Wednesday, 2 April 2014

The Post Office IPO

Most of the objections raised in the media concerning the sale of the Royal Mail are spurious. Most IPOs get away at a discount. Investors are taking on significant risk in buying a share for which there is no established market, and therefore price. Get it wrong, and your investors lose a great deal of money. No further money can be raised by the business in future except at high costs of capital.

A lot is being made of the advice as to the price range:

At the time of the flotation, and more specifically the book-building process, there were significant threats of industrial action. This faded as the floatation day approached. At 330p, the top end of the range, the shares yielded 6% or so, which appears about right for a floatation of a regulated utility the sale of which was driving the trades union movement nuts. SSE at the time yielded significantly more than that and 5% or so is about normal. 290p was cheap but 330 looked about right to me at the time.

Setting the price too high would ensure much less demand. And there are big magnifying effects at work.

There are known problems with the book-build process. The main one is that it is inflexible should demand prove higher than expected. And it was massively over-subscribed. Politicians running round telling everyone it's undervalued might have something to do with this. There was an immediate buzz, as everyone tried to get as much as they can. This flattered the figures for demand. Once it is clear the demand is greater than supply, this creates more demand and so on in a virtuous circle. It became clear, as I endured my busiest week ever that everyone would get substantially less than they put in for. This in turn encouraged retail customers to bid for £20,000 in the hope of getting £3000 worth, further flattering demand.

So was the demand really 24 times over-subscribed by institutions as reported by the National Audit Office? No.

If the issue was priced at £5, just over 10% below the trading range it established following the flotation, it's unlikely, at a yield of around 4% that I'd have been recommending it to clients. There would have been no politicians running round telling everyone how under-valued it was, and in the absence of the excitement, there wouldn't have been people putting in for significantly more than they actually wanted. The issue may have been a flop, and been pulled. The Government would have been left with egg on its face, and the price it could achieve in future may well be worse than the 330p it actually achieved for the 60% of the company it sold, if it could get it away at all. This is of course the real objection from Labour and the Unions, who simply object to any and all privatisations.

Could the Government have got more than 330p? Yes, but not much more, and at significant risk to a successful flotation.

People are objecting that institutions which took part in the flotation have sold some or all of their holding. Well why shouldn't they if they think as I do that at 560p, at a yield of 3.7%, Royal Mail is over-priced? I simply don't understand this fetish for long-term holders. Royal Mail is a successful flotation with a deep and liquid market in its stock and so as a result, can if needs-be raise money at a low cost of capital. Those institutions which put in for the flotation early did so at some risk. They have been paid for this risk handsomely and early, as have the 600,000 or so retail investors, many of whose holdings of 227 for which they paid £750 are worth well over £1200. I don't regard this as a bad thing. If you think the shares were sold off cheap, you could have bought some (unless, of course you were overseas, or an MP).

Should more have been made available to retail investors? Yes. But at the cost of securing the IPO, when it was not at all clear what demand for the shares was out there. Could a different flotation mechanism be used in future - an auction perhaps? Yes but these are a great deal harder for retail clients to understand and access. And if there are to be privatisations in future, we want to allow retail clients - individual British people to take part.

These quibbles aside, the IPO was a great success, and most of the objections to it are mere left-wing cant. The risk of owning Royal Mail to the tax-payer has been reduced. You can still post a first class letter from the Scilly isles to Shetland. Private money now underpins the business, and thanks to a hugely successful flotation, the Government can, at a time of its choosing, sell some of the remaining stake for which it will get a better price. The National Audit Office made an estimate of the value to the taxpayer of keeping the company in public ownership of £1. Labour is not making much of this figure. It has been sold to people who value it significantly higher. This is why capitalist, free-market economies are richer than the kind of economy Labour MPs want: everyone is better off now the Royal Mail is privatised and no-one is worse off.

Isn't capitalism marvellous?



5 comments:

philmophlegm said...

Clever comment I saw somewhere on this yesterday:

If someone complains that the shares were "undervalued", ask them how many they bought. If they didn't put their life savings in (or at least buy a significant amount), then they didn't really think they were undervalued.

Luke said...

FWIW, it seems to me that there is an inherent conflict in asking an underwriter what the price should be.

But why not auction the shares? Not just for RM, but generally.That's what happens with gilts, and retail investors take the average competitive price.

Bloke In Italy said...

Thanks J for confirming what I suspected that basically there's an insane amount of ignorant lefty shite around the MSM and the state broadcaster, and it is sad that in discussion of this in the House only Jacob Really Smug actually made this point which was reported by Toady as an after-thought.

I take your point about auctioning keeping out the retail investor.

jerred seisyll said...
This comment has been removed by the author.
Anonymous said...

If capitalism is so wonderful, why did the world banking system needed trillions of pounds/dollars/yen to bail it out?

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