IPO's and PO's: To Buy or not to Buy?

Lately I have been thinking whether it is really worth it investing in Initial Public Offers (IPO’s) and Public Offers (PO’s). The main reasons for my second thoughts are:

1) Partial allotment. Most recent IPO’s and PO’s have been hugely over subscribed leading to partial allotment. The first shocker was the PO of First Bank. As it was the first PO to return huge sums of money in recent times, most of us were caught napping. I only got about 23% of what I applied for. In hindsight I should never have bothered buying.

2) Delay in receiving shares allotted. The second reason is the delay in receiving certificates or receiving credit in CSCS account. I participated in the Access Bank Public Offer in August last year. Nine months after I am still waiting for my certificate to be verified. Consequently, I don’t still have access to my money.

3) Delay in receiving return money. The third reason is the delay in receiving return money in respect of shares not allotted. To date I have not received my return money for PHB, AIICO and Costain. These offers closed in December last year.

While it is difficult to know before hand whether it is worth it to invest in these offers, the following could aid the decision making.

• Amount on offer. How much is the company trying to raise? In my view if the amount is less than twenty billion Naira, I will stay clear of the offer. Recent examples include Dangote Flour, NAHCO, AIICO and Costain. All were for under Naira twenty billion and all were hugely over subscribed. In hindsight, one would have been better off buying in the secondary market all except Dangote Flour (not available at it was an IPO). Although this criteria does not completely eliminate the risk, it reduces it. E.g. Bank PHB.

• The discount. This is only relevant to public offers. If there is a significant discount to the secondary market price (30% or more), I will consider investing. Otherwise I will pass. A recent example is Bank PHB. The discount on offer was 33% and there was a potential gain of 50% to be had. Bank PHB has proved to be a good gamble. However, buying Skye Bank offer was not such a good idea. The discount on offer was only 17%. However, you can now buy Skye bank at Naira 16 compared to the offer price of Naira 14. This means one would have been better off not buying the public offer as the certificate and possible return money are not available three months after the offer closed.

• IPO decision spreadsheet. I found this tool http://nivestors.com/yahoo_site_admin/assets/docs/IPO_Decision_Table.59121612.xls

courtesy of www.nivestors.com. It was brought to my attention in the investors forum of stockmarketnigeria.com. It helps in simplifying and quantifying the decision.

In the future I will definitely use the above criteria in deciding whether I should invest in an IPO or PO.

The Craze for Private Placements

A phenomenon is sweeping across the investment landscape in Nigeria. This phenomenon has been gathering storm in the last 2 years. This powerful wave is the Private Placement (PP) phenomenon.

PP’s have been with us for many years but were made more popular by the capital raising of banks in 2004 and 2005. My first investment in a PP was in 2004 when I bought the IBTC placement at N3.9 a share. I sold my holdings in late 2007 at N18+. Not bad but not spectacular compared to recent gains made by some investors in PPs.

It is the lure of these extraordinary gains that is attracting investors and promoters to PPs. Suddenly every company is doing a PP and investors are jumping to invest in any PP in sight.

The strong bull run of 2007 has encouraged many companies to issue PPs. This is because when the investing sentiment is bullish, investors are more willing to take on more risk at high prices. Private companies have latched onto this opportunity to sell a piece of their company at valuations that cannot be justified. The main desire of the promoters is to reward themselves by taking advantage of the general lack of sophistication of majority of investors in Nigeria.

In addition, an ugly trend that has reared its head is staff of issuing houses and placement agents requesting for a premium on the issue price. This is for a PP that has not even close. So they get to make money for nothing! This is fraudulent to say the least and I encourage readers to report such to management of the issuing house or placement agent. These guys need to be taught a lesson.

While investing in PPs could be very profitable, investors should be very careful in which PP they invest in. This is even more relevant with the recent habit of return money on PPs. There are several things an investor can do to safeguard his funds from investing in a very risky PP. These include:

1) Invest only in a reputable company with known products. Eg PP of BGL, Reltel etc. A PP issued by any of the above is surely genuine.

2) Look out for PP packaged by a reputable issuing house such as IBTC, FBN Capital, Afribank Capital and the like. These issuing houses will not get themselves involved in a fishy PP.

3) Do not invest in over priced PPs. To make a reasonable profit, the entry price must be reasonable. The valuations of some recent PPs have been unrealistic. It simply does not make sense to invest in a very risky PP that is over priced.

4) Diligently examine the audited accounts and the forecast. Make sure the fundamentals of the company are sound.

5) Invest only in PPs promoted by reputable business people who know the business.

By concentrating on only PPs that meet the above criteria, investors will be able to separate the wheat from the chaff. In doing so, an investor might discover a gem of a PP, a winner and will stay clear of very risky PP’s that could end up as losers.

What to do in a Bear Market

After the amazing 75% increase in 2007 a lot of us have forgotten or don’t even know what is a bear market. The last one we experienced was in 1999 when the All Share Index fell by 7.2%. We had 3 consecutive bear years between 1997 and 1999 before the market recovered in 2000.

