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IEX IPO - Information Analysis

It is India's largest electricity exchange but how long will this sustain. Here are our findings

IEX IPO - Points to consider

IEX IPO - Points to considerIEX runs India's largest energy exchange based on traded volumes. It operates a marketplace for electricity trading bringing together electricity producers and buyers such as discoms and factories. It helps these buyers meet their short term electricity requirements.It accounted for 95% of the short term electricity contracts (contracts less than 1 year) traded over exchanges in India in FY 17. The short term electricity market however is only 10% of the overall generation capacity of the country giving it plenty of room to grow. IEX was promoted by Financial Technologies India Limited. However, due to regulatory breaches, the promoters stake was divested converting it to a professionally run company with diverse ownership.

Advantages
IEX started its business in 2008 and has the first mover advantage. It has acquired a large number of trading members who actively use its platform. Both revenue and net income have grown at a robust 28% CAGR over the last 5 years. The company has an average profit margin of an astonishing 51% for the last five years. Most of its profits have been transferred to shareholders as dividends with an average dividend payout ratio (what portion of earnings are paid out as dividends) of 96% over the past three years. The UDAY scheme compels discoms to be more efficient in their operations, pushing them towards electricity exchanges such as IEX rather than inefficient bilateral contracts. Globally, 50% of electricity generated is traded through power exchanges. This is only 3% in India indicating a large expansion opportunity.

Disadvantages
The company operates in a highly regulated industry with the Central Electricity Regulatory Commission (CERC) exercising tight control. Business expansion is subject to regulatory approvals to a substantial extent. Demand is also uncertain with cycles such as the current one seeing excess generation and poor electricity demand.The company relies on government entities such as the National Load Distribution company (NLDC) and the Power Grid Corporation of India (PGCIL) for successful execution of transactions entered through its platform. These companies can go the same way as the state discoms and may become an impediment to the company's growth. The company's history has some dark episodes with the original promoters (FTIL lead by Jignesh Shah) being forced to divest their stake following major regulatory breaches. Valuations at 44 times earnings and 16 times book aren't cheap.

Who's Selling?
Its an offer for sale with 69% of the proceeds going to Venture/ Private Equity Funds. Tata Power is also selling its stake garnering 21% of the proceeds while Mutual funds are gathering around 8%.

Size of the Issue - About 1001 crores at the higher end of the price band.

IEX IPO - Points to consider

Company / Business

  1. Are the company's earnings before tax more than Rs 50 cr in the last twelve months?
    Yes. The company's earnings before tax were 173 Crores for the year ended March 31,2017.
  2. Will the company be able to scale up its business?
    Yes. The successful implementation of government schemes such as UDAY will help IEX. UDAY is aimed at improving the financial health of discoms who are major players in the electricity market. The opening of cross border trade in electricity will also boost business for IEX. Higher trading volumes and and better price discovery will progressively shift consumers from offline trades (holding 70% of short term market) to online power exchanges like IEX.
  3. Does the company have recognizable brand/s, truly valued by its customers?
    Yes. IEX has a large number of active participants on its exchange and has a recognizable brand. However the company is yet to receive legal recognition for its brand 'IEX Indian Energy Exchange.'
  4. Does the company have high repeat customer usage?
    Yes. Participants on its platform regularly use its services not only to adjust their electricity demand/supply requirements but also for optimization of power cost.
  5. Does the company have a credible moat?
    No. The company operates in a competitive industry with demand largely still met through offline traditional players.
  6. Is the company sufficiently robust to major regulatory or geopolitical risks?
    No.The policies framed by the Central Electricity Regulatory Commission have a major impact on its business operations.
  7. Is the business of the company immune from easy replication by new players?
    Yes. Any new player would have to first clear stringent regulatory requirements then have to built a marketplace having volumes which would take substantial amount of time.
  8. Is the company's product able to withstand being easily substituted or outdated?
    Yes. The company essentially matches short term electricity demand and supply through its trading platform and helps in price discovery. This need is unlikely to be easily substituted or go out of date.
  9. Are the customers of the company devoid of significant bargaining power?
    No. The customers of the company (its trading members) have various alternatives such as electricity trading licensees, government supported schemes or bilateral trades.
  10. Are the suppliers of the company devoid of significant bargaining power?
    No.The core trading platform of the company was developed by 63 Moon technologies (formerly Financial Technologies Ltd.). The company has bought exclusive usage rights for the platform and it is critical to the company's operations. PTC India Financial Services (an erstwhile shareholder) raised issues with an arbitration panel regarding the failure of IEX to seek shareholders' consent prior to entering into its arrangement with 63 Moon Technologies. The panel decided in favour of IEX, but the decision remains subject to appeal. A successful appeal can potentially jeopardise its exclusive usage rights to the platform.
  11. Is the level of competition the company faces relatively low?
    No.The company faces intense competition from other electricity exchanges as well as offline licensed traders. The Government has also set up schemes and exchanges to address this market. 65% of India's short term electricity requirement is met through means other than power exchanges.

