Should you have invested in the MCX IPO?

The initial public offering of MCX India closed yesterday. Edelweiss Capital, which was the lead manager to the issue, would be more than happy to have brought a successful close (oversubscription of 54 times) to one of the most delayed IPOs in India. Yes, this was probably the third attempt from MCX India to go public. Jignesh Shah, founder of MCX India, would be a much relieved man today. His ability to hold ground against all odds to delay the IPO is highly commendable.

Let me give you a small brief before starting this discussion. MCX or Multi Commodity Exchange is the largest commodity exchange in India. MCX allows one to trade everything from precious metals and base metals to agri commodities and likes. Based on my findings, which date about two years back, MCX handled more than 75% of all organized commodity trades in India. NCDEX, its nearest rival, was nowhere close to the business done at MCX. The situation remains the same till date. In fact, my HT Mint copy informs that it is c.87% for the MCX now. No wonder, the head honchos of MCX and NSE (of NCDEX) do not see eye to eye.

I clearly remember the year 2003. I would pass a red building built by the Silver Group in Andheri East, while traveling in a BEST bus from my uncle’s place to college. The red building housed the headquarters of MCX India. I would always wonder why I didn’t see much activity around the exchange. Coming from a small town, I carried this notion that an exchange (be it a stock exchange or a commodity exchange) would be similar to a mandi (anaj mandi or sabji mandi) with much noise and human activity. For me, an exchange was supposed to be a marketplace, full of commotion, due to a large number of buyers and sellers and the intermediaries involved. When I visited the NSE to write the derivatives exam the same year, I found that the NSE at Bandra Kurla Complex was an even calmer place. Anyway, that’s a different story, and I guess I am moving away from the topic I am trying to discuss here. The listing of MCX india.

MCX came to the market to raise Rs. 663 crores (based on the upper price band). A retail investor was allowed to bid in lots of 6 shares. Which meant that if Mr. A wanted to place his bet in the IPO, he would need to allocate Rs. 1,98,144/- and bid for 32 lots of six shares each. Lets assume, Mr. A was advised by his neighborhood broker to apply because buyers in the grey market were willing to pay Rs. 3,500/- per application, provided you transfer all the shares allocated to your demat account to them on the day of listing. Assuming that the process would take 21 days from the day of application to the day of listing, it meant a clean profit of 1.8% in 21 days or 30.7% annualized returns.

For the sake of our understanding, let us assume that Mr. A applied but does not trade his shares in the grey market. He feels that the company will have a good listing and he will exit making a higher profit. Based on the bids data pulled from the NSE, it seems that Mr. A now has chances of getting as many as eight shares against his application of 192 shares. The retail portion was oversubscribed 24.1 times. But was he better off than having sold his shares in the grey market? Let’s try and work this out.

If buyers in the grey market were willing to pay Rs. 3,500/- for a full application; they were basically quoting a premium of Rs. 438/- for one share of MCX. This is based on the assumption that the issue price would be set at the higher band of Rs. 1,032 per share. So, Mr. A would do well only if MCX manages to list above Rs. 1470/- per share.

Here pops the next question. What would be a reasonable listing price/fair price for MCX? Let me be frank here. I haven’t done much homework here but according to what I have read in the papers, MCX is already available at 18x its TTM earnings, which is at par with international exchanges like CME Group and CBOE. Considering that MCX would continue to grow at the same pace it has been historically clocking – 50% revenue growth and 22% income growth over 2009 to 2012 – its earnings could expand at anything between 22% to 50% next year. Using next years projected earnings with a P/E of 18x, MCX should command a fair value of Rs. 1260/- or at max Rs. 1550/- .

To conclude, Mr. A might manage to make at most Rs. 80/- (or a total of Rs 640/-) more than what was being promised by the buyers in grey market.