So what should we do now, in what looks like a bear year? Technically we are not in bear territory since the Index is up 2% for the year. However, the market has been sliding down since mid February with no end in sight. At this rate we will be in negative territory by the end of week of May 9th.

Don’t Panic
Whatever you do don’t panic. If you are in it for the long term, short term trends should not panic you. Now is a good time to do spring cleaning. Stick with only sound companies. See the next point.

Sell Early
While you should not panic and sell everything in sight, you should sell your losers early. Don’t sit around and watch some of your stocks loose 20% or more. Once in a while we all buy losers. These are typically stocks with weak fundamentals, stocks we should never have bought but we did anyway. Now is the time to get rid of them.

Selling early has saved me in the current negative run. I bought Japaul at N13.7 and Standard Trust Insurance at N5 purely on speculation. I sold Japaul at N12 and STI at N5.2 when I noticed we were in what looks like a bear run. The current price of Japaul is N9.4 (down by 31%) and STI N4.23 (down by 15%).

Historically, companies with weak fundamentals do worse in a bear run. So get rid of them now.

In addition, sell those stocks you feel are over valued relative to their peers if you need the cash. I needed cash and I felt GT Bank with a PE of 29+ was selling at a premium compared to UBA. So I sold some of my GT Bank at N37.5. Today GT Bank has dropped to N33 while UBA has moved from N49 to N55.

Shop for Bargains
Shop for bargains using the proceeds of sales of losers or extra new cash. Check out those quality stocks now and buy them at reasonable prices. If you are afraid the market might still be going down, use dollar cost averaging to reduce total cost. That is invest the same amount in the same stocks biweekly or monthly. If the market continues to drop you would buy more shares with the same amount in later months.

It is difficult to time the market. No one knows the bottom has been reached until after the fact. Averaging ensures you are in the game without attempting to time the market. However, don’t use this method to average down the cost of losers. This will be like throwing good money after bad money. Use this method to only buy solid companies.

Invest in Mutual Funds
Most mutual funds in Nigeria tend to reflect the performance of the market. Invest in a mutual fund now and you are almost certain of a good return when the market recovers. Most funds are selling at lower prices compared to two months ago, now is a good time to go in.

Reduce Debts
Consider using your spare cash to reduce debts. In the short term it is better to reduce a 14% debt than to invest in a falling market.

Invest in Money Market Instruments
Put some of your cash in short term money market instruments. While the return is usually between 8%-10%, it surely isn’t bad compared to negative returns in stocks.

Finally
Remember, historically, bear runs have been followed by a bull run whose magnitude and length have been greater. The numbers below tells the story.

Whatever you do, don’t panic!

1997... (7.9%)
1998... (11.9%)
1999... (7.2%)
2000... 54%
2001... 35.2%
2002... 10.7%
2003... 65.8%
2004... 18.5%
2005... 1%
2006... 37.8%
2007... 74.7%

My Top Ten Investment Books

Here are my top ten investment books in no particular order although I will start with my favourite.

1. Contrarian Investing: Anthony Gallea & William Patalon. My favourite investment book. Well written and full of excellent advice. Follow the advice in this book and your portfolio will be the better for it.

2. The Intelligent Investor: Banjamin Graham. Written by the acknowledged master of value investing. A classic on value investing. A must have for every investor.

3. The New Money Masters: John Train. A guide to the strategies of Soros, Lynch, Rogers, Neff etc. An excellent treatise on great investors.

4. A Random Walk Down Wall Street: Burton Malkeil. The bestselling book on investing by a Princeton University professor of economics. The book challenged Wall Street and conventional wisdom.

5. One Up on Wall Street: Peter Lynch. From one of the acknowledged masters on Wall Street. Lynch shows us how to beat the pros.

6. Nice Girls Don’t Get Rich: Lois Frankel, PhD. Financial advice for women. Very useful for women of all ages. I enjoyed this quote: “ From birth to 18, a girl needs good parents. From 18 to 35 she needs good looks. From 35 to 55 she needs a good personality. From 55 onwards she needs cash.” Sophie Tucker

7. Why Smart People Make Big Money Mistakes: Gary Belsky & Thomas Gilovich. This book introduced me to behavioral economics. A fascinating book on how we spend, invest, save, borrow and waste money. A must read if you want to understand the psychological causes of irrational behaviour towards money.

8. Common Stock & Uncommon Profits: Philip Fisher. Full of great investment wisdom. Even Warren Buffet recommends it.

9. Contrarian Investment Strategies: David Dreman. Another excellent book on contrarian investing.

10. Lifetime Guide to Money: Wall Street Journal. An invaluable guide to managing your finances.

Lack of Funding as an Obstacle to Solving the Power Crises

As I am writing this I am hot, frustrated and angry. I am using a rechargeable lamp (recharged using my generating set) because I have not had power from PHCN for the past 24 hours. Nothing new.

I am frustrated because although the problems of electric power generation in Nigeria are complex, they can be solved. I am angry because the present government is spending too much time on the past rather than concentrating on doing something now to address the problem. What the government needs to do is to tackle the generation, transmission and distribution problem in a methodical fashion.

