannot make any assumptions about future.

5. Which of the following is the best and the closest to the possible price for the IPO of BPO
Limited which satisfies the advised conditions :--
a) 100 b) 110 c) 95 d) 115
Solution

1) RONW = Profits Available to Equity Shareholders / Net Worth

In this case Profits Available to Equity Shareholders is the same as Profits After Tax

APO Ltd – Profits After Tax = EPS x No. of Shares ie. 12 x 50 lakhs = Rs. 6 Crores
Net Worth as at 31.3.2017 = Rs. 17 Crores
RONW = 6/18 ie. 33.33%

BPO Ltd – Profits After Tax = Rs. 5 Crores

Net Worth as at 31.3.2017 = Rs. 12 Crores
RONW = 5/12 ie. 41.67%

CPO Ltd - Profits After Tax = EPS x No. of Shares ie. 15 x 75 lakhs = Rs. 11.25 Crores
Net Worth as at 31.3.2017 = Rs. 20 Crores
RONW = 11.25/20 ie. 56.25%

FPO Ltd - Profits After Tax = EPS x No. of Shares ie. 15 x 90 lakhs = Rs. 13.50 Crores
Net Worth as at 31.3.2017 = Rs. 20 Crores
RONW = 13.50/26 ie. 51.92%

Correct Answer is c) CPO Ltd

2) Basic Earnings per Share of BPO Limited is worked out as under :-

Profits available to Equity Shares / Weighted Average No. of Equity Shares for the Year
Profits After Tax - for FY ended 31.3.2017 - Rs. 5 Crores
Weighted Average No. of Equity Shares

No. of Outstanding Product

Equity Shares For No. of days

4900000 365 1788500000

1000000 90 90000000

455 1878500000

Weighted Average No. of Shares 5146575

Rounded to 5146575

Earnings Per Share = 50000000/5146575

= 9.71

Correct Answer is b) 10

3) Price to Earnings Ratio = Market Price / Earnings per Share

In the case of BPO Ltd, Issue Price of Rs. 120 per share would be taken as Market Price
 APO Ltd - Market Price 104 EPS 12 Price to Earnings Ratio 8.5
BPO Ltd - Issue Price 120 EPS 12.11 Price to Earnings Ratio 9.9
CPO Ltd - Market Price 160 EPS 15 Price to Earnings Ratio 10.7
FPO Ltd - Market Price 182 EPS 15 Price to Earnings Ratio 12.1

FPO Ltd has the highest PE Ratio

Correct Answer is c) FPO Ltd

4) Correct Answer is c), since merely because EPS is not the only criteria for profitability

5) Two Parameters to be ensured

i) IPO Pricing should be lower than the best performing comparable company in the peer
group by at least 10% in terms of Price Earnings Ratio

Best Performing comparable company in terms of PE Ratio – FPO Limited

Its PE Ratio is 12.1
The maximum PE ratio to be considered by BPO Limited would thus be 12.1 x 90% of
12.1 which is 10.9

BPO’s EPS for FY ended 31.3.2018 was Rs. 12.11

So the issue price should be lower than 12.11 x 10.9, which is 132

ii) not higher than its own EPS multiplied by lowest PE multiple among the peer group
companies for the Year Ended 31st March, 2018

EPS of BPO Ltd 12.11

Lowest PE Multiple among the peer group companies APO Ltd 8.5

So the issue price should not be higher than 12.11 x 8.5, which is 103

Both 95 and 100 satisfies the conditions. But the best and the closest price that satisfies both
the conditions is 100.

The Correct Answer is a)