Case-Analysis#1-IPO-Questions

Case Study #1: Initial Public Offering (01.08.2010) FMI (PGDM IVth Term )

BRG Energy Systems Initial Public Offering

Name: Kunal Jain

Roll: 2009161

Section: B2CD1

Faculty: Kulbir Singh Page 1 of 5


Case: BGR Energy Systems Initial Public Offering,

Q 1. Why does BGR need to go public?

Answer: BGR being a company which deals in products like condenser

tube cleaning systems, rubber cleaning balls, services in the oil and gas and

power industries which require huge investment mainly in capital intensive

technology. The main reasons for the company going public are:

- The energy equipment business requires huge amount of working capital

intensive and thus huge amount of working capital

- The company availed most of the working capital in the form of bank

loans which was shown in its debt-equity ratio which was very high.

- BGR was required to bring in part of the working capital out of net owned

assets (which was as per the lending practice of banks)

- To expand the production capacity by opening new manufacturing

facilities which needed lots of investment

- It wanted to be in public spotlight.

Q 2. What are the benefits and costs of going public?

Answer: There are both benefits and costs for BRG if it goes public. Some

of the benefits are listed below:

- BRG by going public stands to gain access to capital.

- The capital does not have to be repaid and does not involve an interest

charge, which was in case of Bank loan for which they had to pay huge

interest every year

- It would increases BRG’s credibility and exposure (which BRG wanted to

gain)

- BRG may have enhanced credibility with its suppliers, customers, and

lenders, which may lead to improved credit terms.

Some of the disadvantages of going public are listed below:

- It is a very time consuming process (The company’s executives spent

several months preparing the company to take it public, developing the



infrastructure and systems that would enable it to meet the demands

placed on public companies)

- It is a very expensive process (costs like investment bankers fees, stock

exchange listing fees, IPO grading fee etc. The issue expenses could be

as high as 6% of net proceeds).

- Decision making process becomes more formal in case of a public

company.

- In case of public company, the pressure of market makes the company to

focus on short-term goals which contradicts to the services provided by

BRG.

Q 3. Should BGR be worried about IPO under-pricing?

Answer: Yes, as a firm BRG should be worried about the IPO being Under-

priced. There are many drawbacks which we know if a share is underpriced.

The company won’t be able to extract as much capital as it could had been

if share was not underpriced. In terms of economics, we can say that the

under pricing of shares will lead to opportunity cost of the firm because the

amount they would want for the share will not justify the price they get after

the issue leading to economic loss.

Q 4. Can the offer price be justified?

Answer: As per our calculation we came to know that the share is being

underpriced. And as per the growth scenario of the sector, we can see that

the growth is very high and it would continue to increase due to the

relaxation in government regulation to this sector, which means that there

are chances of the share being traded at high price after the IPO so it does

not justify the offer price.

Q 5. On a relative basis, how attractive or unattractive is the issue price

(vis-à-vis Industry peers)?



Answer: P/E ratio act as a measure which tires to show as which share is

more attractive and which is not in relative basis. As high P/E Ratio indicate

that investors expecting higher growth in the earnings and As per Exhibit 6

of the case, it shows that BRG have a higher P/E ratio than its peers, which

means that it is an attractive issue price.

Q 6. As an investor would you invest in the company?

Answer: Yes, as an investor I would like to invest in the company. This is

due to reason of stated in the table below. There are various assumptions

which I took while analyzing the value of the company. As per the

assumptions and calculations I did I found the share to be underpriced and it

is always beneficial for a rational investor to invest in a share which would

give him a positive return. As an underpriced share would mean now ‘in the

money’ as the company wants to issue all of its projected shares, so even if

the price goes up, that does not mean that they could move a large volume

at that price (in fact it usually means that people are holding their shares -

supply down, price up).

Some of the assumptions which lead to the following table are:

- Assuming growth rate to be 25% for next 5years as it is a company which

is in a growing sector.

- Sales for the year 2008 is expected to be Rs.11000million (25%increase

in sales of 2007 year-ending)

- Assuming Capital exp., change in working capital, increase in long term

debt to be in proportion to growth in sales.

- Assuming depreciation to be increasing at 1%p.a. this is due to the

increase in capital intensive goods in the new factories which they would

be starting with the new capital.



Table 1. (`. In millions)

25% 25% 25% 25% 25%

Sales 11000 14300 18590 2416731417.1

40842.2

Net Income 399.64 495 618.75773.437

5966.796

91208.49

6

Net Income(% Sales)0.03633

1 4% 4% 4% 4% 4%

Capex 137.28 170.5 213.125266.406

3333.007

8416.259

8Capex(% Sales) 0.01248 1% 1% 1% 1% 1%

Depreciation 88.8 137.5 171.875214.843

8268.554

7335.693

4Depreciation (% Sales)

0.008073 1% 1% 1% 1% 1%

Change in WC 1156.931445.12

51806.40

62258.00

8 2822.513528.13

7Change in WC (% Sales)

0.105175 11% 11% 11% 11% 11%

Increase in long term debt 1575.14 1969 2461.25

3076.563

3845.703

4807.129

Increase in long term debt (% Sales)

0.143195 14% 14% 14% 14% 14%

FCFE 769.37 985.8751232.34

4 1540.431925.53

72406.92

1NPV 5066.04 No. of Shares outstanding 9.136

Value of the Share554.513

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Case-Analysis#1-IPO-Questions