Take as an example the issue of inadequate generation. Recently we were told that PHCN is currently generating less than 2,000 MW. Quite pathetic one might add. What if I tell you we can double this in the next 3 years by spending between $3 and $4 billion dollars? Believe me it is possible. This is how.

The previous Obasanjo administration mandated Oil Majors who are currently in Joint Venture (JV) partnerships with NNPC to build Independent Power Plants (IPP). The projects will include High Voltage transmission lines, gas i nfrastructure and the gas where required. The Oil Majors will contribute between 40-45% of the cost of the project (this is based on their equity in the JV) while NNPC will contribute between 55% and 60%. There are several benefits of this arrangement:

1. The government will only contribute 55% - 60% cash during the construction of the project (typically 3- 4 years) instead of 100%. Therefore the impact on the cashflow of government is minimized. The JV partners will recover their contribution over a couple of years after the project has become operational.

2. PHCN benefits from the project management experience of the Oil Majors. The IPP’s will surely be delivered by the Oil Majors as they have their reputations to protect. The current scandals surrounding the NIPP projects will certainly not be experienced in the IPP projects. For example Agip have since delivered their IPP project. Without the Agip IPP our current crises could have been even worse.

3. The Oil Majors will ensure gas supply to the IIP since they are directly involved in gas production.

Unfortunately for Nigerians only Agip has been able to deliver on the IPP due to lack of funding from NNPC. While the Oil Majors are willing and able to fund their share of the project, NNPC has failed in the last two years to provide funding for the projects. For one reason or the other, Shell, C hevron, Elf and ExxonMobil have not received the funds from NNPC needed to deliver the p rojects. Shell has made significant progress without f unds from NNPC. However, for how long do we expect Shell to carry our burden? NNPC is not really to blame as the government refused to appropriate NNPC the funds it needs.

The real question t hen is how much money is required to deliver the projects? Between Shell, Elf, Chevron and ExxonMobil the amount that is required from the government is between $3.5 to $4 billion dollars. Let me put this amount in context. The $4 billion is about 37 days of oil production if we assume oil price of $90 and 2.2 million barrels a day production and government take of 55% of the production. Please note that this is a very conservative estimate. Can you imagine! All we need to fund the four IPP’s is to commit 37 days production spread over 3 years (approximately 2 weeks production per year!).

Although what I have proposed is rather simplistic, it is equally not that complex. Unfortunately for Nigerians the government of Yar’Adua and NNPC just don’t get it. The whole country cant move forward because of the power situation. Meanwhile oil price is at record highs and NNPC is starved of funds to execute national priority projects.

For the past few months NNPC has been discussing with Oil Majors on how to fund its projects (including IPP’s). With oil price above $100 this is totally unnecessary. This is the time to use the oil money to invest in infrastructure and the oil industry itself. This is not the time to engage in long discussions with Oil Majors on funding. Unfortunately some advisors have convinced the current president that this is the way to go.

Yar’Adua told us during his campaign that power is a priority. However, his actions contradict this. The 2008 budget did not provide the required amount to execute the IPP projects or any major power project. When something is a priority the logical thing to do is to allocate funds to it.

So we continue to live in darkness. Until such a time when someone does the simple calculation and realizes that all we need is 37 days of production to add 2,000 MW to the national grid. While 2,000 MW might look small,it will be a huge leap as it will double our current generation. And perhaps our nights will be brighter and cooler.

High Expectations Among Investing Public

In the last two years the Nigerian stock exchange has attracted unprecedented interest. This was largely as a result of the banking industry capital raising exercise that saw several banks approach the market for fresh funds. The banks spent millions in advertisement which led to increased awareness among the public of the benefits of investing in the market.

The market posted a gain of 74.7% in 2007. However, it appears such a gain will not be repeated in 2008. At the end of the first quarter of 2007, the NSE All Share Index gained 31% compared to 8.7% at the end of the first quarter of 2008.

Already there is a talk of a crash. Whether there will be a crash or not is difficult to call as this depends on so many factors. Although a correction, not a crash is a possibility as most stocks are currently overvalued.

On the other hand, we might see a modest gain during the year of between 15-20%. Unfortunately, a 20% growth might not satisfy most investors as they have been spoilt by the spectacular growth in 2007. These investors have ignored the performance of the market in the last couple of years in managing their expectations.

2004 – 18.5%
2005 – 1%
2006 – 37.8%
2007 – 74.7%

The growth in 2007 is clearly an exception and cannot be repeated year in year out. Investors will do themselves a favour by lowering their expectations to a more modest 20% annual gain. Anything extra should be seen as a bonus.

On Blogging

I have always wanted to write. I joined a writers club in my home town at 15 but had to drop out after joining a university in another city. Since then, I have written a few pieces but without a medium for publishing, the motivation to write often was none existent. Along came blogging.

I discovered blogging in 2006 but it was only in 2007 that I created a blog for myself. A blog provides the medium to express oneself. Hopefully some readers will find the blog worth visiting.

A writer can only grow and improve by writing. A blog provides a great medium for the would be freelance writer to test the market.

My resolution in 2008 is to post at least one piece on my blog every month. I am sure the adventure will be worth while.