Management

  1. Do any of the founders of the company still hold at least a 5 per cent stake in the company? Or do promoters totally hold more than 25 per cent stake in the company?
    No.It's a professionally managed company with no promoters. The company was initially promoted by Financial Technologies. However in 2014, its promoter was declared 'improper' for this business. The promoter divested its stake following this regulatory action leaving the company with no defined promoter.
  2. Do the top three managers have more than 15 years of combined leadership at the company?
    Yes. The top three managers have more than 15 years of combined leadership.
  3. Is the management trustworthy? Is it transparent in disclosures which are consistent with Sebi guidelines?
    Yes. We have no reason to believe otherwise.
  4. Is the company free of litigation in court or with the regulator that casts doubts on the intention of the management?
    Yes. We have no reason to believe otherwise.
  5. Is the company's accounting policy stable?
    Yes. we have no reason to believe otherwise.
  6. Is the company free of promoter pledging of its shares?
    Not Applicable. It's a professionally managed company with no promoter holding.

Financial

  1. Did the company generate current and five-year average return on equity of more than 15 per cent and return on capital of more than 18 per cent?
    Yes, the company's average five year ROE and ROCE were 43% and 54% respectively. Current ROE and ROCE stand at 42% and 56% respectively.
  2. Was the company's cash flow-positive during the previous year and at least four out of the last five years?
    No, the company's cash flow was positive during the previous year but was negative in three out of the last five years.
  3. Did the company increase its revenue by 10 per cent CAGR in the last five years?
    Yes. The company's revenue increased at a CAGR of 28% in last 5 years.
  4. Is the company's debt-to-equity ratio less than 1 or is its interest coverage ratio more than 2?
    Yes. The company was debt free as at March 31,2017.
  5. Is the company free from reliance on huge working capital for day to day affairs?
    Yes. The company runs an an online trading platform and has little need for a large inventory. It also collects money from its customers in advance for its services.
  6. Can the company run its business without relying on external funding in the next three years?
    No. The company is dependent on technology to run its trading platform. This will require heavy investment in the future bringing in the need for external financing.
  7. Have the company's short term borrowings remained stable or declined (not increased by greater than 15%)?
    Yes. The company has no short term borrowings for past 3 years.

The Stock/Valuation

  1. Does the stock offer operating earning yield of more than 8 per cent on its enterprise value?
    No. The post IPO operating earnings yield of the company will stand at about 3.6% at its current price band.
  2. Is the stock's price to earnings less than that of its peers on average?
    No. In the current price band of 1650-1645, its PE ratio will be about 44. MCX Limited trades at PE of 45 while adjusted PE of BSE Limited is about 28.
  3. Is the stock's price to book value less than that of its peers on average?
    No. At a price band of 1650-1645, its price to book stands at about 16x.MCX Limited trades at PB of 4x while adjusted PB of BSE Limited is around 2x.